What are Capital Markets?
Capital markets are the backbone of modern economies, providing a platform where savings and investments meet. They allow businesses and governments to raise funds, while offering investors opportunities to grow their wealth. From stocks and bonds to more complex instruments, capital markets play a crucial role in driving economic growth, fostering innovation, and distributing financial resources efficiently. Understanding how capital markets work is the first step toward making informed financial decisions and navigating today’s global economy and capital markets.
What is stock and what does it mean to be a stockholder?
A share of stock is a percentage of ownership or “equity” in a company.
Owning stock offers the stockholder certain rights and benefits:
- Voting rights for elections or mergers
- Right to company paid dividends
- Direct way to participate in performance
Stock, also known as shares or equity, is a type of security that grants partial ownership in the issuing corporation.
This entitles the stockholder to that proportion of the corporation’s assets and earnings.
In addition, many stocks carry with them voting rights, though often these rights are limited to electing a Board of Directors or voting in a merger-election, as well as the right to company paid dividends, if any.
Stocks are bought and sold predominantly on stock exchanges and are the foundation of most portfolios.
These transactions must conform to government regulations which are meant to protect investors from fraudulent practices.
Mutual Funds
A mutual fund is a type of investment that pools funds from investors with similar objectives into a large group of assets to diversify risk beyond a singular company.
Mutual fund managers make the decision in the buying and selling of assets within the objectives of the fund.
This may appeal to investors who may not have the time or knowledge to choose and monitor the assets themselves – though this comes at a price.
Fees and commissions charged by the fund may reduce investment returns.
Exchange Traded Funds
Exchange Traded Funds, more commonly referred to as ETFs, are a basket of securities typically correlated to a specific sector, market, or index, similar to a mutual fund.
Like mutual funds, ETFs are usually managed by a company which selects the specific securities that comprise the ETF and can be a way to diversify market exposure.
However, unlike mutual funds, ETFs are publicly traded on an exchange and therefore, share prices are determined by the marketplace.
Due to their versatility, ETFs and options tied to those ETFs have grown to be popular investment vehicles.
Bonds
A bond is an IOU from a company to an investor in return for borrowed capital.
Stock = shares of ownership in a company.
Bonds do not offer ownership but are loans that offer a fixed rate of return.
As the return is tied to interest rates, the price of a bond (and the anticipated return) is inversely correlated with market interest rates.
The higher the interest rate, the lower the price of the bond – and vice versa.
Once a bond is issued, the rate of return is locked in.
If interest rates increase, then the existing bond is deemed less attractive than a newer one with a higher rate of return.
To attract buyers to the existing bond, prices need to fall.
Once the term expires, the loan to the company is repaid to the investor.
A company’s credit rating is built into the price of the bond as it plays a major role in determining its ability to repay.
Futures
Futures Contract:
- Agreement between buyer and seller to deliver/take delivery of an asset
- Usually commodities
- At a specific price and at a specific time
Futures contracts are also one of the oldest known investment types and are still used today by many investors seeking price certainty.
Options
One of the most versatile and flexible types of investments is the options contract.
→ Buyers (Rights)
→ Sellers (Obligations)
In the form of buying or selling shares of the underlying instrument at an agreed upon price and within a specific period of time.
Potentially, options can be used to generate income, mitigate risk, and even acquire stock at below market prices.
Initial Public Offering (IPO)
When a private company first offers shares of stock to the public, the process is known as an Initial Public Offering or IPO. Private businesses may look to go public as a means to raise substantial sums of capital needed for new investment opportunities such as building new factories or expansion into new markets. The IPO process is subject to regulation by the Securities and Exchange Commission (SEC). When it comes to equity options, options on IPO stocks may be listed for trading at the discretion of the exchanges. Rules for listing options on IPO’s and other option guidelines will be discussed later.
Lock-up Period
Immediately after the IPO, the shares are typically subject to a lock-up period in which insiders (those who own more than 10% of a company’s voting stock) and closely-held shareholders (company founders, executives, employees and their families, etc.) that obtained their shares prior to the IPO contractually cannot sell those shares for a specified period of time, typically 90 – 180 days. The purpose of the lock-up period is to prevent insiders from flooding the market with shares to sell, thereby driving prices significantly lower than the initial street price of the stock.
