[Federal Register Volume 62, Number 111 (Tuesday, June 10, 1997)]
[Notices]
[Pages 31643-31650]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15025]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38709; File No. SR-CBOE-97-17]


Self-Regulatory Organizations; Order Granting Approval to 
Proposed Rule Change by the Chicago Board Options Exchange, 
Incorporated and Notice of Filing and Order Granting Accelerated 
Approval to Amendment Nos. 1 and 2 to the Proposed Rule Change Relating 
to Changes to Its margin Rules

June 2, 1997.

I. Introduction

    On March 21, 1997, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or the ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``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 seeking to amend the Exchange's 
margin rules.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 38501 (April 14, 1997), 62 FR 19364 (April 21, 
1997). The CBOE submitted to the Commission Amendment No. 1 on April 
15, 1997,\3\ and Amendment No. 2 on May 30, 1997.\4\ No comments were 
received on the proposal.
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    \3\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE, 
to Michael Walinskas, Senior Special Counsel, Division of Market 
Regulation (``Market Regulation''), Commission, dated April 11, 1997 
(``CBOE Amendment No. 1'') making certain technical changes to the 
rule filing.
    \4\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE, 
to Chester McPherson, Attorney, Market Regulation, Commission, dated 
may 28, 1997 (``CBOE Amendment No. 2'') (providing additional 
information and addressing certain permitted offset issues.
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    This order approves the proposed rule change, as amended.

II. Description of the Proposal

    The CBOE proposes to make revisions to its rules governing margin 
that will (i)

[[Page 31644]]

establish CBOE rules to govern areas of margin regulation that will no 
longer be addressed by Regulation T (``Regulation T'') \5\ of the Board 
of Governors of the Federal Reserve System (``Federal Reserve Board'' 
or ``Board'') as of June 1, 1997, (ii) conform certain CBOE margin 
rules to those of the New York Stock Exchange (``NYSE''), and (iii) 
correct or clarify certain current provisions of the CBOE margin rules.
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    \5\ 12 CFR 220.1 through 19 (1996).
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    The Exchange proposes changes to its margin rules at this time in 
response to recent amendments to the Federal Reserve Board's Regulation 
T, the regulation that covers extensions of credit by and to brokers 
and dealers.\6\ Among other things, the amendments to Regulation T will 
modify or delete certain Board rules regarding options transactions in 
favor of rules to be adopted by the options exchanges, subject to 
approval by the Commission. The new options provisions in Regulation T 
became effective June 1, 1997. The Exchange also has concurrently 
submitted separate changes to its margin rules in another rule filing, 
See SR-CBOE-97-18. That second filing will be referred to herein as the 
``Second margin Filing.'' The present filing will be referred to as the 
``First Margin Filing.''
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    \6\ See 61 FR 20386 (May 6, 1996) (Federal Reserve Board's 
release adopting certain changes to Regulation T).
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Definition Section

    The Exchange proposes adding a definition section in new paragraph 
(a) of Rule 12.3 ``Margin Requirements.'' The first new definition is 
``current market value,'' which is used throughout the Rule. The 
Exchange is also proposing to add an interpretation to Rule 12.3 for 
``current market value'' covering situations where there is no closing 
price, or where trading is halted and not reopened before the normal 
end of the trading day, or where the closing price is outside the last 
bid and offer that was established after the closing price. In such 
situations, the proposed interpretation to Rule 12.3 indicates that a 
member organization may use a reasonable estimate of the market value 
of the security based upon the then current bids and offers in 
determining the ``current market value'' of a security, including an 
option. According to the Exchange, this interpretation will allow 
member organizations to arrive at a more reasonable estimate of the 
current market value, particularly where the underlying security may be 
trading or quoted in other markets or in cases where the underlying 
security re-opens for trading and the overlying option remains closed. 
The exchange also states that the new definition of ``current market 
value'' is consistent with a definition contained in New York Stock 
Exchange Rule 431 (``NYSE Rule 431'').
    The term ``escrow agreement'' also is being defined in new 
paragraph (a) of Rule 12.3. The CBOE definition requires the issuer of 
escrow receipts to be a U.S. bank or trust company supervised and 
examined by state or federal authority. The Regulation T definition 
allows the issuer to be a bank or any person designated as a control 
location under paragraph (c) of Rule 15c3-3 under the Act. The exchange 
is adopting a more restrictive approach because of concerns that 
certain control locations, such as transfer agents, are not appropriate 
issuers of escrow receipts and that Exchange rules should continue to 
limit issuers of receipts to entities such as banks, as currently set 
forth in Rule 24.11(d). The Exchange notes that it is continuing to 
study this issue.
    Finally, the Exchange is revising its definition of ``exempted 
security'' by adopting the Regulation T definition.

