Spreads, Straddles and Combinations

The disclosure document defines these positions for the investor. Cboe then defines the ORDER that establishes them, and the order definitions carry the ratio tests, the leg counts and the ticketing rules an exam scenario turns on.

What Is a Combination Position, and How Do Spreads and Straddles Differ?

The options disclosure document, Characteristics and Risks of Standardized Options, defines the family from the top down.

• Combination positions are positions in more than one option at the same time.
• Spreads and straddles are two types of combination positions.
• A spread involves being both the buyer and writer of the same type of option, puts or calls, on the same underlying interest, with the options having different exercise prices and/or expiration dates.
• A straddle consists of purchasing or writing both a put and a call on the same underlying interest, with the options having the same exercise price and expiration date.

Exam Tip: Gotchas

• The number of options involved does not separate a spread from a straddle. Both are combination positions, and a two-leg position can be either one.
• The spread definition turns on being both buyer and writer of the same TYPE. Puts against puts or calls against calls, with different exercise prices and/or expiration dates.
• The straddle definition allows a trader to be on one side of both options. It is purchasing or writing both a put and a call, so a long straddle and a short straddle both fit; what is fixed is the shared exercise price and expiration date.

What Makes an Order a Complex Order?

The Cboe definitions give the complex order five elements at once. It is an order or quote involving the concurrent execution of two or more different series in the same underlying security or index, called the legs or components.

The order must be for the same account, with its legs occurring at or near the same time, for the purpose of executing a particular investment strategy, and with no more than the applicable number of legs. The Exchange determines that number, and the classes in which complex orders are eligible for processing, on a class-by-class basis.

Unless the context otherwise requires, the term complex order includes Index Combo orders, stock-option orders and security future-option orders.

Exam Tip: Gotchas

• Two legs in the same series are not a complex order. The definition requires two or more DIFFERENT series in the same underlying security or index.
• The leg ceiling is not a fixed number in the rule. The Exchange sets the applicable number of legs class by class, so a scenario asserting a single course-wide limit is inventing one.
• A stock-option order is a complex order. So is an Index Combo order and a security future-option order, unless the context requires otherwise.

Which Complex Orders Conform, and What Happens to One That Does Not?

The definitions split complex orders into conforming and nonconforming on a ratio test. In both definitions the ratio represents the total number of units of the underlying stock or convertible security in the option leg or legs to the total number of units of the underlying stock or convertible security in the stock leg.

A conforming complex order is one of three things:

• A complex order with a ratio on the options legs greater than or equal to one-to-three or less than or equal to three-to-one.
• An Index Combo order.
• A stock-option order with a ratio less than or equal to eight-to-one.

A nonconforming complex order is a complex order with a ratio on the options legs less than one-to-three or greater than three-to-one, except for Index Combo orders, and a stock-option order with a ratio greater than eight-to-one.

Both definitions carry the same two conversion provisos, and each is scoped to a mixed order. For the purpose of applying these ratios to complex orders comprised of legs for both mini-options and standard options, ten mini-option contracts represent one standard option contract.

For the purpose of applying these ratios to complex orders comprised of legs for both micro-options and standard options, 100 micro-option contracts represent one standard option contract.

Nonconforming status costs the order electronic handling. Under the Cboe complex order rule, in classes the Exchange determines, a nonconforming complex order is not eligible for electronic processing, including the Complex Order Auction, the Complex Order Book, the Complex Automated Improvement Mechanism and the Complex Solicitation Auction Mechanism.

The order types rule adds the matching designation ban. In classes the Exchange determines, a User may not designate a nonconforming complex order as Electronic Only.

Exam Tip: Gotchas

• The Index Combo order is carved out of the nonconforming ratio test. It is conforming by name, and the nonconforming definition excludes it explicitly, so the one-to-three and three-to-one ratio test does not reach it; its own eight-to-one ceiling applies, and every other complex order provision still does.
• The mini-option and micro-option conversions apply to a MIXED order. Each proviso is written for an order comprised of legs for both the small contract and the standard contract, not for an order made up entirely of one of them.
• Ineligibility for electronic processing is class-specific. It applies in classes the Exchange determines, not automatically in every class.

Which Spread Strategies Does Cboe Define by Name?

The Cboe price protection rule defines five spread strategies for its complex order checks. Each definition is a leg count plus an expiration and exercise-price pattern.

The butterfly definition splits further. Where the middle leg's exercise price is the average of the other two it is a true butterfly; where the middle leg's exercise price is less in-the-money than that average it is a skewed butterfly. The System considers both to be a butterfly spread.

The vertical and calendar definitions each end with an exception. For the purposes of the debit and credit price reasonability check, the System considers a two-legged strategy with one P.M.-settled leg and one A.M.-settled leg with the same expiration date to be a diagonal spread where both legs have different exercise prices, or a calendar spread where both legs have the same exercise price.

