Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment Nos. 1 and 2 Thereto by the Chicago Board Options Exchange, Incorporated Relating to Customer Portfolio and Cross-Margining Requirements, 22935-22947 [E5-2127]
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Federal Register / Vol. 70, No. 84 / Tuesday, May 3, 2005 / Notices
Section 6(b)(5) of the Act which, among
other things, requires that the rules of a
national securities exchange be
designed to promote just and equitable
principles of trade, to foster cooperation
and coordination with persons engaged
in regulating securities transactions, to
remove impediments to perfect the
mechanism of a free and open market
and a national market system and, in
general, to protect investors and the
public interest.5 The Commission
believes that the proposed rule change
could promote efficiency at the BSE by
reducing the costs associated with
transactions on the Exchange by
allowing brokers to choose the most
efficient and cost-effective way of
conducting their business.
Under the proposed rule change,
Remote Floor Brokers will be governed
by the same general rules that govern
Remote Specialists.6 Specifically,
Remote Floor Brokers will be required
to meet certain minimum requirements
including, but not limited to, their
background, experience, staffing,
training procedures, adequacy of the
floor broker’s confidentiality policies,
its contingency plans for
communication or technology failures,
the adequacy of the floor broker’s offsite facility, performance standards and
minimum capital requirements. Further,
Remote Floor Brokers must comply with
the trading rules that apply to trading on
the BSE floor, including but not limited
to: Chapter II, Section 2, Recording of
Sales; Chapter III, Section 6, Floor
Broker’s Responsibility; Chapter XIV,
Independent Floor Brokers; Chapter
XVII, Members Dealing for Own
Account; and, Chapter XXXIII, Section
2, Order Entry.7 All BSE brokered
orders, including those which would be
handled by a BSE Remote Broker, must
be entered into the BEACON trading
system before being executed by a BSE
specialist.8 Further, the BSE will
maintain communication with its
proposed Remote Brokers via Stentofon,
and dedicated telephone lines so as to
ensure the fulfillment of its regulatory
oversight of remote brokerage units.9
Moreover, as it does with its current
Remote Specialist firms, the Exchange
will conduct both scheduled and
unscheduled compliance inspections of
15 U.S.C. 78f(b)(5).
BSE Rules, Chapter XXXIII, BEACON
Remote; see also Securities Exchange Act Release
No. 43127 (August 8, 2000), 65 FR 49617 (August
14, 2000) (Commission Order approving Remote
Specialists at BSE) (‘‘Remote Specialist Order’’).
7 Letter from John Boese, Vice President, Chief
Regulatory Officer, Exchange, to Kelly M. Riley,
Assistant Director, Division of Market Regulation,
Commission, dated April 11, 2005.
8 Id.
9 Id.
remote brokerage firms. Any regulatory
requirements including trading halts,
trading practices, policies, procedures
or rules requiring floor official
involvement will be coordinated by
Exchange personnel with the remote
brokers through the dedicated telephone
line.10
The proposed rule change should not
alter the duties and obligations of a BSE
Floor Broker in any way, other than the
ability of the Floor Brokers to conduct
their business from locations other than
the BSE floor. In fact, the Commission
notes that the Exchange has represented
that the instant proposed rule change
should have little, if any, impact on the
way that Exchange Floor Brokers
operate since the trading activity on the
BSE floor is conducted exclusively in an
electronic manner.
In the order approving Remote
Specialists, the Commission noted the
ability of the BSE to conduct its
regulatory responsibilities over remote
members, such as conducting market
surveillance, enforcing members’
compliance with BSE rules and the Act,
and coordinating regulatory actions both
on and off the floor. The ability of BSE
to conduct these regulatory activities
over remote floor brokers is critical.
While the Commission is satisfied that
the proposed rule provides an adequate
framework to address these issues,11
BSE must establish and implement a
rigorous surveillance program to ensure
BSE remote members comply with the
federal securities laws and BSE rules
and to ensure BSE’s ability to enforce
such compliance.
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,12 that the
proposed rule change (SR–BSE–2004–
24) is approved.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.13
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5–2120 Filed 5–2–05; 8:45 am]
BILLING CODE 8010–01–P
5 See
6 See
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10 Id.
11 See generally Remote Specialist Order, supra
note 6, for a complete discussion of this framework.
12 See 15 U.S.C. 78s(b)(2).
13 17 CFR 200.30–3(a)(12).
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22935
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–51614; File No. SR–CBOE–
2002–03]
Self-Regulatory Organizations; Notice
of Filing of Proposed Rule Change and
Amendment Nos. 1 and 2 Thereto by
the Chicago Board Options Exchange,
Incorporated Relating to Customer
Portfolio and Cross-Margining
Requirements
April 26, 2005.
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 April 15,
2005, the Chicago Board Options
Exchange, Incorporated (‘‘CBOE’’ or
‘‘Exchange’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’) Amendment No. 2 3 to
the proposed rule change as described
in Items I, II, and III below, which Items
have been prepared by the CBOE. The
Exchange submitted this partial
amendment, constituting Amendment
No. 2, pursuant to the request of
Commission staff. Specifically, the
Exchange proposes to amend the
proposed rule (Rule 12.4) to remove
current paragraph (b)(2) under which
any affiliate of a self-clearing member
organization can participate in portfolio
margining, without being subject to the
$5 million equity requirement.4
The CBOE submitted the original
proposed rule change to the
Commission on January 15, 2002
(‘‘Original Proposal’’). The proposed
rule change was published in the
Federal Register on March 29, 2002.5
The Commission received one comment
letter in response to the March 29, 2002
Federal Register notice.6 On April 2,
2004, the Exchange filed Amendment
No. 1 to the proposed rule change.7 The
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Partial Amendment No. 2 (‘‘Amendment No.
2’’).
4 This partial amendment would not exclude
these affiliates from participating in portfolio
margining; rather, it would subject them to the $5
million equity requirement in paragraph (b)(3) of
proposed Rule 12.4 in Amendment No. 2.
5 See Securities Exchange Act Release No. 45630
(March 22, 2002), 67 FR 15263 (March 29, 2002).
6 See E-mail from Mike Ianni, Private Investor to
rule-comments@sec.gov, dated November 7, 2002
(‘‘Ianni E-mail’’).
7 See letter from Richard Lewandowski, Vice
President, Division of Regulatory Services, CBOE, to
Michael A. Macchiaroli, Associate Director,
Division of Market Regulation (‘‘Division’’),
Commission, dated April 1, 2004 (‘‘Amendment No.
1’’). The CBOE proposed Amendment No. 1 to make
corrections or clarifications to the proposed rule, or
to reconcile differences between the proposed rule
2 17
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Federal Register / Vol. 70, No. 84 / Tuesday, May 3, 2005 / Notices
proposed rule change and Amendment
No. 1 were published in the Federal
Register on December 27, 2004.8 The
Commission received eleven comment
letters in response to the December 27,
2004 Federal Register notice.9
The Commission is publishing this
notice to solicit comments on the
proposed rule change, as amended, from
interested persons.10
1. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The CBOE proposes to amend its
rules, for certain customer accounts, to
allow member organizations to margin
listed, broad-based, market index
options, index warrants and related
and a parallel filing by the NYSE. See Securities
Exchange Act Release No. 46576 (October 1, 2002),
67 FR 62843 (October 8, 2002) (File No. SR–NYSE–
2002–19).
8 See Securities Exchange Act Release No. 50886
(December 20, 2004), 69 FR 77275 (December 27,
2004); see also Securities Exchange Act Release No.
50885 (December 20, 2004), 69 FR 77287 (December
27, 2004).
9 One of the comments responded exclusively to
CBOE Amendment No. 1. See letter from Anthony
J. Saliba, President, LiquidPoint, LLC, to Jonathan
G. Katz, Secretary, Commission, dated February 24,
2005 (‘‘Saliba Letter’’). Ten of the written comments
(letters and emails) responded jointly to CBOE
Amendment No. 1 and NYSE Amendment No. 2.
See letter from Barbara Wierzynski, Executive Vice
President and General Counsel, Futures Industry
Association, and Gerard J. Quinn, Vice President
and Associate General Counsel, Securities Industry
Association, to Jonathan G. Katz, Secretary,
Commission, dated January 14, 2005 (‘‘Wierzynski/
Quinn Letter’’); letter from Craig S. Donohue, Chief
Executive Officer, Chicago Mercantile Exchange, to
Jonathan G. Katz, Secretary, Commission, dated
January 18, 2005 (‘‘Donohue Letter’’); letter from
Robert C. Sheehan, Chairman, Electronic Brokerages
Systems, LLC, to Jonathan G. Katz, Secretary,
Commission, dated January 19, 2005 (‘‘Sheehan
Letter’’); letter from William O. Melvin, Jr.,
President, Acorn Derivatives Management, to
Jonathan G. Katz, Secretary, Commission, dated
January 19, 2005 (‘‘Melvin Letter’’); letter from
Margaret Wiermanski, Chief Operating &
Compliance Officer, Chicago Trading Company, to
Jonathan G. Katz, Secretary, Commission, dated
January 20, 2005 (‘‘Wiermanski Letter’’); email from
Jeffrey T. Kaufmann, Lakeshore Securities, L.P., to
Jonathan G. Katz, Secretary, Commission, dated
January 24, 2005 (‘‘Kaufmann Letter’’); letter from
J. Todd Weingart, Director of Floor Operations,
Mann Securities, to Jonathan G. Katz, Secretary,
Commission, dated January 25, 2005 (‘‘Weingart
Letter’’); letter from Charles Greiner III, LDB
Consulting, Inc., to Jonathan G. Katz, Secretary,
Commission, dated January 26, 2005 (‘‘Greiner
Letter’’); letter from Jack L. Hansen, Chief
Investment Officer and Principal, The Clifton
Group, to Jonathan G. Katz, Secretary, Commission,
dated February 1, 2005 (‘‘Hansen Letter’’); See letter
from Barbara Wierzynski, Executive Vice President
and General Counsel, Futures Industry Association,
and Ira D. Hammerman, Senior Vice President and
General Counsel, Securities Industry Association, to
Jonathan G. Katz, Secretary, Commission, dated
March 2, 2005 (‘‘Wierzynski/Hammerman Letter’’).
10 This release (Release No. 34–51614) seeks
comment on the proposed rule change, as amended,
by Amendment Nos. 1 and 2. Therefore, the
language of the proposed rule change, as amended,
is set forth in the release in its entirety.
