The OCC, the disclosure document and account approval

Who stands behind the contract, and what has to happen first

A listed option is not a private bargain between two investors. It is issued by the Options Clearing Corporation, which stands between the two sides of every trade: once a trade is matched, the buyer holds a contract against the OCC rather than against whoever sold it, and the writer owes the OCC rather than whoever bought. That is why a buyer never has to ask whether the writer is good for the money, and it is why exercise and assignment are handled centrally rather than between the two firms.

Because the product carries obligations an ordinary stock account does not, opening one is governed rather than left to the firm. The options disclosure document, formally titled Characteristics and Risks of Standardized Options, must be delivered to the customer at or prior to approval of the account for options trading. It is not a confirmation enclosure and it does not follow the first trade; it arrives before the account is cleared to trade at all, because its whole purpose is to inform a decision that has not yet been made.

Approval comes next, in writing, based on what the firm learns about the customer. A branch office manager, a Registered Options Principal or a General Securities Sales Supervisor approves or disapproves the account. If the branch office manager is not a Registered Options Principal or General Securities Sales Supervisor, one of those principals must approve or disapprove within ten business days. Only after approval is the last piece due: the written options account agreement must be obtained within fifteen days after the account has been approved for options trading. In it the customer acknowledges receiving the disclosure document and agrees to be bound by the rules of FINRA and of the Options Clearing Corporation.

The order is the whole point, and it is the part questions reverse. Disclosure, then approval, then the signed agreement within fifteen days of that approval. The fifteen days run from approval, not from the account opening, not from the first trade, and not from the day the paperwork was posted.

The firm uses facts about the customer’s financial situation, experience and objectives to decide whether options trading is appropriate and which types of trading to allow. Opening a stock account or reading the disclosure document does not itself supply options permission. Approval for one type of strategy should not be read as approval for every type.

The OCC also keeps existing contracts honest when the underlying company changes shape. Adjustments may be made to the standardized terms of outstanding stock options when events such as a stock dividend, a stock distribution, a stock split, a reverse stock split, a rights offering, a distribution, a reorganization, a recapitalization, a reclassification, or a merger, consolidation, dissolution or liquidation occur in respect of the underlying security. The purpose is preservation, not compensation: after a two-for-one split a 60 call over 100 shares typically becomes two 30 calls, each over 100 shares, so the aggregate exercise price is the $6,000 it always was. This typical split adjustment preserves the aggregate exercise amount. It does not promise that the option’s market value will stay fixed.

Exam terms

Options Clearing Corporation

The body that issues listed options and stands as counterparty to both sides.

Options disclosure document

Characteristics and Risks of Standardized Options, due at or before approval.

Account approval

A qualified principal’s written decision that the customer may trade options; the agreement clock starts here.

Options account agreement

The signed acknowledgment, due within fifteen days after approval.

Worked example

A firm approves an options account on 3 March and asks when each document was or is due.

1. The disclosure document was due at or before 3 March, the day of approval. Sending it later would not cure the failure, because the customer was approved without it.
2. Approval on 3 March starts the fifteen-day clock for the agreement.
3. The signed options account agreement is therefore due by 18 March, fifteen days after approval.
4. A trade placed on 5 March does not move either deadline. Trading activity is not the trigger; approval is.
5. In the agreement the customer acknowledges the disclosure document and agrees to be bound by FINRA and OCC rules, which is why the acknowledgment can only follow delivery.

Check yourself

Try a question, then read the explanation to review the rule.

Same rule, new context

Related practice

• Call vs put, buyer vs writerPractice this