[Federal Register Volume 81, Number 1 (Monday, January 4, 2016)]
[Notices]
[Pages 135-138]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-32991]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-76781; File No. SR-OCC-2015-016]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving a Proposed Rule Change, as Modified by Amendment No. 1,
To Modify the Options Clearing Corporation's Margin Methodology by
Incorporating Variations in Implied Volatility
December 28, 2015.
On October 5, 2015, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-OCC-2015-016 pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule
19b-4 thereunder.\2\ The proposed rule change was published for comment
in the Federal Register on October 19, 2015.\3\ The Commission did not
receive any comments on the proposed rule change. On November 19, 2015,
OCC filed Amendment No. 1 to the proposed rule change.\4\ On November
20, 2015, pursuant to Section 19(b)(2)(A)(ii)(I) of the Exchange
Act,\5\ the Commission extended the time period within which to
approve, disapprove, or institute proceedings to determine whether to
disapprove the proposed rule change to January 17, 2016.\6\ 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. OCC also filed this proposal as an advance
notice pursuant to Section 802(e)(1) of the Payment, Clearing, and
Settlement Supervision Act of 2010 and Rule 19b-4(n)(1) under the
Exchange Act. 15 U.S.C. 5465(e)(1) and 17 CFR 240.19b-4(n)(1). See
Securities Exchange Act Release No. 76421 (November 10, 2015), 80 FR
71900 (November 17, 2015) (SR-OCC-2015-804). The Commission did not
receive any comments on the advance notice.
\3\ Securities Exchange Act Release No. 76128 (October 13,
2015), 80 FR 63264 (October 19, 2015) (SR-OCC-2015-016)
(``Notice'').
\4\ In Amendment No. 1, OCC makes technical corrections to
Exhibit 5. Amendment No. 1 is not subject to notice and comment
because it is a technical amendment that does not materially alter
the substance of the proposed rule change or raise any novel
regulatory issues.
\5\ 15 U.S.C. 78s(b)(2)(A)(ii)(I).
\6\ See Securities Exchange Act Release No. 76496 (November 20,
2015), 80 FR 74179 (November 27, 2015).
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Description
As proposed by OCC,\7\ it is modifying its margin methodology by
more broadly incorporating variations in implied volatility within
OCC's System for Theoretical Analysis and Numerical Simulations
(``STANS'').\8\ As explained below, OCC believes that expanding the use
of variations in implied volatility within STANS for substantially all
\9\ option contracts available to be cleared by OCC that have a
residual tenor \10\ of less than three years (``Shorter Tenor
Options'') will enhance OCC's ability to ensure that option prices and
the margin coverage related to such positions more appropriately
reflect possible future market value fluctuations and better protect
OCC in the event it must liquidate the portfolio of a suspended
clearing member.
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\7\ See Notice, supra note 3, 80 FR at 63264-67.
\8\ This proposal did not propose any changes concerning
futures. According to OCC, OCC uses a different system to calculate
initial margin requirements for segregated futures accounts:
Standard Portfolio Analysis of Risk Margin Calculation System.
\9\ According to OCC, it proposes to exclude: (i) Binary
options, (ii) options on energy futures, and (iii) options on U.S.
Treasury securities. OCC excluded them because: (i) They are new
products that were introduced as OCC was completing this proposal
and (ii) OCC did not believe that there was substantive risk if they
were excluded at this time because they only represent a de minimis
open interest. According to OCC, it plans to modify its margin
methodology to accommodate these new products.
\10\ According to OCC, the ``tenor'' of an option is the amount
of time remaining to its expiration.
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Implied Volatility in STANS Generally
According to OCC, STANS is OCC's proprietary risk management system
that calculates clearing members' margin requirements. According to
OCC, the STANS methodology uses Monte Carlo simulations to forecast
price movement and correlations in determining a clearing member's
margin requirement. According to OCC, under STANS, the daily margin
calculation for each clearing member account is constructed to ensure
OCC maintains sufficient financial resources to liquidate a defaulting
member's positions, without loss, within the liquidation horizon of two
business days.