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exchange-traded funds according to a
portfolio margin methodology as an
alternative to the current strategy-based
margin methodology. The proposed rule
change also will provide for crossmargining by allowing broad-based
index futures and options on such
futures to be included with listed,
broad-based index options, index
warrants and related exchange-traded
funds for portfolio margin treatment, in
a separate cross-margin account. The
text of the proposed rule change is
below. Additions are in italics.
Deletions are in brackets.
*
*
*
*
*
CHAPTER XII
Margins
[Covered Options Contracts]
Portfolio Margin and Cross-Margin for
Index Options
Rule 12.4. [Deleted January 15, 1975.]
As an alternative to the transaction/
position specific margin requirements
set forth in Rule 12.3 of this Chapter 12,
members may require margin for listed,
broad-based U.S. index options, index
warrants and underlying instruments
(as defined below) in accordance with
the portfolio margin requirements
contained in this Rule 12.4.
In addition, members, provided they
are a Futures Commission Merchant
(‘‘FCM’’) and are either a clearing
member of a futures clearing
organization or have an affiliate that is
a clearing member of a futures clearing
organization, are permitted under this
Rule 12.4 to combine a customer’s
related instruments (as defined below)
and listed, broad based U.S. index
options, index warrants and underlying
instruments and compute a margin
requirement (‘‘cross-margin’’) on a
portfolio margin basis. Members must
confine cross-margin positions to a
portfolio margin account dedicated
exclusively to cross-margining.
Application of the portfolio margin
and cross-margining provisions of this
Rule 12.4 to IRA accounts is prohibited.
(a) Definitions.
(1) The term ‘‘listed option’’ shall
mean any option traded on a registered
national securities exchange or
automated facility of a registered
national securities association.
(2) The term ‘‘unlisted option’’ means
any option not included in the
definition of listed option.
(3) The term ‘‘options class’’ refers to
all options contracts covering the same
underlying instrument.
(4) The term ‘‘portfolio’’ means
options of the same options class
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grouped with their underlying
instruments and related instruments.
(5) The term ‘‘option series’’ relates to
listed options and means all option
contracts of the same type (either a call
or a put) and exercise style, covering the
same underlying instrument with the
same exercise price, expiration date,
and number of underlying units.
(6) The term ‘‘related instrument’’
within an option class or product group
means futures contracts and options on
futures contracts covering the same
underlying instrument.
(7) The term ‘‘underlying instrument’’
means long and short positions in an
exchange traded fund or other fund
product registered under the Investment
Company Act of 1940 that holds the
same securities, and in the same
proportion, as contained in a broad
based index on which options are listed.
The term underlying instrument shall
not be deemed to include, futures
contracts, options on futures contracts,
underlying stock baskets, or unlisted
instruments.
(8) The term ‘‘product group’’ means
two or more portfolios of the same type
(see subparagraph (a)(9) below) for
which it has been determined by Rule
15c3–1a under the Securities Exchange
Act of 1934 that a percentage of
offsetting profits may be applied to
losses at the same valuation point.
(9) The term ‘‘theoretical gains and
losses’’ means the gain and loss in the
value of individual option series and
related instruments at 10 equidistant
intervals (valuation points) ranging from
an assumed movement (both up and
down) in the current market value of the
underlying instrument. The magnitude
of the valuation point range shall be as
follows:
Portfolio type
Up/down market
move (high & low
valuation points)
Non-high capitalization,
broad based U.S. market index option 11 .......
High capitalization, broad
based U.S. market
index option 1 ..............
+/¥10%
+6%/¥8%
1 In
accordance
with
sub-paragraph
(b)(1)(i)(B) of Rule 15c3–1a under the Securities Exchange Act of 1934.
(b) Eligible Participants. The
application of the portfolio margin
provisions of this Rule 12.4, including
cross-margining, is limited to the
following:
(1) any broker or dealer registered
pursuant to Section 15 of the Securities
Exchange Act of 1934;
(2) any member of a national futures
exchange to the extent that listed index
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options hedge the member’s index
futures; and
(3) any other person or entity not
included in (b)1 through (b)2 above that
has or establishes, and maintains,
equity of at least 5 million dollars. For
purposes of this equity requirement, all
securities and futures accounts carried
by the member for the same customer
may be combined provided ownership
across the accounts is identical. A
guarantee by any other account for
purposes of the minimum equity
requirement is not to be permitted.
(c) Opening of Accounts.
(1) Only customers that, pursuant to
Rule 9.7, have been approved for
options transactions, and specifically
approved to engage in uncovered short
option contracts, are permitted to utilize
a portfolio margin account.
(2) On or before the date of the initial
transaction in a portfolio margin
account, a member shall:
A. furnish the customer with a special
written disclosure statement describing
the nature and risks of portfolio
margining and cross-margining which
includes an acknowledgement for all
portfolio margin account owners to sign,
and an additional acknowledgement for
owners that also engage in crossmargining to sign, attesting that they
have read and understood the
disclosure statement, and agree to the
terms under which a portfolio margin
account and the cross-margin account,
respectively, are provided [see Rule
9.15(d)], and
B. obtain a signed
acknowledgement(s) from the customer,
both of which are required for crossmargining customers, and record the
date of receipt.
(d) Establishing Account and Eligible
Positions.
(1) Portfolio Margin Account. For
purposes of applying the portfolio
margin requirements provided in this
Rule 12.4, members are to establish and
utilize a dedicated securities margin
account, or sub-account of a margin
account, clearly identified as a portfolio
margin account that is separate from
any other securities account carried for
a customer.
(2) Cross-Margin Account. For
purposes of combining related
instruments and listed, broad-based
U.S. index options, index warrants and
underlying instruments and applying
the portfolio margin requirements
provided in this Rule 12.4, members are
to establish and utilize a portfolio
margin account, clearly identified as a
cross-margin account, that is separate
from any other securities account or
portfolio margin account carried for a
customer.
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A margin deficit in either the portfolio
margin account or the cross-margin
account of a customer may not be
considered as satisfied by excess equity
in the other account. Funds and/or
securities must be transferred to the
deficient account and a written record
created and maintained.
(3) Portfolio Margin Account—Eligible
Positions
(i) A transaction in, or transfer of, a
listed, broad-based U.S. index option or
index warrant may be effected in the
portfolio margin account.
(ii) A transaction in, or transfer of, an
underlying instrument may be effected
in the portfolio margin account
provided a position in an offsetting
listed, broad-based U.S. index option or
index warrant is in the account or is
established in the account on the same
day.
(iii) If, in the portfolio margin
account, the listed, broad-based U.S.
index option or index warrant position
offsetting an underlying instrument
position ceases to exist and is not
replaced within 10 business days, the
underlying instrument position must be
transferred to a regular margin account,
subject to Regulation T initial margin
and the margin required pursuant to the
other provisions of this chapter.
Members will be expected to monitor
portfolio margin accounts for possible
abuse of this provision.
(iv) In the event that fully paid for
long options and/or index warrants are
the only positions contained within a
portfolio margin account, such long
positions must be transferred to a
securities account other than a portfolio
margin account or cross-margin account
within 10 business days, subject to the
margin required pursuant to the other
provisions of this chapter, unless the
status of the account changes such that
it is no longer composed solely of fully
paid for long options and/or index
warrants.
(4) Cross-Margin Account—Eligible
Positions
(i) A transaction in, or transfer of, a
related instrument may be effected in
the cross-margin account provided a
position in an offsetting listed, U.S.
broad based index option, index
warrant or underlying instrument is in
the account or is established in the
account on the same day.
(ii) If the listed, U.S. broad-based
index option, index warrant or
underlying instrument position
offsetting a related instrument ceases to
exist and is not replaced within 10
business days, the related instrument
position must be transferred to a futures
account. Members will be expected to
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22937
monitor cross-margin accounts for
possible abuse of this provision.
(iii) In the event that fully paid for
long options and/or index warrants
(securities) are the only positions
contained within a cross-margin
account, such long positions must be
transferred to a securities account other
than a portfolio margin account or
cross-margin account within 10 business
days, subject to the margin required
pursuant to the other provisions of this
chapter, unless the status of the account
changes such that it is no longer
composed solely of fully paid for long
options and/or index warrants.
(e) Initial and Maintenance Margin
Required. The amount of margin
required under this Rule 12.4 for each
portfolio shall be the greater of:
(1) the amount for any of the 10
equidistant valuation points
representing the largest theoretical loss
as calculated pursuant to paragraph (f)
below or
(2) $.375 for each listed index option
and related instrument multiplied by
the contract or instrument’s multiplier,
not to exceed the market value in the
case of long positions in listed options
and options on futures contracts.
(f) Method of Calculation.
(1) Long and short positions in listed
options, underlying instruments and
related instruments are to be grouped by
option class; each option class group
being a ‘‘portfolio’’. Each portfolio is
categorized as one of the portfolio types
specified in paragraph (a)(9) above.
(2) For each portfolio, theoretical
gains and losses are calculated for each
position as specified in paragraph (a)(9)
above. For purposes of determining the
theoretical gains and losses at each
valuation point, members shall obtain
and utilize the theoretical value of a
listed index option, underlying
instrument or related instrument
rendered by a theoretical pricing model
that, in accordance with paragraph
(b)(1)(i)(B) of Rule 15c3–1a under the
Securities Exchange Act of 1934,
qualifies for purposes of determining the
amount to be deducted in computing
net capital under a portfolio based
methodology.
(3) Offsets. Within each portfolio,
theoretical gains and losses may be
netted fully at each valuation point.
Offsets between portfolios within the
High Capitalization, Broad Based Index
Option product group and the Non-High
Capitalization, Broad Based Index
Option product group may then be
applied as permitted by Rule 15c3–1a
under the Securities Exchange Act of
1934.
(4) After applying paragraph (3)
above, the sum of the greatest loss from
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Federal Register / Vol. 70, No. 84 / Tuesday, May 3, 2005 / Notices
each portfolio is computed to arrive at
the total margin required for the
account (subject to the per contract
minimum).
(g) Equity Deficiency. If, at any time,
equity declines below the 5 million
dollar minimum required under
Paragraph (b)(4) of this Rule 12.4 and is
not brought back up to at least 5 million
dollars within three (3) business days
(T+3) by a deposit of funds or securities,
or through favorable market action;
members are prohibited from accepting
opening orders starting on T+4, except
that opening orders entered for the
purpose of hedging existing positions
may be accepted if the result would be
to lower margin requirements. This
prohibition shall remain in effect until
such time as an equity of 5 million
dollars is established.
(h) Determination of Value for Margin
Purposes. For the purposes of this Rule
12.4, all listed index options and related
instrument positions shall be valued at
current market prices. Account equity
for the purposes of this Rule 12.4 shall
be calculated separately for each
portfolio margin account by adding the
current market value of all long
positions, subtracting the current
market value of all short positions, and
adding the credit (or subtracting the
debit) balance in the account.
