[Federal Register Volume 80, Number 99 (Friday, May 22, 2015)]
[Notices]
[Pages 29784-29786]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-12636]



[[Page 29784]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74966; File No. SR-OCC-2015-010]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Concerning the 
Implementation of New Risk Models in Order To Support the Clearance and 
Settlement of Asian-Style Flexibly Structured Options and Flexibly 
Structured Cliquet Options

May 14, 2015.
    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 May 1, 2015, 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).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This proposed rule change by OCC concerns the implementation of new 
risk models in order to support the clearance and settlement of Asian-
style flexibly structured options (``Asian Options'') and flexibly 
structured Cliquet options (``Cliquet Options'').

II. Clearing Agency'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 these statements.

A. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

1. Purpose
    The purpose of this proposed rule change is to describe the risk 
models that OCC proposes to add to its STANS methodology in order to 
support the clearance and settlement of Asian Options and Cliquet 
Options.
Background
    OCC currently clears flexibly structured options on various 
securities indices (``Current Index Flex Options'').\3\ Current Index 
Flex Options permit the buyer and seller to negotiate certain variable 
terms, pursuant to exchange rules,\4\ in order to customize such terms. 
For example, the parties may select from a variety of underlying 
indices, pick a strike price and expiration date as well as pick the 
exercise-style of the option--i.e., American or European exercise.\5\ 
Current Index Flex Options are cash settled options for which the 
exercise settlement amount is determined based entirely on the strike 
price of a given option and the current underlying interest value on 
the day of exercise, in the case of American style Current Index Flex 
Options, or final day of trading, in the case of European style Current 
Index Flex Options. For risk modeling purposes, OCC computes clearing 
member margin requirements on Current Index Flex Options through 
pricing models within its STANS \6\ methodology that derive prices from 
the implied volatility of index options with the same tenor, strike 
price and underlying interest.
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    \3\ OCC clears Current Index Flex Options on the S&P 500[supreg] 
Index, S&P 100[supreg] Index, Nasdaq 100[supreg] Index and the 
Russell 2000[supreg] Index, among other underlying indexes.
    \4\ See OCC By-Laws Article 1, Section 1(F)(5).
    \5\ Options with an American style exercise may be exercised at 
any time prior to, and including, expiration. Options with a 
European style exercise may only be exercised at expiration.
    \6\ See http://www.theocc.com/risk-management/margins/ for a 
description of OCC's margin methodology. See also OCC Rule 601.
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    Asian Options are European style options that use an ``Asian-
style'' methodology for determining the exercise settlement amount of 
an option, which is the difference between the aggregate exercise price 
and the aggregate current underlying interest value, which is based on 
the average of twelve monthly price ``observations.'' Traders of Asian 
Options would select an observation date as well as an expiration date 
for the contract approximately twelve months following the contract's 
creation.\7\ Consequently, all Asian Options for which OCC would 
provide clearance and settlement services would have a term of 
approximately one year.\8\
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    \7\ Expiration dates must be within 50 to 53 calendar weeks from 
the date of listing.
    \8\ If the expiration date precedes the observation date in the 
final month, then the final ``observation'' would be the current 
underlying interest value on expiration date and not the observation 
date. If one of the observation dates falls on a weekend or holiday, 
the value used would be from the previous business day.
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    Cliquet Options are European style options that use a cliquet \9\ 
method for determining the exercise settlement amount of the option, 
which is the greater of: (i) Zero (i.e., the underlying index had 
negative returns during the option's tenor); and, (ii) the difference 
between the aggregate exercise price and the aggregate current 
underlying interest value, which is based on the sum of the Capped 
Returns (defined below) of the underlying index on 12 predetermined 
``observation dates'' (each an ``Observation Date,'' and the computed 
value an ``Observation''). The parties to a Cliquet Option would 
designate a set of Observation Dates for each contract as well as an 
expiration date.\10\ On each Observation Date, the exchange on which 
the Cliquet Options is listed would determine the actual return of the 
underlying index from observation period-to-observation period, which 
would be compared to the observation cap, which is an amount designated 
the parties to the Cliquet Option.\11\ The lesser of the actual 
observation period-to-observation period return or the observation cap 
would be the Capped Return for a given Observation Date.\12\
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    \9\ Cliquet style settlement provides for payout based on the 
(positive) sum of ``capped'' returns of an index on pre-determined 
dates over a specified period of time.
    \10\ Observations Dates would generally be a given date each 
month for the twelve months preceding the expiration date, with the 
last Observation Date being the expiration date. If the Observation 
Date chosen by the parties to a Cliquet Option precedes the 
expiration date then there would be two Observation Dates in the 
final month (i.e., the expiration date would always be an 
Observation Date) and ten other Observation Dates; one date in each 
of the ten months preceding the expiration month that would coincide 
with the Observation Date that was chosen by the parties to a 
Cliquet Option (not the expiration date). Expiration dates must be 
within 50 to 53 calendar weeks from the date of listing. If one of 
the Observation Dates falls on a weekend or holiday, the previous 
business day would be deemed to be the Observation Date.
    \11\ Id.
    \12\ For example, if the actual return of the underlying index 
was 1.75% and the designated capped return for a Cliquet Option was 
2%, the 1.75% value would be included (and not the 2%) as the value 
for the Observation Date. Using this same example, if the actual 
return of the underlying index was 3.30%, the 2% value would be 
included (and not the 3.30%) as the value for the Observation Date.
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    Both Asian Options and Cliquet Options would be only available in 
European style exercises, and would be subject to OCC's expiration 
exercise procedures set forth in OCC Rule 805, as supplemented by OCC 
Rule 1804. In addition, OCC would initially clear Asian Options and 
Cliquet Options on the S&P 500 Index, Nasdaq100 Index, Russell 2000 
Index and the Dow Jones Industrial Average Index and may clear Asian 
Options and Cliquet Options on other indices in the future.

