[Federal Register Volume 62, Number 111 (Tuesday, June 10, 1997)]
[Notices]
[Pages 31643-31650]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15025]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38709; File No. SR-CBOE-97-17]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change by the Chicago Board Options Exchange,
Incorporated and Notice of Filing and Order Granting Accelerated
Approval to Amendment Nos. 1 and 2 to the Proposed Rule Change Relating
to Changes to Its margin Rules
June 2, 1997.
I. Introduction
On March 21, 1997, the Chicago Board Options Exchange, Incorporated
(``CBOE'' or the ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change seeking to amend the Exchange's
margin rules.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 38501 (April 14, 1997), 62 FR 19364 (April 21,
1997). The CBOE submitted to the Commission Amendment No. 1 on April
15, 1997,\3\ and Amendment No. 2 on May 30, 1997.\4\ No comments were
received on the proposal.
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\3\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE,
to Michael Walinskas, Senior Special Counsel, Division of Market
Regulation (``Market Regulation''), Commission, dated April 11, 1997
(``CBOE Amendment No. 1'') making certain technical changes to the
rule filing.
\4\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE,
to Chester McPherson, Attorney, Market Regulation, Commission, dated
may 28, 1997 (``CBOE Amendment No. 2'') (providing additional
information and addressing certain permitted offset issues.
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This order approves the proposed rule change, as amended.
II. Description of the Proposal
The CBOE proposes to make revisions to its rules governing margin
that will (i)
[[Page 31644]]
establish CBOE rules to govern areas of margin regulation that will no
longer be addressed by Regulation T (``Regulation T'') \5\ of the Board
of Governors of the Federal Reserve System (``Federal Reserve Board''
or ``Board'') as of June 1, 1997, (ii) conform certain CBOE margin
rules to those of the New York Stock Exchange (``NYSE''), and (iii)
correct or clarify certain current provisions of the CBOE margin rules.
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\5\ 12 CFR 220.1 through 19 (1996).
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The Exchange proposes changes to its margin rules at this time in
response to recent amendments to the Federal Reserve Board's Regulation
T, the regulation that covers extensions of credit by and to brokers
and dealers.\6\ Among other things, the amendments to Regulation T will
modify or delete certain Board rules regarding options transactions in
favor of rules to be adopted by the options exchanges, subject to
approval by the Commission. The new options provisions in Regulation T
became effective June 1, 1997. The Exchange also has concurrently
submitted separate changes to its margin rules in another rule filing,
See SR-CBOE-97-18. That second filing will be referred to herein as the
``Second margin Filing.'' The present filing will be referred to as the
``First Margin Filing.''
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\6\ See 61 FR 20386 (May 6, 1996) (Federal Reserve Board's
release adopting certain changes to Regulation T).
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Definition Section
The Exchange proposes adding a definition section in new paragraph
(a) of Rule 12.3 ``Margin Requirements.'' The first new definition is
``current market value,'' which is used throughout the Rule. The
Exchange is also proposing to add an interpretation to Rule 12.3 for
``current market value'' covering situations where there is no closing
price, or where trading is halted and not reopened before the normal
end of the trading day, or where the closing price is outside the last
bid and offer that was established after the closing price. In such
situations, the proposed interpretation to Rule 12.3 indicates that a
member organization may use a reasonable estimate of the market value
of the security based upon the then current bids and offers in
determining the ``current market value'' of a security, including an
option. According to the Exchange, this interpretation will allow
member organizations to arrive at a more reasonable estimate of the
current market value, particularly where the underlying security may be
trading or quoted in other markets or in cases where the underlying
security re-opens for trading and the overlying option remains closed.
The exchange also states that the new definition of ``current market
value'' is consistent with a definition contained in New York Stock
Exchange Rule 431 (``NYSE Rule 431'').
The term ``escrow agreement'' also is being defined in new
paragraph (a) of Rule 12.3. The CBOE definition requires the issuer of
escrow receipts to be a U.S. bank or trust company supervised and
examined by state or federal authority. The Regulation T definition
allows the issuer to be a bank or any person designated as a control
location under paragraph (c) of Rule 15c3-3 under the Act. The exchange
is adopting a more restrictive approach because of concerns that
certain control locations, such as transfer agents, are not appropriate
issuers of escrow receipts and that Exchange rules should continue to
limit issuers of receipts to entities such as banks, as currently set
forth in Rule 24.11(d). The Exchange notes that it is continuing to
study this issue.
Finally, the Exchange is revising its definition of ``exempted
security'' by adopting the Regulation T definition.
Customer Margin Accounts
The Exchange proposes reorganizing Rule 12.3 so that all provisions
concerning customer margin accounts are in the same sections of the
Rule. Currently, customer margin provisions appear throughout the Rule.
Under the Exchange's proposal, Rule 12.3, paragraph (b), will set forth
the default margin requirements on long and short positions in customer
margin accounts. Paragraph (c) will set forth the specific margin
treatment for particular types of securities and positions held in
customer margin accounts.
