Convertible Bonds

A convertible bond gives the bondholder the right to convert the bond into a pre-specified number of common shares of the issuer.


Why may convertible bonds be attractive to investors?

Convertible bonds are attractive to investors as the conversion (to equity) option allows them to benefit from price appreciation of the issuer's stock.

On the other hand, if there is a decline in the issuer's share price (which causes a decline in the value of the embedded equity conversion/call option), the price of the convertible bond cannot fall below the price of an otherwise identical straight bond.


Why do issuers use convertible bonds rather than straight bonds?

Because of these attractive features, convertible bonds offer a lower yield and sell at higher prices than similar bonds without the conversion option.

Note however, that the coupon rate offered on convertible bonds is usually higher than the dividend yield on the underlying equity.



Some useful vocabulary

• The conversion price is the price per share at which the convertible bond can be converted into shares.
• The conversion ratio refers to the number of common shares that each bond can be converted into.  It is calculated as the par value divided by the conversion price.
• The conversion value is calculated as current share price multiplied by the conversion ratio.
• The conversion premium equals the difference between the convertible bond's price and the conversion value.
• Conversion parity occurs if the conversion value equals the convertible bond's price.

Why issuers often embed a call option alongside the conversion option in the convertible bond?

Although it is common for convertible bonds to reach conversion parity before they mature, bondholders rarely exercise the conversion option, choosing to retain their bonds and receive (higher) coupon payments instead of (lower) dividend payments.

As a result, issuers often embed a call option alongside the conversion option in the convertible bond, making them callable convertible bonds.






An example:   Proposed ICUL of Aeon Credit

http://www.bursamalaysia.com/market/listed-companies/company-announcements/5374537

Summary of proposed ICUL (Convertible Bond) of Aeon Credit

1.  Proposed right issue to raise RM432,000,000, represented by the 432,000,000 ICULS to be issued.

2.  The coupon rate for the ICULS will be a minimum of 3.5% per annum, payable on an annual basis (“ICULS Coupon Rate”).

3.  The ICULS holders can convert their ICULS held into new ACSM Shares anytime from and including the date of issuance of the ICULS (“Issue Date”) up to its maturity date, which is the third (3rd) anniversary of the Issue Date (“Maturity Date”). 

4.  Any ICULS which are not converted would be mandatorily converted into new ACSM Shares on the Maturity Date.

5.  The conversion price for the ICULS has not been fixed.

6.  The Board shall determine the ICULS conversion price, taking into consideration the following: 

(i) the theoretical ex-all price (“TEAP”) per ACSM Share taking into account the Proposals, calculated based on the 5-market day volume weighted average market price (“VWAMP”) up to the date immediately preceding the Price Fixing Date;

(ii) the then prevailing market conditions; and

(iii) the final ICULS Coupon Rate and pricing for rights issue exercises. 

7.  In any event, the ICULS conversion price shall be determined at a minimum of 15.0% discount to the TEAP as calculated in (i) above.

[Comments:

Benefits for the issuer:

• Using ICULS, the company, Aeon Credit, would be able to raise fund by paying a lower coupon rate of 3.5% per annum.  
• The issuer also embed a call option along side the conversion option in the ICULS; any ICULS that are not converted before the Maturity Date would be mandatorily converted into new ACSM shares on the Maturity Date.

Benefits for the investors:

• The company has proposed that the ICULS conversion price shall be determined at a minimum of 155 discount to the TEAP (theoretical ex-all price) as calculated in (i) above.  Thus, the investors benefit by buying with a discount to the prevailing mother share price.
• The investors of the ICULS hope to benefit from price appreciation of the issuer's stock.]

MULTIPLE PROPOSALS AEON CREDIT SERVICE (M) BERHAD ("ACSM" OR THE "COMPANY") I) PROPOSED BONUS ISSUE; AND II) PROPOSED RIGHTS ISSUE (COLLECTIVELY REFERRED TO AS THE "PROPOSALS").

