[Federal Register Volume 63, Number 115 (Tuesday, June 16, 1998)]
[Rules and Regulations]
[Pages 32726-32732]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-15977]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 33


Final Rulemaking Permitting Futures-Style Margining of Commodity 
Options

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
repealing Commission Regulation 33.4(a)(2) and amending Commission 
Regulation 33.7(b). The Commission also is implementing technical 
amendments to its regulations imposing financial and segregation 
requirements on futures commission merchants (``FCMs'') and introducing 
brokers (``IBs'').
    Regulation 33.4(a)(2) requires the purchaser of a commodity option 
to pay the full option premium at the initiation of the transaction. 
Regulation 33.7 requires an FCM, or an IB in the case of an introduced 
account, to provide each option customer with a written option 
disclosure statement prior to the opening of the account.
    The repeal of Regulation 33.4(a)(2) will permit commodity options 
to be margined using a ``futures-style'' margining system. Futures-
style margining requires both the purchaser (``long'') and the seller 
(``short'') of a commodity option to post risk-based, original margin 
upon entering into an option position. During the life of the option, 
the option value is marked to market daily, and gains and losses are 
posted to the accounts of the long and short position holders. The 
repeal does not impose an obligation on exchanges to adopt futures-
style margining for commodity options. Exchanges may continue to use 
their current option margining systems. Any exchange wishing to 
implement futures-style margining must submit proposed rules for 
Commission review pursuant to Section 5a(a)(12)(A) of the Commodity 
Exchange Act (``Act'') and Commission Regulation 1.41.
    Regulation 33.7(b) sets forth the terms of the disclosure statement 
and

[[Page 32727]]

currently reflects the prohibition against the margining of long option 
positions. The Commission is amending the disclosure statement to 
reflect the permissibility of futures-style margining for options.

EFFECTIVE DATE: July 16, 1998.

FOR FURTHER INFORMATION CONTACT: Thomas Smith, Attorney, Division of 
Trading and Markets, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. 
Telephone: (202) 418-5495; or electronic mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Background

    On December 19, 1997, the Commission published for public comment 
in the Federal Register a proposal to repeal Commission Regulation 
33.4(a)(2) and proposed amendments to the option disclosure statements 
in Regulation 33.7(b) and Appendix A to Regulation 1.55(c).\1\ The 
original comment period was scheduled to end on February 2, 1998, but 
was extended by the Commission until March 4, 1998.\2\
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    \1\ 62 FR 66569 (December 19, 1997).
    \2\ 63 FR 6112 (February 6, 1998).
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    Regulation 33.4(a)(2) is one of several regulations that were 
implemented as part of a pilot program for the exchange trading of 
options on non-agricultural futures instituted by the Commission on 
November 3, 1981.\3\ Regulation 33.4(a)(2) requires the purchaser of an 
option to pay the full premium at the initiation of the transaction. 
Overall, the Commission's experience with the pilot program was 
positive, and the trading of options on non-agricultural futures was 
made permanent on August 1, 1986.\4\
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    \3\ 46 FR 54500 (November 3, 1981).
    \4\ 51 FR 17464 (May 13, 1986); 51 FR 27529 (August 1, 1986). 
Subsequently, the Commission approved the exchange trading of 
options on agricultural futures and options on non-agricultural 
physicals effective February 9, 1987. 52 FR 777 (January 9, 1987). 
On April 8, 1998, the Commission approved a three-year pilot program 
for the off-exchange trading of certain agricultural trade options 
and also approved exchange trading of options on agricultural 
physicals. 63 FR 18821 (April 16, 1998).
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    Regulation 33.4(a)(2) requires commodity options to be subject to a 
``stock-style'' margining system that obligates the option buyer to pay 
the full purchase premium when the transaction is initiated.\5\ The 
long is not required to make any additional payments during the life of 
the option. The option premium is credited to the account of the option 
seller, who must keep it posted with his or her FCM. The short also 
must deposit risk margin with his or her FCM to cover potential adverse 
market moves in the option position. If the option increases in value, 
the short must deposit additional funds into the account. These funds, 
however, are not transferred to the long, who must exercise or offset 
the option in order to realize any increase in its value. By contrast, 
if the option value decreases, the short may withdraw any excess funds 
from its account.
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    \5\ Regulations 33.4 in pertinent part states:
    Sec. 33.4  Designation as a contract market for the trading of 
commodity options.
    The Commission may designate any board of trade...as a contract 
market for the trading of options on contracts of sale for future 
delivery... when the applicant complies with and carries out the 
requirements of the Act (as provided in Sec. 33.2), these 
regulations, and the following conditions and requirements with 
respect to the commodity option for which the designation is sought:
    (a) Such board of trade * * *
    (2) Provides that the clearing organization must receive from 
each of its clearing members, that each clearing member must receive 
from each other person for whom it clears commodity option 
transactions, and that each futures commission merchant must receive 
from each of its option customers, the full amount of each option 
premium at the time the option is purchased.
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    Futures-style margining of commodity options will require that both 
the long and the short position holders post risk-based, original 
margin upon entering into their option positions. The option value will 
be marked to market daily during the life of the option. Any increase 
in value will result in a credit to the long option holder's account 
and a corresponding debit against the short option seller's account. 
Conversely, any decrease in value will result in a credit to the 
short's account and a corresponding debit to the long's account.
    Thus, under futures-style margining, the cash flows associated with 
option contracts will be symmetric, as is the case for cash flows for 
futures. Futures-style margining, however, will not alter the 
fundamental nature of each party's overall obligation. A long's 
potential for loss will remain limited to the full option premium and 
transaction costs. As is the case now, a short's potential for loss 
will not be so limited.
    In the Notice of Proposed Rulemaking, the Commission identified 
several potential benefits and potential costs that may result from the 
adoption of futures-style margining. The potential benefits included 
the enhancement of the financial integrity and market liquidity that 
may result from the more efficient cash flows associated with futures-
style margining. The potential costs included an increase in the use of 
leverage in the futures markets, an increase in customer confusion, 
including an increase in the opportunity for unscrupulous individuals 
to mislead unsophisticated option customers, and transition costs to 
the industry in adopting futures-style margining.\6\
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    \6\ See, 62 FR 66571-66572
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II. Comments Received

