[Federal Register Volume 64, Number 173 (Wednesday, September 8, 1999)]
[Notices]
[Pages 48882-48885]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-23239]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41808; File No. SR-Amex-99-27]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the American Stock Exchange LLC To Revise the Exchange's 
Margin Requirements

August 30, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 23, 1999, the American Stock Exchange LLC (``Exchange'' or 
``Amex'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. 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).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes to revise Exchange Rule 462, ``Minimum 
Margins.'' Principally, the revisions would permit the extension of 
credit on certain long term options and warrants (i.e., more than 9 
months from expiration); revise the margin requirements for butterfly 
spreads and box spreads; and modify the maintenance margin requirements 
for hedging strategies that pair stock positions with options (e.g., 
conversions, collar).
    The text of the proposed rule change is available at the Office of 
the Secretary, the Exchange, and 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 Exchange 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 Exchange has prepared summaries, set forth in 
section 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 proposes to revise Exchange Rule 462, ``Minimum 
Margins,'' to: (i) permit the extension of credit on certain long term 
options and warrants, and certain long box spreads comprised entirely 
of European-style options; (ii) recognize butterfly and box spread 
strategies for purposes of margin treatment and establish appropriate 
margin requirements; (iii) recognize various strategies involving stock 
(or other underlying instruments) paired with a long option, and 
provide for lower maintenance margin requirements on such hedged stock 
positions; (iv) expand the types of short positions that would be 
considered ``covered'' in a cash account; specifically, certain short 
positions that are components of limited risk spread strategies (e.g., 
butterfly and box spreads); (v) allow a bank issued escrow agreement to 
serve as cover for certain spread positions held in a cash account; and 
(vi) update and improve, as necessary, current margin rules.
    Previously, the margin requirements governing options were set 
forth in Regulation T, ``Credit by Brokers and Dealers.'' \3\ However, 
amendments to Regulation T that became effective June 1, 1997, modified 
or deleted certain margin requirements regarding options transactions 
in favor of rules to be adopted by the options self-regulatory 
organizations (``OSROs''), subject to approval by the Commission.\4\ In 
a rule filing approved by the Commission in 1997, the Exchange adopted 
various margin requirements pertaining to options that were to be 
deleted from Regulation T.\5\ That previous margin filing also 
contained several necessary changes that clarified certain provisions 
and established better consistency with the margin rules of the New 
York Stock Exchange.
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    \3\ 12 CFR 220 et seq. The Board of Governors of the Federal 
Reserve System adopted Regulation T pursuant to Section 7(a) of the 
Act.
    \4\ See Board of Governors of the Federal Reserve System Docket 
No. R-0772 (Apr. 26, 1996), 61 FR 20386 (May 6, 1996).
    \5\ See Securities Exchange Act Release No. 38710 (June 2, 
1997), 62 FR 31638 (June 10, 1997).
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    In accordance with Regulation T, the OSROs have the ability, 
subject to SEC approval, to adopt rules governing the margin treatment 
of options.\6\ The Exchange therefore proposes to revise its margin 
rules to implement enhancements long desired by Exchange members and 
member firms, public investors, and Exchange staff. The Exchange 
believes that certain multiple options position strategies and other 
strategies that combine stock with option positions warrant recognition 
for purposes of establishing more equitable margin requirements. 
Currently, the components of such strategies must be margined 
separately. The Exchange believes the risk limitation that results in 
the component positions are viewed collectively is not reflected in 
current margin requirements. The Exchange further believes that market 
participants should have the ability to utilize these strategies for 
the least amount of margin necessary. The other significant change 
sought by the Exchange would permit the extension of credit on certain 
long term options and warrants.
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    \6\ The Chicago Board Options Exchange (``CBOE''), New York 
Stock Exchange (``NYSE''), and Pacific Exchange (``PCX'') have filed 
similar margin proposals with the Commission. The CBOE proposal was 
approved on July 27, 1999. See Securities Exchange Act Release No. 
41658 (July 27, 1999), 64 FR 47736 (Aug. 5, 1999). The NYSE and PCX 
margin proposals are still pending with the Commission. See File 
Nos. SR-NYSE-99-03 and SR-PCX-98-59.
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    In developing this proposal, the Exchange reviewed all of its 
margin rules with a view toward updating or improving margin provisions 
as necessary. The Exchange also found it necessary to propose minor 
changes to certain rules because they are closely related to, and will 
be impacted by, the more substantive proposals.
    a. Definitions Section. Presently, the Exchange's definition of 
``current market value'' is equivalent to the definition found in 
Regulation T. Instead of repeating the Regulation T definition, the 
proposal would revise

