[Federal Register Volume 89, Number 235 (Friday, December 6, 2024)]
[Notices]
[Pages 97131-97138]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-28538]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-101780; File No. SR-OCC-2024-016]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change by The Options Clearing
Corporation Concerning Enhancements to the System for Theoretical
Analysis and Numerical Simulations (``STANS'') and OCC's Comprehensive
Stress Testing (``CST'') Methodology, To Better Capture the Risks
Associated With Short-Dated Options
December 2, 2024.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on November 22, 2024, The Options Clearing
Corporation (``OCC'') filed with the Securities and Exchange Commission
(``SEC'') 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 Pursuant to the provisions of Section
19(b)(1) of the Securities Exchange Act of 1934 (``Exchange Act'' or
``Act''),\3\ and Rule 19b-4 thereunder,\4\ The Options Clearing
Corporation (``OCC'') is filing with the Securities and Exchange
Commission (``Commission'') a proposed rule change in connection with
enhancements to the modeling approach for implied volatility components
within OCC's margin methodology, the System for Theoretical Analysis
and Numerical Simulations (``STANS'') and OCC's Comprehensive Stress
Testing (``CST'') methodology, to better capture the risks associated
with short-dated options. Specifically, this proposed rule change
would, as described below: (1) align the day-count convention between
option price smoothing and implied volatility scenario generation, and
(2) extend the term structure of the implied volatility shocks to cover
implied volatility risk associated with options of less than one-month
expiration.
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\3\ 15 U.S.C. 78s(b)(1).
\4\ 17 CFR 240.19b-4.
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The proposed changes to OCC's STANS Methodology Description \5\ and
Comprehensive Stress Testing & Clearing Fund Methodology, and Liquidity
Risk Management Description \6\ (``CST Methodology Description'') are
contained in Exhibits 5A and 5B, to File No. SR-OCC-2024-016,
respectively. Material proposed to be added is marked by underlining
and material proposed to be deleted is marked with strikethrough text.
Within the documents, new, revised, and deleted text related to the
proposed rule change have been incorporated in section 2.1.3 (Implied
Volatilities Scenarios) and 2.1.4 (S&P 500 Implied Volatilities
Scenarios) of the STANS Methodology Description and section 3.3.2
(Volatility Shock Model) of the
[[Page 97132]]
CST Methodology Description. The proposed rule change does not require
any changes to the text of OCC's By-Laws or Rules. All terms with
initial capitalization that are not otherwise defined herein have the
same meaning as set forth in the OCC By-Laws and Rules.\7\
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\5\ OCC has filed the STANS Methodology Description and
amendments thereto with the Commission. See Exchange Act Release
Nos. 100528 (July 15, 2024), 89 FR 58836 (July 19, 2024) (SR-OCC-
2024-008); 98101 (Aug. 10, 2023), 88 FR 55775 (Aug. 16, 2023) (SR-
OCC-2022-012); 95319 (July 19, 2022), 87 FR 44167 (July 25, 2022)
(SR-OCC-2022-001); 93371 (Oct. 18, 2021), 86 FR 58704 (Oct. 22,
2021) (SR-OCC-2021-011); 91833 (May 10, 2021), 86 FR 26586 (May 14,
2021) (SR-OCC-2021-005); 91079 (Feb. 8, 2021), 86 FR 9410 (Feb. 12,
2021) (SR-OCC-2020-016). OCC makes its STANS Methodology Description
available to Clearing Members. An overview of the STANS methodology
is on OCC's public website: https://www.theocc.com/Risk-Management/Margin-Methodology.
\6\ OCC has filed the CST Methodology Description and amendments
thereto with the Commission. See Exchange Act Release Nos. 100455
(July 2, 2024), 89 FR 56452 (July 9, 2024) (SR-OCC-2024-006); 90827
(Dec. 30, 2020), 86 FR 659 (Jan. 6, 2021) (SR-OCC-2020-015); 89014
(June 4, 2020), 85 FR 35446 (June 10, 2020) (SR-OCC-2020-003); 87718
(Dec. 11, 2019), 84 FR 68992 (Dec. 17, 2019) (SR-OCC-2019-010);
87717 (Dec. 11, 2019), 84 FR 68985 (Dec. 17, 2019) (SR-OCC-2019-
009); 83735 (July 27, 2018), 83 FR 37855 (Aug. 2, 2018) (SR-OCC-
2018-008).
\7\ OCC's By-Laws and Rules can be found on OCC's public
website: https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
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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
OCC is the sole clearing agency for standardized equity options
listed on national securities exchanges registered with the Commission.
In its role as a clearing agency, OCC acts as a central counterparty
(``CCP''), guarantying all contracts it clears. That is, OCC becomes
the buyer to every seller and the seller to every buyer, which exposes
OCC to risk because OCC is obligated to perform even when one of its
members defaults. These risks include: (i) credit risk, which is the
risk that OCC would not maintain sufficient financial resources to
cover exposures; and (ii) liquidity risk, which is the risk that OCC
would not have sufficient liquid resources to meet payment obligations
when due.