(i) Additional Margin.
(1) If at any time, the equity in any
portfolio margin account, including a
cross-margin account, is less than the
margin required, additional margin
must be obtained within one business
day (T+1). In the event a customer fails
to deposit additional margin within one
business day, the member must
liquidate positions in an amount
sufficient to, at a minimum, lower the
total margin required to an amount less
than or equal to account equity.
Exchange Rule 12.9—Meeting Margin
Calls by Liquidation shall not apply to
portfolio margin accounts. However,
members will be expected to monitor the
risk of portfolio margin accounts
pursuant to the risk monitoring
procedures required by Rule 15.8A.
Guarantees by any other account for
purposes of margin requirements are not
to be permitted.
(2) The day trading requirements of
Exchange Rule 12.3(j) shall not apply to
portfolio margin accounts, including
cross-margin accounts.
(j) Cross-Margin Accounts—
Requirement to Liquidate.
(1) A member is required immediately
either to liquidate, or transfer to another
broker-dealer eligible to carry crossmargin accounts, all customer crossmargin accounts that contain positions
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in futures and/or options on futures if
the member is:
(i) insolvent as defined in section 101
of title 11 of the United States Code, or
is unable to meet its obligations as they
mature;
(ii) the subject of a proceeding
pending in any court or before any
agency of the United States or any State
in which a receiver, trustee, or
liquidator for such debtor has been
appointed;
(iii) not in compliance with applicable
requirements under the Securities
Exchange Act of 1934 or rules of the
Securities and Exchange Commission or
any self-regulatory organization with
respect to financial responsibility or
hypothecation of customers’ securities;
or
(iv) unable to make such
computations as may be necessary to
establish compliance with such
financial responsibility or
hypothecation rules.
(2) Nothing in this paragraph (j) shall
be construed as limiting or restricting in
any way the exercise of any right of a
registered clearing agency to liquidate or
cause the liquidation of positions in
accordance with its by-laws and rules.
*
*
*
*
*
Chapter XIII
Net Capital
Customer Portfolio Margin Accounts
Rule 13.5. (a) No member
organization that requires margin in any
customer accounts pursuant to Rule
12.4—Portfolio Margin and CrossMargin for Index Options, shall permit
gross customer portfolio margin
requirements to exceed 1,000 percent of
its net capital for any period exceeding
three business days. The member
organization shall, beginning on the
fourth business day of any noncompliance, cease opening new
portfolio margin accounts until
compliance is achieved.
(b) If, at any time, a member
organization’s gross customer portfolio
margin requirements exceed 1,000
percent of its net capital, the member
organization shall immediately transmit
telegraphic or facsimile notice of such
deficiency to the Securities and
Exchange Commission, 450 Fifth Street
NW., Washington, DC 20549; to the
district or regional office of the
Securities and Exchange Commission
for the district or region in which the
member organization maintains its
principal place of business; and to its
Designated Examining Authority.
*
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Chapter XV
Records, Reports and Audits
Risk Analysis of Portfolio Margin
Accounts
Rule 15.8A. (a) Each member
organization that maintains any
portfolio margin accounts for customers
shall establish and maintain written
procedures for assessing and monitoring
the potential risk to the member
organization’s capital over a specified
range of possible market movements of
positions maintained in such accounts.
Current procedures shall be filed and
maintained with the Department of
Financial and Sales Practice
Compliance. The procedures shall
specify the computations to be made,
the frequency of computations, the
records to be reviewed and maintained,
and the position(s) within the
organization responsible for the risk
function.
(b) Upon direction by the Department
of Financial and Sales Practice
Compliance, each affected member
organization shall provide to the
Department such information as the
Department may reasonably require
with respect to the member
organization’s risk analysis for any or
all of the portfolio margin accounts it
maintains for customers.
(c) In conducting the risk analysis of
portfolio margin accounts required by
this Rule 15.8A, each affected member
organization is required to follow the
Interpretations and Policies set forth
under Rule 15.8—Risk Analysis of
Market-Maker Accounts. In addition,
each affected member organization
shall include in written procedures
required pursuant to paragraph (a)
above the following:
(1) Procedures and guidelines for the
determination, review and approval of
credit limits to each customer, and
across all customers, utilizing a
portfolio margin account.
(2) Procedures and guidelines for
monitoring credit risk exposure to the
member organization, including intraday credit risk, related to portfolio
margin accounts.
(3) Procedures and guidelines for the
use of stress testing of portfolio margin
accounts in order to monitor market risk
exposure from individual accounts and
in the aggregate.
(4) Procedures providing for the
regular review and testing of these risk
analysis procedures by an independent
unit such as internal audit or other
comparable group.
*
*
*
*
*
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Chapter 9
Doing Business with the Public
Delivery of Current Options Disclosure
Documents and Prospectus
Rule 9.15. (a) no change
(b) no change
(c) no change
(d) The special written disclosure
statement describing the nature and
risks of portfolio margining and crossmargining, and acknowledgement for
customer signature, required by Rule
12.4(c)(2) shall be in a format prescribed
by the Exchange or in a format
developed by the member organization,
provided it contains substantially
similar information as the prescribed
Exchange format and has received prior
written approval of the Exchange.
Sample Risk Description for Use by
Firms to Satisfy Requirements of
Exchange Rule 9.15(d)
Portfolio Margining and CrossMargining Disclosure Statement and
Acknowledgement
For a Description of the Special Risks
Applicable to a Portfolio Margin
Account and its Cross-Margining
Features, See the Material Under Those
Headings Below.
Overview of Portfolio Margining
1. Portfolio margining is a margin
methodology that sets margin
requirements for an account based on
the greatest projected net loss of all
positions in a ‘‘product class’’ or
‘‘product group’’ as determined by an
options pricing model using multiple
pricing scenarios. These pricing
scenarios are designed to measure the
theoretical loss of the positions given
changes in both the underlying price
and implied volatility inputs to the
model. Portfolio margining is currently
limited to product classes and groups of
index products relating to broad-based
market indexes.
2. The goal of portfolio margining is
to set levels of margin that more
precisely reflect actual net risk. The
customer benefits from portfolio
margining in that margin requirements
calculated on net risk are generally
lower than alternative ‘‘position’’ or
‘‘strategy’’ based methodologies for
determining margin requirements.
Lower margin requirements allow the
customer more leverage in an account.
Customers Elibible for Portfolio
Margining
3. To be eligible for portfolio
margining, customers (other than
broker-dealers) must meet the basic
standards for having an options account
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that is approved for uncovered writing
and must have and maintain at all times
account net equity of not less than $5
million, aggregated across all accounts
under identical ownership at the
clearing broker. The identical ownership
requirement excludes accounts held by
the same customer in different
capacities (e.g., as a trustee and as an
individual) and accounts where
ownership is overlapping but not
identical (e.g., individual accounts and
joint accounts).
Positions Eligible for a Portfolio Margin
Account
4. All positions in broad-based U.S.
market index options and index
warrants listed on a national securities
exchange, and exchange traded funds
and other fund products registered
under the Investment Company Act of
1940 that are managed to track the
same index that underlies permitted
index options, are eligible for a portfolio
margin account.
Special Rules for Portfolio Margin
Accounts
5. A portfolio margin account may be
either a separate account or a
subaccount of a customer’s regular
margin account. In the case of a
subaccount, equity in the regular
account will be available to satisfy any
margin requirement in the portfolio
margin subaccount without transfer to
the subaccount.
6. A portfolio margin account or
subaccount will be subject to a
minimum margin requirement of $.375
multiplied by the index multiplier for
every options contract or index warrant
carried long or short in the account. No
minimum margin is required in the case
of eligible exchange traded funds or
other eligible fund products.
7. Margin calls in the portfolio margin
account or subaccount, regardless of
whether due to new commitments or the
effect of adverse market moves on
existing positions, must be met within
one business day. Any shortfall in
aggregate net equity across accounts
must be met within three business days.
Failure to meet a margin call when due
will result in immediate liquidation of
positions to the extent necessary to
reduce the margin requirement. Failure
to meet an equity call prior to the end
of the third business day will result in
a prohibition on entering any opening
orders, with the exception of opening
orders that hedge existing positions,
beginning on the fourth business day
and continuing until such time as the
minimum equity requirement is
satisfied.
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22939
8. A position in an exchange traded
index fund or other eligible fund
product may not be established in a
portfolio margin account unless there
exists, or there is established on the
same day, an offsetting position in
securities options or other eligible
securities. Exchange traded index funds
and/or other eligible funds will be
transferred out of the portfolio margin
account and into a regular securities
account subject to strategy based margin
if, for more than 10 business days and
for any reason, the offsetting securities
options or other eligible securities no
longer remain in the account.
9. When a broker-dealer carries a
regular cash account or margin account
for a customer, the broker-dealer is
limited by rules of the Securities and
Exchange Commission and of The
Options Clearing Corporation (‘‘OCC’’)
in the extent to which the broker-dealer
may permit OCC to have a lien against
long option positions in those accounts.
In contrast, OCC will have a lien against
all long option positions that are carried
by a broker-dealer in a portfolio margin
account, and this could, under certain
circumstances, result in greater losses to
a customer having long option positions
in such an account in the event of the
insolvency of the customer’s broker.
Accordingly, to the extent that a
customer does not borrow against long
option positions in a portfolio margin
account or have margin requirements in
the account against which the long
option can be credited, there is no
advantage to carrying the long options
in a portfolio margin account and the
customer should consider carrying them
in an account other than a portfolio
margin account.
Special Risks of Portfolio Margin
Accounts
10. Portfolio margining generally
permits greater leverage in an account,
and greater leverage creates greater
losses in the event of adverse market
movements.
11. Because the time limit for meeting
margin calls is shorter than in a regular
margin account, there is increased risk
that a customer’s portfolio margin
account will be liquidated involuntarily,
possibly causing losses to the customer.
12. Because portfolio margin
requirements are determined using
sophisticated mathematical calculations
and theoretical values that must be
calculated from market data, it may be
more difficult for customers to predict
the size of future margin calls in a
portfolio margin account. This is
particularly true in the case of
customers who do not have access to
specialized software necessary to make
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such calculations or who do not receive
theoretical values calculated and
distributed periodically by The OCC.
13. For the reasons noted above, a
customer that carries long options
positions in a portfolio margin account
could, under certain circumstances, be
less likely to recover the full value of
those positions in the event of the
insolvency of the carrying broker.
