Position Limit

A protective put is used primarily to:

1. A.Generate premium incomePremium income comes from writing options and collecting the premium. A protective put is bought, so the cash flows out rather than in, and the sign is backward. The description given here fits a covered call instead.
2. B.Increase leverageAdding a put to a long stock position shrinks net exposure rather than magnifying it, leaving less downside than holding the shares alone. Leverage would mean controlling more stock per dollar, not insuring what is already owned.
3. C.Limit downside risk on a long stock positionCorrect - it insures a long position.
4. D.Speculate on a price declineTrue of a standalone long put, which is exactly why it tempts. But protective specifies the put is held against shares the customer already owns, so a decline damages the stock and the put only offsets it. The motive is insurance on an existing position, not a bearish bet.

Why: Buying a put against a long stock position limits downside risk (a hedge).

A market maker carries a large short call position fully hedged with long stock. Regarding exchange POSITION LIMITS, the hedged position:

1. A.Must be liquidated within five daysWrong-but-tempting. Forced liquidation follows VIOLATIONS - hedged positions can be maintained.
2. B.Counts double against the limitWrong. No doubling penalty exists for hedged exposure.
3. C.May qualify for a hedge exemption permitting it to exceed the standard limitCorrect. Offsetting stock unlocks exemption capacity.
4. D.Is banned entirely for market makersWrong. Market makers rely on hedged books constantly.

Why: Exchange rules provide hedge exemptions allowing positions offset by the underlying or equivalents to exceed the standard contract limits upon qualification, since offset positions lack manipulative leverage. Citation: exchange position limit hedge exemption rules; FINRA Rule 2360(b)(3). Takeaway: bona fide hedges can outgrow the standard limits.

For purposes of exchange POSITION LIMITS on listed options, which positions are aggregated as being on the SAME side of the market?

1. A.Long calls with long putsWrong. Those are OPPOSITE directional bets.
2. B.Short calls with short putsWrong-but-tempting. A short straddle spans BOTH sides, not one.
3. C.All option positions regardless of directionWrong. Aggregation is directional by design.
4. D.Long calls with short putsCorrect. Both profit from rising prices - one bullish side.

Why: Position limits combine bullish positions (long calls + short puts) on one side and bearish positions (long puts + short calls) on the other, preventing evasion through equivalent structures. Citation: exchange position limit rules; FINRA Rule 2360(b)(3). Takeaway: aggregate by market direction, not option type.

The options exchanges impose both POSITION limits and EXERCISE limits on listed equity options. An exercise limit restricts:

1. A.The number of contracts on the same side of the market that an investor, or a group acting in concert, may exercise within any five consecutive business daysCorrect. The exercise limit is the five business day companion to the position limit.
2. B.The number of contracts a market maker may write in a single sessionThe limits apply to positions and exercises, not to a market maker's writing capacity in a session.
3. C.The number of contracts on the same side of the market that may be opened in a single trading dayNeither limit is expressed as a daily opening cap.
4. D.The number of contracts an investor may hold open at any one timeThat is the position limit, not the exercise limit.

Why: A position limit caps how many contracts on the same side of the market an investor, or a group of investors acting in concert, may hold open at one time. An exercise limit is the companion restriction on the way out: it caps the number of contracts on the same side of the market that may be exercised within any five consecutive business days. Without it, a trader could simply hold a permissible position and then demand delivery of an overwhelming quantity of stock, defeating the purpose of the position limit. Both limits aggregate accounts under common control, and bullish positions, long calls and short puts, count together on the same side.