[Federal Register Volume 64, Number 22 (Wednesday, February 3, 1999)]
[Notices]
[Pages 5333-5334]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-2482]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40976; File No. SR-OCC-98-11]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving a Proposed Rule Change Regarding the Calculation of the 
Short Option Adjustment

January 27, 1999.
    On September 10, 1998, the Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') a 
proposed rule change (File No. SR-OCC-98-11) pursuant to Section 
19(b)(1) of the Securities and Exchange Act of 1934 (``Act'').\1\ 
Notice of the proposal was published in the Federal Register on 
December 23, 1998.\2\ No comment letters were received. For the reasons 
discussed below, the Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 40800 (December 16, 
1998), 63 FR 71179.
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I. Description

    The rule change amends Rules 601 and 602 to enable OCC to use a 
``sliding scale'' to calculate the short option adjustment contained in 
OCC's Theoretical Intermarket Margin System (``TIMS'').\3\ The short 
option adjustment is a component of the additional margin calculation 
in TIMS that imposes a minimum margin amount on deep out of the money 
short options.
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    \3\ OCC Rule 601 describes TIMS as it applies to equity options 
(``equity TIMS'') and OCC Rule 602 describes TIMS as it applies to 
non-equity options (``non-equity TIMS'').
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A. Additional Margin Calculation

    OCC requires its clearing members to adjust their margin deposits 
with OCC in the morning of every business day based on OCC's overnight 
calculations. OCC imposes a margin requirement on short positions in 
each clearing member account and gives margin credit for unsegregated 
long positions.\4\ Under TIMS, margin for positions in a class group is 
based on premium levels at the close of trading on the preceding day 
and is increased or decreased by the additional margin amount for that 
class group.\5\
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    \4\ A long position is unsegregated for OCC's purposes if OCC 
has a lien on the position (i.e., has recourse to the value of the 
position in the event that the clearing member does not perform an 
obligation to OCC). Long positions in firm accounts and market-maker 
accounts are unsegregated. Long positions in the clearing member's 
customers' account are unsegregated only if the clearing member 
submits instructions to that effect in accordance with Rule 611.
    \5\ For purposes of equity TIMS, a class group consists of all 
put and call options, all BOUNDS, and all stock loan and borrow 
positions relating to the same underlying security. For purposes of 
non-equity TIMS, a class group consists of all put and call options, 
certain market baskets, and commodity options and futures (that are 
subject to margin at OCC because of a cross-margining program with a 
commodity clearing organization) that relate to the same underlying 
asset. A non-equity TIMS class group may also contain stock loan 
baskets and stock borrow baskets.
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    TIMS calculates additional margin amounts using options price 
theory. TIMS first calculates the theoretical liquidating value for the 
positions in each class group by assuming either an increase or 
decrease in the market value of the underlying asset in an amount equal 
to the applicable margin interval. The margin interval is the maximum 
one day price movement that OCC wants to protect against in the price 
of the underlying asset.\6\ Margin intervals are determined separately 
for each underlying interest to reflect the volatility in the price of 
the underlying interest.
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    \6\ Some combinations of positions can present a greater net 
theoretical liquidating value at an intermediate value that at 
either of the endpoint values. As a result, TIMS also calculates the 
theoretical liquidating value for the positions in each class group 
assuming intermediate market values of the underlying asset.
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    TIMS then selects the theoretical liquidating value that represents 
the greatest decrease (where the actual

[[Page 5334]]

liquidating value is positive) or increase (where the actual 
liquidating value is negative) in liquidating value compared with the 
actual liquidating value based on the premium levels at the close of 
trading on the preceding day. The difference between that theoretical 
liquidating value and the actual liquidating value is the additional 
margin amount for that class group unless the class group is subject to 
the short option adjustment.

B. Short Option Adjustment

    For net short positions \7\ in deep out of the money options, 
little or no change in value would be predicted given a change in value 
of the underlying interest equal to the applicable margin interval. As 
a result, TIMS normally would calculate additional margin amounts of 
zero or close to zero for deep out of the money short options. However, 
volatile markets could cause such positions to become near to or in the 
money and thereby could create increased risk to OCC. OCC protects 
against this risk with an adjustment to the additional margin 
calculation known as the short option adjustment.\8\
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    \7\  A net position in an option series in an account is the 
position resulting from offsetting the gross unsegregated long 
position in that series against the gross short position in that 
series. After netting, an account will reflect a net short position 
or a net long position for each series of options held in the 
account.
    \8\ The short option adjustment is described in Rule 
601(c)(1)(C)(1) for equity options and Rule 602(c)(1)(ii)(C)(1) for 
non-equity options. OCC recently amended Interpretation .06 to Rule 
602 so that net short non-equity option positions can be paired off 
against net long non-equity positions whose underlying interests 
exhibit price correlation of at least seventy percent. Securities 
Exchange Act Release No. 40515 (September 30, 1998), 63 FR 53970.
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    Currently, the short option adjustment requires a minimum 
additional margin amount equal to twenty-five percent of the applicable 
margin interval for all unpaired \9\ net short positions in options 
series for which the ordinary calculation of the additional margin 
requirement would be less than twenty-five percent of the applicable 
margin interval. As a result, clearing members are required to deposit 
margin in excess of the risk presented by some unpaired net short 
positions in out of the money options.
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    \9\ The term unpaired is defined in Interpretation .04 to Rule 
601 for equity options and Interpretation .06 to Rule 602 for non-
equity options.
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    To address these situations, the rule change establishes a sliding 
scale short option adjustment methodology. Using the sliding scale, the 
short option adjustment percentage will be applied to a particular 
series according to the extent to which the series is out of the money. 
In addition, OCC will use different sliding scales for put options and 
for call options.
    The proposed rule change modifies Rules 601 and 602 to provide that 
the short option adjustment to be applied to any unpaired short 
position will be determined using a percentage that OCC deems to be 
appropriate.\10\
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    \10\ A schedule of the sliding scales that OCC intends to use is 
attached as Exhibit A to its filing, which is available for 
inspection at the Commission's Public Reference Room and through 
OCC. OCC will always specify a minimum short option adjustment 
percentage. OCC will inform its members of the initial schedule of 
the sliding scales through an Important Notice and will notify its 
members of any changes to the schedule.
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II. Discussion

    Section 17A(b)(3)(F) of the Act \11\ requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds which are in its custody or control or for which it is 
responsible. The Commission believes that the rule change is consistent 
with OCC's obligations under Section 17A(b)(3)(F) because it should 
reduce overcollateralization of OCC's clearing members' positions 
without impairing OCC's overall protection against member default.
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular with Section 17A of the Act \12\ and the rules and 
regulations thereunder.
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    \12\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-98-11) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-2482 Filed 2-2-99; 8:45 am]
BILLING CODE 8010-01-M