A sideways market

Joey Investor is long 1,000 shares of ORCL common stock. It is now June, and Joey feels that the market for ORCL is headed sideways over the next several weeks. Therefore, he should
A. sell 10 ORCL Jul calls
B. buy 10 ORCL Jul puts
C. sell 10 ORCL Jul puts
D. buy 10 ORCL Jul calls

EXPLANATION: Always sell options if the market is supposed to go "sideways" or "remain unchanged." That way, you get the premium now, and then the option expires. Don't sell puts if you own stock--if the stock goes to zero, you lose 100% on the stock, then you have the OBLIGATION TO BUY the stock for the strike price . . . even though it's worthless. Sell covered calls in this situation. Joey owns 1,000 shares, so he can cover 10 call options.

ANSWER: A

Bad Boys, Whatchu Gonna Do?

It's Friday morning, a balmy 30 degrees in Chicago, and, as usual, I am reading the disciplinary actions that FINRA has taken recently. Today I skipped over the firms that have been fined and sanctioned and jumped straight to the "Individuals Barred and Suspended." So far this month that category takes about 13 pages to cover . . . with almost two weeks more to go in December.

The first gentleman apparently decided to start entering trades using his discretion, the only problem being that the customer never gave him that discretion, and the firm never accepted the account as a discretionary account. Oopsie. The results? 60-day suspension from any FINRA firm in any capacity, $7,500 fine, and "disgorgement" of the $2,300 or so he made in commissions. The next guy up apparently thought FINRA and his compliance officers were kidding about the requirement to notify the firm of any outside business activities. I mean, I take my hat off to the guy for making $251,616.18, but I'm wondering if it was actually worth it, what with the whole four-month suspension and $10,000 fine that will now go into "broker check," the publicly available part of CRD, indefinitely. Then again, compared to the next guy on the list, that gentleman actually got off easy. The next individual only earned $13,950 through outside business activities, but through AWC (acceptance, waiver, and consent) was permanently barred from any association with any member firm.

Ever. Of course, he didn't help himself any by refusing to comply with FINRA's requests for information. Here's a tip--it's always better to cooperate with FINRA, no matter how much you have screwed up.

I guess the title of this post is a little off, with the "boys" reference, as Ms. Damon up there in Minnesota there showed by exercising discretion that she didn't actually have. She's also a walking test question, as she "only" used "time and price discretion," but, she used it the day after the order was entered. An order such as, "Buy me 1,000 shares of MSFT" is a "market not held order," but it's only good for that particular day. If not, some poor customer could have put in an order to buy 1,000 shares of Google when it was trading for $90 and then getting confirmation 10 months later that he just got filled at $555 a share. Of course, I think she'll remember that next time, after the 10-day suspension and $10,000 fine.

The next guy, in upstate New York, received a harsh $25,000 fine and one-year suspension for posting electronic communications on an Internet message board about a stock that his broker-dealer makes a market in. As the notice points out, "The findings stated that Dunne posted the advertisements without a registered principal’s prior approval and none of the advertisements named the firm or reflected Dunne’s relationship with the firm. The findings also stated that the advertisements constituted purchase recommendations for the company and failed to provide, or offer to furnish upon request, available investment information supporting each recommendation; failed to disclose that Dunne’s firm was a market maker in the company; that the firm and/or its officers or partners had a financial interest in the company, the nature of the
financial interest; and failed to provide a fair and balanced assessment, referring only to the company’s upside without any disclosure of the risks."

Oh well, it would take too much time to go through all these disciplinary actions in a blog post, but you are advised to go through them yourself at http://www.finra.org/web/groups/industry/@ip/@enf/@da/documents/disciplinaryactions/p120557.pdf

Have a nice weekend, and STAY OUT OF TROUBLE.

Municipal Bonds in the Lone Star State

Sometimes it's dangerous to read the Wall Street Journal, Forbes, etc. when studying for the Series 7 because the terminology used in the "real world" often doesn't jibe with what you're studying for the exam. However, more often than not, the "real world" will help you understand what the heck the Series 7 is talking about.

Take a look at the article from the Bond Buyer at the link posted below. You may struggle a bit with some jargon, but you will almost certainly come away with a better understanding of municipal bonds after reading this:

http://www.bondbuyer.com/issues/118_229/texas-tollway-p3-1004415-1.html?ET=bondbuyer:e344:1836724a:&st=email

You will see why a credit analyst looks at competing facilities, such as a free highway, when analyzing the credit quality of a tollway bond. You will see that qualifying for tax-exempt status is something to be approached creatively. Since "PABs" would normally not be tax-exempt, the politicians figured out a way to create a separate entity to issue the bonds and thereby make the interest tax-exempt. And you'll see references to the three major credit ratings agencies.

I'll let you take it from here--feel free to post questions if you have them.

Securities Fraud Right Next Door

A few days ago while reading my morning Sun-Times, I found this headline: Investors bilked of millions: charges. Then the lead-in, which declared: A North Shore businessman was arrested this week after he allegedly swindled investors out of several million dollars.