One further protection sits next to those definitions. The System cancels or rejects a market order that would execute at a net debit price after receiving a partial execution at a net credit price.

Exam Tip: Gotchas

• A two-leg order with the same expiration is not automatically a vertical spread. Where one leg is P.M.-settled and the other A.M.-settled, the reasonability check treats it as a diagonal or a calendar spread instead, depending on the exercise prices.
• A skewed butterfly is still a butterfly. The middle strike need not be the exact average; if it is less in-the-money than the average, the System still treats the order as a butterfly spread.
• The box spread definition fixes the contract count. All four legs share the same expiration date and are for the same number of contracts, so an unequal-size four-leg order is not a box under this definition.

How Does Cboe Treat an Index or Index-Component Combination Order?

Two order shapes pair option series with an offsetting number of synthetic stock positions.

An Index Combo order is an order to purchase or sell one or more index option series and the offsetting number of index combinations defined by the delta. Within it, an index combination is a purchase (sale) of an index option call and a sale (purchase) of an index option put with the same underlying index, expiration date and strike price.

The delta is the positive (negative) number of index combinations that must be sold (purchased) to establish a market neutral hedge with one or more series of the same index option. The order may not have a ratio greater than eight options to one index combination.

It will be subject to all provisions applicable to complex orders in the Rules, excluding the one-to-three and three-to-one ratio.

The S&P 500 Index (SPX) Combo Order is the same shape written for that index. It is an order to purchase or sell one or more SPX option series and the offsetting number of SPX combinations defined by the delta.

An SPX combination is a purchase (sale) of an SPX call and a sale (purchase) of an SPX put with the same expiration date and strike price. The delta is the positive (negative) number of SPX combinations that must be sold (bought) to establish a market neutral hedge with one or more SPX option series.

Ticketing is where the rule gets specific. An SPX Combo Order for 100 legs or fewer must be entered on a single order ticket at the time of systemization.

If permitted by the Exchange, an SPX Combo Order for more than 100 legs may be represented or executed as a single SPX Combo Order if it is split across multiple order tickets, the Trading Permit Holder representing it uses the fewest order tickets necessary to systematize the order, and it identifies for the Exchange the order tickets that are part of the same SPX Combo Order.

An SPX Combo Order may execute only through the open outcry SPX Combo procedure.

A User may not designate an SPX Combo Order as Electronic Only.

Exam Tip: Gotchas

• The Index Combo order escapes one ratio and keeps another. It is subject to every complex order provision except the one-to-three and three-to-one ratio, and its own ceiling of eight options to one index combination still binds.
• The single-ticket requirement has a stated exit for a large order. Above 100 legs the order may be split across tickets, but only if the Exchange permits it, the representing firm uses the fewest tickets necessary, and it identifies the related tickets to the Exchange.
• The delta in these definitions is a count, not a percentage. It is the number of combinations that must be sold or bought to establish a market neutral hedge.

What Is a Multi-Class Spread Order?

A Multi-Class Spread Order is an order or quote to buy a stated number of contracts of a Broad-Based Index Option and to sell an equal number, or an equivalent number, of contracts of a related Broad-Based Index Option. It may execute only under the open outcry conditions of the Cboe crossing and open outcry rule.

For this order type only, the term Broad-Based Index Option means options on a named list of broad-based indexes, exchange-traded funds and exchange-traded notes. The definition then opens.

It also reaches any other Broad-Based Index, or any other exchange-traded fund or note derived from a Broad-Based Index, that the Exchange determines creates an appropriate hedge with any other Broad-Based Index Option.

The rule then names the permitted combinations, and any other combination of related Broad-Based Index Options the Exchange determines.

A User must enter a Multi-Class Spread Order on a single order ticket at the time of systemization to be eligible for the procedures and relief the Rules provide for it, and may not designate it Electronic Only.

Exam Tip: Gotchas

• Both lists in this definition are open, not closed. The instrument list and the combination list each end with a clause letting the Exchange add what it determines is a related or appropriately hedging product.
• The two sides need not be an equal number of contracts. The definition allows an equal number or an equivalent number of contracts of the related option.
• The single-ticket rule here is a condition of relief, not of validity. Entering the order on one ticket at systemization is what makes it eligible for the procedures and relief the Rules provide.

What Should You Check on Exam Day?

• Separate the position from the order: the disclosure document defines the spread and the straddle, while Cboe's definitions govern the order that establishes them.
• On a ratio question, identify the stock leg first, then apply one-to-three and three-to-one to option legs and eight-to-one to a stock-option order.
• Check whether the order mixes mini-options or micro-options with standard options before applying either conversion proviso.
• On a two-leg strategy with one A.M.-settled and one P.M.-settled leg, reclassify it as diagonal or calendar before answering.
• Count the legs on an index-component combination order, and apply the single-ticket rule at 100 legs or fewer.