    The Commission received 27 comment letters on the proposal. 
Supporting comments were submitted by six futures exchanges, four trade 
associations, one clearing organization, one FCM and one law firm.\7\ 
Eight commercial firms, two securities options exchanges, one FCM and 
one investment management firm submitted opposing comments.\8\ Two FCMs 
submitted comments that, while not opposing the proposal, raised 
concerns about the implementation and operation of futures-style 
margining.\9\
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    \7\ Supporting comments were submitted by: Chicago Board of 
Trade; Chicago Mercantile Exchange; New York Mercantile Exchange; 
Coffee, Sugar & Cocoa Exchange, Inc.; New York Cotton Exchange; 
Minneapolis Grain Exchange; National Grain Trade Council; Commodity 
Floor Brokers & Traders Association; National Grain and Feed 
Association; Futures Industry Association; Board of Trade Clearing 
Corporation; ABN Amro Chicago Corporation; and Philip McBride 
Johnson of Skadden, Arps, Slate, Meagher & Flom, and a former 
Chairman of the Commission.
    \8\ The opposing comments were submitted by: Andre & CIE S.A. 
Lausanne; Transcatalana De Comercio, S.A.; Garnac Grain Co., Inc.; 
Refinadora De Oleos Brasil LTDA.; SAROC S.P.A.; Compagnie 
Commerciale Andre; La Plata Cereal; Andre & CIE (Singapore) PTE 
LTD.; The Options Clearing Corporation; The Chicago Board Options 
Exchange; The Clifton Group; and FIMAT Futures USA, Inc.
    \9\ The two comments were submitted by Lind Waldock & Company 
and DKB Financial Futures Corp.
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    The material issues raised by the comment letters are set forth 
below. In most instances, the issues raised were previously identified 
by the Commission in the Notice of Proposed Rulemaking.
    One commenter stated that many of the cash flow benefits identified 
in the Notice of Proposed Rulemaking could be achieved by expanding the 
availability of cross-margining between futures markets and securities 
markets. Another commenter stated that the Standard Portfolio Analysis 
of Risk (``SPAN'') margining system provides market participants with 
many of the cash flow benefits that are identified with futures-style 
margining.\10\
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    \10\ The SPAN margining system was developed by the Chicago 
Mercantile Exchange and is currently used by all domestic futures 
exchanges and clearing organizations, except the Philadelphia Board 
of Trade.
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    The Commission recognizes that cross-margining and the SPAN 
margining system provide cash flow benefits to market participants. The 
Commission believes, however, that futures-style margining could 
provide additional cash flow benefits not

[[Page 32728]]

