Exam 1 Flashcards
To open an options account to sell uncovered calls, the minimum equity requirement is: A $2,000 B $25,000 C $100,000 D established by the member firm
D.
When opening an account to sell naked options, the member firm must follow special procedures that include:
Specific criteria and standards to be used in evaluating the customer for uncovered short options positions;
Specific procedures for written approval by the BOM/ROP;
Designation of a specific ROP as the person responsible for approving accounts that do not meet the specific criteria and standards and for maintaining written records of the reasons for every such account approved;
Establishment of minimum net equity requirements for initial approval and account maintenance; and
Requirements that the customer be provided with a special written description of the risks inherent in naked options writing at, or prior to, the initial transaction in the account.
The minimum net equity in a customer account required to sell naked options:
I can be set by the member firm at a higher level than SRO minimum requirements
II cannot be set by the member firm at a higher level than SRO minimum requirements
III can be set at a dollar amount determined by the trading activity in the account
IV cannot be set at a dollar amount determined by the trading activity in the account
A I and III
B I and IV
C II and III
D II and IV
B.
Member firms are permitted to set their own levels of margin for customers to sell naked options - both initial and minimum margins. These can be the same as, or higher, than regulatory requirements, but never lower. For example, the margin to sell a naked call is set by Regulation T at 20% of the market value of the stock, with a 10% minimum requirement. The member firm could set its own levels at 30% and 20% respectively. Note that the dollar margin requirements are determined by percentages, as well as a flat dollar minimum. For example, the member firm could state that while minimum equity to open an account is set by FINRA and the CBOE at $2,000, the firm wants $10,000 of equity minimum to open an account that will sell naked options. A flat dollar minimum cannot be based on account activity, because this must be a uniform amount for all such accounts.
Options sales literature that is accompanied or preceded by the ODD:
I can include a recommendation of a specific options contract
II must be approved in advance by the ROP designated in the firm’s written supervisory procedures
III must be filed 10 days in advance with the SRO
IV must receive approval from the SRO prior to use
A I and II only
B III and IV only
C I, II, III
D I, II, III, IV
A.
Recommendation of a specific options contract can be made in an options communication if it has been preceded or accompanied by delivery of the ODD. Note that this precludes making a recommendation of a specific options contract in general advertising. All options advertising, sales literature, and independently prepared reprints must be approved in advance by the designated ROP with a Series 4 license (this is the individual that has been designated in the firm’s supervisory procedures to approve options communications - a main office compliance function).
Regarding filing with the SRO, only advertising, sales literature, and independently prepared reprints that are NOT preceded by delivery of the ODD (Options Disclosure Document) are required to be filed with the SRO 10 days in advance and must receive SRO approval prior to use. Any communication that is accompanied or preceded by the ODD is not subject to SRO filing (which is the case here).
A customer lodges a written complaint against a registered representative in your branch office concerning recommended options transactions. The complaint must be retained:
A for a minimum of 1 year
B for a minimum of 6 years
C until an appropriate resolution is reached
D for as long as the account remains open
D.
The CBOE procedure for written options complaints is that the complaint must be retained in the branch file for the life of the account; and the copy that is forwarded to the central file must be retained there for 3 years. Do not confuse this options complaint retention rule with either FINRA’s 4-year complaint retention rule or the MSRB’s 6-year complaint retention rule. (Isn’t it nice that the regulators are all on the same page on this matter!?)
Which security is NOT marginable?
A Long LEAP call option with 18 months to expiration
B Long call option with 8 months to expiration
C Long convertible bond position
D Long mutual fund position held for 30 days
B.
Long options positions with 9 months or less to expiration must be paid in full - they are not marginable and they have no loan value. LEAP (long-term) options with over 9 months to expiration must be margined at 75%, so they have a loan value of 25%. Convertible bond positions are marginable at 50% (same as stock) and have a loan value of 50%. At issuance, mutual funds are not marginable because every share is a “new issue.” However, once the mutual fund position has been held for at least 30 days, they become marginable at 50%.
A customer wishes to open an options account with your firm. Which of the following procedures are required prior to the first trade?
