Exam 3 Flashcards
A customer has a $4,000,000 portfolio with the following positions: $2,000,000 Blue Chip Equities $2,000,000 Technology Stocks The customer believes that the market outlook is stable for the upcoming months and is interested in producing extra income during this time period. The best strategy to recommend to meet the customer's objective is to: I Buy OEX Puts II Buy High Tech Index Puts III Sell OEX Calls IV Sell High Tech Index Calls A I and II only B III and IV only C II and IV only D I and III only
B.
Only the sale of options will produce premium income to meet the customer’s objective. The customer could sell OEX calls against the “blue chip” stock positions and could sell “high tech index” calls against the technology stock positions for extra premium income in a flat market.
A registered representative submits the following order for approval to the Branch Office Manager:
Buy 1 ABC Jul 50 Call @ $7
Sell 1 ABC Jul 55 Call @ $3
The principal should:
A approve the order as presented
B approve the order if the customer has specifically
authorized these trades
C decline approval of the order since these positions are
uneconomic
D approve the order if the customer has signed a non-
solicitation letter for these transactions
C.
This spread has a maximum gain potential of 5 points. If the market rises, the customer can buy the stock at 50 through the long call, but must deliver the stock at $55 when exercised on the short call. Since the position is created at a net debit of $4, there is only a $1 profit potential. Add on the commissions for both opening the positions and closing the positions, and there is no way that the customer could ever make a profit. This position is uneconomic and should not be approved by the principal.
A floor broker on the Chicago Board Options Exchange receives the following order:
“Sell, to close, firm”
Which statement is TRUE?
A A customer of a member firm is closing a long position
B A customer has placed a firm order to close an existing
long position
C A member firm is closing a long position for its own
account
D A member firm is establishing a long position for its own
account
C.
-All options orders must be marked as “opening” or
“closing.” Thus, this is an order for a closing sale
transaction.
-“Firm” in this case means that the order is placed for the
account of a member firm (this is noted since customer
orders have priority over equivalent orders for the firm’s
account). Please note that this is not a “firm” quote - this is
an order to be executed against the quote (which must be
a “firm” quote) of a market maker of another broker on the
floor.
A member firm is permitted to execute an options trade for a customer outside of the exchange floor if:
A approval of the exchange is received prior to
“executing away” from the trading floor
B the order is placed by the customer as a “market
not-held” order
C a better execution can be obtained for the
customer, resulting in a lower purchase price or
higher sale price
D a narrower bid-ask spread is present in the
alternate marketplace, resulting in a better
execution for the member firm
C.
Under the “best execution” rule, a member firm must send a customer order to the market venue that is posting the best price. There is competition for the CBOE floor in the form of the other options trading venues which compete each other for options trading business.
If the ROP gives an institutional client of a registered representative direct market access, what should the ROP be MOST concerned about?
A The suitability of transactions recommended by
the registered representative to the institutional
client
B The institutional client’s experience with
algorithmic trading
C The institutional client’s internal risk monitoring
controls
D The ability of the institutional client to
electronically link to the broker-dealer’s internal
order routing system
B.
“DMA” – Direct Market Access – has been given by broker-dealers to hedge funds and other institutional traders that had “direct access” to systems such as the NASDAQ Market Center or NYSE Super Display Book. These institutions placed “rapid-fire” algorithmic trades that could swamp them and cause them to crash. Now, broker-dealers cannot give these customers unfiltered market access. The broker-dealer must route these orders to its internal systems first for automated order review to reject orders from being entered that exceed pre-set credit thresholds; that reject erroneous orders; and that reject orders that exceed price or size parameters.
The question is judgmental, but the best choice is that the customer must have algorithmic trading experience before such an account would be permitted. These are institutional traders that “know what they are doing,” so they are not subject to the “suitability rule,” making Choice A incorrect. It is not the client’s risk monitoring controls that are relevant here, but rather the broker-dealer’s risk-monitoring controls, making Choice C incorrect. Finally, Choice D is a “technical consideration,” and is not relevant to the risk level that the firm is assuming for giving the institutional client DMA.
The illegal practice of "capping" a security is likely to be practiced by: I Call holders II Call writers III Put holders IV Put writers A I and II only B III and IV only C I and IV only D II and III only
D.
“Capping” is the illegal attempt to stop a stock’s price from rising in the market. This could be attempted near expiration by call writers whose positions are “going in the money” (creating a loss for the writer); and it could be attempted by put holders who have an “in the money” position that is losing value in a rising market. The opposite illegal practice is “pegging.” When an individual is pegging stock, he or she is attempting to stop the price from dropping. This could be employed near expiration by call holders who have “in the money” positions; and by put writers whose positions are going “in the money” (creating a loss for the writer).
An existing options client has an existing account qualified to sell covered calls and now wants to sell naked puts. The registered representative reviews the customer account information on the new account form with the client and submits the following to the BOM:
Customer Age: 56 Income: $67,000 Net Worth: $725,000 Liquid Net Worth: $75,000 Occupation: Retired Executive Investment Objective: Current Income Investment Experience: 2 Years Covered Options Writing
The BOM should:
A not approve the account because naked put writing is not
suitable for retired individuals
B not approve the account because the customer’s investment
experience is limited
C approve the account as long as the customer meets the firm’s
net worth and income standards for accounts that sell
uncovered options
D contact the customer and confirm that he has requested the
change to the account
C.
