SIE3

Currency Options

-allow investors to speculate on the performance of currencies other than the US dollar or to protect against fluctuating currency exchange rates against the US dollar Traded on US listed exchanges. Importers and exporters use these to hedge currency risk. expire on the 3rd Friday of the month, settle on the next business day. european style exercise only. EPIC Exporters buy Puts Importers buy Calls

At the money

A call and put are in the money when the stock price is equal to the strike price. A buyer will NOT exercise the contract when it is at the money at expiration. Sellers want the contract to be at the money. Sellers keep the premium without the obligation to perform.

In the money

A call is in the money when the price of the stock exceeds the strike price of the call. Buyer will exercise the call when it is in the money. Buyers want the call to be in the money. A put is in the money when the price of the stock is lower than the strike price. A buyer will exercise the call when the put is in the money. Buyer wants it to be in the money.

Puts - Long

A put buyer is long on the put and owns the right to sell shares of a stock at the strike price if they choose to exercise the contract. The put buyer is BEARISH because he wants the price to FALL. Wants to sell the stock at the strike price which will hopefully be higher than the market price.

Parity

A put option and call option is at parity when the premium equals the intrinsic value.

Puts - Short

A put writer/seller is short and has the obligation to buy the shares of a stock at the specific strike price if the owner/buyer chooses to exercise the contract. The put writer/seller is BULLISH on the price because they want the price to rise so the buyer won't exercise the contract and the writer gets to keep the premium without having to purchase the stock at the strike price.

Protective Calls

A short stock position has unlimited risk. In order for the customer to break even on this position, the value of the stock the customer shorted must fall below what he paid for the stock by enough to cover the cost of the option position. Protective call BE = Stock Price - Premium

FINRA Rule 2210, communications with the public, has a number of filing requirements. Some communications are prefiled, others are postfiled, and some are excluded from filing with FINRA. Included in the list of exclusions would be retail communications A) that do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker. B) that do no more than identify and recommend a specific registered investment company or family of registered investment companies. C) that do not make any financial or investment recommendation, but only promote a service offered by the member. D) dealing with specific index funds that previously have been filed with FINRA and that are to be used, with the only change being a recommendation of index exchange-traded funds from the same sponsoring organization.

Answer is A E: A communication limited to identifying the member's exchange or market-maker symbol is excluded from the FINRA filing requirements. A communication that identifies and recommends a specific investment company or companies must be filed. When previously filed material is used, no filing is necessary as long as there is no material change. However, changing from recommending specific funds to specific ETFs is a material change and would require filing. A retail communication promoting a service offered by a member firm is a communication that would likely need filing with FINRA.

Options communications may contain projected performance figures (including projected annualized rates of return), provided that A) all such communications are accompanied or preceded by the Options Disclosure Document. B) the client has returned the options account agreement within the specified time. C) all such communications are accompanied or preceded by a warning of the possible defalcation by an officer of the exchange. D) in communications relating to annualized rates of return, the returns are not based on any less than a 30-day experience.

Answer is A E: Once the communications get specific enough to include performance figures, prior or concurrent delivery of the ODD is necessary. Although the risks must be disclosed, possible defalcation by an exchange officer (a form of embezzlement), is not an investment-related risk. The requirement to return the options account agreement within 15 days has nothing to do with permitted options communications. When annualized rates of return are shown, the minimum is a 60-day period, not 30 days.

The ABC Insurance Company is advertising its variable annuity product as "ABC Lifetime Income—income generated from mutual fund returns." This advertisement is A) prohibited because it implies returns from mutual funds. B) prohibited because it doesn't reference an annuity. C) permitted. D) permitted as long as there's no guarantee.

Answer is A E: Variable contracts or their underlying accounts cannot be advertised as mutual funds. Proprietary terms can be used instead of words such as "annuity."

Démodé Classic Investments (DCI) is planning a direct mail campaign to several thousand potential investors. The topic of the campaign deals with owning real estate through direct participation program limited partnerships. Under FINRA Rule 2210 on communications with the public, this is considered A) a retail communication and must be filed with FINRA at least 10 business days before first use or publication. B) a retail communication and must be filed with FINRA within 10 business days of first use or publication. C) correspondence and needs review, not approval, by a designated DCI principal. D) a retail communication that needs approval, but not filing, by a designated DCI principal.