Diversification
When it comes to investing, you may have heard the saying “Don’t put all your eggs in one basket”.
So, the portfolio is not overly concentrated in one security or sector which could significantly affect the overall performance.
A well-diversified portfolio is one that spreads market risk across several securities or a mix of investments (Stock, Bonds, Options, Real Estate, etc.).
A financial advisor might suggest spreading out the risk to various sectors or by choosing stocks with different market capitalizations.
For more information on establishing a well-diversified portfolio, please contact your financial professional.
Market Capitalization (Market Cap)
One of the ways an investor might diversify their stock portfolio is by investing in companies with various market capitalizations.
Market cap refers to the total dollar market value of a company’s outstanding shares (shares held by all shareholders, including closely held shares, restricted shares, and institutional blocks).
If company XYZ has 20 million shares of stock outstanding and a current share price of $100, the market cap is said to be $2 billion. It is this metric of market cap that many investors use to compare “apples to apples” when vetting potential investment opportunities.
Large-cap
A “Large-cap” company generally has a market cap of $10 billion or more, and typically might indicate a larger, more established company or a major player in a well-established industry. These companies are often thought of as low risk, with low, but steady rewards.
Mid-cap
“Mid-cap” companies generally have a market cap between $2 billion – $10 billion and may be suited in potentially high growth industries. Though generally riskier than their large cap counterparts, the potential for higher returns is often greater, as well.
Small-cap
“Small-cap” companies generally have market caps below $2 billion and are often new players or emerge in new industries, and therefore often carry the highest levels of risk.
Shares outstanding also leads to another concept to which investors pay attention.
Float is the number of shares outstanding available for public trading, i.e., not owned by “insiders”.
→ The lower the float, possibly higher volatility and wider bid/ask markets.
A low supply of shares may lead to higher prices.
→ Low float stocks may be more expensive than stocks with a higher float.
Let’s assume company XYZ has 50 million shares outstanding, with institutions holding 35 million restricted shares, management and insiders owning 5 million, and the employee stock ownership plan (ESOP) holding 2 million.
Floating stock is therefore only 8 million shares out of the original 50 million outstanding, or roughly 16%.
If each market participant owned 1,000 shares, there would be a pool of 8,000 investors, whereas a similar company with a 50% float would have a pool of 25,000 investors willing to buy and sell shares.
Companies with a lower float percentage might be perceived as having higher risk of price volatility as a limited number of shares available to trade may have a sharp reaction to market news due to a lower supply of shares or shareholders.
A larger supply of shares or shareholders may result in lower share prices, tighter bid and ask spreads, and higher trading volumes.
The Economic Calendar
When it comes to buying and selling stock, or any investment, for that matter, timing is everything.
Knowing when prices may drop or anticipating future price increases can often be the difference between a favorable investment versus an unfavorable one.
Economic events such as Fed meetings, earnings reports, or dividend payouts can have a big effect on an investor’s portfolio.
An economic calendar is a tool investors use to help keep track of events and anticipate potential market changes.
Using a calendar, investors can:
- Anticipate changes
- Gauge their impact
- Make investment decisions
Earnings Reports
Earnings = Revenue – Expenses
This information is made public every three months in the company’s Quarterly Earnings Report.
Earnings reports can be a gauge as to how well the company performed recently – though the numbers may not tell the full story.
Let’s say XYZ Corporation went through a recent period of rapid expansion by spending to increase its infrastructure, acquiring another company, or simply building more factories or retail outlets.
Due to sharp increase in expenses, XYZ might post negative earnings for the last quarter, meaning that their overall expenditures outpaced revenue.
If the negative earnings are seen to be temporary or if there is potential for future growth, an investor might see this as a buying opportunity as the share price is likely to decline with a poor earnings announcement.
The point is that when it comes to earnings, like many things, “perception is reality” and expectations are often the driving force behind stock price movement.
Prior to their release, Wall Street analysts issue their earnings estimates or expectations of the data. These estimates are then compiled into a group or “street” consensus of what the earnings will be.
When the company ‘beats the street’, share prices will usually climb higher. If they miss estimates, share prices will likely drop.