As described by OCC, the STANS margin requirement for an account is
composed of two primary components: A base component and a stress test
component. According to OCC, the base component is obtained from a risk
measure of the expected margin shortfall for an account that results
under Monte Carlo price movement simulations. For the exposures that
are observed regarding the account, the base
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component is established as the estimated average of potential losses
higher than the 99% VaR \11\ threshold. In addition, OCC augments the
base component using the stress test component. According to OCC, the
stress test component is obtained by considering increases in the
expected margin shortfall for an account that would occur due to: (i)
Market movements that are especially large and/or in which certain risk
factors would exhibit perfect or zero correlations rather than
correlations otherwise estimated using historical data or (ii) extreme
and adverse idiosyncratic movements for individual risk factors to
which the account is particularly exposed.
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\11\ The term ``value at risk'' or ``VaR'' refers to a
statistical technique that, generally speaking, is used in risk
management to measure the potential risk of loss for a given set of
assets over a particular time horizon.
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According to OCC, including variations in implied volatility within
STANS is intended to ensure that the anticipated cost of liquidating
each Shorter Tenor Option position in an account recognizes the
possibility that implied volatility could change during the two
business day liquidation time horizon in STANS and lead to
corresponding changes in the market prices of the options. According to
OCC, generally speaking, the implied volatility of an option is a
measure of the expected future volatility of the value of the option's
annualized standard deviation of the price of the underlying security,
index, or future at exercise, which is reflected in the current option
premium in the market. Using the Black-Scholes options pricing model,
the implied volatility is the standard deviation of the underlying
asset price necessary to arrive at the market price of an option of a
given strike, time to maturity, underlying asset price and given the
current risk-free rate. In effect, the implied volatility is
responsible for that portion of the premium that cannot be explained by
the then-current intrinsic value \12\ of the option, discounted to
reflect its time value. According to OCC, it currently incorporates
variations in implied volatility as risk factors for certain options
with residual tenors of at least three years (``Longer Tenor
Options'').
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\12\ According to OCC, generally speaking, the intrinsic value
is the difference between the price of the underlying and the
exercise price of the option.
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Implied Volatility for Shorter Tenor Options
OCC is proposing certain modifications to STANS to more broadly
incorporate variations in implied volatility for Shorter Tenor Options.
Consistent with its approach for Longer Tenor Options, OCC will model a
volatility surface \13\ for Shorter Tenor Options by incorporating into
the econometric models underlying STANS certain risk factors regarding
a time series of proportional changes in implied volatilities for a
range of tenors and absolute deltas. Shorter Tenor Option volatility
points will be defined by three different tenors and three different
absolute deltas, which produce nine ``pivot points.'' In calculating
the implied volatility values for each pivot point, OCC will use the
same type of series-level pricing data set to create the nine pivot
points that it uses to create the pivot points used for Longer Tenor
Options, so that the nine pivot points will be the result of a
consolidation of the entire series-level dataset into a smaller and
more manageable set of pivot points before modeling the volatility
surface.
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\13\ According to OCC, the term ``volatility surface'' refers to
a three-dimensional graphed surface that represents the implied
volatility for possible tenors of the option and the implied
volatility of the option over those tenors for the possible levels
of ``moneyness'' of the option. According to OCC, the term
``moneyness'' refers to the relationship between the current market
price of the underlying interest and the exercise price.
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According to OCC, it considered incorporating more than nine pivot
points but concluded that would not be appropriate for Shorter Tenor
Options because: (i) Back-testing results, from January 2008 to May
2013, revealed that using more pivot points did not produce more
meaningful information (i.e. more pivot points produced a comparable
number of under-margined instances) and (ii) given the large volume of
Shorter Tenor Options, using more pivot points could increase
computation time and, therefore, would impair OCC from making timely
calculations.
Under OCC's model for Shorter Tenor Options, the volatility
surfaces will be defined using tenors of one month, three months, and
one year with absolute deltas, in each case, of 0.25, 0.5, and
0.75,\14\ thus resulting in the nine implied volatility pivot points.
OCC believes that it is appropriate to focus on pivot points
representing at- and near-the-money options because prices for those
options are more sensitive to variations in implied volatility over the
liquidation time horizon of two business days. According to OCC, four
factors explain 99% variance of implied volatility movements: (i) A
parallel shift of the entire surface; (ii) a slope or skewness with
respect to delta; (iii) a slope with respect to time to maturity; and
(iv) a convexity with respect to the time to maturity. According to
OCC, the nine correlated pivot points, arranged by delta and tenor,
give OCC the flexibility to capture these factors.
