Series 7 Exam 2022-2023 For Dummies with Online Practice Tests book cover

Series 7 Exam 2022-2023 For Dummies with Online Practice Tests

By: Steven M. Rice Published: 06-02-2021

The study tool you need for the Series 7 Exam 

Your gateway to the world of finance is the Series 7 Exam: pass it and you’re in for a rewarding career as a stockbroker. You don’t have to study for this important exam alone—Series 7 Exam For Dummies gives you all the tips, tricks, and practice you need to obtain your required certification.  

This book smartly balances three areas of study in one convenient package: the topics on the exam, how to prepare for test day and to take the exam, and practice tests. Find in this book: 

  • How to sign up for the test, and tips to get through test day 
  • Different study strategies 
  • The basics of security investments, such as equity securities and municipal bonds 
  • More advanced security topics, such as margin accounts and packaged securities 
  • How to conduct market research, such as portfolio and securities analysis 
  • Legal concerns: IRS, rules, and regulations 
  • Chapter exams and online practice quizzes 

With Series 7 Exam For Dummies as your study guide, you’ll be ready to tackle the 125 exam questions. Whether it’s a question about the underwriting process, investment companies, or income-tax implications, you’ll find all the information to prepare in this resourceful book. 

Your stockbroker career is just one certification away—get your copy of Series 7 Exam For Dummies (with included online practice tests) to get started on your career you’ve worked hard for. 

Articles From Series 7 Exam 2022-2023 For Dummies with Online Practice Tests

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Series 7 Exam For Dummies Cheat Sheet

Cheat Sheet / Updated 06-09-2021

Taking the Series 7 exam, whether for the first time or the fourteenth, is a huge challenge and requires many hours of preparation. Use this cheat sheet to put your time to good use before the exam even begins and to be successful when it’s completed.

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The Best Way to Study for the Series 7 Exam