This customer is looking for additional income, which selling naked puts will provide (along with the assumption of additional risk). This can be suitable for a retired customer, as long as he or she understands the risks and can bear them. Since this customer is a retired executive, this is probably the case. This customer has been writing covered calls for 2 years, so he has options experience. The BOM should make sure that the customer meets the firm’s income and net worth standards for uncovered options trading. In addition, the customer must be delivered the “Special Statement of Risks” at, or prior to, the first uncovered options transaction in the account.
Call options may be sold in which of the following accounts? I Special Cash Account II Special Subscription Account III Special Memorandum Account IV Margin Account A IV only B I and IV only C I, II, III D I, II, III, IV
B.
Covered call options may be sold against stock held long in a cash account; and covered call options may be sold against stock held in a margin account. Naked call options cannot be sold in a cash account since margin is required; they may only be sold in a margin account. Special Memorandum Accounts (“SMA”) represent unused borrowing in margin accounts and do not reflect any securities positions. Special Subscription Accounts no longer exist (except on this exam!).
Exercise limits on stock option contracts cover a time period of: A 5 business days B 10 business days C one calendar month D nine calendar months
A.
Exercise limits are applied to all exercises of contracts on the same side of the market in the same issuer over a 5 business day period.
Which type of order gives an associated person discretion over the price and time of execution? A All or None B Marketable Limit C Market Not Held D Fill or Kill
C.
A “market not held” order is not held to an immediate execution. The customer specifies the size and security to be traded; and the associated person decides the best price and time of execution. Retail market not held orders must be filled that day. Institutional market not held orders can be filled over multiple days, since these are often larger orders that could impact the market price if a fill was attempted in one shot. A Fill or Kill order is an order to be filled in one shot in its entirety or the order is canceled. An All or None order is an order to be filled in one shot, but if the order can’t be filled in its entirety, reattempts are permitted. A Marketable Limit order is one entered with a limit price equal to the current best bid (for a sell order) or best ask (for a buy order). As long as the market does not move from the limit price, the order will be filled immediately.
A customer who is long 1 ABC Jan 50 Call contract wishes to exercise in time to receive the current dividend declared by ABC Corporation. The last day to exercise and receive the dividend is: A 1 business day prior to ex-date B the ex-date C 1 business day after the ex-date D the record date
A.
To receive a dividend, a customer must be on the record books of the issuer. A customer is recorded on the Record Book if he has settled by the Record Date. To do so, the customer must have bought the stock in a regular way trade prior to the “ex” date. Since the exercise of a call option results in a regular way stock trade, the call must be exercised prior to the “ex” date in order for the holder to receive the dividend.
An existing customer has an Options Agreement on file that only permits the customer to buy call options or sell covered call options. The customer now wishes to buy puts. Which statement is TRUE?
A No amendment of the Options Agreement is required
B The Options Agreement must be updated and signed by the customer prior to the
execution of any opening long put transactions
C The Options Agreement must be updated and signed by the customer within 15 days
of the execution of any opening long put transactions
D The Options Agreement must be updated and approved by the Branch Office
Manager - General Sales Supervisor prior to the execution of any opening long put
transactions
C.
If a customer wishes to initiate transactions in his or her options account that are not specified in the Options Agreement, the Options Agreement must be updated and the customer must sign, and return, the updated Options Agreement within 15 calendar days. Of course, the Branch Office Manager - General Sales Supervisor (Series 9/10) would have to approve the order promptly, and in his review should make sure that this transaction was, indeed, appropriate for the account.
If an options market is “Fast,” all of the following are true EXCEPT the exchange may:
A shift trading in that class of contracts to alternate posts
B allow other Order Book Officials and their clerks to execute transactions in that class
of contracts
C impose trading rotations in that class of contracts
D impose a trading “Halt” until conditions have settled
D. If an options market is "FAST," meaning that trading is exceptionally heavy, the Exchange rules provide for the following measures to help execute all of those orders. The exchange may shift trading in that class of contracts to alternate posts, increasing the number of locations at which trading may occur. The exchange may allow other Order Book Officials and their clerks to execute transactions in that class of contracts, increasing the number of personnel trading that class of contracts. If trading becomes disorderly, the Exchange may impose trading rotations in that class of contracts. There is no provision in the Exchange rules for the imposition of a trading "HALT" until conditions have settled. Generally, trading "HALTS" are imposed if trading in the underlying security has been halted or suspended; or the opening in the primary market for that security has been delayed.
In determining whether there is a violation of position limits, options trades in which of the following accounts will be aggregated?
I A discretionary options account where Broker “A” executes trades for a client
II An options account owned by Broker “A” where he or she trades for his or her
own account
III An options account for an individual customer that is serviced by Broker “A”
A II only
B I and II only
C II and III only
D I, II, III
B.
The accounts that are aggregated are the ones where the investment decisions are being made independently by the broker - these include discretionary accounts managed by the broker and the broker’s own personal account. An individual customer account serviced by the broker will not be aggregated since the investment decision is being made by the customer, not the broker.
A customer has a margin account that is long 100 shares of ABC stock at $52 and long 1 ABC July 50 Call. Under Federal Reserve rules, this account must be marked to market:
A daily
B weekly
C if the market price of ABC falls below $52
D if the market price of ABC falls below $50
A.
Under Federal Reserve rules, stock positions in margin accounts must be marked to market daily. There is no need to mark long options positions to market daily, since they are not margined. The premium must be paid in full. However, any naked short option positions (which must be margined) must be marked to market daily as well.