The margin treatment of ``exempted securities'' is proposed to be
moved from current Rule 12.3, paragraph (b)(3) to new paragraph (c)(3),
and amended so that it is consistent with NYSE Rule 431.\7\
Specifically, the treatment for exempted securities is being revised so
that obligations of the United States (as specified in the rule) will
be subject to a margin requirement of 1% to 6%, depending on the years
to maturity for the obligation. Zero coupon bonds will be subject to a
margin requirement of 3% for bonds with five years or more to maturity.
All other exempted securities will be subject to an initial and
maintenance margin requirement of 15% of the current market value or 7%
of the principal amount, whichever amount is greater. Currently, Rule
12.3(b)(3) requires margin of 5% on obligations of the United States
and margin of 15% of the principal amount or 25% of the current market
value of other exempted securities, whichever amount is lower.
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\7\ See NYSE Rule 431(e).
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The Exchange is also adopting a margin treatment for non-
convertible debt securities which is consistent with the margin
treatment in NYSE Rule 431,\8\ except that the Exchange is not adopting
the special exemptions relating to mortgage related securities at this
time because this provision is currently the subject of discussion by
an industry committee and may be changed. The rule will require margin
to be maintained equal to 20% of the current market value or 7% of the
principal amount of the non-convertible debt, whichever amount is
greater.
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\8\ Id.
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The Exchange is also proposing a new subsection to Rule 12.3
labeled ``Security Offsets,'' which combines two current provisions
from Rule 12.3 and addresses the margin treatment of short securities
offset against (i) Long positions in a security exchangeable or
convertible into the security held in a short position and (ii) long
positions in the same security as the short position. The convertible
or exchangeable provision is the same as contained in current CBOE Rule
12.3(b)(1)(A) except that an incorrect parenthetical referring to
options is being deleted because options cannot be and never have been
considered convertible securities. The Exchange notes that the rules of
the other self-regulatory-organizations (``SROs'') and Regulation T do
not refer to options as convertible securities. The provision dealing
with offsets between long and short positions in the same security is
being moved from paragraph 12.3(b)(1)(D) of current Rule 12.3 to
paragraph 12.3(c), and the margin requirement is being revised from 10%
to 5% of the current market value of the ``long'' securities to conform
the CBOE rule to a similar provision in NYSE Rule 431.\9\
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\9\ Id.
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The Exchange is also proposing, under new paragraph (c) of Rule
12.3, which provides certain exceptions to the default margin treatment
for positions in a customer margin account, new margin treatment for a
short listed equity call option position offset by a warrant to
purchase the underlying security. The proposed treatment is new to Rule
12.3 and is consistent with a provision of Regulation T.\10\ The
provision requires no margin for this position if the warrant to
purchase the underlying security does not expire on
[[Page 31645]]
or before the expiration date of the short call, and if the amount (if
any) by which the exercise price of the warrant exceeds the exercise
price of the short call is deposited in the account.
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\10\ See Regulation T, 12 CFR 220.4(b).
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Rule 12.3 is also being amended to clearly reflect that margin be
deposited and maintained equal to 100% of the purchase price of long
positions in listed equity options. This provision is consistent with
current CBOE Rule 12.5, and is being added to Rule 12.3 for the sake of
clarity.
Proposed Rule 12.3(c)(5), detailing the margin requirements for
short listed equity options is identical to that currently found in
paragraph (a)(5) of Rule 12.3, with three exceptions. First, the
provision has been moved. Second, the treatment of over-the-counter
(``OTC'') options has been deleted from the provision because the
Exchange is proposing to adopt the more extensive OTC margin provisions
of the NYSE. Third, the Exchange is proposing the addition of a
provision that would cap the minimum margin on short puts that are out-
of-the-money at a percentage of the exercise price of the short put.
With regard to capping the required minimum margin for short listed
puts, the Exchange indicates that, under the current provision, minimum
margin is required equal to the option's market value plus 10% of the
current market value of equivalent units of the underlying security.
However, as the market value of the underlying security increases above
the strike price, at some point the put becomes farther out-of-the-
money and the risk of the position decreases. According to the
Exchange, without the cap, the margin requirement would also continue
to increase at the same time that the risk of the position is
decreasing.
The Exchange is also clarifying the margin treatment of interest
rate put options under Rule 23.13 and the margin treatment of put
warrants under Rule 30.53. The treatment is the same as that provided
for short uncovered put options as described above.
The provisions governing margin treatment for options that are
offset or covered by certain defined ``related securities,'' where such
positions are carried in a customer margin account, has been revised
and rearranged. These are now found under new subsection 12.3(c)(5)(B).
This is necessary because various changes made over time have rendered
the provisions difficult to follow. The Exchange believes that the
changes being proposed will simplify the provisions and make them
easier for members to follow.\11\ The treatment for a covered call
writing position where the underlying security is a convertible
security is similar to that currently described in subsection
12.3(b)(1)(C) but has been revised to be consistent with NYSE Rule
431.\12\ The treatment for covered puts is similar to the treatment
under current subsection 12.3(b)(1)(B); however, the language has been
revised to conform the CBOE rule to the language in Regulation T.\13\
The new language of 12.3(c)(5)(B)(2) regarding covered calls has been
reworded from what currently appears in Rule 12.3(b)(1)(C)(1) to also
make it consistent with Regulation T.
