Posted By Chuck Lowenstein, Senior Editor
Updated: July 28, 2017
Hello Series 4 and 9 students! In your License Exam Manuals we speak to recognizing risk when you see it as being an important skill needed to operate as a Registered Option Principal – ROP (Series 4) or a Branch Office Manager – BOM (Series 9). That’s easy when the risk is option position related. For example, knowing that short naked calls, short straddles, and short stock / short put hedge positions all have unlimited maximum loss potential should go without saying.
But let’s speak more specifically to when the risk is to your firm regarding suspicious trade activity or related to a customer account running afoul of the rules. The first line of defense in spotting such occurrences usually comes with screening trade blotters documenting daily customer account activity. While the style and format of a trade blotter is left to the in-house design of each individual broker dealer making no two exactly alike, they all generally carry the same basic information.
From a testing perspective, how might this risk assessment skill arise during your licensing exam? Expect that you might be asked to assess potential risk while looking at a facsimile of a trade blotter in conjunction with some general market or account information given. For example, consider the following:
Using both the market and account information above, assess the trade blotter below for red flags that might indicate violations or potential risks.
|Trade Date||Account Name||Transaction Executions/Prices||Order Type|
|May 18||Leaf Fund||Buy 4000 ZYX June 30 calls @ 3||LMT|
|May 18||Leaf Fund||Buy 4000 ZYX June 35 calls @ 1||LMT|
|May 18||Marie Jones||Buy 5000 shares CBA @ 52||MKT|
|May 18||Marie Jones||Buy 200 May 50 calls @ 2.1||MKT|
|May 18||John Smith||Sell short 100 shares NML @ 39.95||MKT ON CLOSE|
|May 18||Marie Jones||Buy 200 June 55 calls @ 3.5||MKT|
|May 18||Leaf Fund||Write 4000 ZYX June 50 puts @ 11||LMT|
Let’s look at the potential red flags an ROP or BOM should spot when looking at the day’s trade blotter:
1. Account, Leaf Fund - RED FLAG / POSITION LIMIT: Account buys a total of 8,000 ZYX calls and writes 4,000 ZYX puts (long calls and short puts are both on the same side of the market; Bullish). The combined calls and puts of 12,000 contracts exceed the 10,000 contract ZYX position limit.
2. Account, Marie Jones - RED FLAG / INSIDER TRADING: Prior to the positive patent approval announcement after Friday’s close this account went long 5,000 shares of stock and long a total of 400 calls giving the account control over 40,000 additional shares. All buys were entered as market orders. The timing of the transactions just prior to the positive announcement and the willingness to pay any available price using market orders could be a sign indicating inside information.
3. Account, John Smith - RED FLAG / CAPPING: Already short May 40 NML calls the account sells short 100 shares of NML @ 39.95 on the close of May expiration. This could be a sign of “capping”. Capping is an effort to keep the stock price down by shorting near to or on the close so that the stock can’t close above the strike price of calls one is already short in their account. In essence, it is effort to keep from getting assigned on the short calls.
While the positon limit example above is a clear violation, the examples indicating capping and insider trading would need to be reported immediately and investigated further to determine if they were truly violations. They should however initially be spotted as being suspicious.
Students should expect to see questions on test day aligning with the above; Market or account information followed by a trade blotter with the task at hand being to spot potential red flags.