98-15977. Final Rulemaking Permitting Futures-Style Margining of Commodity Options  

  • [Federal Register Volume 63, Number 115 (Tuesday, June 16, 1998)]
    [Rules and Regulations]
    [Pages 32726-32732]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 98-15977]
    
    
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    COMMODITY FUTURES TRADING COMMISSION
    
    17 CFR Parts 1 and 33
    
    
    Final Rulemaking Permitting Futures-Style Margining of Commodity 
    Options
    
    AGENCY: Commodity Futures Trading Commission.
    
    ACTION: Final rule.
    
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    SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
    repealing Commission Regulation 33.4(a)(2) and amending Commission 
    Regulation 33.7(b). The Commission also is implementing technical 
    amendments to its regulations imposing financial and segregation 
    requirements on futures commission merchants (``FCMs'') and introducing 
    brokers (``IBs'').
        Regulation 33.4(a)(2) requires the purchaser of a commodity option 
    to pay the full option premium at the initiation of the transaction. 
    Regulation 33.7 requires an FCM, or an IB in the case of an introduced 
    account, to provide each option customer with a written option 
    disclosure statement prior to the opening of the account.
        The repeal of Regulation 33.4(a)(2) will permit commodity options 
    to be margined using a ``futures-style'' margining system. Futures-
    style margining requires both the purchaser (``long'') and the seller 
    (``short'') of a commodity option to post risk-based, original margin 
    upon entering into an option position. During the life of the option, 
    the option value is marked to market daily, and gains and losses are 
    posted to the accounts of the long and short position holders. The 
    repeal does not impose an obligation on exchanges to adopt futures-
    style margining for commodity options. Exchanges may continue to use 
    their current option margining systems. Any exchange wishing to 
    implement futures-style margining must submit proposed rules for 
    Commission review pursuant to Section 5a(a)(12)(A) of the Commodity 
    Exchange Act (``Act'') and Commission Regulation 1.41.
        Regulation 33.7(b) sets forth the terms of the disclosure statement 
    and
    
    [[Page 32727]]
    
    currently reflects the prohibition against the margining of long option 
    positions. The Commission is amending the disclosure statement to 
    reflect the permissibility of futures-style margining for options.
    
    EFFECTIVE DATE: July 16, 1998.
    
    FOR FURTHER INFORMATION CONTACT: Thomas Smith, Attorney, Division of 
    Trading and Markets, Commodity Futures Trading Commission, Three 
    Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. 
    Telephone: (202) 418-5495; or electronic mail: tsmith@cftc.gov.
    
    SUPPLEMENTARY INFORMATION:
    
    I. Background
    
        On December 19, 1997, the Commission published for public comment 
    in the Federal Register a proposal to repeal Commission Regulation 
    33.4(a)(2) and proposed amendments to the option disclosure statements 
    in Regulation 33.7(b) and Appendix A to Regulation 1.55(c).\1\ The 
    original comment period was scheduled to end on February 2, 1998, but 
    was extended by the Commission until March 4, 1998.\2\
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        \1\ 62 FR 66569 (December 19, 1997).
        \2\ 63 FR 6112 (February 6, 1998).
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        Regulation 33.4(a)(2) is one of several regulations that were 
    implemented as part of a pilot program for the exchange trading of 
    options on non-agricultural futures instituted by the Commission on 
    November 3, 1981.\3\ Regulation 33.4(a)(2) requires the purchaser of an 
    option to pay the full premium at the initiation of the transaction. 
    Overall, the Commission's experience with the pilot program was 
    positive, and the trading of options on non-agricultural futures was 
    made permanent on August 1, 1986.\4\
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        \3\ 46 FR 54500 (November 3, 1981).
        \4\ 51 FR 17464 (May 13, 1986); 51 FR 27529 (August 1, 1986). 
    Subsequently, the Commission approved the exchange trading of 
    options on agricultural futures and options on non-agricultural 
    physicals effective February 9, 1987. 52 FR 777 (January 9, 1987). 
    On April 8, 1998, the Commission approved a three-year pilot program 
    for the off-exchange trading of certain agricultural trade options 
    and also approved exchange trading of options on agricultural 
    physicals. 63 FR 18821 (April 16, 1998).
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        Regulation 33.4(a)(2) requires commodity options to be subject to a 
    ``stock-style'' margining system that obligates the option buyer to pay 
    the full purchase premium when the transaction is initiated.\5\ The 
    long is not required to make any additional payments during the life of 
    the option. The option premium is credited to the account of the option 
    seller, who must keep it posted with his or her FCM. The short also 
    must deposit risk margin with his or her FCM to cover potential adverse 
    market moves in the option position. If the option increases in value, 
    the short must deposit additional funds into the account. These funds, 
    however, are not transferred to the long, who must exercise or offset 
    the option in order to realize any increase in its value. By contrast, 
    if the option value decreases, the short may withdraw any excess funds 
    from its account.
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        \5\ Regulations 33.4 in pertinent part states:
        Sec. 33.4  Designation as a contract market for the trading of 
    commodity options.
        The Commission may designate any board of trade...as a contract 
    market for the trading of options on contracts of sale for future 
    delivery... when the applicant complies with and carries out the 
    requirements of the Act (as provided in Sec. 33.2), these 
    regulations, and the following conditions and requirements with 
    respect to the commodity option for which the designation is sought:
        (a) Such board of trade * * *
        (2) Provides that the clearing organization must receive from 
    each of its clearing members, that each clearing member must receive 
    from each other person for whom it clears commodity option 
    transactions, and that each futures commission merchant must receive 
    from each of its option customers, the full amount of each option 
    premium at the time the option is purchased.
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        Futures-style margining of commodity options will require that both 
    the long and the short position holders post risk-based, original 
    margin upon entering into their option positions. The option value will 
    be marked to market daily during the life of the option. Any increase 
    in value will result in a credit to the long option holder's account 
    and a corresponding debit against the short option seller's account. 
    Conversely, any decrease in value will result in a credit to the 
    short's account and a corresponding debit to the long's account.
        Thus, under futures-style margining, the cash flows associated with 
    option contracts will be symmetric, as is the case for cash flows for 
    futures. Futures-style margining, however, will not alter the 
    fundamental nature of each party's overall obligation. A long's 
    potential for loss will remain limited to the full option premium and 
    transaction costs. As is the case now, a short's potential for loss 
    will not be so limited.
        In the Notice of Proposed Rulemaking, the Commission identified 
    several potential benefits and potential costs that may result from the 
    adoption of futures-style margining. The potential benefits included 
    the enhancement of the financial integrity and market liquidity that 
    may result from the more efficient cash flows associated with futures-
    style margining. The potential costs included an increase in the use of 
    leverage in the futures markets, an increase in customer confusion, 
    including an increase in the opportunity for unscrupulous individuals 
    to mislead unsophisticated option customers, and transition costs to 
    the industry in adopting futures-style margining.\6\
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        \6\ See, 62 FR 66571-66572
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    II. Comments Received
    