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\11\ Telephone conversation between Diane Malley, Supervisor,
Department of Financial Compliance, CBOE, Timothy Thompson, Senior
Attorney, Legal Department, CBOE, and Chester McPherson, Staff
Attorney, Market Regulation, Commission, April 10, 1997.
\12\ See NYSE Rule 431(f)(2)(H)(i).
\13\ See Regulation T, 12 CFR 220.4(b)(9)(iii).
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The treatment of short equity option contracts offset by long
option contracts where the long option expires with or after the short
option under current Rule 12.3(c)(1) is the same as that currently
required for index options under CBOE Rule 24.11. However, the Exchange
is proposing to adopt the language contained in Rule 24.11 because it
is more straightforward than the language in Rule 12.3(c)(1).
The treatment for a straddle (a short call option and a short put
option the same underlying interest) requires margin on the put or
call, whichever amount is greater, plus the current market value of the
other option. The margin treatment for straddles is merely being moved
from current paragraph (a)(5) of Rule 12.3
The rules governing the margin requirements for OTC options are
based on those contained in NYSE Rule 431 \14\ except that the Exchange
has made a slight change to cap the minimum margin on OTC short puts. A
chart submitted with the filing sets forth the specific initial and/or
maintenance margin levels required for OTC options on various types of
underlying securities.\15\
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\14\ See NYSE Rule 431(f)(2)(D)(iii).
\15\ See SR-CBOE-97-17, Exhibit A at 22-23.
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The Exchange is proposing to add new margin treatment provisions
for OTC options positions that are covered or offset by certain
``related securities'' positions when such positions are held in a
customer margin account and also add new margin treatment provisions
for covered write convertibles, covered calls/puts, spreads, and
straddles involving OTC options.\16\ The proposed margin treatment is
the same treatment that is set forth in NYSE Rule 431 except for a
proposed change to cap the minimum margin on short puts.
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\16\ See new Rule 12.3(c)(6)(B) for these provisions.
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Customer Cash Account
The Exchange is proposing to add a provision to Rule 12.3 detailing
the circumstances under which a customer may carry short equity options
in a cash account, i.e. an account in which no credit is extended. This
provision, Rule 12.3(d), is consistent with a provision in Regulation
T.\17\ The proposed rule would permit either a call option contract or
a put option contract held in a short position to be carried in a cash
account if the option contract is covered, i.e., if the account
contains one of the specified offsets.
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\17\ See Regulation T, 12 CFR 220.2.
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In the case of a short call, allowable offsets include: (i) The
underlying security, in an amount equal to or greater than that
underlying the option, provided the option premium is held in the
account until full cash payment for the underlying security is
received; (ii) a security immediately convertible without the payment
of money into an equal or greater quantity of the security underlying
the option, if such security is held or purchased in the account, on
the same day, and provided that the option premium is held in the
account until full cash payment for the convertible security is
received and the ability to convert does not expire before the
expiration of the short call option; or (iii) an escrow agreement \18\
issued by a bank and either held in the account at the time the call is
written or received in the account promptly thereafter.
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\18\ The Exchange proposes to adopt the term ``escrow
agreement'' to mean:
any agreement issued in connection with non cash settled call or
put options under which a bank holding the underlying security or
required cash or cash equivalents, is obligated to deliver to the
creditor (in the case of a call option) or accept from the creditor
(in the cash of a put option) the underlying security against
payment of the exercise price upon exercise of the call or put.
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In the case of a short put option, allowable offsets include: (i)
Cash or cash equivalents as defined in Regulation T of not less than
the aggregate put exercise amount; or (ii) an escrow agreement issued
by a bank which is obligated to deliver the required cash in the event
of assignment of the short put.
CBOE Rule 24.11A currently permits certain debit put spreads
involving European-style broad-based stock index options to be carried
in a cash account. The Exchange proposes to cross-reference the
provisions of Rule 24.11A into Rule 12.3.
[[Page 31646]]
Market Maker and Specialist Accounts
Specific provisions governing permitted offset treatment for
market-makers and specialists have been deleted from Regulation
Specific provisions governing permitted offset treatment for
market-makers and specialists have been deleted from Regulation T,
which now indicates that such offsets are to be determined by the rules
of the applicable SRO. Accordingly, the proposed rule sets forth
various permitted offset positions which may be cleared and carried by
a member organization on behalf of one or more registered specialists,
registered market-makers, or Designated Primary Market-Makers
(hereinafter referred to generically as ``market-makers'') upon a
margin basis satisfactory to the concerned parties. A permitted offset
position will be defined to mean, in the case of an option in which a
market-maker makes a market, a position in the underlying instrument or
other related instrument, and in the case of other securities in which
a market-maker makes a market, a position in options overlying the
securities in which a market-maker makes a market, if the account holds
the following positions: (i) A long position in the underlying
instrument offset by a short option position which is ``in- or at-the-
money;'' (ii) a short position in the underlying instrument offset by a
long option position which is ``in- or at-the-money;'' (iii) a stock
position resulting from the assignment of a market-maker short option
position; (iv) a stock position resulting from the exercise of a
market-maker long position; (v) a net long position in a security
(other than an option) in which a market-maker makes a market; (vi) a
net short position in a security (other than an option) in which the
market-maker makes a market; or (vii) an offset position as defined in
SEC Rule 15c3-1.\19\ All permitted offset transactions must be effected
for the purpose of hedging, reducing the risk of, rebalancing,
liquidating open positions of market-makers, or accommodation of
customer orders, or other similar market-making purpose.
