[Federal Register Volume 63, Number 158 (Monday, August 17, 1998)]
[Notices]
[Pages 43980-43982]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-21958]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40317; File No. SR-OCC-98-07]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Regarding the Short Option
Adjustment as Applied to Non-Equity Options
August 11, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on July 10, 1998, The Options
Clearing Corp. (``OCC'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II, and III below, which items have been prepared primarily by
OCC. The Commission is publishing this notice to solicit comments from
interested persons on the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The purpose of the proposed rule change is to amend OCC's Rule 602
to modify the ``short option adjustment'' as it applies to non-equity
options in OCC's margin system, the theoretical intermarket margin
system (``TIMS'' or ``NEO TIMS'').\2\
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\2\ ``TIMS'' refers to OCC's margin system as it applies to
stock options and ``NEO TIMS'' refers to OCC's margin system as it
applies to non-equity options.
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of such
statements.\3\
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\3\ The Commission has modified the text of the summaries
prepared by OCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
OCC requires its clearing members to adjust their margin deposits
with OCC in the morning on every business day based on OCC's overnight
calculations. OCC imposes a margin requirement on short positions in
each clearing member account and gives margin credit for unsegregated
long positions.\4\ Under TIMS, positions in a class group are margined
based on premium levels at the close of trading on the preceding day
which are then increased or decreased by the additional margin amount
for that class group.\5\
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\4\ A long position is unsegregated for OCC's purposes if OCC
has a lien on the position (i.e., it has recourse to the value of
the position in the event that the clearing member does not perform
an obligation to OCC). Long positions in firm accounts and market-
maker accounts are unsegregated. Long positions in the clearing
member's customers' accounts are unsegregated only if the clearing
member submits instructions to that effect in accordance with Rule
611.
\5\ For purposes of NEO TIMS, a class group consists of all put
and call options, certain market baskets, and commodity options and
futures that are subject to margin at OCC because of a cross-
margining program with a commodity clearing organization. A class
group may also contain stock loan baskets and stock borrow baskets.
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TIMS calculates additional margin amounts using options price
theory. TIMS first calculates the theoretical liquidating value for the
positions in each class group by assuming either an increase or
decrease in the market value of the underlying asset in an amount equal
to the applicable margin interval. The margin interval is the maximum
one price movement that OCC wants to protect against in the price of
the underlying asset.\6\ Margin intervals are determined separately for
each underlying interest to reflect the volatility in the price of the
underlying interest.
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\6\ Some combinations of positions can present a greater net
theoretical liquidating value at an intermediate value than at
either of the endpoint values. As a result, TIMS also calculates the
theoretical liquidating value for the positions in each class group
assuming intermediate market values of the underlying asset.
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TIMS then selects the theoretical liquidating value that represents
the greatest decrease (where the actual liquidating value is positive)
or increase (where the actual liquidating value is negative) in
liquidating value compared with the actual liquidating value based on
the premium levels at the close of trading on the preceding day. The
difference between that theoretical
[[Page 43981]]
liquidating value and the actual liquidating value is the additional
margin amount for that class group unless the class group is subject to
the short option adjustment.
For net short positions \7\ in deep out of the money options,
little or no change in value would be predicted given a change in value
of the underlying interest equal to the applicable margin interval. As
a result, TIMS would calculate additional margin amounts of zero or
close to zero for deep out of the money options. However, volatile
markets could cause such positions to become near to or in the money
and thereby could create increased risk to OCC. OCC protects against
this risk with an adjustment to the additional margin calculation known
as the short options adjustment.\8\
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\7\ A net position in an option series in an account is the
position resulting from offsetting the gross unsegregated long
position in that series against the gross short position in that
series. After netting, an account will reflect a net short position
or a net long position for each series of options held in the
account.
\8\ The short option adjustment for non-equity options is
described in OCC Rule 602(c)(1)(ii)(C)(1).
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Originally, the short option adjustment calculated a minimum
additional margin amount for all net short positions in an options
series for which the ordinary calculation of the additional margin
requirement was less than twenty-five percent of the applicable margin
interval. The original methodology applied the short option adjustment
to all such short option positions and did not attempt to match or pair
net short positions with net long positions which would substantially
reduce or eliminate the risk of such net short positions.\9\ OCC
concluded several years ago that this method required clearing members
to deposit margin in excess of the risk presented by certain net short
positions in deep out of the money options.
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\9\ The term unpaired is defined in Interpretation .04 to Rule
601 for equity options and Interpretation .06 to Rule 602 for non-
equity options.
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As a result, OCC modified the short option adjustment so that it
applied only to unpaired net short positions in deep out of the money
options.\10\ Currently, the term unpaired is defined to mean that a net
short position is not offset by a net long position on the same
underlying interest. By excluding paired net short positions from the
short option adjustment, OCC no longer needs to collect margin
calculated pursuant to the short option adjustment for many short
option positions which in fact pose little or no risk to OCC under
OCC's ordinary additional margin methodology.\11\
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\10\ Securities Exchange Act Release No. 31682 (December 31,
1992), 58 FR 3318 [File No. SR-OCC-91-12].