available through cross-margining or SPAN. For example, cross-margining 
is restricted to specified products with offsetting risk 
characteristics that are traded on different exchanges that have cross-
margining arrangements. In contrast, futures-style margining could be 
available for any futures exchange-traded options, and the cash flow 
benefits would not be dependent on preexisting arrangements between 
exchanges. Similarly, under SPAN, the long is still obligated to pay 
the full option premium at the inception of the transaction regardless 
of the portfolio's risk calculation. Thus, a trader who hedged a short 
futures position with a long option would be required to pay the full 
option premium at the initiation of the transaction under the stock-
style margining system, even though SPAN would calculate the margin on 
the two positions on a portfolio basis.
    Two commenters expressed a concern that futures-style margining 
will result in an increase in the use of leverage in the futures 
market. As the Commission stated in the Notice of Proposed Rulemaking, 
futures-style margining will result in an increase in the amount of 
leverage in the futures market. The purchaser of an option will be able 
to acquire an option position upon payment of less than the full option 
premium at the initiation of the transaction. The option position will 
then be marked to market on a daily basis, with gains or losses posted 
to the respective accounts of the long and short position holders. The 
substitution of a margining system for the full, up-front payment of 
the option also will introduce a risk of default by the long that does 
not exist under the stock-style margining system.
    The Commission believes, however, that the leverage associated with 
long options will not substantially increase the risk to the financial 
integrity of the markets. First, as the Commission noted in the Notice 
of Proposed Rulemaking, long option positions entail less total risk 
than short options or long or short futures positions. Under futures-
style margining, the maximum loss that a long may incur on an option 
position will continue to be limited to the full option premium at the 
initiation of the transaction. In contrast, holders of short options or 
long or short futures positions will continue to be subject to much 
greater risk from adverse market moves.
    Second, with respect to the added risk of default, FCMs that 
currently hold customer accounts that include short options and long 
and short futures positions assess the creditworthiness of each 
customer as part of their normal business practices. Requiring such 
firms to assess the creditworthiness of potential option purchasers 
should not require any significant adjustments in such firms' operating 
procedures in this regard.
    Third, the Commission is not requiring that exchanges adopt 
futures-style margining for options. The exchanges may continue to use 
their current margining systems and require option purchasers to pay 
the option premium at the initiation of the transaction. The Commission 
expects that exchanges will not propose adopting futures-style 
margining until they have developed appropriate systems and/or 
procedures to monitor the margining of long option positions and have 
considered the views and market needs of their members and other market 
participants.
    Finally, an FCM may require that option purchasers pay the full 
option premium at the initiation of the transaction even if the 
exchange permits futures-style margining. Therefore, FCMs that do not 
have the systems or procedures to monitor the margining of long option 
positions may elect to retain the stock-style margining system even 
though an exchange might permit futures-style margining.
    Several commenters expressed a concern that futures-style margining 
would benefit option buyers at the expense of option sellers. The 
primary concern of these commenters is that the Commission did not 
demonstrate that expected increases in option premiums would 
sufficiently compensate option sellers for their loss of interest 
income.
    In the Notice of Proposed Rulemaking, the Commission noted that a 
futures-style margining system may alter option pricing. Sellers of 
options may charge a higher premium to compensate for the loss of 
interest income. Conversely, option buyers may be willing to pay a 
higher premium because they will not have to pay the full premium up-
front. The Commission believes, however, that market forces should 
ensure that pricing changes will not benefit longs at the expense of 
shorts. In this regard, commenters did not submit any support for the 
assertion that futures-style margining would benefit option buyers at 
the expense of option sellers.
    One commenter stated that permitting futures-style margining, which 
does not require the up-front payment of option premiums, may result in 
additional low-capital customers entering the option markets. The 
commenter argued that such customers may not be very knowledgeable 
about futures markets and may be susceptible to unscrupulous 
individuals seeking to take advantage of them.
    By amending the option disclosure statement in Regulation 33.7 to 
reflect the permissibility of futures-style margining, the Commission 
is attempting to ensure that potential option customers receive 
adequate notice concerning the risks of trading in commodity options. 
In addition, the distribution of the disclosure statement does not 
relieve an FCM or IB from any other disclosure obligations that it may 
have under applicable law.
    One commenter stated that futures-style margining will require some 
FCMs to increase staff and upgrade systems capabilities in order to 
perform continuous intraday monitoring of long option positions. The 
commenter further stated that the increased costs may be passed on to 
option customers, thereby making trading more expensive. The commenter 
also claimed that exchanges should not be permitted to offer futures-
style margining until they are able to provide continuous, updated 
information regarding the volatility levels of their options to their 
member firms.
    The Commission recognizes that certain FCMs may be required to 
expend additional capital to monitor properly long option positions 
with the implementation of a futures-style margining system. However, 
many firms already have such systems in place. As noted above, short 
option positions are currently margined and marked to market on a daily 
basis. Firms that carry short option positions on their books must have 
monitoring and margining systems in place in order to track properly 
the short option positions. In addition, futures-style margining has 
been in place at the London International Financial Futures and Options 
Exchange for over ten years.
    In addition, the Commission anticipates that the exchanges will 
take into consideration the views of their members and other market 
participants prior to proposing any changes to their option margining 
systems. Moreover, any proposal to adopt a futures-style margining 
system must be submitted to the Commission for review pursuant to 
Section 5a(a)(12)(A) of the Act and Commission Regulation 1.41. As part 
of the review process, the Commission may determine that publication of 
the proposal in the Federal Register is necessary in order to obtain 
the views and comments of interested persons.
    One commenter stated that the Commission's proposal lacked 
specificity with respect to the implementation and operation of a 
futures-style margining system. The

