[Federal Register Volume 63, Number 194 (Wednesday, October 7, 1998)]
[Notices]
[Pages 53970-53971]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-26864]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40515; File No. SR-OCC-98-07]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving Proposed Rule Change Regarding the Short Option
Adjustment As Applied to Non-Equity Options
September 30, 1998.
On July 10, 1998, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') a proposed
rule change (File No. SR-OCC-98-07) pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'').\1\ Notice of the proposal
was published in the Federal Register on August 17, 1998.\2\ No comment
letters were received. For the reasons discussed below, the Commission
is approving the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 40317 (August 11, 1998),
63 FR 43980.
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I. Description
The rule change amends OCC Rule 602 to modify the ``short option
adjustment'' as it applies to non-equity options. The short option
adjustment is a component of the additional margin calculation in OCC's
margin system, the ``theoretical intermarket margin system'' (``TIMS or
NEO TIMS''), that imposes a minimum margin amount on deep out of the
money short options.\3\
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\3\ TIMS refers to OCC's margin system as it applies to stock
options and NEO TIMS refers to OCC's margin system as it applies to
non-equity options. For a detailed description of NE TIMS, refer to
Securities Exchange Act Release No. 23167 (April 30, 1986), 51 FR
16127 [File No. SR-OCC-85-21] (order approving proposed rule
change).
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A. Additional Margin Calculation
OCC requires its clearing members to adjust their margin deposits
with OCC in the morning of every business day based on OCC's overnight
calculations. OCC imposes a margin requirement on short positions and
gives margin credit for unsegregated long positions.\4\ Under TIMS,
margin for positions in a class group are based on premium levels at
the close of trading on the preceding day and are increased or
decreased by the additional margin amount for that class group.\5\
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\4\ A long position is unsegregated for OCC's purposes if OCC
has a lien on the position (i.e., it has recourse to the value of
the position in the event that the clearing member does not perform
an obligation to OCC). Long positions in firm accounts and market-
maker accounts are unsegregated. Long positions in the clearing
member's customers' accounts are unsegregated only if the clearing
member submits instructions to that effect in accordance with Rule
611.
\5\ For purposes of NEO TIMS, a class group consists of all put
and call options, certain market baskets, and commodity options and
futures covering the same underlying asset that are subject to
margin at OCC because of a cross-margining program with a commodity
clearing organization. A class group may also contain stock loan
baskets and stock borrow baskets.
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TIMS calculates additional margin amounts using options price
theory. TIMS first calculates the theoretical liquidating value for the
positions in each class group by assuming either an increase or
decrease in the market value of the underlying asset in an amount equal
to the applicable margin interval. The margin interval is the maximum
one day price movement in the value of the underlying asset that OCC
wants to protect against.\6\ Margin intervals are determined separately
for each underlying interest to reflect the volatility in the price of
the underlying interest.
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\6\ Some combinations of positions can present a greater net
theoretical liquidating value at an intermediate value than at
either of the endpoint values. As a result, TIMS also calculates the
theoretical liquidating value for the positions in each class group
assuming intermediate market values of the underlying asset.
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TIMS then selects the theoretical liquidating value that represents
the greatest decrease (where the actual liquidating value is positive)
or increase (where the actual liquidating value is negative) in
liquidating value compared with the actual liquidating value based on
the premium levels at the close of trading on the preceding day. The
difference between that theoretical liquidating value and the actual
liquidating value is the additional margin amount for that class group
unless the class group is subject to the short option adjustment.
B. Short Option Adjustment
For net short positions in deep out of the money options, little or
no change in value would be predicted given a change in value of the
underlying interest equal to the applicable margin interval.\7\ As a
result, TIMS would calculate additional margin amounts of zero or close
to zero for deep out of the money options. However, volatile markets
could cause such positions to become near to or in the money and
thereby could create increased risk to OCC. OCC protects against this
risk with an adjustment to the additional margin calculation known as
the short option adjustment.\8\
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\7\ A net position in an option series in an account is the
position resulting from offsetting the gross unsegregated long
position in that series against the gross short position in that
series. After netting, an account will reflect a net short position
or a net long position for each series of options held in the
account.
