[Federal Register Volume 77, Number 172 (Wednesday, September 5, 2012)]
[Notices]
[Pages 54626-54629]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-21765]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67752; File No. SR-CBOE-2012-043]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Approving a Proposed Rule Change Relating to Spread
Margin Rules
August 29, 2012.
I. Introduction
On May 29, 2012, the Chicago Board Options Exchange, Incorporated
(``Exchange'' or ``CBOE'') filed with the Securities and Exchange
Commission (``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 to amend CBOE Rule 12.3 to
propose universal spread margin rules. The proposed rule change was
published for comment in the Federal Register on June 7, 2012.\3\ The
Commission received no comment letters on the proposed rule change.
This order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 67086 (May 31, 2012), 77
FR 33802.
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II. Description of the Proposal
An option spread is typically characterized by the simultaneous
holding of a long and short option of the same type (put or call) where
both options involve the same security or instrument, but have
different exercise prices and/or expirations. To be eligible for spread
margin treatment, the long option may not expire before the short
option. These long put/short put or long call/short call spreads are
known as two-legged spreads.
Since the inception of the Exchange, the margin requirements for
two-legged spreads have been specified in CBOE margin rules.\4\ The
margin requirement for a two-legged spread that is eligible for spread
margin treatment is its maximum risk based on the intrinsic values of
the options, exclusive of any net option premiums paid or received when
the positions were established.\5\ For example, consider the following
equity option spread:
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\4\ CBOE Rules Chapter 12; CBOE Rule 12.3(c)(5)(C)(4).
\5\ Any net credit received for establishing a spread may be
applied to the margin requirement, if any. In the case of a spread
that is established for a net debit, the net debit must be paid for
in full.
Long 1 XYZ May2011 60 call
Short 1 XYZ May2011 50 call
The maximum potential loss (i.e., risk) for this particular spread
would be a scenario where the price of the underlying stock (XYZ) is
$60 or higher. If the market price of XYZ is $60, the May2011 60 call
would have an intrinsic value of zero, because the right to buy at $60
when XYZ can be purchased in the market for $60 has no intrinsic value.
The May2011 50 call would have an intrinsic value of $10 because of the
$10 advantage gained by being able to buy at $50 when it costs $60 to
purchase XYZ in the market. Because each option contract controls 100
shares of the underlying stock, the intrinsic value, which was
calculated on a per share basis, is multiplied by 100, resulting in an
aggregate intrinsic value of $1,000 for the May2011 50 call.\6\
However, because the May2011 50 call is short, the $1,000 intrinsic
value is a loss, because it represents the cost to close (i.e., buy-
back) the short option. At an assumed XYZ market price of $60, netting
the intrinsic values of the options results in a loss of $1,000 (-
$1,000 + $0).\7\ Therefore, the
[[Page 54627]]
maximum risk of, and margin requirement for, this spread is $1,000. If
there is no maximum risk (i.e., there is no loss calculated at any of
the exercise prices found in the spread), no margin is required, but
under Exchange margin rules, any net debit incurred to establish the
spread would be required to be paid for in full. Current CBOE Rule
12.3(c)(5)(C)(4) provides that, when the exercise price of the long
call (or short put) is less than or equal to the exercise price of the
offsetting short call (or long put), no margin is required; and that
when the exercise price of the long call (or short put) is greater than
the exercise price of the offsetting short call (or long put), the
amount of margin required is the lesser of the margin requirement on
the short option, if treated as uncovered, or the difference in the
aggregate exercise prices. The intrinsic value calculation described
above is essentially expressed, in different words, in the current rule
language.
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\6\ The result would be multiplied by the number of contracts
when more than a one-by-one contract spread is involved.
\7\ At an assumed market price of $50, both the May2011 50 call
and May2011 60 call would have no intrinsic value. Thus, there is no
risk (provided any net debit is paid for in full) at an assumed
market price of $50.
