Options Accounts

Options carry more risk than ordinary stock positions, so opening an options account has stricter documentation, disclosure, and approval steps than a cash or margin account, and FINRA's options rule sets them. The Series 63 focus is on the sequence and timing of those steps, plus how an option's premium breaks down.

What Has to Happen Before an Options Account Can Trade?

Three things must happen around the time an options account is opened:

• Deliver the ODD: the customer must receive the Options Disclosure Document (ODD) at or before the time the account is approved for options trading.
• Principal approval: a branch office manager, Registered Options Principal (ROP), or Limited Principal-General Securities Sales Supervisor must approve or disapprove the account in writing.
• Signed agreement: the customer must sign and return the options account agreement within 15 days after the account is approved.

Exam Tip: Gotchas

ODD timing: delivered at or before account approval, not afterward. Approval comes from a branch office manager or an options-qualified principal, not from any principal; a non-qualified branch office manager's approval needs options-principal confirmation within 10 business days.

What Information Must the Firm Gather Before Approving the Account?

Before approving an options account for a natural-person customer, the firm must exercise due diligence to obtain, at minimum:

• Investment objectives (safety of principal, income, growth, trading profits, speculation)
• Employment status (employer, self-employed, or retired)
• Estimated annual income and net worth (excluding the family residence)
• Estimated liquid net worth
• Marital status and number of dependents
• Age
• Investment experience and knowledge across options, stocks and bonds, commodities, and other instruments

This information gathering is more detailed than the standard new-account information required for a basic cash account.

What Happens With the Agreement and Verification After Approval?

The customer must sign and return the options account agreement within 15 days after the account is approved.

• The signed agreement confirms the customer is aware of and agrees to comply with FINRA rules and Options Clearing Corporation (OCC) rules for options trading, has received the current ODD, and agrees not to violate position and exercise limits.
• For a natural-person customer, the firm sends the customer's background and financial information for verification within 15 days of approval, unless it was already included in the account agreement.
• Trading can begin once the ODD is delivered and the account is approved; the signed agreement follows on its own 15-day clock.

If the firm becomes aware of a material change in the customer's financial situation, it must send the background and financial information on file to the customer for verification within 15 days of learning of the change. The signed agreement's deadline still runs from account approval.

Exam Tip: Gotchas

The ODD must be delivered at or before account approval, while the signed options agreement is due within 15 days after approval. A late agreement does not automatically restrict the account to closing transactions only.

What About Uncovered (Naked) Option Writing?

For customers writing uncovered short options, the firm must maintain specific written procedures covering:

• Suitability criteria and standards for approving the strategy
• Written approval by a Registered Options Principal
• A designated principal for approving accounts that do not meet standard criteria
• Minimum net equity requirements

What Suitability Standard Applies to Options?

A firm may not recommend an options transaction unless it has reasonable grounds to believe the recommendation is suitable, based on the customer's investment objectives, financial situation, and needs.

For an opening transaction, the representative must have a reasonable basis for believing the customer has sufficient knowledge and financial capacity to evaluate and bear the risks. This standard applies when the firm recommends the trade.

An unsolicited order is not a recommendation, so the recommendation-suitability rule does not apply to it. The account must still be approved for options trading before the order can be accepted.

How Is an Option's Premium Valued?

An option's premium has two components:

Option Premium = Intrinsic Value + Time Value

Intrinsic value can never be negative. If the formula produces a negative number, intrinsic value is zero and the option is out-of-the-money.

Time value (extrinsic value) is the part of the premium above intrinsic value. All else remaining the same, more time and greater volatility generally increase it. It usually decays as expiration approaches (time decay, or theta), but changing pricing inputs can alter that pattern. Time value is zero at expiration, when the option is worth its intrinsic value or nothing.

Worked examples, with XYZ stock trading at $55:

• An XYZ 50 Call has intrinsic value of $5 ($55 - $50). If the premium is $8, time value is $3 ($8 - $5).
• An XYZ 60 Put has intrinsic value of $5 ($60 - $55). If the premium is $7, time value is $2 ($7 - $5).
• An XYZ 60 Call has no intrinsic value (out-of-the-money). If the premium is $2, the entire $2 is time value.

Exam Tip: Gotchas

Calls are ITM when the market is above the strike; puts are ITM when the market is below the strike. If a calculated intrinsic value would be negative, the answer is zero, not a negative number.

What Should You Check on Exam Day?

• Deliver the ODD at or before approval. The signed agreement is due within 15 days after approval; re-verification information is sent within 15 days after the firm learns of a material financial change.
• Options account approval comes from a branch office manager or an options-qualified principal, not from any principal.
• The options-account rules do not state that a late signed agreement automatically restricts the account to closing transactions only.
• For valuation questions, compute intrinsic value first (never negative), then find time value as premium minus intrinsic value.
• Match calls to "above the strike" and puts to "below the strike" for in-the-money status.