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61 Cards in this Set
- Front
- Back
Option
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Gives the holder the right to buy or sell a certain amount of an underlying asset (such as common stock) for a specified price over a specified amount of time. Puts and calls posses value to the extent that they allow the holder the right to benefit from price movements in the underlying asset
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Put
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Enables the holder to sell the underlying security at a specified price (exercise or strike price) over a set period of time
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Call
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Gives the holder the right to buy the security at the stated (strike) price within a certain time period.
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Covered Position
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You own the underlying position or have something to offset risk
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Naked position
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You do not own the underlying position
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Strike price
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Stated price at which you can buy a security with a call or sell a security with a put
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Expiration date cycles
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Three Cycles:
1) Jan/Apr/July/Oct 2) Feb/May/Aug/Nov 3) Mar/Jun/Sept/Dec Usually last 3, 6, 9 months and they expire on the hird friday of the month of expirations |
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Expiration date
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Stated date when option expires and becomes worthless if not exercised
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In-the-money call
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Stock price > strike price
(good!) |
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Out-of-the-money call
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Stock price < strike price
(bad!) |
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Buying for speculation
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*Don't own the security
*You buy this way when you think you know the direction of the price |
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Hedging
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*Buying the option to protect current systems
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Writing options
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*When you write the put/call
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Straddle (write)
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You write a put and a call and you make money if price is stagnant
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Straddle (buy)
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You buy a put and a call and you make money as long as the price moves
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Hedging with stock options
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*The purpose is to reduce or eliminate risk
*Combines two or more securities into a single investment position *Hedging a long position -you own the position -buying a pit while holding appreciated stock in the same company -would provide insurance in case stock price foes down before you sold the stock *Hedging a short position -selling short and buying a call -cover you if the price goes up |
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Writing Stock Options
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*The seller/maker/writer is betting that the option buyer will be wrong about the direction of the stock price
*Statistically, the odds favor the writer -easy money if the option expires "worthless" -high risk if the option is "in-the-money" >Naked option: no limit on loss of exposure >Covered option: loss exposure is limited to original price paid for security |
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Equity Collars (why)
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Collars are used mostly by investors who have accumulated a large positon in a given stock and who are primarily interested in protecting themselves against risk
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Equity Collars
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*Consists of simultaneous purchase of a put option and the writing of a call option
*Both options are out-of-the-money and have the same expiration date |
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Stock Index options
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*A put or call option written on a specific stock market index
-S&P 500 -S&P 100 -DJIA -NASDAQ 100 |
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Options: Warrants
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*Warrant: a long-lived option that gives the holder the right to buy stock in a company at a price specified on the warrant
*Specified on the warrant -warrants have the longest lives of all types of options with maturities that extend out 5, 10, 20 years or even more -warrants are created by the organizations that issue the underlying financial asset -usually added as "sweeteners" to bond issues -typically trader through brokers |
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Advantages of warrants
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1) Offer a chance to benefit indirectly if the common stock price goes up without buying the stock
2) Low unit cost 3) Loss exposure is limited to price of warrant |
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Disadvantages of Warrants
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1) Have no voting rights
2) Pay no dividends 3) Have no claims on assets of the issuing company 4) Eventually expire |
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Cash Market
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A market where a product or commodity changes hands in exchange for a cash price paid when the transaction is completed
-takes place on location, not on an exchange |
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Futures Markets
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The organized market for the trading of futures contracts
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Futures Contract
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A commitment to deliver a certain amount of some specified item at some specified date in the future at a negotiated price
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Purpose of the futures market
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*Price discovery
*Risk bearing/sharing |
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Futures Participants
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*Speculators
-80-90% lose money *Hedgers -user -producer |
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Futures Exchanges
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*Chicago Board of Trade began in 1848
*US Commodities exhanges -CBOT is the largest -CME group; CBOT, CME, NYME *US exchanges use some e-trading and "open-outcry" auction -futures are mostly electronic -options are mostly open outcry *Serves as a way to provide credibility to the parties involved |
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Advantages of using futures contracts
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*Potential for high return
*Margin buying allows use of leverage -leverage: the ability to obtain a given equity position at a reduced capital investment, thereby magnifying total return *Allows producers to hedge prices -don't have to sell crops at harvest time when prices are often low |
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Disadvantages of using futures contracts
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*High risk of losing more than amount originally invested; no limit on exposure to loss
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Delivery
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*99.2% of contracts are settled without actual delivery