According to the story, Jay C. Nolan was released on a $100,000 bond on allegations that he defrauded individuals who invested in a hedge fund that he managed. Hedge funds are not a big component of the Series 7, but they are testable. Remember that investors need to be accredited to buy into a hedge fund and that hedge funds employ higher risk trading strategies as well as being very difficult to liquidate. They are organized as limited partnerships (DPPs), as we notice by the name of Mr. Nolan's fund, "Lodge Diversified Fund LP," where the "LP" stands for limited partnership. Actually "LP" could also be said to stand for "losing plenty" or "lying phoney," but we'll stick to the traditional reading here.

What happened? Apparently, when the losses began to pile up, the hedge fund manager simply could not admit it to himself or to investors. Allegedly, he sent out account statements revealing that the fund was currently worth $6.3 million, but when an investor did some checking with other sources, he learned that the actual value was only $170,000.
Oopsie! That's more than a typo, isn't it? I'm not sure how large or scary the investor is, but according to the story, Mr. Nolan spilled his guts immediately and admitted he had been sending out bogus account statements.

So now what? First, there will be the massive legal bills paid to Mr. Nolan's attorneys, who will do their best to keep him out of jail or keep his sentence as short as possible. Maybe they'll take it to an embarrassing criminal trial in which angry investors take the witness stand one-by-one and call him every name in the book that the judge will allow. Or, maybe they'll accept a plea bargain in exchange for a shorter sentence. There will also be the civil cases in which investors try to sue to recover some of their money. And, the SEC and/or the State of Illinois will try to make sure he never works in the investment industry again.

Do a google search on "Lodge Diversified Fund LP" and see what you can find. And please remember that sending bogus account statements through the US Mail and by email equals criminal violations known as "mail and wire fraud." When you sit for your Series 63 or 66 you'll learn about "custody" issues in the sense that regulators don't like investment advisers to have control over client assets but prefer that the assets are held by a custodial broker-dealer, who sends account statements to investors with no motiviation to fudge the numbers. Letting your investment adviser tell you what your investment is currently worth is a recipe for fraud and disaster.

Net Asset Value

All of the following would cause NAV for an open-end fund to increase except

A. stocks in the portfolio increase in value

B. stocks in the portfolio pay a dividend

C. investors buy new shares in unexpectedly large quantities

D. bonds in the portfolio make interest payments

EXPLANATION: if you owned stocks and bonds in a brokerage account, the account value would rise whenever the value of the stocks and bonds went up, or whenever they put money into your account via dividend and interest payments. If you multiplied the size of your portfolio by a bazillion and cut it up into shares, the same thing would happen to the mutual owners of your mutual fund. So "A", "B", and "D", all do make the NAV rise. Choice C has nothing to do with NAV--supply and demand does not apply here. At 4 PM or so each day the fund is revalued based on what we just mentioned--THEN, they let buyers in based on that NAV, and they pay sellers out the NAV. But it's all proportional and all done at the same price.

ANSWER: c

Broker Check

Up to now there has been a big difference in the way that state securities regulators and FINRA publish violations of agents, principals, and broker-dealers. While the state securities regulators tend to keep the notices of revocation up indefinitely, FINRA (formerly NASD) has allowed the violations to disappear after two years. That way if an agent were barred by NASD (now FINRA) for cutting bad checks and misappropriating client funds, the public would only know about it for 2 years after he got himself kicked out of the business. The state securities Administrator would usually issue an order of revocation, and that would stay up on the website indefinitely. Apparently, FINRA doesn't think that's good enough, and they're probably right in thinking that more investors will go to the "broker check" site at http://www.finra.org/ than their state regulators' site, especially with all the FINRA TV and radio commercials out there encouraging them to do exactly that.
In any case, starting in a few days, any agents or principals who get in trouble with FINRA will have the violation sitting in broker check indefinitely. That way, if they try to switch to, say, the insurance business, customers will be able to look them up at broker check and see that maybe they aren't the sort of people investors should trust with a $1.5 million annuity purchase.
Go ahead and check out the actual press release at the link below. And, more important, stay out of trouble once you get your securities license.

http://www.finra.org/Newsroom/NewsReleases/2009/P120385

Get the Series 66 Done in 2009

Many people taking the Series 7 will also have to take the Series 66 exam. Usually, the tests are taken in that order, but you might want to consider getting the Series 66 exam done in 2009, even if you have to put the Series 7 on the back burner to make it happen.

Why?

The Series 66 exam is changing. The old 80/20 split between regulatory concerns and investing concerns is changing to 50/50. The test is adding questions on derivatives (options, futures, forwards), hedge funds, statistics (mean, median, mode), annuities, insurance, retirement plans, Efficient Market Theory, and a handful of other exciting topics.

Will the test be easier or harder starting in January?
Nobody knows, but nobody has ever seen these tests get any easier. The regulators feel that they protect investors by flunking a certain percentage of test takers, and we will never convince them otherwise.

To help you get the Series 66 off your plate before all the changes occur, I have created a 50% off coupon code to be used on any purchase at http://www.passthe66.com/. The coupon code is: 66now. Be sure to hit the APPLY button to get the discount.