Compare and contrast the exercise procedure for stock options with that for index options. What major advantages does exercising an index option have over exercising a stock option?( refer attached material)

2.1. Options Markets 2.1.1. The Development of Derivative Markets Many derivative securities were introduced as ways of providing a hedge against risk. As a result, financial risk management has been a growth business since the beginning of the 1970s. The growth was due to the new sources of risk, such as interest rates, exchange rates, and market fluctuations, which were introduced in the 1970s. US interest rates had been stable until the mid-1960s. As the United States entered the Vietnam War in the early 1960s and the US initiated substantial domestic assistance programs, the inflation and the interest rates started to rise. It was in the beginning of the 1970s that the Bretton Woods era of fixed exchange rates started to collapse. The flexible exchange rates were officially adopted in 1973, and the world entered into a new era of increased volatility in the foreign exchange markets. It is not just a coincidence that the first foreign exchange futures were introduced in 1972, and the first (non-currency) financial futures were introduced in 1975. This was a futures contract on the GNMA pass-through security. Shortly thereafter, new financial futures on a variety of instruments came into existence. These newlyintroduced financial futures markets, together with already existing forward markets, provided valuable function of risk management. Also, it was in 1973 that the Chicago Board Option Exchange (CBOE) began trading options on New York Stock Exchange-traded stocks. However, it was not until 1980 that various exchanges started to trade options on instruments other than stocks, such as options on foreign exchange rates, options on interest rates, options on indexes, and options on futures. These derivative securities were brought into the financial markets because the participants needed them, i.e., because of the demand. These derivative securities can be understood as different types of insurance policies. It is very natural that these derivative securities are very risky because any insurance policy is extremely risky. A life insurance policy itself is extremely risky. Most of the time (so far, always) you lose your investment, but there is a very slim chance that your beneficiary gets a huge return (?). However, when the insurance policy is combined with the underlying asset, the whole package becomes a safe asset. 2.1.2 The History of CBOE It was in this conjunction (i.e., the introduction of new sources of risk) that the Chicago Board Option Exchange (CBOE) began trading options on New York Stock Exchange-traded stocks in 1973. The CBOE has been the largest option exchange; its market share is about 35% of all option trading. Now in this section, we'll go over a brief history of CBOE. 1973 * The Chicago Board Options Exchange (CBOE), founded in 1973, revolutionized options trading by creating standardized, listed stock options. CBOE was originally created by the Chicago Board of Trade (CBOT) but has always been managed and regulated as an independent entity. * April 26, the first day of trading, sees 911 contracts traded on 16 underlying stocks. 1975 * Computerized price reporting was introduced. * The Options Clearing Corporation was formed. * The Black-Scholes model was adopted for pricing options. 1977 * Trading in put options begins. * SEC places a moratorium on options expansion pending an in-depth review of the rapidly growing derivative securities market. 1980 * The CBOE and Midwest Stock Exchange consolidate their options businesses. 1983 * CBOE continues to revolutionize the options industry by introducing options on broad-based stock indexes. * On March 11, 1983, CBOE launched the CBOE-100 Index, which was later renamed theS&P 100 Index (OEX), and on July 1, 1983, options trading on the S&P 500 Index (SPX)was launched. 1984 *As volume accelerated rapidly, CBOE quickly outgrew its trading facilities in the Chicago Board of Trade and, in February 1984, moved into its current 10-story building across the street from the CBOT and next to the Chicago Stock Exchange. * Annual volume at CBOE exceeds 100 million contracts for the first time. * CBOE launches its Retail Automatic Execution System (RAES) to facilitate electronic order execution. 1985 * CBOE forms The Options Institute, whose mission is to educate investors around the world about options. * Options on NASDAQ stocks are listed. * The New York Stock Exchange begins listing equity options. 1987 * Stock market crashes in October and interest in derivatives wanes. 