Article / Updated 07-28-2019

When deciding how to go about your Series 7 exam prepartion, your first mission is to identify the training mode that best suits your needs. If you’re likely to benefit from a structured environment, you may be better off in a classroom setting. A prep course can also give you emotional guidance and support from your instructors and others in your class who are forging through this stressful ordeal with you. On the other hand, if you’re the type of person who can initiate and follow a committed study schedule on your own every day, you may be able to pass the Series 7 exam without a prep course, and you can save the money you would have spent for classes. Back to school: Attending a Series 7 exam prep course People who learn best by listening to an instructor and interacting with other students benefit from attending prep courses. Unfortunately, not all Series 7 exam prep courses and training materials are created equally. Unlike high school or college courses, the content of Series 7 prep courses and the qualifications of the instructors who teach them aren’t regulated by your state’s Department of Education, the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), or any other government agency. Do some research to locate the Series 7 training course that works best for you. The following sections explain some things to consider and questions to ask before enrolling. Take a look at the info you gather and trust your gut. Is the primary function of the prep course to train students to be successful on the Series 7 exam, as it should be? Or do you suspect it’s the brainchild of a broker-dealer who’s looking for extra revenue to supplement her failing stockbroker business? (Run away!) Training school background To find information about a program you’re considering, browse the training school’s website or contact the school’s offices. Find out how many years the training school has been in business and check with the Better Business Bureau or the Department of Consumer Affairs to see whether anyone has filed any complaints. Look for a school that has stayed in business at least five years. This staying power is generally a sign that the school is getting referral business from students who took the course and passed the Series 7. Try to get recommendations from others who took the course. Word of mouth is an essential source of referrals for most businesses, and stockbroker training schools are no different. The stockbroker firm you’re affiliated with (or will be affiliated with) should be able to recommend training schools. Courses offered through a local high school’s continuing education program can be just as effective as those offered through an accredited university or a company that focuses solely on test prep, as long as the right instructors are teaching them. Read on. Qualifications of the course instructor(s) The instructor’s qualifications and teaching style are even more important than the history of the company running the course (see the preceding section). An instructor should be not only knowledgeable but also energetic and entertaining enough to keep you awake during the not-so-exciting (all right, boring) parts. When looking for a course, find out whether the teacher has taken — and passed — the Series 7 exam. If so, the instructor probably knows the kinds of questions you’ll be asked and can help you focus on the relevant exam material. The instructor is also likely to have developed good test-taking skills that she can share with her students. Whether the instructor is a part-timer or full-timer may be important. For example, a full-time instructor who teaches 30 classes a year probably has a better grasp on the material than a part-time instructor who teaches 4 classes a year. By the same token, an instructor who owns the school that offers the course probably has greater interest in the success of the students than someone who’s paid to teach the class by the hour. Use your best judgment. Before you register, ask whether you can monitor a class for an hour or so with the instructor who would be training you. If the company says no, I suggest finding another course because that course provider may have something to hide. While you’re at it, make sure the classroom is comfortable, clean, and conducive to learning. Texts, course content, and extra help To really benefit from a course, you need good resources — in terms of not only the actual training material but also the people in the classroom. These elements affect how the class shapes up and what you actually learn: Training material: Will you have a textbook to study from or just some handouts? The