14. Trading of securities index
products in a portfolio margin account
is generally subject to all the risks of
trading those same products in a regular
securities margin account. Customers
should be thoroughly familiar with the
risk disclosure materials applicable to
those products, including the booklet
entitled Characteristics and Risks of
Standardized Options.
15. Customers should consult with
their tax advisers to be certain that they
are familiar with the tax treatment of
transactions in securities index
products.
16. The descriptions in this disclosure
statement relating to eligibility
requirements for portfolio margin
accounts, and minimum equity and
margin requirements for those accounts,
are minimums imposed under exchange
rules. Time frames within which margin
and equity calls must be met are
maximums imposed under exchange
rules. Broker-dealers may impose their
own more stringent requirements.
Overview of Cross-Margining
17. With cross-margining, index
futures and options on index futures are
combined with offsetting positions in
securities index options and underlying
instruments, for the purpose of
computing a margin requirement based
on the net risk. This generally produces
lower margin requirements than if the
futures products and securities products
are viewed separately, thus providing
more leverage in the account.
18. Cross-margining must be done in
a portfolio margin account type. A
separate portfolio margin account must
be established exclusively for crossmargining.
19. When index futures and options
on futures are combined with offsetting
positions in index options and
underlying instruments in a dedicated
account, and a portfolio margining
methodology is applied to them, crossmargining is achieved.
Customers Eligible for Cross-Margining
20. The eligibility requirements for
cross-margining are generally the same
as for portfolio margining, and any
customer eligible for portfolio margining
is eligible for cross-margining.
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21. Members of futures exchanges on
which cross-margining eligible index
contracts are traded are also permitted
to carry positions in cross-margin
accounts without regard to the
minimum aggregate account equity.
Positions Eligible for Cross-Margining
22. All securities products eligible for
portfolio margining are also eligible for
cross-margining.
23. All broad-based U.S. market index
futures and options on index futures
traded on a designated contract market
subject to the jurisdiction of the
Commodity Futures Trading
Commission are eligible for crossmargining.
Special Rules for Cross-Margining
24. Cross-margining must be
conducted in a portfolio margin account
type. A separate portfolio margin
account must be established exclusively
for cross-margining. A cross-margin
account is a securities account, and
must be maintained separate from all
other securities accounts.
25. Cross-margining is automatically
accomplished with the portfolio
margining methodology. Cross-margin
positions are subject to the same
minimum margin requirement for every
contract, including futures contracts.
26. Margin calls arising in the crossmargin account, and any shortfall in
aggregate net equity across accounts,
must be satisfied within the same time
frames, and subject to the same
consequences, as in a portfolio margin
account.
27. A position in a futures product
may not be established in a crossmargin account unless there exists, or
there is established on the same day, an
offsetting position in securities options
and/or other eligible securities. Futures
products will be transferred out of the
cross-margin account and into a futures
account if, for more than 10 business
days and for any reason, the offsetting
securities options and/or other eligible
securities no longer remain in the
account. If the transfer of futures
products to a futures account causes the
futures account to be undermargined, a
margin call will be issued or positions
will be liquidated to the extent
necessary to eliminate the deficit.
28. According to the rules of the
exchanges, a broker-dealer is required to
immediately liquidate, or, if feasible,
transfer to another broker-dealer eligible
to carry cross-margin accounts, all
customer cross-margin accounts that
contain positions in futures and/or
options on futures in the event that the
carrying broker-dealer becomes
insolvent.
PO 00000
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Fmt 4703
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29. Customers participating in crossmargining will be required to sign an
agreement acknowledging that their
positions and property in the crossmargin account will be subject to the
customer protection provisions of Rule
15c3–3 under the Securities Exchange
Act of 1934 and the Securities Investor
Protection Act, and will not be subject
to the provisions of the Commodity
Exchange Act, including segregation of
funds.
30. In signing the agreement referred
to in paragraph 29 above, a customer
also acknowledges that a cross-margin
account that contains positions in
futures and/or options on futures will be
immediately liquidated, or, if feasible,
transferred to another broker-dealer
eligible to carry cross-margin accounts,
in the event that the carrying brokerdealer becomes insolvent.
Special Risks of Cross-Margining
31. Cross-margining must be
conducted in a portfolio margin account
type. Generally, cross-margining and the
portfolio margining methodology both
contribute to provide greater leverage
than a regular margin account, and
greater leverage creates greater losses in
the event of adverse market movements.
32. As cross-margining must be
conducted in a portfolio margin account
type, the time required for meeting
margin calls is shorter than in a regular
securities margin account and may be
shorter than the time ordinarily required
by a futures commission merchant for
meeting margin calls in a futures
account. As a result, there is increased
risk that a customer’s cross-margin
positions will be liquidated
involuntarily, causing possible loss to
the customer.
33. As noted above, cross-margin
accounts are securities accounts and are
subject to the customer protections setforth in Rule 15c3–3 under the
Securities Exchange Act of 1934 and the
Securities Investor Protection Act.
Cross-margin positions are not subject
to the customer protection rules under
the segregation provisions of the
Commodity Exchange Act and the rules
of the Commodity Futures Trading
Commission (‘‘CFTC’’) adopted
pursuant to the Commodity Exchange
Act.
34. Trading of index options and
futures contracts in a cross-margin
account is generally subject to all the
risks of trading those same products in
a futures account or a regular securities
margin account, as the case may be.
Customers should be thoroughly
familiar with the risk disclosure
materials applicable to those products,
including the booklet entitled
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Characteristics and Risks of
Standardized Options and the risk
disclosure document required by the
CFTC to be delivered to futures
customers. Because this disclosure
statement does not disclose the risks
and other significant aspects of trading
in futures and options, customers
should review those materials carefully
before trading in a cross-margin
account.
35. Customers should bear in mind
that the discrepancies in the cash flow
characteristics of futures and certain
options are still present even when those
products are carried together in a crossmargin account. Both futures and
options contracts are generally marked
to the market at least once each
business day, but the marks may take
place with different frequency and at
different times within the day. When a
futures contract is marked to the
market, the gain or loss is immediately
credited to or debited from, respectively,
the customer’s account in cash. While
an increase in value of a long option
contract may increase the equity in the
account, the gain is not realized until
the option is sold or exercised.
Accordingly, a customer may be
required to deposit cash in the account
in order to meet a variation payment on
a futures contract even though the
customer is in a hedged position and
has experienced a corresponding (but as
yet unrealized) gain on a long option.
On the other hand, a customer who is
in a hedged position and would
otherwise be entitled to receive a
variation payment on a futures contract
may find that the cash is required to be
held in the account as margin collateral
on an offsetting option position.
36. Customers should consult with
their tax advisers to be certain that they
are familiar with the tax treatment of
transactions in index products,
including tax consequences of trading
strategies involving both futures and
option contracts.
37. The descriptions in this disclosure
statement relating to eligibility
requirements for cross-margining, and
minimum equity and margin
requirements for cross-margin accounts,
are minimums imposed under exchange
rules. Time frames within which margin
and equity calls must be met are
maximums imposed under exchange
rules. The broker-dealer carrying a
customer’s portfolio margin account,
including any cross-margin account,
may impose its own more stringent
requirements.
*
*
*
*
*
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Acknowledgement for Customers
Utilizing a Portfolio Margin Account—
Cross-Margining and non CrossMargining
Rule 15c3–3 under the Securities
Exchange Act of 1934 requires that a
broker or dealer promptly obtain and
maintain physical possession or control
of all fully-paid securities and excess
margin securities of a customer. Fullypaid securities are securities carried in
a cash account and margin equity
securities carried in a margin or special
account (other than a cash account) that
have been fully paid for. Excess margin
securities are a customer’s margin
securities having a market value in
excess of 140% of the total of the debit
balances in the customer’s non-cash
accounts. For the purposes of Rule
15c3–3, securities held subject to a lien
to secure obligations of the brokerdealer are not within the broker-dealer’s
physical possession or control. The
Commission staff has taken the position
that all long option positions in a
customer’s portfolio-margining account
(including any cross-margining account)
may be subject to such a lien by OCC
and will not be deemed fully-paid or
excess margin securities under Rule
15c3–3.
The hypothecation rules under the
Securities Exchange Act of 1934 (Rules
8c–1 and 15c2–1), prohibit brokerdealers from permitting the
hypothecation of customer securities in
a manner that allows those securities to
be subject to any lien or liens in an
amount that exceeds the customer’s
aggregate indebtedness. However, all
long option positions in a portfoliomargining account (including any crossmargining account) will be subject to
OCC’s lien, including any positions that
exceed the customer’s aggregate
indebtedness. The Commission staff has
taken a position that would allow
customers to carry positions in
portfolio-margining accounts (including
any cross-margining account), even
when those positions exceed the
customer’s aggregate indebtedness.
Accordingly, within a portfolio margin
account or cross-margin account, to the
extent that you have long option
positions that do not operate to offset
your aggregate indebtedness and
thereby reduce your margin
requirement, you receive no benefit from
carrying those positions in your
portfolio margin account or crossmargin account and incur the
additional risk of OCC’s lien on your
long option position(s).
BY SIGNING BELOW, THE
CUSTOMER AFFIRMS THAT THE
CUSTOMER HAS READ AND
PO 00000
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22941
UNDERSTOOD THE FOREGOING
DISCLOSURE STATEMENT AND
ACKNOWLEDGES AND AGREES THAT
LONG OPTION POSITIONS IN
PORTFOLIO-MARGINING ACCOUNTS
AND CROSS-MARGINING ACCOUNTS
WILL BE EXEMPTED FROM CERTAIN
CUSTOMER PROTECTION RULES OF
THE SECURITIES AND EXCHANGE
COMMISSION AS DESCRIBED ABOVE
AND WILL BE SUBJECT TO A LIEN BY
THE OPTIONS CLEARING
CORPORATION WITHOUT REGARD
TO SUCH RULES.
CUSTOMER NAME: lllllllll
llllllllllllllllll
l
BY: llllllllllllllll
llllllllllllllllll
l
(signature/title)
DATE: lllllllllllllll
llllllllllllllllll
l
*
*
*
*
*
ACKNOWLEDGEMENT FOR
CUSTOMERS ENGAGED IN CROSSMARGINING
As disclosed above, futures contracts
and other property carried in customer
accounts with Futures Commission
Merchants (‘‘FCM’’) are normally subject
to special protection afforded under the
customer segregation provisions of the
Commodity Exchange Act (‘‘CEA’’) and
the rules of the CFTC adopted pursuant
to the CEA. These rules require that
customer funds be segregated from the
accounts of financial intermediaries and
be separately accounted for, however,
they do not provide for, and regular
futures accounts do not enjoy the
benefit of, insurance protecting
customer accounts against loss in the
event of the insolvency of the
intermediary carrying the accounts.