Customer Margin Accounts

    The Exchange proposes reorganizing Rule 12.3 so that all provisions 
concerning customer margin accounts are in the same sections of the 
Rule. Currently, customer margin provisions appear throughout the Rule. 
Under the Exchange's proposal, Rule 12.3, paragraph (b), will set forth 
the default margin requirements on long and short positions in customer 
margin accounts. Paragraph (c) will set forth the specific margin 
treatment for particular types of securities and positions held in 
customer margin accounts.
    The margin treatment of ``exempted securities'' is proposed to be 
moved from current Rule 12.3, paragraph (b)(3) to new paragraph (c)(3), 
and amended so that it is consistent with NYSE Rule 431.\7\ 
Specifically, the treatment for exempted securities is being revised so 
that obligations of the United States (as specified in the rule) will 
be subject to a margin requirement of 1% to 6%, depending on the years 
to maturity for the obligation. Zero coupon bonds will be subject to a 
margin requirement of 3% for bonds with five years or more to maturity. 
All other exempted securities will be subject to an initial and 
maintenance margin requirement of 15% of the current market value or 7% 
of the principal amount, whichever amount is greater. Currently, Rule 
12.3(b)(3) requires margin of 5% on obligations of the United States 
and margin of 15% of the principal amount or 25% of the current market 
value of other exempted securities, whichever amount is lower.
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    \7\ See NYSE Rule 431(e).
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    The Exchange is also adopting a margin treatment for non-
convertible debt securities which is consistent with the margin 
treatment in NYSE Rule 431,\8\ except that the Exchange is not adopting 
the special exemptions relating to mortgage related securities at this 
time because this provision is currently the subject of discussion by 
an industry committee and may be changed. The rule will require margin 
to be maintained equal to 20% of the current market value or 7% of the 
principal amount of the non-convertible debt, whichever amount is 
greater.
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    \8\ Id.
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    The Exchange is also proposing a new subsection to Rule 12.3 
labeled ``Security Offsets,'' which combines two current provisions 
from Rule 12.3 and addresses the margin treatment of short securities 
offset against (i) Long positions in a security exchangeable or 
convertible into the security held in a short position and (ii) long 
positions in the same security as the short position. The convertible 
or exchangeable provision is the same as contained in current CBOE Rule 
12.3(b)(1)(A) except that an incorrect parenthetical referring to 
options is being deleted because options cannot be and never have been 
considered convertible securities. The Exchange notes that the rules of 
the other self-regulatory-organizations (``SROs'') and Regulation T do 
not refer to options as convertible securities. The provision dealing 
with offsets between long and short positions in the same security is 
being moved from paragraph 12.3(b)(1)(D) of current Rule 12.3 to 
paragraph 12.3(c), and the margin requirement is being revised from 10% 
to 5% of the current market value of the ``long'' securities to conform 
the CBOE rule to a similar provision in NYSE Rule 431.\9\
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    \9\ Id.
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    The Exchange is also proposing, under new paragraph (c) of Rule 
12.3, which provides certain exceptions to the default margin treatment 
for positions in a customer margin account, new margin treatment for a 
short listed equity call option position offset by a warrant to 
purchase the underlying security. The proposed treatment is new to Rule 
12.3 and is consistent with a provision of Regulation T.\10\ The 
provision requires no margin for this position if the warrant to 
purchase the underlying security does not expire on

[[Page 31645]]

or before the expiration date of the short call, and if the amount (if 
any) by which the exercise price of the warrant exceeds the exercise 
price of the short call is deposited in the account.
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    \10\ See Regulation T, 12 CFR 220.4(b).
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    Rule 12.3 is also being amended to clearly reflect that margin be 
deposited and maintained equal to 100% of the purchase price of long 
positions in listed equity options. This provision is consistent with 
current CBOE Rule 12.5, and is being added to Rule 12.3 for the sake of 
clarity.
    Proposed Rule 12.3(c)(5), detailing the margin requirements for 
short listed equity options is identical to that currently found in 
paragraph (a)(5) of Rule 12.3, with three exceptions. First, the 
provision has been moved. Second, the treatment of over-the-counter 
(``OTC'') options has been deleted from the provision because the 
Exchange is proposing to adopt the more extensive OTC margin provisions 
of the NYSE. Third, the Exchange is proposing the addition of a 
provision that would cap the minimum margin on short puts that are out-
of-the-money at a percentage of the exercise price of the short put.
    With regard to capping the required minimum margin for short listed 
puts, the Exchange indicates that, under the current provision, minimum 
margin is required equal to the option's market value plus 10% of the 
current market value of equivalent units of the underlying security. 
However, as the market value of the underlying security increases above 
the strike price, at some point the put becomes farther out-of-the-
money and the risk of the position decreases. According to the 
Exchange, without the cap, the margin requirement would also continue 
to increase at the same time that the risk of the position is 
decreasing.
    The Exchange is also clarifying the margin treatment of interest 
rate put options under Rule 23.13 and the margin treatment of put 
warrants under Rule 30.53. The treatment is the same as that provided 
for short uncovered put options as described above.
    The provisions governing margin treatment for options that are 
offset or covered by certain defined ``related securities,'' where such 
positions are carried in a customer margin account, has been revised 
and rearranged. These are now found under new subsection 12.3(c)(5)(B). 
This is necessary because various changes made over time have rendered 
the provisions difficult to follow. The Exchange believes that the 
changes being proposed will simplify the provisions and make them 
easier for members to follow.\11\ The treatment for a covered call 
writing position where the underlying security is a convertible 
security is similar to that currently described in subsection 
12.3(b)(1)(C) but has been revised to be consistent with NYSE Rule 
431.\12\ The treatment for covered puts is similar to the treatment 
under current subsection 12.3(b)(1)(B); however, the language has been 
revised to conform the CBOE rule to the language in Regulation T.\13\ 
The new language of 12.3(c)(5)(B)(2) regarding covered calls has been 
reworded from what currently appears in Rule 12.3(b)(1)(C)(1) to also 
make it consistent with Regulation T.
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    \11\ Telephone conversation between Diane Malley, Supervisor, 
Department of Financial Compliance, CBOE, Timothy Thompson, Senior 
Attorney, Legal Department, CBOE, and Chester McPherson, Staff 
Attorney, Market Regulation, Commission, April 10, 1997.
    \12\ See NYSE Rule 431(f)(2)(H)(i).
    \13\ See Regulation T, 12 CFR 220.4(b)(9)(iii).
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    The treatment of short equity option contracts offset by long 
option contracts where the long option expires with or after the short 
option under current Rule 12.3(c)(1) is the same as that currently 
required for index options under CBOE Rule 24.11. However, the Exchange 
is proposing to adopt the language contained in Rule 24.11 because it 
is more straightforward than the language in Rule 12.3(c)(1).
    The treatment for a straddle (a short call option and a short put 
option the same underlying interest) requires margin on the put or 
call, whichever amount is greater, plus the current market value of the 
other option. The margin treatment for straddles is merely being moved 
from current paragraph (a)(5) of Rule 12.3
    The rules governing the margin requirements for OTC options are 
based on those contained in NYSE Rule 431 \14\ except that the Exchange 
has made a slight change to cap the minimum margin on OTC short puts. A 
chart submitted with the filing sets forth the specific initial and/or 
maintenance margin levels required for OTC options on various types of 
underlying securities.\15\
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    \14\ See NYSE Rule 431(f)(2)(D)(iii).
    \15\ See SR-CBOE-97-17, Exhibit A at 22-23.
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    The Exchange is proposing to add new margin treatment provisions 
for OTC options positions that are covered or offset by certain 
``related securities'' positions when such positions are held in a 
customer margin account and also add new margin treatment provisions 
for covered write convertibles, covered calls/puts, spreads, and 
straddles involving OTC options.\16\ The proposed margin treatment is 
the same treatment that is set forth in NYSE Rule 431 except for a 
proposed change to cap the minimum margin on short puts.
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    \16\ See new Rule 12.3(c)(6)(B) for these provisions.
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Customer Cash Account

