[Federal Register Volume 72, Number 186 (Wednesday, September 26, 2007)]
[Notices]
[Pages 54705-54708]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-18963]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56471; File No. SR-OCC-2007-08]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating to Binary Options

September 19, 2007.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on June 28, 2007, The Options 
Clearing Corporation (``OCC'') 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 primarily by 
OCC. 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 proposed rule change would amend OCC's By-Laws and Rules to 
permit OCC to clear and settle various types of binary options, 
including ``fixed return options'' to be listed by the American Stock 
Exchange (``Amex'') and binary options on broad-based securities 
indexes proposed to be listed by the Chicago Board Options Exchange 
(``CBOE'').

[[Page 54706]]

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

    In its filing with the Commission, OCC 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. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\2\
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    \2\ The Commission has modified parts of these statements.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed rule change is to permit OCC to clear 
and settle binary options, including fixed return options (``FROs'') to 
be listed and traded by Amex\3\ and binary options on broad-based 
indexes proposed to be listed and traded by CBOE.\4\ Binary options 
(sometimes referred to as ``digital'' options) are all-or-nothing 
options that pay a fixed amount if exercised in the money and otherwise 
pay nothing. Until recently, OCC did not clear any binary options other 
than credit default options (``CDOs'') traded on CBOE. CBOE and OCC 
recently were granted approval for CBOE to trade and for OCC to clear 
related products called credit default basket options (``CDBOs'').\5\ 
General characteristics of binary options, excluding features unique to 
CDOs and/or CDBOs that were already described in OCC's prior rule 
changes, are described below, followed by an explanation of the 
specific rule changes being proposed by OCC.
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    \3\ Securities Exchange Act Release No. 56251 (August 14, 2007), 
72 FR 46523 (August 20, 2007) (File No. SR-Amex-2004-27).
    \4\ File No. SR-CBOE-2006-105.
    \5\ Securities Exchange Act Release Nos. 56275 (August 17, 
2007), 72 FR 47097 (August 22, 2007) (File No. SR-CBOE-2007-026) and 
56288 (August 20, 2007), 72 FR 49034 (August 27, 2007) (File No. SR-
OCC-2007-06).
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    Description of Binary Options. Binary options are cash-settled 
options that have only two possible payoff outcomes, either a fixed 
exercise settlement amount or nothing at all. They are subject to 
automatic exercise. The underlying interest of a binary option may be 
one or more securities, an index of securities, or some other measure; 
however, OCC presently intends to clear only binary options that are 
within the definition of a ``security'' as determined by the 
Commission. In its capacity as a ``derivatives clearing organization'' 
regulated by the Commodity Futures Trading Commission (``CFTC''), OCC 
may in the future propose to clear binary options that are commodity 
options subject to the jurisdiction of the CFTC.
    A binary option, other than a CDO or CDBO, is in the money and will 
be automatically exercised if its underlying interest value, when 
measured against its exercise price, is determined to meet the criteria 
for automatic exercise as specified in the Exchange Rules of the 
listing Exchange.\6\ For example, in the case of a ``finish high fixed 
return option,'' such option will be automatically exercised and 
settled for a fixed amount of cash if its underlying interest value is 
above its exercise price at expiration. In the case of a ``finish low 
fixed return option,'' such option will be automatically exercised and 