I The new account form must be completed
II The customer must be sent an Options Disclosure Document
III The customer must complete an Options Agreement
IV The BOM or ROP must approve the account before the first trade
A I only
B II and III only
C I, II, IV
D I, II, III, IV
C.
To open an options account, the new account form must be completed and the date that the customer was furnished with the latest Options Disclosure Document must be placed on the new account form. The BOM (Series 9/10) or ROP (Series 4) must approve the new account form and the first trade in writing. The customer does not have to complete the Options Agreement prior to the opening of the account. The Agreement must be sent to the customer and must be signed and returned within 15 days of opening the account.
It is now July 2nd. The VIX contracts that will be trading on the CBOE are: I July II August III November IV February A I and II only B III and IV only C I, II, III D I, II, III, IV
C.
The VIX contracts that are available are the upcoming 2 months plus 1 more upcoming month based on the February quarterly cycle (either Feb., May, Aug., or Nov.). Since it is now July 2nd, the July and August contracts will be trading along with the upcoming cycle month of November.
When completing a new account profile for a customer, the registered representative is informed that the customer has an annual income of $75,000 per year and has a liquid net worth exclusive of home residence of $50,000. The customer has a child, age 12, for which the customer wishes to establish a college education fund, investing the money in options. The best recommendation to the customer would be: A Buy calls and puts B Sell "in the money" calls and puts C Sell "out the money" covered calls D Buy straddles
C.
This customer wishes to establish a college fund, for a child that will attend college in about 6 years. The strategy to meet this objective should be conservative; and selling covered calls (selling calls against long stock positions) is a very conservative strategy that provides a stream of income equal to the collected premiums from the sale of the options contracts plus the dividends received from the underlying stock. Since the calls are “out the money” - for example, a call with a 50 strike price sold when the market is at $46 - the calls will not be exercised unless the market rises above $50. Thus, if the stock is “called away,” the customer will have an additional gain on the stock position. The risk to this strategy is one of a general stock price decline - but this risk is true of any equity investment. Buying calls and puts; or selling calls and puts; are too speculative for a long term investor that needs a fixed sum at a known future date. Buying a straddle is the purchase of both a call and a put on the same stock and, again, is too speculative for a long term investor that needs a fixed sum of money in the future.
A registered representative sends a prospecting letter to customers stating that significant profits can be achieved by purchasing call options in a rising market. This claim:
A is prohibited under the rules of the options exchanges
B must be balanced by a statement that trading options can also result in
significant losses
C can only be made if it is documented by actual customer examples that
occurred within the past year
D is permitted and does not require any prior approval
B.
Under the advertising rules of the exchanges, any claims that profits can be generated from an investment strategy must be balanced by a statement that losses may occur as well.
A customer buys 1 British Pound Mar 162 Call and sells 1 British Pound Jan 162 Call on the same day in a margin account. The position is profitable if:
A the spread between the premiums widens
B the spread between the premiums narrows
C both contracts are exercised
D both contracts expire “out the money”
A.
The customer is buying the “far” expiration and selling the “near” expiration in this calendar spread. Because of its higher time value, the far expiration must be more expensive, so this is a debit spread. Debit spreads are profitable if the spread between the premiums widens. At that time, the positions can be closed out at a larger net credit. In this case, exercising both contracts will not result in a gain because the strike price is the same for both. If both contracts expire, the customer loses the net debit. If both contracts are exercised, the customer buys British Pounds at $1.62 and delivers them for $1.62, incurring commission costs without any gain on the currency.
A customer holds 1 ABC Jan 10 Call contract. If ABC Corp. declares a 1:5 reverse stock split, then on the ex-date, the option contract will:
A be canceled
B be adjusted to cover 20 shares at $10 per share
C be adjusted to cover 20 shares at $50 per share
D not be adjusted
D.
