Series 7: Options (Equity/Stock Options)
A customer places an order to sell 5 ABC Jan 50 straddles at the market. The CBOE market maker's quotes for ABC 50 contracts are: ABCCall Put50.50BidAsk BidAskJan 502.002.25 .751.00Feb 503.003.25 1.001.25Mar 504.004.25 1.251.50 The customer will receive a total premium of:
$1,375 An ABC Jan Straddle consists of: 1 ABC Jan 50 Call1 ABC Jan 50 Put If a straddle is bought, the buyer pays the "Ask" price of the market maker on the exchange floor. If a straddle is "sold," the seller receives the "Bid" price of the market maker. In this case, the customer is selling the straddle, so the premiums are: Sell 1 ABC Jan 50 Call@ $2.00 Sell 1 ABC Jan 50 Put@ $.75 $2.75 Credit = $275 per contract x 5 contracts = $1,375 The total premium received will be $1,375.
The cost of 10 American Electric Power (AEP) May 20 straddles is:
$2,000 1 AEP May 20 straddle consists of 1 AEP May 20 Call @ .75 and 1 AEP May 20 Put @ 1.25. The total cost is 2 points in premium or $200 per straddle. The cost for 10 straddles is $2,000.
The price of 1 AEP Feb 15 Call contract is:
$550.00 The AEP Feb 15 Calls are quoted at 5.50, equals $5.50 premium per share = $550 premium per 100 shares covered by a contract.
The AEP Feb 15 Call has time value of:
.25 The AEP Feb 15 Call is in the money by 5.25 points (the market price is 20.25). The total premium for the contract is 5.50 points. The time premium is the excess above intrinsic value, which is .25 point.
The AEP Nov 20 Call has time value of:
0 The AEP Nov 20 Call is trading at parity (the market price is $20.25, so intrinsic value is .25; and the premium is .25 point). Such a contract has no time value.
DEF Corporation, after many profitable years, declares a one-time special cash dividend of $5.00 per share. After the announcement, the stock is trading at $50 per share. Your customer holds 1 DEF Jan 55 Call. As of the ex date, the customer will have:
1 DEF Jan 50 Call While the OCC does not adjust the strike prices of listed options contracts for regular quarterly cash dividends, since they are a "known quantity" that the market prices into options premiums, "special cash dividends" are a one-time event that the market does not know about. Therefore, the OCC does adjust listed options for special cash dividends that amount to at least $12.50 per contract. Since this special cash dividend amounts to $5 per share x 100 shares = $500 value per contract, it will be adjusted. The new strike price will be 55 - $5 cash dividend = 50. The number of shares covered by the contract does not change.
XYZ Corporation, after many profitable years, declares a one-time special cash dividend of $20.00 per share. After the announcement, the stock is trading at $200 per share. Your customer holds 1 XYZ Jan 220 Call. As of the ex date, the customer will have:
1 XYZ Jan 200 Call While the OCC does not adjust the strike prices of listed options contracts for regular quarterly cash dividends, since they are a "known quantity" that the market prices into options premiums, "special cash dividends" are a one-time event that the market does not know about. Therefore, the OCC does adjust listed options for special cash dividends that amount to at least $12.50 per contract. Since this special cash dividend amounts to $20 per share x 100 shares = $2,000 value per contract, it will be adjusted. The new strike price will be 220 - $20 cash dividend = 200. The number of shares covered by the contract does not change.
The American Hospital May 30 Put premium has time value of:
1.63 The American Hospital May 30 Put is in the money by 1.12 points (the market price is 28.88). The total premium for the contract is 2.75 points. The time premium is the excess above intrinsic value, which is 1.63 points.
A customer holds 10 ABC Jan 60 Call contracts. ABC Corporation is paying a 20% stock dividend. On the ex date, the contracts will show as:
10 ABC Jan 50 Calls This is a stock dividend of 20%. The contract is adjusted by reducing the strike price and increasing the number of shares covered by the contract. The contract holder owns 10 ABC Jan 60 Calls. The strike price of each contract becomes $60/1.20 = $50 and the number of shares covered by each contract becomes 1.20 x 100 = 120 shares. Note that the aggregate exercise value is unchanged.
A customer owns 1 ABC Jul 30 Call. ABC goes ex dividend $1.00. As of the morning of the ex date, the contract will cover:
100 shares at $30 Listed option contracts are not adjusted for cash dividends. They are only adjusted for 2:1 and 4:1 stock splits. For other types of stock splits and stock dividends, there is no adjustment to the contract. However, if the contract is exercised, the "deliverable" is adjusted accordingly.