[[Page 48883]]

the definition found in the Exchange's rules to note that the meaning 
of the term ``current market value'' is as defined in Regulation T. 
Because the Exchange and other OSROs intend to seek a change in the 
Regulation T definition, a linkage to the Regulation T definition will 
keep the Exchange's definition equivalent without requiring a future 
rule filing.
    The Exchange also seeks to adopt definitions for the ``butterfly 
spread'' and ``box spread'' options strategies. The definitions are an 
important part of the Exchange's proposal to recognize and specify cash 
and margin account requirements for butterfly and box spreads. These 
proposals are outlined below in Sections II(A)(1) (c) and (d). The 
Exchange believes that the definitions are necessary to establish in 
specific terms what multiple options positions, if held together, 
qualify for classification as butterfly or box spreads, and 
consequently are eligible for proposed cash and margin treatment.
    Finally, the Exchange seeks to define the term ``listed.'' Because 
the term ``listed'' is frequently used in the Exchange's margin rules, 
the Exchange believes it would be more efficient to define the term 
once rather than specifying the meaning of the term each time it is 
used.
    b. Extension of Credit on Long Term Options, Stock Index Warrants, 
Foreign Currency Warrants, and Currency Index Warrants. The Exchange 
proposes to permit the extension of credit on certain listed, long term 
options and warrant products (including currency and index warrants, 
but excluding traditional stock warrants issued by a corporation on its 
own stock).\7\ Only those long term options or warrants that are more 
than 9 months from expiration will be eligible for credit extension. 
The proposal requires initial and maintenance margin of not less than 
75% of the current market value of a listed, long term option or 
warrant. Therefore, a broker-dealer would be able to loan up to 25% of 
the current market value of a listed, long term option or warrant.
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    \7\ Throughout the entirety of this notice, the term 
``warrant(s)'' means this type of warrant.
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    The proposal also will permit the extension of credit on long term 
options and warrants not listed or traded on a registered national 
securities exchange or a registered securities association (``OTC 
options''). However, in addition to being more than 9 months from 
expiration, an OTC option or warrant must be in-the-money and 
guaranteed by the carrying broker-dealer. The proposal requires initial 
and maintenance margin of not less than 75% of the OTC's option's 
(warrant's) in-the-money amount (i.e., intrinsic value), plus 100% of 
the amount, if any, by which the current market value of the OTC option 
or warrant exceeds the in-the-money amount.
    When the time remaining until expiration for an option or warrant 
(listed and OTC) on which credit has been extended reached 9 months, 
the maintenance margin requirement will become 100% of the current 
market value.
    c. Extension of Credit on Long Box Spread Comprised Entirely of 
European-style Options. The Exchange also proposes to allow the 
extension of credit on a long box spread comprised entirely of 
European-style options. A long box is a strategy comprised of four 
option positions that essentially lock-in the ability to buy and sell 
the underlying component or index for a profit, even after netting the 
cost of establishing the long box. The two exercise prices embedded in 
the strategy determine the buy and the sell price. The Exchange 
believes that because the cost of establishing the long box spread is 
covered by the profit realizable at expiration, there is no risk in 
carrying the debit incurred to establish the long box spread. Although 
the Exchange believes that 100% of the debit could be loaned, the 
Exchange proposes a margin requirement that approximates 50% of the 
debit. The Exchange's proposal will require 50% of the aggregate 
difference in the two exercise prices (buy and sell), which results in 
a margin requirement slightly higher than 50% of the debit typically 
incurred. This is both an initial and maintenance margin requirement. 
The proposal will afford a long box spread position a market value for 
margin equity purposes of not more than 100% of the aggregate exercise 
price differential.
    d. Cash Account Treatment of Butterfly and Box Spreads. The 
proposal will make butterfly and box spreads in cash-settled, European-
style options eligible for the cash account. To qualify for carrying in 
the cash account, the butterfly and box spreads must meet the 
specifications contained in the proposed definition section. The 
proposal will require full cash payment of the debit that is incurred 
when a long butterfly or long box spread strategy is established. The 
Exchange believes that if the debit is fully paid, there is no market 
risk to the carrying broker-dealer.
    Short butterfly spreads generate a credit balance when established. 
However, in the worst case scenario, where all options are exercised, a 
debit (loss) greater than the initial credit balance received would 
accrue to the account. This debit or loss, however, is limited. To pose 
no market risk to the carrying broker-dealer, the proposal will require 
that the initial credit balance, plus an amount equal to the difference 
between the initial credit and the total risk, must be held in the 
account in the form of cash or cash equivalents. The total risk 
potential in a short butterfly spread comprised of call options is the 
aggregate difference between the two lowest exercise prices. With 
respect to short butterfly spreads comprised of put options, the total 
risk potential is the aggregate difference between the two highest 
exercise prices. Therefore, to carry short butterfly spreads in the 
cash account, the proposal will require that cash or cash equivalents 
equal to the maximum risk must be held or deposited.
    Short box spreads also generate a credit balance when established. 
The net credit received from selling a box spread will cover nearly 
all, but not 100%, of the debit (loss) that would accrue to the account 
if held to expiration. The Exchange believes that the credit should be 
retained in the account. Therefore, the proposal will require that cash 
or cash equivalents covering the maximum risk, which is equal to the 
aggregate difference in the two exercise prices involved, must be held 
or deposited.
    In addition, the proposal will allow an escrow agreement to be used 
in lieu of the cash or cash equivalents required to carry short 
butterfly and box spreads in the cash account.
    e. Margin Account Treatment of Butterfly and Box Spreads. 
Currently, the Exchange's margin rules do not recognize butterfly and 
box spreads for margin purposes. Therefore, margin requirements 
tailored to the risks of these respective strategies, which the 
Exchange believes have limited risk, are not currently provided. A 
butterfly spread is a paring of two standard spreads, one bullish and 
one bearish. The two spreads (bullish and bearish) must be margined 
separately under the Exchange's current margin rules. The Exchange 
believes that this practice requires more margin than necessary because 
the two spreads serve to offset each other with respect to risk. The 
Exchange believes that the two individual spreads should be viewed in 
combination to form a butterfly spread, and that commensurate with the 
lower combined risk, investors should receive the benefit of lower 
margin requirements.
    The Exchange's proposal would recognize as a distinct strategy 
butterfly spreads held in margin accounts, and

