Path: senator-bedfellow.mit.edu!dreaderd!not-for-mail
Message-ID: <investment-faq/general/[email protected]>
Supersedes: <investment-faq/general/[email protected]>
Expires: 17 Mar 2003 10:19:33 GMT
References: <investment-faq/general/[email protected]>
X-Last-Updated: 2002/08/14
From: [email protected] (Christopher Lott)
Newsgroups: misc.invest.misc,misc.invest.stocks,misc.invest.technical,misc.invest.options,misc.answers,news.answers
Subject: The Investment FAQ (part 5 of 19)
Followup-To: misc.invest.misc
Reply-To: lott at invest-faq dot com
Summary: Answers to frequently asked questions about investments.
        Should be read by anyone who wishes to post to misc.invest.*
Organization: The Investment FAQ publicity department
Keywords: invest, finance, stock, bond, fund, broker, exchange, money, FAQ
URL: http://invest-faq.com/
Approved: [email protected]
Originator: [email protected]
Date: 01 Feb 2003 10:23:37 GMT
Lines: 1190
NNTP-Posting-Host: penguin-lust.mit.edu
X-Trace: 1044095017 senator-bedfellow.mit.edu 3929 18.181.0.29
Xref: senator-bedfellow.mit.edu misc.invest.misc:38849 misc.invest.stocks:761211 misc.invest.technical:97003 misc.invest.options:48644 misc.answers:15581 news.answers:245649

Archive-name: investment-faq/general/part5
Version: $Id: part05,v 1.58 2002/08/14 10:20:04 lott Exp lott $
Compiler: Christopher Lott, lott at invest-faq dot com

The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance.  This is a plain-text
version of The Investment FAQ, part 5 of 19.  The web site
always has the latest version, including in-line links. Please browse
http://invest-faq.com/


Terms of Use

The following terms and conditions apply to the plain-text version of
The Investment FAQ that is posted regularly to various newsgroups.
Different terms and conditions apply to documents on The Investment
FAQ web site.

The Investment FAQ is copyright 2001 by Christopher Lott, and is
protected by copyright as a collective work and/or compilation,
pursuant to U.S. copyright laws, international conventions, and other
copyright laws.  The contents of The Investment FAQ are intended for
personal use, not for sale or other commercial redistribution.
The plain-text version of The Investment FAQ may be copied, stored,
made available on web sites, or distributed on electronic media
provided the following conditions are met:
   + The URL of The Investment FAQ home page is displayed prominently.
   + No fees or compensation are charged for this information,
     excluding charges for the media used to distribute it.
   + No advertisements appear on the same web page as this material.
   + Proper attribution is given to the authors of individual articles.
   + This copyright notice is included intact.


Disclaimers

Neither the compiler of nor contributors to The Investment FAQ make
any express or implied warranties (including, without limitation, any
warranty of merchantability or fitness for a particular purpose or
use) regarding the information supplied.  The Investment FAQ is
provided to the user "as is".  Neither the compiler nor contributors
warrant that The Investment FAQ will be error free. Neither the
compiler nor contributors will be liable to any user or anyone else
for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.

Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly.  Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it.  Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers.  Readers outside the USA can reach
US-800 telephone numbers, for a charge, using a service such as MCI's
Call USA.  All prices are listed in US dollars unless otherwise
specified.

Please send comments and new submissions to the compiler.

--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Basics

Last-Revised: 26 May 1999
Contributed-By: Art Kamlet (artkamlet at aol.com), Bob Morris, Chris
Lott ( contact me ), Larry Kim (lek at cypress.com)

An option is a contract between a buyer and a seller.  The option is
connected to something, such as a listed stock, an exchange index,
futures contracts, or real estate.  For simplicity, this article will
discuss only options connected to listed stocks.

Just to be complete, note that there are two basic types of options, the
American and European.  An American (or American-style) option is an
option contract that can be exercised at any time between the date of
purchase and the expiration date.  Most exchange-traded options are
American-Style.  All stock options are American style.  A European (or
European-style) option is an option contract that can only be exercised
on the expiration date.  Futures contracts (i.e., options on
commodities; see the article elsewhere in this FAQ) are generally
European-style options.

Every stock option is designated by:
  * Name of the associated stock
  * Strike price
  * Expiration date
  * The premium paid for the option, plus brokers commission.

The two most popular types of options are Calls and Puts.  We'll cover
calls first.  In a nutshell, owning a call gives you the right (but not
the obligation) to purchase a stock at the strike price any time before
the option expires.  An option is worthless and useless after it
expires.

People also sell options without having owned them before.  This is
called "writing" options and explains (somewhat) the source of options,
since neither the company (behind the stock that's behind the option)
nor the options exchange issues options.  If you have written a call
(you are short a call), you have the obligation to sell shares at the
strike price any time before the expiration date if you get called .

Example: The Wall Street Journal might list an IBM Oct 90 Call at $2.00.
Translation: this is a call option.  The company associated with it is
IBM.  (See also the price of IBM stock on the NYSE.) The strike price is
90.  In other words, if you own this option, you can buy IBM at
US$90.00, even if it is then trading on the NYSE at $100.00.  If you
want to buy the option, it will cost you $2.00 (times the number of
shares) plus brokers commissions.  If you want to sell the option
(either because you bought it earlier, or would like to write the
option), you will get $2.00 (times the number of shares) less
commissions.  The option in this example expires on the Saturday
following the third Friday of October in the year it was purchased.

In general, options are written on blocks of 100s of shares.  So when
you buy "1" IBM Oct 90 Call at $2.00 you actually are buying a contract
to buy 100 shares of IBM at $90 per share ($9,000) on or before the
expiration date in October.  So you have to multiply the price of the
option by 100 in nearly all cases.  You will pay $200 plus commission to
buy this call.

If you wish to exercise your option you call your broker and say you
want to exercise your option.  Your broker will make the necessary
requests so that a person who wrote a call option will sell you 100
shares of IBM for $9,000 plus commission.  What actually happens is the
Chicago Board Options Exchange matches to a broker, and the broker
assigns to a specific account.

