Section 5.6 β€” Regulation & Procedures of the Options Market

  • πŸ”Ή Key Regulators:

    • OCC (Options Clearing Corporation)

      • Issues, standardizes, and guarantees performance of all listed option contracts.

    • CBOE (Chicago Board Options Exchange)

      • Primary exchange for trading listed options.

    • SEC (Securities and Exchange Commission)

      • Oversees both the OCC and CBOE as self-regulatory organizations (SROs).

πŸ”Ή The OCC (Options Clearing Corporation):

  • Acts as the issuer and guarantor of all listed option contracts.

  • Ensures the integrity of the market by standing between buyers and sellers.

  • Maintains uniform standards for strike prices, expirations, and contract sizes.

  • Designates contract specifications such as:

    • Strike prices

    • Expiration months

    • Contract size (usually 100 shares)

  1. βœ… Purpose: Standardization promotes liquidity and fairness across all exchanges.

πŸ”Ή Options Account Opening Process:

  • Suitability Check:

    • Registered representative must have reasonable grounds to believe options are suitable for the customer, based on financial situation and investment objectives.

  • Disclosure Document:

    • Customer receives the Options Disclosure Document (ODD), published by the OCC.

    • Explains risks, mechanics, and characteristics of options trading.

  • Account Approval:

    • Account must be approved by a Registered Options Principal (ROP) before any trades.

  • Trading Begins:

    • Customer can begin trading options after approval.

  • Options Agreement (within 15 days):

    • Must be signed and returned by the customer within 15 days of approval.

    • Confirms that the customer:

      • Read the ODD

      • Agrees to abide by OCC and exchange rules

    • ❗ If not returned within 15 days β†’ customer may not open new positions (can only close existing ones).

πŸ”Ή Trading, Settlement & Expiration

Event / Timing or Rule

  • Trading Hours / 9:30 AM – 4:00 PM ET

  • Settlement / T+1 (next business day)

  • Expiration / Third Friday of the expiration month at 11:59 PM ET

  • Exercise Window / From purchase until expiration

  • Automatic Exercise / Any contract in the money by β‰₯ $0.01 is automatically exercised unless β€œDo Not Exercise” instructions are given.

πŸ”Ή Exercise & Assignment Process:

  • Only the holder (buyer) of an option can exercise the contract.

  • When exercised:

    1. The holder notifies their broker-dealer.

    2. The broker-dealer notifies the OCC.

    3. The OCC randomly assigns the exercise to a writer (seller) who is short that contract.

    4. The writer must fulfill their obligation (deliver or buy shares, depending on the option type).

  1. βœ… The OCC guarantees that both sides of the transaction are honored.

Chapter 6

OCC

〰️

OCC 〰️

✺ Review questions ✺

  • A. FINRA
    B. SEC
    C. OCC
    D. CBOE
    βœ… Answer: C – The Options Clearing Corporation issues and guarantees options.

  • A. A margin agreement
    B. The OCC’s Options Disclosure Document (ODD)
    C. A copy of the CBOE rulebook
    D. Confirmation of the first trade
    βœ… Answer: B – They must receive and review the ODD.

  • A. 5 days
    B. 10 days
    C. 15 days
    D. 30 days
    βœ… Answer: C – It must be returned within 15 days.

  • A. The account is closed
    B. The customer cannot open new positions but can close existing ones
    C. All open positions are liquidated
    D. The ROP must reapprove the account
    βœ… Answer: B – They can only close existing positions.

  • A. The third Friday of the month at market close
    B. The third Friday of the month at 11:59 PM ET
    C. The first Monday of the month
    D. Noon on expiration Friday
    βœ… Answer: B – Expire on the third Friday at 11:59 PM ET.

  • A. The OCC
    B. The buyer (holder)
    C. The writer (seller)
    D. The broker-dealer
    βœ… Answer: B – Only the option holder has the right to exercise.