AEON CREDIT SERVICE (M) BERHAD

Type	Announcement
Subject	MULTIPLE PROPOSALS
Description	AEON CREDIT SERVICE (M) BERHAD ("ACSM" OR THE "COMPANY") I) PROPOSED BONUS ISSUE; AND II) PROPOSED RIGHTS ISSUE (COLLECTIVELY REFERRED TO AS THE "PROPOSALS").
On behalf of the Board of Directors of ACSM, CIMB Investment Bank Berhad wishes to announce that the Company proposes to undertake the following: (i)  Proposed bonus issue of 72,000,000 new ordinary shares in ACSM (“Bonus Shares”) at an issue price of RM0.50 each on the basis of 1 bonus share for every 2 existing ACSM ordinary shares (“ACSM Shares”) held (“Proposed Bonus Issue”); and (ii)  Proposed renounceable rights issue of 3-year minimum 3.5% irredeemable convertible unsecured loan stocks (“ICULS”) on the basis of 2 ICULS for every 1 existing ACSM Share held to raise RM432,000,000 in cash (“Proposed Rights Issue”). (collectively referred to as the “Proposals”) Please refer to the attachment for the full text on the announcement of the Proposals. This announcement is dated 23 March 2017. AEON CREDIT SERVICE (M) BERHAD (“ACSM” OR “COMPANY”) (I) PROPOSED BONUS ISSUE OF 72,000,000 NEW ORDINARY SHARES IN ACSM (“BONUS SHARES”) AT AN ISSUE PRICE OF RM0.50 EACH TO BE CAPITALISED FROM THE COMPANY’S RETAINED EARNINGS ON THE BASIS OF 1 BONUS SHARE FOR EVERY 2 EXISTING ACSM ORDINARY SHARES (“ACSM SHARES”) HELD (“PROPOSED BONUS ISSUE”); AND (II) PROPOSED RENOUNCEABLE RIGHTS ISSUE OF 3-YEAR MINIMUM 3.5% IRREDEEMABLE CONVERTIBLE UNSECURED LOAN STOCKS (“ICULS”) ON THE BASIS OF 2 ICULS FOR EVERY 1 EXISTING ACSM SHARE HELD TO RAISE RM432,000,000 IN CASH (“PROPOSED RIGHTS ISSUE”) Proposed Rights Issue 2.2.1 Details The Proposed Rights Issue will be undertaken after the completion of the Proposed Bonus Issue. As mentioned in Section 2.1.1 of this announcement, the Proposed Rights Issue is not conditional upon the Proposed Bonus Issue, and in the event that the Proposed Bonus Issue is not completed for whatsoever reason, subject to obtaining all relevant approvals, the Proposed Rights Issue will be implemented. The Proposed Rights Issue, to be undertaken on a renounceable basis, involves the issuance of 432,000,000 ICULS at 100% of its nominal value of RM1.00 each in cash on the basis of 2 ICULS for every 1 existing ACSM Share held by the Company’s shareholders (“Entitled Shareholders”) whose names appear in ACSM’s ROD as at the close of business on an entitlement date to be determined by the Board and announced later (“ICULS Entitlement Date”) after the completion of the Proposed Bonus Issue. In the event that the Proposed Bonus Issue is not completed for whatsoever reason, the Proposed Rights Issue shall be undertaken on the basis of 3 ICULS for every 1 existing ACSM Share held. The Proposed Rights Issue will raise RM432,000,000 for the Company from the issuance of a total of 432,000,000 ICULS under the Proposed Rights Issue. The Proposed Rights Issue is renounceable in full or in part. This means that the Entitled Shareholders can subscribe for or renounce their entitlements to the ICULS in full or in part. Any ICULS not subscribed or not validly subscribed for shall be made available for excess applications by the Entitled Shareholders or their renouncee(s)/transferee(s).The Board intends to allocate such excess ICULS in a fair and equitable manner on a basis to be determined later by the Board. The ICULS will be provisionally allotted to the Entitled Shareholders on the ICULS Entitlement Date. Any fractional entitlements of ICULS under the Proposed Rights Issue will be disregarded and shall be dealt with in the Board’s absolute discretion in such manner as it deem fits and in the best interests of ACSM. The coupon rate for the ICULS will be a minimum of 3.5% per annum, payable on an annual basis (“ICULS Coupon Rate”). The final ICULS Coupon Rate shall be reflected in the circular to the Company’s shareholders seeking their approval for the Proposed Rights Issue at an extraordinary general meeting to be convened (“EGM”). The ICULS will be constituted by a trust deed to be executed between ACSM and an appointed trustee for the benefit of the ICULS holders. The indicative principal terms and conditions of the ICULS are set out in Appendix I of this announcement. 2.2.2 Basis of determining and justification for the ICULS issue price and ICULS conversion price The ICULS will be issued at its nominal value of RM1.00 each. The nominal value was fixed after taking into account the aggregate proceeds of RM432,000,000 to be raised from the Proposed Rights Issue, represented by the 432,000,000 ICULS to be issued. Due to the timeframe to implement the Proposed Rights Issue and the potential share price movement of the ACSM Shares during this period, the conversion price for the ICULS has not been fixed. The ICULS conversion price will be determined on the price-fixing date to be announced at a later date (“Price Fixing Date”) after receipt of all relevant approvals but prior to the ICULS Entitlement Date. The Board shall determine the ICULS conversion price, taking into consideration the following: (i) the theoretical ex-all price (“TEAP”) per ACSM Share taking into account the Proposals, calculated based on the 5-market day volume weighted average market price (“VWAMP”) up to the date immediately preceding the Price Fixing Date; (ii) the then prevailing market conditions; and (iii) the final ICULS Coupon Rate and pricing for rights issue exercises. In any event, the ICULS conversion price shall be determined at a minimum of 15.0% discount to the TEAP as calculated in (i) above. For illustration purposes only and taking into account the 5-market day VWAMP per ACSM Share up to 22 March 2017, being the market day immediately preceding the date of this announcement of RM16.24 resulting in a TEAP of RM10.48 and assuming a discount to TEAP of 15.0%, the illustrative conversion price of the ICULS is RM8.91 per new ACSM Share after taking into account the completion of the Proposed Bonus Issue (“Illustrative ICULS Conversion Price”). Using the Illustrative ICULS Conversion Price and for illustration purposes only, a total of 48,484,848 new ACSM Shares will be issued upon full conversion of the ICULS. This represents 18.3% of the Company’s enlarged share capital after the completion of the Proposals. 2.2.3 Ranking of the new ACSM Shares arising from the conversion of ICULS The new ACSM Shares to be issued arising from the conversion of the ICULS shall, upon allotment and issuance, rank equally in all respects with the existing ACSM Shares, save and except that they will not be entitled to any dividends, rights, allotments and/or any other distributions that may be declared, made or paid where the entitlement date is before the allotment date of the new ACSM Shares. Based on the terms of the ICULS, the ICULS holders can convert their ICULS held into new ACSM Shares anytime from and including the date of issuance of the ICULS (“Issue Date”) up to its maturity date, which is the third (3rd) anniversary of the Issue Date (“Maturity Date”). Any ICULS which are not converted would be mandatorily converted into new ACSM Shares on the Maturity Date. 2.2.4 Status of ICULS The ICULS shall constitute direct, unconditional, unsecured and unsubordinated obligations of ACSM and subject to the provisions contained in the trust deed, at all times rank equally, without discrimination, preference or priority between themselves and all present and future direct, unconditional, unsecured and unsubordinated debts and obligations of ACSM except those which are preferred by law.