A customer owns 1 XYZ Jul 30 Put. XYZ goes ex dividend $.50. As of the morning of the ex date, the contract will cover:
100 shares at $30.00 Listed option contracts are not adjusted for cash dividends. They are only adjusted for 2:1 and 4:1 stock splits. For other types of stock splits and stock dividends, there is no adjustment to the contract. However, if the contract is exercised, the "deliverable" is adjusted accordingly.
What is the maximum maturity of an equity LEAP?
28 months The CBOE issues equity LEAPs as follows: Cycle 1 companies have LEAPs issued after the September expiration for the January that is 28 months later; Cycle 2 companies have LEAPs issued after the October expiration for the January that is 27 months later; and Cycle 3 companies have LEAPs issued after the November expiration for the January that is 26 months later. For example, for a Cycle 1 company, after the September expiration in 2020, equity LEAPs will be issued for January of 2023, which is 28 months later. The point to know for the exam is not these issuance cycles - it must be known that the longest expiration is 28 months. Also note that index LEAPs have a different maturity - 36 months, instead of 28.
An investor holds 1 ABC Jan 40 Call. ABC splits 4 for 1. On the ex date, the contract becomes:
4 ABC Jan 10 Calls For whole share splits, the number of contracts is increased and the strike price is reduced proportionately. 1 ABC Jan 40 Call becomes (after the 4 for 1 split) 4 ABC Jan 10 Calls (the new strike price is 40/4).
The maximum life on a regular stock option contract is:
8 months The maximum life of a regular stock option contract is 8 months (this may be tested as 9 months, though). Longer term stock options, known as LEAPs (Long Term Equity AnticiPation options) have a maximum life of 28 months.
O.C.C. rules limit the maximum "legal" life of an equity option contract to:
9 months Legally, the maximum life of a regular stock option contract is 9 months. Currently, the way that options are issued, the actual maximum life is 8 months. Longer term stock options, known as LEAPs (Long Term Equity AnticiPation options) have a maximum life of 28 months.
Under O.C.C. rules, the maximum "legal" life of a regular stock option contracts is:
9 months Legally, the maximum life of a regular stock option contract is 9 months. Currently, the way that options are issued, the actual maximum life is 8 months. Longer term stock options, known as LEAPs (Long Term Equity AnticiPation options) have a maximum life of 28 months.
The options positions listed in each of the following choices are in the same "class" EXCEPT:
ABC Jan Calls and ABC Jan Puts A class of options is determined by the underlying security and the type of option (Call or Put). Expiration and strike price are not considered. For example, all ABC Calls are a "class;" all ABC Puts are a "class;" all XYZ Calls are a "class;" all XYZ Puts are a "class."
The options positions listed in each of the following choices are in the same "class" EXCEPT:
ABC Jan Calls and XYZ Jan Calls A class of options is determined by the underlying security and the type of option (Call or Put). Expiration and strike price are not considered. For example, all ABC Calls are a "class;" all ABC Puts are a "class;" all XYZ Calls are a "class;" all XYZ Puts are a "class."
Which of the following contracts is trading at parity?
AEP Nov 20 Call
Which of the following contracts listed below is trading at parity?
Amdahl Feb 15 Put A contract is trading at parity if the premium equals the intrinsic value. Amdahl closed at $10.75. Amdahl Feb 15 Puts closed at $4.25. The contract is "in the money" by 4.25. Thus, the contract is trading at parity.
All of the following contracts listed below are trading "out of the money" EXCEPT:
Amdahl Nov 10 Call Put contracts go "out the money" when the market price exceeds the strike price. Since the market price is $10.75, put contracts with a 10 strike are .75 point "out the money." A call contract goes "out the money" when the market price is below the strike price. A call with a 15 strike, when the market is $10.75, is 4.25 points "out the money." A call with a 10 strike when the market is $10.75 is .75 point "in the money."