[[Page 29785]]

New Risk Models
    OCC would compute clearing member margin requirements on Asian 
Options and Cliquet Options using its STANS methodology. Since STANS 
uses option prices to compute clearing member margin charges, the risk 
model changes necessary to accommodate the clearance and settlement of 
Asian Options and Cliquet Options concern the addition of appropriate 
price models for Asian Options and Cliquet Options. Both Asian Options 
and Cliquet Options are index options, and while OCC computes the price 
of Current Index Flex Options on indices through standard pricing 
models (i.e., the Black-Scholes pricing model) that consider: (i) The 
value of the option's underlying index, (ii) the implied volatility of 
an option's underlying index, (iii) time until expiration, (iv) risk-
free interest rate, and (v) the strike price of the option, certain 
modifications to OCC's existing pricing models for Current Index Flex 
Options are necessary in order to account for certain features of Asian 
Options and Cliquet Options, as described below, so that clearing 
member margin on such options may be computed through STANS. 
Accordingly, OCC proposes to implement the new pricing models described 
below in order to compute prices for Asian Options and Cliquet Options 
thereby allowing for the computation of clearing member margin 
requirements for such options through the STANS methodology.
Asian Options
    Asian Options differ from the Current Index Flex Options currently 
cleared by OCC due to the option's exercise settlement amount being a 
function of the arithmetic average of the underlying index on certain 
observation dates. (In comparison, and in the case Current Index Flex 
Options, the exercise settlement amount of the option is a function of 
the value of underlying index of a given option on the exercise date or 
expiration date, as applicable.) Based on this phenomenon, OCC proposes 
to add a new pricing model for Asian Options that would be a shifted 
lognormal model \13\ to accommodate the fact that Asian Options would 
have an arithmetic average value of the underlying index within the 
final exercise settlement amount calculation. The shifted lognormal 
model would account for the fact that the current underlying interest 
value on the expiration date of an Asian Option is based on an 
arithmetic average of prices, and not the value of the underlying index 
on the option's expiration date, which introduces non-normality into 
the probability distribution of contract payoffs.
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    \13\ See Andreasen, J., ``The pricing of discretely sampled 
Asian and lookback options: A change of numeraire approach,'' 
Journal of Computational Finance, September 2000. See also Brigo, 
D., Mercurio, F., Rapidsarda, F., Scotti, R., ``Approximated moment- 
matching dynamics for basket-options simulation,'' EFMA Lugano 
meetings, November 2001. See also Haug, E.G. and Margrabe, W., 
``Asian Pyramid Power,'' Wilmott Magazine, March 2003.
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    With respect to the Asian Option shifted lognormal pricing model, 
OCC proposes to utilize a modified Black-Scholes pricing model with a 
shift parameter that employs the first three statistical ``moments.'' 
In accordance with such model, the first moment is the expected value 
of an Asian Option's value based on the option's implied volatility. 
The second moment accounts for the statistical volatility of the 
option's value. The third moment accounts for the statistical skewness 
of the option's value. The moments are intended to account for 
variability in the arithmetic average value of an Asian Option's 
underlying index. The shifted lognormal distribution (i.e., the 
lognormal probability distribution derived using the first through 
third moments above) is then priced through the standard Black-Scholes 
equation.\14\ The shift parameters are then adjusted out of the Black-
Scholes price in order to derive a price for a given Asian Option that 
is appropriate to be utilized within the STANS methodology for the 
purposes of computing clearing member margin on Asian Options.
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    \14\ In connection with using the standard Black-Sholes 
equation, OCC would also compute each of the three moments using a 
random shifted lognormal variable.
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Cliquet Options
    Similar to Asian Options, the price of a given Cliquet Options is 
based on monthly Observations of an underlying index. While a shifted 
lognormal model is an appropriate pricing model for Asian Options, the 
capped return feature of Cliquet Options makes the numerical solution 
to the Black-Scholes Partial Differential Equation \15\ the appropriate 
pricing model for Cliquet Options.\16\ OCC therefore proposes to add a 
Cliquet Option pricing model to its STANS methodology that would 
compute the numerical solution to the Black-Scholes Partial 
Differential Equation. Such a solution would provide OCC with the price 
of a given Cliquet Option that would be utilized within the STANS 
methodology for the purposes of computing clearing member margin 
requirements.
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    \15\ The differential equation model incorporates boundary 
conditions that ensure that the value of a given Cliquet Option is 
consistent throughout the equation. (Boundary conditions are 
necessary in order to solve differential equations.)
    \16\ See Andreasen, J., ``The pricing of discretely sampled 
Asian and lookback options: A change of numeraire approach.'' 
Journal of Computational Finance (2000). See also Bernard, C., & Li, 
W.V., ``Pricing and Hedging of Cliquet Options and Locally Capped 
Contracts.'' SIAM Journal on Financial Mathematics, 353-371 (2013). 
See also Hagan, P.S., Kumar, D., & Lesniewski, A.S., ``Managing 
Smile Risk.'' Wilmott Magazine, 84-108 (2002). See also Hull, John 
C., ``Options Futures and other Derivatives.'' McGraw Hill (2000). 
See also Kjaer, M., ``Fast pricing of cliquet options with global 
floor.'' Journal of Derivatives, 14(2), 47-60 (2006).
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    With respect to the pricing of a given Cliquet Option, and based on 
the capped return feature of Cliquet Options, OCC would identify the 
known implied volatility skew of standard options with the same 
underlying interest, a similar tenor and a similar amount of forward 
moneyness \17\ of the given Cliquet Option. OCC's calculation of 
forward moneyness would include an adjustment to account for any known 
Observations of the underlying interest for a given Cliquet Option. The 
known implied volatility skew would subsequently be utilized within the 
Black-Scholes Partial Differential Equation so that OCC would be able 
to derive the price of a given Cliquet Option, which would then be 
utilized within the STANS methodology for purposes of computing 
clearing member margin requirements on a Cliquet Options.
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    \17\ Forward moneyness is the ratio of the strike to the current 
value of the implied forward for the index.
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2. Statutory Basis
    OCC believes that the proposed rule change is consistent with 
Section 17A(b)(3)(F) of the Act \18\ because it would assure the 
safeguarding of securities and funds which are in the custody and 
control of OCC. OCC believes that the proposed rule change assures the 
safeguarding of securities and funds in the custody and control of OCC 
because it would permit OCC to modify its risk models to accommodate 
the manner in which the exercise settlement amount for Asian Options 
and Cliquet Options is determined thereby permitting OCC to risk manage 
Asian Options and Cliquet Options through appropriate risk models. Such 
risk models would reduce the risk that clearing member margin assets 
would be insufficient should OCC need to use such assets to close-out 
the positions of a defaulted clearing member. In addition, the proposed 
rule change is consistent with Rule 17Ad-22(b)(2)