Risks of Equity Securities

Preference shares are less risky than common shares.

Putable common shares are less risky than callable or non-callable common shares.

Callable common and callable preference shares are more risky than their non-callable counterparts.

Cumulative preference shares are less risky than non-cumulative preference shares as they accrue unpaid dividends.



Risks (> = more risky than)

Common shares  >  Preference shares

Callable or non-callable common shares > Putable common shares

Callable common stocks > Non-callable common stocks

Callable preference shares > Non-callable preference shares

 Non-cumulative preference shares > Cumulative preference shares

Beginner Strategies for Investment

Investment strategies aren't just about picking the best investments you can find, but about picking investments that are more beneficial together than they are on their own.

Here are some basic strategies to build your investments.

The most common strategy is simple diversification of investments.

For bonds, this means staggering your coupon and maturity dates not only to provide consistent income but also so that you can more readily respond to changes in the market, rather than having the entirety of your bond investments tied up at the same time.

For stocks, this means picking high-quality investments which tend to fluctuate in price in opposite directions; as one stock decreases in value in the short run, another should increase, but both should appreciate over the long run.

In the same manner, including global diversification of stock investments can reduce the impact of global trends.

Diversifying into types of investment you have can help you find an appropriate balance of potential gain and risk - maintaining a percentage of your portfolio in stocks or even high-risk investments like speculative stocks or junk bonds and the remainder of your portfolio in low-risk investments.



Options

Many options make use of a combination of stocks and derivatives.