\11\ A pair consisting of a net short position and a net long
position on the same underlying interest (i.e., in the same class
group) will pose no risk to OCC if the exercise price of the short
position is higher (in the case of calls) or lower (in the case of
puts) than the exercise price of the long position. A pair
consisting of a net short position and a net long position will pose
a risk to OCC consisting of the difference between the exercise
prices of the short position and long position if the exercise price
of the short position is lower (in the case of calls) or higher (in
the case of puts) than the exercise price of the long position.
However, this risk is relatively small and is not open-ended (i.e.,
the risk cannot be greater than the difference between the two
exercise prices times the applicable unit of trading or index
multiplier and the number of contracts).
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Excluding paired net short positions from the short option
adjustment reduced the overcollateralization caused by the short option
adjustment. However, OCC believes that the short option adjustment
still requires members to deposit margin in excess of the risk created
by certain net short positions. This remaining overcollateralization
occurs because Interpretation .06 to OCC Rule 602 currently provides
that a net short position is unpaired unless the position is offset by
a net long position in the same class group (i.e., the net short and
long positions have the same underlying interest). Therefore,
Interpretation .06 treats a net short position as unpaired even if the
net short position is offset by a net long position in a highly
correlated class group. In other words, Interpretation .06 treats a net
short position on an index options that is offset by a net long
position on a highly correlated index option as unpaired for purposes
of the short option adjustment.
To reduce this remaining overcollateralization, OCC will refine the
short option adjustment logic of NEO TIMS so that it recognizes spreads
between net long and short positions on underlying interests that
exhibit price correlation of seventy percent or greater in addition to
spreads between net long and short positions on the same underlying
interests.\12\ Under the proposed rule change, OCC will modify Rule 602
to provide that NEO TIMS (1) will continue to pair all net short
contracts on a particular underlying interest against all net long
contracts on the same underlying interest and (2) will then pair any
remaining net short positions against any net long positions that
remain in other class groups that exhibit seventy percent or greater
price correlation.\13\ Any short contracts remaining unpaired after
this pairing process will be subject to the short option
adjustment.\14\
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\12\ OCC is not proposing to refine the short option adjustment
in TIMS for equity options. OCC attributes a thirty percent price
correlation to the class groups in the equity option product group,
and the modified short option adjustment would therefore have no
effect on equity options even if Interpretation .04 to Rule 601 were
revised.
\13\ The class groups in OCC's stock index and currency option
product groups satisfy the requirement for seventy percent or
greater price correlation.
\14\ Commodity options and futures held in cross-margin
accounts, market baskets, and stock loan and borrow baskets also
will be included in the pairing process. Long calls, futures,
commodity calls, market baskets, and stock loan baskets will be
netted against short calls and commodity calls. Long puts, commodity
puts, short futures, market baskets, and stock borrow baskets will
be netted against short puts and commodity puts.
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Interpretation .06 currently states that those short contracts
having the lowest premium margin values will be deemed to be unpaired.
Premium margin value is an important criterion used by OCC to identify
the excess short contracts that OCC will deem unpaired, but is not the
only criterion.\15\
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\15\ Other criteria may include identifying contracts that are
furthest from expiration, those that have the highest exercise price
(in the case of calls) or the lowest exercise price (in the case of
puts), or those that have been assigned the largest margin interval.
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Under the proposed rule change, Interpretation .06 will be modified
to provide that OCC will identify which of the excess short contracts
will be deemed unpaired and therefore be subject to margin requirements
using the short option adjustment.
OCC believes that pairing net short positions with net long
positions that do not exhibit one hundred percent price correlation
will create some incremental risk to OCC. However, OCC believes that
this incremental risk is relatively small and that OCC's ordinary
additional margin calculations should generate margin requirements
sufficient to protect OCC.
OCC believes that the proposed rule change is consistent with the
requirements of Section 17A of the Act \16\ and the rules and
regulations thereunder because it should further the public interest by
eliminating overcollateralization of certain short positions in deep
out of the money options where the risk of such positions is offset by
long positions on a highly correlated underlying interest. OCC believes
further that the proposed rule change will remove an impediment to
market liquidity without reducing OCC's protection with respect to
truly uncovered short positions in deep out of the money options.
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\16\ 15 U.S.C. 78q-1(b)(3)(A).
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(B) Self-Regulatory Organization's Statement on Burden on Competition
OCC does not believe that the proposed rule change will have any
material impact on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
Written comments were not and are not intended to be solicited by
OCC with respect to the proposed rule change, and none have been
received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for no
finding or (ii) as to which OCC consents, the Commission will:
(A) By order approve such proposed rule change or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 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 Section, 450 Fifth Street, NW.,
Washington, DC 20549.
Copies of such filing also will be available for inspection and
copying at the principal office of OCC. All submissions should refer to
File No. SR-OCC-98-07 and should be submitted by September 8, 1998.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\17\
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\17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-21958 Filed 8-14-98; 8:45 am]
BILLING CODE 8010-01-M