OCC manages its credit and liquidity risks through various
safeguards to ensure that it has sufficient financial resources in both
form and amount in the event of a Clearing Member failure. To begin
with, OCC periodically collects margin collateral from its Clearing
Members, which is designed to cover the credit exposures they
individually present to OCC with a high degree of confidence. OCC also
maintains a Clearing Fund, which is a mutualized pool of financial
resources to which each Clearing Member is required to contribute to
ensure that OCC maintains sufficient qualifying liquid resources to
manage its liquidity risk, and to address the tail risk that the margin
collateral OCC collects from each Clearing Member might be insufficient
to cover OCC's credit exposure to a defaulting member in extreme but
plausible market conditions. In general, OCC performs daily stress
testing of its financial resources using scenarios designed to assess
whether the resources collected are adequate and inform the size of
OCC's financial resources (``Sizing Scenarios'') and measure the
potential exposures Clearing Members may present to OCC to determine
whether calls for additional collateral in either margin or in the
Clearing Fund would be needed (``Sufficiency Scenarios''). Clearing
Member margin amounts are collected based on calculations obtained from
STANS, while Clearing Fund contributions are default scenario-based
amounts generated by the CST methodology.
Clearing Member portfolios contain a mix of products and positions
in options of various tenors, as well as other cleared positions (e.g.,
futures, stock loans) and collateral (e.g., valued securities, delivery
obligations, US treasuries, Canadian Government bonds, and cash). Over
the past several years, the options markets in particular have
experienced a significant increase in the trading of short-dated
options (``SDOs''), which refer to option contracts with a maturity of
less than or equal to one month to expiration.\8\ However, the increase
in the volume of SDO trading and the larger concentration of SDO
positions held from hedging and speculation activities present unique
challenges to the risk management framework.
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\8\ See, e.g., Cboe, The Rise of SPX & 0DTE Options (July 27,
2023), available at https://go.cboe.com/l/77532/2023-07-27/ffc83k.
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For these reasons, OCC carried out a study to examine the specific
risks posed by SDOs (the ``Study'') \9\ including risks posed by the
increase to volatility due to the feedback between options and equity
hedging activity. OCC also analyzed the valuation of SDOs and option
scenario pricing in OCC's 2-day margin period of risk (``MPOR'') \10\
and assessed the margin risk of portfolios dominated by SDOs through
sensitivity analysis of realized P&L and risk coverage metrics. OCC
concluded from the Study that valuation of SDOs and options scenario
pricing in the 2-day MPOR was in general reasonable, but that
opportunities exist to improve model performance for Clearing Member
portfolios dominated by SDOs. Moreover, a reasonableness analysis of
the mark-to market pricing and theoretical price simulation of SDOs in
the MPOR indicated that certain existing margin model assumptions
having a direct impact on SDO risk coverage needed further enhancement
and update.
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\9\ OCC has included the Study as confidential Exhibit 3A to
File No. SR-OCC-2024-016.
\10\ OCC collects its credit resources with an assumption of a
two-day MPOR (i.e., two days after the last good margin collection)
and potential liquidity obligations are evaluated using the same
concept and assuming the liquidation processes details in OCC's
Default Management Policy.
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Specifically, the Study referred to a difference between option
price smoothing \11\ that uses calendar day convention, and implied
volatility \12\ simulation that uses trading day convention. The usage
of two day count conventions \13\ results in differences in implied
volatility, especially when non-trading days make up a large portion of
the time-to-expiration (e.g., on Fridays for options that expire the
following Monday). In this regard, SDOs are far more sensitive to
differences in day-count convention than contracts with longer
expiries. In addition, OCC's model for simulating the theoretical
prices assumes that the implied volatility shocks of the one-month
tenor (``1M'') are sufficient to cover the implied volatility changes
for SDO tenors.\14\ However, empirical results indicate that the
implied volatility changes from SDOs can be much larger than those for
options with one month to expiration.\15\
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\11\ The smoothing algorithm is the process that OCC uses to
estimate fair values for plain vanilla listed options based on
closing bid and ask price quotes. See Exchange Act Release No. 86731
(Aug. 22, 2019), 84 FR 45188, 45189 (Aug. 28, 2019) (File No. SR-
OCC-2019-005).
\12\ Generally speaking, the implied volatility of an option is
a measure of the expected future volatility of the option's
underlying security at expiration, which is reflected in the current
option premium in the market.
\13\ The term ``day count convention'' refers to a standardized
methodology for calculating the number of days between two dates.
Both calendar and business day conventions are used by OCC in STANS
and CST calculations.
\14\ The ``tenor'' of an option is the amount of time remaining
to its expiration or maturity.
\15\ OCC has observed that the day-over-day at the money implied
volatility changes for the 1W tenor are approximately twice that of
the 1M tenor on certain risk factors such as SPX, RUT, QQQ, AAPL,
TSLA.