[[Page 48884]]

specify requirements that are the same as the cash account requirements 
for butterfly spreads.\8\ Specifically, in the case of a long butterfly 
spread, the net debit must be paid in full. For short butterfly spreads 
comprised of call options, the initial and maintenance margin must 
equal at least the aggregate difference between the two lowest exercise 
prices. For short butterfly spreads comprised of put options, the 
initial and maintenance margin must equal at least the aggregate 
difference between the two highest exercise prices. The net credit 
received from the sale of the short option components may be applied 
towards the margin requirement for short butterfly spreads.
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    \8\ The margin requirements would apply to butterfly spreads 
where all option positions are listed or guaranteed by the carrying 
broker-dealer.
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    The proposed requirements for box spreads held in a margin account, 
where all option positions making up the box spread are listed or 
guaranteed by the carrying broker-dealer, also are the same as those 
applied to the cash account. With respect to long box spreads, where 
the component options are not European-style, the proposal would 
require full payment of the net debit that is incurred when the spread 
strategy is established. For short box spreads held in the margin 
account, 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 deposited and maintained. The 
net credit received from the sale of the short option components may be 
applied towards the requirement.
    Generally, long and short box spreads will not be recognized for 
margin equity purposes; however, the proposal will allow loan value for 
one type of long box spread where all component options have a 
European-style exercise provision and are listed or guaranteed by the 
carrying broker-dealer. As noted above in Section II(A)(1)(c), the 
margin required for a long box spread comprised entirely of European-
style options is 50% of the aggregate difference in the two exercise 
prices framing the strategy. This is both an initial and maintenance 
margin requirement. For margin equity purposes, a long box spread made 
up of European-style options could not be valued at more than 100% of 
the aggregate exercise price differential.
    f. Margin Account Treatment of Stock Positions Held with Options 
Positions. In addition to butterfly and box spreads, the Exchange 
proposes to recognize five options strategies that are designed to 
limit the risk of a position in the underlying component. The five 
strategies are: (i) Long Put/Long Stock; (ii) Long Call/Short Stock; 
(iii) Conversion; (iv) Reverse Conversion; and (v) Collar. Proposed 
Exchange Rule 462(d)(10)(B)(iv), ``Exceptions,'' will identify and set 
forth the margin requirements for these hedging strategies.
    the five strategies are summarized below in terms of a stock 
position held in conjunction with an overlying option (or options). 
However, the proposal is structured to also apply to components that 
underlie index options and warrants.
    The Exchange's proposal only addresses maintenance margin relief 
for the stock component (or other underlying instrument) of the five 
proposed strategies. The Exchange believes that a reduction in the 
initial margin requirement for the stock component of these strategies 
is not currently possible because the 50% initial margin requirement in 
Regulation T continues to apply, and the Exchange has no independent 
authority to lower the initial margin requirement for stock. However, 
the Exchange notes that the Federal Reserve Board is considering 
recognizing the reduced risk afforded stock by these options strategies 
for the purpose of lowering initial stock margin requirements, and is 
also considering other changes that would facilitate risk-based 
margins.
    The ``Long Put/Long Stock'' and the ``Long Call/Short Stock'' 
hedging strategies are very similar to the ``Collar'' and ``Reverse 
Conversion'' strategies, respectively, and are addressed below in 
reference to the Collar and Reverse Conversion descriptions.
    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. The long put/short call is essentially a 
synthetic short stock position that offsets the long stock, and the 
exercise price of the options acts like 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. 
Regardless of any decline in market value, the stock is, in effect, 
worth no less than the put exercise price.
    A ``Reverse Conversion'' is a short stock, short put, and long call 
trio. Again, the put and call must have the same expiration and 
exercise price. The long call/short put is essentially a synthetic long 
stock position that offsets the short stock, and the exercise price of 
the options acts like 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. 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. The Long Call/Short Stock hedge described above is a Reverse 
Conversion without the short put, or simply short stock offset by a 
long call.
    A ``Collar'' is a long stock position held in conjunction with a 
long put and a short call. A Collar differs from a Conversion in 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. The Long Put/Long Stock hedge 
mentioned above is similar to a Collar without the short call, or 
simply long stock hedged by a long put.
    The proposal would establish reduced maintenance margin 
requirements for the stock component of these five strategies as 
follows:
1. Long Put/Long Stock
    The lesser of:
     10% of the put exercise price, plus 100% of any amount by 
which the put is out-of-the money; or
     25% of the long stock market value.
2. Long Call/Short Stock
    The lesser of:
     10% of the call exercise price, plus 100% of any amount by 
which the call is out-of-the-money; or
     the maintenance margin requirement on the short stock
3. Conversion
     10% of the exercise price.