        The Commission received 27 comment letters on the proposal. 
    Supporting comments were submitted by six futures exchanges, four trade 
    associations, one clearing organization, one FCM and one law firm.\7\ 
    Eight commercial firms, two securities options exchanges, one FCM and 
    one investment management firm submitted opposing comments.\8\ Two FCMs 
    submitted comments that, while not opposing the proposal, raised 
    concerns about the implementation and operation of futures-style 
    margining.\9\
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        \7\ Supporting comments were submitted by: Chicago Board of 
    Trade; Chicago Mercantile Exchange; New York Mercantile Exchange; 
    Coffee, Sugar & Cocoa Exchange, Inc.; New York Cotton Exchange; 
    Minneapolis Grain Exchange; National Grain Trade Council; Commodity 
    Floor Brokers & Traders Association; National Grain and Feed 
    Association; Futures Industry Association; Board of Trade Clearing 
    Corporation; ABN Amro Chicago Corporation; and Philip McBride 
    Johnson of Skadden, Arps, Slate, Meagher & Flom, and a former 
    Chairman of the Commission.
        \8\ The opposing comments were submitted by: Andre & CIE S.A. 
    Lausanne; Transcatalana De Comercio, S.A.; Garnac Grain Co., Inc.; 
    Refinadora De Oleos Brasil LTDA.; SAROC S.P.A.; Compagnie 
    Commerciale Andre; La Plata Cereal; Andre & CIE (Singapore) PTE 
    LTD.; The Options Clearing Corporation; The Chicago Board Options 
    Exchange; The Clifton Group; and FIMAT Futures USA, Inc.
        \9\ The two comments were submitted by Lind Waldock & Company 
    and DKB Financial Futures Corp.
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        The material issues raised by the comment letters are set forth 
    below. In most instances, the issues raised were previously identified 
    by the Commission in the Notice of Proposed Rulemaking.
        One commenter stated that many of the cash flow benefits identified 
    in the Notice of Proposed Rulemaking could be achieved by expanding the 
    availability of cross-margining between futures markets and securities 
    markets. Another commenter stated that the Standard Portfolio Analysis 
    of Risk (``SPAN'') margining system provides market participants with 
    many of the cash flow benefits that are identified with futures-style 
    margining.\10\
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        \10\ The SPAN margining system was developed by the Chicago 
    Mercantile Exchange and is currently used by all domestic futures 
    exchanges and clearing organizations, except the Philadelphia Board 
    of Trade.
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        The Commission recognizes that cross-margining and the SPAN 
    margining system provide cash flow benefits to market participants. The 
    Commission believes, however, that futures-style margining could 
    provide additional cash flow benefits not
    
