Series 7 exam question. Need explaniation please.

Here is the question

An investor owns 10 MMM May 50 Calls. MMM increases to $60, and the investor exercises the calls. The investor tells his registered rep to sell the stock immediately after purchase. If all these trades happen in a margin account, how much must the investor deposit.

A. 3000
B. 30,000
C. 35,000
D. No deposit is required.

I have the answer, but want to hear how you guys would look at this question. Thank you for your help.

 

I would have to guess, because I don't have a Series 7 license and don't plan to get one. I believe the answer is "D". The broker has no risk, so no margin should be required.

 

I would say B

need 50% to exercise the option

 

The answer is D. But I thought it would be B as well, because once you buy the 1000 shares of stock at $50, worth 50,000, you instantly have 60,000 worth of stock in your account. Seems like you would need 30,000 in your account for this. But like the first guy said, since you executed it the same day there is no need to have the excess money. It just doesn't seem like you should be able to bend the rules like that.

 

So... Where's my cigar?

 

dont you spend all the money on the options in the beginning (your total risk). why do you need to add more to sell? of course i know nothing about options

 

The Answer is D. You are selling right away so you dont need any money to buy the options, although generally you dont even exercise the options, you just sell them because usually the options will be worth more by selling than if you exercise them, not to mention you would be paying two commissions to your broker (one to exercise the options and one to sell the stock)

 

I don't have a series 7, but I believe D is the answer just from common sense experience, since the trade will net out. I've gotten assigned when I didn't have enough free cash in my account in the past, and broker policy sells at open to clear the balance. If you wanted to keep the stock you need $25000 (1:2 margin) or even only 12500 if you are intraday with some brokers that do 4:1. $50k is the purchase price.

And its another story if you have portfolio margin. You could just as easily short the shares at 60 before you exercise to completely offset your risk here. Then no money is needed, besides the commission of course.