[Federal Register Volume 61, Number 171 (Tuesday, September 3, 1996)]
[Notices]
[Pages 46500-46502]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-22279]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37603; File No. SR-OCC-95-20]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving a Proposed Rule Change Relating to the Issuance,
Clearance, and Settlement of Buy-Write Options Unitary Derivatives
August 26, 1996.
On December 27, 1995, the Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') a
proposed rule change (File No. SR-OCC-95-20) pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ On
February 5, 1996, OCC filed Amendment No. 1 to the proposed rule
change.\2\ Notice of the proposed rule change, as amended, was
published in the Federal Register on March 20, 1996.\3\ No comment
letters were received. On March 20, 1996, OCC filed Amendment No. 2.\4\
Notice of the amendment was published in the Federal Register on May
15, 1996.\5\ No comment letters were received. For the reasons
discussed below, the
[[Page 46501]]
Commission is approving the proposed rule change.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ Letter from James C. Yong, First Vice President and General
Counsel, OCC, to Jerry W. Carpenter, Assistant Director, Division of
Market Regulation (``Division''), Commission (February 5, 1996).
\3\ Securities Exchange Act Release No. 36960 (March 13, 1996),
61 FR 11458.
\4\ Letter from James C. Yong, First Vice President and General
Counsel, OCC, to Jerry W. Carpenter, Esq., Assistant Director,
Division, Commission (March 19, 1996).
\5\ Securities Exchange Act Release No. 37203 (May 10, 1996), 61
FR 24995.
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I. Description of the Proposal
The purpose of the proposed rule change is to amend certain OCC By-
Laws and Rules and to add new sections to OCC's By-Laws and Rules to
provide for the issuance, clearance, and settlement of a new equity
derivatives product referred to as Buy-Write Options Unitary
Derivatives (``BOUNDs''). The Commission recently approved proposed
rule changes filed by the American Stock Exchange (``Amex''), the
Chicago Board Options Exchange (``CBOE''), and the Pacific Stock
Exchange (``PSE'') (collectively referred to as the ``exchanges'') to
list and trade BOUNDs.\6\
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\6\ For a complete description of the characteristics of BOUNDs,
refer to Securities Exchange Act Release No. 36710 (January 11,
1996), 61 FR 1791 [File Nos. SR-AMEX-94-56, SR-CBOE-95-14, and SR-
PSE-95-01] (order approving proposed rule changes relating to
BOUNDs).
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The purchase of a BOUND is intended to be substantially equivalent
to a buy-write transaction (i.e., the simultaneous writing of a call
option and purchase of the underlying stock). However, unlike an actual
buy-write transaction, the purchase of a BOUND is effected in a single
exchange transaction. As with all OCC issued options, BOUNDs will be
created when an opening buy and an opening sell order are executed. The
execution of every such order will increase the open interest in
BOUNDs.\7\
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\7\ Open interest refers to the total number of contracts that
have neither been closed out nor been allowed to expire.
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The exchanges have indicated that BOUNDs will be listed on the same
securities on which Long-Term Equity Options Series (``LEAPS'') \8\ are
listed because the criteria used for stocks underlying BOUNDs will be
the same criteria that is used for stocks underlying LEAPS. The
exchanges expect that BOUNDs will be listed with a duration equal to
that of LEAPS, which is currently thirty-nine months from the date of
issuance.
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\8\ Generally, LEAPS are long-term equity option securities that
expire up to 39 months from the date of issuance. For a complete
description of LEAPS, refer to Securities Exchange Act Release No.
28890 (February 15, 1991), 56 FR 7439 [File No. SR-CBOE-90-32]
(order approving proposed rule change regarding the listing of
LEAPS).
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A BOUND holder will be in essentially the same economic position as
a covered writer of a European-style call option. BOUND holders will
profit from the stock's movement up to the strike price and will
receive payments equivalent to any cash dividends paid on the
underlying stocks (``dividend equivalent''). Non-cash distributions may
be reflected either through the delivery of the distributed property or
by means of adjustments in the terms of the BOUNDs. The right of a
BOUND holder to receive and the obligation of a BOUND writer to pay or
deliver a dividend equivalent will be fixed at the close of trading on
the business day preceding the ex dividend date. The actual payment of
the dividend equivalent may occur days or weeks later to coincide with
the payable date for the corresponding dividend on the underlying
stock.\9\
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\9\ It is possible that an obligation to pay or a right to
receive a dividend equivalent that accrued prior to the expiration
date of a BOUND will remain outstanding after the expiration date
and even after expiration settlement has been completed. OCC simply
will continue to carry the dividend equivalent right or obligation
in a manner similar to a settlement obligation of an exercised
option. It will be margined and marked to the market each day
similar to other settlement obligations.
