[Federal Register Volume 64, Number 53 (Friday, March 19, 1999)]
[Notices]
[Pages 13620-13623]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-6788]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41168; File No. SR-NYSE-99-03]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the New York Stock Exchange, Inc. Relating to NYSE Rule 431, 
``Margin Requirements''

March 12, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on January 27, 1999, the New 
York Stock Exchange, Inc. (``NYSE'' or ``Exchange'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the NYSE. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The NYSE proposes to amend NYSE Rule 431, ``Margin Requirements,'' 
to: (1) expand the types of short options positions that will be 
considered ``covered'' and eligible for the cash account to include 
short positions that are components of certain limited risk spread 
strategies (box spreads, butterfly spreads, and debt and credit 
spreads); (2) allow an escrow agreement that conforms with NYSE 
standards to be utilized in lieu of the cash or cash equivalents 
required to carry short butterfly, box, and debit and credit spreads in 
the cash account; (3) reduce the required margin for butterfly and box 
spreads by recognizing butterfly and box spreads as strategies (rather 
than separate transactions) for purposes of margin treatment; (4) 
recognize various strategies involving stocks (or other underlying 
instruments) paired with long options, and reduce the required margin 
on such hedged stock positions; (5) permit the extension of credit on 
listed and over-the-counter (``OTC'') options with over nine months 
until expiration; and (6) permit the extension of credit on certain 
long box spreads.
    Copies of the proposed rule change are available at the NYSE and at 
the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NYSE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NYSE has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

(1) Purpose
    The Exchange is proposing amendments to NYSE Rule 431 relating to 
margin treatment of options.
(2) Background
    In April 1996, the Exchange established an NYSE Rule 431 Committee 
(the ``Committee'') to review the Exchange's margin requirements. The 
Committee consists of individuals representing different types of 
member organizations with divergent areas of expertise. The Committee 
has been reviewing all aspects of NYSE Rule 431 and making 
recommendations to the Exchange in view of the recent changes in 
federal margin regulations and changing industry conditions. The 
Committee created various subcommittees, including an Options 
Subcommittee (``Options Subcommittee''), to review specific areas of 
NYSE Rule 431, utilizing additional industry representatives that are 
knowledgeable in each area. The Options Subcommittee has reviewed and 
recommended changes to NYSE Rule 431 relating to margin treatment of 
options.
    Some of the changes recommended by the Options Subcommittee reflect 
changes to Regulation T \2\ of the Board of Governors of the Federal 
Reserve System (``FRB''). Regulation T governs the extension of credit 
by and to broker-dealers. Recent amendments to Regulation T that became 
effective on June 1, 1997, modified or deleted certain margin 
requirements regarding options transactions in favor of rules to be 
adopted by the options self-

[[Page 13621]]