    The Exchange is proposing to add a provision to Rule 12.3 detailing 
the circumstances under which a customer may carry short equity options 
in a cash account, i.e. an account in which no credit is extended. This 
provision, Rule 12.3(d), is consistent with a provision in Regulation 
T.\17\ The proposed rule would permit either a call option contract or 
a put option contract held in a short position to be carried in a cash 
account if the option contract is covered, i.e., if the account 
contains one of the specified offsets.
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    \17\ See Regulation T, 12 CFR 220.2.
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    In the case of a short call, allowable offsets include: (i) The 
underlying security, in an amount equal to or greater than that 
underlying the option, provided the option premium is held in the 
account until full cash payment for the underlying security is 
received; (ii) a security immediately convertible without the payment 
of money into an equal or greater quantity of the security underlying 
the option, if such security is held or purchased in the account, on 
the same day, and provided that the option premium is held in the 
account until full cash payment for the convertible security is 
received and the ability to convert does not expire before the 
expiration of the short call option; or (iii) an escrow agreement \18\ 
issued by a bank and either held in the account at the time the call is 
written or received in the account promptly thereafter.
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    \18\ The Exchange proposes to adopt the term ``escrow 
agreement'' to mean:
    any agreement issued in connection with non cash settled call or 
put options under which a bank holding the underlying security or 
required cash or cash equivalents, is obligated to deliver to the 
creditor (in the case of a call option) or accept from the creditor 
(in the cash of a put option) the underlying security against 
payment of the exercise price upon exercise of the call or put.
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    In the case of a short put option, allowable offsets include: (i) 
Cash or cash equivalents as defined in Regulation T of not less than 
the aggregate put exercise amount; or (ii) an escrow agreement issued 
by a bank which is obligated to deliver the required cash in the event 
of assignment of the short put.
    CBOE Rule 24.11A currently permits certain debit put spreads 
involving European-style broad-based stock index options to be carried 
in a cash account. The Exchange proposes to cross-reference the 
provisions of Rule 24.11A into Rule 12.3.

[[Page 31646]]