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    available through cross-margining or SPAN. For example, cross-margining 
    is restricted to specified products with offsetting risk 
    characteristics that are traded on different exchanges that have cross-
    margining arrangements. In contrast, futures-style margining could be 
    available for any futures exchange-traded options, and the cash flow 
    benefits would not be dependent on preexisting arrangements between 
    exchanges. Similarly, under SPAN, the long is still obligated to pay 
    the full option premium at the inception of the transaction regardless 
    of the portfolio's risk calculation. Thus, a trader who hedged a short 
    futures position with a long option would be required to pay the full 
    option premium at the initiation of the transaction under the stock-
    style margining system, even though SPAN would calculate the margin on 
    the two positions on a portfolio basis.
        Two commenters expressed a concern that futures-style margining 
    will result in an increase in the use of leverage in the futures 
    market. As the Commission stated in the Notice of Proposed Rulemaking, 
    futures-style margining will result in an increase in the amount of 
    leverage in the futures market. The purchaser of an option will be able 
    to acquire an option position upon payment of less than the full option 
    premium at the initiation of the transaction. The option position will 
    then be marked to market on a daily basis, with gains or losses posted 
    to the respective accounts of the long and short position holders. The 
    substitution of a margining system for the full, up-front payment of 
    the option also will introduce a risk of default by the long that does 
    not exist under the stock-style margining system.
        The Commission believes, however, that the leverage associated with 
    long options will not substantially increase the risk to the financial 
    integrity of the markets. First, as the Commission noted in the Notice 
    of Proposed Rulemaking, long option positions entail less total risk 
    than short options or long or short futures positions. Under futures-
    style margining, the maximum loss that a long may incur on an option 
    position will continue to be limited to the full option premium at the 
    initiation of the transaction. In contrast, holders of short options or 
    long or short futures positions will continue to be subject to much 
    greater risk from adverse market moves.
        Second, with respect to the added risk of default, FCMs that 
    currently hold customer accounts that include short options and long 
    and short futures positions assess the creditworthiness of each 
    customer as part of their normal business practices. Requiring such 
    firms to assess the creditworthiness of potential option purchasers 
    should not require any significant adjustments in such firms' operating 
    procedures in this regard.
        Third, the Commission is not requiring that exchanges adopt 
    futures-style margining for options. The exchanges may continue to use 
    their current margining systems and require option purchasers to pay 
    the option premium at the initiation of the transaction. The Commission 
    expects that exchanges will not propose adopting futures-style 
    margining until they have developed appropriate systems and/or 
    procedures to monitor the margining of long option positions and have 
    considered the views and market needs of their members and other market 
    participants.
        Finally, an FCM may require that option purchasers pay the full 
    option premium at the initiation of the transaction even if the 
    exchange permits futures-style margining. Therefore, FCMs that do not 
    have the systems or procedures to monitor the margining of long option 
    positions may elect to retain the stock-style margining system even 
    though an exchange might permit futures-style margining.
        Several commenters expressed a concern that futures-style margining 
    would benefit option buyers at the expense of option sellers. The 
    primary concern of these commenters is that the Commission did not 
    demonstrate that expected increases in option premiums would 
    sufficiently compensate option sellers for their loss of interest 
    income.
        In the Notice of Proposed Rulemaking, the Commission noted that a 
    futures-style margining system may alter option pricing. Sellers of 
    options may charge a higher premium to compensate for the loss of 
    interest income. Conversely, option buyers may be willing to pay a 
    higher premium because they will not have to pay the full premium up-
    front. The Commission believes, however, that market forces should 
    ensure that pricing changes will not benefit longs at the expense of 
    shorts. In this regard, commenters did not submit any support for the 
    assertion that futures-style margining would benefit option buyers at 
    the expense of option sellers.
        One commenter stated that permitting futures-style margining, which 
    does not require the up-front payment of option premiums, may result in 
    additional low-capital customers entering the option markets. The 
    commenter argued that such customers may not be very knowledgeable 
    about futures markets and may be susceptible to unscrupulous 
    individuals seeking to take advantage of them.
        By amending the option disclosure statement in Regulation 33.7 to 
    reflect the permissibility of futures-style margining, the Commission 
    is attempting to ensure that potential option customers receive 
    adequate notice concerning the risks of trading in commodity options. 
    In addition, the distribution of the disclosure statement does not 
    relieve an FCM or IB from any other disclosure obligations that it may 
    have under applicable law.
        One commenter stated that futures-style margining will require some 
    FCMs to increase staff and upgrade systems capabilities in order to 
    perform continuous intraday monitoring of long option positions. The 
    commenter further stated that the increased costs may be passed on to 
    option customers, thereby making trading more expensive. The commenter 
    also claimed that exchanges should not be permitted to offer futures-
    style margining until they are able to provide continuous, updated 
    information regarding the volatility levels of their options to their 
    member firms.
        The Commission recognizes that certain FCMs may be required to 
    expend additional capital to monitor properly long option positions 
    with the implementation of a futures-style margining system. However, 
    many firms already have such systems in place. As noted above, short 
    option positions are currently margined and marked to market on a daily 
    basis. Firms that carry short option positions on their books must have 
    monitoring and margining systems in place in order to track properly 
    the short option positions. In addition, futures-style margining has 
    been in place at the London International Financial Futures and Options 
    Exchange for over ten years.
        In addition, the Commission anticipates that the exchanges will 
    take into consideration the views of their members and other market 
    participants prior to proposing any changes to their option margining 
    systems. Moreover, any proposal to adopt a futures-style margining 
    system must be submitted to the Commission for review pursuant to 
    Section 5a(a)(12)(A) of the Act and Commission Regulation 1.41. As part 
    of the review process, the Commission may determine that publication of 
    the proposal in the Federal Register is necessary in order to obtain 
    the views and comments of interested persons.
        One commenter stated that the Commission's proposal lacked 
    specificity with respect to the implementation and operation of a 
    futures-style margining system. The
    