Investors must make their own decisions regarding timing a purchase or sale of shares around earnings season or avoiding it altogether.
Many professional traders avoid taking a position around earnings due to the risk of uncertainty while others may look at it as an opportunity for potential profits.
The advantage of knowing when a company is releasing earnings data could mean the difference between buying, selling, or staying out of the market altogether.
Gross Domestic Product (GDP)
Besides earnings release dates, a robust economic calendar lists many other dates relevant to investors.
Gross Domestic Product (GDP) serves as the gauge to the economy’s overall size, health and well-being.
GDP is the total market value of all goods and services produced in a given period.
GDP equals consumer spending + private investment + government spending + net exports (exports – imports).
GDP = CS + PI + GS + (X – M)
GDP is an important economic indicator as when compared to previous quarters or years, it can reveal whether the economy is expanding or contracting and at what rate.
GDP helps policymakers and the Fed make economic policy decisions and recognize the threat of recession or inflation.
It can also help us compare economies around the world.
If the economy is expanding at a rapid rate, there might be a risk of inflation, meaning the same goods and services might cost more than they did previously.
To quell inflation, the Fed may raise interest rates as businesses and consumers cut back spending in response. As the economy slows, GDP declines and the Fed may lower interest rates until the economy reaches a satisfactory growth rate.
GDP does not account for all economic factors and relies on official reported data which may vary from country to country.
GDP is a benchmark indicator of growth. Significant change in GDP may result in rising or decreasing interest rates which can affect the cost of doing business. Higher business costs often lead to lower earnings and lower stock prices.
By knowing when GDP data is being released and what the expectations are, investors can plan their strategy accordingly.
Open Market Committee (FOMC)
One of the agencies charged with oversight of the banking industry and the economy is the Fed.
The key objectives of the Fed are to:
- Maximize employment
- Stabilize prices
- Moderate long-term interest rates
The Fed is responsible for setting monetary policy by controlling the money supply, i.e. cash in circulation or raising or lowering short-term interest rates.
These decisions about monetary policy are made roughly every six weeks when the Federal Open Market Committee (FOMC) meets to discuss and dissect various economic data.
During these meetings, decisions are made to expand or decrease money supply and raise, lower, or hold steady short-term interest rates.
To increase the money supply, the Fed implements what is known as expansionary monetary policy.
The Fed buys government bonds and puts cash in the hands of banks, which will then lend those funds to the public at lower interest rates to attract borrowers.
Increased borrowing leads to expansion of the economy through new investment by business in building, hiring, and innovating.
Business expansion also often leads to lower levels of unemployment as companies have more cash to take on new workers.
And those new workers, in turn, now have more cash in their pockets to spend and help boost the economy.
To decrease money supply and slow the economy in the face of inflation, the Fed reverses course and enacts a contractionary monetary policy, whereby they sell bonds to take cash out of the hands of the banking industry and the public.
Less cash means that banks will be more selective in their lending and raise interest rates.
Higher rates lead to less borrowing by businesses, less expansion and possible job losses.
By employing expansionary or contractionary policy, the Fed has the power to influence markets in a significant way.
Not only does the policy play a major role, but indications of future changes by the Fed play a part, too.
Known as “forward guidance”, this communication from the Fed as to what may loom on the horizon in terms of monetary policy and future interest rate changes affect businesses when making decisions about future spending and investment.
As mentioned previously, perception is reality and, in this case, what may happen down the road has a direct effect on financial and economic conditions today.
Keeping the Fed’s FOMC meetings on your radar and familiarizing yourself with the “street’s” expectations can go a long way in anticipating potential market moves.
The Jobs Report
When it comes to gauging the health of the economy, many analysts look to the monthly Jobs Report as it measures both wage and job growth.
In addition, the tone of the report can move markets as it lays the foundation of expectations for other economic reports released throughout the month.
The Bureau of Labor Statistics releases the report at 8:30 am ET on the first Friday of every month.
In essence, the report provides an estimate as to the number of employed and unemployed in the U.S., plus a host of other data including hours worked and wage levels.
These numbers are used by decision makers to forecast future business performance and make hiring decisions.
