[Federal Register Volume 63, Number 246 (Wednesday, December 23, 1998)]
[Notices]
[Pages 71179-71181]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33911]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40800; File No. SR-OCC-98-11]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Regarding the Calculation of
the Short Option Adjustment
December 16, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on September 10, 1998, The
Options Clearing Corp. (``OCC'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II, and III below, which items have been prepared primarily by
OCC. The Commission is publishing this notice to solicit comments from
interested persons on the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Under the proposed rule change, OCC will amend the short option
adjustment contained in OCC's Theoretical Intermarket Margin System
(``TIMS'') to enable OCC to use a ``sliding scale'' to calculate short
option adjustment amounts.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of such
statements.\2\
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\2\ The Commission has modified the text of the summaries
prepared by OCC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
Under the proposed rule change, OCC will amend Rules 601 and 602 to
[[Page 71180]]
provide OCC with more flexibility in calculating the amount of the
short option adjustment.\3\
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\3\ OCC Rule 601 describes TIMS as it applies to equity options
(``equity TIMS'') and OCC Rule 602 describes TIMS as it applies to
non-equity options (``non-equity TIMS'').
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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 in
each clearing member account and gives margin credit for unsegregated
long positions.\4\ Under TIMS, the margin for positions in a class
group is based on premium levels at the close of trading on the
preceding day and is then 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., 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' account are unsegregated only if the clearing member
submits instructions to that effect in accordance with Rule 611.
\5\ For purposes of equity TIMS, a class group consists of all
put and call options, all BOUNDS, and all stock loan and borrow
positions relating to the same underlying security. For purposes of
non-equity TIMS, a class group consists of all put and call options,
certain market baskets, and commodity options and futures (that are
subject to margin at OCC because of a cross-margining program with a
commodity clearing organization) that relate to the same underlying
asset. A NEO TIMS 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 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 that OCC wants to protect against in the price of the
underlying asset.\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.
For net short positions \7\ 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. 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
such risk by incorporating into the additional margin calculation a
margin cushion 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 is described in Rule
601(c)(1)(C)(1) for equity options and Rule 602 (c)(1)(ii)(C)(1) for
non-equity options. OCC recently amended Interpretation .06 to Rule
602 so that net short non-equity option positions can be paired off
against net long non-equity positions whose underlying interests
exhibit price correlation of at least seventy percent. Securities
Exchange Act Release No. 40515 (September 30, 1988), 63 FR 53970.
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Currently, the short option adjustment requires a minimum
additional margin amount equal to twenty-five percent of the applicable
margin interval for all unpaired\9\ net short positions in options
series for which the ordinary calculation of the additional margin
requirement would be less than twenty-five percent of the applicable
margin interval. OCC believes that this methodology requires clearing
members to deposit margin in excess of the risk presented by some
unpaired net short positions in out of the money options.
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\9\ 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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OCC believes that this excess margin requirement can be attributed
essentially to two causes. First, some short positions are so far out
of the money that even an extreme market move would not cause them to
prevent risk to OCC commensurate with a short option adjustment
equivalent to twenty-five percent of the applicable margin interval. To
illustrate, on October 27, 1997, the S&P 500 Index fell 6.9% to 876.98
from its closing value of 941.64 on October 24, 1997.\10\ There was a
series of SPX 11/97 put options with an exercise price of 700 open on
that date. At the close of October 24, 1997, that series was 25.7% out
of the money and had a closing premium of $25.00. At the close on
October 27, 1997, that series was 20.2% out of the money and had a
closing premium of $56.25. The increase in the closing premium from
October 24 to October 27 was $31.25. In the absence of the short option
adjustment, TIMS would have required additional margin of $23.25. With
the short option adjustment, TIMS required additional margin of $875.00
(equal to the margin interval, which was 35 points, times the index
multiplier of 100, times 25%). Even in this extreme market move the
short option adjustment required far more collateral than OCC needed to
hedge the risk presented to it by unpaired short positions in this
series.