A customer writes 1 XYZ Jan 40 Put. To cover the position, the customer would:
Buy 1 XYZ Feb 50 Put The customer has sold 1 XYZ Jan 40 Put. Thus, if the customer is exercised, he or she is obligated to buy XYZ stock at $40 per share. If the customer buys 1 XYZ Jan 50 Put, then the customer can always exercise the long put and sell that stock for $50, if it is put to him for $40. By purchasing the 50 put, the customer has created a "long put spread."Purchasing the XYZ Jan 30 Put does not cover the customer under O.C.C. rules. If the customer is exercised on the short put, buying the stock for $40, by exercising the long 30 put, he can only sell at $30 per share, losing 10 points in the process. To be covered under O.C.C. rules, the strike price of the long put must be the same or higher than that of the short put. Furthermore, the expiration on the long put must be the same, or longer than the short put. If the customer buys a Dec 50 Put and the short Jan 40 Put is exercised in January, then the December put expired and the writer is "naked." If the customer buys a Feb 50 Put and the short Jan 40 Put is exercised in January obligating the customer to buy the stock at $40, then the customer simply exercises the Feb 50 Put and puts the stock to someone else at $50, for a $10 point profit.
The New York Stock Exchange stops the trading of a company's stock, pending release of an important news announcement. The trading of the option will be halted by the:
Exchange where the option trades When an exchange stops trading in a stock, the options exchange stops trading in the option (since there is no longer a way to price these "derivative" securities, whose price is based on the price movements of the underlying stock).
On the Chicago Board Options Exchange, the person responsible for handling those orders that can be executed immediately is the:
Floor Broker Floor brokers on the CBOE accept orders from member firms for execution. Orders are filled under an open outcry auction system in the trading "pits." Market makers maintain bid and ask quotes in options contracts. Order book officials maintain the book of public orders that cannot be immediately filled.
Which of the following cover the sale of 1 ABC Jan 50 Call contract? I The deposit of 100 shares of ABC stock II The purchase of 1 ABC Apr 50 call III The purchase of 1 ABC Oct 50 call IV The deposit of $5,000
I and II The deposit of 100 shares of ABC stock covers the sale of the ABC Jan 50 Call because should the call be exercised, the stock can be delivered. Similarly, the purchase of 1 ABC Apr 50 Call covers the short call. If the short call is exercised, forcing delivery, the long call can be exercised into April to get the stock. The purchase of 1 ABC Oct 50 Call does not cover the sale of the Jan 50 Call. Assume, for example, that in November, the short call is exercised. The long call expired in October, so you must go to the market to get the stock. This position is not covered. The long call must have the same expiration or later to cover the short call. The deposit of cash will not cover the sale of a call since the potential loss is unlimited.
Which of the following persons trade for their own account on the floor of an options exchange? I Market Maker II Registered Options Trader III Order Book Official IV Floor Broker
I and II only On the Options Exchanges, floor brokers (who execute orders for retail member firms) and order book officials (who run the book of public limit orders) handle trades as agent only. They accept orders from the public for execution but do not trade for their own account. Market makers on the exchange floor make markets in option contracts, buying and selling for their own account. Registered options traders and competitive options traders are individuals that trade on the floor for themselves to add liquidity to the market. They can take positions and carry them.
The last time to trade expiring equity options is: I 4:00 PM EST II 11:59 PM EST III on the third Friday of the month IV on the Saturday following the third Friday of the month
I and III Listed equity options trade until 4:00 PM Eastern Standard Time on the third Friday of the expiration month.The contracts expire at 11:59 PM Eastern Standard Time, on the third Friday of the month.
Stock options contracts: I are American style II are European style III can be issued at any time IV can be exercised at any time
I and IV The very first options contracts were single stock options, which started trading on the CBOE in 1973. All single stock options are "American Style" - these are options that can be exercised at any time. In contrast, European style options can only be exercised at expiration and not before. All options contracts can be traded anytime until expiration. Options contracts can only be issued based on the cycles set by the Options Clearing Corporation.
A customer sells a call. In order to cover the position, the customer must: I buy a call with the same strike price or lower than the one he sold II buy a call with the same strike price or higher than the one he sold III buy a call with the same expiration or shorter than the one sold IV buy a call with the same expiration or longer than the one sold
I and IV To cover the sale of a call contract, the customer may purchase 100 shares of ABC stock; or may purchase a call at the same or lower strike price; with the same or later expiration.
Cabinet trades effected on the CBOE: I can be used by customers to close out worthless long positions II can be used by customers to close out worthless short positions III result in an aggregate $1 premium per contract as a result of the transaction IV result in an aggregate $1 commission per contract as a result of the transaction
I, II, III Cabinet trades on the CBOE, also called "accommodation liquidations," are a means for customers to close out worthless contracts. If a contract is left to expire worthless, the customer does not have a printed record of this event. With a cabinet trade, the customer can close out worthless long or short positions at a premium of $.01 per share ($1 per contract). This results in a printed closing trade confirmation for the customer's records. For executing the trade, the broker will charge a commission - which will surely be more than $1!
