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CBOE Rule 9.8: Supervision of Securities Accounts

Instructor: Byron Yee

Byron has over 5 years of experience in banking and investments and is currently a Candidate for the Chartered Financial Analyst (CFA) Institute. He also is registered with FINRA Series 7 and 66 and has his Life & Disability Insurance producers license for WA state. Previous to his career in banking, he spent 2 years in West Africa as a Peace Corps Volunteer and 4 years in China as an English teacher and financial analyst. Byron double majored in Theatre Arts and Business Administration at Western Washington University. In his free time he enjoys hiking, cycling, running, and being in the great outdoors with his family.

This lesson briefly describes options trading before discussing the role of a supervisor and compliance policies and practices as required by the CBOE.

Unknowingly Engaging in Illegal Activity

Brian works as a trader for Company ABC, an options trading brokerage firm. Last week, regulatory authorities delivered a notice to the company that Brian had committed trading activities that were illegal based on new trading laws. When asked about this, Brian said he was unaware of the new trading regulations, but later discovered he had missed his most recent policy training session. As a result, Brian's trading license was temporarily suspended and the company was required to pay a large fine.

Brian's violations may have truly been an honest mistake, however the failure of him and his company to ensure he was up-to-date on trading regulations led to very costly consequences. This is an example of why managing and maintaining strong compliance policies is so important for this particular industry. This lesson covers how to establish a good rulebook and the role of a supervisor.

Quick Overview of Options and CBOE

As a starting point for this lesson, it is important to quickly explain some key terms and concepts related to trading options.

Options are a contract that gives the holder the right, but not the obligation to buy or sell a stock at a set price. A call option is the right to buy a stock, while a put option is the right to sell a stock. Both of these types of options contracts are securities themselves, which means they can be bought or sold to other investors.

The Chicago Board Options Exchange (CBOE) is the exchange platform that manages the majority of options contracts bought and sold in the open market. Similar to the Securities Exchange Commission (SEC), which regulates equities on stock exchanges, CBOE has established a clear set of rules for traders and brokers when trading options.

The SEC requires brokers to obtain a license to legally trade stocks and bonds. Similarly, CBOE requires all options brokers to register their firm and employees in order to legally trade options contracts. A registered firm is referred to as a trading permit holder (TPH), which means they have been approved and are legally allowed to trade options through the CBOE.

Guidelines for Compliance

As you may have discovered by now, the securities industry is regulated by a lot of rules. While some seem very tedious, these regulations are in place to protect the customer, the investment firm, and the firm's employees. The CBOE requires all TPHs to develop a compliance plan, which is a firm's set of rules and policies that adhere to the CBOE's official rulebook. The policies covered in a firm's compliance plan generally include rules about:

  • Trading: The timing and procedures for processing an options trade request.
  • Data security: Guidelines for protecting sensitive customer and company information.
  • Ethical code: A guideline for behaviors and decisions when a person is confronted with an unclear or uncomfortable situation.
  • Auditing: Schedules and procedures for conducting regular audits of the firm's files, trading activity information, and making sure employees have a clear understanding of proper procedures.

Federal laws and a firm's specific policies are constantly being revised. In order for all staff members to be fully up to date on any policy changes, most regulatory organizations require employee training to be conducted at least annually. This ensures that all new and existing employees have a clear understanding of the most recent set of rules and regulations. In the opening example, this annual training was crucial for Brian to have be aware of, and therefore avoided violating new trading laws.

Now that we have a clear understanding of a compliance plan, we can discuss how supervision comes into play with these firms.

CBOE Rules on Supervision

Beyond just requiring each TPH firm to create a compliance plan, the CBOE also has rules for maintaining this plan and for the general supervision of trading operations. First, we should define a supervisor as a high level director or officer who is responsible for maintaining an updated compliance plan, monitoring trading activity to ensure operations are within the guidelines of this plan, and managing registrations and permits for the firm and its employees. Typically a firm has a dedicated compliance officer staff position who is the designated supervisor.

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