Market Maker and Specialist Accounts

    Specific provisions governing permitted offset treatment for 
market-makers and specialists have been deleted from Regulation
    Specific provisions governing permitted offset treatment for 
market-makers and specialists have been deleted from Regulation T, 
which now indicates that such offsets are to be determined by the rules 
of the applicable SRO. Accordingly, the proposed rule sets forth 
various permitted offset positions which may be cleared and carried by 
a member organization on behalf of one or more registered specialists, 
registered market-makers, or Designated Primary Market-Makers 
(hereinafter referred to generically as ``market-makers'') upon a 
margin basis satisfactory to the concerned parties. A permitted offset 
position will be defined to mean, in the case of an option in which a 
market-maker makes a market, a position in the underlying instrument or 
other related instrument, and in the case of other securities in which 
a market-maker makes a market, a position in options overlying the 
securities in which a market-maker makes a market, if the account holds 
the following positions: (i) A long position in the underlying 
instrument offset by a short option position which is ``in- or at-the-
money;'' (ii) a short position in the underlying instrument offset by a 
long option position which is ``in- or at-the-money;'' (iii) a stock 
position resulting from the assignment of a market-maker short option 
position; (iv) a stock position resulting from the exercise of a 
market-maker long position; (v) a net long position in a security 
(other than an option) in which a market-maker makes a market; (vi) a 
net short position in a security (other than an option) in which the 
market-maker makes a market; or (vii) an offset position as defined in 
SEC Rule 15c3-1.\19\ All permitted offset transactions must be effected 
for the purpose of hedging, reducing the risk of, rebalancing, 
liquidating open positions of market-makers, or accommodation of 
customer orders, or other similar market-making purpose.
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    \19\ See Securities Exchange Act Release No. 38248 (February 6, 
1997) 62 FR 6474 (February 12, 1997) (Final rule adopting changes to 
SEC Rule 15c3-1).
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    For purposes of Rule 12.3, ``in- or at-the-money'' means the 
current market price of the underlying security is not more than two 
standard exercise price intervals below (with respect to a call option) 
or above (with respect to a put option) the exercise price of the 
option. In determining the types of instruments which are entitled to 
be carried in a permitted offset position, reference can be made to the 
definition of ``related instrument'' which is set forth in the rule. 
``Related instrument'' within an option class or product group is any 
related derivative product that meets the offset level requirements for 
product groups under Rule 15c3-1, including all appendices of the Act, 
or any applicable SEC staff interpretations or no-action positions 
(hereinafter referred to collectively as ``SEC Rule 15c3-1''). The term 
``product group'' means two or more option classes, related 
instruments, and qualified stock baskets for which it has been 
determined that a percentage of offsetting profits may be applied to 
losses in the determination of net capital as set forth in SEC Rule 
15c3-1.
    The Exchange also proposes adding a provision regarding trading in 
a deficit account. The provision generally states that nothing shall 
prohibit the carrying firm from effecting hedging transactions in the 
deficit account with the prior written approval of the carrying firms's 
SEC designated examining authority.

Broker-Dealer Account

    The Exchange is also proposing to add a provision that would 
provide margin relief to accounts held by non-market-maker broker-
dealers. Under the new provision, a member organization may carry the 
proprietary account of another registered broker-dealer upon a margin 
basis which is satisfactory to both parties, provided the requirements 
of Regulation T are adhered to and the account is not carried in a 
deficit equity condition. The amount of any deficiency between the 
equity maintained in the account and the margin required by the other 
provisions of this Rule shall be deducted in computing the net capital 
of the member organization under Rule 15c3-1 of the Act. This new 
provision is similar to the provision of NYSE Rule 431(e)(6), and would 
permit the proprietary accounts of all registered broker-dealers to be 
carried on a ``good faith'' margin basis for purposes of maintenance 
margin. Broker-dealers would still be subject to initial margin 
requirements under Exchange rules and Regulation T.

Interpretations to Rule 12.3

    The Exchange is proposing to add four interpretations to Rule 12.3. 
Also, current Interpretation .01 to Rule 12.3 is proposed for deletion 
because the interpretation concerns SuperShares, which the Exchange no 
longer trades.\20\ New Interpretation .01 sets forth in chart form the 
margin requirements applicable to short positions in listed options and 
in index and foreign currency warrants. It reflects that margin is 
required equal to the current market value of the option/warrant plus 
the applicable percentage of the underlying instrument (set forth in 
the chart). The margin required may be reduced by any ``out-of-the 
money'' amount, as defined in the rule. However, the margin may not be 
reduced below the option market value plus the specified percentage of 
the current market value of the underlying instrument, as set forth in 
the chart. The determination of the ``out-of-the-money amount'' is also 
set forth in a separate chart.
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    \20\ The Exchange is also proposing to delete interpretation .07 
of Rule 24.11 because it also concerns SuperShares.
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    Interpretation .02 describes how a member organization may 
determine ``current market value'' in the event there is no closing 
price or trading has been halted.
    Interpretation .03 specifies that for purposes of the CBOE margin 
rules, index warrants should be treated as if they were index options 
unless the rules specify otherwise. The Exchange states that this 
interpretation recognizes that the two types of products are 
essentially equivalent from a market risk standpoint.

Changes to Rule 12.11

    The Exchange is proposing a minor change to Rule 12.11. Rule 12.11 
allows a member organization that is a member of the NYSE to elect to 
be bound by the rules of the NYSE instead of the requirements set forth 
in Rules 12.3 to 12.10. The Exchange is changing Rule 12.11 to allow 
the member organization to exempt themselves from Rules 12.3 to 12.9, 
but not from 12.10. Rule 12.10 establishes that the margin requirements 
set forth in the rule are minimum requirements and authorizes the 
Exchange to impose higher margin requirements when it deems such higher 
requirements to be advisable. The Exchange has determined that it is 
necessary to clarify that the Exchange may still impose higher margin 
requirements on its members when the Exchange believes such higher 
requirements are warranted, even when those members have elected to 
generally be subject to the margin rules of the NYSE. The change to 
Rule 12.11 also clarifies that if a member organization chooses to be 
bound by NYSE margin rules it will be exempt not only from CBOE margin 
rules in Chapter 12, but also from those margin rules in other chapters 
of the Exchange's rules.

[[Page 31647]]

Changes to Rule 24.11

    The Exchange is proposing to add to Rule 24.11 (which covers margin 
requirements for index options) a provision setting forth the margin 
requirements for covered calls and covered puts that is essentially 
identical to an existing CBOE provision applicable to equity options. 
In addition, the Exchange is proposing to add a definition of 
``qualified stock basket'' to rule 24.11 This definition is used to 
describe allowable offsets in customer accounts for covered calls and 
covered puts. In addition, the Exchange makes a cross-reference to the 
provision of Rule 12.3 that governs the cash account treatment of short 
index options offset by long index options. Finally, the Exchange is 
proposing to change Interpretation .04 which defines ``cash 
equivalent.'' Instead of specifically defining cash equivalent as it is 
currently defined in the rule, the Exchange has decided to defer to the 
definition in Regulation T because the Exchange expects that the 
definition in Regulation T may change from time to time.