In addition, the Fed may use these numbers in dictating potential economic policy and the setting of short-term interest rates.
However, the data is based on several surveys rather than an actual accounting of every worker in America, which are then used to estimate the labor landscape as a whole.
As such, it is often subject to revisions in the following months and is often seen as historic view of labor versus a predictive one.
However, this historic view can often be relevant to the present as those past conditions might still exist in the labor force for the current month.
That being said, why is the Jobs Report so important?
When one person loses their job, their family is affected.
When many people lose their jobs, eventually the whole nation is affected as each dollar earned is a dollar either saved or spent.
It is when these dollars decrease or disappear altogether that the economy suffers as consumer spending directly impacts GDP.
The flexibility of options
Options are one of the most flexible investment vehicles available.
- Generate income
- Protect against risk
- Acquire stock
With stock, share price appreciation is necessary to realize a profit as stagnant share prices reap few, if any, rewards.
And when it comes to risk, it is not unheard of for shares to decline in value in times of volatility and crises.
As we know, even some well-established companies have closed their doors in turbulent times.
With the flexibility of options, investors can capitalize on stagnant markets or protect themselves against many of those worst-case scenarios.
And as an efficient use of capital, options can give investors the opportunity to benefit from the same number of shares at just a fraction of the cost.
You might be familiar with some options terms and concepts already and not even know it.
Just like with stocks, investors can take a bullish outlook (expecting the market to go up) or bearish (expecting the market to go down) market directional bias.
Investors might also be neutral, expecting limited price movement or stagnant markets and pick an options strategy to profit from this expectation.
It may be possible to use options to help protect your stock or portfolio by buying puts, or to potentially generate income on an existing stock holding (a popular strategy known as the covered call).
Options can also be a vehicle for leverage as lower capital requirements have the potential to provide much greater returns on investment (ROI).
But options, like all investments, are not without their risks.
When buying options, the premium paid represents the dollars you have at risk, and 100% of your investment can be lost, just like with buying stock.
When selling options, it’s possible to lose significantly more as your risk could theoretically be unlimited, just like with selling stock short.
When engaging in such strategies with unlimited risk, it is essential that investors be fully aware of the risks and have a sound plan to protect themselves from such an outcome.
Though stock and stock options, known as equity options, share several similarities, they also have a few key differences.
To begin with, your trading/brokerage account will require additional approvals to trade options and the criteria for these approvals may vary for different types of options strategies.
As such, it is best to contact your broker to find out how their policies may affect your ability to trade.
Also, some of the benefits that shareholders (stock owners) enjoy such as voting rights and potential dividend payments, are not shared with options holders.
While there is a process by which options holders can become shareholders, the right to vote or to receive a dividend is not an intrinsic right of an options holder.
It is also possible that certain options strategies or trading options on specific securities may have certain tax implications which should be discussed with your tax professional.
An option contract conveys specific rights to its buyer and specific obligations upon the seller.
There are only two types of options: calls and puts.
Call option buyers have the right to purchase shares of stock at a specific price (called the strike price) within a specific time period, known as the expiration date.
For this right, the buyer pays the seller a premium – the cost of the contract.
Call option sellers have the obligation to sell shares of stock at the strike price within the expiration date, if called upon to do so.
For accepting this obligation, the call seller receives the option premium from the buyer.
Put options are the opposite of calls: put buyers have the right to sell shares at the strike price up until expiration while put sellers have the obligation to buy those shares, if called upon to do so.
A buyer of a $50 strike call option expiring in January has the right to purchase stock at $50 per share up until the January monthly expiration.
For this right, let’s assume the buyer pays $2.00 in premium to the seller.
As each standard option contract typically represents 100 shares of stock, the $2.00 premium represents $200 of investment (and subsequent risk) for the buyer.
In return for the $200, the seller of the contract accepts the obligation to deliver 100 shares of stock as $50 per share (regardless of where it is trading at that time) from now until the January monthly expiration.
Come January (or before, in some cases), the buyer can purchase the stock at $50 per share and the seller is obligated to deliver those shares.
Buy Calls: *Right to purchase 100 shares of stock at the strike price prior to expiration.