[[Page 32729]]

commenter argued that a lack of specificity may result in the adoption 
of different margining systems or standards for each exchange or 
different systems within one exchange. In contrast, two other 
commenters stated that exchanges should have discretion to determine 
which option contracts should be subject to a stock-style or futures-
style margining system as part of the contract design process. In 
addition, one of these two commenters stated that an exchange should be 
afforded the flexibility of designing margining systems that result in 
a hybrid of the stock-style and futures-style system. For example, an 
exchange should have the discretion to design an option contract that 
would require the option buyer to pay the full premium at the time of 
purchase (stock-style) while also allowing that customer to withdraw 
any subsequent option value gains from the account (futures-style).
    By repealing Commission Regulation 33.4(a)(2), the Commission does 
not intend to require that an exchange use a uniform margining system 
for all of its listed option markets or that the exchanges adopt 
futures-style margining in a concerted manner. While the Commission 
recognizes that a uniform margining system across all futures markets 
might increase efficiency and reduce potential confusion among market 
participants, the Commission believes that it is not its role to 
mandate such a result. Each exchange should have the discretion to 
design margining systems that it believes are appropriate for its 
option markets. Accordingly, the Commission will review each proposal 
to implement a futures-style margining system on an individual basis.

III. Amendments to the Option Disclosure Statement

A. Amendments to the Option Disclosure Statement in Regulation 33.7(b)

    Commission Regulation 33.7 was issued as part of the initial option 
pilot program in November 1981 and requires an FCM, or an IB in the 
case of an introduced account, to provide each option customer with a 
detailed disclosure statement prior to the opening of an account. The 
customer is required to sign an acknowledgment indicating that he or 
she read and understood the document before any transaction is effected 
for that customer's account.
    The disclosure statement, which is set forth in Regulation 33.7(b), 
contains a detailed description of option trading and the risks 
associated with option positions. The statement was drafted to reflect 
the prohibition against the margining of long option positions.
    In the Notice of Proposed Rulemaking, the Commission proposed 
several amendments to the disclosure statement to reflect the 
permissibility of futures-style margining. The Commission has 
determined to adopt the amendments with one modification.
    The Commission's proposed amendments included adding the following 
language to the option disclosure statement:

    BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS SUBJECT TO A 
``STOCK-STYLE'' OR ``FUTURES-STYLE'' SYSTEM OF MARGINING. UNDER A 
STOCK-STYLE MARGINING SYSTEM, A PURCHASER IS REQUIRED TO PAY THE 
FULL PURCHASE PRICE OF THE OPTION AT THE INITIATION OF THE 
TRANSACTION. THE PURCHASER HAS NO FURTHER OBLIGATION ON THE OPTION 
POSITION. UNDER A FUTURES-STYLE MARGINING SYSTEM, THE PURCHASER 
DEPOSITS INITIAL MARGIN AND MAY BE REQUIRED TO DEPOSIT ADDITIONAL 
MARGIN IF THE MARKET MOVES AGAINST THE OPTION POSITION. THE 
PURCHASER'S TOTAL MARGIN OBLIGATION, HOWEVER, WILL NOT EXCEED THE 
ORIGINAL OPTION PREMIUM. IF THE PURCHASER OR GRANTOR DOES NOT 
UNDERSTAND HOW OPTIONS ARE MARGINED UNDER A STOCK-STYLE OR FUTURES-
STYLE MARGINING SYSTEM, HE OR SHE SHOULD REQUEST AN EXPLANATION FROM 
THE FUTURES COMMISSION MERCHANT (``FCM'') OR INTRODUCING BROKER 
(``IB''). (Emphasis added.)

    One commenter stated that the statement--THE PURCHASER'S TOTAL 
MARGIN OBLIGATION, HOWEVER, WILL NOT EXCEED THE ORIGINAL OPTION 
PREMIUM--while strictly true, could be open to honest 
misinterpretation. The commenter stated that under certain 
circumstances a long option position holder may incur margin payment 
obligations that exceed the initial option premium. For example, an FCM 
may require risk margin that exceeds the option premium. In addition, a 
bought option may first increase substantially in value immediately 
after purchase and then lose nearly all of its value on the next day. 
If the option owner had withdrawn the initial value increase from the 
account, he or she would be required to make a large daily variation 
margin payment to the FCM to settle the subsequent value loss. In such 
situations, the variation margin payments on the second day may exceed 
the initial option premium. Accordingly, the commenter proposed that 
the sentence be modified to state:

    THE PURCHASER'S TOTAL SETTLEMENT VARIATION MARGIN OBLIGATION 
OVER THE LIFE OF THE OPTION, HOWEVER, WILL NOT EXCEED THE ORIGINAL 
OPTION PREMIUM, ALTHOUGH SOME INDIVIDUAL PAYMENT OBLIGATIONS AND/OR 
RISK MARGIN REQUIREMENTS MAY AT TIMES EXCEED THE ORIGINAL OPTION 
PREMIUM.