[[Page 29786]]

under the Act,\19\ because the proposed rule change because [sic] would 
allow OCC to implement risk-based models and parameters, as described 
above, to set margin requirements for clearing members who trade Asian 
Options and Cliquet Options. The proposed rule change is not 
inconsistent with any existing OCC By-Laws or Rules, including any 
rules proposed to be amended.
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    \18\ 15 U.S.C. 78q-1(b)(3)(F).
    \19\ 17 CFR 240.17Ad-22(b)(2).
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B. Clearing Agency's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose a 
burden on competition.\20\ As described above, the proposed rule change 
concerns implementation of certain pricing models in to the STANS 
methodology in order to facilitate the margining of clearing member 
positions in Asian Options and Cliquet Options. The proposed rule 
change would uniformly affect all clearing members who trade Asian 
Options and Cliquet Options and therefore OCC does not believe that 
proposed rule change would impose a burden on competition.
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    \20\ 15 U.S.C. 78q-1(b)(3)(I).
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C. Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants or Others

    Written comments on the proposed rule change 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 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate 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 or disapprove 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 email to [email protected]. Please include 
File Number SR-OCC-2015-010 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-OCC-2015-010. This file 
number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filings also will be available 
for inspection and copying at the principal office of OCC and on OCC's 
Web site at http://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_15_010.pdf.
    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-2015-010 
and should be submitted on or before June 12, 2015.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-12636 Filed 5-20-15; 4:15 pm]
BILLING CODE 8011-01-P