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OCC proposes to improve the theoretical price simulation of SDOs
and enhance the modeling of the implied volatility risk associated with
SDOs by: (1) aligning the day-count convention used between option
price smoothing and its models for simulating implied volatility, and
(2) extending the term structure \16\ to cover implied volatility risk
associated with options expiring in less than one-month. The
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proposed changes will be introduced to the Implied Volatilities
Scenarios Model and S&P 500 Implied Volatility Simulation Model in
STANS and the Volatility Shock component in CST. The impact of the
proposed enhancements on Clearing Member margin and on CST is presented
further below.
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\16\ The ``term structure'' of implied volatility is the curve
that depicts the relationship between the implied volatilities of
options with different expiration (or maturity) dates on the same
underlying. Expiration and maturity are used interchangeably but
reflect the same meaning.
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1. Purpose
Background
OCC's risk framework includes its STANS methodology used to
calculate Clearing Member margin amounts, and its CST methodology used
to stress test Clearing Member portfolios in order to determine the
appropriate size of the Clearing Fund and allocate portions to Clearing
Members commensurate with the risk they present to OCC.
STANS Overview
STANS is OCC's proprietary risk management system for calculating
Clearing Member margin requirements. The STANS methodology utilizes
large-scale Monte Carlo simulations to forecast price and volatility
movements in determining a Clearing Member's margin requirement.\17\
OCC uses a smoothing algorithm to generate theoretical prices and
volatilities for option contracts based on the fair value for plain
vanilla listed options from closing bid and ask price quotes.\18\ OCC
does this by first filtering out certain poor-quality quotes on
contracts based on certain conditions and estimates the forward prices
of the securities underlying these options. OCC then generates the
theoretical option prices based on the filtered bid and ask quotes and
constructs a volatility surface \19\ using the smoothed prices to
approximate option contract prices. The output of the Smoothing
Algorithm, consisting of various theoretical option contract prices and
volatilities, is then used downstream as a starting point to simulate
variations in implied volatility for option contracts.
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\17\ See OCC Rule 601.
\18\ See Exchange Act Release No. 86731 (Aug. 22, 2019), 84 FR
45188 (Aug. 28, 2019) (SR-OCC-2019-005).
\19\ The ``volatility surface'' refers to a three-dimensional
plot of the implied volatilities of the various options on the same
stock reflecting time to maturity, and different strike prices for
the option.
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Using the Black-Scholes options pricing model, the implied
volatility is the standard deviation of the underlying asset price
necessary to arrive at the market price of an option of a given strike,
time to maturity, underlying asset price and the current discount
interest rate. In effect, the implied volatility is responsible for
that portion of the premium that cannot be explained by the current
intrinsic value of the option (i.e., the difference between the price
of the underlying and the exercise price of the option), discounted to
reflect its time value. OCC considers variations in implied volatility
within STANS to ensure that the anticipated cost of liquidating options
positions in an account recognizes the possibility that the implied
volatility could change during the two-business day liquidation time
horizon and lead to corresponding changes in the market prices of the
options. Specifically, OCC models variations in implied volatility
using its (1) Implied Volatilities Scenarios Model for non-S&P 500
based products, and (2) S&P 500 Implied Volatility Simulation Model for
products in the S&P 500 group.\20\
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\20\ See generally Exchange Act Release No. 95319, supra note 3,
at 44168-69.
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Implied Volatilities Scenarios Model
Using its current Implied Volatilities Scenarios Model, OCC models
the variations in implied volatility used to re-price non-S&P 500 based
options within STANS. Variations in implied volatility are modeled
through a volatility surface by incorporating certain risk factors
(i.e., implied volatility pivot points) based on a range of tenors and
option deltas \21\ into the models in STANS. These implied volatility
pivot points consist of three tenors of one month, three months and one
year, and three deltas of 0.25, 0.5, and 0.75, resulting in nine
implied volatility risk factors.\22\ These pivot points are chosen such
that their combination allows the model to capture changes in level,
skew (i.e., strike price), convexity, and term structure of the implied
volatility surface.\23\
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\21\ The ``delta'' of an option represents the sensitivity of
the option price with respect to the price of the underlying
security.
\22\ See Exchange Act Release No. 94165 (Feb. 7, 2022), 87 FR
8072, 8073 (Feb. 11, 2022) (SR-OCC-2022-001).
\23\ Id.
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The Implied Volatility Scenarios Model has certain limitations
related to SDOs. First, the underlying prices and implied volatilities
generated from the Smoothing Algorithm, which are an input to the
Implied Volatility Scenarios Model, are generated using a calendar day
convention, which is not consistent with the trading day convention
used in the calibration of the model parameters. The misalignment in
day-count conventions may result in over- or under-estimation of option
prices based on the implied volatility scenarios. SDOs are more
sensitive to day-count convention alignment than contracts with longer
expirations due to the proportionally larger difference in time to
expiry between the trading day convention and calendar day convention
for shorter dated tenors.
Second, the model imposes a flat term structure on SDOs, which
forces the use of the implied volatility shock from the 1M tenor on all
option contracts expiring in less than one month. Because the term
structure for the Implied Volatilities Scenarios Model starts at the 1M
tenor, the current model is not consistent with the observed dynamics
of the underlying assets and the implied volatility surface for SDOs.