As also has been discussed above,
cross-margining must be conducted in a
portfolio margin account dedicated
exclusively to cross-margining, and
cross-margin accounts are not treated as
a futures account with an FCM. Instead,
cross-margin accounts are treated as
securities accounts carried with brokerdealers. As such, cross-margin accounts
are covered by Rule 15c3–3 under the
Securities Exchange Act of 1934, which
protects customer accounts. Rule 15c3–
3, among other things, requires a brokerdealer to maintain physical possession
or control of all fully-paid and excess
margin securities and maintain a
special reserve account for the benefit of
their customers. However, in respect of
cross-margin accounts, there is an
exception to the possession or control
requirement of Rule 15c3–3 that permits
The Options Clearing Corporation to
have a lien on long positions. This
aspect is outlined in a separate
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acknowledgement form that must be
signed prior to or concurrent with this
form. Additionally, the Securities
Investor Protection Corporation
(‘‘SIPC’’) insures customer accounts
against the financial insolvency of a
broker-dealer in the amount of up to
$500,000 to protect against the loss of
registered securities and cash
maintained in the account for
purchasing securities or as proceeds
from selling securities (although the
limit on cash claims is $100,000).
According to the rules of the exchanges,
a broker-dealer is required to
immediately liquidate, or, if feasible,
transfer to another broker-dealer eligible
to carry cross-margin accounts, all
customer cross-margin accounts that
contain positions in futures and/or
options on futures in the event that the
carrying broker-dealer becomes
insolvent.
BY SIGNING BELOW, THE
CUSTOMER AFFIRMS THAT THE
CUSTOMER HAS READ AND
UNDERSTOOD THE FOREGOING
DISCLOSURE STATEMENT AND
ACKNOWLEDGES AND AGREES THAT:
1) POSITIONS AND PROPERTY IN
CROSS-MARGINING ACCOUNTS, WILL
NOT BE SUBJECT TO THE CUSTOMER
PROTECTION RULES UNDER THE
CUSTOMER SEGREGATION
PROVISIONS OF THE COMMODITY
EXCHANGE ACT (‘‘CEA’’) AND THE
RULES OF THE COMMODITY
FUTURES TRADING COMMISSION
ADOPTED PURSUANT TO THE CEA,
AND 2) CROSS-MARGINING
ACCOUNTS THAT CONTAIN
POSITIONS IN FUTURES AND/OR
OPTIONS ON FUTURES WILL BE
IMMEDIATELY LIQUIDATED, OR, IF
FEASIBLE, TRANSFERED TO
ANOTHER BROKER-DEALER ELIGIBLE
TO CARRY CROSS-MARGIN
ACCOUNTS, IN THE EVENT THAT
THE CARRYING BROKER-DEALER
BECOMES INSOLVENT.
CUSTOMER NAME: lllllllll
llllllllllllllllll
l
BY: llllllllllllllll
llllllllllllllllll
l
(signature/title)
DATE: lllllllllllllll
llllllllllllllllll
l
*
*
*
*
*
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
CBOE included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
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rule change. The text of these statements
may be examined at the places specified
in Item IV below. The CBOE has
prepared summaries, set forth in
Sections A, B, and C below, of the most
significant aspects of such statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
a. Introduction
The CBOE proposes to expand its
margin rules by providing a portfolio
margin methodology for listed, broadbased market index options, index
warrants and related exchange-traded
funds that clearing member
organizations may extend to eligible
customers as an alternative to the
current strategy-based option margin
requirements. The proposed rule change
would also allow broad-based index
futures and options on such futures to
be included in a separate portfolio
margin account, thus providing a crossmargin capability. The CBOE seeks to
introduce the proposed new rule as a
two-year pilot program that would be
made available to member organizations
on a voluntary basis.
The proposed rule change would
permit self-clearing member
organizations to apply a prescribed
portfolio margin methodology to an
account 11 of another broker-dealer and
an account of a member of a national
futures exchange who is a futures floor
trader. Any other customers or affiliates
of the clearing member would be
required to have account equity of at
least $5 million to be eligible for
portfolio margin treatment. This
circumscribes the number of accounts
able to participate and adds safety in
that such accounts are more likely to be
of significant financial means and
investment sophistication.
The Exchange submitted this partial
amendment, constituting Amendment
No. 2, pursuant to the request of
Commission staff. Specifically, the
Exchange proposes to amend the
proposed rule (Rule 12.4) to remove the
provision in current paragraph (b)(2)
that makes ‘‘any affiliate of a selfclearing member organization’’ eligible
for portfolio margining. Removal of this
provision would not exclude an affiliate
of a self-clearing member organization
from participation, but would
necessitate that such entities have
minimum account equity of five million
dollars in order to participate, as
required under current paragraph (b)(4).
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11 An
account dedicated to portfolio margining.
Frm 00102
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Current paragraph (b)(3) would be
renumbered (b)(2), and current
paragraph (b)(4) would be renumbered
(b)(3).
In relation to the change noted above,
the Exchange also proposes in
Amendment No. 2 to revise paragraph
number 3 of the Sample Risk
Description for Use by Firms To Satisfy
Requirements of Exchange Rule 9.15(d)
to remove the words ‘‘and certain nonbroker-dealer affiliates of the carrying
broker-dealer’’ in the first sentence. This
change to the notice would reflect that
non-broker-dealer affiliates would be
subject to the $5 million equity
requirement. With the exception of
these changes, the rest of the proposed
rule changes, as contained in the
Original Proposal, as amended by
Amendment No. 1,12 remain
unchanged.
Portfolio margining is most effective
when applied to larger accounts with
diverse option positions and related
securities, and any related futures
contracts. It is expected that
institutional customers will be the
primary participants. Whether the
account equity requirement should be
lowered to allow participation of more
customers will be assessed at the end of
the pilot program period. Application of
portfolio margin, including crossmargin, to an IRA account would be
prohibited under the proposed rule
change.
The proposed portfolio margin and
cross-margin rules have been developed
by the CBOE in cooperation with The
Options Clearing Corporation (‘‘The
OCC’’), the New York Stock Exchange,
Inc. (‘‘NYSE’’), the American Stock
Exchange LLC, the Board of Trade of the
City of Chicago, Inc., and the Chicago
Mercantile Exchange Inc. (‘‘CME’’). The
CBOE intends to provide a written
overview describing the operational
details of the portfolio margin and crossmargin pilot program to potential
member organization participants to
introduce and explain the pilot
program.
A committee of representatives from
the member organizations identified as
potential participants, and staff of the
sponsoring exchanges and The OCC (the
‘‘Portfolio Margin Committee’’) was
formed and met several times in 1999
and 2000 to refine the portfolio margin
and cross-margin pilot program. This
12 A number of revisions contained in
Amendment No. 1 were deemed warranted, or
requested or recommended by staff of the
Commission. In either case, the reason for these
revisions was to make corrections or clarifications
to the proposed rule, or to reconcile differences
between the proposed rule and a parallel filing by
the NYSE. See, supra notes 7 and 8.
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group has recommended adoption of the
portfolio margin and cross-margin pilot
program, as finalized by the group, and
the related rule proposals. In addition,
the portfolio margin and cross-margin
pilot program has been presented to the
NYSE’s Rule 431 Committee 13 on two
occasions, with draft rules included on
the second occasion, and has received
the NYSE’s Rule 431 Committee’s
support.
b. Overview—Portfolio Margin
Computation
(1) Portfolio Margin
Under a portfolio margin system,
margin is required based on the greatest
loss that would be incurred in a
portfolio if the value of components
(underlying instruments in the case of
options) move up or down by a
predetermined amount (e.g., +/¥5%).
Under the Exchange’s proposed
portfolio margin rule, listed index
options and underlying instruments
(also related instruments 14 in the case
of a cross-margin account) would be
grouped by class 15 (e.g., S&P 500, S&P
100, etc.), each class group being a
portfolio.16 The gain or loss on each
position in a portfolio would be
calculated at each of 10 equidistant
points (‘‘valuation points’’) set at and
between the upper and lower market
range points. A theoretical options
pricing model would be used to derive
position values 17 at each valuation
point for the purpose of determining the
gain or loss. Gains and losses would
then be netted for positions within the
class or portfolio at each valuation
point. The greatest net loss among the
10 valuation points would be the margin
required on the portfolio or class. The
margin for all other portfolios within an
account would be calculated in a similar
manner. Broad-based index classes
(portfolios) that are highly correlated
13 The NYSE Rule 431 Committee is comprised of
securities industry representatives, primarily
representatives of NYSE member organizations.
NYSE Rule 431 contains the NYSE’s margin rules.
The function of the NYSE Rule 431 Committee is
to assess the adequacy of NYSE Rule 431 on an
ongoing basis, review proposals for changes to
NYSE Rule 431, and recommend changes that are
deemed appropriate.
14 Under the proposed rule change, the term
‘‘related instrument’’ would mean, with respect to
an options class or product group, futures contracts
and options on futures contracts covering the same
underlying instrument.
15 Under the proposed rule change, the term
‘‘options class’’ would refer to all options contracts
covering the same underlying instrument.
16 CBOE’s pilot program would permit an
exchange-traded fund structured to replicate the
composition of the index to be included; however,
stock baskets would not be permitted at this time.
17 Position values would represent the difference
between the position closing price and the
theoretical value at each valuation point.
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would be allowed offsets such that, at
the same valuation point, for example,
90% of a gain in one class may reduce
or offset a loss in another class. The
amount of offset allowed between
portfolios would be the same amount
that is permitted under the risk-based
haircut methodology set forth in
Appendix A of the Commission’s net
capital rule.18 A per contract minimum
would be established and would
override if a lesser requirement is
rendered by the portfolio margin
computation.19 Member organizations
would not be permitted to use any
theoretical pricing model to generate the
prices used to calculate theoretical
profits and losses. Under the proposed
rule change, the theoretical prices used
for computing profits and losses must
come from a theoretical pricing model
that, pursuant to the Commission’s net
capital rule,20 qualifies for purposes of
determining the amount to be deducted
in computing net capital under a
portfolio-based methodology. CBOE
believes that delineating acceptable
theoretical pricing models is best
achieved by applying the Commission’s
net capital rule by reference. In this
way, consistency with the Commission’s
net capital rule is maintained. In
addition, since theoretical pricing
models must be approved by a
Designated Examining Authority and
reviewed by the Commission to qualify,
uniformity across models can be
assured. As a result, portfolio margin
and cross-margin requirements will not
vary materially from firm to firm.
