[Federal Register Volume 61, Number 55 (Wednesday, March 20, 1996)]
[Notices]
[Pages 11458-11461]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-6643]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36960; File No. SR-OCC-95-20]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of a Proposed Rule Change Relating to the Issuance,
Clearance, and Settlement of Buy-Write Options Unitary Derivatives
March 13, 1996
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on December 27, 1995, The
Options Clearing Corporation (``OCC'') filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change (File No.
SR-OCC-95-20) as described in Items I, II, and III below, which items
have been prepared primarily by OCC. On February 5, 1996, OCC filed an
amendment to the proposed rule change.\2\ The Commission is publishing
this notice to solicit comments on the proposed rule change from
interested persons.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ Letter from James C. Young, First Vice President and General
Counsel, OCC, to Jerry W. Carpenter, Assistant Director, Division of
Market Regulation, Commission (February 5, 1996).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The purpose of the proposed rule change is to amend certain OCC By-
Laws and Rules and to add new sections to OCC By-Laws and rules and to
add new sections to OCC's By-Laws and Rules to provide for the
issuance, clearances, and settlement of a new equity derivatives
product referred to as Buy-Write Options Unitary Derivatives
(``BOUNDs'').
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 that 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.\3\
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\3\ The Commission has modified the text of the summaries
submitted by OCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The purpose of the proposed rule change is to amend certain OCC By-
Laws and Rules and to add new sections to OCC's By-Laws and Rules to
provide for the issuance, clearance and settlement of a new equity
derivatives product referred to as BOUNDs. The Commission recently
approved proposed rule changes filed by the American Stock Exchange
(``Amex''), the Chicago Board Options Exchange (``CBOE''), and the
Pacific Stock Exchange (``PSE'') (collectively referred to as the
``exchanges'') to list and trade BOUNDs.\4\
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\4\ For a complete description of the characteristics of BOUNDs,
refer to Securities Exchange Act Release No. 36710 (January 11,
1996), 61 FR 1791 [File Nos. SR-AMEX-94-56, SR-CBOE-95-14, and SR-
PSE-95-01] (order approving proposed rule change relating to
BOUNDs).
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1. Organization of Proposed Rule Change
The proposed rule change consists of five sections: (i) a
description of BOUNDs; (ii) amendments to existing By-Laws; (iii) a new
Article XXIV of the By-Laws applicable only to BOUNDs; (iv) amendments
to existing Rules; and (v) a new Chapter XXV of the Rules applicable
only to BOUNDs.
2. Description of BOUNDs
The purchase of a BOUND is intended to be substantially equivalent
to a ``buy-write'' transaction (i.e., the simultaneous writing of a
call option and purchase of the underlying stock). However, unlike an
actual buy-write transaction, the purchase of a BOUND is effected in a
single exchange transaction. As with all OCC issued options, BOUNDs
will be created when an opening buy and an opening sell order are
executed. The execution of
[[Page 11459]]
every such order will increase the open interest in BOUNDs.\5\ The
exchanges have indicated that BOUNDs will be listed on the same
securities on which Long-Term Equity Option Series (``LEAPS'')\6\ are
listed because the criteria used for stocks underlying BOUNDs will be
the same criteria that is used for stocks underlying LEAPS. The
exchanges expect that BOUNDs will be listed with a duration equal to
that of LEAPS, which is currently thirty-nine months from the date of
issuance.
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\5\ Open interest refers to the total number of contracts that
have neither been closed out nor been allowed to expire.
\6\ Generally, LEAPS are long-term equity option securities that
expire up to 39 months from the date of issuance. For a complete
description of LEAPS, refer to Securities Exchange Act Release No.
28890 (February 15, 1991), 56 FR 7439 [File No. SR-CBOE-90-32]
(order approving proposed rule change regarding the listing of
LEAPS).
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A BOUND holder will be in essentially the same economic position as
a covered writer of a European-style call option. BOUND holders will
profit from the stock's movement up to the strike price and will
receive payments equivalent to the cash dividends paid on the
underlying stocks. Non-cash distributions may be reflected either
through the delivery of the distributed property or by means of
``adjustments'' in the terms of the BOUNDs as described more fully
below.
BOUNDs are ``European'' style options because the holder cannot
exercise a BOUND prior to expiration. In contrast, LEAPS are
``American'' style options, which can be exercised at any time prior to
expiration. At the expiration of a BOUND, either delivery of the
underlying stock or payment of the strike price is always required, and
notice of ``exercise'' is not required. Therefore, the concepts of
``exercise'' and ``assignment'' are not used in relation to BOUNDs.