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The maximum risk remains constant at $1,000 for XYZ market prices
higher than $60 because for each incremental increase in the assumed
market price of XYZ above $60, the loss on the short option is equally
offset by a gain on the long option in terms of their intrinsic values.
By calculating the net intrinsic value of the options at each exercise
price found in the spread, as in the computation exemplified above, the
maximum risk of, and margin requirement for, any two-legged spread can
be determined.
On July 27, 1999, the Commission approved the Exchange's
implementation of specific definitions and margin requirements for
butterfly spreads and box spreads.\8\ In a butterfly spread, a two-
legged spread is combined with a second two-legged spread (same type--
put or call--and same underlying security or instrument) as in the
following example:
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\8\ The butterfly and box spread margin rules, and various other
CBOE margin rule changes, were approved by the Commission on July
27, 1999. See Securities Exchange Act Release No. 41658 (July 27,
1999), 64 FR 42736 (SR-CBOE-97-67).
Long 1 XYZ May2011 50 call
Short 1 XYZ May2011 60 call
Long 1 XYZ May2011 70 call
Short 1 XYZ May2011 60 call
Note that a short XYZ May2011 60 call option is common to both two-
legged spreads. Therefore, by adding the May2011 60 call options
together, the two spreads can be combined to form a butterfly spread as
follows:
Long 1 XYZ May2011 50 call
Short 2 XYZ May2011 60 calls
Long 1 XYZ May2011 70 call \9\
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\9\ This configuration represents a long butterfly spread. The
opposite (i.e., short 1 XYZ May2011 50 call, long 2 XYZ May2011 60
calls and short 1 XYZ May2011 70 call) would be a short butterfly
spread.
The margin requirement for a butterfly spread is its maximum risk.
The maximum risk can be determined in the same manner as demonstrated
above for two-legged spreads. In this example, the net intrinsic values
would be calculated at assumed prices for the underlying security or
instrument of $50, $60 and $70, which are the exercise prices found in
the butterfly spread. The greatest loss, if any, from among the net
intrinsic values is the margin requirement. For this particular
butterfly spread, there is no loss in terms of net intrinsic values at
any of the assumed underlying prices ($50, $60 or $70). Therefore,
there is no margin requirement. However, the net debit incurred to
establish this butterfly spread must be paid for in full.
In a box spread, a two-legged call spread is combined with a two-
legged put spread. The exercise prices of the long and short put
options are the reverse of the call spread. All options have the same
underlying security or instrument and expiration date. An example is as
follows:
Long 1 XYZ May2011 50 call
Short 1 XYZ May2011 60 call
Long 1 XYZ May2011 60 put
Short 1 XYZ May2011 50 put \10\
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\10\ This configuration represents a long box spread. The
opposite (i.e., short 1 XYZ May2011 50 call, long 1 XYZ May2011 60
call, short 1 XYZ May2011 60 put and long 1 XYZ May2011 50 put)
would be a short box spread.
The margin requirement for a box spread, unless all options are
European style, is its maximum risk. The maximum risk of a box spread
can be determined in the same manner as demonstrated above for two-
legged spreads and butterfly spreads. In this example, the net
intrinsic values would be calculated at assumed prices for the
underlying security or instrument of $50 and $60, which are the
exercise prices found in the box spread. The greatest loss, if any,
from among the net intrinsic values is the margin requirement. For this
particular box spread (long box spread), there is no loss in terms of
net intrinsic values at either of the assumed underlying prices ($50 or
$60). Therefore, there is no margin requirement. However, the net debit
incurred to establish this box spread must be paid for in full. In the
case of a long box spread where all options are European style, the
margin requirement is 50% of the difference in the exercise prices (in
aggregate).\11\
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\11\ A 50% margin requirement is allowed because a long box
spread has an intrinsic value at expiration equal to the difference
in the exercise prices (in aggregate), which will more than cover
the net debit incurred to establish the spread. A long box spread
is, essentially, a riskless position. The difference between the
value of the long box spread realizable at expiration and the lower
cost to establish the spread represents a risk-free rate of return.
