[Federal Register Volume 64, Number 22 (Wednesday, February 3, 1999)] [Notices] [Pages 5333-5334] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 99-2482] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Release No. 34-40976; File No. SR-OCC-98-11] Self-Regulatory Organizations; The Options Clearing Corporation; Order Approving a Proposed Rule Change Regarding the Calculation of the Short Option Adjustment January 27, 1999. On September 10, 1998, the Options Clearing Corporation (``OCC'') filed with the Securities and Exchange Commission (``Commission'') a proposed rule change (File No. SR-OCC-98-11) pursuant to Section 19(b)(1) of the Securities and Exchange Act of 1934 (``Act'').\1\ Notice of the proposal was published in the Federal Register on December 23, 1998.\2\ No comment letters were received. For the reasons discussed below, the Commission is approving the proposed rule change. --------------------------------------------------------------------------- \1\ 15 U.S.C. 78s(b)(1). \2\ Securities Exchange Act Release No. 40800 (December 16, 1998), 63 FR 71179. --------------------------------------------------------------------------- I. Description The rule change amends Rules 601 and 602 to enable OCC to use a ``sliding scale'' to calculate the short option adjustment contained in OCC's Theoretical Intermarket Margin System (``TIMS'').\3\ The short option adjustment is a component of the additional margin calculation in TIMS that imposes a minimum margin amount on deep out of the money short options. --------------------------------------------------------------------------- \3\ OCC Rule 601 describes TIMS as it applies to equity options (``equity TIMS'') and OCC Rule 602 describes TIMS as it applies to non-equity options (``non-equity TIMS''). --------------------------------------------------------------------------- A. Additional Margin Calculation OCC requires its clearing members to adjust their margin deposits with OCC in the morning of 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, margin for positions in a class group is based on premium levels at the close of trading on the preceding day and is increased or decreased by the additional margin amount for that class group.\5\ --------------------------------------------------------------------------- \4\ A long position is unsegregated for OCC's purposes if OCC has a lien on the position (i.e., 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' account are unsegregated only if the clearing member submits instructions to that effect in accordance with Rule 611. \5\ For purposes of equity TIMS, a class group consists of all put and call options, all BOUNDS, and all stock loan and borrow positions relating to the same underlying security. For purposes of non-equity 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) that relate to the same underlying asset. A non-equity TIMS class group may also contain stock loan baskets and stock borrow baskets. --------------------------------------------------------------------------- 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 day 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. --------------------------------------------------------------------------- \6\ Some combinations of positions can present a greater net theoretical liquidating value at an intermediate value that 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. --------------------------------------------------------------------------- TIMS then selects the theoretical liquidating value that represents the greatest decrease (where the actual [[Page 5334]] 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 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. B. 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 normally would calculate additional margin amounts of zero or close to zero for deep out of the money short 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 option adjustment.\8\ --------------------------------------------------------------------------- \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 is described in Rule 601(c)(1)(C)(1) for equity options and Rule 602(c)(1)(ii)(C)(1) for non-equity options. OCC recently amended Interpretation .06 to Rule 602 so that net short non-equity option positions can be paired off against net long non-equity positions whose underlying interests exhibit price correlation of at least seventy percent. Securities Exchange Act Release No. 40515 (September 30, 1998), 63 FR 53970. --------------------------------------------------------------------------- Currently, the short option adjustment requires a minimum additional margin amount equal to twenty-five percent of the applicable margin interval for all unpaired \9\ net short positions in options series for which the ordinary calculation of the additional margin requirement would be less than twenty-five percent of the applicable margin interval. As a result, clearing members are required to deposit margin in excess of the risk presented by some unpaired net short positions in out of the money options. --------------------------------------------------------------------------- \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. --------------------------------------------------------------------------- To address these situations, the rule change establishes a sliding scale short option adjustment methodology. Using the sliding scale, the short option adjustment percentage will be applied to a particular series according to the extent to which the series is out of the money. In addition, OCC will use different sliding scales for put options and for call options. The proposed rule change modifies Rules 601 and 602 to provide that the short option adjustment to be applied to any unpaired short position will be determined using a percentage that OCC deems to be appropriate.\10\ --------------------------------------------------------------------------- \10\ A schedule of the sliding scales that OCC intends to use is attached as Exhibit A to its filing, which is available for inspection at the Commission's Public Reference Room and through OCC. OCC will always specify a minimum short option adjustment percentage. OCC will inform its members of the initial schedule of the sliding scales through an Important Notice and will notify its members of any changes to the schedule. --------------------------------------------------------------------------- II. Discussion Section 17A(b)(3)(F) of the Act \11\ requires that the rules of a clearing agency be designed to assure the safeguarding of securities and funds which are in its custody or control or for which it is responsible. The Commission believes that the rule change is consistent with OCC's obligations under Section 17A(b)(3)(F) because it should reduce overcollateralization of OCC's clearing members' positions without impairing OCC's overall protection against member default. --------------------------------------------------------------------------- \11\ 15 U.S.C. 78q-1(b)(3)(F). --------------------------------------------------------------------------- III. Conclusion On the basis of the foregoing, the Commission finds that the proposed rule change is consistent with the requirements of the Act and in particular with Section 17A of the Act \12\ and the rules and regulations thereunder. --------------------------------------------------------------------------- \12\ 15 U.S.C. 78q-1. --------------------------------------------------------------------------- It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (File No. SR-OCC-98-11) be and hereby is approved. For the Commission by the Division of Market Regulation, pursuant to delegated authority.\13\ --------------------------------------------------------------------------- \13\ 17 CFR 200.30-3(a)(12). --------------------------------------------------------------------------- Margaret H. McFarland, Deputy Secretary. [FR Doc. 99-2482 Filed 2-2-99; 8:45 am] BILLING CODE 8010-01-M