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. 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 (other than for an OCC-cleared OTC option).
• 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. If the branch office manager holds neither principal qualification, an ROP or Limited Principal-General Securities Sales Supervisor must approve or disapprove within 10 business days.
• 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. Account approval is an options-qualified job, not any principal's. If the branch office manager is neither an ROP nor a Limited Principal-General Securities Sales Supervisor, an ROP or Limited Principal-General Securities Sales Supervisor still has to approve or disapprove 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 the Verification Clock?

The signed options agreement is one of two separate 15-day clocks the exam tests:

• The signed agreement confirms the customer is aware of and agrees to comply with FINRA rules and OCC rules for options trading, has received the current ODD, and agrees not to violate position and exercise limits.
• For a natural-person customer, background and financial information (unless already included in the account agreement) is separately sent to the customer for verification within 15 days of approval, and again within 15 days whenever the firm learns of a material change in the customer's financial situation.
• Absent contrary notice from the customer, the information is deemed verified.
• Trading can begin once the ODD is delivered and the account is approved; the agreement and verification steps run on their own 15-day clocks afterward.

Exam Tip: Gotchas

The exam frequently tests the 15-day rule. The ODD must be delivered at or before account approval. The signed options agreement and the verification of customer information are two separate 15-day clocks that both start at approval. The options-account-opening rule states these deadlines but does not create an automatic closing-transactions-only restriction if the agreement runs late.

What Extra Review Applies to a Discretionary Options Account?

For a discretionary options account, a Registered Options Principal other than the one who accepted the account must separately review whether the accepting principal had a reasonable basis for believing the customer understood the proposed strategies and risks.

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 Ongoing Supervision Applies to Options Accounts?

The options rulebook requires ongoing supervisory systems addressing the compatibility of transactions with the customer's objectives, transaction size and frequency relative to resources, commission activity and account profit or loss, concentration in specific options classes, and margin compliance.

Statement frequency for options accounts comes from the options exchange rules: at least monthly to accounts with an entry with respect to an option contract during the preceding month, and at least quarterly to accounts with an open option position or money balance. This is a separate, options-specific standard from the general quarterly floor that applies to customer accounts overall.

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. It reflects the probability that the option moves into or further into the money before expiration, and is highest with more time to expiration and greater volatility. Time value decays as expiration approaches (time decay, or theta) and is zero at expiration, when the option is worth only 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?

• Keep the ODD's timing (at or before approval) separate from the two post-approval 15-day clocks (signed agreement, information verification).
• A branch manager who is neither an ROP nor a Limited Principal-General Securities Sales Supervisor still needs an ROP or Limited Principal-General Securities Sales Supervisor to approve or disapprove within 10 business days.
• 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.