\8\ The short option adjustment for non-equity options is
described in OCC Rule 602(c)(1)(ii)(C)(1).
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Originally, the short option adjustment calculated a minimum
additional margin amount for all net short positions in an options
series for which the ordinary calculation of the additional margin
requirement was less than twenty-five percent of the applicable margin
interval. The original methodology applied the short option adjustment
to all such short option positions and did not attempt to match or pair
net short positions with net long positions which could have reduced
the risk of such net short positions.
In 1992, OCC modified the short option adjustment so that it
applied only to unpaired net short positions in deep out of the money
options.\9\ Currently, the term unpaired is defined to mean that a net
short position is not offset by a net long position on the same
underlying interest.\10\ However, Interpretation .06 to OCC Rule 602
provides that a net short position is unpaired unless the position is
offset by
[[Page 53971]]
a net long position in the same class group (i.e., the net short and
long positions have the same underlying interest). Therefore,
Interpretation .06 currently treats a net short position as unpaired
even if the net short position is offset by a net long position in a
highly correlated class group. For example, Interpretation .06 treats a
net short position in an index option that is offset by a net long
position in a highly correlated but different index option as unpaired
for purposes of the short option adjustment.
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\9\ Securities Exchange Act Release No. 31682 (December 31,
1992) 58 FR 3318 [File No. SR-OCC-91-12].
\10\ The term unpaired is defined in Interpretation .04 to Rule
601 for equity options and Interpretation .06 to Rule 602 for non-
equity options.
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The rule change modifies the short option adjustment logic of NEO
TIMS so that it recognizes spreads between net long and short positions
on underlying interests that exhibit price correlation of seventy
percent or greater in addition to spreads between net long and short
positions on the same underlying interests. The rule change amends Rule
602 to provide that NEO TIMS (1) will continue to pair all net short
contracts on a particular underlying interest against all net long
contracts on the same underlying interest and (2) will then pair any
remaining net short positions against any net long positions that
remain in other class groups that exhibit seventy percent or greater
price correlation.\11\ Any short contracts remaining unpaired after
this pairing process will be subject to the short option
adjustment.\12\
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\11\ The class groups in OCC's stock index and currency option
produce groups satisfy the requirement for seventy percent or
greater price correlation.
\12\ Commodity options and futures held in cross-margin
accounts, market baskets, and stock loan and borrow baskets also
will be included in the pairing process. Long calls, futures,
commodity calls, market baskets, and stock loan baskets will be
netted against short calls and commodity calls. Long puts, commodity
puts, short futures, market baskets, and stock borrow baskets will
be netted against short puts and commodity puts.
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Interpretation .06 currently states that those short contracts
having the lowest premium margin values will be deemed to be unpaired.
Premium margin value is an important criterion used by OCC to identify
those excess short contracts which it will deem unpaired, but it is not
the only criterion. Other criterion may include identifying contracts
that are farthest from expiration, that have the highest exercise price
(in the case of calls) or the lowest exercise price (in the case of
puts), or that have been assigned the largest margin interval. The rule
change amends Interpretation .06 to provide that OCC will identify
which of the excess short contracts will be deemed unpaired and
therefore will be subject to margin requirements using the short option
adjustment.
II. Discussion
Section 17A(b)(3)(F) of the Act \13\ requires that the rules of a
clearing agency be designed to assure the safeguarding of securities
and funds which are in its custody or control or for which it is
responsible. The Commission believes that the rule change is consistent
with OCC's obligation under Section 17A(b)(3)(F) because it should
reduce overcollateralization of OCC's clearing members' positions
without impairing OCC's overall protection against member default.
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\13\ 15 U.S.C. 78q-1(b)(3)(F).
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular with Section 17A of the Act \14\ and the rules and
regulations thereunder.
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\14\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-98-07) be and hereby is
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-26864 Filed 10-6-98; 8:45 am]
BILLING CODE 8010-01-M