The stock may not be valued at more than the exercise price.\9\
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    \9\ The writer of a call option has an obligation to sell the 
underlying component at the call exercise price. The writer cannot 
receive the benefit of a market value that is above the call 
exercise price because, if assigned an exercise. The underlying 
component would be sold at the exercise price, not the market price.
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4. Reverse Conversion
     10% of the exercise price, plus any in-the-money 
amount.\10\
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    \10\ The writer of a put option has an obligation to buy the 
underlying component at the put exercise price. If assigned an 
exercise, the underlying component would be purchased (the short 
position effectively closed) at the exercise price, even in the 
event the market price is lower. To offset the benefit to the 
account of a lower market value, the put in-the-money amount is 
added to the requirement.
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5. Collar
    The lesser of:

[[Page 48885]]

     10% of the put exercise price, plus 100% of any amount by 
which the put is out-of-the-money; or
     25% of the call exercise price.

The stock may not be valued at more than the call service price.
    These same maintenance margin requirements will apply, for example, 
when these strategies are used with a mutual fund or a stock basket 
underlying index option or warrants.
    g. Effect of Mergers and Acquisitions on the Margin Required for 
Short Equity Options. The Exchange proposes to adopt Commentary .10 to 
Exchange Rule 462 to provide an exception to the margin requirement for 
short equity options in the event trading in the underlying security 
ceases due to a merger or acquisition. Under this exception, if an 
underlying security ceases to trade due to a merger or acquisition, and 
a cash settlement price has been announced by the issuer of the option, 
margin would be required only for in-the-money options and would be set 
at 100% of the in-the-money amount.
    h. Determination of Value for Margin Purposes. The proposal will 
revise Exchange Rule 462(d)(1) to make it consistent with the other 
portion of the Exchange's proposal that allows the extension of credit 
on certain long term options. Currently, Exchange Rule 462(d)(1) does 
not allow the market value of long term options to be considered for 
margin equity purposes. The revision will allow options and warrants 
eligible for loan value pursuant to proposed Exchange Rules 462(c) and 
(d) to be valued at current market prices for margin purposes. The 
Exchange believes this change is necessary to ensure that the value of 
the option or warrant (the collateral) is sufficient to cover the debit 
carried in conjunction with the purchase.
    i. OTC Options. The proposal makes some minor corrections to the 
table in Exchange Rule 462 that displays the margin requirements for 
short OTC options.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act.\11\ in general, and furthers the 
objectives of Section 6(b)(5),\12\ in particular, in that it is 
designed to prevent fraudulent and manipulative acts and practices, 
promote just and equitable principles of trade, and does not permit 
unfair discrimination between customers, issuers, brokers, and dealers.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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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.

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

    The Exchange did not solicit or receive comments with respect to 
the proposed rule change.

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 the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if its finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Exchange consents, the Commission will:
    (A) By order approve the proposed rule change, or
    (B) 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, N.W., Washington, D.C. 20549-
0609. Copies of the submissions, 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 persons, 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 Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-Amex-99-27 and should be 
submitted by September 29, 1999.

    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 99-23239 Filed 9-7-99; 8:45 am]
BILLING CODE 8010-01-M