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    commenter argued that a lack of specificity may result in the adoption 
    of different margining systems or standards for each exchange or 
    different systems within one exchange. In contrast, two other 
    commenters stated that exchanges should have discretion to determine 
    which option contracts should be subject to a stock-style or futures-
    style margining system as part of the contract design process. In 
    addition, one of these two commenters stated that an exchange should be 
    afforded the flexibility of designing margining systems that result in 
    a hybrid of the stock-style and futures-style system. For example, an 
    exchange should have the discretion to design an option contract that 
    would require the option buyer to pay the full premium at the time of 
    purchase (stock-style) while also allowing that customer to withdraw 
    any subsequent option value gains from the account (futures-style).
        By repealing Commission Regulation 33.4(a)(2), the Commission does 
    not intend to require that an exchange use a uniform margining system 
    for all of its listed option markets or that the exchanges adopt 
    futures-style margining in a concerted manner. While the Commission 
    recognizes that a uniform margining system across all futures markets 
    might increase efficiency and reduce potential confusion among market 
    participants, the Commission believes that it is not its role to 
    mandate such a result. Each exchange should have the discretion to 
    design margining systems that it believes are appropriate for its 
    option markets. Accordingly, the Commission will review each proposal 
    to implement a futures-style margining system on an individual basis.
    
    III. Amendments to the Option Disclosure Statement
    
    A. Amendments to the Option Disclosure Statement in Regulation 33.7(b)
    
        Commission Regulation 33.7 was issued as part of the initial option 
    pilot program in November 1981 and requires an FCM, or an IB in the 
    case of an introduced account, to provide each option customer with a 
    detailed disclosure statement prior to the opening of an account. The 
    customer is required to sign an acknowledgment indicating that he or 
    she read and understood the document before any transaction is effected 
    for that customer's account.
        The disclosure statement, which is set forth in Regulation 33.7(b), 
    contains a detailed description of option trading and the risks 
    associated with option positions. The statement was drafted to reflect 
    the prohibition against the margining of long option positions.
        In the Notice of Proposed Rulemaking, the Commission proposed 
    several amendments to the disclosure statement to reflect the 
    permissibility of futures-style margining. The Commission has 
    determined to adopt the amendments with one modification.
        The Commission's proposed amendments included adding the following 
    language to the option disclosure statement:
    
        BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
    PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS SUBJECT TO A 
    ``STOCK-STYLE'' OR ``FUTURES-STYLE'' SYSTEM OF MARGINING. UNDER A 
    STOCK-STYLE MARGINING SYSTEM, A PURCHASER IS REQUIRED TO PAY THE 
    FULL PURCHASE PRICE OF THE OPTION AT THE INITIATION OF THE 
    TRANSACTION. THE PURCHASER HAS NO FURTHER OBLIGATION ON THE OPTION 
    POSITION. UNDER A FUTURES-STYLE MARGINING SYSTEM, THE PURCHASER 
    DEPOSITS INITIAL MARGIN AND MAY BE REQUIRED TO DEPOSIT ADDITIONAL 
    MARGIN IF THE MARKET MOVES AGAINST THE OPTION POSITION. THE 
    PURCHASER'S TOTAL MARGIN OBLIGATION, HOWEVER, WILL NOT EXCEED THE 
    ORIGINAL OPTION PREMIUM. IF THE PURCHASER OR GRANTOR DOES NOT 
    UNDERSTAND HOW OPTIONS ARE MARGINED UNDER A STOCK-STYLE OR FUTURES-
    STYLE MARGINING SYSTEM, HE OR SHE SHOULD REQUEST AN EXPLANATION FROM 
    THE FUTURES COMMISSION MERCHANT (``FCM'') OR INTRODUCING BROKER 
    (``IB''). (Emphasis added.)
    
        One commenter stated that the statement--THE PURCHASER'S TOTAL 
    MARGIN OBLIGATION, HOWEVER, WILL NOT EXCEED THE ORIGINAL OPTION 
    PREMIUM--while strictly true, could be open to honest 
    misinterpretation. The commenter stated that under certain 
    circumstances a long option position holder may incur margin payment 
    obligations that exceed the initial option premium. For example, an FCM 
    may require risk margin that exceeds the option premium. In addition, a 
    bought option may first increase substantially in value immediately 
    after purchase and then lose nearly all of its value on the next day. 
    If the option owner had withdrawn the initial value increase from the 
    account, he or she would be required to make a large daily variation 
    margin payment to the FCM to settle the subsequent value loss. In such 
    situations, the variation margin payments on the second day may exceed 
    the initial option premium. Accordingly, the commenter proposed that 
    the sentence be modified to state:
    
        THE PURCHASER'S TOTAL SETTLEMENT VARIATION MARGIN OBLIGATION 
    OVER THE LIFE OF THE OPTION, HOWEVER, WILL NOT EXCEED THE ORIGINAL 
    OPTION PREMIUM, ALTHOUGH SOME INDIVIDUAL PAYMENT OBLIGATIONS AND/OR 
    RISK MARGIN REQUIREMENTS MAY AT TIMES EXCEED THE ORIGINAL OPTION 
    PREMIUM.
    
    The Commission concurs with the commenter and is amending the risk 
    disclosure statement to include the above sentence in lieu of the 
    proposed sentence.
    