This may lead to inadequate coverage for portfolios with concentrations
in SDOs.
S&P 500 Implied Volatility Simulation Model
OCC uses the S&P 500 Implied Volatility Simulation Model for the
S&P 500 product group.\24\ The purpose of the S&P 500 Implied
Volatility Simulation Model is to establish a consistent and robust
framework for implied volatility simulation and provide natural offsets
for volatility products with similar characteristics to S&P 500 implied
volatility. The output of the S&P 500 Implied Volatility Simulation
Model is used by OCC's options pricing model, as well as the Volatility
Index Futures Model. The S&P 500 Implied Volatility Simulation Model is
a Monte Carlo simulation model that captures the risk dynamics in the
S&P 500 implied volatility surface utilizing standardized log-moneyness
\25\ and a fixed number of key tenors as well as skew to generate an
S&P 500 1M at-the-money (``ATM'') risk factor.\26\ OCC then uses the
generated implied volatility scenarios to produce option prices in
margin estimation and stress testing.\27\
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\24\ See generally Exchange Act Release No. 95319, supra note 3,
at 44168-69.
\25\ The term ``moneyness'' of an option refers to the
relationship between the strike price and the price of the option
underlying.
\26\ See Exchange Act Release No. 94165, supra note 20, at 8075.
\27\ Id.
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The S&P 500 Implied Volatility Simulation Model has certain
limitations related to SDOs. Like the Implied Volatilities Scenarios
Model discussed above, the S&P 500 Implied Volatility Simulation Model
uses a trading day convention in the calibration of the model, which is
not consistent with the calendar day convention used in the generation
of the input from the Smoothing Algorithm. As for the Implied
Volatilities Scenarios Model, this misalignment may result in
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over- or under-estimation of option prices, particularly for SDOs.
Second, the S&P 500 Implied Volatility Simulation Model uses a fixed
number of key tenors beginning with the 1M tenor. Because the term
structure for the S&P 500 Implied Volatility Simulation Model starts at
the 1M tenor, the current model is not consistent with the observed
dynamics of the underlying assets and the implied volatility surface
for SDOs, which may lead to inadequate coverage for portfolios with
concentrations in SDOs.
CST Overview
As described in the CST Methodology Description, OCC uses CST to
analyze the adequacy of its financial resources in extreme but
plausible scenarios. It enables OCC to better manage its risks by
promoting OCC's ability to thoroughly monitor its potential exposure
under varied sets of stressed market scenarios and provides it with the
ability to review the sufficiency of its financial resources. Moreover,
the methodology includes stress tests designed to size and monitor the
sufficiency of both prefunded credit and liquidity resources. OCC
relies upon a set of stress scenarios constructed pursuant to the CST
Methodology Description, including both Sizing and Sufficiency
scenarios.
CST is a scenario-based, one-factor risk model with four principal
elements.\28\ First, a set of risk drivers is selected based on the
portfolio exposures of all Clearing Members in the aggregate.\29\
Second, each individual underlying security from the portfolio of a
Clearing Member is mapped to a key risk driver, to estimate the
sensitivity for the beta \30\ of the security with respect to the
corresponding risk driver.\31\ Third, stress scenarios are generated by
assigning a stress shock to each of the risk drivers, which drives the
shock of an individual underlying security.\32\ Fourth, the aggregate
risk exposure or shortfall of each portfolio is generated for each
stress scenario for each Clearing Member and the Clearing Member Group
level.\33\ The CST methodology consists of several component models,
including the Volatility Shocks, the VIX Futures Prices Shocks, and
Idiosyncratic Scenarios models.
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\28\ See Exchange Act Release No. 83406 (Jun 11, 2018), 83 FR
28018, 28022 (June 15, 2018) (SR-OCC-2018-008).
\29\ Id.
\30\ The ``beta'' of a security is the sensitivity of the price
of the security relative to the price of the security.
\31\ Exchange Act Release No. 83406, supra note 26, at 28022.
\32\ Id.
\33\ Id.
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Volatility Shocks
The Volatility Shocks model component of the CST methodology
provides a method to generate implied volatility in a stress scenario
for all individual option products that are cleared by OCC.\34\ This
model component is used to shock any option product cleared by OCC.
Shocked implied volatility is needed at the product, expiration, and
strike level to evaluate individual option implied volatilities in
stressed market conditions, which is then used to determine options
prices and calculate the profit and loss of Clearing Member accounts in
stress scenarios. For all systemic stress scenarios,\35\ the Cboe
Volatility Index (``VIX'') is used as the main risk driver in
determining shocked implied volatility.\36\
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\34\ See generally id. at 28023.
\35\ The term ``systemic stress scenarios'' are scenarios
designed to the capture risk to OCC in an extreme event impacting
all positions driven by risk drivers.
\36\ Exchange Act Release No. 83406, supra note 26, at 28023.