If you instead wish to sell (sell=write) that call option, you instruct
your broker that you wish to write 1 Call IBM Oct 90s, and the very next
day your account will be credited with $200 less commission.  If IBM
does not reach $90 before the call expires, you (the option writer) get
to keep that $200 (less commission).  If the stock does reach above $90,
you will probably be "called." If you are called you must deliver the
stock.  Your broker will sell IBM stock for $9000 (and charge
commission).  If you owned the stock, that's OK; your shares will simply
be sold.  If you did not own the stock your broker will buy the stock at
market price and immediately sell it at $9000.  You pay commissions each
way.

If you write a Call option and own the stock that's called "Covered Call
Writing." If you don't own the stock it's called "Naked Call Writing."
It is quite risky to write naked calls, since the price of the stock
could zoom up and you would have to buy it at the market price.  In
fact, some firms will disallow naked calls altogether for some or all
customers.  That is, they may require a certain level of experience (or
a big pile of cash).

When the strike price of a call is above the current market price of the
associated stock, the call is "out of the money," and when the strike
price of a call is below the current market price of the associated
stock, the call is "in the money." Note that not all options are
available at all prices: certain out-of-the-money options might not be
able to be bought or sold.

The other common option is the PUT.  Puts are almost the mirror-image of
calls.  Owning a put gives you the right (but not the obligation) to
sell a stock at the strike price any time before the option expires.  If
you have written a put (you are short a put), you have the obligation to
buy shares at the strike price any time before the expiration date if
you get get assigned .  Covered puts are a simple means of locking in
profits on the covered security, although there are also some tax
implications for this hedging move.  Check with a qualified expert.  A
put is "in the money" when the strike price is above the current market
price of the stock, and "out of the money" when the strike price is
below the current market price.

How do people trade these things? Options traders rarely exercise the
option and buy (or sell) the underlying security.  Instead, they buy
back the option (if they originally wrote a put) or sell the option (if
the originally bought a call).  This saves commissions and all that.
For example, you would buy a Feb 70 call today for $7 and, hopefully,
sell it tommorow for $8, rather than actually calling the option (giving
you the right to buy stock), buying the underlying stock, then turning
around and selling the stock again.  Paying commissions on those two
stock trades gets expensive.

Although options offically expire on the Saturday immediately following
the third Friday of the expiration month, for most mortals, that means
the option expires the third Friday, since your friendly neighborhood
broker or internet trading company won't talk to you on Saturday.  The
broker-broker settlements are done effective Saturday.  Another way to
look at the one day difference is this: unlike shares of stock which
have a 3-day settlement interval, options settle the next day.  In order
to settle on the expiration date (Saturday), you have to exercise or
trade the option by Friday.  While most trades consider only weekdays as
business days, the Saturday following the third Friday is a business day
for expiring options.

The expiration of options contributes to the once-per-quarter
"triple-witching day," the day on which three derivative instruments all
expire on the same day.  Stock index futures, stock index options and
options on individual stocks all expire on this day, and because of
this, trading volume is usually especially high on the stock exchanges
that day.  In 1987, the expiration of key index contracts was changed
from the close of trading on that day to the open of trading on that
day, which helped reduce the volatility of the markets somewhat by
giving specialists more time to match orders.

You will frequently hear about both volume and open interest in
reference to options (really any derivative contract).  Volume is quite
simply the number of contracts traded on a given day.  The open interest
is slightly more complicated.  The open interest figure for a given
option is the number of contracts outstanding at a given time.  The open
interest increases (you might say that an open interest is created) when
trader A opens a new position by buying an option from trader B who did
not previously hold a position in that option (B wrote the option, or in
the lingo, was "short" the option).  When trader A closes out the
position by selling the option, the open interest either remain the same
or go down.  If A sells to someone who did not have a position before,
or was already long, the open interest does not change.  If A sells to
someone who had a short position, the open interest decreases by one.

For anyone who is curious, the financial theoreticians have defined the
following relationship for the price of puts and calls.  The Put-Call
parity theorem says:
P = C - S + E + D
where
P = price of put
C = price of call
S = stock price
E = present value of exercise price
D = present value of dividends


The ordinary investor will occasionally see a violation of put-call
parity.  This is not an instant buying opportunity, it's a reason to
check your quotes for timeliness, because at least one of them is out of
date.

My personal advice for new options people is to begin by writing covered
call options for stocks currently trading below the strike price of the
option; in jargon, to begin by writing out-of-the-money covered calls.

The following web resources may also help.

  * For the last word on options, contact The Options Clearing
    Corporation (CCC) at 1-800-OPTIONS and request their free booklet
    "Characteristics and Risks of Listed Options." This 94-page
    publications will give you all the details about options on equity
    securities, index options, debt options, foreign currency options,
    principal risks of options positions, and much more.  The booklet
    is published jointly by the American Stock Exchange, The Chicago
    Board Options Exchange, The Pacific Exchange, and The Philadelphia
    Stock Exchange.  It's available on the web at:
    http://www.optionsclearing.com/publications/riskstoc.htm
  * The Chicago Board Options Exchange (CBOE) maintains a web site with
    extensive information about equity and index options.  Visit them
    at:
    http://www.cboe.com
  * The Orion Futures Group offers an "Options 101" primer.
    http://www.orionfutures.com/opts.htm


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Covered Calls

Last-Revised: 17 July 2000
Contributed-By: Chris Lott ( contact me ), Art Kamlet (artkamlet at
aol.com), John Marucco

A covered call is a stock call option that is written (i.e., created and
sold) by a person who also owns a sufficient number of shares of the
stock to cover the option if necessary.  In most cases this means that
the call writer owns at least 100 shares of the stock for every call
written on that stock.

The call option, as explained in the article on option basics , grants
the holder the right to buy a security at a specific price.  The writer
of the call option receives a premium and agrees to deliver shares
(possibly from his or her holdings, but this is not required) if the
option is called.  Because the call writer can deliver the shares from
his or her holdings, the writer is covered: there is no risk to the call
writer of being forced to buy and subsequently deliver shares of the
stock at a huge premium due to some fantastic takeover offer (or
whatever event that drives up the price).