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Options (vs. futures contracts)
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*Right to buy
*Strike price specified in option contract *Loss limited to price paid for option |
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Futures contracts (vs. options)
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*Obligation to buy
*Delivery price set by supply and demand *No limit on potential loss |
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Trading Mechanics
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*Bought and sold through brokerage offices
*Same types of orders are used as stocks -market -limit *Long position; buying a contract -investor wants contract price to go up *Short position -investor wants contract price to go down *Long and short positions can be liquidated by executing an offsetting transaction -about 1-4% of futures contracts are settled by delivery |
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Margin trading
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*All futures contracts are trading on margin
*Initial margin deposit -amount deposited with broker at the time of commodity transaction to cover any loss in market value of futures contracts due to price movements $10-20,000 Margin requirements = 2-10% *Maintenance deposit -Minimum amount of deposit required at all times -Margin call occurs if value drops below allowed amount -mark-to-the-market occurs daily |
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Factors in commodity price behavior
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*weather and crop forecasts
*Economic factors *Political factors *International pressures |
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Commodity price behavior
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*because of leverage, small unit price changes can cause large total dollar changes in contract price
*to protect investors, daily price changes limit are set -daily price limit: restriction on the day to day change in price -maximum daily price range: the amount a commodity price can change during the day; usually equal to twice the daily price limit |
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Financial Futures
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*Future contract in which the commodity is a financial asset, such as debit securities, foreign currencies or market baskets of common stock
*Often used by large institutional investors to hedge |
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Types of Financial Futures
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*Currency futures
-US dollar -Japanese Yen -British pound *Interest rate futures -US treasury bills -notes -bonds -foreign gov't bonds *Stock Index Futures -DJIA -S&P 500 -Nasdaq |
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Speculating with Financial Futures
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*Leverage provides high returns/losses
*"long" used when prices are expected to rise *"short" used when prices are expected to fall (during an unstable market) |
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Hedging with financial features
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*Effective way of protecting stock or other securities holdings in a declining market
*Stock index futures to hedge stock portfolio *Interest Rate futures to hedge bond portfolios *Foreign currency to hedge foreign exchange rate risk |
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IRS Tax Rules
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*Publication 550
*Income reported on various schedules *Investment expenses on miscellaneous expenses on schedule |
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Holding Periods
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*Assets held </= 1 year are taxed as ordinary income (0-39.6%)
*Assets held > 1 year are taxed at capital gains rates of 0%, 15%, 20% *High income earners (200,000-250,000) also pay 3.8% net investment income tax |
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Reporting Losses (the good news)
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*Can be used to offset gains
*Losses of up to $3000 can be used to reduce ordinary income *Losses over $3000 can be carried over |
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Reporting Losses (the bad news)
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*Losses from a wash sale are not permitted
*Wash Sale: the sale and repurchase of a stock within 30 days *While the loss is not tax deductible it can be added to the basis on the new purchase |
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Tax strategies-Avoidance or transfer
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*Distribute Assets to family members
-during life-to a lower tax bracket -through your estate for a stepped up basis -create a trust to use your personal gift exemption -charitable gifts of appreciated assets |
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Deferral Strategies
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*Favoring growth stocks
*401K *IRA *Roth IRA (never have to pay taxes) *Annuities |
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Tax Favored Strategies
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*Qualified dividends instead of interest-taxed at 0-20%
*Gov't/Municipal Bonds *Selling a personal residence |
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Penny Stocks
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*Trade at or under $5
*Less than 4 million in net tangible assets *Some are "legit" *Shell companies |
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Pricing
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*Quoted on "pink sheets"
*Bid/Ask *High Spreads -more than other stocks -sometimes 25-33% -maybe 50-100% *Mark ups |
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Trading
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*OTC bulletin board
*Pink sheets *Sellers are often market makers |
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Risks
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*Heavily promoted but thinly traded
*Manipulation *High pressure sales *Unscrupulous *Unauthorized transactions *Lack of "due diligence" |
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Why Real Estate? Pro
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*A hedge against inflation
*Leverage enhances your returns *RE will increase because they're not making more land *RE is safer than the stock market *A man's property is his castle *RE is a tax shelter |
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Why Real Estate? Con
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*Inflation increases IR and other casts (taxes, etc)
*Leverage makes you a slave *There is a lot of vacant land in the US *RE value is hard to determine, it lacks utility *Building codes control you *Tax laws change and that can hurt you |
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Key Factors of Real Estate
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*Location, Location, Location***
*Timing |
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Real Estate Alternatives
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*Land use determines value
-Farm -Recreational Area -Single family homes -Industrial -Apartments -Commercial |
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Real Estate Alternatives
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*Single family residence
*Apartments *Commercial (retail rentals and office space) *REIT (real estate investment trusts) -equity -mortgage -hybrids |
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Assessing the Risk
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*Community
-growing or stable *Neighborhood -vacant shops -homes for sale *Immediate surroundings -condition of buildings -safety *Financial standards -occupy rate, operating expenses |
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REIT types
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*Equity
*Mortgage *Hybrid |
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Evaluation
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*degree of diversification
*amount of debt *experience of management *does management have ownership stake *income and cash flow |