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BOUNDs are European style options because the holder cannot
exercise a BOUND prior to expiration. In contrast, LEAPS are American
style options, which can be exercised at any time prior to expiration.
At the expiration of a BOUND, either delivery of the underlying stock
or payment of the strike price is always required, and notice of
exercise is not required. Therefore, the concepts of exercise and
assignment are not used in relation to BOUNDs.
Under the proposed rule change, the expiration settlement date of a
BOUND contract is the third business day following the expiration date.
The expiration settlement date for a particular BOUND contract will not
depend on whether the contract is to be settled by cash or by the
delivery of stock. BOUNDs to be settled in cash will be settled through
OCC's cash settlement system. BOUNDs that are to be settled by delivery
of stock ordinarily will be settled in the same manner that exercised
stock options are settled (i.e., through stock clearing
corporations).\10\
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\10\ In the event the BOUND transaction cannot be settled
through regular-way settlement (i.e., on the third business day
following the expiration date), the contract will be settled on a
broker-to-broker basis.
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Like put and call stock options, BOUNDs ordinarily will trade in
standardized contract units of one hundred shares of underlying stock
per BOUND contract. Positions in BOUNDs will be included in the formula
to determine a clearing member's stock clearing fund contribution, and
BOUNDs will be included with stock options for purposes of margin
calculations. The clearing fund pool for BOUNDs will be the same fund
pool used for stock options, and the rule change amends the definition
of a ``stock clearing member'' to be a clearing member approved to
clear transactions in stock options and BOUNDs. Accordingly, stock
clearing members will be qualified automatically to engage in
transactions in BOUNDs without any additional qualification.
At expiration, if on the last day of trading the underlying stock
closes at or below the strike price, BOUND holders will receive one
hundred shares of the underlying stock for each BOUND contract held,
and BOUND writers will be required to deliver one hundred shares of the
underlying stock for each BOUND contract written. If at expiration the
underlying stock closes above the strike price, the BOUND holder will
receive a payment equal to one hundred times the BOUND's strike price
for each BOUND contract held, and BOUND writers will be required to
make payment equal to one hundred times the BOUND's strike price for
each BOUND contract written. In either case, the BOUND holder
ordinarily will be left in the same economic position as a covered call
writer that holds the position until the expiration of the call option.
Technically, there is no premium in a BOUND transaction because
that term generally is used to denote the purchase price of an option.
However, in order to accommodate transactions in BOUNDs, the proposed
rule change amends the definition of the term ``premium'' to permit the
term to include the trade price with respect to BOUNDs.
Pursuant to the rule change, OCC will margin BOUNDs as part of the
stock option product group and will include BOUNDs in the same class
group with put and call options on the same underlying stock. Special
provisions have been added to the definition of ``premium margin'' to
provide an appropriate definition of the term when applied to an
expired but unsettled BOUND contract. The added provisions reflect that
premium margin with respect to an expired long or short position in a
BOUND may call for either the marking price of such underlying security
due to be settled by delivery or the payment of the strike price
depending upon the closing price of the underlying stock when the BOUND
expires. The definition of the term ``marking price'' with respect to
margins on options and BOUNDs has been changed to reflect that OCC will
use the highest reported asked quotation in valuing an underlying
security if no last sale price is available. The minimum margin
required for the stock option product group includes protection against
the bid/ask spread; therefore, it is not necessary to use a different
[[Page 46502]]
quotation for puts than for calls (i.e., highest reported ask quotation
for call options and the lowest reported bid quotation for put
options).
The term ``closing price'' is defined under the rule change to mean
the closing price for the underlying security on the primary market on
the business day prior to the expiration date of the BOUND contract.