settled for a fixed amount of cash if its underlying interest value is 
below its exercise price at expiration. The rules proposed in this 
current filing for binary options are intended to be sufficiently 
generic to be the basis for clearing binary options proposed to be 
listed by Amex and CBOE as well as other binary options in the future.
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    \6\ CDOs and CDBOs, on the other hand, do not have exercise 
prices. A CDO or CDBO will be deemed to be in the money and will be 
automatically exercised if a credit event occurs at any time prior 
to the last day of trading.
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    By-Law and Rule Amendments Applicable to Binary Options. In order 
to provide a framework of rules that can accommodate clearance and 
settlement of various kinds of binary option products, OCC proposes to 
broaden the By-Law Article and Rule Chapter covering CDOs and CDBOs.
(1) Terminology--Article I, Section 1 and Article XIV, Section 1
    ``Binary option'' would be defined in Article XIV, Section 1 of the 
By-Laws, and the definition would be cross-referenced in Article I of 
the By-Laws.
    The definitions of ``option contract'' and ``type of option'' in 
Article I of the By-Laws would be amended to include a binary option.
    OCC proposes to redefine the term ``class'' in Article XIV, Section 
1 so that it will apply to binary options generally. To be within the 
same class, binary options other than CDOs or CDBOs must cover the same 
underlying interest and have otherwise identical terms except for 
exercise price (if any) and expiration date.
    The definition of ``exercise price'' in Article I would be replaced 
with respect to binary options with a revised definition in Article 
XIV, Section 1 which would recognize that binary options will be 
settled by a fixed cash payment. The exercise price of a binary option 
is neither an amount that is paid in exchange for an underlying 
interest nor is it used to determine the exercise settlement amount as 
in the case of other cash-settled options. In the case of a binary 
option other than a CDO or CDBO, the exercise price of a binary option 
is simply a defined value or range of values for the underlying 
interest. If the underlying interest value falls within the defined 
range at expiration of such binary option, the option will be 
automatically exercised; otherwise, the option will expire unexercised. 
A CDO or CDBO is said to have no exercise price.
    OCC proposes to redefine the term ``underlying interest'' in 
Article XIV, Section 1 so that it will apply to binary options 
generally. In the case of a binary option other than a CDO or CDBO, the 
underlying interest is the underlying security, securities, index, 
basket, or measure whose value is compared to such option's exercise 
price to determine whether the option is in the money and will be 
automatically exercised. In conjunction with the revised definitions of 
``exercise price'' and ``underlying interest,'' OCC also proposes to 
add a new defined term, ``underlying interest value,'' to Article XIV, 
Section 1. When used with respect to a binary option other than a CDO 
or CDBO, underlying interest value means the value or level of the unit 
of trading of the underlying interest at any point in time as reported 
by the reporting authority. A new definition for the term ``unit of 
trading'' would state ``unit of trading'' when used with respect to a 
binary option means the quantity of the underlying interest on which 
the underlying interest value is based and is ordinarily a single share 
in the case of binary options on individual equity securities or one 
(1) In the case of binary index options. The terms ``unit of trading'' 
and ``underlying interest value'' would not be applicable to CDOs and 
CDBOs.
    Other terms that were created or amended for CDOs and CDBOs will be 
modified to apply to binary options generally.
(2) Terms of Cleared Contracts--Article VI, Section 10(e)
    Paragraph (e) of Article VI, Section 10 would be further amended to 
apply to binary options generally.

