[Federal Register Volume 70, Number 108 (Tuesday, June 7, 2005)]
[Notices]
[Page 33230]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-2889]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51766; File No. SR-CBOE-2004-54]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change and Partial 
Amendment No. 1 To Amend Rules Relating to Margin Treatment on Stock 
Transactions Effected by an Options Market Maker to Hedge Options 
Positions

May 31, 2005.

I. Introduction

    On July 30, 2004, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 \2\ 
thereunder, a proposed rule change seeking to amend rules relating to 
margin treatment on stock transactions effected by an options market 
maker to hedge options positions. On February 22, 2005, the CBOE filed 
a partial amendment to its proposed rule change.\3\ The proposed rule 
change, as amended, was published for comment in the Federal Register 
on April 13, 2005.\4\ The Commission received no comments on the 
proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ SR-CBOE-2004-54: Amendment No. 1. Under the partial 
amendment, the options market maker must be able to demonstrate that 
it effected its permitted offset transactions for market-making 
purposes.
    \4\ See Securities Exchange Act Release No. 51497 (April 6, 
2005), 70 FR 19536 (April 13, 2005).
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II. Description

    The Exchange has proposed to eliminate a rule that essentially 
disallows favorable margin treatment on stock transactions initiated by 
options market makers to hedge an option position if the exercise price 
of the option is more than two standard exercise price intervals above 
the price of the stock in the case of a call option, or below in the 
case of a put option. When options market makers hedge their option 
positions by taking a long or short position in the underlying 
security, the underlying security is allowed ``good faith'' margin 
treatment, provided the underlying security meets the definition of a 
``permitted offset.'' To qualify as a permitted offset, CBOE Rule 
12.3(f)(3) requires, among other things, that the transaction price of 
the underlying security be not more than two standard exercise price 
intervals below the exercise price of the option being hedged in the 
case of a call option, or above in the case of a put option. The term 
``in-or-at-the-money'' is used in CBOE Rule 12.3(f)(3) to refer to the 
two standard strike price interval requirement. Stated another way, 
``in-or-at-the-money'' means the option being hedged cannot be ``out-
of-the-money'' by more than two standard exercise price intervals.
    The Exchange has stated that the intent of this requirement was to 
confine good faith margining of transactions in the underlying security 
to those that constituted meaningful hedges of an option position. The 
Exchange has proposed to remove the ``in-or-at-the-money'' 
requirement.\5\
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    \5\ The New York Stock Exchange (``NYSE'') also has filed a 
proposed rule change to remove the ``in-or-at-the-money'' language 
from its rules on permitted offsets. Although the language of the 
NYSE's proposed rule change differs from the language of the CBOE's 
proposed rule change, the proposed changes from the two exchanges 
are substantively identical. The Commission is publishing a notice 
to solicit comments on the NYSE's proposed rule change.
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    The Exchange noted that the ``in-or-at-the-money'' requirement is 
not consistent with current options market-maker hedging technique. 
Options market-makers will take a less than 100 share position in the 
underlying security per option being hedged so that any gain/loss on 
that position in dollar terms closely tracks that of the dollar gain/
loss on the option position. When options market-makers hedge in this 
manner, known as ``delta neutral hedging,'' they cannot benefit from 
any gain on a position in the underlying security because it is equally 
offset by a loss in the option being hedged.
    The Exchange further noted that the ``in-or-at-the-money'' 
requirement is unnecessary because, when a clearing firm extends good 
faith margin on a security underlying an option, it must reduce its net 
capital by any amount by which the deduction required by Rule 15c3-1 
under the Securities Exchange Act of 1934 (the ``haircut'') exceeds the 
amount of equity in the options market maker's account.

III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\6\ In particular, the Commission believes that the 
proposed rule change is consistent with Section 6(b)(5) of the Act \7\, 
which requires that the rules of the exchange be designed, among other 
things, to remove impediments to and perfect the mechanisms of a free 
and open market, and, in general, to protect investors and the public 
interest. The Commission finds that amending the rules relating to 
margin treatment on stock transactions effected by an options market 
maker to hedge options positions, by eliminating the ``in-or-at-the-
money'' requirement, is consistent with the requirements of Section 
6(b)(5), in that the ``in-or-at-the-money'' requirement impedes options 
market makers from hedging, on a good faith margin basis, ``out-of-the-
money'' options having standard exercise price intervals of less than 
five points.
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    \6\ In approving this proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \7\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion.

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\8\ that the proposed rule change (File No. SR-CBOE-2004-54), as 
amended, be, and it hereby is, approved.
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    \8\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-2889 Filed 6-6-05; 8:45 am]
BILLING CODE 8010-01-P