Meme Stock Phenomenon Sparks FINRA Crackdown

As option traders, we of course must pay close attention to the rules of the game. Most of the time, trading regulations are clearly spelled out and identifiable. With new technology and an influx of thousands of retail options traders, a number of issues have come up that have caught the attention of the SEC. Right on schedule, the regulatory fallout from the GameStop saga of earlier this year is beginning to have an impact on market participants. The Financial Industry Regulatory Authority (FINRA) recently announced that it will be conducting a focused review of broker-dealer “practices and controls” with regards to supervising options account trading of their retail clients. Let’s take a look at how the process works and how this news will likely impact options traders.

How the Process Works

The Securities & Exchange Commission (SEC) is the overriding federal entity that has the authority to set the direction and focus of federal policy in response to various retail trading issues. As such, the SEC then seeks to gather info through various methods to identify the problem and determine a solution. FINRA is then charged with creating the specific rules that put the SEC’s policies into effect. FINRA’s application of these mandates most directly impacts brokers and is subsequently felt by traders as well.

In a publicly released examination letter, FINRA indicates that broker-dealers must provide information related to self-directed options trading accounts and accounts in which registered representatives recommended options. The letter excludes both institutional and managed accounts and covers the period from Jan. 1, 2020, to the date of letter (Aug. 10).

According to FINRA, it will examine how brokers gauge retail customers’ eligibility to trade, what features and privileges are made available to the customer, the procedures that firms use to approve new clients, as well as the types of options trading that is permitted. The FINRA letter noted covered calls and cash-secured puts, call and put spreads of every type (long and short), and naked short options as examples. The review on options trading will look into brokers’ written supervisory procedures (WSPs), as well as their compliance manuals. A big thing that could affect retail options traders is that FINRA will be gathering information about how brokers treat options account openings, as well as the due diligence firms perform related to them.

What It Means for Traders

Here is where the impact may be the greatest for traders. FINRA will be specifically identifying the way broker-dealers review existing options accounts and how brokers determine whether those accounts require restrictive trading limits or may even be deemed as ineligible for options trading. Notably, they will be looking to see if the broker required customers to open margin accounts or otherwise be approved for margin in connection with the options activity. They will want to know if the broker has any technology and/or process for systematic approval or denial of margin accounts. FINRA is asking brokers to describe instances where options limitations (account approval or transactions in options accounts) were not appropriately applied, and any steps taken to date to prevent future breaches of requirements.

This all means that your status and ability to trade different strategies might be affected. Depending on the findings of FINRA, new restrictions might be implemented that could disqualify you from being able to trade options.

Stay Tuned

It will be in traders’ best interest to stay tuned to this topic and watch for any guidance that will be provided by their brokers and regulators. During the next several months, traders should make certain they do not violate any margin rules and stay well within their risk limits, so they don’t get flagged and possibly restricted.

Joe Leska, Market Taker Mentoring

Trader Education