Note the difference between selling something in an opening transaction
and selling something in a closing transaction.  When you sell a call
you already own, you are selling to close a position.  When you sell a
call you do not own (whether it is covered by a stock position or not),
you are selling to open the option position; i.e., you are writing the
call.  You might compare this with selling stock short, where you are
selling to open a position.

A call writer is covered in the broker's opinion if the broker has on
deposit in the call writer's option account the number of shares needed
to cover the call.  The call writer might have shares in his or her safe
deposit box, or in another broker's account, or in that same broker's
cash account -- this makes the investor covered, but not as far as the
broker is concerned.  So the call writer might consider himself covered,
but what will happen if the call is exercised and the shares are not in
the appropriate account? Quite simply, the broker will think the call is
naked, and will immediately purchase shares to cover.  That costs the
call writer commissions -- and the writer will still own the shares that
were supposed to cover the call!

A call is also considered covered if the call writer has an escrow
receipt for the stock, owns a call on the same stock with a lower strike
price (a spread), or has cash equal to the market value of the stock.
But a person who writes a covered call and doesn't have the sahres in
the brokerage account might be well advised to check with his or her
broker to make sure the broker knows all the details about how the call
is covered.

While the covered-call writer has no risk of losing huge amounts of
money, there is an attendant risk of missing out on large gains.  This
is pretty simple: if a stock has a large run-up in price, and calls are
nearing expiration with a strike price that is even slightly in the
money, those calls will be exercised before they expire.  I.e., the
covered call writer will be forced to deliver shares (known as having
the shares "called away").

If the call writer does not want the shares to get called away, he or
she can buy back the option if it hasn't been exercised yet.  And then
the call writer can roll up (higher strike price) or roll over (same
strike price, later expiration date), or roll up and over.  Of course
the shares could be bought on the open market and delivered, but that
would get expensive.

If you write a covered call and are concerned about indicating specific
shares to be delivered in case you are called, it may be possible to
have your broker write a note on the call to specify a vs date.  The
call confirmation might read: "Covered vs.  Purchase 4/12/97." In other
words the decision on which shares you are covering is made at the time
you write the call.  This should be more than enough to prove your
intent.  What your individual broker or brokerage service will do for
you is a business matter between them and you.

My personal advice for new options people is to begin by writing covered
call options for stocks currently trading below the strike price of the
option; in jargon, to begin by writing out-of-the-money covered calls.

For comprehensive information about covered calls, try this site:
http://www.coveredcalls.com


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Covered Puts

Last-Revised: 30 May 2002
Contributed-By: Art Kamlet (artkamlet at aol.com), Chris Lott ( contact
me )

A covered put is a stock put option that is written (i.e., created and
sold) by a person who also is short (i.e., has borrowed and sold) a
sufficient number of shares of the stock to cover the option if
necessary.  In most cases this means that the put writer is short at
least 100 shares of the stock for every put written on that stock.

The put option, as explained in the article on option basics , grants
the holder the right to sell a security at a specific price.  The writer
of the put option receives a premium and agrees to buy shares if the
option is exercised.  For an explanation of what it mans to borrow and
sell shares, please see the FAQ article on selling short .

Note the difference between selling something in an opening transaction
and selling something in a closing transaction.  When you sell a put you
already own, you are selling to close a position.  When you sell a put
you do not own, you are selling to open a position.  So when you sell a
put in an opening transaction (you give an instruction to your broker
"Sell 1 put to open"), that is known as writing the put.  You might
compare this with selling stock short, where you are selling to open a
position.

If you write a naked put, and the stock price goes way way down, you
have incurred a significant loss because you must buy the stock at the
strike price, which (in this example) is well above the current price.

If you write a covered put, that is you hold a short postion on the
underlying stock, then past the strike price the put is covered.  For
every dollar the stock price goes down, the cost to you of getting put
(i.e., of buying the shares because the option gets exercised) is
exactly offset by the decrease in the stock you hold short.  In other
words, for the covered put writer, the shares s/he is put balance the
shares s/he will have to deliver to close out the short position in
those shares, so it balances out pretty well.  The put is covered.

Like the covered call, the covered put does not do a thing to protect
you against the rise (in this case) in price of the underlying stock you
hold short.  But if the price of the stock rises, the put itself is
safe.  So the put writer is covered from loss due to the put.

While the covered-put writer has no risk of losing huge amounts of
money, there is an attendant risk of missing out on large gains.  This
is pretty simple: if a stock has a large fall in price, and puts are
nearing expiration with a strike price that is even slightly in the
money, those puts will be exercised before they expire.  I.e., the
covered put writer will be forced to buy shares (known as "being put").


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Ordering

Last-Revised: 25 Jan 96
Contributed-By: Hubert Lee (optionfool at aol.com)

When you are dealing in options, order entry is a critical factor in
getting good fills.  Mis-spoken words during order entry can lead to
serious money errors.  This article discusses how to place your order
properly, and focuses on the simplest type of order, the straight buy or
sell.

There is a set sequence of wording that Wall Street professionals use
among themselves to avoid errors.  Orders are always "read" in this
fashion.  Clerks are trained from day one to listen for and repeat for
verification the orders in the same way.  If you, the public customer,
adopt the same lingo, you'll be way ahead of the game.  In addition to
preventing errors in your account, you will win the respect of your
broker as a savvy, street-wise trader.  Here is the "floor-ready"
sequence:

After identifying yourself and declaring an intent to place an order,
clearly say the following:
[For a one-sided order (simple buy or sell)]
"Buy 10 Calls XYZ February 50's at 1 1/2 to open, for the day"

Always start with whether it is a buy or sell.  When you do so, the
clerk will reach for the appropriate ticket.

Next comes the number of contracts.  Remember, to determine the money
amount of the trade, you multiply this number of contracts by 100 and
then by the price of the option.  In the above example, 10 x 100 x 1 1/2
= $1,500.  Don't ever mention the equivalent number of underlying
shares.  One client of mine used to always order 1000 contracts when he
really meant to buy 10 options (equivalent to 1000 shares of stock).

Thirdly, you name the stock.  Call it by name first and then state the
symbol if you know it.  Be aware of similar sounding letters.  B, T, D,
E etc., can all sound alike in a noisy brokerage office.  Over The
Counter stocks can have really strange option symbols.