III. Discussion

    After careful review of the Exchange's proposed amendment to its 
margin rules, and for the reasons discussed below, the Commission 
believes that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to national securities exchanges, and, in particular, with 
the requirements of Section 6(b) of the Act.\21\ Specifically, the 
Commission believes the proposal is consistent with the Section 6(b)(5) 
requirements that the rules of an exchange be designed to promote just 
and equitable principles of trade, to remove impediments to and perfect 
the mechanism of a free and open market and a national market system, 
to prevent fraudulent and manipulative acts, and, in general, to 
protect investors and the public interest.\22\
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    \21\ 15 U.S.C. Sec. 78f(b).
    \22\ In approving these rules, the Commission has considered the 
proposed rules' impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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Definition and Interpretation Sections

    The Exchange proposes to include a definition section in Rule 12.3. 
The proposed definitions are: ``bank,'' ``current market value,'' 
``escrow agreement,'' and ``exempted security.''
    The definition of ``bank'' is similar to that term as currently 
defined in the Act. Accordingly, the proposed definition does not raise 
new or unique issues.
    The proposed definition of the term ``current market value'' for 
Rule 12.3 purposes, is modelled on a similar term currently defined in 
Exchange Rule 24.11(a), and also includes the incorporation of certain 
parts of a similar definition found in NYSE Rule 431(a)(1). 
Accordingly, the proposed definition does not raise new or unique 
issues. The Exchange is also adopting an interpretation to the 
definition of ``current market value,'' as discussed below.
    The term ``escrow agreement'' being adopted by the Exchange is 
nearly identical to that of Regulation T except that it represents a 
more restrictive approach, reflecting CBOE's concern that certain 
control locations, such as transfer agents, are not appropriate issuers 
of escrow receipts. The Commission concludes that it is reasonable for 
the Exchange to limit the allowed issuers of escrow receipts to 
entities such as banks.
    The Commission believes that the proposed deletion of references to 
SuperShares is appropriate because the product no longer trades on the 
Exchange. The Commission also believes that the interpretive section 
discussing ``current market value,'' which is new to Rule 12.3, 
provides useful guidance to members, especially in circumstances where 
trading in a security has been halted but the OTC market is still open. 
As the Exchange indicates, without this guidance, members would not 
know what approach is acceptable to the Exchange in determining 
``current market value.''
    Other changes to the interpretation section of Rule 12.3 are 
discussed elsewhere in this discussion section.

Customer Margin Accounts

    The Commission supports the Exchange's efforts to consolidate those 
rules relating to customer margin accounts into one subsection of the 
rule. In addition to moving and reorganizing the customer margin 
provisions, the Exchange also is adopting a new margin treatment for 
exempted securities. The proposal would generally lower the maintenance 
margin rates for United States debt securities from the existing 5%, 
and instead establish margin requirements of 1% to 6% depending on the 
years to maturity for the obligation. However, zero coupon bonds will 
be subject to a margin requirement of 3% for bonds with five years or 
more to maturity, and all other exempted securities, i.e., other than 
obligation of the United States, will be subject to an initial and 
maintenance margin requirement of 15% of the current market value or 7% 
of the principal amount, whichever is lower.
    The Commission notes that the CBOE's proposed margin treatment for 
exempted securities is nearly identical to an existing NYSE provision. 
When the NYSE adopted its provision, it stated that a sliding scale 
would provide greater margin requirements for the more volatile long-
term securities, and reduce margin requirements as government 
securities approach maturity to reflect the reduced risk in carrying 
those securities. Prior to adopting the proposal, the NYSE had also 
conducted an analysis of two-year historical price information for 
three Treasury securities of different maturities, a short-, 
intermediate-, and long-term instrument, and concluded that the 
proposed margin requirements for the more volatile long-term government 
instrument would provide at least a 96% confidence level that price 
movements over one and two week periods would be covered.\23\ 
Accordingly, the Commission believes that the proposal by the CBOE to 
adopt the same margin rates for U.S. obligations as required by the 
NYSE is reasonable and should provide member organizations with 
adequate protection against adverse short-term market movements of 
securities in customer margin accounts. Additionally, the Commission 
believes uniform margin rates in this area will enhance efficiency in 
the market place for these securities. Nevertheless, the Commission 
reiterates that maintenance margin rates are intended to set a minimum 
margin standard and should not be construed as limiting the Exchange's 
ability to require margin to be deposited in excess of the minimum 
margin when appropriate.
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    \23\See Securities Exchange Act Release No. 24144 (February 27, 
1987) 52 FR 7245 (March 9, 1987).
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    The proposed treatment of non-convertible debt securities is new to 
Rule 12.3. The Exchange does not currently have a margin treatment 
specifically applicable to non-convertible debt securities and has 
decided to adopt the approach used by the NYSE for the sake of 
uniformity and because the Exchange believes that this approach is 
sensible. The Commission believes that this proposed revision does not 
raise new regulatory issues and, accordingly, is appropriate.
    The proposed treatment of security offset is not new to Rule 12.3. 
Rather, it is a combination of two current provisions of Rule 12.3, 
with the deletion of an incorrect parenthetical reference to options as 
convertible

