General Questions Flashcards
Initial approval of each discretionary options account, in writing, is performed by the: A BOM B Designated ROP C General Principal D Financial and Operations Principal
A.
Approval of discretionary options accounts, in writing, is performed by the Branch Manager (who has the Series 9/10 license) or ROP (who has the Series 4 license).
The “designated ROP” with a Series 4 license is a compliance officer, usually in a supervisory office, that has been designated as the individual that is responsible for
-creating and enforcing options supervisory procedures;
-for approving options accounts that will sell naked options that do not meet firm standards;
-for reviewing discretionary orders and accounts that have been accepted by the BOM;
-for approving communications with the public.
Basically, this is the main office supervisor of options transactions and accounts.
The General Principal (Series 24) is responsible for overall firm supervision, with the exception of options.
The Financial and Operations Principal (Series 27) is responsible for preparing the firm’s financial reports filed with FINRA and the SEC.
Discretionary options orders must be approved and initialed by the:
A BOM prior to execution
B BOM promptly after execution
C designated ROP in a supervisory office prior to
execution
D designated ROP in a supervisory office promptly after
execution
B.
Approval of options accounts, and transactions in accounts, is the responsibility of the Branch Office Manager (Series 9/10) or Registered Options Principal (Series 4) licensed individual located in a branch office. The Branch Office Manager or ROP must approve discretionary options account orders by initialing the order ticket on the day the order is entered - note that there is no requirement for ROP approval prior to executing the transaction. Also note that the BOM or ROP (Branch Manager), not the designated ROP (who is located in the supervisory office) performs this function.
A member firm has 3 branch offices. Branch office “A” has 3 registered representatives; branch office “B” has 38 registered representatives; and branch office “C” has 12 registered representatives. A Registered Options Principal is required to be resident in:
A either branch office “A,” “B,” or “C,” with oversight
responsibility for all 3 branch offices
B branch office “B,” with oversight responsibility for all 3
branch offices
C branch offices “B” and “C,” but not in branch office “A”
D branch offices “A,” “B,” and “C”
C.
If there are 4 or more registered persons in a branch, then there must be a resident BOM/ROP (Series 9/10 or Series 4 license) in that location. Since branch office “A” only has 3 representatives, there is no requirement for a BOM/ROP in that location.
A customer buys 100 shares of ABC stock at $50 and sells 1 ABC Jan 50 Call @ $5. Later, the 50 Call is closed, and the customer sells 1 ABC Jan 45 Call. The customer is: A rolling up B rolling down C spreading D hedging
B.
This covered call writer is “buying back” the call contract as the market declines (at a low premium since the contract is now out the money) and selling a new contract at the lower strike price (earning an additional premium). This strategy is known as “rolling down” the option position. By employing this strategy, a covered call writer continues to earn premiums as the market price of the stock falls, limiting his loss on the physical stock position
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 does not include 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)
Which of the following has unlimited loss potential? I Short Naked Call II Short Stock/Long Call III Short Straddle IV Short Call/Long Stock
A I only
B I, III
C II, III
D I, II, III, IV
B.
Selling a naked call obligates the writer to deliver stock he does not own - thus there is unlimited risk. A short stock position is hedged by a long call - the long call allows the purchase of the stock at a fixed price, which can then be used to cover the short stock position. A short straddle involves the sale of a call and a put - both of which are naked. A naked call writer has unlimited risk. A long stock / short call position is a covered call writer - where the maximum loss would occur if the stock became worthless.
A customer buys 1 ABC Jan 50 Call and sells 1 ABC Oct 50 Call. This is a: A calendar debit spread B calendar credit spread C vertical debit spread D vertical credit spread
A.
Since Oct expires before Jan, it will be cheaper. The customer is selling the Oct 50 Call (cheaper) and buying the more expensive Jan 50 Call, so this is a debit spread.
On the same day a customer buys 1 ABC Jan 50 Call @ $2 and sells 1 ABC Jan 35 Call @ $8 when the market price of ABC is $41. The maximum potential loss is: A $600 B $800 C $900 D unlimited
C.
If the market rises, the short call will be exercised, requiring the customer to deliver the stock for $35 a share. The customer can always exercise the long call to buy the stock at $50, for a 15-point loss. Since 6 points were collected in premiums, the net loss is 9 points or $900.
On the CBOE, customer limit orders that are away from the market are handled by the: A Specialist/DMM B Market Maker C Order Book Official D Floor Broker
C.
The CBOE splits the specialist function into two. The Order Book Official handles the book of customer limit orders and takes market orders prior to opening. The Market Maker acts as the dealer in the security.
All of the following can participate in an opening rotation EXCEPT: A OBO (Order Book Official) B DPM (Desginated Primary Market Maker) C LMM (Lead Market Maker) D Floor Official
D.