    B. Proposed Amendments to Appendix A of Regulation 1.55(c)
    
        Appendix A of Commission Regulation 1.55(c) contains a generic risk 
    disclosure statement applicable to the Commission's disclosure 
    requirements for domestic and foreign commodity futures and commodity 
    option transactions.\11\ The disclosure statement includes a discussion 
    of the risks associated with the futures-style margining of options, 
    which has been permitted on certain foreign exchanges, including the 
    London International Financial Futures and Option Exchange.
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        \11\ The disclosure statement was developed by the Commission in 
    cooperation with various international regulators and self-
    regulatory organizations who also have adopted the statement for use 
    in their jurisdictions. The disclosure statement permits firms doing 
    multinational business to use the same risk disclosure statement for 
    foreign and U.S.-based business. The Commission adopted the 
    disclosure statement on July 5, 1994. 59 FR 34376 (July 5, 1994).
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        In the Notice of Proposed Rulemaking, the Commission proposed minor 
    amendments to the risk disclosure statement to reflect explicitly the 
    permissibility of futures-style margining for options traded on U.S. 
    markets. Upon reconsideration, the Commission has determined that the 
    disclosures in the risk disclosure statement, as currently drafted, are 
    appropriate. Accordingly, the Commission is not amending Appendix A to 
    Commission Regulation 1.55(c).
    
    IV. Technical Amendments
    
        In the Notice of Proposed Rulemaking, the Commission requested 
    comment on any amendments that would need to be made to the 
    Commission's regulations governing net capital requirements for FCMs 
    and IBs to reflect the permissibility of futures-style margining. No 
    comments were received on this point.
        Several of the Commission's regulations impose financial 
    requirements on FCMs and IBs. In various sections of those regulations, 
    reference is made to the manner in which an FCM's net capital 
    requirement
    
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    is to be calculated. The calculation excludes the value of long options 
    positions because such options, under current methodologies, are fully 
    paid for and pose no financial risk to the FCM. The Commission, as 
    suggested in the Notice of Proposed Rulemaking, is making technical 
    amendments to these regulations in order to reflect the permissibility 
    of a futures-style margining system for commodity options and to make 
    clear that only the value of fully paid for long options may be 
    excluded from the capital requirement formula. Specifically, the 
    Commission is amending the definition of customer funds in Regulation 
    1.3(gg) and certain reporting requirements and financial requirements 
    set forth in Regulations 1.12(b)(2), 1.17(a)(1)(i)(B), 1.17(e)(1)(ii), 
    1.17(h)(2)(vi)(C)(2), 1.17(h)(2)(vii)(A)(2), 1.17(h)(2)(vii)(B)(2), 
    1.17(h)(2)(viii)(A)(2), 1.17(h)(3)(ii)(B), and 1.17(h)(3)(v)(B).\12\
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        \12\ The Commission's Division of Trading and Markets previously 
    has issued guidance on the proper accounting and segregation 
    treatment of exchange-traded options subject to a stock-style 
    margining system. See, Financial and Segregation Interpretation No. 
    8--Proper Accounting, Segregation and Net Capital Treatment of 
    Exchange Traded Option Transactions, Comm. Fut. L. Rep. (CCH) para. 
    7118 (Division of Trading and Markets, August 12, 1982). The 
    Commission may determine that it would be appropriate to revise this 
    Interpretation if exchanges seek to implement futures-style 
    margining.
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    V. Conclusion
    
        The Commission is repealing Regulation 33.4(a)(2), amending the 
    option disclosure statement in Regulation 33.7(b) and implementing 
    technical amendments to several financial regulations in order to 
    permit the futures-style margining of commodity options. The repeal of 
    Regulation 33.4(a)(2) is consistent with the Commission's ongoing 
    commitment to implement regulatory reforms that reduce unnecessary 
    burdens on the futures industry while also preserving important 
    customer protections and market safeguards. In this regard, it has been 
    seventeen years since the Commission authorized the first option pilot 
    program. During that time, option trading volume has grown from less 
    than 2 million transactions a year to over 100 million transactions a 
    year. During this period of remarkable growth, the Commission, 
    exchanges, FCMs and market participants have gained extensive 
    experience on the operations of the option markets. In light of this 
    experience and upon consideration of all the comments, the Commission 
    believes that with adequate disclosure to public customers it is no 
    longer necessary for the Commission to require option purchasers to pay 
    the full option premium at the initiation of the transaction.
    
    VI. Related Matters
    
    A. Regulatory Flexibility Act
    
        The Regulatory Flexibility Act (``RFA''), 5 U.S.C. Sec. 601 et 
    seq., requires that agencies, in promulgating rules, consider the 
    impact of those rules on small businesses. The rules discussed herein 
    will affect contract markets, clearing organizations, FCMs and IBs. The 
    Commission has established certain definitions of ``small entities'' to 
    be used by the Commission in evaluating the impact of its rules on such 
    small entities in accordance with the RFA. Contract markets and FCMs 
    have been determined not to be small entities under the RFA. 47 FR 
    18616 (April 30, 1982). Furthermore, the then Chairman of the 
    Commission previously has certified on behalf of the Commission that 
    comparable rules affecting clearing organizations do not have a 
    significant economic impact on a substantial number of small entities. 
    51 FR 44866, 44868 (December 12, 1986).
        With respect to IBs, the Commission has stated that it is 
    appropriate to evaluate within the context of a particular rule 
    proposal whether some or all IBs should be considered to be small 
    entities and, if so, to analyze that economic impact on such entities 
    at that time. The proposed rule amendments would not require any IB to 
    alter its current method of doing business as FCMS have the 
    responsibility of administering customer funds. Further, these rule 
    amendments, as proposed, should impose no additional burden or 
    requirements on IBs and, thus, if adopted would not have a significant 
    economic impact on a substantial number of IBs.
        Therefore, the Chairperson, on behalf of the Commission, hereby 
    certifies pursuant to 5 U.S.C. Sec. 605(b) that the action taken herein 
    would not have a significant economic impact on a substantial number of 
    small entities.
    
