[Federal Register Volume 59, Number 146 (Monday, August 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-18579]
[[Page Unknown]]
[Federal Register: August 1, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34430; File No. SR-OCC-90-10]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Temporarily Approving Proposed Rule Change Relating to Put Margin
Credit Program
July 22, 1994.
On September 5, 1990, The Options Clearing Corporation (``OCC'')
filed a proposed rule change (File No. SR-OCC-90-10) with the
Securities and Exchange Commission (``Commission'') pursuant to Section
19(b) of the Securities Exchange Act of 1934 (``Act'').\1\ Notice of
the proposal appeared in the Federal Register on December 6, 1990, to
solicit public comment from interested persons.\2\ No comments were
received. This order temporarily approves the proposed rule change
through October 31, 1995.
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\1\15 U.S.C. 78s(b) (1988).
\2\Securities Exchange Act Release No. 28658 (November 29,
1990), 55 FR 50438.
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I. Description of the Proposal
The proposed rule change adds a new Paragraph (e) (``Put Margin
Credit'') to OCC's existing Rule 604 (``Forms of Margin'') to implement
OCC's Put Margin Credit (``PMC'') Program. The PMC program will
maximize the margin credit that OCC can give to its clearing members
where they hold long positions in put options on individual stocks\3\
and deposit the underlying stock with OCC. The proposed PMC Program
combines such stock and option positions to generate greater clearing
margin credits than either position could provide individually in
either OCC's existing clearing margin system or in its valued
securities program.\4\ Specifically, the PMC Program will allow
clearing members who are carrying long put option positions in a
market-maker's or specialist's account or in a stock market-maker's or
stock specialist's account and who have deposited with and pledged to
OCC the underlying securities with respect to such options to direct
OCC to treat the options and underlying securities as a combined
position for margin purposes.\5\ OCC then will pair such directing
clearing members' long put option positions with the underlying stocks
in an amount deliverable upon exercise of such put options.
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\3\Only American-style options are eligible for the PMC Program.
Letter from Stuart C. Harvey, Jr., OCC, to Thomas Etter, Staff
Attorney, Commission, (October 26, 1990).
\4\OCC Rule 604(d).
\5\Clearing members deposit the underlying securities with OCC
through its valued securities program.
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Because the combined option/stock position can never be worth less
than the option's exercise price, which will be realized if the
underlying stock is delivered pursuant to an exercise of the put
option, OCC can prudently give clearing margin credit for the combined
position equal to 100% of the exercise price. On the other hand, the
combined position theoretically can be worth more than the exercise
price if the market value of the stock substantially exceeds the
exercise price of the option. Accordingly, OCC will give margin credit
for the combined position equal to the greater of the exercise price of
the option or the maximum loan value given to the stock alone under
OCC's valued securities program.\6\
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\6\Presently, the maximum loan value under the valued securities
program is 60% of the stocks current market value.
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In order to avoid any double counting, options that are included in
the PMC Program will generate no margin credit pursuant to OCC Rule 601
in calculating the clearing margin requirement for the account.
Similarly, the underlying securities that are included in the PMC
Program will not receive any additional credit under the valued
securities program during the time they are included in the PMC
Program.
Because under certain circumstances long put options can provide
more margin credit if they are spread against short option positions
than if they are included in the PMC Program, the decision as to
whether or not to include long put option positions in the PMC Program
will be made by the clearing members. Clearing members will be
permitted to make this decision on a daily basis.
Finally, underlying stocks that are included in the PMC Program
will not be counted in the valued securities program's 10%
concentration limitation.\7\ The 10% limitation is intended to prevent
a clearing member from fulfilling a large percentage of its margin
requirement with a concentration of any particular stock. This
limitation is to protect OCC from loss should OCC be forced to convert
stock margin deposits to cash at a time when the value of the stock is
decreasing in value. Because a combined position in the PMC Program
will never be worth less than the exercise price of the put option
regardless of the market value of the underlying stock, OCC believes
that application of the 10% limitation is unwarranted in the PMC
Program.