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\19\ See Securities Exchange Act Release No. 38248 (February 6,
1997) 62 FR 6474 (February 12, 1997) (Final rule adopting changes to
SEC Rule 15c3-1).
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For purposes of Rule 12.3, ``in- or at-the-money'' means the
current market price of the underlying security is not more than two
standard exercise price intervals below (with respect to a call option)
or above (with respect to a put option) the exercise price of the
option. In determining the types of instruments which are entitled to
be carried in a permitted offset position, reference can be made to the
definition of ``related instrument'' which is set forth in the rule.
``Related instrument'' within an option class or product group is any
related derivative product that meets the offset level requirements for
product groups under Rule 15c3-1, including all appendices of the Act,
or any applicable SEC staff interpretations or no-action positions
(hereinafter referred to collectively as ``SEC Rule 15c3-1''). The term
``product group'' means two or more option classes, related
instruments, and qualified stock baskets for which it has been
determined that a percentage of offsetting profits may be applied to
losses in the determination of net capital as set forth in SEC Rule
15c3-1.
The Exchange also proposes adding a provision regarding trading in
a deficit account. The provision generally states that nothing shall
prohibit the carrying firm from effecting hedging transactions in the
deficit account with the prior written approval of the carrying firms's
SEC designated examining authority.
Broker-Dealer Account
The Exchange is also proposing to add a provision that would
provide margin relief to accounts held by non-market-maker broker-
dealers. Under the new provision, a member organization may carry the
proprietary account of another registered broker-dealer upon a margin
basis which is satisfactory to both parties, provided the requirements
of Regulation T are adhered to and the account is not carried in a
deficit equity condition. The amount of any deficiency between the
equity maintained in the account and the margin required by the other
provisions of this Rule shall be deducted in computing the net capital
of the member organization under Rule 15c3-1 of the Act. This new
provision is similar to the provision of NYSE Rule 431(e)(6), and would
permit the proprietary accounts of all registered broker-dealers to be
carried on a ``good faith'' margin basis for purposes of maintenance
margin. Broker-dealers would still be subject to initial margin
requirements under Exchange rules and Regulation T.
Interpretations to Rule 12.3
The Exchange is proposing to add four interpretations to Rule 12.3.
Also, current Interpretation .01 to Rule 12.3 is proposed for deletion
because the interpretation concerns SuperShares, which the Exchange no
longer trades.\20\ New Interpretation .01 sets forth in chart form the
margin requirements applicable to short positions in listed options and
in index and foreign currency warrants. It reflects that margin is
required equal to the current market value of the option/warrant plus
the applicable percentage of the underlying instrument (set forth in
the chart). The margin required may be reduced by any ``out-of-the
money'' amount, as defined in the rule. However, the margin may not be
reduced below the option market value plus the specified percentage of
the current market value of the underlying instrument, as set forth in
the chart. The determination of the ``out-of-the-money amount'' is also
set forth in a separate chart.
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\20\ The Exchange is also proposing to delete interpretation .07
of Rule 24.11 because it also concerns SuperShares.
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Interpretation .02 describes how a member organization may
determine ``current market value'' in the event there is no closing
price or trading has been halted.
Interpretation .03 specifies that for purposes of the CBOE margin
rules, index warrants should be treated as if they were index options
unless the rules specify otherwise. The Exchange states that this
interpretation recognizes that the two types of products are
essentially equivalent from a market risk standpoint.
Changes to Rule 12.11
The Exchange is proposing a minor change to Rule 12.11. Rule 12.11
allows a member organization that is a member of the NYSE to elect to
be bound by the rules of the NYSE instead of the requirements set forth
in Rules 12.3 to 12.10. The Exchange is changing Rule 12.11 to allow
the member organization to exempt themselves from Rules 12.3 to 12.9,
but not from 12.10. Rule 12.10 establishes that the margin requirements
set forth in the rule are minimum requirements and authorizes the
Exchange to impose higher margin requirements when it deems such higher
requirements to be advisable. The Exchange has determined that it is
necessary to clarify that the Exchange may still impose higher margin
requirements on its members when the Exchange believes such higher
requirements are warranted, even when those members have elected to
generally be subject to the margin rules of the NYSE. The change to
Rule 12.11 also clarifies that if a member organization chooses to be
bound by NYSE margin rules it will be exempt not only from CBOE margin
rules in Chapter 12, but also from those margin rules in other chapters
of the Exchange's rules.
[[Page 31647]]
Changes to Rule 24.11
The Exchange is proposing to add to Rule 24.11 (which covers margin
requirements for index options) a provision setting forth the margin
requirements for covered calls and covered puts that is essentially
identical to an existing CBOE provision applicable to equity options.
In addition, the Exchange is proposing to add a definition of
``qualified stock basket'' to rule 24.11 This definition is used to
describe allowable offsets in customer accounts for covered calls and
covered puts. In addition, the Exchange makes a cross-reference to the
provision of Rule 12.3 that governs the cash account treatment of short
index options offset by long index options. Finally, the Exchange is
proposing to change Interpretation .04 which defines ``cash
equivalent.'' Instead of specifically defining cash equivalent as it is
currently defined in the rule, the Exchange has decided to defer to the
definition in Regulation T because the Exchange expects that the
definition in Regulation T may change from time to time.