[[Page 31648]]

securities. These proposed changes are therefore reasonable and should 
provide clearer guidance on the treatment of security offsets.
    The proposed treatment for a short listed call covered by a warrant 
is new to Rule 12.3 but it is substantially similar with the current 
treatment under Regulation T, 12 CFR 220.4(b) and, accordingly, is 
reasonable.
    The proposed treatment for long listed equity options is new to 
Rule 12.3 and its provisions essentially clarify the application of 
Regulation T, 12 CFR 220.18(a) to such options. Specifically, the 
provision confirms that long listed equity options must be fully paid 
for at the time of purchase.\24\
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    \24\ The Commission notes the recent amendments to Regulation T 
permitting SROs' rules, pursuant to SEC-approval, to allow the 
extension of loan value to listed options. See supra note 6. The 
current proposal, however, does not address this issue or otherwise 
permit the extension of loan value for long listed options.
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    The proposed treatment for a short listed equity option has been 
slightly revised from the current requirements by combining existing 
language from the Rule 12.3 \25\ with language from Regulation T. In 
addition, the Exchange proposes revising the margin cap for out-of-the 
money short puts. Currently, the margin requirement on a short 
uncovered listed equity option is calculated by adding to the option 
premium a percentage (20%) of the underlying instrument's value, and 
then subtracting any out-of-the-money amount. The Exchange also has an 
overriding minimum margin formula, based on a percentage (10%) of the 
value of the underlying instrument's market price.
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    \25\ See CBOE Rule 12.3(a)(5).
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    According to the Exchange, the existing methods for calculating the 
margin treatment for short uncovered listed equity options works 
reasonably well, except when the overriding minimum is applied to an 
out-of-the-money put. Under the overriding minimum margin requirement, 
as a short uncovered put option becomes increasingly out-of-the-money, 
the margin requirement increases because the value of the underlying 
instrument is increasing. As a result, the CBOE indicates that margin 
calls may be issued for uncovered puts that are out-of-the-money. The 
Exchange proposes to remedy this situation by revising the method for 
calculating the overriding minimum margin. Specifically, the Exchange 
proposes to substitute the market value of the underlying instrument 
with a percentage of the put's aggregate exercise price. Under this new 
method, the minimum requirement is a fixed value and, therefore, and 
increasingly higher minimum requirement will not occur as the value of 
the underlying rises. The Commission believes this new method for 
calculating the overriding minimum margin for short listed equity 
options is reasonable and should result in adequate margining for the 
affected positions.\26\
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    \26\ The Commission notes that the new minimum margin 
requirement should often result in higher margin levels for deep in-
the-money puts. This will occur because the current minimum margin 
requirement for a short put is based, in part, on the underlying 
instrument's value, an amount that decreases as the put becomes 
deeper in-the-money. The new formula corrects this result by 
requiring a minimum margin amount based in part on the aggregate 
exercise value of the option, an amount that remains constant as the 
value of the underlying security decreases in value.
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    The Exchange states that the proposed treatment of short listed 
equity options offset by long listed equity options where the long 
option expires with or after the short option under Rule 12.3 is 
actually the same as that currently permitted for index options under 
Rule 24.11. The Exchange indicates that because the treatment under its 
current rules for equity and index options is actually the same, 
adopting the more straightforward of the two treatment is a reasonable 
approach in that the cumbersome language of Rule 12.3 is being replaced 
by the easier to understand language of Rule 24.11.
    The proposed treatment for a straddle (a short call option and a 
short put option on the same underlying interest) requires margin on 
the put or call, whichever amount is greater, plus 100% of the current 
market value of the other option. This is not a substantive change. 
Rather, the Exchange is merely moving the margin treatment for a 
straddle from current paragraph (a)(5) of Rule 12.3.
    Rule 12.3(c)(6) governing the margin treatment of OTC options is 
new to the Exchange. It is being patterned after, and is nearly 
identical to the provisions contained in NYSE Rule 431(f)(2)(D)(iii). A 
slight difference is that the Exchange has proposed the inclusion of a 
cap for the minimum margin on OTC short puts for the same reasons that 
it proposes changing its formula for capping the margin on short listed 
equity options, as discussed above.
    Given the near identical nature of the CBOE's proposals to the 
NYSE's previously approved proposal, the Commission believes that 
adoption of these proposed standards is reasonable. With regard to the 
cap on short put positions, the Commission believes such treatment is 
also reasonable for the same reasons set forth regarding the identical 
proposed treatment for listed positions.
    The proposed treatment of related securities positions in OTC 
options also is substantially similar to that of the NYSE and 
accordingly does not raise new regulatory issues.\27\ The Commission 
also believes that the Exchange's decision to model its margin 
treatment for OTC options and related securities positions based on the 
NYSE positions should help foster coordination between markets by 
achieving parity between the margin requirements of the various SROs. 
The Commission also believes that this approach will promote 
coordination in regulating, clearing, settling, and facilitating 
transactions in securities by providing for uniformity in this area of 
the SROs' margin schemes and reducing confusion among customers.
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    \27\ See NYSE Rule 431(f)(2).
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Customer Cash Account