1989 * CBOE begins trading options on interest rate products. Options on Interest Rates allow investors to take a position on interest rate movements or hedge their interest rate exposure. Options are based on the 13-week U.S. Treasury Bill yield, and on the 5-year, 10-year, and 30-year yields to maturity of U.S. Treasury Notes and Bonds. * CBOE introduces EBook, the first electronic customer limit order book. 1990 * CBOE creates Long-term Equity AnticiPation Securities, or LEAPS, which are long-term options in equity, index, and interest rate classes that allow investors to establish positions that can be maintained for a period of up to three years. 1992 * The Options Industry Council is formed as an industry body devoted to the expansion of investor education. * Sector indexes begin trading at CBOE. 1993 * CBOE introduces FLEX options, which allow investors to create certain specifications on options contracts. * Market makers on the CBOE trading floor use electronic, hand-held terminals. * CBOE unveils the VIX, a market volatility index that gauges investor sentiment, widely referred to as the "fear gauge." 1997 * CBOE introduces options on the Dow Jones Industrial Average. * Myron Scholes and Robert Merton are awarded the Nobel Prize in Economics for their development of the Black-Scholes model for pricing options. * CBOE acquires NYSE options trading business. New York options traders move to Chicago and the CBOE's "Green Room"-- an auxiliary trading floor off of the main trading floor that became the home for many transplanted NYSE traders. 1998 * CBOE annual volume surpasses 200 million contracts for the first time. 1999 * CBOE converts to Designated Primary Market Maker system, ensuring that specialists maintain fair and orderly markets and always provide continuous, two-sided markets. * CBOE introduces ROS, the Rapid Opening System, significantly shortening the time taken for the opening rotation. 2000 * SEC adopts CBOE plan to link U.S. options markets. * CBOE average daily volume exceeds 1 million contracts for the first time. * Annual volume at CBOE surpasses 300 million contracts for the first time. 2001 * CBOE launches CBOEdirect, the exchange's screen-based trading system that is initially used for extended hours trading. * Securities industry completes transfer from fractional pricing to pricing in decimals, narrowing spreads and reducing costs for investors. * Interim intermarket linkage among the options exchanges begins. * CBOE develops the VXN volatility index, based on the Nasdaq-100 Index and a complement to the VIX volatility index. 2002 * CBOE continues expansion of electronic trading systems. * CBOE begins development of a Hybrid Trading System that will marry the strengths of open outcry trading with the efficiencies of screen-based trading. 2003 * CBOE debuts CBOEdirect HyTS, the Hybrid Trading System. * CBOE and the other options exchanges successfully complete their intermarket linkage program. * CBOE celebrates the 20th anniversary of index options trading and the 30th anniversary of the exchange and industry. 2004 The CBOE Futures Exchange, LLC (CFE) launched trading with futures on the CBOE Volatility Index (VIX). 2006 VIX options are launched. 2010 CBOE converts to publicly-traded corporation, CBOE Holdings, with IPO ceremony held on the trading floor. C2, an all-electronic exchange, launches. As of May 29, 2015, there are 12 exchanges in the U.S, where options are traded, as shown in the next table. Many of those started trading options in recent years. BATS began trading options in Feb. 2010. C2 Option Exchange, CBOE's all-electronic options exchange launched in the fall of 2010. MIAX began option trading in Dec. 2012. ISE's Gemini launched option trading in Aug. 2013. Exchange Market Share Exchange Market Share AMEX 6.69% GEM 4.23% ARCA 8.26% ISE 12.71% BATS 10.86% MIAX 7.48% BOX 2.23% NOBO 0.68% C2 2.55% NASDAQ NOM 6.72% CBOE 24.11% PHLX 13.48% As of May 29, 2015, the CBOE and C2 together hold about 26.66% market share of the total options industry volume. It is much lower compared to 15 years ago, when it commanded about 45%market share. The CBOE has been losing ground to NASDAQ OMX and to the International Securities Exchange (ISE), which hold 20.88% and 16.94% market shares, respectively. NASDAQ's market share is composed of PHLX (Philadelphia exchange), NASDAQ NOM (NASDAQ's online options exchange) and, NOBO (Boston Exchange). ISE's market share is based on ISE and Gemini, ISE's second option exchange. NYSE has also 14.95% market share through AMEX and ARCA, which NYSE acquired in 2009 and 2005, respectively. 