Series 7 - Options: Equity (Stock) Options
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? A This is not a violation of position limits because the positions were taken in different accounts B This is not a violation of position limits because of the exemption from position limit violations given to positions taken in 10 or fewer accounts C This is not a violation of position limits because position limit violations only apply to the down-side of the market D This is a violation of position limits
The best answer is D. 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.
The January stock option contracts of a company assigned to Cycle 3 have just expired. Which contracts will commence trading on the CBOE? A February B March C July D September
The best answer is D. The options cycles are: Cycle 1 Jan Apr Jul Oct Cycle 2 Feb May Aug Nov Cycle 3 Mar Jun Sep Dec At any time, for any equity option, the contracts that can trade are: this month; next month: and the next 2 months in the cycle. Cycle 3 contracts are issued for the months of Mar - Jun - Sept - Dec. One can always get a contract for this month, next month, and the next 2 months in the Cycle. In January, prior to expiration, the contracts that will trade are January (this month), February (next month), March and June (the next 2 months in the cycle). After January contracts expire, the contracts that will trade are February (this month), March (next month), June and September (the next 2 months in the cycle).
All of the following cover a short call contract according to O.C.C. rules EXCEPT: A long the stock B long an escrow receipt for the stock C long a depository receipt for the stock D long the cash value of the stock
The best answer is D. 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.
Equity options contracts for a given month expire: I on the 2nd Friday of the month II on the 3rd Friday of the month III at 4:00 PM Eastern Standard Time IV at 11:59 PM Eastern Standard Time A I and III B I and IV C II and III D II and IV
The best answer is D. Equity options contracts for a given month expire on third Friday of the month at 11:59 PM Eastern Standard Time. The trading cut-off is 4:00 PM ET on the same day.
Which of the following are standardized for listed option contracts? I Contract size II Expiration date III Strike price interval IV Expiration time A I and II only B III and IV only C I, II, III D I, II, III, IV
The best answer is D. Exchange traded option contracts have standardized contract sizes (e.g., 100 shares of stock), standardized expiration date and time (11:59 PM Eastern Standard Time on the 3rd Friday of the month), and standardized strike price intervals (generally 5 point intervals). The premium or "price" of the option is determined minute by minute in the trading market.
If an issue listed on the NYSE stops trading, a holder of a listed call option on that can do all of the following EXCEPT: A exercise the option B let the option expire C give the option as a gift to a relative D trade the option
The best answer is D. If the exchange where the stock is listed stops trading, the option stops trading on its exchange. When a stock stops trading, there is no way to price the option contracts since the premium varies with the market price movements of the stock. Existing holders can still exercise or let the option expire, since these actions take place through the Options Clearing Corporation - not the exchange floor. Anyone can give a gift to anyone else - at any time.
Trading in a stock is suspended. Which statement is TRUE regarding the trading of listed options on that stock? A Only opening transactions are permitted B Only closing transactions are permitted C Both opening and closing transactions are permitted until the contracts expire D Trading will be halted in options contracts on the suspended stock
The best answer is D. 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.
An opening trade in a call option contract takes place on the American exchange (AMEX) between a buyer at ABCD Securities and a writer at PDQR Securities. The issuer of the contract is: A American Stock Exchange B ABCD Securities C PDQR Securities D Options Clearing Corporation
The best answer is D. 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.)
If it is now December, regular options contracts could be traded with all of the following expirations EXCEPT: A January B April C July D November
The best answer is D. 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.
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: A on the ex date B on the record date C before the ex date D before the record date
The best answer is A. If a customer owns stock and owns a put on the stock, in order to receive a cash dividend on that stock, the customer cannot exercise until the ex date or after.
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: A immediately B no earlier than 10:00 AM Eastern Standard Time, the next business day C no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D no earlier than the Friday immediately preceding the third Saturday of the expiration month
The best answer is A. 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.