Buy Puts: *Right to sell 100 shares of stock at the strike price prior to expiration.
Sell Calls: **Obligation to sell 100 shares of stock at the strike price prior to expiration.
Sell Puts: **Obligation to buy 100 shares of stock at the strike price prior to expiration.
*Upon Exercise
**Upon Assignment
Early 1970s
Listed options were created in the 1970s. At that time, U.S. markets and stock exchanges were in full swing and investors had at their disposal any number of different investment vehicles: stocks, bonds, commodities, and futures contracts, just to name a few – all being publicly traded under the watchful eye of various governing bodies. Behind the scenes, however, some market participants found they had a need for a different type of product – options that would allow them to hedge exposures to individual stocks or generate income from their holdings. They began to privately negotiate such contracts with each other and trade them via what is known as over-the-counter (OTC) trading. OTC markets continue today for certain issues, but the broadest set of investors now use exchange-listed options markets.
1973-1975
On April 26, 1973, the Chicago Board Options Exchange (Cboe) opened its doors for options trading. An offshoot of the Chicago Board of Trade (CBOT), the Cboe began with a handful of visionaries, risk-takers and 16 options on publicly listed stocks upon which to trade. Total volume that day was just over 900 contracts. Initially only offering call options, Cboe was a unique marketplace in that not only were the option contracts standardized and traded in a central location, but they were cleared and guaranteed by the exchange’s clearing entity which evolved as the central clearinghouse for all U.S. listed options and known today as OCC or The Options Clearing Corporation.
Sixteen stocks soon became 32 and within a year, average daily volume (ADV) eclipsed 30,000. Soon, competing option exchanges were opening in New York City (AMEX-1975) and Philadelphia (PHLX-1975). A decree by the SEC led to common central clearing by OCC and transparent price reporting among the new exchanges. By the end of 1975, average daily volume across the three exchanges topped 60,000 with over $4 billion in notional value traded, quadrupling the previous year’s total.
1977
As the popularity of options trading grew, so did the volume. By 1977 trading volume had increased to nearly 100,000 contracts a day just on Cboe alone. By this time, the number of exchanges listing options increased to four with the addition of the Pacific Coast Exchange (PCX). And the SEC allowed the creation of a new kind of option – the put contract. Whereas call options allowed buyers the right to purchase stock at the strike price and obligated sellers to deliver those shares, the advent of puts now allowed buyers to take a short or bearish position on a stock without shorting the shares themselves. Puts also allowed buyers to take a protective position against their portfolios. And sellers a way to get long stock in a new and sometimes more cost-effective way.
The Role of OCC
Let’s take a closer look at how OCC fits into the trading landscape of today.
The concept of central clearing is that a single entity takes on counterparty risk by becoming the buyer to every seller and the seller to every buyer.
By ensuring that the terms of the contract will be fulfilled, buyers and sellers can have peace of mind when it comes to default risk.
In the U.S., OCC is the central counterparty (CCP) that protects against default risk for option trades enacted on its participant exchanges (those operated by BOX, Cboe, MEMX, MIAX, Nasdaq and NYSE).
OCC accomplishes this by monitoring the overall risk managed by its clearing member firms and requiring enough capital as collateral to meet the credit risk amounts.
For the average investor, OCC as the CCP means that the terms and obligations of the option contract are guaranteed by OCC and not subject to risk of default by the original counterparty.
Black-Scholes Model
One aspect of options trading that professional traders found highly attractive was its pricing model.
In 1973, a team of economics professors from MIT, Fischer Black and Myron Scholes, hypothesized that option premium values could be theoretically calculated with their Black-Scholes options pricing model using specific inputs – namely stock price, strike price, time until expiration, implied volatility, dividends and interest rates.
The Black-Scholes model was revolutionary and contributed to the growth of the options industry.
The basic premise of trading options is that buyers want their contract to finish (expire) “in-the-money” and with intrinsic value while sellers want it to finish “out-of-the-money” and without intrinsic value.
This new model devised a way to calculate the probability of this desired outcome as well as an innovative way to calculate the ‘fair value’ of an option.
As the formula is quite complex, it is fortunate that today’s traders and investors can turn to their trading platform’s option calculator to accomplish these same calculations with just a few clicks.