Currently, the theoretical model used by
The OCC is the only model qualified
pursuant to the Commission’s net
capital rule. Consequently, all member
organizations participating in the pilot
program would, at least for the
foreseeable future, obtain their
theoretical values from The OCC.
The Exchange’s proposed rule would
propose a market range of +/¥10% for
computing theoretical gains and losses
in broad-based, non-high capitalization
index portfolios. A market range of +6%
/¥8% is proposed for broad-based, high
capitalization index portfolios.21 These
18 Rule
15c3–1a under the Act, 17 CFR 240.15c3–
1a.
19 The proposed rules set a per contract minimum
of $37.50.
20 See Rule 15c3–1a(b)(1)(i)(B) under the Act, 17
CFR 240.15c3–1a(b)(1)(i)(B).
21 CBOE believes that it is imperative that these
market move ranges be competitive with the range
used in the futures industry for computing margin
(performance bond) on broad-based index futures.
The proposed ranges accomplish this goal.
Customer performance bond in the futures industry
is computed using a portfolio margining system
known as the Standard Portfolio Analysis of Risk
(‘‘SPAN’’). The terms ‘‘high capitalization’’ and
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22943
are the same ranges currently applied to
options market makers for the purpose
of computing portfolio or risk-based
haircuts. On a historical basis, these
ranges cover one day moves at a very
high level of confidence, and would be
competitive with the market range
coverage applied for performance bond
(margin) purposes in the futures
industry on comparable index futures.
The proposed rule change requires that
a separate securities margin account (or
subaccount of a securities margin
account) be used for portfolio
margining.
Amendment No. 1 to the proposed
rule change also adds rule language that
requires fully paid for long options
(and/or index warrants) to be transferred
out of the portfolio margin account and/
or cross-margin account and into a
securities account that is not a portfolio
margin account, in the event that such
long positions are the only components.
(2) Cross-Margining
The proposed rule permits related
index futures and options on such
futures to be carried in a separate
portfolio margin account, thus affording
a cross-margin capability. Amendment
No. 1 contains changes that primarily
relate to the addition of rule language
(i.e., Rule 12.4(j)) that, pursuant to
agreement between Commission staff,
the Exchange and The OCC, requires
cross-margin positions to be liquidated
or transferred in the event the carrying
broker-dealer becomes insolvent. The
Original Proposal allowed crossmargining to be commingled with other,
non-cross margin portfolio margin
positions in the same account. However,
the proposal of Amendment No. 1 to
require liquidation or transfer of the
cross-margin account necessitates that
cross-margining be conducted in an
account separate from non-crossmargining activity. Therefore,
Amendment No. 1 contains a number of
proposed revisions that relate to
isolation of cross-margin positions in a
separate account.
In a portfolio margin account,
including one that is used exclusively
for cross-margining, constituent
portfolios may be formed containing
index options, index warrants and
exchange-traded funds structured to
replicate the composition of the index
underlying a particular portfolio, as well
as related index futures and options on
such futures. Cross-margining would
operate similar to the cross-margin
program that was approved by the
‘‘non-high capitalization’’ have the same meaning
as they do for the purposes of risk-based haircuts
(Rule 15c3–1 under the Act, 17 CFR 240.15c3–1).
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Commission and the Commodity
Futures Trading Commission (‘‘CFTC’’)
for listed options market-makers and
proprietary accounts of clearing member
organizations. For determining
theoretical gains and losses, and
resultant margin requirements, the same
portfolio margin computation program
will be applied to portfolio margin
accounts, as well as cross-margin
accounts.
c. Margin or Minimum Equity Deficiency
Under proposed CBOE Rule 12.4(h),
positions in a portfolio margin account
would be valued at current market
prices, as currently defined in the
Exchange’s margin rules. Under the
proposed rule change, account equity
would be calculated and maintained
separately for each portfolio margin
account. For purposes of the $5 million
minimum account equity requirement,
all accounts owned by an individual or
entity may be combined. Proposed
CBOE Rule 12.4(i) requires that
additional margin must be obtained
within one business day (T+1)
whenever equity is below the margin
required, regardless of whether the
deficiency is caused by the addition of
new positions, the effect of unfavorable
market movement on existing positions,
or a combination of both. The portfolio
margin requirement, therefore, would be
both the initial and maintenance margin
requirement, and no differentiation
would be necessary. In addition,
proposed CBOE Rule 12.4(g) would
require that, in the event account equity
falls below the $5 million minimum,
additional equity must be deposited
within 3 business days (T+3). If the
deficiency were not resolved within 3
business days, the carrying member
organization would be prohibited under
the proposed rule change from
accepting any new opening orders
beginning on T+4, with the exception of
opening orders that hedge existing
positions. This prohibition would
remain in effect until a $5 million
equity was established.
d. Risk Disclosure Statement and
Acknowledgement
In addition, the Exchange proposes
that member organizations provide
every portfolio margin customer with a
written risk disclosure statement at or
prior to the initial opening of a portfolio
margin account.22 This disclosure
statement highlights the risks and
operation of portfolio margin accounts,
22 Even
a customer that engages exclusively in
cross-margining is a portfolio margin customer, as
the proposed rule change permits cross-margining
to be conducted only by applying the portfolio
margin methodology.
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including cross-margining, and the
differences between portfolio margin
and strategy-based margin requirements.
The disclosure statement is divided into
two sections, one dealing with portfolio
margining and the other with crossmargining. The disclosure statement
clearly notes that additional leverage is
possible in an account margined on a
portfolio basis in relation to strategybased margin. Among other things, the
disclosure statement covers who is
eligible to open a portfolio margin
account, the instruments that are
allowed, and when deposits to meet
margin and minimum equity are due.
The fact that long option positions held
in a portfolio margin account are not
segregated, as they generally would be
in the case of a regular margin account
under the Commission’s customer
protection rules, is explained. Also
included within the portfolio margin
section is a summary list of the special
risks of portfolio margin accounts, such
as: Increased leverage; shorter time for
meeting margin; involuntary liquidation
if margin not received; inability to
calculate future margin requirements
because of the data and calculations
required; and that long positions are
subject to a lien. The risks and operation
of a cross-margin feature are outlined in
the cross-margin section of the
disclosure statement, and a summary
list of the special risks associated with
cross-margining is included.
Further, at or prior to the time a
portfolio margin account is initially
opened, member organizations would be
required to obtain a signed
acknowledgement concerning portfolio
margining in general from the customer.
In addition, prior to accommodating
cross-margining, member organizations
would be required to obtain a second
signed acknowledgement within the
same time frame that pertains to crossmargin.
By signing the general
acknowledgement required of all
customers, the customer would attest to
having read the disclosure statement
and being aware of the fact that long
option positions in a portfolio margin
account (which includes cross-margin
accounts) are not subject to the
segregation requirements under the
customer protection rules of the
Commission, and would be subject to a
lien by The OCC. In signing the
additional acknowledgement applicable
to cross-margining, the customer would
attest to having read the disclosure
statement and being aware of the fact
that futures positions are being carried
in a securities account, are subject to the
Commission’s customer protection
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rules,23 and fall under the authority of
the SIPC in the event the carrying
broker-dealer becomes financially
insolvent. Within Chapter 9 of the
Exchange’s rules (‘‘Doing Business with
the Public’’), the Exchange would
prescribe the format of the written
disclosure statement and
acknowledgements in proposed
Exchange Rule 9.15(d)—Delivery of
Current Options Disclosure Documents
and Prospectus. Like a current Exchange
rule that prescribes the format for a
Special Statement for Uncovered
Options Writers (CBOE Rule 9.15(c)),
proposed Exchange Rule 9.15(d) would
allow member organizations to develop
their own format, provided it contains
substantially similar information and it
is approved in advance by the
Exchange.
e. Net Capital
The Exchange also proposes to add a
new requirement in CBOE Rule 13.5 to
mandate that the gross customer
portfolio margin requirements of a
broker-dealer may at no time exceed
1,000 percent of a carrying brokerdealer’s net capital (a 10:1 ratio). This
requirement is intended to place a
ceiling on the amount of margin a
broker-dealer can extend to its
customers in relation to its net capital.
f. Internal Risk Monitoring Procedures
The Exchange further proposes a
separate, related rule that would require
member organizations that carry
portfolio margin or cross-margin
accounts to establish and maintain
written procedures for assessing and
monitoring the potential risks to their
capital. Specifically, proposed CBOE
Rule 15.8A (Risk Analysis of Portfolio
Margin and Cross-Margin Accounts)
would require that the member
organization file and maintain its
current procedures with its DEA, and
provide the DEA with such information
as the DEA may reasonably require
regarding the member organization’s
risk analysis of any and all portfolio
margin and cross-margin accounts
carried for customers. Proposed CBOE
Rule 15.8A would incorporate current
Exchange Rule 15.8—Risk Analysis of
Market-Maker Accounts—by reference
to require that the risk analysis be
conducted in the same manner as
prescribed in Exchange Rule 15.8.
Additionally, proposed CBOE Rule
15.8A would set forth certain
23 As disclosed in the general acknowledgement
form (required of any portfolio or cross-margin
customer), portfolio margin and cross-margin
accounts operate pursuant to an exception to the
customer protection rules in that fully paid long
positions will not be segregated.
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undertakings that must be included in
the written procedures (e.g., review and
approval of credit limits for each
customer and across all accounts).
Because member organizations would
be required under the proposed rule
change to have risk monitoring
procedures, proposed CBOE Rule 12.4(i)
states that the current CBOE Rule 12.9—
Meeting Margin Calls by Liquidation
Prohibited—prohibiting excessive
liquidations to meet margin
requirements will not apply to portfolio
margin and cross-margin accounts.
Furthermore, given the proposed risk
monitoring procedures, CBOE proposes
that day trading margin requirements
would not apply to portfolio margin and
cross-margin accounts. Through these
risk-monitoring procedures, member
organizations will be expected to
oversee portfolio margin and crossmargin accounts for excessive
liquidations and day trading and take
appropriate action according to their
procedures.