Exercise limits on stock options refer to limits on the number of contracts that can be: A exercised within any 5 business day period B purchased within any 5 business day period C sold within any 5 business day period D aggregated within any 5 business day period
The best answer is A. 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 holds 10 ABC Jan 100 Call contracts. ABC Corporation is paying a $1 per share cash dividend. On the ex date, the customer will hold: A 10 ABC Jan 100 Calls covering 100 shares each B 10 ABC Jan 99 Calls covering 100 shares each C 10 ABC Jan 101 Calls covering 100 shares each D 10 ABC Jan 101 Calls covering 99 shares each
The best answer is A. Listed option contracts are not adjusted for cash dividends. They are adjusted for whole share splits and stock dividends.
Regular way trades of all of the following securities settle next business day EXCEPT: A Listed stocks B Listed stock options C U.S. Government securities D Agency securities
The best answer is A. Regular way trades of U.S. Government and agency issues settle next business day. Regular way trades of options settle next business day. Regular way trades of listed stocks settle 2 business days after trade date.
A customer sells 1 ABC Jan 55 Call. To cover the position, the customer could: A buy 1 ABC Jan 50 Call B sell 1 ABC Jan 50 Put C buy 1 ABC Jan 60 Call D sell 1 ABC Jan 60 Put
The best answer is A. The only way to cover a short call with another option contract is to buy an option that allows for the purchase of the stock (meaning a call option). The option must have the same strike price or lower (allowing the stock to be purchased at the same price or cheaper) as that of the contract which is sold and must have the same expiration or longer than the contract sold. Thus, to cover the short Jan 55 Call, a long Jan 50 call is good because the strike price is lower; a long Jan 60 call is not good because the strike price is higher.
An American Style stock option differs from a European style stock options because it can be: A traded anytime until expiration B exercised anytime until expiration C issued at any time until expiration D redeemed anytime until expiration
The best answer is B. 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 cannot be redeemed and they can only be issued based on the cycles set by the Options Clearing Corporation.
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: A 1 DEF Jan 45 Call B 1 DEF Jan 50 Call C 1 DEF Jan 55 Call D 1 DEF Jan 60 Call
The best answer is B. 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.
In order to receive a dividend distribution, the last time for the holder of a call option to exercise is: A at least 2 business days prior to the ex date B just prior to the ex date C just prior to the record date D just after the ex date
The best answer is B. 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.
After exercising an equity options contract, the trade settles: A next business day after trade date B in 2 business days after trade date C in 3 business days after trade date D in 7 calendar days after trade date
The best answer is B. Exercise of an option results in a regular way trade. Stocks trades settle regular way 2 business days after trade date.
An investor holds 1 ABC Jan 40 Call. ABC splits 2 for 1. On the ex date, the holder will have: A 2 ABC Jan 20 Calls covering 50 shares B 2 ABC Jan 20 Calls covering 100 shares C 1 ABC Jan 20 Call covering 200 shares D 1 ABC Jan 40 Call covering 100 shares
The best answer is B. 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 2 for 1 split) 2 ABC Jan 20 Calls (the new strike price is 40/2), with each contract covering 100 shares. Note that the aggregate exercise value of the contracts remains unchanged.
A customer owns an ABC Call option. ABC declares a dividend for shareholders on record July 10th. The last day to exercise the option and get the dividend is: A July 5th B July 8th C July 9th D July 10th
The best answer is B. 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 10th, which is July 8th. 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 9th).
A put is assigned just after the ex date for a cash dividend. The customer: A will receive the dividend B will not receive the dividend C must pay the dividend D is not required to pay the dividend
The best answer is B. 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.
The maximum "legal" life on a regular stock option contract is: A 6 months B 9 months C 12 months D 28 months
The best answer is B. 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 Clearing Corporation is responsible for all of the following EXCEPT: A standardization of listed options contracts B trading of listed options contracts C issuance of listed options contracts D assignment of exercises of listed options contracts
The best answer is B. 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.
