Wednesday, February 17, 2010

Buy-Stop Limits

Let's enjoy a fun question on types of orders that customers can place either online or over the phone with their trusted registered representative (you). Ready? Let's take a stab at it, anyway:

A customer of a broker-dealer places a buy-stop @45 limit 45 order on XYZ. The following trades in XYZ are reported to the consolidated tape:

44.50, 44.95, 45.10, 45.05, 44.95, 45.00

What is the most likely result?
A. the order has not yet been executed
B. the order has not yet been activated
C. the customer was filled at $44.95
D. the customer was filled at $45.05

EXPLANATION: many candidates absolutely loathe questions like this one, almost as much as they hate options questions. Oh well. If you're going to be entering orders for customers, you'll need to know this stuff, which is why it's very likely fodder for the Series 7. Remember that a buy-stop @45 is activated when the stock trades at $45 or higher. So, this order was activated when it traded at $45.10. That eliminates Choice B. Can the order be filled at $45.05? No, the customer won't pay any more than $45. That eliminates Choice D. Can the order be filled at $44.95? Yes, so the answer is . . . c.

Saturday, February 13, 2010

A twisted spread

I was listening to the playback of yesterday's Friday Free Broadcast on Straddles, Spreads, and Combinations, and I realized how hard a guy could make an options question on the Series 7 concerning any of these topics. With that in mind, let's see how twisted a question on option spreads could actually get on the Series 7:

Joe E. Investor buys an ABC Apr 45 put, writing an ABC Apr 50 put. Which of the following is/are true of this position?
I. Joe will profit if the spread widens
II. Joe will profit if ABC drops below 45
III. Joe will establish this position at a net credit to his account
IV. Joe will profit if ABC rises to 50 or above

A. I
C. I, II

EXPLANATION: okay, let's see what can be eliminated. Widen vs. narrow has to do with whether Joe has a debit or a credit spread. Which put is worth more, the ability to sell stock at $50 or at $45? Obviously, the April 50 put is worth more. Since Joe sold that one, he has a credit spread. Credit = narrow, so eliminate anything with "I" in it. A, and C are gone. And, suddenly "III" is in your answer. And, you just determined that Joe has a credit, so there is no doubt that "III" is in your answer. All you have to do is eliminate "II" or "IV," and you're done. Choice "II" implies that Joe is bearish on ABC. Does that make sense? Is he "long-the-lower-strike"? Yes. So, it does not make sense, because this is a B-U-L-L spread. Choice "II" is eliminated, making the correct answer . . . d

Now quick, what is your middle name?
Sorry--it can get a little confusing, can't it? Notice how I approach every "Roman Numeral" question as if it's a chess game. I'm using logic to eliminate players until I get down to just one remainder. Don't deal with the A-B-C-D structure first. Take each Roman Numeral choice and try to decide if it's in, or if it's out. Then, eliminate the A-B-C-D choices accordingly. This is how you need to approach the Series 7. This is how you take away the upper hand and turn it back on the test itself.

Wednesday, February 10, 2010

Holy Hypothecation Mishap, Batman!

You could easily see a Series 7 question like this one at the testing center:

Broker-dealers may lawfully hypothecate which of the following?
A. customers' fully paid securities
B. customers' excess margin securities
C. customers' securities held in safekeeping
D. customers' securities upon which the firm holds a proper lien

EXPLANATION: one of my pet peeves with all these license exams is that it eventually becomes a guessing game rather than an opportunity to teach new hires some very important information. This question here appears to mean absolutely nothing, but, in fact, a failure to understand its meaning can cost you a big fine by FINRA and a suspension or revocation of your license. A broker-dealer called a "clearing member" or a "custodial broker-dealer" routinely holds customer assets on its books. When I cut a check to my SIMPLE IRA each month, TD Ameritrade puts it on their books--do they wrap up $875 with my name on it? No--like a bank, they play with my cash and merely put it down as what is owed to me. Similarly, I've never seen any of the stock certificates that I've purchased because my broker-dealer holds them in street name, on my behalf. In other words, I put a lot of trust in my broker-dealer. I assume they're good for that cash balance in my account and that all of those shares of stock are actually still under their control/possession. If FINRA found out that a broker-dealer was going around pledging customer assets as collateral for a loan to the firm, that could be a problem. It would be similar to having your neighbor take out a home equity loan but actually pledge your house as collateral. Wouldn't that be awkward if your neighbor couldn't pay off the loan, and the bank foreclosed on your house. To prevent that, FINRA, the SEC, and the state regulators will only allow broker-dealers to pledge customer securities required to secure the margin loan in a margin account. Fully paid securities belong to customers, even if the firm holds them in street name or in the customer's name in "safekeeping." When the customer signs the margin agreement, including the hypothecation agreement, then the firm can pledge the customer's securities as collateral. But if a firm accidentally pledges securities it has no business pledging, bad things can happen. Just a few weeks ago, we saw an instance where a principal got in trouble for hypothecating securities the firm had no right to hypothecate. To read about it yourself, go to, click on "industry professionals" then under Enforcement click on "disciplinary actions" then find the January 2010 summary. On page 11, you'll see that a principal accidentally hypothecated customer securities worth about $106 million dollars, earning him a suspension and a small fine. You'll also see that it takes about 10 clicks to find anything on the FINRA website, but that's another matter.