instructor should provide you with textbooks that include sample exams, and a prep course should be loaded with in-class questions for you to work on. The course should also provide you with chapter exams that you can work on at night before the next session (yes, homework is a good thing). Remember, the more questions you see and answer, the better. In-class practice tests: You want a prep course that includes test sessions where the instructor grades your exams, identifies incorrect answers, and reviews the correct answers. Instructor availability: Ask whether the course instructors will be available to answer your questions after the class is over — not only at the end of the day but also during the weeks after you’ve completed the course and are preparing for the Series 7. The practical details The perfect course can’t do you any good if you never show up for class. Here are some issues to consider about the course offering: Days and times: Make sure the class fits your schedule. If getting there on time is too stressful or you can’t attend often enough to justify the expense, you won’t benefit from registering to take the course. Class size: If more than 30 to 35 people are in the class, the instructor may not be able to give you the individual attention you need. Cost: Obviously, cost is a major concern, but it definitely shouldn’t be your only consideration. Choosing a course because it’s the least expensive one you can find may be a costly mistake if the course doesn’t properly prepare you. You end up wasting your time and spending more money to retake the exam. You can expect to pay anywhere from $300 to $600 for a standard Series 7 prep course, including training materials (textbooks and final exams). Quite a few people don’t pass the first time around, so find out whether the school charges a fee for retaking the prep course if you don’t pass the Series 7 exam or even if you feel that you’re not quite ready to take the test. How to select prep material to study on your own If you’re the type of person who can follow a committed study schedule on your own every day, you may be able to pass the Series 7 exam without a prep course. Many different types of study aids are available to help you prepare. No matter what your learning style is, I’m a firm believer in using a textbook as a primary training aid. You can use online courses, online testing programs, CDs, apps, and flash cards as supplements to your textbook, but give your textbook the starring role. By virtue of its portability and ease of use (you don’t have to turn it on, plug it in, or have access to the Internet, and it can never, ever run out of batteries), the textbook is simply the most efficient and effective choice. My personal favorites are the Empire Stockbroker Training Institute’s Series 7 Coursebook and its companion, Series 7 Final Exams. The textbook focuses on the relevant exam topics, is easy to read and understand, and includes plenty of practice questions and detailed explanations. Securities Training Corporation and Kaplan Financial also publish quality Series 7 books. A lot of the better Series 7 course textbooks are available online rather than in bookstores. In addition to Series 7 Exam For Dummies and a textbook, consider investing in one or more of the following popular study aids: Online testing: I’m all for online testing. Certainly, the more exams you take, the better. If the practice exam simulates the real test, it’s even more valuable. With this study aid, you have access 24 hours a day, 7 days a week, and can pace yourself to take the exams at your leisure. Select a program (for example, Empire Stockbroker Training Institute always has the most current, updated simulated exams) with a couple thousand questions or more, along with answers and explanations. Audio CDs: You may still be able to find audio CDs or audio courses to help you prepare for the Series 7. This form of training can be beneficial as a review for people who already have a decent understanding of the course material. You can listen to recorded material while on the go or in your home. Personally, recording your own notes — especially on topics you’re having trouble with — might be a better use of your time. Putting the info in your own words, saying ideas out loud, and listening to the recordings can really help reinforce the concepts. Flash cards: For those who already have a grasp on the subject matter, flash cards are good because you can tuck ’em in your pocket and look at ’em anytime you want. Commercial cards may be confusing and long-winded. You’re better off making cards that focus on the areas that are most problematic for you.