Changes to the industry
Decimalization
For the first 25+ years of its existence, the options market reflected the stock market in terms of its pricing – meaning, option prices were calculated in fractions, just as they were with stock.
The smallest fraction or pricing increment an investor could use when buying or selling options was one-sixteenth of a dollar, or a “teeny” as they were called, and was the equivalent of .0625 or six and one-quarter cents.
While trading professionals were quick to calculate the value of a trade using fractions, the practice was not user-friendly with the investing public and international market participants.
In 2001, the SEC mandated that all stock and option pricing convert from fractional quotes to decimals to facilitate more efficient trading.
The switch to decimals was a boon to investors as the spread between what market participants were willing to pay for an option versus what they were willing to sell it for (commonly referred to as the bid/ask spread) went from six and a quarter cents wide to only a penny wide, in many cases.
Tighter spreads are more favorable to individual investors as they could now get in and out of a trade with more favorable pricing.
However, this is one of the many changes that paved the way for the beginning of the end to the traditional trading floor and ushered in a new way of trading.
Open Outcry vs. Electronic Trading
In the not too distant past, open outcry trading was the lifeblood of the options exchanges.
Professional traders, or market makers, were crammed into a trading pit and stood shoulder to shoulder while providing bid/ask markets either verbally or via hand signals to brokers in the trading pit and to communicate information to their nearby trading desks.
At the time, the advantage of the open outcry system was that it was completely transparent, allowing for fair price discovery as every trader was able to see orders as they came in to the pit and compete by providing a bid and/or offer price.
However, as efficient as open outcry was for the times, it paled in comparison to electronic trading.
Open outcry relied on human interaction and required manual order entry and pricing calculations which lacked the desired speed for trade execution.
As technology became more advanced, option pricing became even more efficient resulting in tighter bid/ask spreads.
Trade execution was reduced to a fraction of the time it previously took and investors became more actively engaged as accessibility to the marketplace and transparency of trading data increased.
Full-service vs. Discount Brokers
As investors became more engaged and advancements in technology led to more intuitive trading platforms for individual investors, more of them began to turn to self-directed trading and obtaining research to make their own investment decisions.
Historically, full-service brokers retained highly coveted research and provided expert guidance.
Traditional full-service brokers offer personalized service and a wide array of other financial services including retirement planning, tax advice, and access to other markets such as mutual funds, commodities, and bonds, among others.
These services come at a cost in the form of fees and commissions which impact an investor’s potential profits.
However, for investors looking for expertise, a full-service broker could be the right choice.
For self-directed investors, many have turned to discount or self-directed brokers to take advantage of lower costs.
Many firms now offer low or zero commissions.
However, as most of their services are provided online, investors might be limited in accessing direct customer service.
As such, it is incumbent upon the investor to familiarize themselves with the policies of their brokerage firm in order to ensure that no unexpected issues arise when trading.
The Options Industry Council (OIC)
The options industry has seen significant change since the first options trade was completed on Cboe in 1973.
The one constant in the industry has been the need for investor education.
To address this need, the Options Industry Council (OIC) was formed in 1992 and continues to be an instrumental part in the development of the options market. OIC’s mission is to increase awareness, knowledge and responsible use of exchange-listed equity options among a global audience of investors including individuals, financial advisors and institutional managers by providing professional and independent education and practical knowledge.
Stock Exchanges and Option Exchanges
The purpose of an exchange is to provide an open, transparent marketplace for trading and efficient pricing dissemination for the products listed on that exchange.
As you already know, when a private company decides to offer shares to the public, it typically does so via an IPO and the company will reach out to stock exchanges for possible listing.
The two primary stock exchanges in the U.S. are Nasdaq and NYSE, although there are others as well.
If the company meets the listing requirements of one of these exchanges, upon listing, their shares will be available to trade publicly.
The process is different with options as it is the option exchanges themselves that make the decision whether or not to list options on publicly traded companies – the company itself has no say in the matter.
However, like the stock exchanges, the option exchanges have criteria that must be met prior to listing, including:
- Shares must be publicly listed on a national exchange
- IPO values meeting exchange requirements
- Minimum of seven million publicly held shares (Float)
- At least 2,000 shareholders
However, meeting these criteria DOES NOT guarantee listing.