Like put and call options, BOUNDs ordinarily will trade in
standardized contract units of one hundred shares of underlying stock
per BOUND contract. At expiration, if on the last day of trading the
underlying stock closes at or below the strike price, BOUND holders
will receive one hundred shares of the underlying stock for each BOUND
contract held. If at expiration the underlying stock closes above the
strike price, the BOUND holder will receive a payment equal to one
hundred times the BOUND's strike price for each BOUND contract held. In
either case, the BOUND holder ordinarily will be left in the same
economic position as a covered call writer that holds the position
until the expiration of the call option. At expiration, depending on
the price of the underlying stock at that time, writers of BOUND
contracts will be required to deliver either one hundred shares of the
underlying stock for each BOUND contract or payment equal to one
hundred times the BOUND's strike price for each BOUND contract.
It is anticipated that the sum of the market prices of a LEAP and a
BOUND on the same underlying stock with the same expiration date and
exercise price will closely approximate the market price of the
underlying stock. If the combined price of the LEAP and BOUND diverge
from that of the underlying stock, it is anticipated that arbitrage
activity will bring the price relationships back into line.
3. Proposed Amendments to OCC By-Laws
The proposed rule change defines the term BOUND as a security
issued by OCC pursuant to Article XXIV of the By-Laws and Chapter XXV
of the Rules. The proposed rule change also amends OCC's By-Laws by
modifying several defined terms to indicate how those terms apply to
BOUNDs. For example, the definition of ``clearing fund'' is amended to
provide that the clearing fund pool for BOUNDs will be the same fund
pool used for stock options. The proposed amendment to the definition
of a ``clearing member'' defines a ``stock clearing member'' as a
clearing member approved to clear transactions in stock options and
BOUNDs. Accordingly, stock clearing members will be qualified
automatically to engage in transactions in BOUNDs without any
additional qualification.
The proposed amendment to the definition of the term ``trade
price'' in the By-Laws defines that term to mean the price agreed upon
in a BOUND transaction. Technically there is no ``premium'' in a BOUND
transaction because that term generally is used to denote the purchase
price of an option. However, in order to accommodate transactions in
BOUNDs, the proposed amendment to the term ``premium'' defines it
broadly to permit the term to include the trade price with respect to
BOUNDs.
The proposed amendments to Article VI of the By-Laws include minor
additions to several sections in order to make the By-Laws pertaining
to the clearance of exchange transactions applicable to contracts in
BOUNDs. The proposed amendment to Article VI, Section 6 provides that
BOUNDS are issued by OCC and that the rights and obligations attaching
to purchasing clearing members and writing clearing members are
contained in new Article XXIV. Interpretations and Policies
(``Interpretation'') .01 to Article VI, Section 9 has been amended to
make clear that the general rights and obligations of options writers
and holders outlined by Section 9 apply only to stock option contracts
and not to BOUNDs. Parallel provisions for BOUNDs are in Article XXIV.
Old subsection (c) of Article VI, Section 10 is being deleted
because subsection (a) is being modified by adding the more generic
term ``cleared securities'' in place of the term ``option contract.'' A
new subsection (d) has been proposed for Article VI, Section 10 to set
forth rules governing the opening by the exchanges of new series of
BOUNDs. These procedures are parallel to rules governing opening of new
series of options.
Section 11 of Article VI has been amended only in order to provide
that OCC's Securities Committee shall have the authority to make
adjustments in BOUNDs contracts through the same procedures as in the
case of option adjustments. Although other provisions of Section 11
also are applicable to BOUNDs, the precise way in which those
provisions are applied is set forth in Article XXIV.
Proposed amendments to Article VIII of the By-Laws include minor
additions to several sections to include BOUNDs in the stock clearing
fund. Certain other changes in the text of these sections are purely
technical and not intended to affect the meaning. The added reference
to ``IPs'' in Interpretation .02 following Section 5 corrects and
apparent omission in an earlier filing.
4. Proposed Article XXIV of OCC By-Laws
The introduction to proposed Article XXIV makes it clear that the
By-Laws in Articles I through XI are also applicable to BOUNDs except
where expressly modified or made inapplicable by Article XXIV. The
effect on other By-Laws of each By-Law Section in Article XXIV is
stated in brackets at the end of each By-Law section in Article XXIV.
Proposed Article XXIV, Section 1, adds certain new definitions
relevant to BOUNDs and redefines certain terms defined in Article I of
the By-Laws to assign different meanings when those terms are used with
respect to BOUNDs. With respect to BOUND contracts, the term ``ex
dividend date'' has been defined to mean the ``ex'' date for the
corresponding dividend on the underlying security. The proposed term
``dividend payable date'' has been defined to mean the date on which
the dividend equivalent is required to be paid by the writer of a BOUND
to OCC
[[Page 11460]]
and by OCC to the holder of a BOUND. Consequently, the right of a BOUND
holder to receive and the obligation of a BOUND writer to pay or
deliver a dividend equivalent will be fixed at the close of trading on
the business day preceding the ex dividend date. The actual payment of
the dividend equivalent may occur days or weeks later to coincide with
the payable date for the corresponding dividend on the underlying
stock. It is desirable to harmonize the payable dates for the BOUNDs
and the underlying stock in order to make hedging and other strategies
involving combined positions in BOUNDs and the underlying stock most
efficient. As a result, it is possible that an obligation to pay or a
right to receive a dividend equivalent that accrued prior to the
expiration date of a BOUND will remain outstanding after the expiration
date and even after expiration settlement has been completed. OCC
simply will continue to carry the dividend equivalent right or
obligation in a manner similar to a settlement obligation or an
exercised option. It will be margined and marked to the market each day
similar to other settlement obligations.