Answer is B E: A direct mail communication to more than 25 existing and/or potential clients within a 30-day period is a retail communication. Unless an exception applies, a designated principal of the firm must approve all retail communications. DPPs are part of a group of securities (other common examples are investment companies and CMOs) where filing with FINRA within 10 business days of first use or publication is the rule.

Which of the following would be defined as a research report? A) A notice that the rating for a bond has been downgraded by Moody's B) A document that states the banking industry is ready for recovery but ABC Bank will not participate in the recovery and if owned, investors should sell the security C) A written opinion that the economy is poised for recovery D) A technical analysis that indicates the demand for steel is increasing based on the trading volume and price of the steel industry

Answer is B E: One of the keys to defining a research report is that it suggests taking action (buy, sell, or hold) on the subject security. The term does not include commentaries on economic, political, or market conditions.

Your broker-dealer has prepared an advertising piece for general distribution to all of its retail customers regarding numerous option strategies. Filing the piece with FINRA is A) not required. B) required to occur no later than the end of the month during which it was used. C) required within 10 business days of the time it is first used or published. D) required at least 10 business days before first use or publication.

Answer is D E: Filing with FINRA is required at least 10 business days before first use or publication for retail communications having to do with options

Under Options Clearing Corporation (OCC) rules regarding options communications with the public, if an educational piece making no projected performance figures or recommendations is distributed to customers, it A) can only be distributed to institutional customers. B) need not be approved by a registered options principal (ROP). C) can only be distributed to retail customers. D) need not be preceded by an options disclosure document (ODD).

Answer is D E: OCC communications rules do not distinguish between retail and institutional customers. Therefore, their communications rules apply to all customers. All communications pieces must be approved by an ROP. If the educational piece makes no recommendations or performance projections, it need not be preceded by an ODD, but it must be accompanied by a notice containing a name and address where the ODD can be obtained.

Break Even - Puts

BE point is found by subtracting the premium from the strike price. For the put buyer, the contract is profitable below the BE at expiration. For the put seller, the contract is profitable at or above the BE point.

Hedging a portfolio with Index Options

Buy puts on the index to offset losses if the market falls is called portfolio insurance. Using index options to protect against the risk of a decline in the market is called systematic or systemic risk.

Calls - Long

Buying Calls (purchase/go long) - Buying the right to purchase stock at the strike price if they exercise the contract. They are BULLISH and anticipate the price of the security to RISE.

Out of the money

Calls - is out of the money when the stock price is lower than the strike price. Buyer will NOT exercise the the call. Seller keeps the premium. Puts - a put is out of the money when the price of the stock is higher than the strike price. Buyers do not want the put to be out of the money. Sellers want the put to be out of the money so they keep the premium.

Writing a Put Option

Covered - the writer already has sufficient cash to buy the stock. Uncovered = The writer does not have enough cash to purchase the stock. Writer will need to come up with the cash from somewhere.

Writing a Call Option

Covered = already owns the underlying security. Uncovered = writer does not already own the security. Potentially unlimited risk. Writers of Naked calls are willing to accept that risk in return for takin in the premium when selling short the call. The covered call is the most common. It is a proven and relatively conservative way to generate income against a stock position.

VIX Options

Fear index. Measures the expected volatility of the US Stock market. based on pricing from the S&P 500 index. Settle in cash with European exercise provisions.

Primary Regulators for Options

For Options: Options Clearing Corporation (OCC) For Trading Options: Chicago Board of Options Exchange (CBOE)

Break Even point is the Strike price + premium

For a call, BE point is the Strike Price + Premium

Break Even - Calls

For calls - the BE is found by adding the strike price and the premium. For the call buyer, the contract is profitable above the BE point. For the call seller, the contract is only profitable below the BE point.

Index options strategy

If an investor believes the market will rise, he can purchase index calls or write index puts. If an investor believes the market will fall, he can purchase index puts or write index calls.

Intrinsic Value

Intrinsic Value is the same as the amount a contract is in the money. A call has IV when the market price of the stock is above the strike price of the call. A put has IV when the market price of the stock is below the strike price of the put. IV is always positive or zero. Buyers like to have intrinsic value. Sellers do not.

Protective Puts

Married Position. Long stock and long put. The value of the stock the customer owns must rise above what he paid for the stock by enough to cover the cost of the option position BE = Stock Price + Premium

Index Options

Not related to one underlying stock. Rather the performance of a group of stocks such as the S&P 500 index or Dow Jones Industrial Average. No delivery of shares is made if option is exercised, instead the writer pays the owner in cash.