    B. Paperwork Reduction Act
    
        The Paperwork Reduction Act of 1995 \13\ imposes certain 
    requirements on federal agencies (including the Commission) in 
    connection with their conducting or sponsoring any collection of 
    information as defined by the Paperwork Reduction Act.
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        \13\ Pub. L. 104-13 (May 13, 1995).
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        While Rules 1.3, 1.12, and 1.17 do not effect the burden, the group 
    of rules (3038-0024) of which Rules 1.3, 1.12, and 1.17 are a part have 
    the following burden.
        Average burden hours per response: 128.
        Number of respondents: 3,148.
        Frequency of responses: on occasion.
        While Rule 33.7 does not effect the burden, the group of rules 
    (3038-0007) of which Rule 33.7 is a part has the following burden.
        Average burden hours per response: 50.57.
        Number of respondents: 190,422.
        Frequency of responses: on occasion.
        Copies of the information collection submission to the Office of 
    Management and Budget are available from the CFTC Clearance Officer, 
    1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5160.
    
    List of Subjects
    
    17 CFR Part 1
    
        Commodity Futures, Reporting and recordkeeping requirements.
    
    17 CFR Part 33
    
        Commodity Futures, Domestic exchange-traded commodity option 
    transactions, Consumer protection, Fraud.
    
        In consideration of the foregoing, and pursuant to the authority 
    contained in the Commodity Exchange Act and, in particular, sections 
    2(a)(1), 4b, 4c, and 8a thereof, 7 U.S.C. 2a, 6b, 6c, and 12a, the 
    Commission hereby amends Chapter I of Title 17 of the Code of Federal 
    Regulations as follows:
    
    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
    
        1. The authority citation for Part 1 continues to read as follows:
    
        Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
    6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
    12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.
    
        2. Section 1.3 is amended to revise paragraph (gg)(2)(iv) to read 
    as follows:
    
    
    Sec. 1.3  Definitions
    
    * * * * *
        (gg) * * *
        (2) * * *
        (iv) Representing accruals (including, for purchasers of a 
    commodity option for which the full premium has been paid, the market 
    value of such commodity option) to an option customer.
    * * * * *
        3. Section 1.12 is amended by revising paragraph (b)(2) to read as 
    follows:
    
    [[Page 32731]]
    
    Sec. 1.12  Maintenance of minimum financial requirements by futures 
    commission merchants and introducing brokers.
    
    * * * * *
        (b) * * *
        (2) 6 percent of the following amount: The customer funds required 
    to be segregated pursuant to the Act and the regulations in this part 
    and foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by such customers on or subject to 
    the rules of a contract market or a foreign board of trade for which 
    the full premiums have been paid: Provided, however, That the deduction 
    for each such customer shall be limited to the amount of customer funds 
    in such customer's account(s) and foreign futures and foreign options 
    secured amounts;
    * * * * *
        4. Section 1.17 is amended by revising paragraphs (a)(1)(i)(B), 
    (e)(1)(ii), (h)(2)(vi)(C)(2), (h)(2)(vii)(A)(2), (h)(2)(vii)(B)(2), 
    (h)(2)(viii)(A)(2), (h)(3)(ii)(B) and (h)(3)(v)(B) to read as follows:
    
    
    Sec. 1.17  Minimum financial requirements for futures commission 
    merchants and introducing brokers.
    
    * * * * *
        (a)(1)(i) * * *
        (B) Four percent of the following amount: The customer funds 
    required to be segregated pursuant to the Act and the regulations in 
    this part and the foreign futures or foreign options secured amount, 
    less the market value of commodity options purchased by customers on or 
    subject to the rules of a contract market or a foreign board of trade 
    for which the full premiums have been paid: Provided, however, That the 
    deduction for each customer shall be limited to the amount of customer 
    funds in such customer's account(s) and foreign futures and foreign 
    options secured amounts;
    * * * * *
        (e) * * *
        (1) * * *
        (ii) For a futures commission merchant or applicant therefor, 7 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (h) * * *
        (2) * * *
        (vi) * * *
        (C) * * *
        (2) For a futures commission merchant or applicant therefor, 7 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (vii) * * *
        (A) * * *
        (2) For a futures commission merchant or applicant therefor, 7 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (B) * * *
        (2) For a futures commission merchant or applicant therefor, 10 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (viii) * * *
        (A) * * *
        (2) For a futures commission merchant or applicant therefor, 6 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (3) * * *
        (ii) * * *
        (B) For a futures commission merchant or applicant therefor, 6 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
        (v) * * *
        (B) For a futures commission merchant or applicant therefor, 7 
    percent of the following amount: The customer funds required to be 
    segregated pursuant to the Act and the regulations in this part and the 
    foreign futures or foreign options secured amount, less the market 
    value of commodity options purchased by customers on or subject to the 
    rules of a contract market or a foreign board of trade for which the 
    full premiums have been paid: Provided, however, That the deduction for 
    each customer shall be limited to the amount of customer funds in such 
    customer's account(s) and foreign futures and foreign options secured 
    amounts;
    * * * * *
    
    PART 33--REGULATION OF DOMESTIC EXCHANGE TRADED COMMODITY OPTION 
    TRANSACTIONS
    
        5. The authority citation for Part 33 continues to read as follows:
    
    
    [[Page 32732]]
    
    
        Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
    6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 12c, 13a, 13a-
    1, 13b, 19, and 21.
    