[[Page 54707]]

(3) General Rights and Obligations--Article XIV, Section 2B
    Article XIV, Section 2B would define the general rights and 
obligations of holders and writers of binary options other than CDOs or 
CDBOs. As noted above, the holder of a binary option that is 
automatically exercised would have the right to receive the fixed 
exercise settlement amount from OCC, and the assigned writer would have 
the obligation to pay that amount to OCC.
(4) Adjustments of Binary Options Other than CDOs or CDBOs--Article 
XIV, Section 3A; Unavailability or Inaccuracy of Final Underlying 
Interest Value--Article XIV, Section 5; Determination of Final 
Underlying Interest Value--Article XIV, Section 6
    Article XIV, Section 3A would describe the methods by which binary 
options other than CDOs or CDBOs generally will be adjusted if 
adjustments are deemed to be necessary. Special adjustment rules are 
needed because of the fixed, cash-settlement feature of binary options. 
For instance, under Article VI, Section 11A(d), which governs 
adjustment of other equity options, if there is a stock dividend, 
distribution, or split whereby a whole number of shares of the 
underlying security is issued for each outstanding share, the exercise 
price is proportionately reduced, and the number of option contracts is 
increased by the number of shares issued with respect to each share of 
the underlying security. This adjustment would be inappropriate for 
binary options for which the underlying interest is an equity security. 
For example, an XYZ option with an exercise price of $50 would be 
adjusted to become two XYZ options, each with an exercise price of $25. 
Because the fixed exercise settlement amount of a binary option is 
intended to remain at $100, this adjustment would increase the total 
payout upon exercise to $200. To avoid this result, Article XIV, 
Section 3A(a)(4) would provide that the number of option contracts 
would not proportionally increase and only the exercise price would be 
adjusted. The other provisions of Article XIV, Section 3A are similar 
to Article VI, Section 11A, with appropriate modifications for binary 
options. In order to maintain consistency with adjustment policies for 
physically settled stock options where such consistency is appropriate, 
certain changes in the treatment of dividends that were proposed in SR-
OCC-2006-01 to become effective at a future date, will become effective 
on the same date for binary options on single stocks.
    Article XIV, Section 3A(b) would govern adjustments of binary 
options for which the underlying interest is an index of equity 
securities and would be similar to Article XVII, Section 3, which 
governs index options, with appropriate modifications to reflect unique 
features of binary options. For instance, because binary options do not 
have an index multiplier, the Securities Committee would generally 
adjust the exercise price of a binary option of which the underlying 
interest is an index of equity securities to get the appropriate 
result.
    Article XIV, Section 5, would give OCC the authority to fix the 
underlying interest value for a binary option other than a CDO or CDBO 
and to rely on that value for determining whether such binary option 
would be exercised under circumstances similar to those in which OCC 
may currently fix the exercise settlement amount for index options.
    Article XIV, Section 6 would provide, in essence, that the 
underlying interest value of a series of binary options at expiration, 
other than CDOs or CDBOs, would be determined by the Exchange or 
Exchanges on which such series is traded subject to any overriding 
provision of OCC's By-Laws and Rules. If a series of options is traded 
on more than one Exchange, OCC could use the underlying interest value 
received from the Exchange deemed by OCC to be the principal Exchange, 
or OCC could employ a procedure to derive a single value based on some 
or all of the values received.
(5) Exercise and Settlement--Chapter XV of the Rules and Rule 801
    Binary options would not be subject to the exercise-by-exception 
procedures applicable to most other options under OCC's Rules but would 
instead be automatically exercised prior to or at expiration if the 
specified criterion for exercise is met. The procedures for the 
automatic exercise of binary options, as well as assignment and 
settlement of exercises (including provisions applicable to a suspended 
Clearing Member), would be set forth in Rules 1501 through 1505 of new 
Chapter XV and in revised Rule 801(b).
(6) Margin Requirements--Rule 601; Deposits in Lieu of Margin--Rule 
1506
    OCC would margin binary options through its usual ``STANS'' system. 
STANS has been modified to accommodate the particular binary options to 
be traded by Amex and the binary index product currently proposed by 
CBOE. CDOs and CDBOs will be margined as described in the applicable 
rule filings cited above.
    OCC is not proposing to accept escrow deposits in lieu of clearing 
margin for binary options. Therefore, Rule 1506 would state that Rule 
610, which otherwise would permit such deposits, does not apply to 
binary options.
(7) Acceleration of Expiration Date--Rule 1507(d)
    This new provision would accelerate the expiration date of a binary 
option other than a CDO or CDBO when OCC determines in its discretion 
that the underlying interest value of such option has become fixed 
prior to the expiration of the option (e.g., where the equity security 
underlying a binary option has been converted by a merger into the 
right to receive a fixed amount of cash). If the option is out of the 
money, it would expire unexercised. Otherwise, it would be 
automatically exercised.
    The proposed changes to OCC's By-Laws and Rules are consistent with 
the purposes and requirements of Section 17A of the Act because they 
are designed to promote the prompt and accurate clearance and 
settlement of transactions in, including exercises of, binary options, 
and to foster cooperation and coordination with persons engaged in the 
clearance and settlement of such transactions, to remove impediments to 
and perfect the mechanism of a national system for the prompt and 
accurate clearance and settlement of such transactions, and in general 
to protect investors and the public interest. The proposed rule change 
accomplishes this purpose by applying substantially the same rules and 
procedures to these transactions as OCC applies to similar transactions 
in other cash-settled options except to the extent that special rules 
and procedures are required in order to accommodate unique features of 
binary options.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.

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

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change and none have been received.

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

    Within thirty-five days of the date of publication of this notice 
in the Federal

[[Page 54708]]

Register or within such longer period (i) As the Commission may 
designate up to ninety 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:
    (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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml) or
     Send an e-mail to [email protected]. Please include 
File Number SR-OCC-2007-08 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2007-08. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of OCC and on OCC's Web 
site at http://www.optionsclearing.com. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-OCC-2007-08 and should be submitted on 
or before October 17, 2007.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-18963 Filed 9-25-07; 8:45 am]
BILLING CODE 8010-01-P