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On August 13, 2003, the Exchange issued a Regulatory Circular
(RG03-066) to define additional types of multi-leg option spreads, and
to set margin requirements for these spreads through interpretation of
Exchange margin rules. The Regulatory Circular had been filed with the
Commission and was approved on August 8, 2003, on a one year pilot
basis.\12\ The Regulatory Circular was reissued as RG04-90 (dated
August 16, 2004) and RG05-37 (dated April 6, 2005) pursuant to one year
extensions of the pilot granted by the Commission on August 6, 2004,
and March 22, 2005, respectively.\13\
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\12\ See Securities Exchange Act Release No. 48306 (Aug. 8,
2003), 68 FR 48974 (Aug. 15, 2003) (SR-CBOE-2003-24).
\13\ See Securities Exchange Act Release No. 50164 (Aug. 6,
2004), 69 FR 50405 (Aug. 16, 2004) and Securities Exchange Act
Release No. 51407 (Mar. 22, 2005), 70 FR 15669 (Mar. 28, 2005).
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The Regulatory Circular identified seven spread strategies by
presenting an example of each spread's configuration, and numbering
each configuration, rather than designating the configurations by names
commonly used in the industry. The seven configurations would be
referred to in the industry as:
Long Condor Spread,
Short Iron Butterfly Spread,
Short Iron Condor Spread,
Long Calendar Butterfly Spread,
Long Calendar Condor Spread,
Short Calendar Iron Butterfly Spread and
Short Calendar Iron Condor Spread.
On July 30, 2004, the Exchange filed proposed rule amendments with
the Commission to codify the provisions of the Regulatory Circular in
Exchange margin rules. Included in the proposal were definitions of
Long Condor Spread (which includes a Long Calendar Condor Spread),
Short Iron Butterfly Spread (which includes a Short Calendar Iron
Butterfly Spread), and Short Iron Condor Spread (which includes a Short
Calendar Iron Condor Spread). In addition, it was proposed that the
existing definition of Long Butterfly Spread be amended to include a
Long Calendar Butterfly Spread. The margin requirements, specific to
each type of spread, as had been set-forth in the Regulatory Circulars,
were also proposed for inclusion in Exchange
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margin rules.\14\ Contemporaneously, the New York Stock Exchange filed
similar margin rule proposals with the Commission.\15\ CBOE's proposed
rule amendment was approved by the Commission on December 14, 2005.\16\
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\14\ See Securities Exchange Act Release No. 52739 (Nov. 4,
2005), 70 FR 69173 (Nov. 14, 2005) (SR-CBOE-2004-53). This release
also noticed a partial amendment (Amendment No. 1) that was filed on
August 23, 2005 (in coordination with the New York Stock Exchange).
\15\ See Securities Exchange Act Release No. 52738 (Nov. 4,
2005), 70 FR 68501 (Nov. 10, 2005) (SR-NYSE-2004-39). For approval
order, see Securities Exchange Act Release No. 52951 (Dec. 14,
2005), 70 FR 75523 (Dec. 20, 2005).
\16\ See Securities Exchange Act Release 52950 (Dec. 14, 2005),
70 FR 75512 (Dec. 20, 2005).
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Because a number of variations are possible for each basic type of
multi-leg option spread strategy, it is problematic to maintain margin
rules specific to each.\17\ It becomes difficult to continually
designate each variation by name, and define and specify a margin
requirement for it in the rules. For example, consider the following
spreads:
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\17\ A long calendar butterfly spread is an example of a
variation. The basic type would be a butterfly spread. In a long
calendar butterfly spread, one of the long options expires after the
other two options expire concurrently, whereas in the basic
butterfly spread, all options expire concurrently. Another example
of a variation of a butterfly spread would be a configuration where
the intervals between the exercise prices involved are not equal. In
a basic butterfly spread, the intervals are equal (i.e., symmetric).