Buying stocks as well as a put option gives you the upside potential of the stock but limits your potential losses by guaranteeing you will be able to resell the stock at the price noted in the option.  So long as your gains exceed the purchase cost of the put option, you will remain "in the black".

If you believe a stock will decrease in price, you can sell it short and then buy a call option, so that if you are wrong you can repurchase the stock at a guaranteed maximum price, putting a limit on the immense risk associated with shorting stock.

Buying both a call and a put option with the same strike price (the price at which you can exercise your option) means that you will make money regardless of which direction the stock moves, so long as the move is large enough that you earn more money than the cost of the options.  This strategy is known as a "straddle".

In a strategy known as a "collar", you buy a stock and sell a call option on the stock , so that if the price of the stock increase, the option buyer will likely exercise their option; this creates limited upside potential, but the money from the sale of the call option can be used to fund a put option, so that you eliminate the cost of the option.  The result is that you create both a "floor" and a "cap" (a maximum amount of loss and gain, respectively), functioning as a collar that limits the amount of movement in the stock price.

The strategies available to you are varied and numerous.  As you get more practice using them, you can expand to develop multi-step strategies.




[Diversification:  The act of investing in several different investments to reduce the potential value of loss if a single investment fails.

Buying a call option gives you the choice to purchase a given volume of something at a specified price, so long as you do so before the maturity date.

Buying a put option gives you the choice to sell a given volume of something at a specified price.

Regardless of what happens to the market price, the seller of the option is obligated to participate in the exchange if the buyer decides to exercise the option.]

When Call Options May be Used?

1.  Call options benefit buyers when the price of the underlying stock rises above the strike or exercise price. 

• Investors buy calls when they are bullish on the stock.
• If an investor bought the call option instead of the stock, the greatest percentage return would come from selling the option, due to the concept of leverage.  
• If the market price of the stock declines below the strike price of the option, the most the investor would lose is the option premium.

2.  Call options may also be used as a hedge against an upturn in the price of a stock on a short position.  

• Assume that an investor had sold short 100 shares of stock A when it was $80 per share.  
• When the price of stock A declines to $69 per share, the investor wants to protect the $11 profit per share against a rise in the price of the stock A.  
• The investor could buy a call option , which has a strike price of $70 per share.  
• For every $1 increase in stock A above $70 per share, there is a profit on the call option that offsets the loss on the short sale..  
• If, however, stock A continues to go down in price, the investor has lost only the amount paid to buy the option.  
• This strategy allows an investor to protect profits without having to close out his position.

How to benefit from call options?

A call option gives the holder the right to buy 100 shares of the underlying stock at the exercise or strike price up through the date of expiration of the option.

The basic problem is that the stock would have to move up in price above the strike price before the option expires because the option is worth nothing at expiration.

Intrinsic value of call option = Market Price of the Stock - Strike Price

The option premium price fluctuates depending on two factors:( a) the underlying price of the stock, and  (b) the time left until the expiration of the option.

Should you Buy and Sell the Option or the Stock?

Stock Price $35   Option Price $0.50  Strike Price $35

Stock Price rises to $42   Option premium price increases to $7.25

Scenario Analysis

1.  Buying the Stock

Buy 100 shares of the stock at $35 per share    Total Cost  $3,500

Sell 100 shares of the stock at $42 per share     Total Proceeds $4,200

Profit = 4,200 - 3,500 = $700

Return on Investment = 700/3500 = 20%

2.  Buying and Selling the Option

Buy stock option   Total Cost $50

Sell stock option   Total Proceeds  $725

Profit = 725 - 50 = $675

Return on Investment = 675/50 = 1350%

3.  Exercise Option

Buy stock option   Cost $50

Cost to exercise option at strike price   Cost $3,500

Total Cost = 50 + 3500 = $3,550

Sell stock at $42 per share   Total Proceeds $4,200

Profit = 4,200 - 3,550 = $650

Return on Investment 650/3550 = 18.3%

1. Buying and selling the stock, in scenario 1, results in a 20% return.  
2. This is not to be sneezed at, but compared to buying and selling the option in scenario 2, buying and selling the stock comes in as a poor second to a return of 1350%.
3. Comparatively, scenario 3, buying and exercising the option, produces the smallest return of 18.3%.  
4. Moreover, this scenario 3 also requires the largest outlay of capital ($3,550 versus only $50 for the call option and $3,500 to buy the stock).  