The Commission concurs with the commenter and is amending the risk 
disclosure statement to include the above sentence in lieu of the 
proposed sentence.

B. Proposed Amendments to Appendix A of Regulation 1.55(c)

    Appendix A of Commission Regulation 1.55(c) contains a generic risk 
disclosure statement applicable to the Commission's disclosure 
requirements for domestic and foreign commodity futures and commodity 
option transactions.\11\ The disclosure statement includes a discussion 
of the risks associated with the futures-style margining of options, 
which has been permitted on certain foreign exchanges, including the 
London International Financial Futures and Option Exchange.
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    \11\ The disclosure statement was developed by the Commission in 
cooperation with various international regulators and self-
regulatory organizations who also have adopted the statement for use 
in their jurisdictions. The disclosure statement permits firms doing 
multinational business to use the same risk disclosure statement for 
foreign and U.S.-based business. The Commission adopted the 
disclosure statement on July 5, 1994. 59 FR 34376 (July 5, 1994).
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    In the Notice of Proposed Rulemaking, the Commission proposed minor 
amendments to the risk disclosure statement to reflect explicitly the 
permissibility of futures-style margining for options traded on U.S. 
markets. Upon reconsideration, the Commission has determined that the 
disclosures in the risk disclosure statement, as currently drafted, are 
appropriate. Accordingly, the Commission is not amending Appendix A to 
Commission Regulation 1.55(c).

IV. Technical Amendments

    In the Notice of Proposed Rulemaking, the Commission requested 
comment on any amendments that would need to be made to the 
Commission's regulations governing net capital requirements for FCMs 
and IBs to reflect the permissibility of futures-style margining. No 
comments were received on this point.
    Several of the Commission's regulations impose financial 
requirements on FCMs and IBs. In various sections of those regulations, 
reference is made to the manner in which an FCM's net capital 
requirement

[[Page 32730]]

is to be calculated. The calculation excludes the value of long options 
positions because such options, under current methodologies, are fully 
paid for and pose no financial risk to the FCM. The Commission, as 
suggested in the Notice of Proposed Rulemaking, is making technical 
amendments to these regulations in order to reflect the permissibility 
of a futures-style margining system for commodity options and to make 
clear that only the value of fully paid for long options may be 
excluded from the capital requirement formula. Specifically, the 
Commission is amending the definition of customer funds in Regulation 
1.3(gg) and certain reporting requirements and financial requirements 
set forth in Regulations 1.12(b)(2), 1.17(a)(1)(i)(B), 1.17(e)(1)(ii), 
1.17(h)(2)(vi)(C)(2), 1.17(h)(2)(vii)(A)(2), 1.17(h)(2)(vii)(B)(2), 
1.17(h)(2)(viii)(A)(2), 1.17(h)(3)(ii)(B), and 1.17(h)(3)(v)(B).\12\
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    \12\ The Commission's Division of Trading and Markets previously 
has issued guidance on the proper accounting and segregation 
treatment of exchange-traded options subject to a stock-style 
margining system. See, Financial and Segregation Interpretation No. 
8--Proper Accounting, Segregation and Net Capital Treatment of 
Exchange Traded Option Transactions, Comm. Fut. L. Rep. (CCH) para. 
7118 (Division of Trading and Markets, August 12, 1982). The 
Commission may determine that it would be appropriate to revise this 
Interpretation if exchanges seek to implement futures-style 
margining.
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V. Conclusion

    The Commission is repealing Regulation 33.4(a)(2), amending the 
option disclosure statement in Regulation 33.7(b) and implementing 
technical amendments to several financial regulations in order to 
permit the futures-style margining of commodity options. The repeal of 
Regulation 33.4(a)(2) is consistent with the Commission's ongoing 
commitment to implement regulatory reforms that reduce unnecessary 
burdens on the futures industry while also preserving important 
customer protections and market safeguards. In this regard, it has been 
seventeen years since the Commission authorized the first option pilot 
program. During that time, option trading volume has grown from less 
than 2 million transactions a year to over 100 million transactions a 
year. During this period of remarkable growth, the Commission, 
exchanges, FCMs and market participants have gained extensive 
experience on the operations of the option markets. In light of this 
experience and upon consideration of all the comments, the Commission 
believes that with adequate disclosure to public customers it is no 
longer necessary for the Commission to require option purchasers to pay 
the full option premium at the initiation of the transaction.