It should be noted that the disclosure
statement delivery requirement, the $5
million minimum equity requirement,
and the next day deposit condition for
additionally required margin were all
added by the Portfolio Margin
Committee. The Portfolio Margin
Committee deemed these requirements
prudent given that less margin is
generally required under a portfolio
margining approach than under the
current strategy-based methodology, and
these measures made the plan entirely
acceptable to the member firm
representatives.
g. Margin at the Clearing House Level 24
The Exchange proposes that all
customer portfolio margin account
transactions not involving a futures
transaction (e.g., cross-margin) be
cleared in one special omnibus account
for the clearing firm at The OCC. In
addition, the Exchange proposes that all
transactions involving cross-margining,
both the security and futures products,
be cleared in one of two additional
special omnibus accounts for crossmargining, depending on the entity that
clears the futures product being crossmargined. One cross-margin omnibus
account corresponds to a crossmargining agreement between The OCC,
the CME and the New York Clearing
Corporation. The other omnibus account
corresponds to a cross-margining
agreement between The OCC and the
Board of Trade Clearing Corporation.
24 The Commission anticipates that the clearing
arrangements described in this section will be the
subject of a separate proposed rule change filed by
The OCC.
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The OCC will compute margin for the
special omnibus accounts using the
same portfolio margin methodology
applied at the customer level. The OCC
will continue to require full payment
from the clearing firm for all long option
positions. However, as previously
noted, long positions will not be
segregated like they are in the firm’s
regular customer range account at The
OCC. This is necessary and preferred
with a portfolio margining methodology
because all long positions must be
available for margin offset. Margin relief
is based on a dollar offset basis as
opposed to identifying specific contract
to contract offsets under a strategy-based
methodology. This may result in
situations where the long positions of a
given customer could serve to offset the
risk in another customer’s short
position. Long positions would,
therefore, be subject to The OCC lien.
An OCC clearing member currently has
the ability to unsegregate a long position
in order to pair it with a short position
(contract to contract basis) and form a
qualified spread. Under the proposed
treatment of long positions in a portfolio
margin omnibus account at The OCC, all
long positions would be unsegregated,
freeing The OCC clearing member from
the task of determining which long
positions offset risk and from specifying
each position to be unsegregated.
h. Rationale for Portfolio Margin
Portfolio margining brings a modern
approach to quantifying risk and offers
a number of efficiencies. It eliminates
the task of analyzing the portfolio and
sorting it according to currently
recognized strategies (e.g., spreads), and
computing a margin requirement for
each individual position or strategy.
This process becomes quite
cumbersome in an account with
multiple positions and complex
strategies. More importantly, for a given
market move, up or down, in a diverse
portfolio there will be listed option
positions that appreciate and other
option positions that will depreciate.
Under a portfolio margin system, offsets
are fully realized, whereas, under the
current strategy-based system, positions
and/or a group of positions comprising
a single strategy are margined
independent of each other and offsets
between them do not figure into the
total margin requirement as efficiently.
In addition, under a portfolio margin
system, the volatility of an individual
listed option series is used in the
theoretical pricing model that renders
the price used to compute a gain/loss on
that option position at each valuation
point. This links the margin required to
the risk in each particular position in
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22945
contrast to the strategy-based margin.
Strategy-based margin applies a
universal percentage requirement (of the
underlying index value) to all short
option positions in the same category
(e.g., broad-based), irrespective of the
fact that all options prices do not change
equally (in percentage terms) with a
change in the price or level of the
underlying instrument.
Theoretical options pricing models
have become widely accepted and
utilized since Fischer Black and Myron
Scholes first introduced a formula for
calculating the value of a European style
option in 1973. Other formulas, such as
the Cox-Ross-Rubinstein model have
since been developed. Option pricing
formulas are now used routinely by
option market participants to analyze
and manage risk and have proven to be
highly effective and preferred. In
addition, essentially the same portfolio
methodology described above has been
used successfully by broker-dealers
since 1994 to calculate haircuts on
option positions for net capital
purposes.25
The Board of Governors of the Federal
Reserve System (the ‘‘Federal Reserve
Board’’ or ‘‘FRB’’) in its amendments to
Regulation T in 1998 permitted SROs to
implement portfolio margin rules,
provided they are approved by the
Commission.26 A portfolio margin
system recognizes the offsetting gains
from positions that react favorably in
market declines, while market rises are
tempered by offsetting losses from
positions that react negatively. A
portfolio margin approach can thus have
a neutralizing effect on option portfolio
volatility. In times of market stress, the
current strategy-based margin can result
in margin calls and forced liquidations,
thus contributing to the selling pressure
in the market. The offset ability of
portfolio margining can alleviate the
need for liquidations, slowing
acceleration of volatility in a crisis.
More recently, the FRB encouraged
the development of a portfolio margin
approach in a letter to the Commission
and the CFTC delegating authority to
the agencies to jointly prescribe margin
25 On March 15, 1994, the Commission issued a
no-action letter allowing the implementation of a
risk-based haircut pilot program. See letter from
Brandon Becker, Director, Division, Commission, to
Mary Bender, First Vice President, Division of
Regulatory Services, CBOE, and Timothy Hinkes,
Vice President, The OCC, dated March 15, 1994.
The risk-based haircut program took full effect on
September 1, 1997. See ‘‘Net Capital Rule,’’
Securities Exchange Act Release No. 38248
(February 6, 1997), 62 FR 6474 (February 12, 1997).
26 See Federal Reserve System, ‘‘Securities Credit
Transactions; Borrowing by Brokers and Dealers’’;
Regulations G, T, U and X; Docket Nos. R–0905, R–
0923 and R–0944, 63 FR 2806 (January 16, 1998).
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regulations for security futures
products.27 In that letter, the FRB wrote
that it ‘‘has encouraged the development
of [portfolio margin approaches] by, for
example, amending its Regulation T so
that portfolio margining systems
approved by the Commission can be
used in lieu of the strategy-based system
embodied in the Board’s regulation.’’
The FRB concluded that letter by
writing ‘‘The Board anticipates that the
creation of security future products will
provide another opportunity to develop
more risk sensitive, portfolio-based
approaches for all securities, including
security options and security futures
products.’’
An ability to cross-margin listed index
options with index futures, and options
on such futures, is critical because many
professional investors hedge their listed
index options with futures. Although
haircuts assessed on broker-dealers with
respect to computing their net capital
requirement recognize offsets between
securities index options and index
futures, current margin practice does
not allow these offsets. Cross-margin
benefits the financial markets and
clearing system in general, not just
individual investors. Cross-margin
would reduce the number of forced
liquidations. Currently, an option
(securities) account and futures account
of the same customer are viewed as
separate and unrelated. In addition,
currently an option account must be
liquidated if the risk in the positions has
increased dramatically or margin calls
cannot be met, even if gains in the
customer’s futures account offset the
losses in the options account. If the
accounts can be combined (i.e., crossmargined), there is little or no net
change in risk and unnecessary
liquidation can be avoided. The severity
of a period of high volatility in the
market is lessened if the number of
liquidations is reduced because, for
example, liquidating into a declining
market exacerbates the decline. A
capability to cross-margin listed index
options and index futures would further
alleviate excessive margin calls,
improve cash flows and liquidity, and
reduce volatility, particularly in times of
market downturns. Various government
agencies and task groups have
previously advocated implementation of
a cross-margin system. Those groups
include the Presidential Task Force on
Market Mechanics (also know as the
27 See letter from the FRB to James E. Newsome,
Acting Chairman, CFTC, and Laura S. Unger, Acting
Chairman, Commission, dated March 6, 2001.
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Brady Commission) 28 and the
Commission.29
Listed index options are now at a
disadvantage to economically
equivalent derivative products traded
on futures exchanges in terms of margin
requirements. Since 1988, index futures
and options have been margined under
a portfolio margin system known as
SPAN. While the risks of listed index
options are no greater than an
equivalent position in an index future or
option on the future, margin required on
listed securities index options is
significantly higher in many cases.
Currently, listed index options margin
(excluding the option premium) for a
short at-the-money contract
approximates 15% of the underlying
index value while SPAN margin on a
comparable futures index option
contract is approximately 6% of the
index value. When faced with such a
disparity, investment managers
discerningly choose futures products
over listed index options for their
hedging to reduce their costs. A
portfolio style margin application for
listed index options will reduce
disparities between securities index
options and futures products, thus
making listed index products more
competitive and more effective tools for
investors.
Relief provided by a portfolio margin
system is also needed so that listed
index options can compete with overthe-counter derivatives, which can be
margined on a good faith basis if hedged
with a listed option.30
2. Statutory Basis
The Exchange believes the proposed
rule change, as amended, is consistent
with Section 6(b) of the Act 31 in
general, and furthers the objectives of
Section 6(b)(5) of the Act 32 in
particular, in that it is designed perfect
the mechanism of a free and open
market and to protect investors and the
public interest. The proposed portfolio
margin rule change is intended to
promote greater reasonableness,
accuracy and efficiency in respect of
Exchange margin requirements for
complex, multiple position listed index
‘‘The Brady Report,’’ Report of the
Presidential Task Force on Market Mechanisms,
January 1988, p. 59 and pp. 65–66.
29 See ‘‘The October 1987 Market Break: Report
by the Division,’’ Commission, February 1988, pp.
10–57. See also the interim report of the ‘‘Working
Group on Financial Markets,’’ (Department of the
Treasury, CFTC, Commission and FRB), May 1988,
Appendix D III A.
30 See ‘‘OTC Derivatives Dealers,’’ Securities
Exchange Act Release No. 40594 (October 23, 1998),
63 FR 59362 (November 3, 1998).
31 15 U.S.C. 78f(b).
32 15 U.S.C. 78f(b)(5).
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option strategies, and to offer a crossmargin capability with related index
futures positions in eligible accounts.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
The Exchange does not believe that
the proposed rule change will impose
any burden on competition that is not
necessary or appropriate in the
furtherance of the purposes of the Act.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received from
Members, Participants, or Others
No written comments were either
solicited or received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of
publication of this notice in the Federal
Register or within such longer period (i)
as the Commission may designate up to
90 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 Exchange consents,
the Commission will:
(A) by order approve such proposed
rule change, as amended, 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, as amended, 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/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–CBOE–2002–03 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, NW., Washington, DC
20549–0609.
All submissions should refer to File
Number SR–CBOE–2002–03. 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
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Internet Web site (https://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, 450 Fifth Street, NW.,
Washington, DC 20549. Copies of such
filing also will be available for
inspection and copying at the principal
office of the CBOE. 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–CBOE–
2002–03 and should be submitted on or
before May 24, 2005.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.33
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5–2127 Filed 5–2–05; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–51619; File No. SR–ISE–
2005–09]
Self-Regulatory Organizations; Notice
of Filing and Order Granting
Accelerated Approval of Proposed
Rule Change and Amendment Nos. 1
and 2 Thereto by the International
Securities Exchange, Inc. To List and
Trade Options on Various Russell
Indexes
April 27, 2005.
