US Options Market Regulations

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US Options Market Regulations

Technical and financial developments have resulted in the emergence of complex financial products and worldwide trading methods. Transparency, protocols, and control are at risk as a consequence of some of these advances. Preventing illicit conduct is becoming more difficult for regulators, and options, as intricate products, add many additional layers to the needed laws, with their varied brokerage costs, complex structures, and permitted leverage levels with high-risk exposure. In this essay, we will go through the fundamental legislation, regulating bodies, and activities for the US options market.

A regulated financial market’s principal goal is to safeguard the rights and interests of the average investor by enforcing the necessary set of regulations. Options regulators in the United States develop, register, standardize, update, or revise (as needed) the regulations governing options trading in the United States, which include:

  • Option chains with specified strike prices and expiration dates
  • Trading units
  • Lot size
  • Position holding limits
  • Limit exemptions for hedged holdings
  • Exercise mechanisms
  • Order reporting and exception handling policies
  • Off-exchange option transaction rules
  • Limiting leverage and margins
  • Short selling rules

Furthermore, authorities set trade reporting requirements, dispute resolution systems, and disciplinary measures against non-compliant persons and firms. The majority of these laws and restrictions are applied via brokerage companies.

As an underlying, an option contract may be traded on a stock/index or on forex/commodity/futures. These categories are governed by several organizations in the United States. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) supervise all option contracts traded over stock/index, whereas the Commodity Futures Trading Commission (CFTC) and the National Futures Association supervise option contracts traded over forex/commodity/futures (NFA).

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The Securities and Exchange Commission

The SEC was established in 1934 with the purpose of “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital creation.” It provides laws to guarantee that fair practices in markets are followed with full openness. The full set of SEC option trading guidelines may be seen here.

Financial Industry Regulatory Authority

FINRA, founded in 2007, is a non-governmental organization dedicated to investor protection and market dependability via regulation. Its primary aim is on guaranteeing market transparency and the compliance of security companies and brokers with a set of guidelines. FINRA operations are grouped into four categories:

  • Through training programs accessible on its website, it educates the public about investing, money management, fraud, and risk management.
  • Broker-dealer registration is required: all firms in the securities transaction industry in the United States must register with FINRA and become licensed brokers-dealers. If they do not, they may face fines, legal action, and perhaps a shutdown.
  • Exams and licensing for securities
  • Keeping track of disciplinary proceedings.

The thorough option regulatory guide from FINRA contains the option-specific requirements. Proposals from member exchanges are carefully reviewed for effect, and if appropriate, rule changes are enacted in line with the SEC.

The Commodity Futures Trading Commission

The CFTC, which was founded in 1974, is a federal agency that facilitates future trading in many industries such as agricultural, global markets, energy, and environmental markets. Its legislation strives to meet its objective of “protecting market participants and the public against derivatives fraud, manipulation, abusive practices, and systemic risk.” Individual traders may also submit complaints with the CFTC, and there is a whistleblower program. The CFTC monitors the following exchanges:

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  1. Chicago Board Options Exchange
  2. Chicago Board of Trade
  3. Chicago Mercantile Exchange
  4. HedgeStreet
  5. US Futures Exchange
  6. Kansas City Board of Trade
  7. Minneapolis Grain Exchange
  8. New York Mercantile Exchange
  9. New York Board of Trade
  10. OneChicago

The National Futures Association (NFA)

The National Futures Association (NFA) is the “primary independent supplier of efficient and creative regulatory initiatives that protect derivatives market integrity” (including options).The official NFA website has a full regulatory guidance (with choices). The following responsibilities apply to all NFA members:

  • To be a listed/registered NFA member.
  • Maintain key capital needs.
  • Record keeping and reporting for all transactions and associated company activity should be extensive.

Key US Options Regulations

Here are some of the key regulations in the U.S.:

  • Option traders in the United States are obliged to trade within the restrictions imposed by the relevant regulator.
  • Because short trading on options may often result in losses greater than the amount exchanged, leverage restrictions, margin requirements, and short positions are the most heavily regulated to protect investors and traders from unexpected hazards.
  • Option traders are obligated by law to maintain the minimum margin amount specified by the broker.
  • For FX short options, the notional transaction value plus the option premium received should be kept as a security deposit.
  • The whole option premium is required as a deposit for long options.
  • The first-in, first-out (FIFO) rule prohibits holding identical option positions.

The Bottom Line

The degree to which regulators assure smooth operation via defined norms, rules, and dispute resolution methods reveals the true efficiency of a specific market. While trading on complicated financial assets such as options and other derivatives in the hopes of making more money is always thrilling, care should be taken to ensure that the markets, participants, and facilitator businesses are effectively regulated.

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