However, the exchange(s) on which any series of BOUNDs trades may
provide that the closing price of a BOUND be based on an average of
prices of the underlying security near the close of trading on such
business day.\11\ The rule change also sets forth the steps OCC may
take in the event the closing price for an underlying security is
unreported or otherwise unavailable. In addition to any other actions
OCC may be entitled to take under its By-Laws and Rules, OCC may
suspend settlement obligations for the affected BOUNDs until a closing
price is available or until OCC determines the closing price. OCC has
the authority to determine the closing price for BOUNDs by means of a
panel consisting of two designated representatives of each exchange on
which the affected series is open for trading and OCC's Chairman.
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\11\ The exchange(s) must specify that an average of prices will
be used prior to the opening of trading in any BOUNDs series.
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The rule change adds a provision to OCC's By-Laws to specify that
the closing price for the underlying security of a BOUND is
conclusively presumed to be accurate and shall be final for purposes of
determining settlement rights and obligations with respect to a BOUND.
The rule change also adds an Interpretation to OCC's By-Laws to provide
that except in extraordinary circumstances OCC will not adjust an
officially reported closing price for exercise settlement purposes even
if the closing price is subsequently found to have been erroneous.
OCC's Securities Committee shall have the authority to make
adjustments in BOUNDs contracts through the same procedures as in the
case of option adjustments.\12\ BOUNDs ordinarily will be adjusted
according to existing adjustment rules, and adjustments are expected to
ordinarily conform to adjustments made with respect to LEAPs on the
same underlying stock. Whenever additional shares or other property are
distributed with respect to shares of an underlying security (i.e., a
stock split or stock dividend) and the number of BOUND contracts
outstanding is adjusted to reflect the number of shares distributed or
the unit of trading for such BOUND contract is adjusted to include the
distributed property, then such adjustment will not include the
obligation to pay and received a dividend equivalent. However, when the
strike price of a BOUND is reduced to reflect the value of a
distribution, the writer of the BOUND will be obligated to pay a
dividend equilvant to the holder of the BOUND. This will occur because,
unlike in the case of adjusting an option, lower the strike price of a
BOUND will not give the holder the benefit of the distribution because
the holder does not pay the strike price (The strike price of a BOUND
caps the value that the holder will receive upon expiration of the
BOUND.) Therefore, it is appropriate to give the holder the benefit of
certain extraordinary distributions through a dividend equivalent at
the time the distribution is made and also to reduce the strike price
so that the BOUND holder cannot again receive the benefit of the
distribution when the BOUND expires.
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\12\ OCC's Securities Committee consists of one designated
representative of each exchange and the Chairman of OCC.
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In the case of a cash-out merger of similar transaction, a BOUND
will be adjusted to require the writer to pay expiration an amount
equal to the lesser of the price paid for the underlying security in
the merger or the strike price of the BOUND. Because there no longer
will be an underlying security, the expiration date of the BOUND will
be accelerated so that the cash will be paid to the BOUND holder at or
about the same time that payment of the cash-out value is paid to
holders of the underlying security. While the mechanics are somewhat
different from the adjustment ordinarily made for the same event in the
case of an option, the economic result is quite similar. Because the
value of an option because fixed as the result of adjusting for a cash-
out merger, in-the-money options are effectively terminated because
they have no time value and because holders have every incentive to
exercise them immediately to receive the cash. The expiration date of
the BOUND will be accelerated because BOUNDs are European style and
cannot be exercised prior to expiration.
II. Discussion
Section 17A(b)(3)(F) \13\ requires that the rules of a clearing
agency be designed to assure the safeguarding of securities and funds
in the custody or control of the clearing agency or for which it is
responsible. The Commission believes that OCC's proposal is consistent
with OCC's obligations under Section 17A(3)(F) to assure the
safeguarding of securities and funds in its custody or control because
the proposal provides that OCC will process BOUNDs transactions in
accordance with its existing risk-reduction methodology. For example,
under the proposal, BOUNDs will be included with stock options for
purposes of margin calculations, and positions in BOUNDs will be
included in the formula to determine a clearing member's proportionate
share of contribution to the clearing fund. Therefore, a clearing
member's activity in BOUNDs will be reflected in the amount of funds
collected (e.g., margin and clearing fund deposits) by OCC to safeguard
it against losses resulting from a clearing member's failure to settle.
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\13\ 15 U.S.C. Sec. 78q-1(b)(3)(F) (1988).
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of Section 71A(b)(3)(F) of
the Act and the rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-95-20) be, and hereby
is, approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\14\
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\14\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-22279 Filed 8-30-96; 8:45 am]
BILLING CODE 8010-01-M