Long 10 XYZ May2011 50 call
Short 10 XYZ May2011 55 call
Long 5 XYZ May2011 70 call
Short 5 XYZ May2011 60 call
These two spreads combined are a variation of a condor spread. In a
basic condor spread, the number of option contracts would be equal
across all option series and the interval between the exercise prices
of each spread would be equal. In the above variation, there is a 10-
by-10 contract spread vs. a 5-by-5 contract spread, and a spread with a
5 point interval between exercise prices vs. a spread with a 10 point
interval between exercise prices. The two spreads in the above example
offset each other in terms of risk, and no margin requirement is
necessary. However, margin of $5,000 is required under the Exchange's
current margin rules, because this variation of the condor spread is
not specified in the rules. Because it is not recognized in Exchange
margin rules, the two spreads must be treated as separate, unrelated
spread strategies for margin purposes. As a result, spread margin of
$5,000 is required (on the May2011 70/May2011 60 call spread) versus no
requirement (other than pay for the net debit in full), if the two
spreads could be recognized as one strategy.
The Exchange proposed a single, universal definition of a spread
and one spread margin requirement that consists of a universal margin
requirement computation methodology. In this manner, the margin
requirement for all types of option spreads would be covered by a
single rule, without regard to the number of option series involved or
the term commonly used in the industry to refer to the spread. This
would eliminate the need to define, and refer to, particular spreads by
monikers commonly used in the industry. Therefore, this rule filing
would eliminate definitions of each particular spread strategy (e.g.,
butterfly, condor, iron butterfly, iron condor, etc.), with one
exception.
The one exception would be ``Box Spreads.'' A definition for ``Box
Spread'' would be retained because loan value is permitted under
Exchange margin rules for box spreads. Box spreads are the only type of
spread that is eligible for loan value. They, therefore, need to be
specially identified in the rules.
Additionally, the proposed rule changes would automatically enable
variations not currently recognized in Exchange margin rules (because
only a limited number of specific spread strategies are defined) to
receive spread margin treatment.
The Exchange proposed a new definition of a spread as CBOE Rule
12.3(a)(5). The key to the definition is that it designates a spread as
being an equivalent long and short position in different call option
series and/or equivalent long and short positions in different put
option series, or a combination thereof.\18\ With respect to
equivalency of long and short positions, the definition further
requires that the long and short positions be equal in terms of the
aggregate value of the underlying security or instrument covered by
each leg. The aggregate value equivalency is included so that it is
clear that a spread composed of one standard option contract and one
reduced value option contract covering the same underlying security or
instrument would be permissible. For example, if reduced value options,
equal to 1/10th the value of a standard option contract are trading, a
spread consisting of 10 reduced value contracts vs. one standard
contract would be permissible.\19\ As with spreads under the current
rule, the proposed rule further requires that the long option(s) expire
after, or at the same time as, the short option(s). Additionally, under
the proposed rule definition, all options in a spread must have the
same exercise style (American or European) and either be composed of
all listed options or all over-the-counter (OTC) options. Spreads that
do not conform to the definition would be ineligible for spread margin
treatment.
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\18\ An option series means particular exercise price and
expiration date with respect to a put or call option.
\19\ Currently, spreads consisting of standard contracts and
reduced value contracts are permitted by the rules, although the
current rule does not go into detail to require equivalent aggregate
underlying value between the long and short legs.
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Amendments to CBOE Rule 12.3(c)(5)(C)(4) would implement language
specifying how a margin requirement is to be computed for any spread
that meets the definition, and limit eligibility for spread margin
treatment to spreads that meet the definition. The computational method
would require that the intrinsic value of each option series contained
in a spread be calculated for assumed prices of the underlying security
or instrument. The exercise prices of the option series contained in
the spread would be required to be used as the assumed prices of the
underlying security or instrument. For each assumed price of the
underlying, the intrinsic values would be netted. The greatest loss
from among the netted intrinsic values would be the spread margin
requirement. As an example, consider the following spread:
Long 1 XYZ May2011 50 put
Short 1 XYZ May2011 60 put
Short 1 XYZ May2011 65 call
Long 1 XYZ May2011 70 call
This spread is a variation of an iron condor spread. It consists of
a put spread and a call spread, with all options covering the same
underlying security or instrument. There are an equal number of
contracts long and short in both the put spread and call spread. The
short options expire with or after the long options (with, in this
case). It is assumed that all options are of the same exercise style
(American or European). This spread would, therefore, be eligible for
the spread margin requirement computation in this proposed rule
amendment.