    Rule 24.11A currently permits certain debit put spreads involving 
European-style broad-based stock index options to be carried in a cash 
account. The Exchange proposes to copy a certain section of 24.11A 
(specifically, 24.11A(f)) into Rule 12.3. Essentially, the new 
provision concerning debit put spreads in Rule 12.3 will serve as a 
cross-reference to the more detailed provisions contained in Rule 
24.11A. Accordingly, although not specifically contained in the Rule 
12.3 cross-reference, all of the applicable conditions contained in 
Rule 24.11A must be met before the described debit put spreads may be 
carried in a cash account.\28\
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    \28\ See Letter from Timothy H. Thompson, Senior Attorney, CBOE, 
to Chester McPherson, Staff Attorney, Market Regulation Commission, 
dated May 30, 1997.
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Market Maker and Specialist Accounts

    The Exchange has also proposed to adopt specific provisions 
governing permitted offset treatment for market-makers and specialists 
that are being deleted from Regulation T as of June 1, 1997. The 
proposed rule sets forth various permitted offset positions which may 
be cleared and carried by a member organization on behalf of one or 
more market-makers upon a margin basis satisfactory to the concerned 
parties (``good faith'' margin). In addition, it requires that the 
amount of any deficiency between the equity maintained by the market-
maker and the haircuts specified in SEC Rule 15c3-1 shall be considered 
as a deduction from net worth in the net capital computation of the 
carrying broker.
    A permitted offset position will be defined to mean, in the case of 
an option in which a market-maker makes

[[Page 31649]]

a market, a position in the underlying instrument or other related 
instrument, and in the case of other securities in which a market-maker 
makes a market, a position in options overlying the securities in which 
a market-maker makes a market, if the account holds the following 
positions: (i) A long position in the underlying instrument offset by a 
short option position which is ``in- or at-the-money;'' (ii) a short 
position in the underlying instrument offset by a long option position 
which is ``in- or at-the-money;'' (iii) a stock position resulting from 
the assignment of a market-maker short option position; (iv) a stock 
position resulting from the exercise of a market-maker long position; 
(v) a net long position in a security (other than an option) in which a 
market-maker makes a market; (vi) a net short position in a security 
(other than an option) in which the market-maker makes a market; or 
(vii) an offset position as defined in SEC Rule 15c3-1.
    The six proposed offsets described in proposed Rule 12.3(f)(3)(A) 
(i) to (vi) codify the existing permitted offsets that were provided 
under Regulation T until June 1, 1997. These offsets reflect well-
recognized market-making hedging transactions involving certain options 
offset strategies involving the related underlying stock. The addition 
of Rule 12.3(f)(3)(A)(vii), allowing any offset position defined under 
SEC Rule 15c3-1,\29\ constitutes a significant expansion of permitted 
offset positions. According to the Exchange, the inclusion of item 
(vii) recognizes that options market-makers and specialists must engage 
in various hedging transactions to manage the risk involved in 
fulfilling their role, and, therefore, allows a member organization to 
clear and carry market-maker's offset positions as defined in SEC Rule 
15c3-1 upon a good faith margin basis. The Exchange has clarified its 
proposal to reflect that market-makers are permitted to receive good 
faith margin for all permitted offset positions only if they are 
effected for market-making purposes such as hedging, reducing the risk 
of rebalancing, liquidating open positions of the market-maker, 
accommodating customer orders, or another similar market-making 
purpose.
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    \29\ See supra note 19.
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    The Commission believes that the proposal is a reasonable effort by 
the CBOE to accommodate the needs of CBOE market-makers in undertaking 
their market-making responsibilities as it recognizes the occasional 
need for market-makers to effect transactions in their course of 
dealing in options classes for which the marker-maker is not 
registered. The Commission believes that this approach will not 
adversely affect the depth and liquidity necessary to maintain fair and 
orderly markets. The Commission expects CBOE clearing firms and other 
CBOE members that extend margin to market-makers to implement adequate 
procedures to ensure that offsets elected by market-makers are recorded 
accurately and cleared into appropriate accounts. In addition, such 
members should have a reasonable basis for determining that the offset 
transactions satisfy the marketmaking purpose requirements set forth in 
CBOE Rule 12.3(f). The Commission believes that these requirements will 
ensure that transactions effected by market-makers and specialists 
receiving the offset treatment are in fact directly related to their 
market-making function and are not effected for speculative purposes on 
a margin basis which should be available only for bona fide market-
making activity.
    The Exchange indicates that its proposed definition of ``in-or at-
the-money,'' for purposes of permitted offset transactions, represent a 
codification of its long standing practice of permitting the financing 
of options market-makers underlying stock positions on a good faith 
basis when offset on a share-for-share basis by options which are ``in- 
or at-the-money,'' i.e., where the current market price of the 
underlying security is not more than two standard exercise price 
intervals below (with respect to a call option) or above (with respect 
to a put option) the exercise price of the option (emphasis added). 
According to the Exchange, this practice evolved after it made changes 
in 1985 to its Rule 5.5 so that the interval between strike prices of 
options series on individual stocks is 2\1/2\ points where the strike 
price is greater than $25, but less than $200; and 10 points where the 
strike price is greater than $200. The Exchange indicates that this 
position was represented to the Federal Reserve Board as consistent 
with Regulation T, 12 CFR 220.12 \30\ and that the Board has not 
objected to this practice.\31\ At this time, the Commission believes it 
is appropriate for the CBOE to codify this longstanding practice.
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    \30\ Regulation T, 12 CFR 220.2 defines ``in- or at-the-money,'' 
to mean (until June 1, 1997) the current market price of the 
underlying security is not more than one (emphasis added) standard 
exercise interval below (with respect to a call option) or above 
(with respect to a put option) the exercise price of the option.
    \31\ Telephone conversation between Diane Malley, Supervisor, 
Department of Financial Compliance, CBOE, and Chester McPherson, 
Staff Attorney, Market Regulation, Commission, May 28, 1997. See 
also Letter from Mary L. Bender, Assistant Vice President, CBOE, to 
Laura Homer, Federal Reserve Board, dated May 23, 1985 outlining the 
issue.
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Broker-Dealer Account