2.1.3. The Over-the-Counter Options Markets Even though the CBOE has enjoyed the lion's share in the options market, it was not without competition. Actually, very keen competition has taken place between the exchanged-traded options markets and over-the-counter (OTC) options markets. Many CBOE products, such as LEAPS and Flex options, have been introduced as ways of competing against the OTC options markets. OTC options are can be tailored to individual clients' needs. The client arranges the option with his or her bank or merchant bank instead of buying an 'off-the-peg' model, such as an exchange-traded option, so that details (amount, maturity, and price) are arranged between client and bank. Over-the-counter options cannot be traded but they can be sold back to the bank or investment bank that initiated the transaction. These options are a useful hedging device and like exchange-traded options they involve the cost of a premium. The OTC options markets has the following advantages and disadvantages compared to the organized options market, or the exchanged-traded options markets. Advantages 1. Tailor-made options = flexibility 2. Privacy 3. Unregulated Disadvantages 1. Credit risk exists 2. Large transaction size 2.2. Basics of Options Trading 2.2.1. How Options Work Much like stocks, options can be used to take a position on the market in an effort to capitalize on an upward or downward market move. Unlike stocks, however, options can provide an investor the benefits of leverage over a position in an individual stock or basket of stocks reflecting the broad market. At the same time, options buyers also can take advantage of predetermined, limited risk. Conversely, options writers assume significant risk if they do not hedge their positions. An option is the right, but not the obligation, to buy or sell a stock (or other security) for a specified price on or before a specific date. A call is the right to buy the stock, while a put is the right to sell the stock. The person who purchases an option, whether it is a put or a call, is the option "buyer." Conversely, the person who originally sells the put or call is the option "seller." Options are contracts in which the terms of the contract are standardized and give the buyer the right, but not the obligation, to buy or sell a particular asset (e.g., the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration). To the buyer, an equity call option normally represents the right to buy 100 shares of underlying stock, whereas an equity put option normally represents the right to sell 100 shares of underlying stock. The seller of an option is obligated to perform according to the terms of the options contract -- selling the stock at the contracted price (the strike price) for a call seller, or purchasing it for a put seller -- if the option is exercised by the buyer. All option contracts trade on U.S. securities exchanges are issued, guaranteed, and cleared by the Options Clearing Corporation (OCC). OCC is a registered clearing corporation with the SEC and has received "AAA" credit rating form Standard & Poor's Corporation. The "AAA" credit rating corresponds to OCC's ability to fulfill its obligations as counter-party for options trades. The price of an option is called its "premium." The potential loss to the buyer of an option can be no greater than the initial premium paid for the contract, regardless of the performance of the underlying stock. This allows an investor to control the amount of risk assumed. On the contrary, the seller of the option, in return for the premium received from the buyer, assumes the risk of being assigned if the contract is exercised. In accordance with the standardized terms of their contracts, all options expire on a certain date, called the "expiration date." For conventional listed options, this can be up to nine months from the date the options are first listed for trading. There are longer-term option contracts, called LEAPS, which can have expiration dates up to three years from the date of the listing. American-style options (the most commonly traded) and European-style options possess different regulations relating to expiration and the exercising of an option. An American-style option is an option contract that may be exercised at any time between the date of purchase and the expiration date. Conversely, a European-style option (used primarily with cash settled options) can only be exercised during a specified period of time just prior to expiration. 