The opening rotation is conducted by the Designated Primary Market Maker (DPM) or the Order Book Official (OBO). Floor Brokers can participate in the opening rotation, as can LMMs (Lead Market Makers). Floor Officials do not trade - they oversee the options trading floor.
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 is long 1 ABC Jan 60 Call contract. If the stock goes ex for a 3:2 stock split, all of the following statements are true EXCEPT:
A The strike price will be adjusted to $40 per share
B The contract size will be adjusted to 150 shares
C The aggregate exercise value of the contract will remain the same
D The contract expiration will be extended by 1.5 months
D.
For a 3:2 stock split, the number of shares per contract is increased and the strike price is reduced proportionally. The number of shares per contract becomes 1.5 x 100 = 150 shares; and the strike price becomes $60/1.5 = $40. Note that the aggregate exercise value of the contract remains unchanged at $6,000 (150 shares x $40 per share).
A customer sells an equity LEAP contract on the first day that the option starts trading. If the contract expires "out the money," the customer will have a: A short term capital gain B short term capital loss C long term capital gain D long term capital loss
A.
If an option contract expires, the writer has a capital gain equal to the premium collected. Sellers of options are treated the same as short sellers of stock. Because a holding period is never established, a long term holding period can never exist. Thus, all gains and losses are always short term for sellers of options.
A customer buys 1 ABC Jul 50 Put @ $3. The customer lets the contract expire. Which statement is TRUE?
A The holder has a $300 capital loss as of the date the contract was
purchased
B The holder has a $300 capital loss as of the date the contract expires
C The holder has a $4,700 capital gain as of the date the contract was
purchased
D The holder has a $4,700 capital loss as of the date the contract
expired
B.
If the holder of an option contract allows the option to expire, he or she has a capital loss equal to the premium paid on the expiration date. For tax purposes, since regular stock options have a maximum life of 9 months, the loss is short term.
Under the “wash sale rule,” a loss on the sale of a security is disallowed, if between 30 days prior to the sale until 30 days after the sale, the customer:
I buys a security convertible into that which was sold
II buys a call option on the security which was sold
III sells a call option on the security which was sold
IV sells a put option on the security which was sold
A I and II
B III and IV
C II and III
D I and IV
A.
The wash sale rule states that if a security is sold at a loss, and from 30 days prior to the sale date until 30 days after the sale date, the same security is purchased; or an equivalent security such as a convertible is purchased; or a call option, warrants or rights are purchased; then the loss deduction is disallowed. All of these “equivalents” effectively restore long the position, “washing out” the sale.
Which of the following will affect the VIX option premium? A Time to expiration B SPX price level C SPX volatility D All of the above
C.
The VIX option is a pure price volatility indicator, based upon the expected SPX price movements over the upcoming month. It excludes the standard “Black-Scholes” options pricing formula inputs of time to expiration, stock price level, expected single stock price volatility, interest rates and dividend yields.
On the floor of the Chicago Board Options Exchange, duties similar to those performed by the NYSE Specialist/Designated Market Maker are handled by the: A floor broker B market maker C floor trader D competitive trader
B.
The Specialist/Designated Market Maker on the NYSE floor performs 2 functions. He acts as market maker in a specific security, buying and selling for his own account. He also keeps the “book” of limit orders that are away from the market for other brokers, and executes these orders for a commission. The CBOE splits this “dual function” into two jobs. The market maker on the CBOE buys and sells for his own account but does not hold a “book” of public orders. The “book” of limit orders is handled by the Order Book Official. Note that the OBO cannot accept contingency orders such as stop orders on the book.
Any option communication that is NOT accompanied or preceded by delivery of the ODD (Options Disclosure Document) can: A make a recommendation B show past performance C project future performance D describe how options work
D. The basic rule for options communication is that:
• if the communication has been preceded or accompanied by delivery of the ODD (Options Disclosure Document), it DOES NOT require SRO filing and approval; but
• if the communication has NOT been preceded or accompanied by delivery of the ODD (Options Disclosure Document), it DOES require SRO filing and approval.
Furthermore, any options communication that is NOT preceded or accompanied by the ODD (Options Disclosure Document) is not permitted to be “promotional.” It:
• is limited to a general description of options;
• must contain information on where a copy of the ODD may be obtained;
• cannot contain recommendations;
• cannot name specific securities;
• cannot contain past performance or performance projections;
• may contain a brief description of options, the operations of the options exchanges and options pricing;
• must include any statement required by law; and
• may include attention-getting graphics, headlines and photographs, as long as they are not misleading.
