How the Options Market Functions
Open Interest in an option is:
-the number of contracts outstanding -higher the open interest, the more liquid option -Open interest begins to decline as expiration approaches and investors close-out or exercise options
The OCC automatically exercises an open equity option contract if, at expiration, the contract is in-the-money by:
.01 or more for a member firm. .01 or more for a public customer. *At expiration, the OCC automatically exercises options that are in-the-money by .01 or more for both customer and member firm accounts
If a 5% stock dividend is declared, the owner of 1 XYZ Jul 30 call owns:
1 contract for 105 shares with an effective exercise price of $28.57. *When a company pays a stock dividend or effects a fractional stock split, the underlying option is adjusted by increasing the number of shares the contract covers (5% × 100 shares = 5 additional shares). The number of contracts owned remains the same and the effective exercise price is adjusted so that the position value before and after the adjustment remains the same ($3000 / 105 = $28.57).
If a 50% stock dividend is declared, the owner of 1 XYZ Jul 30 call owns:
1 contract for 150 shares with an exercise price of 20.
When determining a position limit, a member firm aggregates which of the following customer positions?
1.) Long calls and short puts 2.) Long puts and short calls Contracts on each side of the market are used for determining position limits. Long calls and short puts are on the same side (bullish); long puts and short calls are on the same side (bearish).
A customer is long 10 XYZ Jan 60 calls, and XYZ declares a 20% stock dividend. On the ex-date, the customer will have:
10 XYZ Jan 50 calls (120 shares per contract). *When adjusting options contracts for stock dividends and fractional splits, the number of contracts held will not change. The number of shares covered by each contract is increased (100 shares × 120%) so that in this example each adjusted contract now represents 120 shares. The effective exercise price is adjusted so that the position value remains the same before and after the adjustment. Therefore the new strike price will be 50 ($6,000 / 120 shares = $50).
Listed options expire at:
11:59 pm ET on the third Friday of the expiration month
DWQ declares a quarterly cash dividend of $.20. After the ex-dividend date, what will be the exercise price of a listed DWQ May 25 call option?
25 *Because a listed option is not adjusted for a cash dividend, the exercise price of a DWQ May 25 call option remains the same: $25.
Trading in expiring options series concludes the same day as expiration at
4:00pm *The official close is 4:00 pm ET on the 3rd Friday of the expiration month. Expiring options may be exercised until 5:30 pm ET on the same day. Options EXPIRE at 11:59.
A customer wishes to close a short option position. The order ticket must be marked as:
A closing purchase *The investor opened with a sale, so the position must close with a purchase.
If at expiration for XYZ options, XYZ stock closes at 40.15 which of the following open option positions will automatically be exercised by the OCC?
A customer long 1 XYZ 40 call.
All of the following are characteristics of unlisted options EXCEPT:
Answer) active secondary trading. -negotiated exercise prices. -premiums determined by participants. -negotiated expiration dates. *Unlike listed options, unlisted options do not trade continuously in an organized secondary market; trades are negotiated between individuals.
If your client was recently approved to trade options and writes 1 XYZ Oct 60 put, but fails to return the signed option agreement within 15 days of account approval, which of the following orders could you accept?
Buy 1 XYZ Oct 60 put. *If a customer fails to return a signed options agreement within 15 days of account approval, your firm can permit closing transactions only. While the customer may offset his existing position, he may not offset a short position in an Oct 60 put by buying an XYZ put with a different expiration month and/or a different strike price.
A firm may assign option exercises using which of the following methods?
FIFO or by random assignment *A firm may assign an exercise either randomly or using the FIFO accounting method. LIFO is not permitted nor is assigning by position size, smallest or largest.
If the holder of a call tenders an exercise notice after the ex-dividend date for a cash dividend, which of the following statements is TRUE?
He is not entitled to the dividend. *If the holder of a call exercises before the ex-date, the trade settles on or before the record date and he is on record for the dividend. If the holder exercises on or after the ex-date, the trade settles after the record date and he is neither on record for the dividend nor entitled to it.