2.2.2. Terminology (1) Types of options There are two types of options, calls and puts. Call Options The buyer of an equity call option has purchased the right to buy 100 shares of the underlying stock at the stated exercise price. Thus, the buyer of one XYZ June 110 call option has the right to purchase 100 shares of XYZ at $110 up until June expiration. The buyer may do so by filing an exercise notice through his broker or trading firm to the Options Clearing Corporation prior to the expiration date of the option. All calls covering XYZ are referred to as an "option class." Each individual option with a distinctive trading month and strike price is an "option series." The XYZ June 110 calls would be an individual series. Put Options The buyer of a put option has purchased the right to sell the number of shares of the underlying stock at the contracted exercise price. Thus, the buyer of one ZYX June 50 put has the right to sell 100 shares of ZYX at $50 any time prior to the expiration date. In order to exercise the option and sell the underlying at the agreed upon exercise price, the buyer must file a proper exercise notice with the OCC through a broker before the date of expiration. All puts covering ZYX stock are referred to as an "option class." Each individual option with a distinctive trading month and strike price is an "option series." The ZYX June 50 puts would be an individual series. Class of Options All calls and puts on a given underlying security or index represent an "option class." In other words, all calls and puts on XYZ stock are one class of options, while all calls and puts on ZYX index are another class. Series All options of a given type (calls or puts) with the same strike price and expiration date are classified as an "option series." For example, all XYZ June 110 calls would be an individual series, while all XYZ June 110 puts would be another series. Example: IBM options Calls - Dec 2009 Puts - Dec 2009 Strike Last Bid Ask Volum Intere Last e st 115.0 13.8 13.7 13.8 0 0 5 5 15 120.0 9.05 9.05 9.10 0 125.0 4.80 4.80 4.90 0 433 Bid Ask Volum Intere e st 0.19 0.18 0.19 543 9,575 18 2,511 0.45 0.44 0.45 695 8,032 745 13,91 1.20 1.20 1.22 1,243 4 6,348 130.0 1.81 1.80 1.82 2,055 0 8,749 3.15 3.15 3.20 788 4,124 135.0 0.46 0.43 0.46 1,565 0 6,899 6.62 6.80 6.90 184 358 140.0 0.08 0.08 0.09 0 230 1,374 11.7 11.4 11.5 0 0 5 115 389 145.0 0.02 0.02 0.03 0 10 711 17.9 16.3 16.5 5 5 0 30 107 (2) Contract Size A standard exchange-traded option contract consists of 100 individual options. However, if the stock splits or the company declares a stock dividend, the contract size should be adjust for the changes. The next example shows such cases. Try the third case by yourself. Example: What adjustments to the contract terms of the CBOE options would be made in the following situations? 1. An option has an exercise price of $100. The company declares a 10% percent stock dividend. One contract = 1.1 x 100 = 110 shares Exercise price (X) = $100/1.1 = $90.91 2. An option has an exercise price of $40. The company declares a two-for-one stock split. Two contracts for every one formerly held Exercise price (X) = $40 / 2 = $20 3. An option has an exercise price of $60. The company declares a four-for-three stock split. 4. An option has an exercise price of $40. The company declares a cash dividend of $.55. No adjustment is needed. Click here for the correct answers to the third case above. (3) Exercise Price (X) = Striking Price = Strike Price The price at which the option holder may buy or sell the underlying security, as defined in the terms of his option contract, is the strike price. It is the price at which the call holder may exercise to buy the underlying security or the put holder may exercise to sell the underlying security. The exercise price intervals are determined by the price of the underlying assets as follows: Price range Exercise Price Interval P X Stock Price X (5) American-style versus European-style Options The following table summarizes the differences between these two different styles of options. American-Style * An option contract that may be exercised at any time between the date of purchase and the expiration date. * Most exchange-traded options are American-style. European-Style *An option contract that may be exercised only during a specified period of time just prior to its expiration. (6) Expiration Date The day on which an option contract becomes void is the expiration date. The expiration date for listed stock options is the Saturday after the third Friday of the expiration month. Holders of options should indicate their desire to exercise, if they wish to do so, by this date. Automatic Exercise A protection procedure whereby the Options Clearing Corporation attempts to protect the holder of an expiring in-the-money option by automatically exercising the option on behalf of the holder is known as automatic exercise. Expiration cycle An expiration cycle relates to the dates on which options on a particular underlying security expire. A given option, other than LEAPS, will be assigned to one of three cycles, the January cycle, the February cycle, or the March cycle. The available expirations are the current month, the next month, and the next two months within the cycle. January cycle February cycle March cycle Jan - Apr - Jul - Oct Feb - May - Aug - Nov Mar - Jun - Sep - Dec (7) Premium The price of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the option contract is the premium. (8) Position Limits and Exercise Limit The maximum number