The CBOE's spread priority rule states that which order(s) has(have) priority over single orders? I Spreads II Straddles III Combinations
I, II, III To facilitate the handling of "one-on-one" orders - meaning that two options positions must be taken simultaneously to create the desired position - the CBOE has the "spread priority rule." This rule states that a spread, straddle or combination order has priority over equivalent single sided orders on the trading floor. In this manner, it is easier for traders to successfully execute spread, straddle and combination orders.
Listed options are traded on which of the following? I American Stock Exchange II Philadelphia Stock Exchange III Chicago Board Options Exchange IV Pacific Stock Exchange
I, II, III, IV All options trades are effected on exchange floors, with the CBOE - Chicago Board Options Exchange being the largest options exchange. The other exchanges that trade options are the American Stock Exchange (AMEX), Philadelphia Stock Exchange (PHLX); and the Pacific Stock Exchange (PSE) - now owned by the NYSE and renamed the ARCA Exchange. No options are traded on NASDAQ.
Which of the following cover a short call contract? I Long a depository receipt for the stock II Long the cash value of the stock III Long an escrow receipt for the stock IV Long the stock
I, III, IV A short call cannot be covered by the deposit of cash because the theoretical loss is unlimited. The only way to cover a short call is with the ownership of the stock or owning an option that allows for the purchase of the stock at a price not to exceed the strike price of the short call, good for the entire life of the short call. Being long the stock covers a short call; long an escrow receipt shows that the stock is on deposit at a bank; long a depository receipt shows that the stock is on deposit with a clearing corporation.
The O.C.C. is responsible for which of the following? I Standardization of listed options contracts II Trading of listed options contracts III Issuance of listed options contracts IV Assignment of exercises of listed options contracts
I, III, IV The Options Clearing Corporation is the technical issuer and guarantor of listed options contracts. The O.C.C. standardizes the options contracts that it will issue to increase potential investor participation. If there is an exercise of an option contract, it is the O.C.C. who assigns the exercise notice to a writer of that contract. Trading of listed options contracts takes place on exchange floors, under the rules of the exchange. The O.C.C. does not establish options trading rules - these are established by the exchanges.
Which of the following cover a short ABC put? I Long ABC stock position II Short ABC stock position III Cash equal to the aggregate exercise price
II and III A long stock position is not considered "cover" for a short put since as the market goes down, the short put is exercised and there is increasing loss on the stock position. The O.C.C. accepts as "cover" a long put with the same strike price or higher (thus creating a long put spread), a bank guarantee letter (where the bank assumes responsibility for loss), or an escrow receipt for cash sufficient to pay for the stock should the put be exercised. A short stock position also covers a short put, since the credit from the sale of the stock is available to "pay" for the purchase of the stock should the short put be exercised.
Which statements are TRUE about the CBOE Order Support System? I The order is directed to the brokerage firm's communication post on the exchange floor II The order is directed to the trading post III Execution notices are sent directly from the trading post to the brokerage firm
II and III All automated trading systems function in a similar fashion. Orders are routed directly to the trading post, eliminating the need for the order to be wired to the communication post on the exchange floor and then written by hand to be given to a floor broker. The execution report is sent directly to the originating firm; it does not go through the firm's communication post.
Equity options for a given month expire at: I 4:00 PM EST II 11:59 PM EST III on the third Friday of the month IV on the Saturday following the third Friday of the month
II and III Listed equity options trade until 4:00 PM Eastern Standard Time on the third Friday of the expiration month. The contracts expire at 11:59 PM Eastern Standard Time that same day - the third Friday of the month.
The Order Book Official: I is an exchange member II is an exchange employee III manages the book of public orders IV maintains bid and ask quotes in options contracts
II and III The Order Book Official (OBO) is an exchange employee who manages the book of public limit orders for options contracts. The OBOs cannot act as market makers, therefore they cannot maintain bid and ask quotes in options contracts. Market makers are separate individuals under the CBOE system.
The November stock option contracts of a company assigned to Cycle 1 have just expired. Which contracts will commence trading on the CBOE?
