This SIE study material page covers trading, settlement, and corporate actions. Here, you’ll learn various types of orders, trade settlement rules set forth by regulatory bodies, and corporate actions that affect the securities price.
Trading
Trading is buying and selling financial instruments in securities markets, such as stocks, bonds, commodities, or currencies. It involves the exchange of assets to capitalize on price fluctuations and achieve investment goals.
Types of Orders
You must know various order types in the securities market to score high in the SIE exam. Approximately 5 to 7 questions come from this topic in the FINRAs SIE exam. Here are some popular order types available on stock broker’s platforms.
- Limit Order: If an investor wants to purchase a share at a specific maximum price, he/she will place the limit order at the price he/she wants. If the stock price reaches that price, investors limit the orders that will be executed. The limit order will never be executed if the stock never reaches that limit price. For example, if the current price of TESLA stock is $190, but an investor wants to buy at $180, he’ll place the limit order with a limit price of $180. His order will be executed if the TESLA share price reaches $180.
- Market Order: If an investor instantly wants to buy or sell a stock at whatever the current market price, he/she will place the market order. The market order will be immediately executed at the current market price. However, there is always a chance of slippage in market order. For example, if the current price of TESLA stock is $180 and you want to purchase this stock anyhow, the market order will be executed at the next bid price.
- Stop Order: If an investor has already bought a stock and wishes to sell it if the price goes below a specific price, it is called a stop price. In the past, Wall Street referred to it as a stop loss order because it stops big losses in the securities market. For example, if an investor buys 100 shares of TESLA at a $200 price and he/she is ready to risk a maximum of up to $2000, he/she will place the stop order at $180, and his 100 shares will be automatically sold if TESLA shares price to drop below $180.
- Good-til-Canceled Order (GTC): A Good-til-Canceled (GTC) order is an order to buy or sell a security that remains active until it is executed or manually canceled by the investor. Unlike day orders, GTC orders do not expire at the end of the trading day, allowing investors to keep their orders open for an extended period.
Discretionary vs. Non-Discretionary Order
Sometimes, an investor may provide limited power of attorney to his/her registered representative (RR) to make trading decisions on the client’s behalf without contacting in advance. This authoritativeness is known as discretionary power, and such accounts are known as discretionary accounts.
The client must sign and return the proper documents to the brokerage firm before executing a discretionary order. FINRA has created some rules for members or employees of member organizations to use discretionary power.
- No member or employee of a member organization shall exercise any discretionary power in any customer’s account without first notifying and obtaining the approval of another person delegated under Exchange Rule 342(b)(1) with authority to approve the handling of such accounts.
- No member or employee of a member organization shall exercise any discretionary power in any customer’s account or accept orders for an account from a person other than the customer without first obtaining the written authorization of the customer, the signature of the person or persons authorized to exercise discretion in the account (and of any substitute so authorized), and the date such discretionary authority was granted.
- No member or employee of a member organization exercising discretionary power in any customer’s account shall (and no member organization shall permit any member or employee thereof exercising discretionary power in any customer’s account to) effect purchases or sales of securities that are excessive in size or frequency because of the financial resources of such customer.
- The provisions of this rule shall not apply to discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed. The authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written, contrary indication signed and dated by the customer. This limitation shall not apply to time and price discretion exercised in an institutional account pursuant to valid Good-Till-Cancelled instructions issued on a “not-held” basis. Any exercise of time and price discretion must be reflected on the order ticket.
Solicited vs. Unsolicited Order
If an investor wants to buy or sell a stock, he/she contacts his/her registered representative (RR) or broker to execute this order. This order is known as an unsolicited order because it’s 100% the investor’s individual decision.
On the other hand, if a registered representative or brokerage firm recommends investors buy or sell a stock, this order is known as a solicited order. It’s mandatory to mark the order as solicited or unsolicited to comply with regulations.
Trade Capacity
Trade capacity refers to a broker-dealer’s role in a transaction, either as an agent or principal. As an agent, the broker-dealer acts on behalf of a client, facilitating the trade and earning a commission. As a principal, the broker-dealer trades for its own account, buying and selling securities and potentially earning a profit from the price difference.
Types of Strategies
- Long-Short Equity: Investors take long positions in undervalued stocks and short positions in overvalued stocks. The aim is to capitalize on the difference in price movements. This strategy provides flexibility to profit in both rising and falling markets, offering a hedge against market volatility.
- Naked Options: These involve selling options without holding the underlying asset. This strategy can be highly speculative and risky because the seller faces unlimited potential losses. It includes two main types: naked call writing and naked put writing.
- Naked Call Writing: It involves selling call options without owning the underlying stock. The seller bets that the stock price will remain below the strike price until the option expires. If the stock price exceeds the strike price, the seller must buy the stock at the market price to fulfill the obligation, potentially incurring unlimited losses. This strategy is risky and typically used by experienced investors.
- Naked Put Writing: It involves selling put options without having the funds to purchase the underlying stock if assigned. The seller believes the stock price will stay above the strike price until the option expires. If the stock price falls below the strike price, the seller must buy the stock at the strike price, which can result in significant losses. This strategy is also high-risk and requires careful consideration.
- Covered Options: These refer to options strategies where the seller owns the underlying asset. In covered call writing, the seller owns the stock and sells call options, earning premium income while potentially being obligated to sell the stock if the option is exercised. In covered put writing, the seller holds enough cash to buy the stock if assigned, earning premiums while being prepared to purchase the stock. This strategy reduces risk compared to naked options and generates additional income.