Stock Price $35   Option Price $0.50  Strike Price $35

Stock Price falls to $30  

Scenario Analysis

1.  Buying the Stock

Buy 100 shares of the stock at $35 per share    Total Cost  $3,500

Sell 100 shares of the stock at $30 per share     Total Proceeds $3,000

Loss = 3,500 - 3,000 = $500

Return on Investment = -500/3500 = -14.28%

2.  Buying and Selling the Option

Buy stock option   Total Cost $50

Stock option expires  Total Proceeds  $0

As the strike price is above the current price, the intrinsic value of the option is zero.

Loss = cost of buying the option = $ 50 

3.  Exercise Option

Buy stock option   Cost $50

Cost to exercise option at strike price   Cost $ -

As the strike price is above the current price, so the option would not be exercised.  

Loss = cost of buying the option = $50

1. However, if the stock price declines to $30 per share, buying the stock at $35 and selling it at $30 results in a $500 loss and a 14.28% loss (= -500/3500)
2. Buying the stock option and having it expire results in a 100% loss on invested capital and a $50 loss of capital.
3. There is no third alternative; the strike price is above the current price, so the option would not be exercised.  The maximum loss is the cost of the option, $50.

Conclusion:

• Buying and selling the option not only gives the greatest return on investment but also requires the lowest capital outlay.
• By buying a call option instead of the stock, the investor invests a small fraction of the cost of the stock.
• If the stock price rises significantly above the strike price within the period before expiration, the investor can profit by selling or exercising the option.
• In the later case, the investor can then sell the stock or hold it for long-term capital appreciation.
• The most an investor can lose from buying a call option is the cost of the option.
• Thus, the downside risk is limited, as opposed to the potential loss in the case of buying the stock.
• There are many examples of high-flying stocks that have risen to abnormally high prices only to fall back into oblivion, resulting in tremendous losses for those investors who had invested when the stocks were trading at excessively high price.

Options, rights and warrants

Options have many uses and investors need to be aware of their ramifications in order to be able to use them.

In order to do so, investors need to familiarize themselves with knowledge about options.

Learning the Vocabulary

Options:  They are stock derivative investments.

Derivative security:  A financial security that derives its value from another security.

Options and futures:  These are stock derivatives that offer investors some of the benefits of stocks without having to own them.

Options contract:  This gives the holder the right to buy or sell shares of a particular common stock at a predetermined price (strike price) on or before a specified date (expiration date).

Option:  An option is a right, not an obligation, to buy or to sell stock at a specified price before or on an expiration date.

Strike price:  The price at which the holder of the option can buy or sell the stock.

Expiration date:  An option expires on its expiration date.

Stock Option:  This is a derivative security because its value depends on the underlying security, which is the common stock of the company.

Options market:  Chicago Board Options Exchange (CBOE), New York Stock Exchange (NYSE), the American Options Exchange (AOE), the Philadelphia Exchange (PHO), and the Pacific Exchange (PSE).  Options can also be traded in the over-the-counter market.

Options websites:  www.cboe.com, www.nyse.com/futuresoptions/nyseamex, www.amex.com, www.phlx.com.  Click on all exchanges and list all options and LEAPS.  Click on Submit, and a list of options for the stock you requested will appear.

Options contracts:  Calls and Puts

Call option:  A call option gives the option owner the right to buy shares of the underlying company at a predetermined price (strike price) before expiration.

Put option:  A put option contract gives the option owner the right to sell shares of the underlying company at the strike price before expiration.

Option holder:  Option holder has the right to convert the contract at his/her discretion.  It is not an obligation.  Holders of the option can exercise the option when it is to their advantage and let the options contract expire if it is not advantageous.

Options contract:  SIX items of note in an options contract.  1.  Name of the company whose shares can be bought or sold.  2.  The number of shares that can be bought or sold, generally 100 shares per contract.  3.  The exercise or strike price, which is the stated purchase or sale price of the shares in the contract.  4.  The expiration date, which is the date when the option to buy or sell expires.  5.  The settlement procedure.  6.  The options exercise style.

Option buyer:  The option buyer is also referred to as the option holder.

Option seller:  The seller of the original contract is referred to as the option writer.  In any contract, there are at least two parties:  buyers and sellers.

Settlement procedure:  This is stipulated for stock options, which indicates when delivery of the underlying common stock takes place after the holder exercises the option.

Options exercise style:  There are two basic exercise styles that determine when the option can be exercised, namely, American style and European style.

