Question

Explain the concept and how it might be used in the stock market - particularly with the events of the few weeks.

a. Active Trading

b. Selling short OR shorting a stock

c. A stop loss order vs. market order

d. A limit order

e. What is a margin account and what would you use if for?

f. what is a margin call?

g. Options - a Call vs. Put

Answer 1

Solution.>

Part a> Active trading is the act of buying and selling stocks based on short-term fluctuations to benefit from the market changes on a short-term stock map.

Active traders assume that short-term fluctuations and catching the market trend are where the gains are made.

Part b> Short selling occurs when an investor borrows a security and sells it on the open market, planning to buy it back later for less money. Short-sellers bet on, and profit from, a drop in a security's price. It has a high risk/reward ratio: It can offer big profits, but losses can mount quickly and infinitely.

Part c> A stop-loss order is an order placed with a broker to buy or sell once the stock reaches a certain price. A stop-loss is designed to limit an investor's loss on a security position. For eg., suppose you buy a stock A at $20 per share. Right after buying the stock you enter a stop-loss order for $18. If the stock falls below $18, your shares will then be sold at the prevailing market price.

A market order is a buy or sell order to be executed immediately at the current market prices. As long as there are willing sellers and buyers, market orders are filled.

Part d> A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute.

Part e> A margin account is a brokerage account in which the broker lends the customer cash to purchase stocks or other financial products.

For eg., Assume an investor with $2,500 in a margin account wants to buy Stock A for $5 per share. The customer could use additional margin funds of up to $2,500 supplied by the broker to purchase $5,000 worth of Stock A, or 1,000 shares. If the stock appreciates to $10 per share, the investor can sell the shares for $10,000. If they do so, after repaying the broker's $2,500, and not counting the original $2,500 invested, the trader profits $5,000.

Had they not borrowed funds, they would have only made $2,500 when their stock doubled. By taking double the position the potential profit was doubled.

Part f> A margin call occurs when the value of an investor's margin account falls below the broker's required amount. In that case, investor has to deposit required funds in the brokerage account according to the maintainance margin set in the account to continue the investing.

Part g> Options can be defined as contracts that give a buyer the right to buy or sell the underlying asset, or the security on which a derivative contract is based, by a set expiration date at a specific price.

This specific price is often referred to as the "strike price." It's the amount at which a derivative contract can be bought or sold.

A call option is bought if the trader expects the price of the underlying to rise within a certain time frame. A put option is bought if the trader expects the price of the underlying to fall within a certain time frame.

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