July The options cycles are: Cycle 1 Jan. Apr. Jul. Oct. Cycle 2 Feb May Aug Nov Cycle 3. Mar. Jun. Sep. Dec Cycle 1 contracts are issued for the months of Jan - Apr - Jul - Oct. One can always get a contract for this month, next month, and the next 2 months in the Cycle. In November, prior to expiration, the contracts that will trade are November (this month), December (next month), January and April (the next 2 months in the cycle). After November contracts expire, the contracts that will trade are December (this month), January (next month), April and July (the next 2 months in the cycle).
A customer owns an ABC Call option. ABC declares a dividend for shareholders on record July 23rd. The last day to exercise the option and get the dividend is:
July 19th If an option is exercised, a regular way stock trade results (2 business day settlement). To be an owner of record, the call must be exercised 2 business days prior to July 23rd, which is July 19th. Notice that to get the dividend, the call must be exercised just prior to the ex date (which is the business day before the record date, so in the case the ex date is July 22nd).
The issuer of listed options contracts is the:
Options Clearing Corporation The Options Clearing Corporation (O.C.C.) is the legal issuer and guarantor of all exchange traded options. Thus, the purchaser of an option contract is relieved of the worry that a writer will not perform on an exercise - since technically, the O.C.C. is the writer of the contract. (The O.C.C. requires that member firms deposit daily monies to ensure that the firms, if their customers are writers who have been exercised, can perform on the exercise.)
On the CBOE, customer good-til-canceled orders are handled by the:
Order Book Official The CBOE splits the specialist function into two. The order book official handles the book of customer limit orders. The market maker acts as the dealer in that option contract.
Which of the following options strategies would be considered a covered put?
Short 1 ABC Jan 50 Put; Short 100 ABC stock A covered put writer sells a put contract against the underlying short security position. The short put is covered, because if the market falls, and the put is exercised, the credit received from selling the stock "short" can be used to pay for the stock that must be bought by the exercised put writer.
An investor has 1 ABC Jan 50 Call contract. ABC declares a 25% stock dividend. Which statement is TRUE regarding the option contract after adjustment for the dividend?
The contract becomes 1 ABC Jan 40 Call covering 125 shares This is a stock dividend of 25%. The contract is adjusted by reducing the strike price and increasing the number of shares covered by the contract. The contract holder owns 1 ABC Jan 50 Call. The strike price becomes $50/1.25 = $40 and the number of shares covered by the contract becomes 1.25 x 100 = 125 shares. Note that the aggregate exercise value of the contract is unchanged.
John is a registered representative who has discretionary options accounts for 25 of his largest customers. John likes the news coming out of ABCD Corporation and decides to buy ABCD calls for some of his clients. He buys 30,000 ABCD call contracts each for 10 out of the 25 discretionary accounts that he manages. The position limit for ABCD is 250,000 contracts on each side of the market. Which statement is TRUE?
This is a violation of position limits Any accounts that are under "common control" are aggregated to determine if there is a position limit violation. Control is deemed to exist for: all owners in a joint account; each general partner in a partnership account; accounts with common directors or management; and an individual with authority to execute transactions in an account. Also considered are: similar patterns of trading activities for different entities; the sharing of similar business purposes or interests; and the degree of contact and communication between the managers of separate accounts. The most common situation where this comes up is a registered representative who exercises discretionary authority over a number of customer accounts - these would be aggregated to see if there is a violation of position limits. In this case, because the registered representative bought 30,000 calls in each of 10 discretionary accounts, the positions in the accounts will be aggregated to see if there is a position limit violation. With a 250,000 position limit (on each side of the market), the positions are aggregated to 300,000 contracts on the up-side of the market and exceed the 250,000 contract limit.
John and Joe are successful business associates and have been good friends for many years. John has an options account at BD "A," while Joe has his options account at BD "B." John and Joe have given each other full power of attorney over their respective accounts. John and Joe have been discussing ABCD stock and they are both bullish. John buys 150,000 ABCD call contracts in his account at BD "A." Joe buys 175,000 ABCD call contracts in his account at BD "B." The position limit for ABCD is 250,000 contracts. Which statement is TRUE about their actions?
This is a violation of position limits Any accounts that are under "common control" are aggregated to determine if there is a position limit violation. Control is deemed to exist for: all owners in a joint account; each general partner in a partnership account; accounts with common directors or management; and an individual with authority to execute transactions in an account. The most common situation where this comes up is a registered representative who exercises discretionary authority over a number of customer accounts - these would be aggregated to see if there is a violation of position limits. In this case, because the 2 individuals have trading authority over each other's account, they are deemed to be under common control and are aggregated. With a 250,000 position limit (on each side of the market), the 150,000 long calls and 175,000 long calls in the 2 accounts are aggregated to 325,000 contracts on the up-side of the market and exceed the 250,000 contract limit.