regulatory organizations (``SROs''), subject to approval by the 
Commission.\3\
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    \2\ 12 CFR 220 et seq. The Board of Governors of the Federal 
Reserve System issued Regulation T pursuant to the Act.
    \3\ See FRB Docket No. R-0772 (April 26, 1996), 61 FR 20386 (May 
6, 1996).
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(3) Proposed Amendments to NYSE Rule 431
    As described more fully below, the proposal amends NYSE Rule 431 
to: (1) expand the types of positions that would be considered 
``covered'' in a cash account, specifically, certain short positions 
that are components of limited risk spread strategies; (2) permit 
butterfly and box spreads to be recognized as strategies for purposes 
of margin treatment; (3) recognize various strategies involving stocks 
(or other underlying instruments) paired with long options and provide 
for lower maintenance margin requirements on such hedged stock 
positions; and (4) permit the extension of credit on certain long-term 
options and certain long box spreads.
    (a) Cash Account Transactions. The NYSE notes that, pursuant to the 
recent amendments to Regulation T, certain limited risk spread 
strategies are eligible for the cash account. Accordingly, the NYSE 
proposes to amend NYSE Rule 431 to expand the types of limited risk 
options strategies that may be transacted in cash accounts, provided 
the risk is paid for in full. As described more fully below, NYSE Rule 
431, as amended, will permit the following limited risk spread 
strategies in the cash account: (1) long and short box spreads; (2) 
long and short butterfly spreads; and (3) debit and credit spreads.
    Under the proposal, only butterfly and box spreads comprised of 
cash-settled, European-style options will be eligible for the cash 
account. In addition, the butterfly and box spreads must meet the 
specifications contained in the definition section of the proposal 
(proposed NYSE Rule 431(f)(2)(C)).\4\ For long butterfly spreads and 
long box spreads, the proposal will require full cash payment of any 
debt incurred when the long butterfly spread or long box spread 
strategy is established. According to the NYSE, full payment of the 
debt incurred to establish a long butterfly spread or a long box spread 
will cover any potential risk to the carrying broker-dealer.
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    \4\ Proposed NYSE Rule 431(f)(2)(C) defines a butterfly spread 
as an aggregation of positions in three series of either puts or 
calls all having the same underlying component or index, and time of 
expiration, and based on the same aggregate current underlying 
value, where the interval between the exercise price of each series 
is equal, which positions are structured as either: (A) a ``long 
butterfly spread'' in which two short options in the same series are 
offset by one long option with a higher exercise price and one long 
option with a lower exercise price, or (B) a ``short butterfly 
spread'' in which two long options in the same series offset one 
short option with a higher exercise price and one short option with 
a lower exercise price.
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    The NYSE notes that short butterfly spreads generate a credit 
balance when established. However, if all of the options were 
exercised, a debit (loss) greater than the initial credit balance would 
accrue to the account. According to the NYSE, this debit or loss is 
quantifiable. Specifically, the NYSE states that the total risk 
potential in a short butterfly spread comprised of call options is the 
aggregate difference between the two lowest exercise prices. For a 
short butterfly spread comprised of put options, the total risk 
potential is the aggregate difference between the two highest exercise 
prices. Accordingly, to cover the risk to the carrying broker-dealer, 
the NYSE proposes to require a deposit in cash or cash equivalents 
equal to (1) the amount of the aggregate difference between the two 
lowest exercise prices for a short butterfly spread comprised of call 
options; and (2) the amount of the aggregate difference between the two 
highest exercise prices for a short butterfly spread comprised of put 
options. The net proceeds from the sale of the short option components 
may be applied to the required deposit. According to the NYSE, when the 
