Tier 1 Approval, Short Strangles, and a Retroactive Upgrade
Bright Harbor's options matrix has four tiers; tier 1 is covered calls and protective puts only. Client Patel, approved at tier 1 in 2022, has $95,000 and a moderate-growth objective. Over six weeks his rep, Kim, executes 14 short strangles and 6 uncovered puts in Patel's account, describing them in emails as 'covered because we hold cash to buy the stock if assigned.' Patel's cash covers only 2 of the 6 puts. Patel recently inherited $300,000 and told Kim he now wants 'more action.' Kim emails you: 'He's rich now, so bump him to tier 4 and I'll keep going - can you approve retroactively?' The strangles are currently about $40,000 underwater.
1. Was the trading within the account's approval? Identify the supervisory failures.
Read the worked answer
No - every one of those 20 orders exceeded tier 1.
- A short strangle is short a call and short a put. The short call is uncovered unless the shares are owned; the short put is uncovered unless cash is fully reserved. 'We hold cash' covers nothing unless the cash is dedicated to a single put's full assignment obligation - here, 2 of 6.
- Approval levels are strategy-specific and cumulative risk matters. Tier 1 permitted covered calls and protective puts. Nothing on the record permitted short strangles or cash-secured puts, and Patel's cash could not support the puts even if they had been approved.
- Failures to name: no strategy-level check at order entry or in the daily review; a written rationale from a rep about 'coverage' accepted without verification; six weeks of two-sided short premium in a moderate-growth account with no principal pushback; no re-approval when the customer's circumstances and stated appetite changed.
- This is a Rule 2360 approval failure layered on a Rule 3110 supervision failure.
2. Can you approve tier 4 retroactively? What is the correct path to a higher level?
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No retroactive approval - ever.
- An approval levels for future activity; it cannot legalize trades already done. Backfilling the file to cover six weeks of unapproved trades is falsification.
- Correct path: obtain updated financial information from the customer (directly, not via the rep's email), confirm the ODD is current, document the customer's actual objectives and experience, and have the qualified options principal approve in writing the specific strategies. The inheritance is relevant but is a fact to verify, not a shortcut.
- 'More action' is not an objective. It is a statement to be translated - growth? speculation? - and tested against the $95,000 plus $300,000, the customer's time horizon, and his tolerance for assignment.
- Until a proper approval exists, the account stays at tier 1 and no new short-premium positions may be opened. Any order for a higher-level strategy is rejected at entry, not caught afterward.
3. What do you do now about the open positions, the customer, and the rep?
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- Manage the live risk. The $40,000 deficit is real; unwinding short options can be costly and assignment can accelerate. Work the positions with the customer informed, and document margin exposure and any house call.
- Tell the customer the truth about the account. She should hear from a principal that the account was traded outside its approval and what is being done about it. Handling it only through the rep compounds the problem.
- Decide on restitution separately from the approval question: whether commissions on unauthorized trades are reversed is a firm decision, but it must be considered and documented.
- The rep: a written rationale that misstates 'coverage' and a request to approve retroactively are both serious. Consider restricting the rep's options business to pre-approved orders, notify compliance, and review whether any of this is reportable.
- Root cause: add an automated strategy-vs-approval check at order entry and a daily principal review of short-premium activity in lower-tier accounts.