American style:  Options on individual stocks can be exercised ANY time before the expiration date.

European style:  Stock index options can be exercised ONLY on expiration date.

Life of the option:  The expiration date is also important, as it specifies the life of the option.

Standardized expiration dates:  The expiration dates are standardized for options contracts listed on the exchanges.  There are three cycles for listed option expirations, and each option is assigned to one of these cycles:  January cycle: January-April-July-October; February:cycle: February-May-August-November; and March cycle: March-June-September-December.

Options Clearing Corporation (OCC):  The trading of options is greatly facilitated by the Options Clearing Corporation, which, besides maintaining a liquid marketplace, also keeps track of the options and the positions of each investor.  Buyers and writers of options do not deal directly with one another but instead with the OCC.

Contract period for stock options:  The contract period for stock options is standardized with three-, six-, and nine-month expiration dates.  Generally, two options on a stock are introduced to the market at the same time with identical terms except for the strike (exercise) price.

LEAPS (long-term equity anticipation securities):  Longer-term options contracts, called LEAPS have life spans of up to three years before expiry.  They have similar characteristics to the short-term options contracts but, because of their longer expiration periods, have higher premium prices.

Time value of an option:  An option is a wasting asset.   There is a time value to the price of an option.  The more time before the option expires, the greater is the time value of the option.  As the option moves closer to its expiration, so the time value of the option decreases in value.  Generally, options are not normally exercised until they are close to expiry because an earlier exercise means throwing away the remaining time value.  Another generalization with options (both calls and puts) is that most options are not bought with the intention of exercising them.  Instead, they are bought with the intention of selling them.

Intrinsic value of the call option:  The intrinsic value of a call option is the difference between the market price of the stock and the strike price.  Intrinsic Value of Call Option = Market Price of the Stock - Strike Price.

In the money call option:  When the market price is greater than the strike price, the call option is said to be in the money.

Out of the money call option:  A call option is said to be out of the money when the market price of the stock is less than the strike price.

At the money call option:  The market price of the option equals the strike price.

Time value of put option:  Puts are wasting assets and have no value at expiration.

Intrinsic value of put option:  The intrinsic value of the put option is determined by subtracting the market price of the stock from the strike price.  Intrinsic Value of a Put Option = Strike Price - Market Price of the Stock.

Out of the money put option:  If the put option has no intrinsic value, it is out of the money.

In the money put option:  If the put option has intrinsic value, it is in the money; and it is profitable to exercise the put option.

At the money put option:  If the strike price equals the market price of the stock, the option is at the money.

Writing options:  Investors can also write or sell options, which provide additional income from the premiums received from the buyers of the option contracts.  The upside potential to this strategy for option writers is limited, however, because the most money the writer can make is the amount of the option premium.

Writing covered option:  A covered option is an option that is written against an underlying stock that is owned, or sold short, by the writer.  The writer of the option owns the stock against which the options are written.

Writing naked option:  This is the second method of writing an option.  A naked option, is  an option written on an underlying stock that is not owned or sold short by the writer.

Writing covered calls:  A covered call limits the appreciation the writer can realize.  Therefore, it is a good idea to write covered calls on the stocks you think won't rise or fall very much in price.

Writing naked call:  Writing a naked call on a stock is more risky than writing a covered call because of the potential for unlimited losses.  A naked call is when the writer does not own the underlying stock, which would limit the losses if the stock rocketed up in the price.  Investors can profit from writing naked calls on stocks whose prices either decline or remain relatively flat below the strike price for calls.

Writing covered puts:  The writer of a covered put sells short the underlying stock and receives a premium for the covered put.  If the option is exercised, the writer would buy back the stock at the strike price and use the shares to close out his short position.

Writing naked puts:  The writer of a put option expects the stock to rise or at best not fall in price.  If the put writer does not own the underlying stock, the contract is a naked or uncovered put, which necessitates that the writer deposits an amount of money with the brokerage firm for the required margin.Without owning the underlying stocks, the potential loss is not cushioned if the price of the stock falls rapidly.

Combination of Puts and Calls:  Straddle and Spread

Straddle:  A straddle is the purchase (or sale) of a put and a call with the same strike price and the same expiration date.

Spread:  A spread is the purchase or sale of a combination of put and call options contracts with different strike prices.