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\14\ According to OCC, given that premiums of deep-in-the-money
options (those with absolute deltas closer to 1.0) and deep-out-of-
the-money options (those with absolute deltas closer to 0) are
insensitive to changes in implied volatility, in each case
notwithstanding increases or decreases in implied volatility over
the two business day liquidation time horizon, those higher and
lower absolute deltas have not been selected as pivot points.
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According to OCC, it first will use its econometric models to
jointly simulate changes to implied volatility at the nine pivot points
and changes to underlying prices.\15\ For each Shorter Tenor Option in
the account of a clearing member, changes in its implied volatility
then will be simulated according to the corresponding pivot point and
the price of the option will be computed to determine the amount of
profit or loss in the account under the particular STANS price
simulation. Additionally, as OCC does today, it will continue to use
simulated closing prices for the assets underlying options in the
account of a clearing member that are scheduled to expire within the
liquidation time horizon of two business days to compute the options'
intrinsic value and use those values to help calculate the profit or
loss in the account.\16\
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\15\ According to OCC, STANS relies on 10,000 price simulation
scenarios that are based generally on a historical data period of
500 business days, which is updated monthly to keep model results
from becoming stale.
\16\ For such Shorter Tenor Options that are scheduled to expire
on the open of the market rather than the close, OCC will use the
relevant opening price for the underlying assets.
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Effects of the Proposed Change and Implementation
OCC believes that the proposed change will enhance OCC's ability to
ensure that STANS appropriately takes into account normal market
conditions that OCC may encounter in the event that, pursuant to OCC
Rule 1102, it suspends a defaulted clearing member and liquidates its
accounts.\17\ Accordingly, OCC believes that the change will promote
OCC's ability to ensure that margin assets are sufficient to liquidate
the accounts of a defaulted clearing member without incurring a loss.
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\17\ According to OCC, under authority in OCC Rules 1104 and
1106, OCC has authority to promptly liquidate margin assets and
options positions of a suspended clearing member in the most orderly
manner practicable, which might include, but would not be limited
to, a private auction.
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OCC estimates that this change generally will increase margin
requirements overall, but will decrease
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margin requirements for certain accounts with certain positions.
Specifically, OCC expects this change to increase aggregate margins by
about 9% ($1.5 billion). OCC also estimates the change will most
significantly affect customer accounts and least significantly affect
firm accounts, with the effect on market maker accounts falling in
between.
According to OCC, it expects customer accounts to experience the
largest margin increases because positions considered under STANS for
customer accounts typically consist of more short than long options
positions, and therefore reflect a greater magnitude of directional
risk than other account types. According to OCC, positions considered
under STANS for customer accounts typically consist of more short than
long options positions to facilitate clearing members' compliance with
Commission requirements for the protection of certain customer property
under Exchange Act Rule 15c3-3(b).\18\ Therefore, OCC segregates the
long option positions in the customer accounts of each clearing member
and does not assign the long option positions any value when
determining the margin for the customer account, resulting in higher
margin.\19\
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\18\ 17 CFR 240.15c3-3(b).
\19\ See OCC Rule 601(d)(1). According to OCC, pursuant to OCC
Rule 611, however, a clearing member, subject to certain conditions,
may instruct OCC to release segregated long option positions from
segregation. Long positions may be released, for example, if they
are part of a spread position. Once released from segregation, OCC
receives a lien on each unsegregated long securities option carried
in a customers' account and therefore OCC permits the unsegregated
long to offset corresponding short option positions in the account.
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OCC expects margin requirements to decrease for accounts with
underlying exposure and implied volatility exposure in the same
direction, such as concentrated call positions, due to the negative
correlation typically observed between these two factors. According to
OCC, over the back-testing period, about 28% of the observations for
accounts on the days studied had lower margins under the proposed
methodology and the average reduction was about 2.7%. Parallel results
will be made available to the membership in the weeks ahead of
implementation.
To help clearing members prepare for the proposed change, OCC has
provided clearing members with an information memorandum explaining the
proposal, including the planned timeline for its implementation, and
discussed with certain other clearinghouses the likely effects of the
change on OCC's cross-margin agreements with them. OCC also published
an information memorandum to notify clearing members of the submission
of this filing to the Commission. Subject to all necessary regulatory
approvals regarding the proposed change, OCC intends to begin making
parallel margin calculations with and without the changes in the margin
methodology. The commencement of the calculations will be announced by
an information memorandum, and OCC will provide the calculations to
clearing members each business day. OCC also will provide at least
thirty days prior notice to clearing members before implementing the
change. OCC believes that clearing members will have sufficient time
and data to plan for the potential increases in their respective margin
requirements.
