Registered Options Principal Exam

Options accounts are typically approved at different strategy levels based on the customer's experience, financial resources, and investment objectives. Lower levels permit covered strategies (such as covered calls and cash-secured puts), while higher levels allow uncovered (naked) writing and complex multi-leg strategies.

The Registered Options Principal (ROP) must review and approve each account before options trading begins. The ROP evaluates the customer's financial background, investment experience, and stated objectives to determine the appropriate approval level. Accounts must be reviewed periodically and may be upgraded or downgraded as circumstances change.

The Options Disclosure Document (ODD), published by the Options Clearing Corporation (OCC), is a standardized document titled "Characteristics and Risks of Standardized Options." It must be delivered to every customer at or before the time the account is approved for options trading.

The ODD explains the mechanics of options, the risks involved, and the characteristics of different options strategies. Firms must deliver the most current version of the ODD. Supplements to the ODD must also be provided when applicable, such as when new types of options products are introduced. Failure to deliver the ODD in a timely manner is a supervisory violation.

Exercise occurs when an option holder chooses to invoke their right to buy (call) or sell (put) the underlying security at the strike price. The OCC automatically exercises options that are in-the-money by $0.01 or more at expiration unless the holder provides contrary instructions.

Assignment is the process by which an option writer is obligated to fulfill the terms of the contract when the holder exercises. The OCC assigns exercises randomly among member firms, and each firm must then allocate assignments among its customers using either a random or first-in-first-out (FIFO) method. The ROP must ensure the firm's allocation method is fair and consistently applied.

A covered call writer owns the underlying security, limiting risk because the writer can deliver the shares if assigned. Covered writing is considered a conservative income strategy and is typically approved at lower account levels.

Uncovered (naked) writing involves selling options without holding the underlying security (for calls) or without sufficient cash or short position (for puts). Naked call writing carries theoretically unlimited risk, as the stock price can rise indefinitely. Naked writing requires the highest approval level and significant margin deposits. The ROP must carefully evaluate whether uncovered writing is suitable for the customer.

Position limits restrict the number of options contracts on the same side of the market (bullish or bearish) that any person or group of related persons can hold or control. Long calls and short puts are on the same side (bullish), as are long puts and short calls (bearish). Limits vary by underlying security based on trading volume and float.

Exercise limits restrict the number of contracts that can be exercised within a specified period (typically five consecutive business days). Exercise limits generally equal the position limits. Firms must monitor both limits and report positions that exceed reporting thresholds to the exchange. Violations can result in disciplinary action against both the customer and the supervising principal.

Options margin requirements differ significantly from equity margin. Long options (purchased calls and puts) must be paid for in full and are not marginable. Short (written) options require margin deposits because of the potential obligation to buy or sell the underlying security.

For uncovered equity options, the margin requirement is typically 100% of the option premium received plus 20% of the underlying stock's market value, less any out-of-the-money amount (with a minimum of the premium plus 10% of the underlying value). Spread positions have reduced margin requirements because the long leg limits the risk of the short leg. The ROP must ensure all accounts meet margin requirements and that margin calls are issued and enforced promptly.

Equity options are based on individual stocks and settle through physical delivery of the underlying shares. They are American-style, meaning they can be exercised at any time before expiration. Standard equity options represent 100 shares of the underlying stock.

Index options are based on stock indexes (such as the S&P 500 or Russell 2000) and settle in cash rather than through physical delivery. Broad-based index options are typically European-style (exercisable only at expiration), while narrow-based index options may be American-style. Index options are subject to different position limit rules and margin requirements than equity options. Supervisors must understand these distinctions to properly oversee customer trading activity.

LEAPS (Long-Term Equity Anticipation Securities) are long-dated options with expiration dates up to three years in the future. They function identically to standard options but provide a longer time horizon for the strategy to work, making them suitable for investors with a longer-term outlook.

LEAPS carry higher premiums than shorter-term options due to greater time value. They are available on selected equities and indexes. From a supervisory perspective, LEAPS require the same account approval as standard options, but the ROP should consider the larger capital commitment and the extended period of exposure when evaluating suitability.