Stock Index Options:  Stock index options allow investors to take long and short positions on the market without having to buy or sell short the stocks that make up the index.  A stock index option is a put or call written on a market index.  With stock index options you can track the markets without having to buy or sell the stocks.  Options on stock indices are valued and trade in the same way as options on individual stocks with the notable exceptions that settlement is made in cash for the former.

Rights:  A right, also known as a preemptive right, is an option allowing a shareholder to by additional shares of new stock of the company at a specified price within a specified time period before the shares are offered to the public.  A right allows a current shareholder to buy more common stock of the company in advance of the public at a discounted price (subscription price).  Stock rights are issued to existing shareholders on a stated date.  These rights give existing shareholders the opportunity to maintain their same proportionate ownership in the company after the new issue of common stock.  Rights, like options, can be bought for one of two reasons:  either to exercise the rights or to speculate on the rights.

Trading cum rights:  To be eligible to buy these additional shares at the subscription price, the common stock of the company must be owned as of the record date set by the board of directors.  Most rights offering have a short period of time (between two and six weeks) for existing shareholders to either subscribe to the new shares or sell the rights.  It is during this period that the stock is said to be trading cum rights, where the value of the right is included in the market price of the stock.

Trading ex-rights date:  After a specified date, known as the ex-rights date, stock transactions do not include the rights.  Theoretically, the stock price goes down after this date, when the rights trade separately.
Value of a right:  The value of a right depends on the market price of the stock, the subscription price of the right, and the number of rights necessary to buy each new share.

Cum Rights Value:  The formula to determine the value of the rights before they trade independently of the stock is as follows:  Cum Rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights to Buy a Share + 1)

Ex-rights Value:  After the stock trades ex-rights, its price declines by the value of the right, because rights trade separately from the stock.  Investors who want to buy the rights can purchase them on the market in the same way they can purchase the stock.  The ex-rights value is calculated as follows;  Ex-rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights Needed to Buy a Share)

Warrants:  A warrant is a security that allows its owner to purchase a stated number of shares of common stock at a specified price within a specified time period.  A warrant is similar to a long-term option in that it gives the owner the right to by a stated number of shares of the underlying company's stock at a specific price within a specific period of time.  The differences between warrants and options are that with warrants the specified price can be fixed or it can rise at certain intervals, such as every five years, and the company can extend the expiration date.  Warrants have longer lives than options.  An option can have a life of nine months or less; warrants extend for years, and some companies have issued perpetual warrants.  Generally, there is a waiting period before warrants can be exercised.  Corporations issue warrants as sweeteners with other securities issued by the company.  Warrants can be attached to bonds or preferred stocks.  In some cases, warrants have been distributed to shareholders in place of stock or cash dividends.   The major advantage of warrants over options is that warrants have longer lives.  Warrants do well when stock prices are rising, but investors should still be selective about the warrants they buy.  If the stock never goes up in price, there is little to no opportunity to profit from buying the warrants.  Generally, as with options, warrants should be bought to trade and not to exercise.

Value of a warrant:  When a company issues warrants, the purchase price of the stock is generally fixed at a higher price than the market price of the stock at issue.  Value of a warrant = (Market price of stock - Exercise price ) x (Number of shares purchased with the warrant).

Premium of a warrant:  Premium = Market price of the warrant - Value of the warrant.  If the market price of the stock never rises to the strike price of the warrant during its life, the warrant is not exercised and expires.



Related:
http://www.investlah.com/forum/index.php/topic,42222.0.html

A look at the Options table

Let's take a look at the Options table:

Column 1: Strike Price. This is the stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract. When you exercise a call option, this is the value for which you purchase the shares. Option strike prices typically move in increments of $2.50 or $5. In the example above, the strike price moves in $2 increments.

Column 2: Expiry Date. This shows the end of the life of an options contract. Options expire on the third Friday of the expiry month.

Column 3: Call or Put. This column refers to whether the option is a call or a put. A call is the option to purchase, whereas a put is the option to sell.

Column 4: Volume. This indicates the total number of options contracts traded for the day. The total volume of all contracts is listed at the bottom of each table.

Column 5: Bid. The price someone is willing to pay for the options contract. To get the cost of one contract you need to multiply the price by 100.

Column 6: Ask. The price for which someone is willing to sell an options contract. To get the cost of one contract you need to multiply the price by 100.

Column 7: Open Interest. Open interest is the number of options contracts that are open. These are contracts that have not expired or have not been exercised.