- Bearish: In the securities market, being bearish means expecting a decline in asset prices. Investors with a bearish outlook anticipate that the market, or specific securities, will decrease in value. This sentiment often leads to selling off stocks, short selling, or buying put options to profit from falling prices.
- Bullish: In the securities market, bullish signifies a positive outlook on asset prices, anticipating an upward trend. Investors with a bullish perspective expect that the market or specific securities will increase in value. This optimism often leads to buying stocks, call options, or other securities to capitalize on the expected price rise.
Trade Settlement
The Securities Exchange Commission (SEC) has revised the trade settlement rule from May 28, 2024, and all securities transactions must settle on the next business day. This is also known as the (T+1) settlement cycle.
This means that if you buy or sell securities on any stock exchange, the U.S. financial institutions (brokerage firm/asset management company) will settle this transaction within one business day of the transaction date.
Earlier, most securities transactions followed the T+2 settlement cycle, which means all securities transactions must be settled in two business days (T+2). However, the SEC revised this rule on February 15, 2023, to enhance transparency and reduce risk in the stock market.
Investment Returns
- Bond Interest: It is the periodic payment that a bond issuer makes to bondholders for borrowing their funds. It is typically expressed as a percentage of the bond’s face value and paid semiannually or annually until it matures. The interest is known as return on investment (ROI).
- Dividends: Dividends are payments made by a corporation to its shareholders, typically derived from the company’s profits. These payments can be issued in the form of cash or additional shares. The additional share allotted to shareholders is known as stock dividends.
There are four dates to keep in mind concerning dividends:
- Declaration Date: The Declaration Date is when a company’s board of directors announces that a dividend will be paid to shareholders. This announcement includes vital details such as the dividend amount, the record date, and the payment date.
- Record Date: The Record Date is the cutoff date set by a company to determine which shareholders are eligible to receive a declared dividend. Only those holding shares on this date will receive the dividend payment. It ensures accurate and fair distribution of dividends to shareholders.
- Payment Date: The Payment Date is the date on which a declared dividend is actually paid to eligible shareholders. It follows the declaration and record dates, marking when the dividend funds are distributed to shareholders’ accounts, providing them with the expected income from their investments.
- Ex-Dividends Date: The Ex-Dividend Date is the first day a stock trades without the right to receive the upcoming dividend. Investors who purchase the stock on or after this date will not be eligible for the declared dividend. The ex-dividend date typically falls one business day before the record date, ensuring proper dividend allocation.
- Capital Gains — Realized vs. Unrealized: Capital Gains are profits from selling an asset at a higher price than its purchase cost. Realized Gains occur when the asset is sold and the profit is booked. Unrealized Gains are increases in asset value while still held. For example, if you buy a stock for $50 and its value rises to $70, the $20 increase is an unrealized gain. If you sell the stock at $70, the $20 profit becomes a realized gain. Realized gains are subject to capital gains taxes.
Corporate Actions
Corporate actions are events a company initiates that affect its securities and shareholders. These actions can significantly impact the company’s stock price and the shareholders’ equity. The Securities and Exchange Commission (SEC) oversees these actions to ensure they are conducted fairly and transparently, protecting investors’ interests.
- Buybacks (From Section 1.4 Offerings): Buybacks, or share repurchases, occur when a company buys back its own shares from the marketplace. This reduces the number of outstanding shares, often boosting the stock’s price and earnings per share (EPS). Buybacks can signal confidence in the company’s future and return value to shareholders. The SEC requires companies to disclose buyback plans and adhere to certain conditions to prevent market manipulation.
- Follow-on Offering (FPO): A Follow-on Offering (FPO) is an issuance of additional shares to the public after the initial public offering (IPO). This can be used to raise more capital for expansion, reduce debt, or fund other corporate activities. The SEC requires companies to file a registration statement and prospectus, ensuring transparency and protecting investors by providing comprehensive information about the offering.
- Tender Offers: A Tender Offer is an entity’s public, open offer to purchase a substantial portion of a company’s shares at a premium over the current market price. Shareholders can tender their shares within a specified period. The SEC mandates detailed disclosures and filing requirements for tender offers to ensure fairness and provide shareholders with adequate information to make informed decisions.
- Exchange Offers: It allows shareholders to exchange their current shares or securities for different shares or securities. This can be part of restructuring or refinancing efforts. Exchange offers must comply with SEC rules, including disclosure requirements, to protect investors and ensure they understand the terms and potential impacts of the exchange.
- Rights Offerings: It gives existing shareholders the right to purchase additional shares at a discounted price before the new shares are offered to the public. This allows shareholders to maintain their proportional ownership in the company. The SEC requires companies to provide detailed information about the rights offering, including the subscription price, ratio, and expiration date, ensuring shareholders have the information required to exercise their rights.
- Mergers & Acquisitions (M&A): A merger combines two companies into one, while an acquisition involves one company taking over another. The SEC oversees M&A activities to ensure compliance with antitrust laws and protect shareholder interests. Detailed disclosures are required to inform shareholders about the transaction’s terms, benefits, and risks.
- Stock Splits: It occur when a company divides its existing shares into multiple shares to increase liquidity and make the stock more affordable. For example, in a 2-for-1 split, each shareholder receives an additional share for every share held, halving the stock price. Stock splits do not affect the company’s market capitalization.
Adjustments to Market Price and Cost Basis: Corporate actions such as stock splits, dividends, and spin-offs can lead to Adjustments to Market Price and Cost Basis. For instance, the share price is adjusted after a stock split, and the cost basis per share is recalculated. These adjustments are essential for tax purposes and for accurately determining capital gains or losses.