The month of expiration comes next.  Again, be careful.  September and
December can sound alike.  Floor lingo uses colorful nicknames to
differentiate.  The "Labor Day" 50s are Sept options while the
"Christmas" 50s are the December series.  But don't get carried away
with trying to use the slang.  Don't ever use it to show off to a clerk.
Simply use it for accuracy (e.g.  "the December as in Christmas 50s").

Then comes the strike price.  Read it plainly and clearly.  15 and 50
sound alike as does 50 and 60.

Name the limit price or whether it is a market order.  Qualify it if it
is something other than a limit or market order.  For example, 1 1/2
Stop.  Pet peeve of many clerks: Don't say "or better" when entering a
plain limit order.  That is assumed in the definition of a limit order.
"Or better" is a designation reserved for a specific instance where one
names a price higher than the current market bid-ask as the top price to
be paid.  For instance, an OEX call is 1 1/2 to 1 5/8 while you are
watching the President on CNN.  He hints at a budget resolution and you
jump on the phone.  You want to buy the calls but not with a market
order.  Instead, you give the floor some room with an "1 7/8 or better
order".  Clerks use this tag as a courtesy to each other to let them
know they realize the current market is actually below the limit price.
This saves them a confirming phone call.

Next is the position of the trade, that is, to Open or to Close.  This
is the least understood facet.  It has nothing to do with the opening
bell or closing bell.  It tells the firm if you are establishing a new
position (opening) or offsetting an existing one (closing).  Don't just
think that by saying "Buy", your firm knows you are opening a new
position.  Remember, options can be shorted.  One can buy to open or to
close.  Likewise, one can sell to open or to close.

If your order has any restrictions, place them here at the end.
Examples are All or None, Fill or Kill, Immediate or Cancel, Minimum of
15 (or whatever you want).  Remember, restricted order have no standing.
Unrestricted orders have execution priority.

Finally, state if the order is a day order or Good Till Canceled.  If
you don't say, the broker will assume it to be a day order only, but the
client should mention it as a courtesy.

Very Important: Your clerk will read the order back to you in the same
way for verification.  LISTEN CAREFULLY.  If you don't catch an error at
this point, they can stick you with the trade.

Proper order entry can mean the difference between a successful
execution and a missed fill or a poor price.  Doing it the right way can
save you precious seconds.  Further, it will mean a better relationship
with your broker.  The representative will act differently when he sees
a customer who knows what he is doing.  The measure of respect given to
someone who knows how to give an order properly is considerable.  After
all, you've just proven that you "speak" his language.

This article is Copyright 1996 by Hubert Lee.  For more insights from
Hubert Lee, visit his site:
http://www.optionfool.com


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Splits

Last-Revised: 23 Apr 1998
Contributed-By: Art Kamlet (artkamlet at aol.com)

When a stock splits, call and put options are adjusted accordingly.  In
almost every case the Options Clearing Corporation (OCC) has provided
rules and procedures so options investors are "made whole" when stocks
split.  This makes sense since the OCC wishes to maintain a relatively
stable and dependable market in options, not a market in which options
holders are left holding the bag every time that a company decides to
split, spin off parts of itself, or go private.

A stock split may involve a simple, integral split such as 2:1 or 3:1,
it may entail a slightly more complex (non-integral) split such as 3:2,
or it may be a reverse split such as 4:1.  When it is an integral split,
the option splits the same way, and likewise the strike price.  All
other splits usually result in an "adjustment" to the option.

The difference between a split and an adjusted option, depends on
whether the stock splits an integral number of times -- say 2 for 1, in
which case you get twice as many of those options for half the strike
price.  But if XYZ company splits 3 for 2, your XYZ 60s will be adjusted
so they cover 150 shares at 40.

It's worth reading the article in this FAQ on stock splits , which
explains that the owner of record on close of business of the record
date will get the split shares, and -- and -- that anyone purchasing at
the pre-split price between that time and the actual split buys or sells
shares with a "due bill" attached.

Now what about the options trader during this interval? He or she does
have to be slightly cautious, and know if he is buying options on the
pre-split or the post-split version; the options symbol is immediately
changed once the split is announced.  The options trader and the options
broker need to be aware of the old and the new symbol for the option,
and know which they are about to trade.  In almost every case I have
ever seen, when you look at the price of the option it is very obvious
if you are looking at options for the pre or post-split shares.

Now it's time for some examples.
  * Example: XYZ Splits 2:1
    The XYZ March 60 call splits so the holder now holds 2 March 30
    calls.
  * Example: XYZ Splits 3:2
    The XYZ March 60 call is adjusted so that the holder now holds one
    March $40 call covering 150 shares of XYZ.  (The call symbol is
    adjusted as well.)
  * Example: XYZ declares a 5% stock dividend.
    Generally a stock dividend of 10% or less is called a stock
    dividend and does not result in any options adjustments, while
    larger stock dividends are called stock splits and do result in
    options splits or readjustments.  (The 2:1 split is really a 100%
    stock dividend, a 3:2 split is a 50% dividend, and so on.)
  * Example: ABC declares a 1:5 reverse split
    The ABC March 10 call is adjusted so the holder now holds one ABC
    March 50 call covering 20 shares.

Spin-offs and buy-outs are handled similarly:
  * Example: WXY spins off 1 share of QXR for every share of WXY held.
    Immediately after the spinoff, new WXY trades for 60 and QXR trades
    for $40.  The old WXY March 100 call is adjusted so the holder now
    holds one call for 100 sh WXY @ 60 plus 100 sh WXY at 40.


  * Example: XYZ is bought out by a company for $75 in cash, to holders
    of record as of March 3.
    Holders of XYZ 70 call options will have their option adjusted to
    require delivery of $75 in cash, payment to be made on the
    distribution date of the $75 to stockholders.

Note: Short holders of the call options find themselves in the same
unenviable position that short sellers of the stock do.  In this sense,
the options clearing corporation's rules place the options holders in a
similar risk position, modulo the leverage of options, that is shared by
shareholders.

The Options Clearing Corporation's Adjustment Panel has authority to
deviate from these guidelines and to rule on unusual events.  More
information concerning options is available from the Options Clearing
Corporation (800-OPTIONS) and may be available from your broker in a
pamphlet "Characteristics and Risks of Standardized Options."