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\7\OCC Rule 604(d)(1) sets forth that equity issues of any one
issuer shall not be valued at an amount in excess of 10% of the
margin requirement for the account in which such securities are
deposited.
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II. Discussion
The Commission believes the proposal is consistent with the
purposes and requirements of Section 17A of the Act.\8\ In particular,
the Commission believes the proposal meets the requirements of Sections
17A(b)(3) (A) and (F) which require, among other things, that a
clearing agency's rules be designed to safeguard securities and funds
in its custody or control or for which it is responsible.\9\ The
Commission believes that OCC's PMC program, while structured to insure
that OCC fulfills its statutory obligation to safeguard securities and
funds in its custody or control, will enable OCC clearing members to
reduce their financing needs through the margin credits given their
long put option/underlying stock positions.
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\8\15 U.S.C. 78q-1 (1988).
\9\15 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
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One of the major problems that arose during the October 1987 and
October 1989 market breaks was a generalized cash squeeze for OCC's
clearing members. In particular, OCC clearing members that were
utilizing OCC's pledge program\10\ to pledge long call option positions
to banks as collateral for loans were faced with repaying the loans as
the value of their long calls rapidly declined. At the same time,
clearing members that had stocks pledged as collateral for loans and
letters of credit or were lenders of such securities in stock loan
transactions had to use substantial amounts of their cash to reduce
outstanding loans or to pay for the return of loaned stock as the value
of their collateral fell.
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\10\OCC Rule 614(a).
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During these same periods, many of OCC's clearing members held in
their market-maker's or specialist's accounts substantial long put
positions that were rapidly increasing in value. At that time, many
banks were reluctant to accept long put options as collateral for
loans. Although clearing members received clearing margin credit from
OCC for their long put positions, the clearing margin credit calculated
by OCC's clearing margin system did not reflect the full value of put
options that were held in combination with the underlying stocks.
OCC believes the PMC Program will be helpful in addressing the
liquidity squeeze that can occur in a declining market. OCC anticipates
that in some situations clearing members will have reduced needs to
borrow from commercial banks in order to meet their clearing margin
requirements at OCC. The PMC program will allow OCC to internalize a
portion of its clearing members' financing requirements by maintaining
control over deposited margin collateral that has a known and fixed
market value. Because OCC monitors the financial condition and
portfolio risk of each of its clearing members through its risk
reduction systems,\11\ the Commission believes that the PMC program
could facilitate effective use of long put option and long stock
positions deposited for margin purposes.
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\11\Among other risk reduction systems, OCC's Theoretical
Intermarket Margin System (``TIMS'') and Concentration Monitoring
System (``ConMon'') are designed to evaluate and manage the market
risks and to set margin requirements for equity and non-equity
option positions of OCC's clearing members. TIMS uses the Cox-
Rubenstein binomial options pricing model to determine the
liquidating value of an option portfolio given a theoretical ``worst
case'' market scenario. ConMon is designed to address risks
resulting from concentrated, undiversified portfolios of options
that may not be covered by OCC's margin methodology. Essentially,
the ConMon system uses TIMS methodology to analyze the theoretical
values of each members's positions in the event of an abnormally
large market movement and relates the resulting theoretical gain or
loss to the member's net worth and capital. A member's margin
requirement may be increased as a result.
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During the first twelve months of the temporary approval period,
OCC will monitor such things as the number of participants in the PMC
Program, such participants' margin savings and the average percentage
of participants' total margin requirements reduced by the program. In
addition, OCC will review its risk reduction systems, specifically TIMS
and ConMon, to insure that OCC is able to determine and protect against
any undue risk arising from the PMC program. Before the end of the
temporary approval period, OCC will submit a written report to the
Commission setting forth the results of its review of the PMC Program.
III. Conclusion
For the reasons discussed in this order, the Commission finds that
the proposed rule change is consistent with the requirements of the Act
and the rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the above-mentioned proposed rule change (File No. SR-OCC-90-10)
be, and hereby is, temporarily approved through October 31, 1995.
For the Commission, by the Division of Market Regulation
pursuant to delegated authority.\12\
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\12\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-18579 Filed 7-29-94; 8:45 am]
BILLING CODE 8010-01-M