Trading in a stock is suspended. Which statement is TRUE regarding the trading of listed options on that stock?
Trading will be halted in options contracts on the suspended stock If trading in a stock is suspended, say on the New York Stock Exchange, the exchange where the option trades will also stop trading in the option contracts. This must occur because there is no longer any way to price the option contracts if there is no current market for the underlying stock. Any holders of outstanding options can still exercise their contracts during a trading halt, since this is performed through the Options Clearing Corporation and does not occur on the exchange floor.
In order to receive a dividend distribution, the last time for the holder of a call option to exercise is:
just prior to the ex date Exercise of an option results in a regular way trade. Stocks settle regular way 2 business days after trade date. Since the ex date is set at 1 business day prior to the record date, to receive the dividend, the stock must be bought 2 business days prior to the record date (or just prior to the ex date). Exercising the call just prior to the ex date is the same as buying the stock just prior to the ex date.
The market maker on the CBOE gives the following quotes: BidAskABC Jan 50 Call44.50ABC Jan 50 Put22.50ABC Jan 60 Call22.25ABC Jan 60 Put88.50 A customer wishes to buy 5 ABC Jan 50 Calls and buy 5 ABC Jan 50 Puts, but does not wish to spend more than $7 for each combined position; and wants the orders executed as close together as possible. The appropriate order that should be placed is:
a straddle order This customer is specifying that a straddle be purchased for a combined premium not to exceed $7. The successful execution of this order requires that both "legs" of the straddle be executed at the same time within the customer's limit (a debit). To facilitate the handling of such "one-on-one" orders, the CBOE has the "spread priority rule." This rule states that a spread, straddle or combination order has priority over equivalent single sided orders on the trading floor. In this manner, it is easier for traders to successfully execute spread, straddle and combination orders. In this example, the 50 Call can be purchased at the ask price of $4.50; and the 50 Put can be purchased at the ask price of $2.50; for a combined debit of $7.
A customer writes 1 XYZ Jan 40 Put. To cover the position, the customer would:
buy 1 XYZ Jan 50 Put The customer has sold 1 XYZ Jan 40 Put. Thus, if the customer is exercised, he or she is obligated to buy XYZ stock at $40 per share. If the customer buys 1 XYZ Jan 50 Put, then the customer can always exercise the long put and sell that stock for $50, if it is put to him for $40. By purchasing the 50 put, the customer has created a "long put spread." Purchasing the XYZ Jan 30 Put does not cover the customer under O.C.C. rules. If the customer is exercised on the short put, buying the stock for $40, by exercising the long 30 put, he can only sell at $30 per share, losing 10 points in the process. To be covered under O.C.C. rules, the strike price of the long put must be the same or higher than that of the short put.
A customer writes 1 XYZ Jan 55 Put. To cover the position, the customer would:
buy 1 XYZ Jan 60 Put The customer has sold 1 XYZ Jan 55 Put. Thus, if the customer is exercised, he or she is obligated to buy XYZ stock at $55 per share. If the customer buys 1 XYZ Jan 60 Put, then the customer can always exercise the long put and sell that stock for $60, if it is put to him for $55. By purchasing the 60 put, the customer has created a "long put spread." Purchasing the XYZ Jan 40 Put does not cover the customer under O.C.C. rules. If the customer is exercised on the short put, buying the stock for $55, by exercising the long 40 put, he can only sell at $40 per share, losing 15 points in the process. To be covered under O.C.C. rules, the strike price of the long put must be the same or higher than that of the short put.
Exercise limits on stock options refer to limits on the number of contracts that can be:
exercised within any 5 business day period Exercise limits on stock options refer to limits on the number of contracts that can be exercised within any 5 business day period.
A customer is long 10 ABC Jan 60 Call contracts. ABC Corporation has just declared a $1 per share dividend. To receive the dividend, the customer must:
file an effective exercise notice with the Options Clearing Corporation prior to the ex date To receive a dividend, the holder of a call contract must exercise the contract prior to the ex date. Since settlement of exercise takes place in 2 business days, the customer will have settled the exercise on, or before, the record date, and will receive the dividend.