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Two methods are used to generate strike-level shocked implied
volatility from VIX shocks: (1) an approach for equity products,
including equity ETFs, indexes and futures that have the S&P 500 Index
(``SPX'') as the risk driver; and (2) an approach used for options on
all risk factors that do not have SPX as a risk driver. The term
structure of SPX-driven implied volatilities is based on volatility
betas versus VIX, while a standardized log-moneyness metric is used to
model the implied volatility curves.\37\ For non-SPX driven risk
factors, the implied volatility shocks are based on historical
volatility beta regressed directly against the VIX.\38\
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\37\ Id.
\38\ Id.
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The Volatility Shocks component of CST has certain limitations
related to SDOs. First, like the STANS models discussed above, the
Volatility Shocks component uses a trading day convention in the
calibration of model parameters, which is not consistent with the
calendar day convention used by the Smoothing Algorithm. As discussed
above, this misalignment may result in over- or under-estimation of
option prices, particularly for SDOs. Second, Volatility Shock imposes
a flat term structure for SDOs when calculating shocked implied
volatility, which is not consistent with the observed dynamics of the
underlying assets and the implied volatility surface for SDOs. These
limitations may result in inadequate shocks for SDOs.
VIX Futures Price Shocks
The VIX is an index for measuring implied volatility based on
options on the SPX with approximately 30 days to expiration. OCC
derives VIX futures prices shocks from SPX volatility betas and VIX
index shocks using the VIX Futures Price Shocks component of CST.\39\
The term structure of the VIX futures prices shocks is modeled from
that of the SPX ATM implied volatility shocks. OCC first determines the
term structure of the SPX volatility beta, by running regression of the
2-day returns of SPX ATM implied volatility with respect to the 2-day
returns of the VIX index for different expirations, ranging from 1M to
twelve months (``12M'').\40\ Through linear interpolation on the term
structure curve of SPX volatility beta OCC determines the volatility
beta at the VIX futures expiration and 30 days after, which are the
basis to calculate VIX futures price shocks. As a final step a
constraint is then applied to ensure that the VIX futures price shocks
do not exceed the VIX index shock.
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\39\ See Exchange Act Release No. 87386 (Oct. 23, 2019), 84 FR
57911, 57913-14 (Oct. 29, 2019) (SR-OCC-2019-009).
\40\ See id. at 57916 n. 29 and accompanying text.
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Like the Volatility Shocks model, the VIX Futures Price Shocks
component imposes a flat term structure for SDOs when calculating
shocked implied volatility, which is not consistent with the observed
dynamics of the underlying assets and the implied volatility surface
for SDOs. This limitation of the VIX Futures Price Shocks model may
result in inadequate shocks for SDOs.\41\
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\41\ Unlike the other model discussed herein, the VIX Futures
Price Shocks model uses the SPX volatility beta with extended tenors
less than 1 month from the Volatility Shocks model component and
Dynamic VIX Calibration model component as inputs, and day-count
convention alignment is not within the scope for this model
component.
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Idiosyncratic Scenarios
OCC uses Idiosyncratic Scenarios to generate and capture the risk
from extreme non-systemic events that may impact OCC's financial
resources.\42\ Specifically, OCC captures the risk of extreme non-
systemic market moves on single name equity securities (non-ETF, non-
Index) through individual up and down shocks (assuming all other
products are unchanged). Single-name equities are classified into large
and small capitalization (cap) for the price shocks. Four types of
idiosyncratic moves are constructed based on the
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market capitalization and direction of the price shock: large cap up,
large cap down, small cap up and small cap down.\43\ A fixed price
shock for each of the four scenarios is calibrated from historical
price return data such that probability of idiosyncratic moves is
comparable to systemic scenarios and probability in all four scenarios
is approximately equal. Based on price shocks, ATM implied volatility
shocks are calibrated for each of the four scenarios.\44\
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\42\ See generally Exchange Act Release No. 87386, supra note
37, at 57913.
\43\ Id.
\44\ Id.
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The Idiosyncratic Scenarios component of CST shares the limitations
related to SDOs discussed above with respect to the other models.
Specifically, the Idiosyncratic Scenarios component uses a trading day
convention in the calibration of model parameters, which is not
consistent with the Smoothing Algorithm's calendar day convention. As
discussed above, this misalignment may result in over- or under-
estimation of option prices, particularly for SDOs. Second, like the
Volatility Shocks model, Idiosyncratic Scenarios imposes a flat term
structure for SDOs when calculating shocked implied volatility, which
is not consistent with the observed dynamics of the underlying assets
and the implied volatility surface for SDOs. These limitations may
result in inadequate shocks for SDOs.
Proposed Change
OCC proposes to capture the risks associated with SDOs by applying
enhancements to the implied volatility modeling approach to: (1) align
the day-count convention between option price smoothing and implied
volatility scenario generation, and (2) extend the term structure to
cover implied volatility risk associated with options with less than
one month to expiration. These enhancements will be implemented for
model components in STANS and CST.
Day-Count Convention Alignment
At present, the implied volatility output from smoothing,
determined using a calendar day convention, is directly applied in the
initial implied volatility scenarios in STANS and CST. However, the
calibration of the parameters used in implied volatility scenarios uses
a trading day convention, which is also used to model forecasted
variance as well as the shocks in CST. OCC proposes to align the day-
count convention to be consistent between calibration and price
smoothing in both STANS and CST.