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - Stock Option Symbols

Last-Revised: 21 Oct 1997
Contributed-By: Chris Lott ( contact me )

The following symbols are used for the expiration month and price of
listed stock options.

Month Call Put
Jan A M
Feb B N
Mar C O
Apr D P
May E Q
Jun F R
Jul G S
Aug H T
Sep I U
Oct J V
Nov K W
Dec L X


Price Code Price
A x05
U 7.5
B x10
V 12.5
C x15
W 17.5
D x20
X 22.5
E x25
F x30
G x35
H x40
I x45
J x50
K x55
L x60
M x65
N x70
O x75
P x80
Q x85
R x90
S x95
T x00


The table above does not illustrate the important fact that price code
"A", just to pick one example, could mean any of the following strike
prices: $5, $105, $205, etc.  This is not so much of a problem with
stocks, because they usually split to stay in the $0-$100 range most of
the time.

However, this is particularly confusing in the case of a security like
the S&P 100 index, OEX, for which you might find listings of more than
100 different options spread over several hundred dollars of strike
price range.  The OEX is priced in the hundreds of dollars and sometimes
swings wildly.  To resolve the multiple-of-$100 ambiguity in the strike
price codes, the CBOE uses new "root symbols" such as OEW to cover a
specific $100 range on the S&P 100 index.  This is very confusing until
you see what's going on.


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Derivatives - LEAPs

Last-Revised: 30 Dec 1996
Contributed-By: Chris Lott ( contact me )

A Long-term Equity AnticiPation Security, or "LEAP", is essentially an
option with a much longer term than traditional stock or index options.
Like options, a stock-related LEAP may be a call or a put, meaning that
the owner has the right to purchase or sell shares of the stock at a
given price on or before some set, future date.  Unlike options, the
given date may be up to 2.5 years away.  LEAP symbols are three
alphabetic characters; those expiring in 1998 begin with W, 1999 with V.

LEAP is a registered trademark of the Chicago Board Options Exchange.
Visit their web site for more information: http://www.cboe.com/


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - The American Stock Exchange

Last-Revised: 19 Jan 2000
Contributed-By: Chris Lott ( contact me )

The American Stock Exchange (AMEX) lists over 700 companies and is the
world's second largest auction-marketplace.  Like the NYSE (the largest
auction marketplace), the AMEX uses an agency auction market system
which is designed to allow the public to meet the public as much as
possible.  In other words, a specialist helps maintain liquidity.

Regular listing requirements for the AMEX include pre-tax income of
$750,000 in the latest fiscal year or 2 of most recent 3 years, a market
value of public float of at least $3,000,000, a minimum price of $3, and
a minimum stockholder's equity of $4,000,000.

In 1998, a merger between the NASD and the AMEX resulted in the
Nasdaq-Amex Market Group.

For more information, visit their home page: http://www.amex.com


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - The Chicago Board Options Exchange

Last-Revised: 19 Jan 2000
Contributed-By: Chris Lott ( contact me )

The Chicago Board Options Exchange (CBOE) was created by the Chicago
Board of Trade in 1973.  The CBOE essentially defined for the first time
standard, listed stock options and established fair and orderly markets
in stock option trading.  As of this writing, the CBOE lists options on
over 1,200 widely held stocks.  In addition to stock options, the CBOE
lists stock index options (e.g., the S&P 100 Index Option, abbreviated
OEX), interest rate options, long-term options called LEAPS, and sector
index options.  Trading happens via a market-maker system.  For more
information, visit the home page: http://www.cboe.com


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - Circuit Breakers, Curbs, and Other Trading
Restrictions

Last-Revised: 2 Aug 2002
Contributed-By: Chedley A.  Aouriri, Darin Okuyama, Chris Lott ( contact
me ), Charles Eglinton

A variety of mechanisms are in place on the U.S.  exchanges to restrict
program trading (i.e., to cut off the big boy's computer connections)
whenever the market moves up or down by more than a large number of
points in a trading day.  Most are triggered by moves down, although
some are triggered by moves up as well.

The idea is that these curbs on trading, also known as collars, will
limit the daily damage by restricting activities that might lead towards
greater volatility and large price moves, and encouraging trading
activities that tend to stabilize prices.  Although these trading
restrictions are commonly known as circuit breakers, that term actually
refers to just one specific restriction.

These changes were enacted in 1989 because program trading was blamed
for the fast crash of 1987.  Note that the NYSE defines a Program Trade
as a basket of 15 or more stocks from the Standard & Poor's 500 Index,
or a basket of stocks from the Standard & Poor's 500 Index valued at $1
million or more.

Trading restrictions affect trading on the New York Stock Exchange
(NYSE) and the Chicago Mercantile Exchange (CME) where S&P 500 futures
contracts are traded.  When these restrictions are triggered, you may
hear the phrase "curbs in" if you listen to CNBC.

Here's a table that summarizes the trading restrictions in place on the
NYSE and CME as of this writing.  The range is always checked in
reference to the previous close.  E.g., a move of up 200 and down 180
points would still be an up of 20 with respect to the previous close, so
the first restriction listed below would not be triggered.  Any curb
still in effect at the close of trading is removed after the close;
i.e., every trading day starts without curbs.

Note that the "sidecar" rules were eliminated on Tuesday, February 16,
1999.

Restriction Triggered by
NYSE collar (Rule 80A) DJIA moves 2%
CME restriction 1 S&P500 futures contract moves 2.5%
CME restriction 2 S&P500 futures contract moves 5%
CME restriction 3 S&P500 futures contract moves 10%
NYSE circuit breaker nr.  1 DJIA moves 10%
NYSE circuit breaker nr.  2 DJIA moves 20%
NYSE Circuit breaker nr.  3 DJIA moves 30%


Now some details about each.