Option Exchanges
Regulated by the SEC, option exchanges are SROs (self-regulatory organizations) and as such, have certain responsibilities related to market integrity.
The exchanges have their own rules which must be filed with the SEC for approval, that govern how they operate.
Some of those rules relate to listing requirements, bid/ask market widths, listed strike intervals, closing only transactions on delisted stocks, position limits, etc.
As an example, one of the more common questions investors have centers around the availability of option strikes.
Generally, strikes are listed in $2.50 increments for stocks under $25, $5 increments for those trading from $25 through $200, and $10 for those stocks with share prices above $200.
However, exchanges can allow for strike-interval listing beyond the standard method.
It is not uncommon to see $1 strike intervals available for some of the more heavily traded and higher volume securities.
Exchanges also can add additional option series (expirations) beyond the exchange minimum.
Typically, the minimum number of expiration dates to trade in a given security is four: the two “front-months” which are the current monthly expiration series and the next monthly series, and the nearest two quarterly cycles.
However, the exchanges often extend the available expiration series beyond the standard four depending on the trading volume of the security.
Exchanges have been known to list up to sixteen different series covering several years for some of the more heavily traded securities and that doesn’t even include weekly expiring contracts.
The Securities and Exchange Commission (SEC)
In response to the stock market crash of October 1929, Congress enacted laws to place controls on the issuance and trading of securities and restore public faith in the markets.
Congress first enacted the Securities Act of 1933, which required public companies to register their stock sales and make regular financial disclosures.
Essentially, Congress wanted to ensure more transparency in a company’s financial statements so that investors could be better informed about their investment decisions.
A year later, Congress passed the Securities Act of 1934, establishing the creation of the SEC and giving the agency the authority to regulate exchanges, brokers, clearinghouses, and all aspects of the securities industry.
Its mission is to protect investors against fraud, maintain fair and orderly public markets, and facilitate capital formation by publicly traded companies.
The Role of the SEC
The SEC establishes and enforces regulations for all aspects of the securities markets, designed to maintain fair and orderly markets for all participants.
The SEC also requires all publicly traded companies to release scheduled financial disclosures (quarterly earnings reports, for example), thereby allowing the investing public to access the information and draw conclusions as to fair stock prices and the soundness of any investment decision.
EDGAR
To aid investors in their research of public companies, the SEC created EDGAR, the Electronic Data Gathering, Analysis, and Retrieval system.
As a central repository for financial information gathered from companies that are required by law to file financial information with the SEC, EDGAR increases the transparency of the financial markets.
As a free public database, EDGAR allows investors to review and research a public company’s financial filings such as annual reports, proxy statements for potential mergers, and the prospectus for a potential IPO.
The Financial Industry Regulatory Authority (FINRA)
FINRA is the frontline regulator of brokerage firms and under the oversight of the SEC.
FINRA licenses individual brokers and examines brokerage firms for compliance with SEC and FINRA rules.
While brokerages and their registered representatives are overseen by FINRA and the SEC, investment advisers are overseen by either the SEC or state regulators depending upon the level of assets under management.
SEC and FINRA Resources
To research the history of a brokerage firm or its registered representatives, the SEC and FINRA provide tools on their websites (linked above under the Resources tab) to assist investors in making informed decisions when selecting a broker or brokerage firm.
The SEC provides two tools on their website to help investors research the background of an adviser.
The first one is the Investment Adviser Public Disclosure (IAPD), which provides investors the opportunity to research an investment professional’s background to see if they are registered.
It should raise a red flag if an adviser is not registered with this program.
The second resource is the SEC’s Action Look-up Individuals (SALI), where investors can find information concerning individuals that have been named in SEC court actions or may have judgements or orders against them.
FINRA’s BrokerCheck allows investors to make informed choices when selecting their broker or brokerage firm by disclosing a broker’s registration status, employment history, regulatory actions, and complaints, if any. You do not need to know if your financial professional is registered with a brokerage, investment adviser, or both, as the SEC’s website provides a consolidated search tool that will query both the IAPD and BrokerCheck.