Options Account Approval and Regulations

The final piece of options fundamentals is the regulatory framework. Before any customer can trade options, specific procedures must be followed under the options-trading rule, which sets the requirements, timelines, and consequences for non-compliance.

How Is an Options Account Opened and Approved?

Before approving an options account, the firm must complete a specific sequence:

1. Obtain background and financial information from the customer (for a natural person, at minimum):
   • Investment objectives
   • Employment status
   • 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
2. Deliver the Options Disclosure Document (ODD) at or before the time the account is approved
3. Have the branch office manager, a Registered Options Principal (ROP), or a Limited Principal-General Securities Sales Supervisor specifically approve or disapprove the account in writing
4. If the branch manager who initially approves isn't an ROP or a Limited Principal-General Securities Sales Supervisor, that decision must go to a qualified principal (ROP or GSSS) for approval or disapproval within 10 business days

The 15-Day Rules

• The customer must return the signed options agreement within 15 days of account approval
• If the agreement is not returned within 15 days, the account is restricted to closing transactions only (no new positions can be opened)
• The account is not frozen and not liquidated; it is just restricted to closing
• Separately, the firm must send a natural-person customer's background and financial information back for verification within 15 days after approval (unless it's already in the account agreement), and again within 15 days of learning of a material change in the customer's financial situation

Exam Tip: Gotchas

• The customer has 15 days to return the signed options agreement AFTER the account is approved. If not returned in time, the account is limited to closing transactions only (not liquidated, not frozen, just restricted).
• ODD must be delivered at or before account approval (not after).
• Don't confuse the customer's 15-day agreement return with the firm's separate 15-day verification mailing; they run on different triggers and serve different purposes.
• A non-ROP branch manager's initial approval isn't final. It must reach a qualified principal (ROP or Limited Principal-GSSS) within 10 business days.

What Are the Suitability and Approval Levels?

Options recommendations are subject to Regulation Best Interest (Reg BI) and suitability standards. The firm must assess whether the customer has sufficient knowledge and financial resources for the strategies being considered.

Customer accounts are typically approved at one of several levels (tiers), with each level permitting progressively riskier strategies:

• The ROP must review and approve each level of authorization
• A customer approved for Level 3 can also execute Level 1 and Level 2 strategies
• Naked writing (Level 4) carries the highest risk and requires the most financial resources
• Before a customer's first uncovered-writing transaction, the firm must deliver a special written risk statement for uncovered option writers, approved by FINRA, describing the risks of that strategy

Exam Tip: Gotchas

• Approval levels are progressive. A customer approved for Level 3 can also execute Level 1 and Level 2 strategies.
• Level 4 (naked writing) requires the most scrutiny because potential losses are theoretically unlimited.

What Are the Options Communications Rules?

The rules distinguish between communications sent before and after the customer receives the ODD:

Pre-ODD Communications

• Must be filed with FINRA at least 10 calendar days before use
• Permitted content: General descriptions of options, descriptions of exchanges and clearing agencies, contact information for obtaining the ODD
• Prohibited content: Recommendations, past or projected performance, names of specific securities

Post-ODD Communications

• Subject to the general content standards of the communications-with-the-public rule
• More flexibility in content since the customer has already received the risk disclosures
• Retail options communications (other than completed worksheets) need advance approval from an ROP
• Standardized-options communications may use projections and historical performance only after the ODD accompanies or precedes the communication, and any historical-performance material must cover at least the most recent 12 months
• A firm that fails these standards can be required to pre-file specified options communications for up to one year; that requirement takes effect 21 calendar days after written notice unless the firm requests a hearing

Exam Tip: Gotchas

• Pre-ODD communications cannot include recommendations, performance data, or specific security names. They must be filed with FINRA 10 calendar days before use.
• Post-ODD communications follow the standard communications-with-the-public rule, not the stricter pre-ODD requirements, but still need ROP approval and, for historical-performance material, at least 12 months of coverage.

What Reporting and Exercise Deadlines Apply?

• A firm must report an account once it reaches an aggregate position of 200 or more contracts on the same side of the market in puts and calls on the same underlying security or index. The report identifies interested persons and each class of contracts, due by the close of business on the next business day after the triggering transaction
• Standardized equity-option holders must make their final exercise or non-exercise decision by 5:30 p.m. ET on expiration (or the prior business day if expiration isn't a business day); a customer's Contrary Exercise Advice is due by 7:30 p.m. ET. These cutoffs don't apply to currency options or standardized index options
• A member relying on a permitted post-cutoff exception must document the circumstances and file the memorandum by 12:00 p.m. ET the next business day

Exam Tip: Gotchas

• The 200-contract report and the 5:30 p.m./7:30 p.m. exercise cutoffs are two different rules. One tracks large positions; the other governs the final decision to exercise. Currency options and standardized index options are exempt from the exercise-cutoff times.

What Should You Check on Exam Day?

• Account-opening sequence: background/financial information, ODD delivered at or before approval, written approval from the branch manager, an ROP, or a Limited Principal-GSSS
• Missing the 15-day options-agreement return restricts the account to closing transactions only
• Approval levels are progressive; Level 3 approval also permits Level 1 and Level 2 strategies
• Pre-ODD communications file with FINRA 10 calendar days ahead and exclude recommendations, performance, and named securities
• A 200-contract aggregate position triggers a next-business-day report; equity-option exercise decisions are due by 5:30 p.m. ET