In STANS, OCC proposes to align the day-count convention between
price smoothing and its model components used for forecasting changes
in implied volatility through amendments to the sections of the STANS
Methodology Description that address the Implied Volatilities Scenarios
Model and the S&P 500 Implied Volatility Simulation Model.\45\ For the
Implied Volatilities Scenarios Model (pivot-based), implied volatility
levels would be initially converted into trading day convention before
application of pivot scenario shocks. The shocked implied volatility
scenarios would then be converted back to calendar day convention
before being used to calculate shocked option price scenarios. For the
S&P 500 Implied Volatility Simulation Model, the process for generating
the shocked implied volatility scenarios for listed tenors would
convert the initial implied volatility from using calendar day
convention to using trading day convention followed by generation of
the ATM implied volatility log-return scenarios for listed tenors. The
skew shock scenarios would be generated next, followed by the shocked
implied volatility scenarios. The outputs of the shocked implied
volatility scenarios would then be converted back to calendar day
convention before calculating the theoretical option price scenarios.
These conversion steps taken together would then align the day-count
convention used in both option price smoothing and implied volatility
simulations.
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\45\ OCC would also make conforming changes to the whitepapers
for these models. OCC has provided updates to its STANS whitepapers
for the impacted models in confidential Exhibit 3B and 3C to File
No. SR-OCC-2024-016.
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Similarly, OCC would align the day-count convention of the Implied
Volatility Shocks in CST through conversion of the initial volatility
surface from the output of the Smoothing Algorithm to business day
convention before application of any volatility shocks.\46\ After the
volatility shock is applied, the shocked implied volatility would then
be scaled back to calendar day convention, before being used downstream
for option pricing in CST. These changes would be reflected in
amendments to the CST Methodology Description's section that addresses
the Volatility Shock Model. With respect to the Idiosyncratic
Scenarios, the CST methodology already provides that after calculating
the shocked ATM volatility, the shocked implied volatility for all the
strikes in the expiration follows the same methodology as for the
Volatility Shock Model.
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\46\ OCC would also make conforming changes to the whitepapers
for these models. OCC has provided updates to its CST whitepapers
for the impacted models in confidential Exhibit 3D and 3F to File
No. SR-OCC-2024-016.
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Extension of the Term Structure
At present, the STANS Implied Volatilities Scenarios model uses a
flat term structure for options with listed tenors that are shorter
than one month, which means that the implied volatility shock is
derived from the 1M key tenor or pivot. OCC proposes to change the
Implied Volatility Scenarios term structure for the implied volatility
simulation of all non-SPX related risk factors, such that for points
with shorter than one month to maturity, a squared-root decay is
applied with respect to one month to expiration up to a predetermined
shortest time to maturity. For the S&P 500 Implied Volatility
Simulation Model term structure and SPX related risk factors, the
applicable sections of the STANS Methodology Description would be
updated to provide for a shorter key tenor than the current 1M time to
maturity.
With respect to the CST Volatility Shocks model, which uses the
volatility beta from the 1M tenor for SDOs, OCC proposes to extend the
volatility beta approach to cover constant maturity tenors of less than
one-month expiration by adding constant maturity tenors at the 1-week
(``1W'') and 2-week (``2W'') key points of the term structure.
Similarly, for the VIX Futures Price Shocks model, OCC proposes that
the volatility beta for listed tenors that are less than the 1W tenor
and down to the 3-day (``3D'') tenor would be linearly interpolated
from the 1W tenor and 2W tenor volatility betas, i.e., the 1W and 2W
tenor expirations would be added as inputs to the term structure of SPX
volatility betas. As for Idiosyncratic Scenarios, the term structure
would be extended from 1M down to the 1W tenor and 2W tenor. These
changes would be applied to the section of the CST Methodology
Description that addresses the Volatility Shock Model, the same
methodology for which also applies to the Idiosyncratic Scenarios
Models as described above. In addition, this change would also apply to
the VIX Futures Price Shock Model because the Volatility Shock Model's
method is incorporated by reference in the section that describes the
volatility beta shocks applied to volatility instruments.
OCC also proposes to update the day count to the more precise value
of 365.25 within the CST Methodology Description when referring to
calendar days in a year and also when used in a formula. This amendment
to the CST Methodology Description conforms with
[[Page 97136]]
how the system was designed to be consistent with the day-count
convention specified in the STANS Methodology Description. Since the
CST system already uses a 365.25 day count convention, the proposed
change to correct the documentation would have no impact on stress test
results. Additionally, OCC plans to make several other minor non-
substantial typographical changes throughout the document.
In addition, OCC proposes to further revise the relevant sections
of the STANS Methodology Description concerning the S&P 500 Implied
Volatility Simulation model to eliminate redundant and duplicative
information. Specifically, OCC proposes to remove sections related to
the generation of the simulation of certain shocks that are duplicative
of information covered in the STANS Methodology Description's
discussion of the theory and specifications for that model. The
sections related to the simulation of the shocked implied volatility
scenarios would be amended to instead refer to those previous sections,
which would be updated to reflect the two changes proposed herein.