NYSE Collar (Rule 80A): Index arbitrage tick test
    Rule 80A provides that index arbitrage orders can only be executed
    on plus or minus ticks depending on which way the DJIA is.  In the
    parlance of the NYSE, the orders must be "stabilizing." This rule
    only effects S&P 500 stocks, and is also known as the "uptick
    downtick rule" because it restricts sells to upticks and buys to
    downticks.  In other words, when the market is down (last tick was
    down), sell orders can't be executed at lower prices.  In an up
    market (last tick was up), buy orders can't be executed for higher
    prices.  This collar is removed when the DJIA retraces its gain or
    loss to within approximately 1% of the previous close.  As of 3Q02,
    the collar is imposed at 180 points and removed when the DJIA
    retraces its position to within 90 points of the previous day's
    close.


CME Restrictions
    Trading in the S&P500 futures contract is halted just for a few
    minutes if the prices moves 2.5%, 5%, or 10% from the previous
    close.  Because restrictions on the NYSE effectively shut down
    trading in this futures contract, there is little need for
    additional restrictions on the CME.


NYSE Circuit Breakers
    These restrictions are also known as "Rule 80B." The first version
    of this rule, adopted in 1988, set triggers at 250 DJIA points and
    400 DJIA points.  These restrictions are updated quarterly to
    reflect the heights to which the Dow Jones Industrial Average has
    climbed.

       * 10% decline (950 points for 3Q02)
         The first circuit breaker is triggered if the DJIA declines by
         approximately 10%.  The restrictions that are put into place
         -- if any -- depend on the time of day when the circuit
         breaker is triggered.  If the trigger occurs before 2pm
         Eastern time, trading is halted for 1 hour.  If the trigger
         occurs between 2 and 2:30pm Eastern, trading is halted for 30
         minutes.  If the trigger occurs after 2:30pm Eastern time, no
         restrictions are put into place.  (This restriction was first
         used during the afternoon of 27 Oct 97.) Note that there is no
         similar restriction to the downside; nothing is done if the
         Dow rallies 10%.


       * 20% decline (1900 DJIA points for 3Q02)
         The second circuit breaker is triggered if the DJIA declines
         by approximately 20%.  The restrictions that are put into
         place again depend on the time of day when the circuit breaker
         is triggered.  If the trigger occurs before 1pm Eastern time,
         trading is halted for 2 hours.  If the trigger occurs between
         1 and 2pm Eastern, trading is halted for 1 hour.  If the
         trigger occurs after 2pm Eastern time, the NYSE ends trading
         for the day.  Again there is no similar restriction to the
         downside; nothing is done if the Dow rallies 20%.


       * 30% decline (2850 DJIA points for 3Q02)
         The third circuit breaker is triggered if the DJIA declines by
         approximately 30%.  The restriction is very simple: the NYSE
         closes early that day.  And like the other cases, again no
         restrictions are imposed if the Dow rallies 30%.


The circuit breakers cut off the automated program trading initiated by
the big brokerage houses.  The big boys have their computers directly
connected to the trading floor on the stock exchanges, and hence can
program their computers to place direct huge buy/sell orders that are
executed in a blink.  This automated connection allows them to short-cut
the individual investors who must go thru the brokers and the
specialists on the stock exchange.

Statistical evidence suggests that about 2/3 of the Mar-Apr 1994 down
slide was caused by the program traders trying to lock in their profits
before all hell broke loose.  The volume of their trades and their very
action may have accelerated the slide.  The new game in town is how to
outfox the circuit breakers and buy or sell quickly before the 50-point
move triggers the halting of the automated trading and shuts off the
computer.

Here are sources with more information:
  * HL Camp & Company offers a concise summary of program trading
    collars including current numbers on their web site.
    http://www.programtrading.com/curbs.htm
  * The Chicago Mercantile Exchange publishes their equity index price
    limits.
    http://www.cme.com/products/index/products_index_pricelimitguide.cfm
  * The NYSE publishes press releases every quarter with the numbers
    for that quarter's circuit breakers.
    http://www.nyse.com/press/prcircuit.html
  * The NYSE's glossary includes definitions of the term "Circuit
    Breakers".
    http://www.nyse.com/help/glossary.html


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - Contact Information

Last-Revised: 13 Aug 1993
Contributed-By: Chris Lott ( contact me )

Here's how to contact the stock exchanges in North America.
  * American Stock Exchange (AMEX), +1 212 306-1000,
    http://www.amex.com
  * ASE, +1 403 974-7400

  * Montreal Stock Exchange (MSE), +1 514 871-2424
  * NASDAQ/OTC, +1 202 728-8333/8039, http://www.nasdaq.com
  * New York Stock Exchange (NYSE), +1 212 656-3000,
    http://www.nyse.com
  * The Philadelphia Stock Exchange (PHLX), http://www.phlx.com/
  * Toronto Stock Exchange (TSE), +1 416 947-4700
  * Vancouver Stock Exchange (VSE), +1 604 689-3334/643-6500

If you wish to know the telephone number for a specific company that is
listed on a stock exchange, call the exchange and request to be
connected with their "listings" or "research" department.


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - Instinet

Last-Revised: 11 May 1994
Contributed-By: Jeffrey Benton (jeffwben at aol.com)

Instinet is a professional stock trading system which is owned by
Reuters.  Institutions use the system to trade large blocks of shares
with each other without using the exchanges.  Commissions are slightly
negotiable but generally $1 per hundred shares.  Instinet also runs a
crossing network of the NYSE last sale at 6pm.  A "cross" is a trade in
which a buyer and seller interact directly with no assistance of a
market maker or specialist.  These buyer-seller pairs are commonly
matched up by a computer system such as Instinet.

Visit their web site: http://www.instinet.com/


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - Market Makers and Specialists

Last-Revised: 28 Jan 1994
Contributed-By: Jeffrey Benton (jeffwben at aol.com)

Both Market Makers (MMs) and Specialists (specs) make market in stocks.
MMs are part of the National Association of Securities Dealers market
(NASD), sometimes called Over The Counter (OTC), and specs work on the
New York Stock Exchange (NYSE).  These people serve a similar function
but MMs and specs have a number of differences.  See the articles in the
FAQ about the NASDAQ and the NYSE for a detailed discussion of these
differences.


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - The NASDAQ

Last-Revised: 6 June 2000
Contributed-By: Bill Rini (bill at moneypages.com), Jeffrey Benton
(jeffwben at aol.com), Chris Lott ( contact me )

NASDAQ is an abbreviation for the National Association of Securities
Dealers Automated Quotation system.  It is also commonly, and
confusingly, called the OTC market.