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. Sec. 601 et 
seq., requires that agencies, in promulgating rules, consider the 
impact of those rules on small businesses. The rules discussed herein 
will affect contract markets, clearing organizations, FCMs and IBs. The 
Commission has established certain definitions of ``small entities'' to 
be used by the Commission in evaluating the impact of its rules on such 
small entities in accordance with the RFA. Contract markets and FCMs 
have been determined not to be small entities under the RFA. 47 FR 
18616 (April 30, 1982). Furthermore, the then Chairman of the 
Commission previously has certified on behalf of the Commission that 
comparable rules affecting clearing organizations do not have a 
significant economic impact on a substantial number of small entities. 
51 FR 44866, 44868 (December 12, 1986).
    With respect to IBs, the Commission has stated that it is 
appropriate to evaluate within the context of a particular rule 
proposal whether some or all IBs should be considered to be small 
entities and, if so, to analyze that economic impact on such entities 
at that time. The proposed rule amendments would not require any IB to 
alter its current method of doing business as FCMS have the 
responsibility of administering customer funds. Further, these rule 
amendments, as proposed, should impose no additional burden or 
requirements on IBs and, thus, if adopted would not have a significant 
economic impact on a substantial number of IBs.
    Therefore, the Chairperson, on behalf of the Commission, hereby 
certifies pursuant to 5 U.S.C. Sec. 605(b) that the action taken herein 
would not have a significant economic impact on a substantial number of 
small entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 \13\ imposes certain 
requirements on federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the Paperwork Reduction Act.
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    \13\ Pub. L. 104-13 (May 13, 1995).
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    While Rules 1.3, 1.12, and 1.17 do not effect the burden, the group 
of rules (3038-0024) of which Rules 1.3, 1.12, and 1.17 are a part have 
the following burden.
    Average burden hours per response: 128.
    Number of respondents: 3,148.
    Frequency of responses: on occasion.
    While Rule 33.7 does not effect the burden, the group of rules 
(3038-0007) of which Rule 33.7 is a part has the following burden.
    Average burden hours per response: 50.57.
    Number of respondents: 190,422.
    Frequency of responses: on occasion.
    Copies of the information collection submission to the Office of 
Management and Budget are available from the CFTC Clearance Officer, 
1155 21st Street, N.W., Washington, D.C. 20581, (202) 418-5160.

List of Subjects

17 CFR Part 1

    Commodity Futures, Reporting and recordkeeping requirements.

17 CFR Part 33

    Commodity Futures, Domestic exchange-traded commodity option 
transactions, Consumer protection, Fraud.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, sections 
2(a)(1), 4b, 4c, and 8a thereof, 7 U.S.C. 2a, 6b, 6c, and 12a, the 
Commission hereby amends Chapter I of Title 17 of the Code of Federal 
Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for Part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.

    2. Section 1.3 is amended to revise paragraph (gg)(2)(iv) to read 
as follows:


Sec. 1.3  Definitions

* * * * *
    (gg) * * *
    (2) * * *
    (iv) Representing accruals (including, for purchasers of a 
commodity option for which the full premium has been paid, the market 
value of such commodity option) to an option customer.
* * * * *
    3. Section 1.12 is amended by revising paragraph (b)(2) to read as 
follows:

[[Page 32731]]

Sec. 1.12  Maintenance of minimum financial requirements by futures 
commission merchants and introducing brokers.

* * * * *
    (b) * * *
    (2) 6 percent of the following amount: The customer funds required 
to be segregated pursuant to the Act and the regulations in this part 
and foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by such customers on or subject to 
the rules of a contract market or a foreign board of trade for which 
the full premiums have been paid: Provided, however, That the deduction 
for each such customer shall be limited to the amount of customer funds 
in such customer's account(s) and foreign futures and foreign options 
secured amounts;
* * * * *
    4. Section 1.17 is amended by revising paragraphs (a)(1)(i)(B), 
(e)(1)(ii), (h)(2)(vi)(C)(2), (h)(2)(vii)(A)(2), (h)(2)(vii)(B)(2), 
(h)(2)(viii)(A)(2), (h)(3)(ii)(B) and (h)(3)(v)(B) to read as follows:


Sec. 1.17  Minimum financial requirements for futures commission 
merchants and introducing brokers.

* * * * *
    (a)(1)(i) * * *
    (B) Four percent of the following amount: The customer funds 
required to be segregated pursuant to the Act and the regulations in 
this part and the foreign futures or foreign options secured amount, 
less the market value of commodity options purchased by customers on or 
subject to the rules of a contract market or a foreign board of trade 
for which the full premiums have been paid: Provided, however, That the 
deduction for each customer shall be limited to the amount of customer 
funds in such customer's account(s) and foreign futures and foreign 
options secured amounts;
* * * * *
    (e) * * *
    (1) * * *
    (ii) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (h) * * *
    (2) * * *
    (vi) * * *
    (C) * * *
    (2) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (vii) * * *
    (A) * * *
    (2) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (B) * * *
    (2) For a futures commission merchant or applicant therefor, 10 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (viii) * * *
    (A) * * *
    (2) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (3) * * *
    (ii) * * *
    (B) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (v) * * *
    (B) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *

PART 33--REGULATION OF DOMESTIC EXCHANGE TRADED COMMODITY OPTION 
TRANSACTIONS

    5. The authority citation for Part 33 continues to read as follows:


[[Page 32732]]


    Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 12c, 13a, 13a-
1, 13b, 19, and 21.