    The Exchange proposes adding a provision that would provide margin 
relief to accounts held by non-market-maker broker-dealers. Under the 
new provision, a member organization may carry the proprietary account 
of another registered broker-dealer upon a margin basis which is 
satisfactory to both parties, provided the requirements of Regulation T 
are adhered to and the account is not carried in a deficit equity 
condition. This new provision is substantially similar to the provision 
of NYSE Rule. 431(e)(6) and is being adopted by the Exchange for the 
sake of uniformity. Accordingly, this change is appropriate.

Changes to Rule 12.11

    The Exchange has determined to allow its members who are also 
members of the NYSE to exempt themselves from CBOE Rules 12.3 to 12.9. 
However, the Exchange has determined to not allow its members to exempt 
themselves from CBOE Rule 12.10. Rule 12.10 authorizes the Exchange to 
impose higher margin requirements when it deems such higher 
requirements to be advisable. The Commission agrees that it is 
reasonable for the CBOE to be able to determine when higher margin 
requirements will be required for positions in Exchange-traded products 
and that, therefore, its members should not be permitted to exempt 
themselves from this rule. The Commission notes that the Exchange is 
under no obligation to allow its members to be exempted from any of its 
applicable rules unless the Exchange believes such exemption is 
appropriate.

Changes to Rule 24.11

    The addition of this section is intended to provide the same margin 
cover for covered calls and covered puts involving index options \32\ 
as is currently allowed for equity options. The recent amendments to 
Regulation T include a new provision that allows SROs, subject to SEC 
approval, to expand the allowed types of covered transactions (in 
addition to those allowed under the Regulation T definition of covered 
transactions), provided that: (i) The position has finite

[[Page 31650]]

risk; (ii) the amount at risk is held in the account in cash, cash 
equivalents, or via an escrow agreement; and (iii) the transaction is 
eligible for the cash account. The existing covered transaction 
provisions of Regulation T do not address positions involving index 
options. The Commission has addressed this area in the past by granting 
a number of no-action positions that allow certain short index call 
option positions to be offset by a portfolio of stocks that exactly 
replicates the index option.\32\ The proposed revision to Rule 24.11 
essentially codifies the margin treatment permitted under these prior 
positions and therefore is appropriate. Although these prior no-action 
positions did not address or grant no-action relief to short index put 
options offset by short positions in a portfolio of stocks replicating 
the index option, the Commission concludes that such positions 
nonetheless satisfy the noted regulatory standards required for covered 
transactions and such treatment is consistent with the covered 
treatment afforded to transactions in equity options. Accordingly, this 
provision is reasonable and appropriate.
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    \32\ The current proposal only addresses index options that are 
covered by a ``qualified portfolio'' containing all of the stocks 
represented in the index, in proportion to their representation in 
the index. Provisions for short index options offset by long index 
options are proposed in the Second Margin Filing.
    \33\ See, eq., Letter from Sharon Lawson, Senior Special 
Counsel, Market Regulation, to Diane Malley, CBOE, dated October 4, 
1996 (short index call positions in Goldman Sachs Technology 
Composite Index and Goldman Sachs Technology sub-Index options).
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Accelerated Approval of Amendment Nos. 1 and 2

    The Commission finds good cause for approving Amendment Nos. 1 and 
2 period to the thirtieth day after the date of publication of notice 
of filing thereof. Amendment No. 1 addresses technical changes by 
making corrections to certain typographical mistakes appearing in the 
rule filing. Amendment No. 2 also makes technical changes by correcting 
an incorrect cross-reference in CBOE Rule 12.5 and other inadvertent 
omissions. In addition, it addresses a number of substantive issues, 
including limiting the availability of good faith margin for permitted 
offset to only bona fide market-making transactions. Amendment No. 2 
also addresses the margin treatment applicable to long listed equity 
options. Instead of requiring margin to be equal to the current market 
value of long listed equity options, the requirement has been changed 
to equal at least the purchase price of the option. This change better 
reflects the purpose of the proposed change, which was to confirm that 
long listed options must be paid for in full at the time of purchase. 
The originally proposed language could possibly be interpreted to 
impose a maintenance margin requirement for such positions, which is 
not required for fully paid long positions. The remainder of Amendment 
No. 2 merely provided additional information regarding issues that were 
adequately published through the notice of this proposed rule filing. 
All of the amended changes strengthen and clarify the proposal. Based 
on the above, the Commission finds that there exists good cause 
consistent with Section 6(b)(5) of the Act, to accelerated approval of 
the amendments.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 1 and 2. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of all such 
filing will also be available for inspection and copying at the 
principal office of the CBOE. All submissions should refer to the file 
number SR-CBOE-97-17 and should be submitted by June 23, 1997.
    It is therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\34\ that the proposed rule change (SR-CBOE-97-17) is approved.

    \34\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-15025 Filed 6-9-97; 8:45 am]
BILLING CODE 8010-01-M