III. Discussion
After careful review of the Exchange's proposed amendment to its
margin rules, and for the reasons discussed below, the Commission
believes that the proposed rule change is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to national securities exchanges, and, in particular, with
the requirements of Section 6(b) of the Act.\21\ Specifically, the
Commission believes the proposal is consistent with the Section 6(b)(5)
requirements that the rules of an exchange be designed to promote just
and equitable principles of trade, to remove impediments to and perfect
the mechanism of a free and open market and a national market system,
to prevent fraudulent and manipulative acts, and, in general, to
protect investors and the public interest.\22\
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\21\ 15 U.S.C. Sec. 78f(b).
\22\ In approving these rules, the Commission has considered the
proposed rules' impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
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Definition and Interpretation Sections
The Exchange proposes to include a definition section in Rule 12.3.
The proposed definitions are: ``bank,'' ``current market value,''
``escrow agreement,'' and ``exempted security.''
The definition of ``bank'' is similar to that term as currently
defined in the Act. Accordingly, the proposed definition does not raise
new or unique issues.
The proposed definition of the term ``current market value'' for
Rule 12.3 purposes, is modelled on a similar term currently defined in
Exchange Rule 24.11(a), and also includes the incorporation of certain
parts of a similar definition found in NYSE Rule 431(a)(1).
Accordingly, the proposed definition does not raise new or unique
issues. The Exchange is also adopting an interpretation to the
definition of ``current market value,'' as discussed below.
The term ``escrow agreement'' being adopted by the Exchange is
nearly identical to that of Regulation T except that it represents a
more restrictive approach, reflecting CBOE's concern that certain
control locations, such as transfer agents, are not appropriate issuers
of escrow receipts. The Commission concludes that it is reasonable for
the Exchange to limit the allowed issuers of escrow receipts to
entities such as banks.
The Commission believes that the proposed deletion of references to
SuperShares is appropriate because the product no longer trades on the
Exchange. The Commission also believes that the interpretive section
discussing ``current market value,'' which is new to Rule 12.3,
provides useful guidance to members, especially in circumstances where
trading in a security has been halted but the OTC market is still open.
As the Exchange indicates, without this guidance, members would not
know what approach is acceptable to the Exchange in determining
``current market value.''
Other changes to the interpretation section of Rule 12.3 are
discussed elsewhere in this discussion section.
Customer Margin Accounts
The Commission supports the Exchange's efforts to consolidate those
rules relating to customer margin accounts into one subsection of the
rule. In addition to moving and reorganizing the customer margin
provisions, the Exchange also is adopting a new margin treatment for
exempted securities. The proposal would generally lower the maintenance
margin rates for United States debt securities from the existing 5%,
and instead establish margin requirements of 1% to 6% depending on the
years to maturity for the obligation. However, zero coupon bonds will
be subject to a margin requirement of 3% for bonds with five years or
more to maturity, and all other exempted securities, i.e., other than
obligation of the United States, will be subject to an initial and
maintenance margin requirement of 15% of the current market value or 7%
of the principal amount, whichever is lower.
The Commission notes that the CBOE's proposed margin treatment for
exempted securities is nearly identical to an existing NYSE provision.
When the NYSE adopted its provision, it stated that a sliding scale
would provide greater margin requirements for the more volatile long-
term securities, and reduce margin requirements as government
securities approach maturity to reflect the reduced risk in carrying
those securities. Prior to adopting the proposal, the NYSE had also
conducted an analysis of two-year historical price information for
three Treasury securities of different maturities, a short-,
intermediate-, and long-term instrument, and concluded that the
proposed margin requirements for the more volatile long-term government
instrument would provide at least a 96% confidence level that price
movements over one and two week periods would be covered.\23\
Accordingly, the Commission believes that the proposal by the CBOE to
adopt the same margin rates for U.S. obligations as required by the
NYSE is reasonable and should provide member organizations with
adequate protection against adverse short-term market movements of
securities in customer margin accounts. Additionally, the Commission
believes uniform margin rates in this area will enhance efficiency in
the market place for these securities. Nevertheless, the Commission
reiterates that maintenance margin rates are intended to set a minimum
margin standard and should not be construed as limiting the Exchange's
ability to require margin to be deposited in excess of the minimum
margin when appropriate.
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\23\See Securities Exchange Act Release No. 24144 (February 27,
1987) 52 FR 7245 (March 9, 1987).
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The proposed treatment of non-convertible debt securities is new to
Rule 12.3. The Exchange does not currently have a margin treatment
specifically applicable to non-convertible debt securities and has
decided to adopt the approach used by the NYSE for the sake of
uniformity and because the Exchange believes that this approach is
sensible. The Commission believes that this proposed revision does not
raise new regulatory issues and, accordingly, is appropriate.
The proposed treatment of security offset is not new to Rule 12.3.