As defined in Article XXIV, the ``expiration settlement date'' of a
BOUND contract is specified in Rule 2502 and currently is the third
business day following the expiration date. The expiration settlement
date for a particular BOUND contract will not depend on whether the
contract is to be settled by cash or by the delivery of stock.
The term ``closing price'' has been defined to mean the closing
price for the underlying security on the primary market on the business
day prior to the expiration date of the BOUND contract. However, the
exchange(s) on which a BOUND trades may provide that the closing price
of a BOUND be based on an average of prices of the underlying security
near the close on that day. The exchange(s) must specify that an
average of prices will be used prior to the opening of trading in any
BOUNDs series.
The proposed definition of ``strike price'' provides that any
reference to ``exercise price'' in the By-Laws or Rules will refer to
the ``strike price'' of a BOUND contract. As stated earlier, notice of
exercise is not required at the expiration of a BOUND, and the concept
of ``exercise'' has no relevance to BOUNDs.
Proposed Article XXIV, Section 2 sets forth the general rights and
obligations of holders and writers of BOUND contracts. Proposed Article
XXIV, Section 3 sets forth the agreements of a writing clearing member
when effecting an opening writing transaction in a BOUND.
Section 4 of Article XXIV describes the application of the
adjustment rules of Article VI, Section 11 to BOUNDs. BOUNDs ordinarily
will be adjusted according to existing adjustment rules, and
adjustments are expected to ordinarily conform to adjustments made with
respect to LEAPs on the same underlying stock. Where an adjustment
results in a change in the number of option and BOUND contracts
outstanding, which usually occurs to reflect a stock split or stock
dividend, that event also will not be reflected in a dividend
equivalent. Similarly, where the unit of trading of a BOUND is adjusted
to require delivery of additional shares of the underlying security or
other property that was distributed with respect to each share of the
underlying security, that distribution also will not be reflected in a
dividend equivalent. However, when the strike price of a BOUND is
reduced to reflect the value of a distribution, a dividend equivalent
also will be paid. This will occur because, unlike in the case of
adjusting an option, lowering the strike price of a BOUND will not give
the holder the benefit of the distribution because the holder does not
pay the strike price. (The strike price of a BOUND caps the value that
the holder will receive upon expiration of the BOUND.) Therefore, it is
appropriate to give the holder the benefit of certain extraordinary
distributions through a dividend equivalent at the time the
distribution is made and also to reduce the strike price so that the
BOUND holder cannot again receive the benefit of the distribution when
the BOUND expires.
In the case of a ``cash-out'' merger or similar transaction, a
BOUND will be adjusted to require the writer to pay at expiration an
amount per share equal to the lesser of the price paid for the
underlying security in the merger or the strike price of the BOUND.
Because there will no longer be an underlying security, the expiration
date of the BOUND will be accelerated so that the cash will be paid to
the BOUND holder at or about the same time that payment of the cash-out
value is paid to holders of the underlying security. While the
mechanics are somewhat different from the adjustment ordinarily made
for the same event in the case of an option, the economic result is
quite similar. Because the value of an option becomes fixed as the
result of adjusting for a cash-out merger, in-the-money options are
effectively terminated because they have no time value and holders have
every incentive to exercise them immediately to receive the cash. The
expiration date of the BOUND will be accelerated because BOUNDs are
European style and cannot be exercised prior to expiration.
Proposed Article XXIV, Section 5 sets forth the steps OCC may take
in the event the closing price for an underlying security is
unavailable. In addition to any other actions OCC may be entitled to
take under the By-Laws and Rules, OCC may suspend settlement
obligations for the affected BOUNDs. OCC also will have the authority
to fix the closing price for BOUNDs by means of a panel consisting of
exchange representatives and OCC's Chairman.
The provisions in Article VI, Section 19 relating to ``shortages of
underlying securities'' are applicable to BOUNDs except that
restrictions on exercises cannot be applied to BOUNDs because BOUNDs
are not exercisable.
5. Proposed Amendments to Existing OCC Rules
Proposed amendments to existing rules include minor additions to
several rules in order to indicate how those rules will apply to
BOUNDs. Many changes are self-explanatory and are not described in this
notice.