of put or call contracts on the same side of the market that can be held in any one account or group of related accounts is known as position limits. Short puts and long calls are on the same side of the market. Short calls and long puts are on the same side of the market. Limits vary according to the number of outstanding shares and past six-month trading volume of the underlying stock. The largest in capitalization and most frequently traded stocks have an option position limit of 250,000 contracts on the same side of the market; smaller capitalization stocks have position limits of 200,000, 75,000, 50,000 or 25,000 contracts on the same side of the market. The number of contracts on the same side of the market that may be exercised within any five consecutive business days is equal to the position limit. These limits are set by the appropriate option exchange, it is designed to prevent an investor or group of investors from "cornering" the market in a stock. 2.2.3. Options on Various Types of Underlying Assets . (1) Equity Options Example: IBM options (11/23/2009) -- IBM stock price: $128.62 (CBOE.com) Example: IBM options (11/23/2009) -- IBM stock price: $128.62 (CBOE.com) Calls - Dec 2009 Strike Last Bid Ask Puts - Dec 2009 Volum Interes Last Bid e t 115.0 13.8 13.7 13.8 0 0 5 5 15 120.0 9.05 9.05 9.10 0 18 125.0 4.80 4.80 4.90 0 745 433 Ask Volum Interes e t 0.19 0.18 0.19 543 9,575 2,511 0.45 0.44 0.45 695 8,032 13,914 1.20 1.20 1.22 1,243 6,348 130.0 1.81 1.80 1.82 2,055 8,749 3.15 3.15 3.20 788 4,124 0 135.0 0.46 0.43 0.46 1,565 6,899 6.62 6.80 6.90 0 184 358 140.0 0.08 0.08 0.09 0 230 1,374 11.7 11.4 11.5 0 0 5 115 389 145.0 0.02 0.02 0.03 0 10 711 17.9 16.3 16.5 5 5 0 30 107 The above table shows only a small portion of the options traded on IBM stock. The (open) interest is the number of outstanding option contracts in a particular class or series of option. The volume and open interest are usually high for the options with the exercise price close to the current stock price. (2) Index Options An index option is a call or put based on a stock market index such as S&P 500 or DJIA. Like equity options, index options offer the investor an opportunity to either capitalize on an expected market move or to protect holdings in the underlying instruments. The difference is that the underlying instruments are indexes. Index options may be tied to the price of either broad-based indexes like the S&P 500 Index, DJIA, or the Russell 2000 Index or to narrow-based indexes, which is an index that is limited to a particular industry like the mining industry or the semiconductor industry. Index options are cash-settled. When an index option is exercised by its holder, and when an index option writer is assigned, cash changes hands. Only a representative amount of cash changes hands from the investor who is assigned on a written contract to the investor who exercises his purchased contract. Example: Index Options Mr. A purchases a March 110 index call at 2.25. The multiplier for that option is 100. Q: How much is the dollar amount of the premium? A: The premium is calculated as $2.25 x 100 = $225 Q: If Mr. A exercises the call option when the index goes up to 120, what is the profit from the investment? A: 100 x {(120 - 110) - 2.25} = 100 x 7.75 = $775 Example: S&P 500 Index options (11/23/2009) -- Underlying index value: 1109.84 (CBOE.com) Calls - Dec 2009 Strike Last Bid Puts - Dec 2009 Ask Volume Interest Last Bid Ask Volume Interest 1,105 22.70 22.20 23.30 1,818 22,020 19.50 19.00 19.70 1,595 18,902 1,110 20.00 19.40 20.40 4,522 42,799 21.00 21.20 21.90 5,164 13,080 1,115 17.60 16.80 17.80 13,272 23.60 23.00 24.40 50 101 1,120 15.15 14.50 15.30 1,080 12,194 25.31 25.60 27.10 42 136 1,125 12.95 12.30 13.10 6,271 76,333 28.05 28.30 29.90 58 5,833 1,130 11.00 10.40 11.10 13,792 31.05 31.20 32.90 40 304 2,880 10,410 53.20 34.40 36.30 1 65 1,135 8.95 8.70 9.40 104 505 The following are some of the index options traded on the CBOE with their ticker symbols. Underlying Index Ticker Symbol Underlying Index Ticker Symbol DJIA DJX S&P 500 SPX Russell 2000 RUT S&P 100 American OEX NASDAQ 100 NDX S&P 100 European XEO NASDAQ 100 Tracking Stock QQQ CBOE Volatility Index VIX (3) Futures Options Futures options give their holders the right to buy or sell a specified futures contracts. A call option holder receives upon exercise net proceeds equal to the difference between the current futures price on the specified asset and the exercise price of the option. (4) Foreign Exchange Options (FX Options, Currency Options) A currency option offers the right to buy or sell a quantity of foreign currency for a specified amount of domestic currency. The FX options market is the deepest, largest and most liquid market for options of any kind in the world. Most of the FX option volume is traded over-the-counter (OTC) and is lightly regulated, but a fraction is traded on exchanges like the International Securities Exchange, Philadelphia Stock Exchange, which is now owned by NASDAQ. (5) Interest Rate Options Interest Rate Options are options on the spot yield of U.S. Treasury securities. Available to meet the investor's needs are options on short-, medium- and long-term rates. CBOE lists options based on the yield-to-maturity of the most recently auctioned 13-week U.S. Treasury Bill (IRX), 5-year Treasury Note (FVX), 10-year Treasury Note (TNX) and the 30-year Treasury Bond (TYX). Interest Rate Options features: Cash settled. Interest Rate Options are settled in cash. There is no need to own or deliver any Treasury securities upon exercise. Contract size. Interest Rate Options use the same $100 multiplier as options on equities and stock indexes. European-style exercise. The holder of the option can exercise the right to buy or sell only at expiration. This eliminates the risk of early exercise and simplifies investment decisions. In general, when yield-based option positions are purchased, a call buyer and a put buyer have opposite expectations about interest rate movements. A call buyer anticipates interest rates will go up, increasing the value of the call position. A put buyer anticipates that rates will go down, increasing the value of the put position. A yield-based call option holder will profit if, by expiration, the underlying interest rate rises above the strike price plus the premium paid for the call. Conversely, a yield-based put option holder will profit if, by expiration, the interest rate has declined below the strike price less the premium. Underlying values for the option contracts are 10 times the underlying Treasury yields (rates) - 13-week T-bill yield (for IRX), 5-year T-note yield (for FVX), 10-year Tnote yield (for TNX) and 30-year T-bond yield (for TYX). An annualized discount rate of 5.5% on the newly auctioned 13-week Treasury bills would place the underlying value for the option on short-term rates (IRX) at 55.00. A yield-to-maturity of 6% on the 30-year T-bond would place the underlying value of the yield-based option on the 30-year T-bond (TYX) at 60.00. When Treasury rates change, corresponding underlying values for the options on interest rates also change. For example, if the yield-to-maturity on the 30-year Tbond increases from 6.25% to 6.36%, TYX would move from 62.50 to 63.60. For every one percentage point rise or fall in interest rates, underlying values would rise or fall 10 points. Exchange-listed options are created on an exchange, which is a legal corporate entity whose members are individuals or firms. each membership is referred to as seat. Membership generally entitles one to physically go onto the trading floor and trade options. The following table shows the most recent prices of a seat at the CBOE. Click here for the most current information. 2.2.4. Options Traders Exchange-listed options are created on an exchange, which is a legal corporate entity whose members are individuals or firms. each membership is referred to as seat. Membership generally entitles one to physically go onto the trading floor and trade options. The following sections discuss the types of traders who operate on the CBOE trading floor. (1) DPM (Designated Primary Market-Maker) The DPM (Designated Primary Market-Maker) is the trading firm designated by the exchange to insure that a fair and orderly market is kept in their assigned option classes traded on the CBOE. The DPM is physically located on the CBOE trading floor, is the main point-of-contact to brokerage firms regarding trading issues, and also performs the roles of a market-maker. In return, the DPM has certain participation rights on orders traded both electronically and via open outcry in assigned classes. In addition to the DPM is the e-DPM who fulfills all the obligations of the DPM, but does so from a remote location. All equity options listed on the CBOE have a DPM. (2) Market-Maker A market-maker trades options for his own accounts, providing liquidity in the market place. Marketmakers trade in a different way from investors. They typically are not concerned about the long-term direction an underlying stock or index price might take. Instead, they earn money by making tiny profits on each trade, and are interested in trading as many options as possible. Many market-makers focus on trading fluctuating implied volatility levels, or taking advantage of overor undervalued option prices (with respect to put-call parity). (3) Floor Broker A floor broker is a broker on the exchange floor who executes the orders of public customers or other investors who do not have physical access to the trading area. (4) Order Book Official Order Book Official is the exchange employee in charge of keeping a book of public limit orders on exchanges utilizing the market-maker system, as opposed to the specialist system, of executing orders. 