Rather, it is a combination of two current provisions of Rule 12.3,
with the deletion of an incorrect parenthetical reference to options as
convertible
[[Page 31648]]
securities. These proposed changes are therefore reasonable and should
provide clearer guidance on the treatment of security offsets.
The proposed treatment for a short listed call covered by a warrant
is new to Rule 12.3 but it is substantially similar with the current
treatment under Regulation T, 12 CFR 220.4(b) and, accordingly, is
reasonable.
The proposed treatment for long listed equity options is new to
Rule 12.3 and its provisions essentially clarify the application of
Regulation T, 12 CFR 220.18(a) to such options. Specifically, the
provision confirms that long listed equity options must be fully paid
for at the time of purchase.\24\
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\24\ The Commission notes the recent amendments to Regulation T
permitting SROs' rules, pursuant to SEC-approval, to allow the
extension of loan value to listed options. See supra note 6. The
current proposal, however, does not address this issue or otherwise
permit the extension of loan value for long listed options.
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The proposed treatment for a short listed equity option has been
slightly revised from the current requirements by combining existing
language from the Rule 12.3 \25\ with language from Regulation T. In
addition, the Exchange proposes revising the margin cap for out-of-the
money short puts. Currently, the margin requirement on a short
uncovered listed equity option is calculated by adding to the option
premium a percentage (20%) of the underlying instrument's value, and
then subtracting any out-of-the-money amount. The Exchange also has an
overriding minimum margin formula, based on a percentage (10%) of the
value of the underlying instrument's market price.
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\25\ See CBOE Rule 12.3(a)(5).
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According to the Exchange, the existing methods for calculating the
margin treatment for short uncovered listed equity options works
reasonably well, except when the overriding minimum is applied to an
out-of-the-money put. Under the overriding minimum margin requirement,
as a short uncovered put option becomes increasingly out-of-the-money,
the margin requirement increases because the value of the underlying
instrument is increasing. As a result, the CBOE indicates that margin
calls may be issued for uncovered puts that are out-of-the-money. The
Exchange proposes to remedy this situation by revising the method for
calculating the overriding minimum margin. Specifically, the Exchange
proposes to substitute the market value of the underlying instrument
with a percentage of the put's aggregate exercise price. Under this new
method, the minimum requirement is a fixed value and, therefore, and
increasingly higher minimum requirement will not occur as the value of
the underlying rises. The Commission believes this new method for
calculating the overriding minimum margin for short listed equity
options is reasonable and should result in adequate margining for the
affected positions.\26\
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\26\ The Commission notes that the new minimum margin
requirement should often result in higher margin levels for deep in-
the-money puts. This will occur because the current minimum margin
requirement for a short put is based, in part, on the underlying
instrument's value, an amount that decreases as the put becomes
deeper in-the-money. The new formula corrects this result by
requiring a minimum margin amount based in part on the aggregate
exercise value of the option, an amount that remains constant as the
value of the underlying security decreases in value.
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The Exchange states that the proposed treatment of short listed
equity options offset by long listed equity options where the long
option expires with or after the short option under Rule 12.3 is
actually the same as that currently permitted for index options under
Rule 24.11. The Exchange indicates that because the treatment under its
current rules for equity and index options is actually the same,
adopting the more straightforward of the two treatment is a reasonable
approach in that the cumbersome language of Rule 12.3 is being replaced
by the easier to understand language of Rule 24.11.
The proposed treatment for a straddle (a short call option and a
short put option on the same underlying interest) requires margin on
the put or call, whichever amount is greater, plus 100% of the current
market value of the other option. This is not a substantive change.
Rather, the Exchange is merely moving the margin treatment for a
straddle from current paragraph (a)(5) of Rule 12.3.
Rule 12.3(c)(6) governing the margin treatment of OTC options is
new to the Exchange. It is being patterned after, and is nearly
identical to the provisions contained in NYSE Rule 431(f)(2)(D)(iii). A
slight difference is that the Exchange has proposed the inclusion of a
cap for the minimum margin on OTC short puts for the same reasons that
it proposes changing its formula for capping the margin on short listed
equity options, as discussed above.
Given the near identical nature of the CBOE's proposals to the
NYSE's previously approved proposal, the Commission believes that
adoption of these proposed standards is reasonable. With regard to the
cap on short put positions, the Commission believes such treatment is
also reasonable for the same reasons set forth regarding the identical
proposed treatment for listed positions.
The proposed treatment of related securities positions in OTC
options also is substantially similar to that of the NYSE and
accordingly does not raise new regulatory issues.\27\ The Commission
also believes that the Exchange's decision to model its margin
treatment for OTC options and related securities positions based on the
NYSE positions should help foster coordination between markets by
achieving parity between the margin requirements of the various SROs.
The Commission also believes that this approach will promote
coordination in regulating, clearing, settling, and facilitating
transactions in securities by providing for uniformity in this area of
the SROs' margin schemes and reducing confusion among customers.
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\27\ See NYSE Rule 431(f)(2).