Oh yeah, and the answer to the question is . . . D.

Tuesday, February 9, 2010

Good news from the battlefield

While there are no guarantees for people studying the Series 7, I am often amazed by how many people pass the exam, and on their first attempt. Like the customer who just sent me this email:

I have conquered the beast and made it into the coveted fraternity! I am pleased and relieved to say that I passed the 7 this past Saturday in Phoenix. At the break, I had my doubts. All 10 of the additional phantom questions were stacked in the first half. You are right, they are nasty people who write the exam. I am totally convinced that I could not have done it without your weekly webinars, your on demand classes, your practice lessons, your practice exams and your printed material. It took the whole enchilada to "get 'er done." But... WE did it. Thank you!

Friday, February 5, 2010

Fun with IRAs

Remember that when you're doing the 1,500 or so practice questions in our new Pass the 7 ExamCram Online Test Prep, you're seeing questions that should be very similar to what you'll see on the test. But only some of them will seem like close replicas; many of the questions at the testing center are going to shock the heck out of you. Half of those shockers are really familiar concepts that have been distorted so horribly that you no longer recognize what you're being asked. The other half are just questions no one could have known would show up based on the exam outline. That's why you have to develop test-taking skills. You need to use process of elimination so that you will minimize the errors that people make on questions they sort of knew and maximize the number you get right on questions your sort of don't. Let's enjoy a practice question on IRAs and approach it with all the skill and strategy you can muster:

Which of the following is true of a Roth Individual Retirement Arrangement but not a Traditional Individual Retirement Arrangement?
A. REITs may be held within the account
B. income limits prevent the deductibility of contributions
C. income limits prohibit certain individuals from making contributions
D. withdrawals must begin the year following the individual's 70 1/2th birthday

EXPLANATION: your job is to read each answer choice and ask first if it's true about Roth IRAs and then, is it not true of Traditional IRAs. Start with A--is that true of a Roth; can you buy REITs in it? Sure? Is that not true of the Traditional IRA? No, you can also buy them in a Traditional IRA, so choice "A" is eliminated. Your odds now rise from 25% to 33.3%. What about B--do income limits prevent the deductibility of contributions? Uh-oh. You don't deduct contributions to a Roth, so I guess income limits don't affect the deductibility. Unless you're reading it wrong, which is what the question wants you to worry about. Hmm. What about C--do income limits prohibit individuals from making contributions to their Roth IRA? Yes. Does that happen in a Traditional IRA? Actually, no, it does not. But most people confuse this statment with whether a rich person with a 401K established can deduct her contribution to a Traditonal IRA--totally different question. Of course, you're all turned around now and might not recognize that you just found the right answer--you did. But, you have to eliminate D before you pull the trigger. When do withdrawals have to begin in the Roth? They don't. So, D is, in fact, eliminated. And, even though "B" left us confused, "C" is our best answer.

Excellent, only 259 more questions to go.

Thursday, February 4, 2010

Margin Question

Margin questions are always fun, so let's enjoy one right now, shall we?

A customer of a broker-dealer purchases $30,000 of XYZ in a new margin account. The margin requirement is 60%; therefore, the required equity initially is
A. $18,000
B. $15,000
C. $12,000
D. $2,000

EXPLANATION: if the question says the intial margin requirement is above 50%, you have to accept that fact and work with it. If margin is what the customer has to deposit, he has to deposit $18,000. Which makes the initial equity $18,000.


Also, for anyone who remembers back when I was willing to discuss the stupid loan I took from "SMA" in my own margin account, the debit balance is now $4,700 with the little interest charges adding up each month. The 90 shares of Hospira that I plan to sell to pay off the debit is worth about $4,500, after advancing 17%. Back when I started blogging about my adventures in margin, Hospira was in negative territory. Unfortunately, as it slowly rises in value, it never seems to quite catch up to the interest charged on the loan. Even if/when it rises above what I owe, it will still be an idiotic maneuver. I'll end up selling a stock that would otherwise pay me dividends for decades and probably end up worth three times what I bought it for when/if I reach retirement age. Oh well. I needed the cash at that point, and I was willing to sacrifice good judgment for the sake of my Series 7 customers, who deserve to see at least a few testable points played out in the real world.