Options Equities

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Straddle

an option strategy involving either buying a call and a put on the same stock; or selling a call and a put on the same stock; with both options having the same strike price and expiration date. If an investor buys both the call and the put simultaneously, this is a long straddle and the investor expects the price of the stock to move either up or down. If an investor sells both the call and the put simultaneously, this is a short straddle and the investor expects the price of the stock to remain relatively flat.

HOW ARE PUTS QUOTED? .1? .01?

he AEP Nov 20 Puts are quoted at .40, equals $.40 premium per share = $40 premium per 100 shares covered by a contract.

Which of the following are "classes" of options? I ABC Calls II ABC Puts III ABC Jan 50 Calls IV ABC Jan 50 Puts A I and II B I and III C II and III D III and IV

A. A class of option consists of all options of one type on an underlying security. For example, all ABC calls are a "class;" all ABC puts are a "class." In contrast, an options "series" would be all ABC Jan 50 Calls - a series is a class of option on the same underlying stock with the same strike and expiration.

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: 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

A. 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.

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

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.

Which statement is TRUE? A If the NYSE stops trading in a stock, the CBOE stops trading in options on that stock B If the NYSE stops trading in a stock, the CBOE does not stop trading in options on that stock C If the CBOE stops trading in an option, the NYSE stops trading in that stock D If the CBOE stops trading in an option, the SEC closes the securities markets for 1 trading day

A. 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).

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. The first date that the customer can exercise the put and still retain the dividend is: A any date before the ex date B the ex date C any date before the record date D the record date

B. 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.

ABC Corporation, after many profitable years, declares a one-time special cash dividend of $10.00 per share. After the announcement, the stock is trading at $100 per share. Your customer holds 1 ABC Jan 110 Call. As of the ex date, the customer will have: A 1 ABC Jan 90 Call B 1 ABC Jan 100 Call C 1 ABC Jan 110 Call D 1 ABC Jan 120 Call

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 $10 per share x 100 shares = $1,000 value per contract, it will be adjusted. The new strike price will be 110 - $10 cash dividend = 100. The number of shares covered by the contract does not change.

Cabinet trades effected on the CBOE can be used by customers to: I open worthless long positions II close out worthless long positions III open worthless short positions IV close out worthless short positions A I and III only B II and IV only C I and II only D I, II, III, IV

B. 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!

If the writer of a put contract is assigned, the put writer must: A pay the strike price for the security in next business day B pay the strike price for the security in 2 business days C deliver the security the next business day D deliver the security in 2 business days

B. If the writer of a put is "assigned," this means that the OCC has assigned an exercise notice to that put writer. The put writer is then obligated to buy the stock from the put holder in a regular way trade, with the transaction price being the strike price. Regular way settlement of stock trades occurs 2 business days after trade (exercise) date.

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: A 100 shares at $29.50 B 100 shares at $30.00 C 101 shares at $29.50 D 101 shares at $30.00

B. Listed option contracts are not adjusted for cash dividends. They are adjusted for whole share splits and stock dividends.

HOW ARE CALLS QUOTED? .1? .01?

B. The Amdahl Nov 15 Calls are quoted at .10, equals $.10 premium per share = $10.00 premium per 100 shares covered by a contract x 10 contracts = $100 total premium, ignoring commissions.

If an opening trade of an option contract occurs on the Chicago Board Options Exchange, the issuer of the contract is the: A Chicago Board Options Exchange B Options Clearing Corporation C Securities Exchange Commission D Registered Options Trader

B. 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.)

The Floor Broker holds an order to buy an option contract from 1 customer at the market; and an order to sell the same contract from another customer at the market. The Floor Broker could not execute the orders in the open market; and therefore, executed the orders by matching them. This practice is known as: A Arbitrage B Crossing C Backing Away D Free Riding

B. 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.

The maximum life on a regular stock option contract is: A 4 months B 8 months C 12 months D 24 months

B. 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. Review

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 A I and III B I and IV C II and III D II and IV

B. 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.

To determine if position limits have been violated, the O.C.C. would combine: A long calls and long puts B short calls and long puts C long calls and long stock positions D short stock and short stock positions

B. 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.

In mid-September 2020, equity LEAPs that are issued for a Cycle 1 company will expire in January of what year? A 2021 B 2022 C 2023 D 2024

C. 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. After the September expiration in 2021, LEAPs expiring in January of 2024 are issued, etc.

On the Chicago Board Options Exchange, bid and ask quotes for options contracts are maintained by the: A Specialist (DMM) B Floor Broker C Market Maker D Order Book Official (OBO)

C. The Specialist (now renamed the DMM - Designated Market Maker) function on the NYSE floor is handled by 2 separate individuals on the CBOE. On the NYSE floor, the Specialist/DMM performs 2 functions. The DMM acts as market maker in 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. Floor brokers on the CBOE are agents, executing orders for customers. They cannot be market makers.