Administration and Compliance

Once an account is approved by a ROP, option trades may be entered. Then no later than 15 days after the aaccount approval, the customer MUST returned the signed options agreement. Options are bought and sold T+!.

Option 2 party System

One party has right to exercise the contract to buy or sell the underlying security and the other party is obligated to fulfill the terms of the contract. The buyer who pays the premium and owns the contract is called the owner and is the party who is LONG on the contract. They buyer has the right to exercise the contract. The seller(writer of contract) receives the premium and is SHORT on the contract. The seller is obligated to perform if the buyer chooses to exercise the contract. Sellers can profit by the amount of premium received if the option expires as worthless.

Exercise and Assignment

Only owners of options contracts (long) have the right to exercise them. The writers of the contracts are then assigned to fulfill their obligation to perform (either sell or buy) depending on it its a call or put option.

Intrinsic Value and the Premium

Premium = Intrinsic Value + Time Value

Calls - Short

Selling Calls (write/seller) has the obligation to sell the shares at a specific strike price if the buyer exercises the contract. The writer/seller is BEARISH on the future price of the security and expects the price to FALL. They receive the premium and keep it if the price does not go up and the contract is not exercised. Their max gain is the premium received.

Maximum Gain - Puts

The MG for a put buyer is the strike price - the premium. Same as the premium. A stock price can only fall to zero. For the put seller, the MG is the premium received.

Maximum Loss - Calls

The ML for a call buyer is the premium. The ML for a call seller/writer is unlimited.

Maximum Loss

The ML for a put buyer is the premium paid. The ML for a put seller is the strike price - the premium. (same as the BE point.

Hedging Risk with Options

The hedge insurance policy profits if the core stock position moves in the wrong direction

Maximum Gain - Calls

The potential gains to call buyers is unlimited. No limit to how high a stock price could go. The call seller, the MG is the premium received.

Index Options and Equity Options Expirations

They expire on the 3rd friday of every month. Index options settle the next business day. Equity Options settle in 2 business days.

Options Clearing Corporation

They provide an Options Disclosure Document which must be provided at or before the time of account approval. This document explains options strategies, risks, and rewards and is designed to provide full and fair disclosure to customers before they begin options trading. Before any trading, an options account must be approved by a Registered Options Principal (ROP)

Derivative Securities

a type of security whose value is based on its relationship to another asset or referenced value. Used primarily for speculation or protection A derivative is a contract that derives its value from an underlying asset. There are two parties to the contract: a buyer and a seller. The buyer has teh right to take an action (buy or sell) the underlying asset from the seller. In some derivative contracts (futures), the buyer will be obligated to buy the asset on a specific date. Derivatives are often used for commodities, such as oil, gasoline, or gold. Another asset class is currencies, often based on the value of a foreign currency vs the US Dollar. There are derivatives based on stocks and stock indices. Still others use interest rates, such as the yield on the 10-year treasury note. Options are derivative securities. This means they derive their value from that of an underlying instrument such as a stock, stock index, interest rate, or foreign currency. Option contracts offer investors a means to hedge or protect an investment's value or speculate on the price movement of individual securities, markets, foreign currencies, and other instruments.

American-style exercise rules

allows the owner to exercise the contract anytime before expiration. Nearly all equity and equity index options are american style.

The Options Clearing Corporation

clearing agent for listed options contracts. Settlement - listed options must settle on the next business day. Expiration - listed options expire on the 3rd friday of each month Exercise - listed options can be exercised by the owner from the time of purchase until they expire. The holder's BD notifies the OCC that they wish to exercise their contract. Automatic Exercise - Any contract in the money by .01 will be exercised automatically. Assignment - When the OCC receives an exercise notice, it assigns the notice to a short BD. The OCC assigns exercise nottices to short BDs on a RANDOM basis. The BDs may then assign exercise notices to their short customers on a random basis, FIFO basis, or any other method that is fair and reasonable. Options contracts are traded WITHOUT a certificate. The proof of ownership is the trade confirmation.

European -style exercise rules

options can only be exercised on the expiration day. Foreign currency and yield-based options are european style.

Interest Rate Options

yield based options on T-Bills, T-notes, and T-bonds. They have a direct relationship to movements in interest rates. If a portfolio manager believes the rates will fall, the manager will buy puts or write calls. If the manager believes the rates will rise, they buy calls and write puts. All yield based options are european style exercised only on expiration day.