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\10\ This market decline of 64.66 points was the 14th largest
one day percentage decline in the period from January 1930 through
June 1998, and it constituted a more extreme daily move than 99.9%
of the daily moves during this period. The decline on October 27,
1997, actually represents a more rigorous test of the short option
adjustment methodology than the market move on October 19, 1987.
There are several reasons for this, such as the option implied
volatility was so high on October 19, 1987, and the theoretical
additional margin levels calculated by TIMS generally exceeded the
alternative short option adjustment calculations.
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Second, out of the money short call positions present less risk to
OCC than short put positions that are equally out of the money. This is
essentially because a market that moves sharply down (presenting risk
to OCC from short put positions) is generally associated with an
increase in option implied volatility whereas a market that moves
sharply up (presenting risk to OCC from short call positions) is
generally associated with a decrease in option implied volatility.
Other things being equal, an upward move in the market of a given size
creates less risk for OCC from short call positions than a downward
move in the market of the same size from short put positions.
Therefore, because TIMS employs a twenty-five percent short option
adjustment for both puts and calls, it tends to require excessive
additional margin particularly with respect to short call positions.
To address these situations, the proposed rule change will
establish a sliding scale short option adjustment methodology. Using
the sliding scale, the short option adjustment percentage will be
applied to a particular series according to the extent to which the
series is out of the money. In addition, OCC will use different sliding
scales for put options and for call options.
OCC believes that the margin required by these sliding scales
should be sufficient to protect it against the risks
[[Page 71181]]
presented by out of the money short positions even in extreme market
conditions. For example, in the illustration described above, the
sliding scale short option adjustment would still have required
additional margin of $350.00 (equal to the margin interval of 35
points, times the index multiplier of 100, times 10%, the applicable
percentage for a short put 25.7% out of the market) which is well in
excess of the risk presented to OCC by the short puts in the SPX 11/97
700 series.
Under the proposed rule change, OCC will modify Rules 601 and 602
to provide that the short option adjustment to be applied to any
unpaired short position will be determined using a percentage that OCC
deems to be appropriate. A specific short option adjustment percentage
will not be included in the rules.\11\
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\11\ A schedule of the sliding scales that OCC intends to use
initially is attached as Exhibit A to its filing, which is available
for inspection at the Commission's Public Reference Room and through
OCC. OCC will always specify a minimum short option adjustment
percentage. OCC will inform its members of the initial schedule of
the sliding scales through an Important Notice and will notify its
members of any changes to the schedule.
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OCC believes that this information provides appropriate flexibility
to make adjustments to the sliding scales from time to time as OCC
determines is warranted. OCC further believes that the proposed rule
change is consistent with the approach taken in Rule 60(c)(1)(C)(1) and
Rule 602(c)(1)(ii)(C)(1) which both permit OCC to use such formulas,
assumptions, and data as it deems appropriate for purposes of
calculating additional margin.
OCC believes that the proposed rule change is consistent with
Section 17A of the Act \12\ and the rules and regulations thereunder
because it furthers the public interest by reducing the
overcollateralization of certain short positions in deep out of the
money options. In addition, OCC believes that the proposed rule change
should remove an impediment to market liquidity while still providing
OCC with appropriate protection to the risks presented by short out of
the money option positions.
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\12\ 15 U.S.C. 78q-1.
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B. Self-Regulatory Organization's Statement on Burden on Competition
OCC does not believe that the proposed rule change would impose any
burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
Written comments were not and are not intended to be solicited with
respect to the proposed rule change, and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which OCC consents, the Commission will:
(A) by order approve such proposed rule change or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing also will be available
for inspection and coping at the principal office of OCC. All
submissions should refer to File No. SR-OCC-98-11 and should be
submitted by January 12, 1999.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\13\
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\13\ 17 CFR 200-30(a) (12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33911 Filed 12-22-98; 8:45 am]
BILLING CODE 8010-01-M