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Securities Analysis on the Series 7 Exam

Article / Updated 07-28-2019

Although many brokerage firms have their own financial analysts, you do need to know some of the basics of securities analysis to pass the Series 7. Your customers face some investment risks, and you should know the differences between technical analysis and fundamental analysis. Securities risk analysis Investors face many risks (and hopefully many rewards) when investing in the market. You need to understand the risks because not only can this knowledge make you sound like a genius, but it can also help you score higher on the Series 7: Market (systematic) risk: The risk of a security declining due to negative market conditions. All securities have market risk. Call risk: The risk that a corporation could call its callable bonds at a time that's not advantageous to investors. Corporations will more likely call their bonds when interest rates decrease. Business (nonsystematic) risk: The risk of a corporation failing to perform up to expectations. Credit risk: The risk that the principal and interest aren’t paid on time. Moody’s, Standard & Poor’s, and Fitch are the main bond-rating companies. Liquidity (marketability) risk: The risk that the security is not easily traded. Long-term bonds and limited partnerships have more liquidity risk. Interest (money rate) risk: The risk of bond prices declining with increasing interest rates. (When interest rates increase, outstanding bond prices decrease.) All bonds (even zero-coupon bonds) are subject to interest risk. Reinvestment risk: The risk that interest and dividends received will have to be reinvested at a lower rate of return. Zero coupon bonds, T-bills, T-STRIPS, and so on have no reinvestment risk because they don’t receive interest payments. Purchasing power (inflation) risk: The risk that the return on the investment is less than the inflation rate. Long-term bonds and fixed annuities have high inflation risk. To avoid inflation risk, investors should buy stocks and variable annuities. Capital risk: The risk of losing all money invested (for options and warrants). Because options and warrants have expiration dates, purchasers may lose all money invested at expiration. To reduce capital risk, investors should buy investment-grade bonds. Regulatory (legislative) risk: The risk that law changes will affect the market. Currency risk: The risk that an investment’s value will be affected by a change in currency exchange rates. Investors who have international investments are the ones most affected by currency risk. Nonsystematic risk: A risk that is unique to a certain company or a certain industry. To avoid nonsystematic risk, investors should have a diversified portfolio. Political (legislative) risk: The risk that the value of a security could suffer due to instability or political changes in a country (for example, the nationalization of corporations). Prepayment risk: The type of risk mostly associated with real-estate investments such as CMOs. CMOs and other mortgage-backed securities have an average expected life, but if mortgage interest rates decrease, more investors will refinance and the bonds will be called earlier than expected. Timing risk: The risk of an investor buying or selling a security at the wrong time, thus failing to maximize profits. On the Series 7 exam, to determine the best investment for a customer, pay close attention to the investor's risk tolerance, financial considerations, non-financial considerations, risk(s) mentioned, and so on. If the question isn’t specific about the type of risk, use strategic asset allocation to determine the best answer. Mitigation of risk with diversification Certainly, all investments have a certain degree of risk. Younger investors, sophisticated investors, and wealthy investors can all afford to take more risk than the average investor. However, when you are talking to your clients, you should examine their portfolio and help them make decisions that will help them mitigate their risk. You should help them invest in securities that aren't too volatile for their situation and make them aware of the potential tax ramifications of certain investments. You’ve probably heard the expression, “Don’t put all your eggs in one basket.” Well, the same holds true for investing. Suppose for instance that one of your customers has everything invested in DIMP Corporation common stock. All of a sudden, DIMP Corporation loses a big contract or is being investigated. Your customer could be wiped out. However, if your customer had a diversified portfolio, DIMP Corporation would likely only be a small part of her investments and she wouldn’t be ruined. This is the reason that having a diversified portfolio is so important. You are responsible for making sure that your clients understand the importance of having a diversified portfolio to minimize risk. Investors with securities concentration are at risk of major losses due to having a large portion of their holdings in a particular market segment (for example, automotive stocks) or investment class. There are many ways to diversify: Geographical: Investing in securities in different parts of the country or world. Buying bonds with different maturity dates: Buying a mixture of short-term, intermediate-term, and long-term debt securities. Buying bonds with different credit ratings: You may purchase high-yield bonds (ones with a low credit rating) with highly rated bonds with lower returns so that you get a mixture of high returns with the safety of the highly rated bonds. Investing in stocks from different sectors: Often, certain sectors of the market perform better than others. By spreading your investments out among these different sectors, you can minimize your risk and hopefully make a profit if one or more sector happens to be performing well. The sectors include financials, utilities, energy, healthcare, industrials, technology, and so on. Type of investment: Investing in a mixture of different types of stocks, bonds, DPPs, real estate, options, and so on. There are certainly many more ways to diversify a portfolio than the ones listed previously — use your imagination. In addition, they aren’t mutually exclusive. Remember that mutual funds (packaged securities) provide a certain amount of diversification within an individual stock. This is why smaller investors who may not be able to afford to diversify their portfolio are ideal candidates for mutual funds.