II. Discussion and Commission Findings
Section 19(b)(2)(C) of the Exchange Act \20\ directs the Commission
to approve a proposed rule change of a self-regulatory organization if
it finds that the proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder applicable to such organization.
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\20\ 15 U.S.C. 78s(b)(2)(C).
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The Commission finds that the proposed rule change is consistent
with Section 17A(b)(3)(F) of the Exchange Act \21\ and Rule 17Ad-
22(b)(2) under the Exchange Act.\22\ Rule 17Ad-22(b)(2) under the
Exchange Act \23\ requires OCC to establish, implement, maintain and
enforce written policies and procedures reasonably designed to use
margin requirements to limit its credit exposures to participants under
normal market conditions and use risk-based models and parameters to
set margin requirements, among other things. Through this proposal, OCC
is modifying its margin methodology, which is designed to use margin
requirements to limit its credit exposures to clearing members holding
Shorter Tenor Options under normal market conditions. Specifically, OCC
is modifying its risk-based model, STANS, to set margin requirements in
a way that includes changes in implied volatility for Shorter Tenor
Options. With this change in place, STANS is now designed to recognize
a range of possible changes in implied volatility during the two
business day liquidation time horizon that could lead to corresponding
changes in the market prices of Shorter Tenor Options. Therefore, OCC's
change is consistent with Rule 17Ad-22(b)(2) under the Exchange
Act.\24\
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\21\ 15 U.S.C. 78q-1(b)(3)(F).
\22\ 17 CFR 240.17Ad-22(b)(2).
\23\ Id.
\24\ Id.
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By limiting its credit exposure in this way that is consistent with
Rule 17Ad-22(b)(2) under the Exchange Act,\25\ OCC is less likely to be
subject to disruptions in its operations as a result of a participant
default, thereby promoting the prompt and accurate clearance and
settlement of securities transactions, consistent with Section
17A(b)(3)(F) of the Exchange Act.\26\ Section 17A(b)(3)(F) of the
Exchange Act requires OCC to have rules designed to, among other
things, promote the prompt and accurate clearance and settlement of
securities transactions, and to assure the safeguarding of securities
and funds which are in the custody or control of OCC or for which it is
responsible.\27\ This change is also consistent with assuring the
safeguarding of securities and funds which are in the custody or
control of OCC. According to OCC, it has custody and control of margin
deposits it requires members to post to limit credit exposure to
members under normal market conditions. According to OCC, in the event
of a member default, that member's margin deposits are the first pool
of resources OCC would use to cover losses associated with the default.
With this change in place, STANS is now designed to recognize a range
of possible changes in implied volatility during the two business day
liquidation time horizon that could lead to corresponding changes in
the market prices of Shorter Tenor Options. This change is designed to
enable OCC to more accurately calculate the amount of margin a member
must post, and, therefore, make it less likely, in the event of a
member default, that OCC will need to access mutualized clearing fund
deposits to cover losses associated with such member's default, which
is consistent with assuring the safeguarding of securities and funds
which are in the custody or control of OCC or for which OCC is
responsible. Therefore, this change is consistent with Section
17A(b)(3)(F) of the Exchange Act.\28\
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\25\ Id.
\26\ 15 U.S.C. 78q-1(b)(3)(F).
\27\ Id.
\28\ Id.
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Exchange Act and in
particular with the requirements of Section 17A of the
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Exchange Act \29\ and the rules and regulations thereunder.\30\
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\29\ 15 U.S.C. 78q-1.
\30\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\31\ that the proposed rule change (SR-OCC-2015-016), as
modified by Amendment No. 1, be, and it hereby is, approved as of the
date of this order or the date of a notice by the Commission
authorizing OCC to implement OCC's advance notice proposal that is
consistent with this proposed rule change (SR-OCC-2015-804), whichever
is later.
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\31\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\32\
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\32\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2015-32991 Filed 12-31-15; 8:45 am]
BILLING CODE 8011-01-P