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

C. 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.

All of the following are standardized for listed option contracts EXCEPT: A strike price B contract size C premium D expiration

C. 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.

An investor holds 1 ABC Jan 80 Call. ABC splits 2 for 1. On the ex date, the holder will have: A 1 ABC Jan 40 Call B 1 ABC Jan 80 Call C 2 ABC Jan 40 Calls D 2 ABC Jan 80 Calls

C. For whole share splits, the number of contracts is increased and the strike price is reduced proportionately. 1 ABC Jan 80 Call becomes (after the 2 for 1 split) 2 ABC Jan 40 Calls (the new strike price is 80/2), with each contract covering 100 shares. Note that the aggregate exercise value of the contracts remains unchanged.

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

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.

Under O.C.C. rules, the maximum "legal" life of a regular stock option contracts is: A 3 months B 6 months C 9 months D 12 months

C. 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.

All of the following exchanges trade listed stock options EXCEPT: A CBOE B AMEX C NASDAQ D PHLX

C. Listed stock options are traded on the CBOE (Chicago Board Options Exchange); AMEX (American Stock Exchange); PHLX (Philadelphia Stock Exchange); and the PSE (Pacific Stock Exchange) - now owned by the NYSE and renamed the ARCA Exchange.. By far, the largest options market is the CBOE. Review

A customer writes 1 XYZ Jan 40 Put. To cover the position, the customer would: A buy 1 XYZ Jan 30 Put B sell 1 XYZ Jan 30 Put C buy 1 XYZ Jan 50 Put D sell 1 XYZ Jan 50 Put

C. 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.

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

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. Review

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: A Options Clearing Corporation B Specialist (DMM) on the NYSE floor C Exchange where the option trades D Issuer of the securities

C. 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).

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? A This is not a violation of position limits because the positions were taken in accounts at different broker-dealers B This is not a violation of position limits because the positions were initiated by 2 different persons C This is not a violation of position limits because John and Joe have a power of attorney over each other's account D This is a violation of position limits

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. 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.

The seller of an XYZ Mar 60 call is covered by all of the following EXCEPT: A long 100 shares of XYZ stock B long 1 XYZ Apr 50 Call C long an escrow receipt for 100 shares of XYZ stock D long 1 XYZ Feb 40 Call

D. If the seller (writer) of a call is exercised, he or she must deliver the stock at the strike price. A seller of a call who does not own the stock is said to be "naked" because, if exercised, that person must buy the stock in the market and deliver it at the strike price - and the market price will be higher (otherwise the contract would not be exercised by the holder). The seller is said to be "naked" because he or she is exposed to unlimited upside market risk. Now if the seller of the call actually owns the underlying stock, then that stock is delivered on an exercise - this "covers" the seller of the call. He or she is no longer exposed to market risk. The stock can be held at the broker or at an OCC-approved depository bank (evidenced by an escrow receipt for the stock). If the seller owns a call that can be exercised to buy the stock at no loss, then he or she is covered as well. Thus, Choice B covers the sale of the Mar 60 Call, because if that contract is exercised, the long April 50 Call can be exercised and the stock is purchased at $50, sold at $60, and there is a $10 per share gain. On the other hand, Choice D does NOT cover the sale of the Mar 60 Call, because it expires in February - a month prior to the expiration of the Mar 60 Call, leaving that contract naked for March. You might ask: "How do you know it is February followed by March, 1 month later and not March followed by February, 11 months later?" Answer - the maximum life of a listed option contract is 9 months, so it can only be the former and not the latter!

Which of the following options strategies would be considered a covered put? A Short 1 ABC Jan 50 Put; Long 1 ABC Jan 50 Call B Short 1 ABC Jan 50 Put; Long 2 ABC Jan 50 Calls C Short 1 ABC Jan 50 Put; Long 100 ABC stock D Short 1 ABC Jan 50 Put; Short 100 ABC stock

D. 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. Review

All of the following cover a short call contract according to O.C.C. rules EXCEPT being long: A the stock B a security that is convertible into the stock position C a fully paid warrant exercisable into the stock position D the cash value of the stock

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. Being long a convertible security, convertible into that stock; or a fully paid warrant that is exercisable to obtain the stock for delivery, are considered to be the same as a long stock position, and therefore also cover a short call option.

Which of the following orders has priority during trading on the Chicago Board Options Exchange? A stop limit order B limit order C stop order D spread order

D. Spread orders entered on a one-to-one basis (both sides of the spread are on one ticket) have priority on the CBOE. This rule helps spread orders be completed, since both "legs" of the order must be filled to complete the spread position.

The issuer of listed options contracts is the: A holder of the contract B writer of the contract C exchange where the contract is traded D Options Clearing Corporation

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

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.

When an exchange stops trading in a stock, the options exchange: A keeps trading in the option B exercises all outstanding option contracts C lets all outstanding option contracts expire D stops trading in the option

D. 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).

Position Limits

Position limit under Options Clearing Corporation (OCC) regulation, the maximum number of options positions that an investor can maintain on the same "side" of the market on the same underlying security. Long calls and short puts are the same side of the market because in both cases the investor is bullish and will buy securities if and when the option is exercised. Long puts and short calls are the same side of the market because in both cases the investor is bearish and will sell securities if and when the option is exercised. (see: Sides of the market)


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