Seller Option Settlement

Barnaby Quill sells bonds to a dealer under a SELLER'S OPTION contract that calls for delivery in 20 business days rather than regular way. Which statement about that trade is correct?

1. A.The trade nevertheless settles regular way, because negotiated settlement terms are not enforceableSeller's option settlement is a recognized contract term and displaces regular way settlement.
2. B.The seller must deliver on the stated date and may never deliver earlierEarly delivery is permitted with one business day's written notice.
3. C.The buyer may demand delivery at any time after the trade dateThe option belongs to the seller, so the buyer cannot accelerate settlement.
4. D.Settlement occurs on the agreed date, but the seller may deliver earlier after giving the buyer written notice one business day in advanceCorrect. The seller holds the flexibility and may accelerate delivery with proper notice.

Why: In a seller's option contract the parties negotiate a settlement date later than regular way, and the option belongs to the seller. Settlement occurs on the agreed date, but the seller may deliver ahead of that date after giving the buyer written notice one business day in advance. The buyer cannot demand early delivery, and cannot refuse delivery that arrives with proper notice. Sellers use the arrangement when securities are not immediately available for delivery.

Ingrid arranges with the contra party that her corporate bond trade will settle in 20 business days rather than on the regular-way cycle. Separately, she enters an order for a new municipal issue that has been awarded to the syndicate but not yet delivered by the issuer. These two arrangements are known, respectively, as:

1. A.A seller option trade and a when-issued tradeCorrect. Seller option is a negotiated settlement beyond the regular-way cycle; when-issued applies to a security authorised or awarded but not yet delivered.
2. B.A cash trade and a seller option tradeA cash trade settles the same day the trade is made, which is the opposite of the 20-day arrangement described.
3. C.A buyer option trade and a delayed delivery tradeThe extended settlement here was arranged for the seller benefit, and the new issue situation has its own established name, when-issued.
4. D.A when-issued trade and a seller option tradeThese are reversed. The negotiated 20-day settlement is the seller option; the undelivered new issue is when-issued.

Why: A seller option trade is a negotiated settlement later than regular way, agreed between the parties at the time of the trade. A when-issued trade is one in a security that has been authorised or awarded but not yet issued and delivered, so settlement waits until the securities actually exist in deliverable form.