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Customer Cash Account
Rule 24.11A currently permits certain debit put spreads involving
European-style broad-based stock index options to be carried in a cash
account. The Exchange proposes to copy a certain section of 24.11A
(specifically, 24.11A(f)) into Rule 12.3. Essentially, the new
provision concerning debit put spreads in Rule 12.3 will serve as a
cross-reference to the more detailed provisions contained in Rule
24.11A. Accordingly, although not specifically contained in the Rule
12.3 cross-reference, all of the applicable conditions contained in
Rule 24.11A must be met before the described debit put spreads may be
carried in a cash account.\28\
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\28\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE,
to Chester McPherson, Staff Attorney, Market Regulation Commission,
dated May 30, 1997.
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Market Maker and Specialist Accounts
The Exchange has also proposed to adopt specific provisions
governing permitted offset treatment for market-makers and specialists
that are being deleted from Regulation T as of June 1, 1997. The
proposed rule sets forth various permitted offset positions which may
be cleared and carried by a member organization on behalf of one or
more market-makers upon a margin basis satisfactory to the concerned
parties (``good faith'' margin). In addition, it requires that the
amount of any deficiency between the equity maintained by the market-
maker and the haircuts specified in SEC Rule 15c3-1 shall be considered
as a deduction from net worth in the net capital computation of the
carrying broker.
A permitted offset position will be defined to mean, in the case of
an option in which a market-maker makes
[[Page 31649]]
a market, a position in the underlying instrument or other related
instrument, and in the case of other securities in which a market-maker
makes a market, a position in options overlying the securities in which
a market-maker makes a market, if the account holds the following
positions: (i) A long position in the underlying instrument offset by a
short option position which is ``in- or at-the-money;'' (ii) a short
position in the underlying instrument offset by a long option position
which is ``in- or at-the-money;'' (iii) a stock position resulting from
the assignment of a market-maker short option position; (iv) a stock
position resulting from the exercise of a market-maker long position;
(v) a net long position in a security (other than an option) in which a
market-maker makes a market; (vi) a net short position in a security
(other than an option) in which the market-maker makes a market; or
(vii) an offset position as defined in SEC Rule 15c3-1.
The six proposed offsets described in proposed Rule 12.3(f)(3)(A)
(i) to (vi) codify the existing permitted offsets that were provided
under Regulation T until June 1, 1997. These offsets reflect well-
recognized market-making hedging transactions involving certain options
offset strategies involving the related underlying stock. The addition
of Rule 12.3(f)(3)(A)(vii), allowing any offset position defined under
SEC Rule 15c3-1,\29\ constitutes a significant expansion of permitted
offset positions. According to the Exchange, the inclusion of item
(vii) recognizes that options market-makers and specialists must engage
in various hedging transactions to manage the risk involved in
fulfilling their role, and, therefore, allows a member organization to
clear and carry market-maker's offset positions as defined in SEC Rule
15c3-1 upon a good faith margin basis. The Exchange has clarified its
proposal to reflect that market-makers are permitted to receive good
faith margin for all permitted offset positions only if they are
effected for market-making purposes such as hedging, reducing the risk
of rebalancing, liquidating open positions of the market-maker,
accommodating customer orders, or another similar market-making
purpose.
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\29\ See supra note 19.
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The Commission believes that the proposal is a reasonable effort by
the CBOE to accommodate the needs of CBOE market-makers in undertaking
their market-making responsibilities as it recognizes the occasional
need for market-makers to effect transactions in their course of
dealing in options classes for which the marker-maker is not
registered. The Commission believes that this approach will not
adversely affect the depth and liquidity necessary to maintain fair and
orderly markets. The Commission expects CBOE clearing firms and other
CBOE members that extend margin to market-makers to implement adequate
procedures to ensure that offsets elected by market-makers are recorded
accurately and cleared into appropriate accounts. In addition, such
members should have a reasonable basis for determining that the offset
transactions satisfy the marketmaking purpose requirements set forth in
CBOE Rule 12.3(f). The Commission believes that these requirements will
ensure that transactions effected by market-makers and specialists
receiving the offset treatment are in fact directly related to their
market-making function and are not effected for speculative purposes on
a margin basis which should be available only for bona fide market-
making activity.
The Exchange indicates that its proposed definition of ``in-or at-
the-money,'' for purposes of permitted offset transactions, represent a
codification of its long standing practice of permitting the financing
of options market-makers underlying stock positions on a good faith
basis when offset on a share-for-share basis by options which are ``in-
or at-the-money,'' i.e., where the current market price of the
underlying security is not more than two standard exercise price
intervals below (with respect to a call option) or above (with respect
to a put option) the exercise price of the option (emphasis added).
According to the Exchange, this practice evolved after it made changes
in 1985 to its Rule 5.5 so that the interval between strike prices of
options series on individual stocks is 2\1/2\ points where the strike
price is greater than $25, but less than $200; and 10 points where the
strike price is greater than $200. The Exchange indicates that this
position was represented to the Federal Reserve Board as consistent
with Regulation T, 12 CFR 220.12 \30\ and that the Board has not
objected to this practice.\31\ At this time, the Commission believes it
is appropriate for the CBOE to codify this longstanding practice.
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\30\ Regulation T, 12 CFR 220.2 defines ``in- or at-the-money,''
to mean (until June 1, 1997) the current market price of the
underlying security is not more than one (emphasis added) standard
exercise interval below (with respect to a call option) or above
(with respect to a put option) the exercise price of the option.