initial credit balance plus an amount equal to the difference between 
the initial credit and the total risk is held in the account in the 
form of cash or cash equivalents, the risk to the broker-dealer is 
covered.
    The NYSE states that short box spreads \5\ also generate a credit 
balance when they are established, but, unlike the butterfly spread, 
the credit is sufficient to cover the total debit (loss) that, in the 
case of the box spread, will accrue to the account if held to 
expiration. The credit must be retained in the account; therefore, the 
proposal would require that cash or cash equivalents covering the 
maximum risk, which is equal to the aggregate difference in the two 
exercise prices involved, be held or deposited.
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    \5\ Proposed NYSE Rule 431(f)(2)(C) defines a ``box spread'' as 
an aggregation of positions in a long call and short put with the 
same exercise price (``buy side'') coupled with a long put and short 
call with the same exercise price (``sell side''), all of which have 
the same underlying component or index and time of expiration, and 
are based on the same aggregate current underlying value, and are 
structured as: (A) a ``long box spread,'' in which the sell side 
exercise price exceeds the buy side exercise price or, (B) a ``short 
box spread,'' in which the buy side exercise price exceeds the sell 
side exercise price.
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    The proposal also will replace the current provisions of NYSE Rule 
431(f)(2)(M) that permit debit put spreads in a cash account with a 
provision allowing short European-style cash-settled stock index 
options or warrants in the cash account when the account holds a long 
position in an option or warrant with the same underlying index or 
component that is based on the same aggregate current underlying value, 
and provided that the long and short position expire concurrently,the 
long position is paid in full, and the account holds cash or cash 
equivalents of not less than the amount by which the aggregate exercise 
price of the long call or call warrant (or the short put or put 
warrant) exceeds the aggregate exercise price of the short call or call 
warrant (or the long put or put warrant). The next proceeds from the 
sale of the short position may be applied to this requirement.
    Under the proposal, an escrow agreement that conforms with Exchange 
standards may be utilized in lieu of the cash or cash equivalents 
required to carry butterfly, box, and debit and credit spreads in the 
cash account.
    (b) Margin Accounts. (i) Butterfly and Box Spreads. The Exchange's 
current rules do not provide consideration for the components of 
butterfly and box spreads in prescribing margin requirements.\6\ The 
proposal will permit combination spread transactions in margin accounts 
where the risk associated with the transactions is identifiable. The 
NYSE states that under its current rules, a butterfly spread--a pairing 
of two standard spreads, one bullish and one bearish--requires the 
separate margining of each transaction. According to the NYSE, the 
current margin requirement does not recognize that the spreads offset 
each other with respect to risk. Under the proposal, the NYSE believes 
that investors will receive the benefit of lower margin requirements on 
bullish and bearish spreads because the individual spreads will be 
treated as a combined position with lower risk. The proposed initial 
and maintenance margin requirements for butterfly spreads are the same 
as the cash account requirements for butterfly spreads described 
above.\7\
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    \6\ The proposed margin requirements for box spreads and 
butterfly spreads apply to options positions issued by a registered 
clearing agency or guaranteed by the carrying broker-dealer.
    \7\ Specifically, for a long butterfly spread, proposed NYSE 
Rule 431(f)(2)(G)(v) will require payment in full of the net debit. 
For a short butterfly spread, the proposal will require the deposit 
and maintenance of margin equal to at least the aggregate difference 
between the two lowest exercise prices for a short butterfly spread 
comprised of calls, or the aggregate difference between the two 
highest exercise prices for a short butterfly spread comprised of 
puts. The net proceeds from the sale of the short option components 
may be applied to the margin requirement.

