Exercise Limits, Reports and Liquidation

The position limit measures what is held at a moment in time. The exercise limit measures what is exercised across a rolling window of five consecutive business days.

A position inside the position limit can still break the exercise limit, because a holder who exercises it, rebuilds it and exercises it again inside the same five days has exercised both amounts, and the rule counts the aggregate long positions exercised in that class.

Long calls and long puts in the same class also count together for the exercise limit, while the position limit keeps them on opposite sides of the market, so a holder inside the position limit on both sides can still exceed the exercise limit.

Who Does the Exercise Limit Bind, and Over What Period?

The Cboe exercise limits rule is built like the position limits rule. Except with the prior permission of the President or a designee, to be confirmed in writing, no Trading Permit Holder shall exercise a long position in any option contract, for any account in which it has an interest or for the account of any customer, in two situations.

Each is triggered where the firm or the customer, acting alone or in concert with others, directly or indirectly:

• Has or will have exercised within any five consecutive business days aggregate long positions in any class of options dealt in on the Exchange in excess of 25,000 or 50,000 or 75,000 or 200,000 or 250,000 option contracts, or such other number as the Exchange fixes from time to time as the exercise limit for that class.
• Has or will have exceeded the applicable exercise limit fixed from time to time by another exchange for an option class not dealt in on the Exchange, when the Trading Permit Holder is not a member of the other exchange which lists the option class.

Three cross-references decide the numbers. Limits are determined in the manner the fund-product interpretation describes, or in the case of a hedged position under the equity hedge exemptions, or in the case of a facilitation exempted position under the firm facilitation exemption. The Exchange must publicly post reasonable notice of each new exercise limit it fixes.

Whether option positions should be aggregated under the exercise limits rule is determined by the same control and aggregation interpretation that governs position limits.

One product carve-out closes the rule. Binary options and credit options are not subject to exercise limits.

Exam Tip: Gotchas

• The two limits run on different clocks over different positions. The position limit caps the aggregate position on the same side of the market at a point in time; the exercise limit caps long positions actually exercised across any five consecutive business days.
• The window is rolling, not calendar. It is any five consecutive business days, so a firm cannot reset the count by starting a new week.
• The exercise limit applies to a long position being exercised. The rule speaks of exercising a long position, and it aggregates by class of options rather than by underlying security.

Which Exercise Limits Apply to Index and Fund Options?

For index option contracts, exercise limits are equivalent to the position limits prescribed for option contracts with the nearest expiration date under the broad-based index, industry index, and individual stock or ETF based volatility index option position limits.

A separate paragraph covers range options (the same limits as options on the same underlying index).

There are no exercise limits for broad-based index options, including reduced-value option contracts and micro-option contracts, on the same named classes that carry no position limit, a list including the S&P 500 Index (SPX) and the Cboe Volatility Index (VIX). Four further provisions refine the calculation.

Options on shares or other securities representing interests in qualifying registered investment companies take exercise limits equivalent to the position limits prescribed for those options in the fund-product interpretation, subject to any exemptions granted in respect of those position limits.

That equivalence carries the chart across. The fifteen named exchange-traded products fix the exercise limit as well as the position limit for those products.

Exam Tip: Gotchas

• The index exercise limit borrows the nearest expiration's number. It is equivalent to the position limit prescribed for contracts with the nearest expiration date, not to the largest limit in the class.
• An exemption becomes the exercise limit rather than adding to it. Where an index or volatility index position has been granted a hedge exemption, the exercise limit equals the amount of that exemption.
• Two capped-style products drop out of the calculation entirely. They are not counted when calculating exercise limits for index option contracts.

Which Exercise Limits Apply to FLEX Options?

Exercise limits for flexible exchange (FLEX) index options and FLEX individual stock or ETF based volatility index options are equivalent to the FLEX option position limits.

There are no exercise limits for the named broad-based FLEX index options, including reduced-value option contracts and FLEX index option contracts with a multiplier of one.

Those named classes are SPX, VIX, NDX, XND, OEX, RUT, DJX, XEO, VXN, VXD, SPEQF, SPEQX, the S&P 500 Dividend Index, BXM at one-tenth value, and the three Cboe S&P 500 classes (AM/PM Basis, Three-Month Realized Variance and Three-Month Realized Volatility).

For determining compliance with the exercise limits in that paragraph, 100 FLEX index option contracts with a multiplier of one equal one FLEX index option contract with a multiplier of 100 with the same underlying index.

FLEX options also carry minimum exercise sizes, which are floors on the size of an exercise rather than ceilings on the total.

• The minimum value size for a FLEX equity option exercise is 25 contracts or the remaining size of the position, whichever is less.
• The minimum value size for a FLEX index option exercise is $1 million Underlying Equivalent Value, or the remaining Underlying Equivalent Value of the position, whichever is less.

Finally, except as the third-Friday aggregation rule and the cash-settled fund carve-out provide, FLEX options shall not be taken into account when calculating exercise limits for non-FLEX option contracts.