Options contracts are only adjusted for stock splits and stock dividends. There is no adjustment for cash dividends or for reverse stock splits. In the case of a reverse stock split, the contract is unchanged but the deliverable is adjusted if there is an exercise. Assume that a company whose stock is trading at $10 declares a 1:5 reverse stock split. Then every 5 shares outstanding will become 1 share, at a new market price of $50. The holder of 1 ABC Jan 10 Call will not see an adjustment to the contract. However, if there is an exercise, the deliverable will be adjusted to cover 100 shares / 5 = 20 shares. The exercise price for delivery per share becomes $10 x 5 = $50 per share.
A customer buys 100 shares of ABC stock at $55. Fourteen months later, the stock rises to $63 and the customer sells 1 ABC Jan 65 Call @ $5 and buys 1 ABC Jan 60 Put @ $5. One month later, the stock rises to $68 and the call is exercised. The customer closes the ABC Jan 60 Put @ $1. The tax consequence of these transactions is:
A $1,000 short term capital gain on ABC stock; no capital gain or loss on the
options premiums
B $1,000 long term capital gain on ABC stock; no capital gain or loss on the
options premiums
C $1,500 long term capital gain on ABC stock; $400 short term capital loss on
the options premiums
D $1,500 long term capital gain on ABC stock; $400 long term capital loss on
the options premiums
C.
This customer has a gain on a long stock position that he or she is protecting by purchasing the put; and the customer is offsetting the cost of the put purchase by selling an “out of the money” call at a premium equal to that paid for the put, creating a “zero-cost” collar on the stock position. Because the put was purchased when the stock was already held long-term, there is no effect on the stock’s holding period. The stock was bought at $55 per share. Upon exercise of the call, the stock is being sold at the strike price of $65 + $5 call premium = $70 sales proceeds for tax purposes. Thus, there is a $15 per share long term capital gain on the stock or $1,500. The put that was purchased at $5 is closed one month later at $1, for a $4 per share short term capital loss, or $400. (Also note that if the put had been purchased when the stock was held for less than 1 year, this would have stopped the counting of the stock’s holding period until the put expired or was closed by trading, at which point the stock’s holding period would resume counting.)
A customer has an existing options account that has been qualified to buy calls and puts. The customer contacts the representative servicing the account to inquire about selling uncovered calls. After reviewing the customer’s new account profile, the representative determines that the customer meets the firm’s income and net worth standards for uncovered call writing. The account cannot be approved by the BOM for this different level of options trading unless:
A a new Options Disclosure Document (ODD) is provided to the customer
B a Special Statement for Uncovered Options Writers is provided to the
customer
C the customer increases the minimum margin in the account to $25,000
D the BOM personally verifies the customer’s change of investment objective
B.
If a customer wishes to effect transactions in uncovered short options, the firm is obligated to establish extra “hurdles” that the customer must clear in order to open such an account. The firm must establish specific criteria and standards for opening such customer accounts; must have the Branch Manager or ROP approve the account in writing; must have the “designated ROP” give specific approval to new accounts that wish to write naked short options that do not meet the specific criteria of the firm; must establish specific net equity criteria for initial approval and maintenance of such accounts; and must provide the customer with a special risk disclosure document, at, or prior to, the initial uncovered short option transaction.
In determining if there is a violation of position limits or exercise limits, the Options Clearing Corporation will aggregate long calls with: I Long Puts II Short Calls III Short Puts A I only B II only C III only D I, II, III
C.
To determine if there is a violation of position or exercise limits, the Options Clearing Corporation aggregates contracts on the same issuer on the same side of the market. Thus, long calls are aggregated with short puts (both representing the “upside” of the market); while long puts are aggregated with short calls (both representing the “downside” of the market).
If the Options Clearing Corporation issues a new Disclosure Document, existing customers that are affected by the change:
A are not required to be sent the Document
B must receive the document no later than with the next trade confirmation
C must receive the document no later than with the next account statement
D must receive the document no later than with the firm’s semi-annual mailing of
its balance sheet to customers
B.
If the Options Clearing Corporation issues a new or revised Options Disclosure Document, existing options customers that are affected by the change must receive the document no later than with the next trade confirmation. Alternatively, firms are allowed to mail the new document to all customers promptly after issuance.