A customer is long 1 ABC Jan 60 Call in her options account. At the NYSE close on the 3rd Friday of the expiration month, the stock closes at $61. At 7:00 PM ET (6:00 PM CT) that day, the customer calls her registered representative and tells her that she does not want the contract to be exercised. The registered representative asks you, the BOM, whether anything can be done for the customer. Your response should be that:
A it is too late to do anything and the contract will be automatically
exercised by the OCC
B a Contrary Exercise Advice can still be filed to not exercise the option
C the “in the money” option position can be transferred to the house
account so the client will not be exercised and the customer account
will be credited with the “in the money” amount
D it is a rule violation to attempt to interfere with the exercise of a listed
options contract
B.
A “CEA” - Contrary Exercise Advice - is a notice that can be used to either:
• exercise an expiring option that is “out the money”; or to
• stop the automatic exercise of an expiring option that is “in the money.”
CEAs are typically used after trading stops on the 3rd Friday of the month at 4:00 PM ET and are accepted until 7:30 PM ET.
For example, a CEA could be used by a customer that is long a slightly “out the money” call that actually wants to buy the underlying stock via the exercise of the option, since otherwise this option would expire. As another example, a CEA could be used by a customer that is long a slightly “in the money” call option that does not want to be automatically exercised (which occurs at 5:30 PM ET for contracts that are “in the money” by $.01). In this case, the customer would not be exercised and would not be obligated to come up with the money to buy the underlying shares.
In this example, the customer telephoned before the CEA cut-off time and can stop the automatic exercise.
If a member firm solicits customers to participate in a discretionary options trading program, which of the following MUST be provided?
I Cumulative history of the program
II Projected future performance of the program
III Written explanation of the workings of the program
IV Written explanation of the tax implications of the program
A I and III
B I and IV
C II and III
D II and IV
A.
If a customer is going to give discretionary authority to a firm to engage in an options trading program, the customer must receive a written explanation of how the program works, along with the costs and risks associated with the program. In addition, the customer must be provided the program’s cumulative performance history (or unproven nature of the program, if there is no history). There is no requirement to show projected performance, nor is there is a requirement to disclose the tax treatment of strategies employed (though this does make sense as well!).
A member who has filed a LOPR (Large Options Position Report) is required to update that report:
A daily regardless of whether a position has changed
B weekly regardless of whether a position has changed
C if there is a change of position, no later than T+1
D if there is a change of position, no later than T+5
D.
Member firms are required to file LOPRs (Large Options Position Reports) with the OCC if any account holds 200 contracts or more on a single stock or index on one side of the market. The rule also applies to individuals or accounts acting in concert, where the 200 position limit is applied to the aggregate. The initial report must be filed no later than T+1.
Once the report has been filed, any changes in the position must be reported for that day (and the rule gives the member firm 5 business days to file this report, for any changes that occurred within the 5-day time window). If the position falls below the 200 contract threshold, the firm must report the first time this happens (this is also reported within the 5-day change reporting window) and then discontinues filing the report. However, if the position subsequently goes above the 200 contract reporting threshold, reporting would have to start again.
The basic thrust of the rule is that the initial report of a large options position is required quickly (T+1). These reports are aggregated by the OCC by the member firm and reported. Any subsequent position change reports are not as critical, and a 5-day window (T+5) is given for filing these.
A customer has a $150,000 portfolio of high-tech stocks that has a beta of +1.3 as measured against the NASDAQ 100 Index, which is currently at 40. To properly hedge the portfolio, the customer would: A Buy 38 NDQ 40 Calls B Buy 49 NDQ 40 Puts C Sell 38 NDQ 40 Calls D Sell 49 NDQ 40 Puts
B.
To hedge the stock portfolio from a market decline, index puts are purchased. The issue here is comparative volatility. The customer’s portfolio is 30% more volatile than the NASDAQ 100 Index (a beta of +1.3 indicates this), so the hedge must be “beta-adjusted.” With the NASDAQ 100 Index at 40, each contract covers a nominal portfolio value of 40 x 100 multiplier = $4,000. Since the customer has a $150,000 portfolio, then $150,000/$4,000 = 37.5 = 38 contracts (rounded) would be needed to hedge if the betas matched. But they don’t - the portfolio beta is 30% more volatile than the NASDAQ 100 Index, so 1.3 times the normal number of contracts (1.3 x 37.5 = 49 contracts rounded) are needed to hedge.
The Options Disclosure Document must be furnished to a new customer at, or prior to, the:
A opening of the account
B approval of the account for options trading
C placement of the first options trade in the account
D confirmation of the first options trade in the account
B.
The actual wording regarding the delivery of the Options Disclosure Document is as follows: “At or prior to the time a customer’s account is approved for options transactions, a member organization shall furnish the customer with one or more current options disclosure documents.”
The minimum equity for an individual customer to open a portfolio margin account is: A $2,000 B $25,000 C $50,000 D $100,000
D.
The minimum equity to open a portfolio margin account for an individual customer is $100,000. This compares to the minimum equity requirement of $2,000 for a regular margin account.