    
    Sec. 33.4  [Amended]
    
        6. Section 33.4 is amended by removing and reserving paragraph 
    (a)(2).
        7. The disclosure statement in paragraph (b) of Sec. 33.7 is 
    amended by revising the text preceding paragraph (1) and paragraphs 
    (2)(v), (4) and (5) to read as follows:
    
    
    Sec. 33.7  Disclosure.
    
    * * * * *
        (b) * * *
    
    Options Disclosure Statement
    
        BECAUSE OF THE VOLATILE NATURE OF THE COMMODITIES MARKETS, THE 
    PURCHASE AND GRANTING OF COMMODITY OPTIONS INVOLVE A HIGH DEGREE OF 
    RISK. COMMODITY OPTION TRANSACTIONS ARE NOT SUITABLE FOR MANY 
    MEMBERS OF THE PUBLIC. SUCH TRANSACTIONS SHOULD BE ENTERED INTO ONLY 
    BY PERSONS WHO HAVE READ AND UNDERSTOOD THIS DISCLOSURE STATEMENT 
    AND WHO UNDERSTAND THE NATURE AND EXTENT OF THEIR RIGHTS AND 
    OBLIGATIONS AND OF THE RISKS INVOLVED IN THE OPTION TRANSACTIONS 
    COVERED BY THIS DISCLOSURE STATEMENT.
        BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
    PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS AN OPTION 
    WHICH, IF EXERCISED, RESULTS IN THE ESTABLISHMENT OF A FUTURES 
    CONTRACT (AN ``OPTION ON A FUTURES CONTRACT'') OR RESULTS IN THE 
    MAKING OR TAKING OF DELIVERY OF THE ACTUAL COMMODITY UNDERLYING THE 
    OPTION (AN ``OPTION ON A PHYSICAL COMMODITY''). BOTH THE PURCHASER 
    AND THE GRANTOR OF AN OPTION ON A PHYSICAL COMMODITY SHOULD BE AWARE 
    THAT, IN CERTAIN CASES, THE DELIVERY OF THE ACTUAL COMMODITY 
    UNDERLYING THE OPTION MAY NOT BE REQUIRED AND THAT, IF THE OPTION IS 
    EXERCISED, THE OBLIGATIONS OF THE PURCHASER AND GRANTOR WILL BE 
    SETTLED IN CASH.
        BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
    PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS SUBJECT TO A 
    ``STOCK-STYLE'' OR ``FUTURES-STYLE'' SYSTEM OF MARGINING. UNDER A 
    STOCK-STYLE MARGINING SYSTEM, A PURCHASER IS REQUIRED TO PAY THE 
    FULL PURCHASE PRICE OF THE OPTION AT THE INITIATION OF THE 
    TRANSACTION. THE PURCHASER HAS NO FURTHER OBLIGATION ON THE OPTION 
    POSITION. UNDER A FUTURES-STYLE MARGINING SYSTEM, THE PURCHASER 
    DEPOSITS INITIAL MARGIN AND MAY BE REQUIRED TO DEPOSIT ADDITIONAL 
    MARGIN IF THE MARKET MOVES AGAINST THE OPTION POSITION. THE 
    PURCHASER'S TOTAL SETTLEMENT VARIATION MARGIN OBLIGATION OVER THE 
    LIFE OF THE OPTION, HOWEVER, WILL NOT EXCEED THE ORIGINAL OPTION 
    PREMIUM, ALTHOUGH SOME INDIVIDUAL PAYMENT OBLIGATIONS AND/OR RISK 
    MARGIN REQUIREMENTS MAY AT TIMES EXCEED THE ORIGINAL OPTION PREMIUM. 
    IF THE PURCHASER OR GRANTOR DOES NOT UNDERSTAND HOW OPTIONS ARE 
    MARGINED UNDER A STOCK-STYLE OR FUTURES-STYLE MARGINING SYSTEM, HE 
    OR SHE SHOULD REQUEST AN EXPLANATION FROM THE FUTURES COMMISSION 
    MERCHANT (``FCM'') OR INTRODUCING BROKER (``IB'').
        A PERSON SHOULD NOT PURCHASE ANY COMMODITY OPTION UNLESS HE OR 
    SHE IS ABLE TO SUSTAIN A TOTAL LOSS OF THE PREMIUM AND TRANSACTION 
    COSTS OF PURCHASING THE OPTION. A PERSON SHOULD NOT GRANT ANY 
    COMMODITY OPTION UNLESS HE OR SHE IS ABLE TO MEET ADDITIONAL CALLS 
    FOR MARGIN WHEN THE MARKET MOVES AGAINST HIS OR HER POSITION AND, IN 
    SUCH CIRCUMSTANCES, TO SUSTAIN A VERY LARGE FINANCIAL LOSS.
        A PERSON WHO PURCHASES AN OPTION SUBJECT TO STOCK-STYLE 
    MARGINING SHOULD BE AWARE THAT, IN ORDER TO REALIZE ANY VALUE FROM 
    THE OPTION, IT WILL BE NECESSARY EITHER TO OFFSET THE OPTION 
    POSITION OR TO EXERCISE THE OPTION. OPTIONS SUBJECT TO FUTURES-STYLE 
    MARGINING ARE MARKED TO MARKET, AND GAINS AND LOSSES ARE PAID AND 
    COLLECTED DAILY. IF AN OPTION PURCHASER DOES NOT UNDERSTAND HOW TO 
    OFFSET OR EXERCISE AN OPTION, THE PURCHASER SHOULD REQUEST AN 
    EXPLANATION FROM THE FCM OR IB. CUSTOMERS SHOULD BE AWARE THAT IN A 
    NUMBER OF CIRCUMSTANCES, SOME OF WHICH WILL BE DESCRIBED IN THIS 
    DISCLOSURE STATEMENT, IT MAY BE DIFFICULT OR IMPOSSIBLE TO OFFSET AN 
    EXISTING OPTION POSITION ON AN EXCHANGE.
        THE GRANTOR OF AN OPTION SHOULD BE AWARE THAT, IN MOST CASES, A 