The last time to trade an equity option that is about to expire is: A 2:00 PM Central Time; 3:00 PM Eastern Time; on the 3rd Friday of the expiration month B 3:00 PM Central Time; 4:00 PM Eastern Time; on the 3rd Friday of the expiration month C 4:00 PM Central Time; 5:00 PM Eastern Time on the 3rd Friday of the expiration month D 5:00 PM Central Time; 6:00 PM Eastern Time on the 3rd Friday of the expiration month
The best answer is B. The largest equity options market is the Chicago Board Options Exchange, which is on Central Time. Thus, cut-off times for options are stated in both Central Time and Eastern Time. Options are traded during the same hours as the NYSE. Trading on the NYSE stops at 4:00 PM (Eastern Time), which is 3:00 PM Central Time, so options trade until 4:00 PM Eastern Time, 3:00 PM Central Time. Trading takes place through the third Friday of the month.
To receive a dividend, the holder of a call contract may exercise the contract on all of the following days EXCEPT: A two business days prior to record date B two business days prior to ex date C one business day prior to record date D one business day prior to ex date
The best answer is C. Assignment of exercise results in a regular way stock trade (2 business day settlement) Call Holder: If call holder wishes to receive a dividend on underlying stock, the ercise must occur at least 2 business days prior to the Record Date. In other words, if a call holder exercises their call 2 business days prior to the Record Date, they will buy the underlying stock and thus become a stock owner and receive the dividend. Put Writer: If the writer of a put is exercised prior to the "ex date", obligating the writer to buy the stock, the writer will receive the dividend. If a written put is exercised, the writer is obligated to buy the stock. Hence, if the written put is exercised prior to the "ex date", the writer of the put is obligated to buy the underlying stock and thus is a stock owner and will receive the dividend. PassPerfect Explanation: 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.
Which of the following positions would "cover" the sale of 1 ABC Jan 30 Put? I Long 100 shares of ABC at $30 II Short 100 shares of ABC at $30 III Long 1 ABC Jan 40 Put IV Short 1 ABC Jan 40 Put A I and III B I and IV C II and III D II and IV
The best answer is C. A short put position may be covered by -selling short the underlying stock, -by purchasing a put option, -or by selling a call option on the stock. A long stock position is not considered a "cover" for a short put since as the market goes down, the short put is exercised and the customer must buy another 100 shares of stock in addition to the shares already owned - so there is double downside risk. A short put is covered if the individual is short 100 shares of the security. As the market goes down, the short put is exercised and the customer is forced to buy back shares that have previously been sold "short." The credit from the short sale is used to buy the shares, so there is no loss to the put writer. The O.C.C. also 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 short put be exercised.
Under O.C.C. rules, all of the following would "cover" a short put EXCEPT a(n): A long put on the same stock with the same strike price or higher with the same expiration or later B bank guarantee letter C long stock position in the underlying security D escrow receipt for cash equal to the exercise price held in a bank vault
The best answer is C. A short put position may be covered by -selling short the underlying stock, -by purchasing a put option, -or by selling a call option on the stock. A long stock position will not "cover" a short put. If the market goes down, the short put is exercised, obligating the customer to come up with the cash to buy the stock. Having a long stock position is of no help here, since the customer has increasing loss on the stock position in a falling market, in addition to the loss experienced on the short put. 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.
An investor holds 1 ABC Jan 40 Call. ABC splits 4 for 1. On the ex date, the contract becomes: A 1 ABC Jan 40 Call B 1 ABC Jan 10 Call C 4 ABC Jan 10 Calls D 4 ABC Jan 40 Calls
The best answer is C. 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 O.C.C. assigns exercise notices on a: A first in; first out basis B last in; first out basis C random order basis D method of reasonable fairness
The best answer is C. 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.
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? A The contract becomes 1 ABC Jan 60 Call covering 125 shares B The contract becomes 1 ABC Jan 40 Call covering 100 shares C The contract becomes 1 ABC Jan 40 Call covering 125 shares D The contract stays as 1 ABC Jan 50 Call covering 100 shares
The best answer is C. 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.