Impact Analysis
OCC has reviewed the potential impact of the proposed changes on
margin across all Clearing Member tier accounts over a 15-month period,
between July 2023 and September 2024. OCC observed that the proposed
enhancements would lead to an average daily total margin \47\ increase
of 0.58% (approximately $0.2 billion, calculated based on the average
daily margin of nearly $38 billion) across all accounts and activity
dates, with the daily total margins falling in a narrow range between
the largest decrease of 0.81% (approximately $0.3 billion) to the
largest increase of 3.21% (approximately $1.1 billion). The results
further demonstrated that the SDO enhancements had a larger measurable
impact for accounts with high concentrations of short-dated options.
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\47\ Margin is calculated as the sum of requirement shortfall
and stress test add-on charge.
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OCC also reviewed the potential impact on CST for the proposed
model enhancements based on backtesting results over the same time
period. OCC observed that the proposed changes had a relatively small
impact on the Cover 1 and Cover 2 shortfalls used in Sufficiency and
Sizing Scenarios for the leading Clearing Member Groups. The impact
varied among Clearing Members, influenced by factors such as portfolio
size, product diversity within those portfolios, and the concentration
of SDO positions. Smaller Clearing Members with a high concentration of
SDO positions experienced relatively more meaningful impacts.
With respect to Sizing Scenarios impacts, OCC observed a decrease
in the average Cover 2 shortfall for the 1-in-80-Year Rally Scenario of
0.1% (approximately $12.7 million) with the daily variation falling in
a narrow range between the largest decrease of 3.18% to the largest
increase of 0.53%. For the Cover 2 shortfall on the 1-in-80-Year
Decline Scenario OCC observed an average decrease of 0.47%
(approximately $65 million) with the daily variation falling in a
narrow range between the largest decrease of 3.17% to the largest
increase of 1.16%.
Simliarly, regarding Sufficiency Scenarios impacts, OCC observed a
decrease in the average Cover 1 shortfall for the 1987 Crash Scenario
of 0.39% (approximately $37 million) with the daily variation falling
in the range between the largest daily decrease of 3.15% and largest
daily increase of 1.97%. For the Largest Rally from 2008 Sufficiency
Scenario, the daily average Cover 2 Shortfall increased by around
0.22%, which is about $16 million. The shortfall ranged between a
decrease of $208 million and an increase of $116 million, which is
about a decrease of 3.54% to an increase of 1.90%. For the Largest
Rally from 2008--Historical Beta Sufficiency Scenario,\48\ the daily
average Cover 2 Shortfall decreased by around 0.1%, which is about $7
million. The shortfall ranged between a decrease of $196 million and an
increase of $143 million, which is about a decrease of 1.93% to an
increase of 1.41%.
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\48\ OCC notes that backtesting data for this scenario is
limited due to its recent deployment and use in production.
---------------------------------------------------------------------------
Overall, OCC observed a reduction to the Clearing Fund size of
around 0.14% (approximately $14 million) based on the changes in Cover
2 shortfalls in Sizing Scenarios. OCC believes that such changes to
margin and Cover 1 Sufficiency Scenarios and Cover 2 Sizing Scenarios
are commensurate with the risks presented by Clearing Members SDO
trading activities.
Implementation and Timeframe
The proposed margin model and CST methodology changes will be
integrated into OCC's current production system, and implemented within
180 days after the date that OCC receives all necessary regulatory
approvals for the proposed changes. OCC will announce the
implementation date of the proposed changes by an Information
Memorandum posted to its public website at least 2 weeks prior to
implementation.
2. Statutory Basis
OCC believes the proposed rule change is consistent with Section
17A of the Exchange Act \49\ and Rules 17Ad-22(e)(6) \50\ and (e)(7)
\51\ thereunder. Section 17A(b)(3)(F) of the Act \52\ requires, among
other things, that the rules of a clearing agency be designed to
promote the prompt and accurate clearance and settlement of securities
transactions, and in general, to protect investors and the public
interest. As described above, OCC could be exposed to increased credit
and liquidity risk if the margin and Clearing Fund models do not
adequately capture changes to the dynamic behavior of the implied
volatility associated with portfolios dominated by SDO positions. As
discussed above, OCC believes the proposed enhancements improve the
model performance for portfolios with high SDO concentration. The
output of these models would be used by OCC to calculate margin and
Clearing Fund requirements designed to limit its credit and liquidity
exposures to participants and ensure that OCC is able to continue the
prompt and accurate clearance and settlement of its cleared products.
The collection of margin and Clearing Fund helps to protect investors
and the public interest by ensuring OCC has sufficient resources to
manage a potential Clearing Member default that may otherwise impose
unexpected costs on non-defaulting Clearing Members and, ultimately,
their customers. For these reasons, OCC believes the proposed changes
are designed to promote the prompt and accurate clearance and
settlement of securities transactions, and, thereby, to protect
investors and the public interest in accordance with Section
17A(b)(3)(F) of the Exchange Act.\53\
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\49\ 15 U.S.C. 78q-1.