All of the following may trade for their own account on the floor of an options exchange EXCEPT a:
floor broker On the Options Exchanges, floor brokers, and order book officials, handle trades as agent only. They accept orders from the public for execution but do not trade for their own account. Market makers on the exchange floor make markets in option contracts and are buying and selling for their own account. Registered options traders and competitive options traders are individuals that trade on the floor for themselves to add liquidity to the market. They can take positions and carry them.
A customer purchases an equity option contract at 1:00 PM Eastern Standard Time on Tuesday, October 10th in a regular way trade. If the customer wishes to exercise, the customer may place an exercise notice with the Options Clearing Corporation:
immediately An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation does not handle the exercise until the morning of the next business day (which is also the day that the customer must pay for the option contract). This procedure is followed because the Options Clearing Corporation does not receive the report of the purchase of the option until the close of trading on the day that the contract is purchased. The O.C.C. opens the next day with the customer recorded as being "long" that contract, and can now assign an exercise notice to a writer.
A customer purchases an equity option contract at 1:00 PM Eastern Standard Time on Tuesday, October 10th in a cash trade. If the customer wishes to exercise, the customer may place an exercise notice with the Options Clearing Corporation:
immediately An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. The Options Clearing Corporation does not assign the exercise until the transaction settles, which is the same day for a cash trade. Once the assignment occurs, the stock must be delivered to the holder of the call; or the stock must be delivered to the writer of the put; 2 business days after assignment.
The AEP Feb 20 Call is:
in the money by .25 point The strike price on the AEP Feb 20 Call is 20 while the market price is $20.25. This call is "in the money" by .25 points. Calls go "in the money" when the market price rises above the strike price.
The Amdahl Feb 10 Call is:
in the money by .75 point The strike price on the Amdahl Feb 10 Call is 10 while the market price is 10.75. This call is "in the money" by .75 point. Calls go "in the money" when the market price rises above the strike price.
The Amdahl Feb 15 Put is:
in the money by 4.25 points The strike price on the Amdahl Feb 15 Put is 15 while the market price is 10.75. This put is "in the money" by 4.25 points. Puts go "in the money" when the market price falls below the strike price. This contract is trading at parity, meaning that the premium equals the "in the money" amount. There is no time premium on this contract - which means it must be quite close to expiration.
On the floor of the Chicago Board Options Exchange, duties similar to those performed by the NYSE Specialist (DMM) are handled by the:
market maker The Specialist (now renamed the DMM - Designated Market Maker) on the NYSE floor performs 2 functions. The DMM acts as market maker is a specific security, buying and selling for his own account. The DMM also keeps the "book" of limit and stop 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 orders is handled by an exchange employee known as the order book official ("OBO").
Regular way trades of options settle:
next business day Regular way trades of stock options are settled next business day. Do not confuse this with an exercise of a stock option. If an exercise occurs, this results in a regular way stock trade that settles 2 business days after exercise date.
A customer owns 100 shares of ABC stock and owns 1 ABC Put option. The customer wishes to sell the stock by exercising the put, but wishes to retain a recently declared cash dividend. In order to receive the dividend, the customer must exercise the put:
on the ex date Because exercise settlement of listed stock options occurs 2 business days after trade date, in order to retain the cash dividend, the holder of the shares cannot sell them before the ex date (which is 1 business day prior to record date). If the put is exercised on the ex date or later, the trade will settle after the record date, and the customer will be on record to receive the cash dividend. On the other hand, if the long put were exercised before the ex date, the trade would settle on the record date or before, and the customer would be selling the stock, taking him- or herself off the record book on the record date or before, so that client would not receive the dividend.
To receive a dividend, the holder of a call contract may exercise the contract on all of the following days EXCEPT:
one business day prior to record date To receive a dividend, the holder of a call contract must exercise the contract prior to the ex date. Settlement of exercise takes place in 2 business days. In Choice A, if the customer exercises 2 business days prior to record date, the holder would be entitled to the dividend since the trade settles on the Record Date (the date that the list of holders of record are taken to be sent the dividend). In Choice B, if exercise occurs two business days prior to ex date, the trade settles on the ex date. Since the ex date is 1 business day prior to the Record Date, the customer has settled in time to receive the distribution. In Choice C, if the customer exercises one business day prior to Record Date, the trade settles on the business day following the Record Date and the customer will not receive the dividend. In Choice D, the customer has effected the trade on the last day possible to receive the dividend - which is the business day prior to the ex date. This is 2 business days prior to the Record Date (the ex date is 1 business day prior to Record Date), so the trade will settle on the Record Date and the customer will receive the dividend.
