Monday, June 28, 2010


The Series 7 could ask you what information is contained in a "tombstone ad." First, remember the context: we're talking about a new offering of securities. Once the registration statement has been filed with the SEC, the issuer and underwriters go into a cooling off period. During this period, no sales or advertising is allowed. Tombstone ads, however, are okay, since they don't really entice anyone or make any claims. They just provide the bare bones facts about an offer of securities. They simply announce that an offering of common stock, preferred stock, bonds etc. is available from a particular issuer. The number of shares is listed, as is the offering price. Then, we see the underwriters, with the lead underwriters in larger text than the syndicate members taking a smaller percentage of the offering. And, there is the disclaimer that this announcement is not an offer to sell the securities or the solicitation of an offer to buy the securities. It's just an announcement. It might help to look at one, which you can do at this link:

Tuesday, June 8, 2010

Time Value Again

A "call" option is the right to buy a stock at a set price known as the "strike price" or "exercise price." If the stock is worth $3 more than that strike/exercise price, the call option is worth that $3 difference, always. That's the intrinsic value of being able to save $3 when buying that stock. But, the option would be worth more than just that $3, as long as there is still some time left. If there is still a month to go, an ABC Aug 50 call might be trading for $4 a share, when ABC common stock is only trading for $53. The intrinsic value is $3, but there is still time for ABC to keep rising. If you want to buy this call option, you pay $4 a share, which is $3 of intrinsic value and $1 of time value. If the stock stops moving at $53, that time value will begin to evaporate quickly, as time runs out on the option. If you buy this option for $4 today, you can only win if the stock rises, and rises fast enough to outweigh the negative effects of time.

Let's work with the concept of time value in a rather annoying practice question:

Which option below has the most time value if ABC currently trades at $51 a share?
A. ABC Aug 50 call @$1.50
B. ABC Oct 50 call @2.50
C. ABC Oct 50 put @2.00
D. ABC Oct 55 put @4.25

EXPLANATION: step one, find the intrinsic value in each option and subtract that out of the premium. An Aug 50 call @1.50 has $1 of intrinsic value, 50 cents of time value. An Oct 50 call (which HAS to have more time value on it than the Aug 50) also has $1 of intrinsic value and, therefore, $1.50 of time value. Choice A is eliminated. An Oct 50 put has ZERO intrinsic value, so the time value is $2.00. Choice B is eliminated. An Oct 55 put has $4 of intrinsic value, so only 25 cents per share of time value. D is eliminated. The Answer is . . .


Saturday, June 5, 2010

Time Value

Remember, not all Series 7 questions concerning options involve calculations or even numbers. Many of the tougher options questions look like the one below:

Which of the following represents an accurate statement about put options on ABC common stock?
A. If ABC common stock drops from $45 to $40, an ABC Aug 40 put goes in the money
B. If ABC common stock drops from $45 to $40, the premium on an ABC Aug 40 put would likely increase
C. If ABC common stock drops from $45 to $40, an ABC Aug 40 put goes out of the money
D. If ABC common stock rises from $35 to $40, the ABC Aug 40 put premiums should increase

EXPLANATION: as always, try to eliminate some answer choices. Choice A says that an ABC Aug 40 put would be in the money with the stock at $40. That makes no sense, so eliminate it. Choice C says that an ABC Aug 40 put would be out-of-the-money with the stock at $40, but, actually, it would be at-the-money. Choice D says that put premiums increase when the stock price rises, but that's backwards. Strike prices are fixed--the puts only become more valuable as the underlying stock drops, making the right to sell it more valuable. Eliminate Choice D, and you're done. Why is Choice B accurate? Remember that even though the ABC Aug 40 put would not go in the money if the stock dropped from $45 to $40, the "time value" would increase, the speculative component of the premium. With the stock at $45, the right to sell it at $40 is not worth much, but if the stock then drops to $40, the market would assume it could easily keep dropping, and any little drop makes the put go in-the-money. The premium would reflect the 50-50 chance that the option will go in-the-money, and, of course, the premium would be 100% time value. So, a seller might like to write an at-the-money option, and then if the stock simply stops moving, that time value will evaporate, letting the seller keep the whole premium without lifting a finger as the option expires.