The proposed amendment to Rule 601 in Chapter VI, which governs
margin, sets forth that BOUNDs will be margined in a clearing member's
accounts as part of the ``stock option product group,'' and BOUNDs will
be included in the same ``class group'' with put and call options on
the same underlying stock. Special provisions have been added to the
definition of ``premium margin'' to provide an appropriate definition
of the term when applied to an expired but unsettled BOUND contract.
The added provisions reflect that the expired contract may call for
either the delivery of stock or the payment of the strike price
depending upon the closing price of the underlying stock when the BOUND
expires.
The definition of ``marking price'' in Rule 601 is being changed to
reflect that OCC will use the highest reported asked quotation in
valuing an underlying security if no last sale price is available. This
is appropriate because the product group minimum margin includes
protection against the bid/offer spread; therefore, it is not necessary
to use a different quotation for puts than for calls.
Rule 1001 in Chapter X provides that positions in BOUNDs will be
included in the formula to determine a clearing member's proportionate
share of the contribution to the stock clearing fund. This is
consistent with BOUNDs also
[[Page 11461]]
being included with stock options for purposes of margin calculations
and clearing member qualifications.
Rules 1104 and 1106 in Chapter XI regarding the liquidation of an
account of a clearing member upon suspension of that clearing member
have been amended to include reference to positions in BOUNDs. Rule
1106(b)(2) contains a reference to specific or escrow deposits with
respect to BOUNDs. No provisions for such deposits have been included
in the present filing; therefore, these references will have no
application until such time as OCC provides for escrow deposits with
respect to BOUNDs.
6. Proposed Chapter XXV of OCC Rules
The introduction to proposed Chapter XXV makes it clear that the
rules in Chapters I through VII and IX through XII also are applicable
to BOUNDs except where expressly modified or made inapplicable by
Chapter XXV. The effect on other rules by each section in Chapter XXV
is stated in brackets at the end of each section in Chapter XXV.
Proposed Rule 2501 of Chapter XXV sets forth the rights and
obligations of holders and writers of BOUNDs with respect to the
payment of dividend equivalents. Under the proposed rule, the holder of
a BOUND is entitled to the dividend payments of a shareholder with a
comparable position (i.e., one hundred shares per contract). The writer
is obligated to pay or deliver the dividend equivalent of either a cash
dividend or a non-cash distribution to the holder of the BOUND. As
noted earlier, certain distribution may result in an adjustment of the
BOUND in lieu of a dividend equivalent while other distributions may
give rise to only a dividend equivalent or both a dividend equivalent
and an adjustment.
Proposed Rule 2501 specifies that on the dividend payable date OCC
will notify each clearing member having a position in BOUNDs of the net
sum or securities it is required to pay or deliver and the net sum or
securities it is entitled to receive. Proposed Rule 2502 sets forth
that the settlement date for a BOUND contract will be the third
business day following the expiration date. Although BOUNDs that settle
in cash (i.e., when the underlying stock price closes above the strike
price) could be settled earlier then BOUNDs that settle by delivery of
the underlying stock (i.e., when the underlying stock price closes at
or below the strike price), it has been determined that the preferable
product design is to have the same settlement period for both types of
settlements. In the event the BOUND transaction cannot be settled
through regular-way settlement (i.e., on the third business day
following the expiration date), the contract will be settled on a
broker-to-broker basis as governed by Rules 902 through 910A in Chapter
IX.
Proposed Rule 2503 sets forth the procedures for settlement of
BOUNDs at expiration. These procedures are straightforward in that
BOUNDs to be settled in cash will be settled through OCC's cash
settlement system. BOUNDs that are to be settled by delivery of stock
ordinarily will be settled in the same manner that exercised stock
options are settled (i.e., through stock clearing corporations).
OCC believes the proposed rule change is consistent with the
requirements of Section 17A of the Act and the rules and regulations
thereunder because the rule proposal should facilitate the prompt and
accurate clearance and settlement of BOUNDs. OCC also believes the
proposed rule change is consistent with the safeguarding of funds and
securities in OCC's custody or control or for which OCC is responsible
because it will apply to BOUNDs a system of safeguards which is
substantially the same as which OCC currently applies to options.
(B) Self-Regulatory Organization's Statement on Burden on Competition
OCC does not believe that the proposed rule change will impact or
impose a 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. 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 5 U.S.C. Sec. 552, will be available for inspection and copying in
the Commission's Public Reference Room, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing will also be available
for inspection and copying at the principal office of OCC. All
submissions should refer to the file number SR-OCC-95-20 and should be
submitted by April 10, 1996.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\7\
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\7\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarlane,
Deputy Secretary.
[FR Doc. 96-6643 Filed 3-19-96; 8:45 am]
BILLING CODE 8010-01-M