2.2.5. Trading Options (1) Different types of orders The next table summarizes different types of orders an investor can place to trade options. Market Order An order to buy or sell securities at the current market. The order will be filled as long as there is a market for the security. Limit Order An order to buy or sell securities at a specified price (the limit). A limit order may also be placed "with discretion." In this case, the floor broker executing the order may use his/her discretion to buy or sell at a set amount beyond the limit if he/she feels it is necessary to fill the order. Good Until A designation applied to some types of orders, meaning the order remains Canceled (GTC) in effect until it is either filled or canceled. Order Stop Order An order, placed away from the current market, that becomes a market order if the security trades at the price specified on the stop order. Buy stop orders are placed above the market while sell stop orders are placed below. Stop-Limit Order Similar to a stop order, the stop-limit order becomes a limit order, rather than a market order, when the security trades at the price specified on the stop. Condition Price below the limit Buy Limit-buy order Stop-buy order Sell Action Price above the limit Stop-loss order Limit-sell order (2) Option Clearing Corporation (OCC) The Option Clearing Corporation (OCC) is the issuer of all listed option contracts that are trading on the national option exchanges. The formation of the OCC in 1973 as the single, independent, universal clearing agency for all listed options, eliminated the problem of credit risk in options trading. Every options Exchange and every brokerage firm that offers its customers the ability to trade options is a member or is associated with a member of the OCC. The OCC stands in the middle of each trade becoming the buyer for all contracts that are sold and the seller for all contracts that are bought. Thus, the OCC is, in fact, the issuer of all listed options contracts and is registered as such with the SEC. (3) Margin Requirement (for options) In the stock market, "margin" refers to buying stock or selling stock short on credit. A margin customer pays for half (50%) of the cost of buying stock (the margin) and the brokerage firm lends the customer the balance. Margin customers are required to keep securities on deposit with their brokerage firms as collateral for their borrowings. Buyers of options can now buy equity options and equity index options on margin, provided the option has more than nine (9) months until expiration. The initial (maintenance) margin requirement is 75% of the cost (market value) of a listed, long-term equity or equity index put or call option. One who takes a "long" position in a non-marginable put option or call option is required to pay the premium amount in full. In the options market, "margin" also means the cash or securities required to be deposited by an option writer with his brokerage firm as collateral for the writer's obligation to buy or sell the underlying interest, or in the case of cash-settled options to pay the cash settlement amount, if assigned an exercise. Minimum margin requirements currently are imposed by the options markets and other self-regulatory organizations, and higher margin requirements may be imposed either generally or for certain positions by the various brokerage firms. The initial margin is the minimum amount of funds the investor supplies on the day of the transaction. The maintenance margin is the minimum amount of funds required each day thereafter. The margin requirement is calculated daily. The following table shows the margin requirements of some basic positions. A written option is considered to be uncovered if the investor does not have an offsetting position in the underlying security. For example, an uncovered call is a transaction in which an investor writes a call on stock not already owned. Stock Initial margin: 50% purchases Maintenance margin: 25% and short sales Option purchase Writing uncovered options Options with maturities of nine months or less must be paid for in full. That is, the margin requirement is 100%. Options with maturities of greater than nine months can, however, be margined. An investor can borrow up to 25% of the cost of these options. {Premium {20%* of the stock's }+ value} - the amount by which the call is out-of-themoney * 15% for index options The margin must be at least the option market value plus 10% of the value of the stock. If X > S, where X is the exercise price and S is the stock price, Writing then no additional margin is required. The premium on the covered call option can be used to reduce the margin required on the stock. options If X