\50\ 17 CFR 240.17Ad-22(e)(6).
\51\ 17 CFR 240.17Ad-22(e)(7).
\52\ 15 U.S.C. 78q-1(b)(3)(F).
\53\ Id.
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OCC also believes that the proposed changes are consistent with
Rule 17Ad-22(e)(6).\54\ In particular, paragraphs (i), (iii), and (v)
of Rule 17Ad-22(e)(6) \55\ require a covered clearing agency that
provides central counterparty services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to cover its credit exposures to its participants by
establishing a risk-based margin system
[[Page 97137]]
that (1) considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market; (2) calculates margin sufficient to cover its potential
future exposure to participants in the interval between the last margin
collection and the close out of positions following a participant
default; and (3) uses an appropriate method for measuring credit
exposure that accounts for relevant product risk factors and portfolio
effects across products. As noted above, OCC's current models in STANS
may not adequately capture the implied volatility behaviors associated
with SDO in portfolios that may be dominated by SDO positions, which
could result in inadequate margin requirements. As described in detail
above, OCC believes that aligning the day count convention and
extending the term structure in OCC's margin system to take into
consideration SDO specific attributes, are appropriate methods to
enable OCC to measure SDO credit exposure and produce margin
requirements commensurate with the risks presented by SDO trading
activities, and as designed enables OCC to calculate margin sufficient
to cover SDO exposure from Clearing Member accounts with high
concentrations of short-dated options. The proposed changes are
designed to enhance model outputs to produce margin requirements that
are commensurate with the risks presented by portfolios containing SDO
s positions. As a result, OCC believes that the proposed changes are
reasonably designed to calculate margin commensurate with risks and
particular attributes of SDO and sufficient to cover its potential
future exposure to participants in the interval between the last margin
collection and the close out of positions following a participant
default, and uses an appropriate method to measure credit exposures
that accounts for the relevant SDO product risk factors in a manner
consistent with Rules 17Ad-22(e)(6)(i), (iii) and (v).\56\
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\54\ 17 CFR 240.17Ad-2(e)(6).
\55\ 17 CFR 240.17Ad-2(e)(6)(i), (iii), (v).
\56\ Id.
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(B) Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) requires that the rules of a clearing agency
do not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act.\57\ The proposed alignment of
the calendar convention between price smoothing and model calibration,
and the extension of the term structure for implied volatility and
volatility shocks, would be used by OCC to manage its credit and
liquidity risk across all Clearing Members. Accordingly, OCC does not
believe that the proposed rule change would unfairly hinder access to
OCC's services.
---------------------------------------------------------------------------
\57\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
While the proposed rule change may impact different accounts to a
greater or lesser degree depending on the composition of SDO positions
in each account, OCC does not believe that the proposed rule change
would impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act. As discussed above,
OCC is obligated under the Exchange Act and the regulations thereunder
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, among
other things, considers, and produces margin levels commensurate with
the risks and particular attributes of each relevant product,
portfolio, and market.\58\ Overall, the impact analysis indicates there
are significant improvements in performance and margin coverage for
SDOs from the proposed model enhancements.
---------------------------------------------------------------------------
\58\ See 17 CFR 240.17Ad-2(e)(6)(i).
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Moreover, while the composition of SDOs within Clearing Member
portfolios may drive margin and scenario charges that may be higher or
lower than under the current regime, nevertheless OCC believes that
margin coverage improvements occur with the adoption of the proposed
enhancements. These enhanced model components would utilize a more
consistent approach to calendar conventions, while the term structure
is also extended to account for SDO tenors, which directly address
certain limitations within the current implementation of STANS and CST
models. In addition, the proposed model enhancements are expected to
produce margin requirements that are more commensurate to the risks
generated from holding SDO positions within Clearing Member portfolios,
and therefore consistent with OCC's obligations under the Exchange Act
and regulations thereunder. Accordingly, OCC believes that the proposed
rule change would not impose any burden or impact on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.
(C) Clearing Agency'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 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 selfregulatory organization consents, the Commission will:
(A) by order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.
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 (https://www.sec.gov/rules-regulations/self-regulatory-organization-rulemaking);
or
Send an email to [email protected]. Please include
file number SR-OCC-2024-016 on the subject line.
Paper Comments
Send paper comments in triplicate to Vanessa Countryman,
Secretary, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-1090.
All submissions should refer to file number SR-OCC-2024-016. 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 website (https://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule
[[Page 97138]]
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 website 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 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 website at https://www.theocc.com/Company-Information/Documents-and-Archives/By-Laws-and-Rules.
Do not include personal identifiable information in submissions;
you should submit only information that you wish to make available
publicly. We may redact in part or withhold entirely from publication
submitted material that is obscene or subject to copyright protection.
All submissions should refer to file number SR-OCC-2024-016 and should
be submitted on or before December 27, 2024.
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\59\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\59\
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-28538 Filed 12-5-24; 8:45 am]
BILLING CODE 8011-01-P