Sec. 33.4  [Amended]

    6. Section 33.4 is amended by removing and reserving paragraph 
(a)(2).
    7. The disclosure statement in paragraph (b) of Sec. 33.7 is 
amended by revising the text preceding paragraph (1) and paragraphs 
(2)(v), (4) and (5) to read as follows:


Sec. 33.7  Disclosure.

* * * * *
    (b) * * *

Options Disclosure Statement

    BECAUSE OF THE VOLATILE NATURE OF THE COMMODITIES MARKETS, THE 
PURCHASE AND GRANTING OF COMMODITY OPTIONS INVOLVE A HIGH DEGREE OF 
RISK. COMMODITY OPTION TRANSACTIONS ARE NOT SUITABLE FOR MANY 
MEMBERS OF THE PUBLIC. SUCH TRANSACTIONS SHOULD BE ENTERED INTO ONLY 
BY PERSONS WHO HAVE READ AND UNDERSTOOD THIS DISCLOSURE STATEMENT 
AND WHO UNDERSTAND THE NATURE AND EXTENT OF THEIR RIGHTS AND 
OBLIGATIONS AND OF THE RISKS INVOLVED IN THE OPTION TRANSACTIONS 
COVERED BY THIS DISCLOSURE STATEMENT.
    BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS AN OPTION 
WHICH, IF EXERCISED, RESULTS IN THE ESTABLISHMENT OF A FUTURES 
CONTRACT (AN ``OPTION ON A FUTURES CONTRACT'') OR RESULTS IN THE 
MAKING OR TAKING OF DELIVERY OF THE ACTUAL COMMODITY UNDERLYING THE 
OPTION (AN ``OPTION ON A PHYSICAL COMMODITY''). BOTH THE PURCHASER 
AND THE GRANTOR OF AN OPTION ON A PHYSICAL COMMODITY SHOULD BE AWARE 
THAT, IN CERTAIN CASES, THE DELIVERY OF THE ACTUAL COMMODITY 
UNDERLYING THE OPTION MAY NOT BE REQUIRED AND THAT, IF THE OPTION IS 
EXERCISED, THE OBLIGATIONS OF THE PURCHASER AND GRANTOR WILL BE 
SETTLED IN CASH.
    BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE 
PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS SUBJECT TO A 
``STOCK-STYLE'' OR ``FUTURES-STYLE'' SYSTEM OF MARGINING. UNDER A 
STOCK-STYLE MARGINING SYSTEM, A PURCHASER IS REQUIRED TO PAY THE 
FULL PURCHASE PRICE OF THE OPTION AT THE INITIATION OF THE 
TRANSACTION. THE PURCHASER HAS NO FURTHER OBLIGATION ON THE OPTION 
POSITION. UNDER A FUTURES-STYLE MARGINING SYSTEM, THE PURCHASER 
DEPOSITS INITIAL MARGIN AND MAY BE REQUIRED TO DEPOSIT ADDITIONAL 
MARGIN IF THE MARKET MOVES AGAINST THE OPTION POSITION. THE 
PURCHASER'S TOTAL SETTLEMENT VARIATION MARGIN OBLIGATION OVER THE 
LIFE OF THE OPTION, HOWEVER, WILL NOT EXCEED THE ORIGINAL OPTION 
PREMIUM, ALTHOUGH SOME INDIVIDUAL PAYMENT OBLIGATIONS AND/OR RISK 
MARGIN REQUIREMENTS MAY AT TIMES EXCEED THE ORIGINAL OPTION PREMIUM. 
IF THE PURCHASER OR GRANTOR DOES NOT UNDERSTAND HOW OPTIONS ARE 
MARGINED UNDER A STOCK-STYLE OR FUTURES-STYLE MARGINING SYSTEM, HE 
OR SHE SHOULD REQUEST AN EXPLANATION FROM THE FUTURES COMMISSION 
MERCHANT (``FCM'') OR INTRODUCING BROKER (``IB'').
    A PERSON SHOULD NOT PURCHASE ANY COMMODITY OPTION UNLESS HE OR 
SHE IS ABLE TO SUSTAIN A TOTAL LOSS OF THE PREMIUM AND TRANSACTION 
COSTS OF PURCHASING THE OPTION. A PERSON SHOULD NOT GRANT ANY 
COMMODITY OPTION UNLESS HE OR SHE IS ABLE TO MEET ADDITIONAL CALLS 
FOR MARGIN WHEN THE MARKET MOVES AGAINST HIS OR HER POSITION AND, IN 
SUCH CIRCUMSTANCES, TO SUSTAIN A VERY LARGE FINANCIAL LOSS.
    A PERSON WHO PURCHASES AN OPTION SUBJECT TO STOCK-STYLE 
MARGINING SHOULD BE AWARE THAT, IN ORDER TO REALIZE ANY VALUE FROM 
THE OPTION, IT WILL BE NECESSARY EITHER TO OFFSET THE OPTION 
POSITION OR TO EXERCISE THE OPTION. OPTIONS SUBJECT TO FUTURES-STYLE 
MARGINING ARE MARKED TO MARKET, AND GAINS AND LOSSES ARE PAID AND 
COLLECTED DAILY. IF AN OPTION PURCHASER DOES NOT UNDERSTAND HOW TO 
OFFSET OR EXERCISE AN OPTION, THE PURCHASER SHOULD REQUEST AN 
EXPLANATION FROM THE FCM OR IB. CUSTOMERS SHOULD BE AWARE THAT IN A 
NUMBER OF CIRCUMSTANCES, SOME OF WHICH WILL BE DESCRIBED IN THIS 
DISCLOSURE STATEMENT, IT MAY BE DIFFICULT OR IMPOSSIBLE TO OFFSET AN 