Which of the following statements regarding the discussion of options with customers is TRUE?
In every discussion about the benefits of options, a statement must be made regarding the corresponding risks. *Any description of options must include a description of the risks. This rule applies to all communications with the public, written, electronic, or in person.
If trading is halted in a listed stock, what happens to the trading in the stock's listed options?
It is halted *Options rely primarily on the underlying market value for premium determination.
With regard to position limits, what is the bullish, or "buy" side of the market?
Long Calls, Short Puts *Long calls give the holder the right to purchase stock, while short puts obligate the writer to buy stock, and both are bullish strategies.
Performance of the terms of a standardized listed option contract are guaranteed by the:
OCC- Options Clearing Corporation
If an investor buys 1 DWQ Apr 70 call at 5, giving him the right to buy 100 shares of DWQ at $70 per share, which aspect of the transaction is NOT set or standardized by the OCC?
Premium of 5. *The OCC sets standard exercise prices and expiration dates for all listed options, but the options premiums that buyers pay are determined by the market.
The Options Clearing Corporation uses which of the following methods to assign exercise notices?
Random selection. *The OCC assigns exercise notices to member firms on a random basis; the members may choose the customers to be exercised on either a random basis or FIFO basis.
Put-Call Ratio
Reflects the current open interest in the trading of our put options to call options -used to gauge investor sentiment (bullish or bearish)
Which of the following are on the same side of the market?
Short 1 XYZ call and long 1 XYZ put.
If a writer of an XYZ equity call option is assigned, which of the following should be delivered to the OCC?
The underlying XYZ security
Listed stock options cease to TRADE on the
Third Friday of the month of expiration *Expiring options cease trading at 4:00 pm ET on the same day as expiration which is the third Friday of the month.
XYZ Corp. has set Friday, January 23rd, as the record date for its next quarterly dividend distribution. To receive the dividend, a customer, long 1 XYZ Feb 40 call, must issue exercise instructions on or before:
Tuesday, January 20th. *Dividends are paid to investors who are owners of record as of the close of business on the record date. When a call option is exercised, money and stock are exchanged on the third business day after notice is given to the OCC. Therefore, an investor who wishes to receive a dividend must exercise a call no later than the third business day prior to the record date (i.e., before the ex-date).
The writer of an in-the-money put will receive the upcoming dividend from the underlying issuer if the contract is exercised:
before the ex-date
The put-call ratio can be used to
gauge investor sentiment as being either bullish or bearish
If a customer is long ABC Sep 30 calls and the stock becomes subject to a trading halt on the floor of the NYSE, the customer is permitted to:
issue exercise instructions *If trading in the underlying security is halted, options trading on that security is also halted. However, the customer may still issue exercise instructions to the OCC because this is an off-floor transaction.
All of the following statements about trading index options on the CBOE are true EXCEPT:
market orders entered by a market maker have priority over public orders.
A Designated Primary Market Maker on the floor of the CBOE:
may trade for his own account *A Designated Primary Market Maker on the floor of the CBOE is an exchange member who acts as both an agent assisting in maintaining the electronic order book on behalf of the CBOE and a market maker who may trade for their own account.
The writer of an equity call option who is exercised:
must deliver stock in 3 business days *If exercised, call writers must deliver the underlying stock within 3 business days.
All of the following are fixed option contract terms EXCEPT the:
premium in a stock option. *The premium is not a predetermined characteristic of the option contract. The premium continually changes throughout the life of the option; reflecting changes in the price of the underlying security, dividends (if any), and interest rates.
It would be fair and equitable for a brokerage firm to assign an option exercise notice to a customer:
who first wrote that option. *The assignment of options contracts can be done on a FIFO basis (first in, first out) or by any other method that the OCC considers fair (i.e., random). Determining assignment by size of contract or on a LIFO (last in, first out) basis is not considered fair.
