Mastering Option Account Supervision On The Series 9 Exam

One of the keys to passing the series 9 exam is to make sure that you have a complete understanding of how option account supervision will be tested on the Series 9 Exam. This article which was produced from material contained in our series 9 textbook and will help you master the material so that you pass the series 9 exam.


Option Account Supervision

Customer option accounts require strict supervision to ensure compliance with all relevant rules and to ensure that customers only trade options within their approval limits. As customers and agents manage positions, it is quite possible for a customer’s account to end up with an option position that is not within the customer’s approval limit.

ROSFPs must review customer accounts frequently to ensure customers stay within their approved guidelines. It would be quite possible for a customer whose account is approved for covered calls only to end up with a naked option position if they sold the underlying stock without covering the short options. If a customer’s account contains a position which is outside of its approval limit, written procedures must be in place detailing how to appeal to the ROSFP for an exception or the options must be covered promptly. ROSFPs must pay close attention to the relationship between customer approval limits and customer positions. When reviewing customer accounts, a ROSFP should also pay close attention to:

  • Any churning or excessive commissions earned from the account
  • The amount of options positions relative to the size of the account
  • Frequent Reg. T extensions
  • Profits and losses for option trades
  • Suitability
  • Any unauthorized transactions
  • Any positions established that cannot result in a profit or are not economical
  • Any suspicious activity i.e. trading on inside information and front running
  • Ensure the customer does not exceed position limits
  • Any manipulative activity such as capping or pegging

It is quite possible for an investor or trader to use options to profit unduly from the knowledge of a large order and to front run the block by entering an order to buy or sell options on the stock. Similarly, a trader or investor could use options to trade on inside information and to profit unduly from non-public material information. To guard against these situations, ROSFPs will look at the account’s option trading history and the time the option order is executed relative to the block transaction or relative to the release of material information. Orders executed just prior to a block transaction or just prior to the release of material information are more suspicious than orders executed much earlier. Additionally, transactions that are outside the account’s normal trading practices would raise a red flag as well. For example, if an account’s normal option trade is 10 contracts and the order being examined is for 100 contracts that would be a cause for concern.

An option trader who has a large option position may be tempted to try to manipulate the price of the underlying stock through capping or pegging. An investor who is long a large number of put contracts may be tempted to enter orders at the end of the day to sell the underlying security to keep the stock price down. This action would be an example of capping. If the same trader was short a large number of put contracts, the trader may be tempted to enter orders at the end of the day to buy the underlying security to keep the stock price up. This would be an example of pegging. Both capping and pegging activities should be guarded against by the ROSFP and are more likely to occur in the firm’s proprietary trading account or in the account of an institutional customer.

Large Option Position Reporting Requirements

Member firms are required to report certain large option positions to the OCC that are established for any account, or for any group of accounts acting in concert. Firms must file a large option position report (LOPR) once the position established exceeds the filing threshold on the same side of the market. For most securities the current filing threshold is 200 contracts on the same side of the market. Firms are required to file the initial LOPR data, as well as any changes in reportable positions to the OCC via the LOPR submission message. Once the data is collected by the OCC, the OCC will in turn provide the data to the self regulatory organizations. Firms are required to send their LOPR batch file to the OCC no later than 8:00 PM CST on or before T+1. The date that the firm establishes, modifies or closes an LOPR is know as the effective date. Firms are only required to send an LOPR submission to update a report when there is:

  • An increase in a reported position
  • A decrease in a reported position
  • A reported position is closed

If a firm reports a large option position for an account it is required to report any changes to that position as long as the position remains above the threshold limit. If the previously reported position falls below the contract threshold the firm only needs file the reduction in the number of contracts in a single report. No subsequent reports are required for the position as long the position remains below the threshold limit.

TAKE NOTE!
The test may refer to the effective date of an LOPR submission as the trade date.

Customer Confirmations and Account Statements

All customers must be provided with a trade confirmation when an option order is executed. All confirmations must be sent to the customer no later than the option’s settlement date or T+1. Option trade confirmations must disclose:

  • The type of option
  • The type of transaction, buy or sell
  • The underlying security
  • The number of contracts
  • The exercise price
  • The expiration date
  • If the transaction was to open or close
  • The trade date
  • The settlement date
  • The premium and amount due or owed
  • The commission charged
  • If the firm acted as a principal or as an agent in the transaction

A customer must receive a statement every month in which there is activity in the account. All customers must receive account statements at least quarterly when there has been no activity in the account. Examples of activity include:

  • Purchases and sales
  • Dividend and interest received
  • Interest charged
  • Addition or withdrawal of cash or securities

Customer account statements must show:

  • All positions in the account
  • All activity since the last statement
  • All credit and debit balances

Brokerage firms are required to disclose their financial condition to their clients by sending them a balance sheet every six months or on the request of a customer with cash or securities on deposit. Customer account statements must be maintained for six years and account statements must contain a notice requesting that the customer notify the firm of any material changes in their investment objectives or financial status.

Customer Complaints

All written complaints received from a customer or from an individual acting on behalf of the customer must be reported promptly to the principal of the firm. The firm is required to:

  • Maintain a copy of the complaint in a central file
  • Maintain a record of the date the compliant was received
  • Maintain a record of the representative handling the account
  • Maintain a record of any corrective action taken

The firm must maintain a separate customer complaint folder, even if it has not received any written customer complaints. If the firm’s file contains complaints, the file must state what action was taken by the firm, if any, and it must disclose the location of the file containing any correspondence relating to the complaint. Branch offices must forward complaints to the central file within 30 days of receipt.

TAKE NOTE!
A principal is required to review all written customer complaints but there is no required time frame to respond or take action.