    COMMODITY OPTION MAY BE EXERCISED AT ANY TIME FROM THE TIME IT IS 
    GRANTED UNTIL IT EXPIRES. THE PURCHASER OF AN OPTION SHOULD BE AWARE 
    THAT SOME OPTION CONTRACTS MAY PROVIDE ONLY A LIMITED PERIOD OF TIME 
    FOR EXERCISE OF THE OPTION.
        THE PURCHASER OF A PUT OR CALL SUBJECT TO STOCK-STYLE OR 
    FUTURES-STYLE MARGINING IS SUBJECT TO THE RISK OF LOSING THE ENTIRE 
    PURCHASE PRICE OF THE OPTION--THAT IS, THE PREMIUM CHARGED FOR THE 
    OPTION PLUS ALL TRANSACTION COSTS.
        THE COMMODITY FUTURES TRADING COMMISSION REQUIRES THAT ALL 
    CUSTOMERS RECEIVE AND ACKNOWLEDGE RECEIPT OF A COPY OF THIS 
    DISCLOSURE STATEMENT BUT DOES NOT INTEND THIS STATEMENT AS A 
    RECOMMENDATION OR ENDORSEMENT OF EXCHANGE-TRADED COMMODITY OPTIONS.
    * * * * *
        (2) * * *
        (v) An explanation and understanding of the option margining 
    system;
    * * * * *
        (4) Margin requirements. An individual should know and 
    understand whether the option he or she is contemplating trading is 
    subject to a stock-style or futures-style system of margining. 
    Stock-style margining requires the purchaser to pay the full option 
    premium at the time of purchase. The purchaser has no further 
    financial obligations, and the risk of loss is limited to the 
    purchase price and transaction costs. Futures-style margining 
    requires the purchaser to pay initial margin only at the time of 
    purchase. The option position is marked to market, and gains and 
    losses are collected and paid daily. The purchaser's risk of loss is 
    limited to the initial option premium and transaction costs.
        An individual granting options under either a stock-style or 
    futures-style system of margining should understand that he or she 
    may be required to pay additional margin in the case of adverse 
    market movements.
        (5) Profit potential of an option position. An option customer 
    should carefully calculate the price which the underlying futures 
    contract or underlying physical commodity would have to reach for 
    the option position to become profitable. Under a stock-style 
    margining system, this price would include the amount by which the 
    underlying futures contract or underlying physical commodity would 
    have to rise above or fall below the strike price to cover the sum 
    of the premium and all other costs incurred in entering into and 
    exercising or closing (offsetting) the commodity option position. 
    Under a future-style margining system, option positions would be 
    marked to market, and gains and losses would be paid and collected 
    daily, and an option position would become profitable once the 
    variation margin collected exceeded the cost of entering the 
    contract position.
        Also, an option customer should be aware of the risk that the 
    futures price prevailing at the opening of the next trading day may 
    be substantially different from the futures price which prevailed 
    when the option was exercised. Similarly, for options on physicals 
    that are cash settled, the physicals price prevailing at the time 
    the option is exercised may differ substantially from the cash 
    settlement price that is determined at a later time. Thus, if a 
    customer does not cover the position against the possibility of 
    underlying commodity price change, the realized price upon option 
    exercise may differ substantially from that which existed at the 
    time of exercise.
    * * * * *
        Issued in Washington, D.C., on this 10th day of June, 1998, by 
    the Commodity Futures Trading Commission.
    Jean A. Webb,
    Secretary of the Commission.
    [FR Doc. 98-15977 Filed 6-15-98; 8:45 am]
    BILLING CODE 6351-01-P
    
    
    

Document Information

Published:
06/16/1998
Department:
Commodity Futures Trading Commission
Entry Type:
Rule
Action:
Final rule.
Document Number:
98-15977
Dates:
July 16, 1998.
Pages:
32726-32732 (7 pages)
PDF File:
98-15977.pdf
CFR: (5)
17 CFR 1.3
17 CFR 1.12
17 CFR 1.17
17 CFR 33.4
17 CFR 33.7