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[[Page 13622]]

    For a long box spread, the proposal requires margin equal to full 
payment of the net debit. For a short box spread, the proposed minimum 
initial and maintenance margin requirement is the aggregate difference 
between the exercise prices. The net proceeds from the sale of short 
option components may be applied to the margin requirement.
    (ii) Hedged Strategies. Currently, the maintenance margin 
requirement for all securities ``long'' in a customer's account is 25% 
of the current market value of the securities.\8\ For stocks trading at 
$5.00 per share or more, the current maintenance margin requirement for 
each stock ``short'' in a customer's account is 30% of the current 
market value of the stock.\9\ The NYSE proposes to reduce the 
maintenance margin requirement for the components underlying options 
and stock index warrants when the components are held in conjunction 
with certain positions in the overlying option or warrant. 
Specifically, the proposal will reduce the maintenance margin 
requirement for component securities held in conjunction with the 
following hedged strategies: (1) Hedged puts (long stock/long put); (2) 
hedged calls (long call/short stock); (3) conversions; (4) reverse 
conversions; and (5) collars. The proposed maintenance margin 
requirements for these five hedged strategies are as follows:
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    \8\ See NYSE Rule 431(c)(2).
    \9\ See NYSE Rule 431(c)(3).
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(1) Long Stock/Long Put (Hedged Put)
    Proposed margin requirement: 10% of the exercise price plus 100% of 
any amount by which the put is out-of-the-money, but no more than 25% 
of the long stock market value.
(2) Long Call/Short Stock (Hedged Call)
    Proposed margin requirement: 10% of the call exercise price, plus 
100% of any amount by which the call is out-of-the-money, but no more 
than 30% of the current market value of the short stock.
(3) Conversion (Long Stock/Long Put/Short Call)
    Proposed margin requirement: 10% of the exercise price.
    A conversion is a long stock position held in conjunction with a 
long put and a short call. The put and call must have the same 
expiration and exercise price. According to the NYSE, the long put/
short call is essentially a synthetic short stock position which 
offsets the long stock, and the exercise price of the options acts as a 
predetermined sale price. The short call is covered by the long stock 
and the long put is a right to sell the stock at a predetermined 
price--the put exercise price. The NYSE states that, regardless of any 
decline in market value, the stock is, in effect, worth no less than 
the exercise price of the put.
(4) Reverse Conversion (Short Stock/Short Put/Long Call)
    Proposed margin requirement: 10% of the exercise price plus any in 
the-money-amount for the put option.
    The put and the call must have the same expiration and exercise 
price. According to the NYSE, the long call/short put is essentially a 
synthetic long stock position which offsets the short stock position. 
The exercise price of the options acts as a predetermined purchase 
(buy-in) price. The short put is covered by the short stock and the 
long call is a right to buy the stock (in this case closing the short 
position) at a predetermined price--the call exercise price. The NYSE 
states that, regardless of any rise in market value, the stock can be 
acquired for the call exercise price; in effect, the short position is 
valued at no more than the call exercise price.
(5) Collar (Long Stock/Long Put/Short Call)
    Proposed margin requirement: The lesser of (1) 10% of the put 
exercise price plus 100% of any amount by which the put is out-of-the-
money, or (2) 25% of the call exercise price.
    A collar is a long stock position held in conjunction with a long 
put and short call. The put and the call must have the same expiration 
date. According to the NYSE, the difference between a collar and a 
conversion is that the exercise price of the put is lower than the 
exercise price of the call in the collar strategy. Therefore, the 
options do not constitute a pure synthetic short stock position.
    (c) Loan Value for Long Term Options. According to NYSE, recent 
amendments to Regulation T permit loan value on options. However, the 
NYSE notes that the FRB deferred to the SROs to determine whether such 
loan value is appropriate as well as to identify specific options, 
prescribe criteria and actual requirements.
    The Committee and the Options Subcommittee recommended that loan 
value be allowed only on long term options and warrants with time 
remaining to expiration exceeding nine months. Where the time remaining 
to expiration is nine months or less, there would be no loan value. The 
proposal applies different criteria to credit extensions for long term 
listed and OTC options and warrants.\10\
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    \10\ Listed options are issued by the Options Clearing 
Corporation (``OCC''). OTC options are not issued by OCC. OTC 
options and warrants are not listed or traded on a registered 
national securities exchange or through the automated quotation 
system of a registered securities association.
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    Specifically, for long listed equity options, stock index options, 
and stock index warrants with time remaining to expiration exceeding 
nine months, the proposed margin requirement will be 75% of the current 
market value of the option or warrant. Because the proposal requires 
initial and maintenance margin of not less than 75% of the current 
market value of a listed option or warrant, a broker-dealer would be 
able to lend up to 25% of the current market value of a listed option 
or warrant.
    For long OTC equity options, index options, and stock index 
warrants with time remaining to expiration exceeding nine months, the 
proposed initial and maintenance margin requirement will be 75% of the 
in-the-money amount (or intrinsic value) plus 100% of the amount, if 
any, by which the current market value exceeds the in-the-money amount. 
In addition to having more than nine months to expiration, the OTC 
option or stock index warrant must be (1) in-the-money; (2) guaranteed 
by the carrying broker-dealer; and (3) American-style (i.e., the option 
or stock index warrant may be exercised at any time up to the day 
before expiration).
    (d) Extensions of Credit for Long Box Spreads Comprised of 
European-Style Options. The proposal also provides for the extension of 
credit on a long box spread comprised entirely of European-style 
options that are issued by a registered clearing agency or guaranteed 
by the carrying broker-dealer. For a long box spread comprised of 
options that satisfy these requirements, the proposed initial and 
maintenance margin requirement is 50% of the aggregate difference in 
the two exercise prices (buy and sell). According to the NYSE, this 
will produce a requirement slightly higher than 50% of the debit 
typically incurred. The proceeds from the sale of the short option 
components may be applied to this requirement. For margin equity 
purposes, the long box spread may be valued at an amount not to exceed 
100% for the aggregate difference in the exercise prices.
(4) Statutory Basis
    The NYSE believes that the proposed rule change is consistent with 
the requirements of Section 6(b)(5) of the Act, which provides that the 
rules of the Exchange must be designed to promote just and equitable 
principles of trade

[[Page 13623]]

and to protect the investing public. The NYSE believes that the 
proposed rule change also is consistent with the rules and regulations 
of the FRB because it is designed to prevent the excessive use of 
credit for the purchase or carrying of securities, pursuant to Section 
7(a) of the Act.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change will not impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others

    No written comments were solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will by 
order approve such proposed rule change, or institute proceedings to 
determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
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 such filing will also be 
available for inspection and copying at the principal office of the 
NYSE. All submissions should refer to file number SR-NYSE-99-03 and 
should be submitted by April 9, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-6788 Filed 3-18-99; 8:45 am]
BILLING CODE 8010-01-M