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The Series 7 Exam Format

Article / Updated 07-28-2019

To make sure you don’t walk into the testing center, take one look at the computer screen, go into shock, and start drooling on the keyboard, your Series 7 exam preparation should include reviewing some of the testing details and the computerized format. Review the exam basics The Series 7 exam is a computerized, closed book (in other words, no book), three-hour and 45-minute exam. The exam consists of 135 multiple-choice questions (although only 125 of them count toward your score). You can take restroom breaks at any time, but the clock continues to tick away, so you may want to reconsider drinking a mega-jumbo iced latte in the morning before you arrive at the exam center. 10 additional trial questions To ensure that new questions to be introduced in future exams meet acceptable standards prior to inclusion, you answer ten additional, unidentified questions that don’t count toward your score. In other words, you get 135 questions to answer, but only 125 are scored. Note: If you see a question on the Series 7 that doesn’t seem even remotely similar to anything that you’ve studied (or even heard about), it may very likely be an experimental question. The computerized format and features Although you don’t need any previous computer experience to do well on the exam, you don’t want your first encounter with a computerized exam to be on the date of the Series 7. Being familiar with the way the questions and answer choices will appear on the screen is essential. Figure 1-1 can help you prepare for exam day. A friendly exam-center employee will give you an introductory lesson to familiarize you with how to operate the computer before the exam session begins. Although the computer randomly selects the specific questions from each category, the operating system tracks the difficulty of each question and controls the selection criteria to ensure that your exam isn’t ridiculously easier or harder than anyone else’s. As a matter of fact, FINRA has recently started weighting the questions so that some will be worth a little more than average and some will be worth a little less depending on FINRA's feeling about how difficult the question is. To get you to a possible score of 100, the questions will average out at 0.8 point each. The following list describes some important computer exam features: Scroll bars for moving the questions on the screen A clock to help you track how much time you have left during each part (if the clock is driving you batty, you can hide it with a click of the mouse) A confirmation box that requires you to approve your answer choice before the computer proceeds to the next question An indication of which question you’re currently on A choice of answering the questions by Typing in the letter for the correct answer on the keyboard Using the mouse to point and click on the correct answer At some test centers, using a computer with a touch screen that lets you select the answer by pressing lightly against the monitor with your fingertip The capability of changing your answers or marking questions that you’re unsure of for later review, which allows you to go back and answer them at any time during that particular part You can mark answers for review or change responses only for the part of the test you’re currently taking. In other words, after you begin the second part, you can’t go back and change answers from the first part. Although you can review and change all your answers at the end, don’t. Your brain is going to feel like it went through a blender by the time you get there. Review only your marked questions and change the answers only if you’re 100 percent sure that you made a mistake. People change a right answer to a wrong one five times more often than they change a wrong one to a right one. Instant gratification: Receiving and evaluating your score Remember having to wait weeks for a standardized test score, hovering somewhere between eagerness and dread? Those days are gone. At the end of the Series 7, the system calculates your score and displays a grade result on the computer screen. Although the wait for your grade to pop up may feel like an eternity, it really takes only a few seconds to see your grade. When you sign out, the test center administrator will tackle you (well, approach you) and give you a printed exam report with your grade and the diagnostic score results with your performance in the specific topics tested on your exam. Each question on the Series 7 exam is worth an average of 0.8 point (some are worth more and some are worth less depending on FINRA’s feeling of how difficult a question is), and candidates need a score of 72 or better to achieve a passing grade. This percentage translates to 90 questions out of 125 that you have to answer correctly. The scores are rounded down, so a grade of 71.6 is scored as 71 on the Series 7. You passed! Now what? After you pass the SIE, Series 7, Series 63, and/or Series 66 exam, FINRA will send your firm confirmation that you passed. At that point, you can buy and sell securities for your customers in accordance with your firm’s customary procedures. To continue working as a registered rep, you’ll need to fulfill FINRA’s continuing education requirements. Within 120 days after your second anniversary as a registered rep, and every three years thereafter, you have to take a computer-based exam covering regulatory elements such as compliance, regulatory, and ethical and sales practice standards at the Prometric exam center. In addition, there is a requirement (called a brokerage firm element) which requires broker-dealers to keep their registered representatives updated on job and product-related topics. Retaking the exam The Series 7 is a difficult exam, and certainly a lot of people need a do-over. If you fail the Series 7, your firm has to request a new test date and pay for you to retake the test. Your sponsors can send in one page of the U-4 requesting a new exam, or they can apply online through the Central Registration Depository (CRD) system. You should reapply immediately, though you have to schedule the new test date for at least 30 days after the day you failed (that’s 30 days of prime studying time!). If you fail the exam three times, you’re required to wait six months before you can retake the exam. Use the time between exams to understand what went wrong and fix it. Here are some of the reasons people fail the Series 7 exam and some of the steps you can take to be successful: Lack of preparation: You have to follow, and stick to, a well-constructed plan of study. You have your diagnostic printout after you take the exam, and you can use that to focus on the areas of study where you fell short. Prep courses can help you identify and focus on the most commonly tested topics and provide valuable tips for mastering difficult math problems. Also consider tutoring sessions tailored to accommodate your busy schedule and pinpoint the areas of study where you need the most help. Nerves won out: Some people are just very nervous test-takers, and they need to go through the process to get comfortable in unfamiliar situations. Next time around, they know what to expect and pass with flying colors. The people who are the most nervous about taking the exam tend to be the ones who haven’t prepared properly. Make sure that you’re passing practice exams on a consistent basis with grades in at least the high 70s before you attempt to take the real exam. Insufficient practice exams: You need to take enough practice exams before you take the real test. Getting used to the question formats and figuring out how to work through them is as important as learning the material.