EXISTING OPTION POSITION ON AN EXCHANGE.
    THE GRANTOR OF AN OPTION SHOULD BE AWARE THAT, IN MOST CASES, A 
COMMODITY OPTION MAY BE EXERCISED AT ANY TIME FROM THE TIME IT IS 
GRANTED UNTIL IT EXPIRES. THE PURCHASER OF AN OPTION SHOULD BE AWARE 
THAT SOME OPTION CONTRACTS MAY PROVIDE ONLY A LIMITED PERIOD OF TIME 
FOR EXERCISE OF THE OPTION.
    THE PURCHASER OF A PUT OR CALL SUBJECT TO STOCK-STYLE OR 
FUTURES-STYLE MARGINING IS SUBJECT TO THE RISK OF LOSING THE ENTIRE 
PURCHASE PRICE OF THE OPTION--THAT IS, THE PREMIUM CHARGED FOR THE 
OPTION PLUS ALL TRANSACTION COSTS.
    THE COMMODITY FUTURES TRADING COMMISSION REQUIRES THAT ALL 
CUSTOMERS RECEIVE AND ACKNOWLEDGE RECEIPT OF A COPY OF THIS 
DISCLOSURE STATEMENT BUT DOES NOT INTEND THIS STATEMENT AS A 
RECOMMENDATION OR ENDORSEMENT OF EXCHANGE-TRADED COMMODITY OPTIONS.
* * * * *
    (2) * * *
    (v) An explanation and understanding of the option margining 
system;
* * * * *
    (4) Margin requirements. An individual should know and 
understand whether the option he or she is contemplating trading is 
subject to a stock-style or futures-style system of margining. 
Stock-style margining requires the purchaser to pay the full option 
premium at the time of purchase. The purchaser has no further 
financial obligations, and the risk of loss is limited to the 
purchase price and transaction costs. Futures-style margining 
requires the purchaser to pay initial margin only at the time of 
purchase. The option position is marked to market, and gains and 
losses are collected and paid daily. The purchaser's risk of loss is 
limited to the initial option premium and transaction costs.
    An individual granting options under either a stock-style or 
futures-style system of margining should understand that he or she 
may be required to pay additional margin in the case of adverse 
market movements.
    (5) Profit potential of an option position. An option customer 
should carefully calculate the price which the underlying futures 
contract or underlying physical commodity would have to reach for 
the option position to become profitable. Under a stock-style 
margining system, this price would include the amount by which the 
underlying futures contract or underlying physical commodity would 
have to rise above or fall below the strike price to cover the sum 
of the premium and all other costs incurred in entering into and 
exercising or closing (offsetting) the commodity option position. 
Under a future-style margining system, option positions would be 
marked to market, and gains and losses would be paid and collected 
daily, and an option position would become profitable once the 
variation margin collected exceeded the cost of entering the 
contract position.
    Also, an option customer should be aware of the risk that the 
futures price prevailing at the opening of the next trading day may 
be substantially different from the futures price which prevailed 
when the option was exercised. Similarly, for options on physicals 
that are cash settled, the physicals price prevailing at the time 
the option is exercised may differ substantially from the cash 
settlement price that is determined at a later time. Thus, if a 
customer does not cover the position against the possibility of 
underlying commodity price change, the realized price upon option 
exercise may differ substantially from that which existed at the 
time of exercise.
* * * * *
    Issued in Washington, D.C., on this 10th day of June, 1998, by 
the Commodity Futures Trading Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 98-15977 Filed 6-15-98; 8:45 am]
BILLING CODE 6351-01-P