Exam Tip: Gotchas

• The minimum exercise size has a built-in escape. It is the stated figure or the remaining size of the position, whichever is less, so a small residual position can still be exercised in full.
• FLEX positions are generally invisible to non-FLEX exercise limits. The exercise limits rule names only the third-Friday aggregation and the cash-settled fund carve-out; the FLEX position limits rule separately brings same-day FLEX individual stock or ETF based volatility index options into the exercise limits.
• The two minimums are measured in different units. The equity minimum is a contract count; the index minimum is an Underlying Equivalent Value in dollars.

Which Customer Positions Must a Firm Report?

The Cboe position limit reports rule attaches three duties to positions, and each has its own trigger.

The large-position report. In a manner and form the Exchange prescribes, each Trading Permit Holder shall report the name, address, and social security or tax identification number of any customer who, acting alone or in concert with others, on the previous business day maintained aggregate long or short positions on the same side of the market of 200 or more contracts of any single class of option contracts dealt in on the Exchange.

The report shall indicate, for each such class of options, the number of option contracts comprising each position and, in the case of short positions, whether covered or uncovered.

The hedged-position report. Each Trading Permit Holder other than an Exchange market-maker or a Designated Primary Market-Maker (DPM) that maintains a position in excess of 10,000 non-FLEX equity option contracts on the same side of the market, on behalf of its own account or for the account of a customer, shall report whether those positions are hedged and provide documentation as to how they are hedged.

Where the Exchange determines that a higher margin requirement is necessary for an under-hedged non-FLEX equity option position of more than 10,000 contracts on the same side of the market, it may consider imposing additional margin on the account, and the carrying clearing firm is subject to capital charges to the extent of any resulting margin deficiency.

The over-limit report. Each Trading Permit Holder shall report promptly to the Department of Market Regulation any instance in which it has reason to believe that a customer, acting alone or in concert with others, has exceeded or is attempting to exceed the position limits.

Exam Tip: Gotchas

• The large-position trigger is far below the equity limits. It bites at 200 contracts in a single class, well under the 25,000-contract lowest equity limit.
• The report is measured on the previous business day. It captures the position as maintained then, not the position at the moment the report is filed.
• An attempt is reportable, not just a breach. The firm must report where it has reason to believe a customer has exceeded or is attempting to exceed the limits.
• The short-position detail is part of the report. For short positions the firm must state whether each is covered or uncovered.

Who Counts as a Customer for These Reports?

The reporting rule widens the word customer for its own purposes: it adds four categories to the ordinary meaning.

• The Trading Permit Holder itself.
• Any general or special partner of the Trading Permit Holder.
• Any officer or director of the Trading Permit Holder.
• Any participant, as such, in any joint, group or syndicate account with the Trading Permit Holder, or with any partner, officer or director of it.

Exam Tip: Gotchas

• The firm reports on itself. The widened definition puts the Trading Permit Holder inside the term customer for this rule, so a proprietary position at the trigger is reportable.
• The definition is scoped to this rule. It widens "customer" for purposes of the Cboe position limit reports rule, not for the position limits or exercise limits rules generally.

What Happens When a Position Exceeds the Limit?

The Cboe position liquidation rule gives the Exchange a remedy separate from discipline. It is triggered by a finding of the President or a designee, made on the basis of a report of the Department of Market Regulation or otherwise.

The finding is that a person or group of persons acting in concert holds or controls, or is obligated in respect of, an aggregate position, whether long or short, in all option contracts of one or more classes or series dealt in on the Exchange in excess of the applicable position limit.

On that finding, the President or the designee may order all Trading Permit Holders carrying a position in option contracts of those classes or series for that person to liquidate the position as expeditiously as possible consistent with the maintenance of an orderly market.

A second consequence follows automatically once such an order is given. No Trading Permit Holder shall accept any order to purchase, sell or exercise any option contract for the account of the person or persons named in the order, unless and until the President or the designee expressly approves those persons for options transactions.

Exam Tip: Gotchas

• The trigger reaches three relationships, not one. The person may hold the position, control it, or be obligated in respect of it, and the position may be long or short.
• The trading ban that follows is total for that person. It covers orders to purchase, to sell and to exercise, so the person cannot even trade out of the position through a Trading Permit Holder without approval.
• Reinstatement requires an express approval. The ban runs unless and until the President or a designee expressly approves that person for options transactions.

What Should You Check on Exam Day?

• Ask whether the scenario measures a position at a point in time or exercises across a window, because only the second is an exercise limit question.
• Count the exercises across any five consecutive business days, not across a calendar week or a single day.
• For an index option, take the exercise limit from the position limit for contracts with the nearest expiration date, and check the no-limit list first.
• Test each reporting trigger separately: 200 contracts in a class and over 10,000 non-FLEX equity contracts for the hedged-position report.
• On a liquidation order, remember the firm may then accept no purchase, sale or exercise order for that person until an express approval.