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Option Basics — Review for the Series 7 Exam

Article / Updated 07-26-2019

Options are just another investment vehicle that (hopefully) more-savvy investors can use. An owner of an option has the right, but not the obligation, to buy or sell an underlying security (stock, bond, and so on) at a fixed price; as derivatives, options draw their value from that underlying security. Investors may either exercise the option (buy or sell the security at the fixed price) or trade the option in the market. All option strategies (whether simple or sophisticated), when broken down, are made up of simple call and/or put options. How to read an option To answer Series 7 questions relating to options, you have to be able to read an option. The following example shows you how an option may appear on the Series 7: Buy 1 XYZ Apr 60 call at 5 Here are the seven elements of the option order ticket and how they apply to the example: Whether the investor is buying or selling the option: Buy When an investor buys (or longs, holds, or owns) an option, she is in a position of power; that investor controls the option and decides whether and when to exercise the option. If an investor is selling (shorting or writing) an option, she is obligated to live up to the terms of the contract and must either purchase or sell the underlying stock if the holder exercises the option. The contract size: 1 You can assume that one option contract is for 100 shares of the underlying stock. Although this idea isn’t as heavily tested on the Series 7 exam, an investor may buy or sell multiple options (for example, five) if she’s interested in having a position in more shares of stock. If an investor owns five option contracts, she’s interested in 500 shares of stock. The name of the stock: XYZ In this case, XYZ is the underlying stock that the investor has a right to purchase at a fixed price. The expiration month for the options: Apr All options are owned for a fixed period of time. The initial expiration for most options is 9 months from the issue date. In the preceding example, the option will expire in April. Options expire on the third Friday of the expiration month. This entire warning needs to be removed. Options used to expire on Saturday, now it’s Friday. The strike (exercise) price of the option: 60 When the holder (purchaser or owner) exercises the option, she uses the option contract to make the seller of the option buy or sell the underlying stock at the strike price (see the next step for info on determining whether the seller is obligated to buy or sell). In this case, if the holder were to exercise the option, the holder of the option would be able to purchase 100 shares of XYZ at $60 per share. The type of option: call An investor can buy or sell a call option or buy or sell a put option. Calls give holders the right to buy the underlying security at a set price; puts give holders the right to sell. So in the example scenario, the holder has the right to buy the underlying security at the price stated in the preceding step. The premium: 5 Of course, an option investor doesn’t get to have the option for nothing. An investor buys the option at the premium. In this case, the premium is 5, so a purchaser would have to pay $500 (5 × 100 shares per option). Call options: The right to buy A call option gives the holder (owner) the right to buy 100 shares of a security at a fixed price and the seller the obligation to sell the stock at the fixed price. Owners of call options are bullish (picture a bull charging forward) because the investors want the price of the stock to increase. If the price of the stock increases above the strike price, holders can either exercise the option (buy the stock at a good price) or sell the option for a profit. By contrast, sellers of call options are bearish (imagine a bear hibernating for the winter) because they want the price of the stock to decrease. For example, assume that Ms. Smith buys 1 DEF October 40 call option. Ms. Smith bought the right to purchase 100 shares of DEF at 40. If the price of DEF increases to over $40 per share, this option becomes very valuable to Ms. Smith, because she can purchase the stock at $40 per share and sell it at the market price or sell the option at a higher price. If DEF never eclipses the 40 strike (exercise) price, then the option doesn’t work out for poor Ms. Smith and she doesn’t exercise the option. However, it does work out for the seller of the option, because the seller receives a premium for selling the option, and the seller gets to pocket that premium. Put options: The right to sell You can think of a put option as being the opposite of a call option (see the preceding section). The holder of a put option has the right to sell 100 shares of a security at a fixed price, and the writer (seller) of a put option has the obligation to buy the stock if exercised. Owners of put options are bearish because the investors want the price of the stock to decrease (so they can buy the stock at market price and immediately sell it at the higher strike price or sell their option at a higher premium). However, sellers of put options are bullish (they want the price of the stock to increase), because that would keep the option from going in-the-money (see the next section) and allow them to keep the premiums they received. For example, assume that Mr. Jones buys 1 ABC October 60 put option. Mr. Jones is buying the right to sell 100 shares of ABC at 60. If the price of ABC decreases to less than $60 per share, this option becomes very valuable to Mr. Jones. If you were in Mr. Jones’s shoes and ABC were to drop to $50 per share, you could purchase the stock in the market and exercise (use) the option to sell the stock at $60 per share, which would make you (the new Mr. Jones) very happy. If ABC never drops below the 60 strike (exercise) price, then the option doesn’t work out for Mr. Jones and he doesn’t exercise the option. However, it does work out for the seller of the option, because the seller receives a premium for selling the option that she gets to keep. Options in-, at-, or out-of-the-money To determine whether an option is in- or out-of-the-money, you have to figure out whether the investor would be able to