Read more: http://www.investopedia.com/university/tables/tables6.asp#ixzz28JFzYsK6

How is Option Priced?

There are 6 factors that affect option's price.  Nevertheless, the impact of interest rate and dividend are often considered negligible as compared to the other factors.  Most of the time, for each level of strike price, an option's price will move due to the movement of underlying stock price, volatility and time.

The Black-Scholes formula can be used to calculate the theoretical value of an option based on the above factors.

Since option's buyers (long position) will profit when the option price rises after they buy (Buy Low, Sell High), whereas the seller (short position) will profit when the option price falls after they sell (Sell High, Buy Low), the impact of the above factors will also be different.  

The following table shows how the major factors (stock price, time to expiration, implied volatility) affect an option's position.

Example:  

Increase in Implied Volatility (IV) would increase option's price (both calls & puts), assuming other factors unchanged.  Hence, this will be favorable for option buyers who will gain if the option price increases (buy low, sell high), but unfavorable for option sellers that will profit if the option price drops (sell high, buy low).

http://optionstradingbeginner.blogspot.com/2007/05/option-pricing-how-is-option-priced_22.html

Intrinsic Value – Stock Options

Intrinsic Value of a Stock Option

Intrinsic value is one of the factors – along with time value – that contribute to the value of a stock option. For an in-the-money stock option, intrinsic value is the difference between the strike price and the price of the underlying stock. For an option that is at-the-money or out-of-the-money, the intrinsic value is zero. An option’s intrinsic value cannot be negative, because if the option is not worth anything, the option holder would not exercise it.

Intrinsic Value – Call Option 

For an in-the-money call option, the intrinsic value equals the price of the underlying stock minus the option’s strike price. (If the stock option is at-the-money or out-of-the-money, the intrinsic value is always zero.)

Call Option Intrinsic Value = Stock Price – Strike Price

Intrinsic Value – Put Option

For an in-the-money put option, the intrinsic value equals the stock option’s strike price minus the price of the underlying stock. (If the option is at-the-money or out-of-the-money, the intrinsic value is always zero.)

Put Option Intrinsic Value = Strike Price – Stock Price


http://www.wikicfo.com/Wiki/Intrinsic%20Value%20Stock%20Options.ashx

Educational experience with an outcome other than expected

During bull markets owning stocks and calls on underpriced stocks should increase the value of the portfolio.

Bear markets should benefit positions in your portfolio that are either short overpriced companies or own puts on the overpriced stock.

Income may be generated by selling covered calls or credit spreads during a neutral market.

Please note that I have made extensive use of the words "should" and "may". Please do not invest any money that you can not afford to lose. Everyone has a different tolerance for risk. It is important that you do your own homework and take responsibility for any decisions that you make.

When investing, it doesn't take very long to have an educational experience with an outcome other than expected.

http://hyperdiversification.com/default.aspx

In Warren Buffet's 1992 letter to the share holders he discussed the following:

• During 1992, their Book Value had increased by 20.3%
  
• Between 1964 and 1992 book value per share (BVPS) had increased from $19 to $7745 resulting in a CAGR of 23.6%.
  
• Used book value for intrinsic value.
  
• CAGR goal 15%
  
• The number of outstanding shares has changed very little between 1964 and 1992 (1,137,778 vs. 1,152,547 respectively)
  
• Requiring a significant Margin of Safety (MOS) when purchasing stock in another company as a cornerstone of Berkshire Hathaway's success

My mom bought her first new car back in 1965. It was a Ford Falcon. She really liked the car. I wonder how much higher her networth would be if she would have bought a used car and invested the difference in Berkshire Hathaway. ;) Of course BH is the exception and not the norm. :))

http://hyperdiversification.com/cagr_main.aspx

Learn from:

Our focus is to protect and accumulate wealth for our clients. To do that, we are guided by one core principal. DON'T LOSE MONEY. It seems simple, but is by far one of the most challenging endeavors an investor can undertake.
In order to achieve the goal of capital preservation, the Strategy must protect previously earned gains while allowing an investor to profit from a market rebound after a substantial market decline. In other words, the Strategy wants to profit from bull markets and protect the portfolio in bear markets. http://www.swaninvesting.com/home

High-net-worth Investors & Listed Options
Portfolio Management Strategies for Affluent Investors, Family Offices, and Trust Companies http://www.swaninvesting.com/HighNetWorthInvestors.pdf