The NASDAQ market is an interdealer market represented by over 600
securities dealers trading more than 15,000 different issues.  These
dealers are called market makers (MMs).  Unlike the New York Stock
Exchange (NYSE), the NASDAQ market does not operate as an auction market
(see the FAQ article on the NYSE).  Instead, market makers are expected
to compete against each other to post the best quotes (best bid/ask
prices).

A NASDAQ level II quote shows all the bid offers, ask offers, size of
each offer (size of the market), and the market makers making the offers
in real time.  These quotes are available from the Nasdaq Quotation
Dissemination Service (NQDS).  The size of the market is simply the
number of shares the market maker is prepared to fill at that price.
Since about 1985 the average person has had access to level II quotes by
way of the Small Order Execution System (SOES) of the NASDAQ.
Non-professional users can get level II quotes for $50 per month.  In
May 2000, the Nasdaq announced a pilot program that would reduce this
fee to just $10 per month.

SOES was implemented by NASDAQ in 1985.  Following the 1987 market
crash, all market makers were required to use SOES.  This system is
intended to help the small investor (hence the name) have his or her
transactions executed without allowing market makers to take advantage
of said small investor.  You may see mention of "SOES Bandits" which is
slang for people who day-trade stocks on the NASDAQ using the SOES.  A
SOES bandit tries to scalp profits on the spreads.  Visit www.attain.com
for more on that topic.

A firm can become a market maker (MM) on NASDAQ by applying.  The
requirements are relatively small, including certain capital
requirements, electronic interfaces, and a willingness to make a
two-sided market.  You must be there every day.  If you don't post
continuous bids and offers every day you can be penalized and not
allowed to make a market for a month.  The best way to become a MM is to
go to work for a firm that is a MM.  MMs are regulated by the NASD which
is overseen by the SEC.

The brokerage firm can handle customer orders either as a broker or as a
dealer/principal.  When the brokerage acts as a broker, it simply
arranges the trade between buyer and seller, and charges a commission
for its services.  When the brokerage acts as a dealer/principal, it's
either buying or selling from its own account (to or from the customer),
or acting as a market maker.  The customer is charged either a mark-up
or a mark-down, depending on whether they are buying or selling.  The
brokerage can never charge both a mark-up (or mark-down) and a
commission.  Whether acting as a broker or as a dealer/principal, the
brokerage is required to disclose its role in the transaction.  However
dealers/principals are not necessarily required to disclose the amount
of the mark-up or mark-down, although most do this automatically on the
confirmation as a matter of policy.  Despite its role in the
transaction, the firm must be able to display that it made every effort
to obtain the best posted price.  Whenever there is a question about the
execution price of a trade, it is usually best to ask the firm to
produce a Time and Sales report, which will allow the customer to
compare all execution prices with their own.

In the OTC public almost always meets dealer which means it is nearly
impossible to buy on the bid or sell on the ask.  The dealers can buy on
the bid even though the public is bidding.  Despite the requirement of
making a market, in the case of MM's there is no one firm who has to
take the responsibility if trading is not fair or orderly.  During the
crash of 1987 the NYSE performed much better than NASDAQ.  This was in
spite of the fact that some stocks have 30+ MMs.  Many OTC firms simply
stopped making markets or answering phones until the dust settled.

Academic research has shown that an auction market such as the NYSE
results in better trades (in tighter ranges, less volatility, less
difference in price between trades).  When you compare the multiple
market makers on the NASDAQ with the few specialists on the NYSE (see
the NYSE article), this is a counterintuitive result.  But it is true.

In 1996 the NASDAQ was investigated for various practices.  It settled a
suit brought against it by the SEC and agreed to change key aspects of
how it does business.  Forbes ran a highly critical article entitled
"Fun and Games" on the NASDAQ.  This was once available on the web, but
has vanished.

Related topics include price improvement, bid and ask, order routing,
and the 1996 settlement between the SEC and the NASDAQ.  Please see the
articles elsewhere in this FAQ about those topics.

In 1998, a merger between the NASD and the AMEX resulted in the
Nasdaq-Amex Market Group.

For more information, visit their home page: http://www.nasdaq.com


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - The New York Stock Exchange

Last-Revised: 4 June 1999
Contributed-By: Jeffrey Benton (jeffwben at aol.com), Chris Lott (
contact me )

The New York Stock Exchange (NYSE) is the largest agency auction market
in the United States.  Visit their home page: http://www.nyse.com

The NYSE uses an agency auction market system which is designed to allow
the public to meet the public as much as possible.  The majority of
volume (approx 88%) occurs with no intervention from the dealer.
Specialists (specs) make markets in stocks and work on the NYSE.  The
responsibility of a spec is to make a fair and orderly market in the
issues assigned to them.  They must yield to public orders which means
they may not trade for their own account when there are public bids and
offers.  The spec has an affirmative obligation to eliminate imbalances
of supply and demand when they occur.  The exchange has strict
guidelines for trading depth and continuity that must be observed.
Specs are subject to fines and censures if they fail to perform this
function.  NYSE specs have large capital requirements and are overseen
by Market Surveillance at the NYSE.  Specs are required to make a
continuous market.

Most academic literature shows NYSE stocks trade better (in tighter
ranges, less volatility, less difference in price between trades) when
compared with the OTC market (NASDAQ).  On the NYSE 93% of trades occur
at no change or 1/8 of a point difference.  It is counterintuitive that
one spec could make a better market than many market makers (see the
article about the NASDAQ).  However, the spec operates under an entirely
different system.  The NYSE system requires exposure of public orders to
the auction, the opportunity for price improvement, and to trade ahead
of the dealer.  The system on the NYSE is very different than NASDAQ and
has been shown to create a better market for the stocks listed there.
This is why 90% of US stocks that are eligible for NYSE listing have
listed.

A specialist will maintain a narrow spread.  Since the NYSE does not
post bid/ask information, you need to check out the 1-minute tick to
figure out the spread.  In other words, you'll need access to a
professional's data feed before you can really see the size of the
spread.  But the structure of the market strongly encourages narrow
spreads, so investors shouldn't be overly concerned about this.

