Options Market Mechanics and OCC – Series 7 Exam
- April 1, 2025
- Posted by: 'FINRA Exam Mastery'
- Category: Finance
🧾 Options Market Mechanics and OCC – Series 7 Exam
📘 Understanding How Options Are Traded and Cleared for the Series 7
Options are a major focus on the Series 7 exam, and knowing how the options market functions—including the role of the Options Clearing Corporation (OCC)—is critical. Here’s a focused guide to help you master the market mechanics and clearing process you’ll need to know.
🎯 1. What Is the Options Clearing Corporation (OCC)?
The OCC is the central clearinghouse for all listed options trades in the United States.
Key Functions:
- Guarantees the performance of options contracts (reduces counterparty risk).
- Matches buyers and sellers after a trade is executed.
- Issues and standardizes option contracts (strike prices, expiration dates, etc.).
- Facilitates exercise and assignment of options.
Memory Tip:
💡 Think of the OCC as the “middleman” that ensures every buyer and seller gets what they are entitled to, no matter who the other party is.
🎯 2. The Lifecycle of an Options Trade
| Step | Action | Details |
|---|---|---|
| 1 | Order placed | Investor places a buy or sell order for an option. |
| 2 | Trade executed | Trade occurs on an exchange like CBOE, NYSE Arca. |
| 3 | OCC matches and clears | OCC steps in to guarantee both sides of the contract. |
| 4 | Position established | Long or short option position recorded. |
| 5 | Exercise or expiration | Option is either exercised or expires worthless. |
🎯 3. Important OCC Rules to Remember
- Options contracts are standardized:
- Strike prices, expiration months, and terms are set by the OCC, not by the parties trading.
- Exercise Process:
- When a holder wants to exercise an option, the broker-dealer notifies the OCC.
- The OCC uses a random assignment method to select a counterparty who holds the short (writer) position.
- Broker-dealers may assign clients using FIFO (First In, First Out) or random selection, based on firm policy.
- Settlement of Options Trades:
- T+1 settlement for listed options (trades settle the next business day after the trade date).
- Exercise of options:
- Equity options settle T+2 (like stock trades).
- Index options usually settle in cash the next business day (T+1).
🎯 4. Types of Options Markets
- Primary Options Market:
- Where the OCC issues new standardized option contracts.
- Secondary Options Market:
- Where investors buy and sell previously issued options on an exchange like the CBOE, NYSE Arca, or MIAX.
Key Point:
💡 You can buy and sell existing option contracts without involving the issuer (OCC) again.
🎯 5. Key Terms to Know for the Series 7
| Term | Definition |
|---|---|
| Assignment | When the writer (seller) of an option is selected to fulfill the contract terms. |
| Exercise Notice | Notification by the buyer to exercise their option rights. |
| Automatic Exercise | OCC will automatically exercise an option in-the-money by at least $0.01 at expiration unless instructed otherwise. |
| Open Interest | Total number of outstanding option contracts that have not been closed or exercised. |
| American Style | Options that can be exercised any time before expiration. |
| European Style | Options that can be exercised only at expiration. |
🎯 6. Quick Chart – Settlement Rules
| Action | Settlement Time |
|---|---|
| Options Trade | T+1 |
| Stock Delivery after Exercise | T+2 |
| Index Option Exercise (Cash Settled) | T+1 |
🚀 Conclusion: What You Need to Master for the Series 7
- Understand the role of the OCC and its guarantee mechanism.
- Know the standardization of options contracts.
- Memorize settlement timelines (T+1 for trades, T+2 for exercised stock delivery).
- Be familiar with exercise and assignment processes, including random assignment.
- Recognize the difference between American-style and European-style options.
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