\31\ Telephone conversation between Diane Malley, Supervisor,
Department of Financial Compliance, CBOE, and Chester McPherson,
Staff Attorney, Market Regulation, Commission, May 28, 1997. See
also Letter from Mary L. Bender, Assistant Vice President, CBOE, to
Laura Homer, Federal Reserve Board, dated May 23, 1985 outlining the
issue.
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Broker-Dealer Account
The Exchange proposes adding a provision that would provide margin
relief to accounts held by non-market-maker broker-dealers. Under the
new provision, a member organization may carry the proprietary account
of another registered broker-dealer upon a margin basis which is
satisfactory to both parties, provided the requirements of Regulation T
are adhered to and the account is not carried in a deficit equity
condition. This new provision is substantially similar to the provision
of NYSE Rule. 431(e)(6) and is being adopted by the Exchange for the
sake of uniformity. Accordingly, this change is appropriate.
Changes to Rule 12.11
The Exchange has determined to allow its members who are also
members of the NYSE to exempt themselves from CBOE Rules 12.3 to 12.9.
However, the Exchange has determined to not allow its members to exempt
themselves from CBOE Rule 12.10. Rule 12.10 authorizes the Exchange to
impose higher margin requirements when it deems such higher
requirements to be advisable. The Commission agrees that it is
reasonable for the CBOE to be able to determine when higher margin
requirements will be required for positions in Exchange-traded products
and that, therefore, its members should not be permitted to exempt
themselves from this rule. The Commission notes that the Exchange is
under no obligation to allow its members to be exempted from any of its
applicable rules unless the Exchange believes such exemption is
appropriate.
Changes to Rule 24.11
The addition of this section is intended to provide the same margin
cover for covered calls and covered puts involving index options \32\
as is currently allowed for equity options. The recent amendments to
Regulation T include a new provision that allows SROs, subject to SEC
approval, to expand the allowed types of covered transactions (in
addition to those allowed under the Regulation T definition of covered
transactions), provided that: (i) The position has finite
[[Page 31650]]
risk; (ii) the amount at risk is held in the account in cash, cash
equivalents, or via an escrow agreement; and (iii) the transaction is
eligible for the cash account. The existing covered transaction
provisions of Regulation T do not address positions involving index
options. The Commission has addressed this area in the past by granting
a number of no-action positions that allow certain short index call
option positions to be offset by a portfolio of stocks that exactly
replicates the index option.\32\ The proposed revision to Rule 24.11
essentially codifies the margin treatment permitted under these prior
positions and therefore is appropriate. Although these prior no-action
positions did not address or grant no-action relief to short index put
options offset by short positions in a portfolio of stocks replicating
the index option, the Commission concludes that such positions
nonetheless satisfy the noted regulatory standards required for covered
transactions and such treatment is consistent with the covered
treatment afforded to transactions in equity options. Accordingly, this
provision is reasonable and appropriate.
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\32\ The current proposal only addresses index options that are
covered by a ``qualified portfolio'' containing all of the stocks
represented in the index, in proportion to their representation in
the index. Provisions for short index options offset by long index
options are proposed in the Second Margin Filing.
\33\ See, eq., Letter from Sharon Lawson, Senior Special
Counsel, Market Regulation, to Diane Malley, CBOE, dated October 4,
1996 (short index call positions in Goldman Sachs Technology
Composite Index and Goldman Sachs Technology sub-Index options).
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Accelerated Approval of Amendment Nos. 1 and 2
The Commission finds good cause for approving Amendment Nos. 1 and
2 period to the thirtieth day after the date of publication of notice
of filing thereof. Amendment No. 1 addresses technical changes by
making corrections to certain typographical mistakes appearing in the
rule filing. Amendment No. 2 also makes technical changes by correcting
an incorrect cross-reference in CBOE Rule 12.5 and other inadvertent
omissions. In addition, it addresses a number of substantive issues,
including limiting the availability of good faith margin for permitted
offset to only bona fide market-making transactions. Amendment No. 2
also addresses the margin treatment applicable to long listed equity
options. Instead of requiring margin to be equal to the current market
value of long listed equity options, the requirement has been changed
to equal at least the purchase price of the option. This change better
reflects the purpose of the proposed change, which was to confirm that
long listed options must be paid for in full at the time of purchase.
The originally proposed language could possibly be interpreted to
impose a maintenance margin requirement for such positions, which is
not required for fully paid long positions. The remainder of Amendment
No. 2 merely provided additional information regarding issues that were
adequately published through the notice of this proposed rule filing.
All of the amended changes strengthen and clarify the proposal. Based
on the above, the Commission finds that there exists good cause
consistent with Section 6(b)(5) of the Act, to accelerated approval of
the amendments.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1 and 2. 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. 552, will be available for inspection and
copying in the Commission's Public Reference Room. Copies of all such
filing will also be available for inspection and copying at the
principal office of the CBOE. All submissions should refer to the file
number SR-CBOE-97-17 and should be submitted by June 23, 1997.
It is therefore Ordered, pursuant to Section 19(b)(2) of the
Act,\34\ that the proposed rule change (SR-CBOE-97-17) is approved.
\34\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\35\
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\35\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-15025 Filed 6-9-97; 8:45 am]
BILLING CODE 8010-01-M