Note that in this example, the interval between the exercise prices
in the put spread is greater than the interval in the call spread. In a
basic iron condor spread, these intervals are equal. This particular
configuration is not recognized under current Exchange margin rules.
Therefore the component put spread and call spread must be viewed as
separate, unrelated strategies for margin purposes. Under current
Exchange margin rules, there is a $1,000
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margin requirement on the put spread and $500 margin requirement on the
call spread. However, there are offsetting properties between the two
spreads, and, if viewed collectively, a total margin requirement of
$1,500 is not necessary. Using the proposed computational methodology,
a margin requirement would be calculated as follows:
Intrinsic Values for Assumed Prices of the Underlying Spread
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$50 $60 $65 $70
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Long 1 XYZ May2011 50 put................................... 0 0 0 0
Short 1 XYZ May2011 60 put.................................. $(1,000) 0 0 0
Short 1 XYZ May2011 65 call................................. 0 0 0 $(500)
Long 1 XYZ May2011 70 call.................................. 0 0 0 0
Net intrinsic values........................................ $(1,000) 0 0 $(500)
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The greatest loss from among the netted intrinsic values is
$1,000.\20\ Under the proposed rule amendments, this would be the
margin requirement. This spread margin requirement is $500 less than
that required under current Exchange margin rules. Note that under both
the current and proposed rules, any net debit incurred when
establishing the spread is required to be paid for in full.
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\20\ Again, depending on the type of spread strategy, there may
be no loss among the netted intrinsic values, in which case there
would be no margin requirement.
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It can be intuitively shown that the put spread and call spread in
the example do not have $1,500 of risk when viewed collectively. If the
price of the underlying security or instrument is at or above $60, the
put spread would have no intrinsic value. At or below $65, the call
spread would have no intrinsic value. Thus, both spreads would never be
at risk at any given price of the underlying security or instrument.
Therefore, margin need be required on only one of the spreads--the one
with the highest risk. In this example, the put spread has the highest
risk ($1,000), and that is the risk (and margin requirement) that would
be rendered by the proposed computational methodology.
In summary, the proposed rule amendments would enable the Exchange,
for margin purposes, to accommodate the many types of spread strategies
utilized in the industry today in a fair and efficient manner.
III. Discussion and Commission's Findings
After careful review of the proposed rule change, the Commission
finds that the proposed rule change is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange.\21\ In particular, the Commission finds
that the proposal is consistent with Section 6(b)(5) of the Act,\22\
which requires, among other things, that the rules of an exchange be
designed to promote just and equitable principles of trade, remove
impediments to and perfect the mechanism of a free and open market and
a national market system, and, in general, protect investors and the
public interest. More specifically, the Commission believes that the
proposed rule change modernizes the treatment of option spread
strategies while maintaining margin requirements that are commensurate
with the risk of those strategies. Further, because it is consistent
with changes being made to FINRA Rule 4210,\23\ the proposed rule
change will provide for a more uniform application of margin
requirements for similar products.
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\21\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
\22\ 15 U.S.C. 78f(b)(5).
\23\ See Securities Exchange Act Release No. 67751 (Aug. 29,
2012) (SR-FINRA-2012-024) (order approving changes to FINRA Rule
4210 relating to spread margin requirements).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\24\ that the proposed rule change (SR-CBOE-2012-043) is approved.
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\24\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-21765 Filed 9-4-12; 8:45 am]
BILLING CODE 8011-01-P