There are 1366 NYSE members (i.e., seats).  Approximately 450 are
specialists working for 38 specialists firms.  As of 11/93 there were
2283 common and 597 preferred stocks listed on the NYSE.  Each
individual spec handles approximately 6 issues.  The very big stocks
will have a spec devoted solely to them.

Every listed stock has one firm assigned to it on the floor.  Most
stocks are also listed on regional exchanges in LA, SF, Chi., Phil., and
Bos.  All NYSE trading (approx 80% of total volume) will occur at that
post on the floor of the specialist assigned to it.  To become a NYSE
spec the normal route is to go to work for a specialist firm as a clerk
and eventually to become a broker.

The New York Stock Exchange imposes fairly stringent restrictions on the
companies that wish to list their shares on the exchange.  Some of the
guides used by the NYSE for an original listing of a domestic company
are national interest in the company and a minimum of 1.1 million shares
publicly held among not fewer than 2,000 round-lot stockholders.  The
publicly held common shares should have a minimum aggregate market value
of $18 million.  The company should have net income in the latest year
of over $2.5 million before federal income tax and $2 million in each of
the preceding two years.  The NYSE also requires that domestic listed
companies meet certain criteria with respect to outside directors, audit
committee composition, voting rights and related party transactions.  A
company also pays significant initial and annual fees to be listed on
the NYSE.  Initial fees are $36,800 plus a charge per million shares
issued.  Annual fees are also based on the number of shares issued,
subject to a minimum of $16,170 and a maximum of $500,000.  For example,
a company that issues 4 million shares of common stock would pay over
$81,000 to be listed and over $16,000 annually to remain listed.  For
all the gory details, visit this NYSE page:
http://www.nyse.com/listed/listed.html


--------------------Check http://invest-faq.com/ for updates------------------

Subject: Exchanges - Members and Seats on AMEX

Last-Revised: 2 Aug 1999
Contributed-By: Jon Feins (proclm at kear.tdsnet.com), J.  Bouvrie (fnux
at thetasys.com)

Most exchanges allow you to buy seats (become a member) without being a
registered securities dealer.  You would not, however, be allowed to use
the seat to transact business on that exchange.  You would be allowed to
lease out the seat and would thus own the seat as an investment.

Here's the disclaimer right up front: I have been negotiating seat
leases for investors for the last 5 years.  My expertise is mainly on
the American Stock Exchange (AMEX) and New York Stock Exchange (NYSE).
I spent 5 years on the floor of the NYSE and NYFE before going to the
AMEX for 3 years as a floor broker/trader.

Anyone can purchase a seat on a major stock exchange as an investment
and lease it to either a floor trader, specialist, or floor broker.
Most people do not realize that they can do this without any background
and without taking a test.  You do not even have to be a registered rep.
or registered with the SEC.  The return is between 12%-20% of the
current seat prices depending on the supply and demand at the time the
lease is negotiated.

The AMEX currently has a very high demand for leases.  The last leases I
negotiated were at a variable rate of 1 5/8%/month (19.5% per year) of
the average seat sales as posted by the exchange in their monthly
bulletin.  AMEX seats are currently quoted $565,000/bid -
$690,000/offer.  The last contracted sale was for $660,000 on 15 July
1999.  You can call the AMEX's 24 hour market line 877-AMEXSEAT to hear
the latest quote.  Amex seats can be put in an IRA or a Keogh Plan
making the investment even more appealing.

In late 1996, the AMEX approved a rule allowing individuals to own more
than one seat.  Since then seats have been slowly going up.  Call the
AMEX market line (212-306-2243) for the current price.

There are only 661 regular seats and 203 Option Principal Memberships
(OPM) on the AMEX.  Every Specialist and Floor Broker needs a regular
membership to do business.  A Trader can use either an OPM or a regular
seat.  If a trader wants to trade listed AMEX stocks (s)he needs to use
a regular seat.

When applying for an AMEX membership you need to fill out an application
which consists of:
 1. Information about the person applying for membership.
 2. Authorization form for orally bidding for or offering the
    membership.
 3. Personal financial statement.
 4. Completed U-4 for for background check along with a fingerprint
    form.
 5. Acknowledgement of non-eligibility of gratuity fund form.

After completing the paperwork a non-refundable application fee of $500
must be submitted to the exchange.  About a week after processing your
application you will be able to buy/bid for a seat.  Other costs
involved with the purchase of a seat on the AMEX include a one time
transfer fee of $2,500 (If/when you sell the seat the buyer of your seat
has to pay this transfer fee).  When the seat is leased out a transfer
fee of $1,500 is paid by the lessee.  Your total costs are:
 1. Purchase price of the seat.
 2. $500 application fee.
 3. One-time $2,500 transfer fee.
 4. $24.50 Finger print processing fee.

When you sell the seat there are no costs, and the exchange will send
you a check for the full selling price which they collect from the buyer
of your seat.

In the deals that I broker, once an investor has purchased the seat I
find a lessee.  All my leases require a letter of indemnity from the
clearing house of the lessee.  A clearing house (Merrill Lynch, Paine
Webber, Bear Stearns etc...) is used by the lessee to clear the trades
they execute.  Whether the lessee is a trader, specialist or a floor
broker they must use a clearing house who charges them commissions for
each of their trades and is liable for their losses.  If a person who is
worth $100,000 dollars loses $500,000 dollars the clearing house is
liable for the losses of the other $400,000.  The letter of indemnity
from the clearing house states that they do not view the seat as
collateral.  In addition to this letter of indemnity, I only lease to
people who are employed by a well-capitalized firm which also signs the
lease as a guarantor.  My leases have attorney reviewed modifications
which further protect the interests of the owner of the seat.  Just like
a person who rents a house needs to be careful of who they lease to, so
does the lessor of a seat.


--------------------Check http://invest-faq.com/ for updates------------------

Compilation Copyright (c) 2002 by Christopher Lott.

You are viewing proxied material from ftp.icm.edu.pl. The copyright of proxied material belongs to its original authors. Any comments or complaints in relation to proxied material should be directed to the original authors of the content concerned. Please see the disclaimer for more details.