If a customer exercises an equity call contract, the customer must:
pay the strike price for the security in 2 business days If a customer exercises a call contract, the customer is buying the stock in a regular way trade (the exercise date is considered to be the trade date). The customer must pay the strike price to the writer on settlement. Regular way settlement of stock trades occurs 2 business days after trade (exercise) date.
The "crossing" of customer orders by a Floor Broker on the CBOE floor is:
permitted only if the floor broker could not execute each of the orders with other market participants The crossing by a Floor Broker of 2 customer orders at the same time does not expose those orders to the market. To make sure that the orders are exposed, the Floor Broker must attempt an execution on the trading floor prior to being permitted to cross the orders himself.
All of the following are standardized for listed option contracts EXCEPT:
premium Exchange traded option contracts have standardized contract sizes (e.g., 100 shares of stock), expiration dates, and strike prices. The premium or "price" of the option is determined minute by minute in the trading market.
The O.C.C. assigns exercise notices on a:
random order basis If an option contract is exercised by a holder, a writer is selected by the Options Clearing Corporation to perform on the contract on a random order basis.
When the O.C.C. receives an exercise notice from a brokerage firm, it selects a short contract to be exercised on a:
random order basis If an option contract is exercised by a holder, a writer is selected by the Options Clearing Corporation to perform on the contract on a random order basis.
The Options Clearing Corporation is responsible for all of the following EXCEPT:
setting the premium of listed options contracts The Options Clearing Corporation is the technical issuer and guarantor of listed options contracts. The O.C.C. standardizes the options contracts that it will issue to increase potential investor participation. If there is an exercise of an option contract, it is the O.C.C. who assigns the exercise notice to a writer of that contract. Trading of listed options contracts takes place on exchange floors, under the rules of the exchange. The premium is the price of the contract, established in the marketplace - it is not set by the O.C.C.
To determine if position limits have been violated, the O.C.C. would combine:
short calls and long puts To determine if position limits are violated, the O.C.C. aggregates options positions (not stock positions) on the same stock that are on the same "side" of the market. The "up side" of the market consists of long calls and short puts. The "down side" of the market consists of short calls and long puts.
If the New York Stock Exchange stops trading in a security, the exchange where the listed option for that stock trades will:
stop trading in those option classes If an exchange stops trading the common stock, the options exchange will stop trading in the option. This occurs because there is no way to determine the proper option premium without knowing the current market price of the stock. Any holders of contracts are still free to exercise because this goes directly through the O.C.C., bypassing the exchange floor.
When an exchange stops trading in a stock, the options exchange:
stops trading in the option When an exchange stops trading in a stock, the options exchange stops trading in the option (since there is no longer a way to price these "derivative" securities, whose price is based on the price movements of the underlying stock).
All of the following statements are true about the CBOE Order Support System (OSS) EXCEPT:
the customer must request the use of the system when placing an options order All automated trading systems function in a similar fashion. Orders are routed directly to the trading post, eliminating the need for the order to be wired to the communication post on the exchange floor and then written by hand to be given to a floor broker. The execution report is sent directly to the originating firm; it does not go through the firm's communication post. Such systems are cheaper and faster than manual trading. The majority of trades are now handled in this fashion - the use of the system is transparent to the customer.
A customer buys a listed stock option in a regular way trade and exercises that same day. The Options Clearing Corporation will assign the exercise notice to a writer on:
the next business day An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation will not assign the exercise notice until the purchase of the option settles - and this occurs the next business day for a regular way options trade. Once the assignment occurs, the stock must be delivered to the holder of the call; or the stock must be delivered to the writer of the put; 2 business days after assignment.
Equity options contracts for a given month expire on the:
third Friday of the month at 11:59 PM Eastern Standard Time Equity options contracts for that month expire on the third Friday of the month at 11:59 PM Eastern Standard Time. They can be traded until 4:00 PM ET on that day.
A put is assigned just after the ex date for a cash dividend. The customer:
will not receive the dividend If the put is "assigned," it means that the OCC (Options Clearing Corporation) has selected that put writer to receive the exercise notice (because a holder of that contract has chosen to exercise), obligating the writer of the put to buy the stock in a regular way trade. Because the writer of the put is assigned after the ex date, the writer is buying the stock after the last date to get the dividend. Thus, the writer would not get the dividend.