get at least some of his or her premium money back if the option were exercised. You can figure out how much an option is in-the-money or out-of-the-money by finding the difference between the market value and the strike price. Here’s how you know where-in-the-money an option is: When an option is in-the-money, exercising the option lets investors sell a security for more than its current market value or purchase it for less — a pretty good deal. The intrinsic value of an option is the amount that the option is in-the-money; if an option is out-of-the-money or at-the-money, the intrinsic value is zero. When an option is out-of-the-money, exercising the option means investors can’t get the best prices; they’d have to buy the security for more than its market value or sell it for less. Obviously, holders of options that are out-of-the-money don’t exercise them. When the strike price is the same as the market price, the option is at-the-money; this is true whether the option is a call or a put. Call options — the right to buy — go in-the-money when the price of the stock is above the strike price. Suppose, for instance, that an investor buys a DEF 60 call option and that DEF is trading at 62. In this case, the option would be in-the-money by two points (the option’s intrinsic value). If that same investor were to buy that DEF 60 call option when DEF was trading at 55, the option would be out-of-the-money by five points (with an intrinsic value of zero). A put option — the right to sell — goes in-the-money when the price of the stock drops below the strike price. For example, a TUV 80 call option is in-the-money when the price of TUV drops below 80. The reverse holds as well: If a put option is in-the-money when the price of the stock is below the strike price, it must be out-of-the-money when the price of the stock is above the strike price. Don’t take the cost of the option (the premium) into consideration when determining whether an option is in-the-money or out-of-the-money. Having an option that’s in-the-money is not the same as making a profit. (See the next section for info on premiums.) Use the phrases call up and put down to recall when an option goes in-the-money. Call up can help you remember that a call option is in-the-money when the market price is up, or above the strike price. Put down can help you remember that a put option is in-the-money when the market price is down, or below the strike price. When someone purchases an option, it is said that he is long the option. An investor who is long an option is paid the premium for the option so he needs the option to go in-the-money (the price of the underlying security to go in the correct direction) enough for him to not only recoup his premium but also make a few bucks. When someone is short an option, it means that he sold the option. This person is on the opposite side of the transaction than the person who is long the option. In this case, the seller received a premium for selling the option. So someone who is short an option is doing so for income and is hoping that the option expires out-of-the-money so that he gets to keep the premium. Pay the premium: The cost of an option The premium of an option is the amount that the purchaser pays for the option. The premium may increase or decrease depending on whether an option goes in- or out-of-the-money, gets closer to expiration, and so on. The premium is made up of many different factors, including Whether the option is in-the-money The amount of time the investor has to use the option The volatility of the underlying security Investor sentiment (for example, whether buying calls on ABC stock is the cool thing to do right now) One of the questions you may run across on the Series 7 exam requires you to figure out the time value of an option premium. Time value has to do with how long you have until an option expires. There’s no set standard for time value, such as every month until an option expires costs buyers an extra $100. However, you can assume that if two options have everything in common except for the expiration month, the one with the longer expiration will have a higher premium. Hopefully, the following equation can help keep you from getting a “pit” in your stomach: P = I + T In this formula, P is the premium or cost of the option, I is the intrinsic value of the option (the amount the option is in-the-money), and T is the time value of the option. For example, here’s how you find the time value for a BIF Oct 50 call option if the premium is 6 and BIF is trading at 52: Call options (the right to buy) go in-the-money when the price of the stock goes above the strike price. Because BIF is trading at 52 and the option is a 50-call option, it’s two points in-the-money; therefore, the intrinsic value is 2. Because the premium is 6 and the intrinsic value is 2, the premium must include 4 as a time value: P = I + T 6 = 2 + T T = 4 The following question tests your knowledge of using the formula P = I + T. Use the following chart to answer the next question. What is the time value of an LMN Oct 30 call? (A) 2.5 (B) 4 (C) 6.25 (D) 9.5 The answer you’re looking for is Choice (B). This chart is similar to what you may see on the Series 7 exam. Most of the exhibits you get on the Series 7 are simple, and solving the problem is just a matter of locating the information you need. Using the chart, the first column shows the price of the stock trading in the market, the second column shows the strike prices for the options, and the rest of the chart shows the premiums for the calls and puts and the expiration months. Scan the chart under the October calls, which is in the fourth column; then look for the 30-strike price, which is in the first row of data. The column and row intersect at a premium of 14.5. Now you need to find the intrinsic value (how much the option is in-the-money). Remember that call options go in-the-money when the price of the stock is above the strike price (call up). This is a 30-call option and the price of the stock is 40.50, which is 10.5 above the strike price. Plug in the numbers, and you find that the premium includes a time value of 4: P (premium) = I (intrinsic value) + T (time value) 14.5 = 10.5 + T T = 4

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