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 February
1, 2005, the International Securities
Exchange, Inc. (‘‘ISE’’ or ‘‘Exchange’’)
filed with the Securities and Exchange
Commission (‘‘SEC’’ or ‘‘Commission’’)
the proposed rule change as described
in Items I, II, and III below, which Items
have been prepared by the Exchange.
On March 18, 2005, the Exchange filed
33 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
VerDate jul<14>2003
15:43 May 02, 2005
Jkt 205001
Amendment No. 1 to the proposed rule
change.3 On April 22, 2005, the
Exchange filed Amendment No. 2 to the
proposed rule change.4 The Commission
is publishing this notice and order to
solicit comments on the proposed rule
change, as amended, from interested
persons and to approve the proposal on
an accelerated basis.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
ISE is proposing to amend its rules to
list and trade new options on various
Russell Indexes. The text of the
proposed rule change is available on
ISE’s Web site (https://
www.iseoptions.com), at ISE’s principal
office, and at the Commission’s Public
Reference Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
Exchange included statements
concerning the purpose of, and basis for,
the proposed rule change and discussed
any comments it received on the
proposed rule change. The text of these
statements may be examined at the
places specified in Item IV below. The
Exchange has prepared summaries, set
forth in Sections A, B, and C below, of
the most significant aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
The Exchange proposes to amend its
rules to list and trade on the Exchange
cash-settled, European-style index
options on the full and reduced values
of each of the following Russell Indexes:
• Russell 3000 Index.
• Russell 3000 Value Index.
• Russell 3000 Growth Index.
• Russell 2500 Index.
• Russell 2500 Value Index.
• Russell 2500 Growth Index.
• Russell 2000 Index.
• Russell 2000 Value Index.
• Russell 2000 Growth Index.
• Russell 1000 Index.
• Russell 1000 Value Index.
• Russell 1000 Growth Index.
• Russell Top 200 Index.
• Russell Top 200 Value Index.
3 Amendment No. 1 made clarifications to the
Purpose section and included rule text that was
inadvertently left out of the original filing.
4 Amendment No. 2 made clarifications to the
Purpose section.
PO 00000
Frm 00107
Fmt 4703
Sfmt 4703
22947
• Russell Top 200 Growth Index.
• Russell MidCap Index.
• Russell MidCap Value Index.
• Russell MidCap Growth Index.
• Russell Small Cap Completeness
Index.
• Russell Small Cap Completeness
Value Index.
• Russell Small Cap Completeness
Growth Index
Specifically, the Exchange proposes to
list options based upon (i) full values of
the Russell Indexes (‘‘Full Value Russell
Indexes’’) and (ii) one-tenth values of
the Russell Indexes (‘‘Reduced Value
Russell Indexes’’). Each of these Russell
Indexes is a capitalization-weighted
index containing various groups of
stocks drawn from the largest 3,000
companies incorporated in the United
States. All index components are traded
on the New York Stock Exchange
(‘‘NYSE’’), the American Stock
Exchange (‘‘Amex’’), and/or the Nasdaq
Stock Market. Options on all of the
indexes, except for the Russell 2500
Index (regular, value, and growth) and
the Russell Small Cap Completeness
Index (regular, value, and growth),
currently trade on the Chicago Board
Options Exchange (‘‘CBOE’’).5 The
Exchange also is proposing to be able to
list and trade long-term options on each
of the Full Value Russell Indexes noted
above (‘‘Russell LEAPS’’).6
Index Design and Composition
The Russell Indexes are designed to
be a comprehensive representation of
the investable U.S. equity market. These
indexes are capitalization-weighted and
include only common stocks belonging
to corporations domiciled in the United
States are traded on NYSE, Nasdaq, or
Amex. Stocks are weighted by their
‘‘available’’ market capitalization, which
is calculated by multiplying the primary
market price by the ‘‘available’’ shares;
that is, total shares outstanding less
5 See Securities Exchange Act Release No. 49388
(March 10, 2004), 69 FR 12720 (March 17, 2004)
(approving listing and trading on CBOE of options,
including LEAPS, on the Russell Top 200 Index,
Russell Top 200 Growth Index, and the Russell Top
200 Value Index); Securities Exchange Act Release
No. 48591 (October 2, 2003), 68 FR 58728 (October
10, 2003) (approving listing and trading on CBOE
of options, including LEAPS, on the Russell 3000
Index, Russell 3000 Value Index, Russell 3000
Growth Index, Russell 2000 Value Index, Russell
2000 Growth Index, Russell 1000 Index, Russell
1000 Value Index, Russell 1000 Growth Index,
Russell MidCap Index, Russell MidCap Value
Index, and Russell MidCap Growth Index);
Securities Exchange Act Release No. 31382 (October
30, 1992), 57 FR 52802 (November 5, 1992)
(approving listing and trading on CBOE of options,
including LEAPS, on the Russell 2000 Index).
6 Under ISE Rule 2009(b), ‘‘Long-Term Index
Options Series,’’ the Exchange may list long-term
options that expire from 12 to 60 months from the
date of issuance.
E:\FR\FM\03MYN1.SGM
03MYN1
]]>Agencies
[Federal Register Volume 70, Number 84 (Tuesday, May 3, 2005)]
[Notices]
[Pages 22935-22947]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-2127]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-51614; File No. SR-CBOE-2002-03]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendment Nos. 1 and 2 Thereto by the Chicago Board Options
Exchange, Incorporated Relating to Customer Portfolio and Cross-
Margining Requirements
April 26, 2005.
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 April 15, 2005, the Chicago Board Options Exchange, Incorporated
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'') Amendment No. 2 \3\ to the proposed rule
change as described in Items I, II, and III below, which Items have
been prepared by the CBOE. The Exchange submitted this partial
amendment, constituting Amendment No. 2, pursuant to the request of
Commission staff. Specifically, the Exchange proposes to amend the
proposed rule (Rule 12.4) to remove current paragraph (b)(2) under
which any affiliate of a self-clearing member organization can
participate in portfolio margining, without being subject to the $5
million equity requirement.\4\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Partial Amendment No. 2 (``Amendment No. 2'').
\4\ This partial amendment would not exclude these affiliates
from participating in portfolio margining; rather, it would subject
them to the $5 million equity requirement in paragraph (b)(3) of
proposed Rule 12.4 in Amendment No. 2.
---------------------------------------------------------------------------
The CBOE submitted the original proposed rule change to the
Commission on January 15, 2002 (``Original Proposal''). The proposed
rule change was published in the Federal Register on March 29, 2002.\5\
The Commission received one comment letter in response to the March 29,
2002 Federal Register notice.\6\ On April 2, 2004, the Exchange filed
Amendment No. 1 to the proposed rule change.\7\ The
[[Page 22936]]
proposed rule change and Amendment No. 1 were published in the Federal
Register on December 27, 2004.\8\ The Commission received eleven
comment letters in response to the December 27, 2004 Federal Register
notice.\9\
---------------------------------------------------------------------------
\5\ See Securities Exchange Act Release No. 45630 (March 22,
2002), 67 FR 15263 (March 29, 2002).
\6\ See E-mail from Mike Ianni, Private Investor to rule-
comments@sec.gov, dated November 7, 2002 (``Ianni E-mail'').
\7\ See letter from Richard Lewandowski, Vice President,
Division of Regulatory Services, CBOE, to Michael A. Macchiaroli,
Associate Director, Division of Market Regulation (``Division''),
Commission, dated April 1, 2004 (``Amendment No. 1''). The CBOE
proposed Amendment No. 1 to make corrections or clarifications to
the proposed rule, or to reconcile differences between the proposed
rule and a parallel filing by the NYSE. See Securities Exchange Act
Release No. 46576 (October 1, 2002), 67 FR 62843 (October 8, 2002)
(File No. SR-NYSE-2002-19).
\8\ See Securities Exchange Act Release No. 50886 (December 20,
2004), 69 FR 77275 (December 27, 2004); see also Securities Exchange
Act Release No. 50885 (December 20, 2004), 69 FR 77287 (December 27,
2004).
\9\ One of the comments responded exclusively to CBOE Amendment
No. 1. See letter from Anthony J. Saliba, President, LiquidPoint,
LLC, to Jonathan G. Katz, Secretary, Commission, dated February 24,
2005 (``Saliba Letter''). Ten of the written comments (letters and
emails) responded jointly to CBOE Amendment No. 1 and NYSE Amendment
No. 2. See letter from Barbara Wierzynski, Executive Vice President
and General Counsel, Futures Industry Association, and Gerard J.
Quinn, Vice President and Associate General Counsel, Securities
Industry Association, to Jonathan G. Katz, Secretary, Commission,
dated January 14, 2005 (``Wierzynski/Quinn Letter''); letter from
Craig S. Donohue, Chief Executive Officer, Chicago Mercantile
Exchange, to Jonathan G. Katz, Secretary, Commission, dated January
18, 2005 (``Donohue Letter''); letter from Robert C. Sheehan,
Chairman, Electronic Brokerages Systems, LLC, to Jonathan G. Katz,
Secretary, Commission, dated January 19, 2005 (``Sheehan Letter'');
letter from William O. Melvin, Jr., President, Acorn Derivatives
Management, to Jonathan G. Katz, Secretary, Commission, dated
January 19, 2005 (``Melvin Letter''); letter from Margaret
Wiermanski, Chief Operating & Compliance Officer, Chicago Trading
Company, to Jonathan G. Katz, Secretary, Commission, dated January
20, 2005 (``Wiermanski Letter''); email from Jeffrey T. Kaufmann,
Lakeshore Securities, L.P., to Jonathan G. Katz, Secretary,
Commission, dated January 24, 2005 (``Kaufmann Letter''); letter
from J. Todd Weingart, Director of Floor Operations, Mann
Securities, to Jonathan G. Katz, Secretary, Commission, dated
January 25, 2005 (``Weingart Letter''); letter from Charles Greiner
III, LDB Consulting, Inc., to Jonathan G. Katz, Secretary,
Commission, dated January 26, 2005 (``Greiner Letter''); letter from
Jack L. Hansen, Chief Investment Officer and Principal, The Clifton
Group, to Jonathan G. Katz, Secretary, Commission, dated February 1,
2005 (``Hansen Letter''); See letter from Barbara Wierzynski,
Executive Vice President and General Counsel, Futures Industry
Association, and Ira D. Hammerman, Senior Vice President and General
Counsel, Securities Industry Association, to Jonathan G. Katz,
Secretary, Commission, dated March 2, 2005 (``Wierzynski/Hammerman
Letter'').
---------------------------------------------------------------------------
The Commission is publishing this notice to solicit comments on the
proposed rule change, as amended, from interested persons.\10\
---------------------------------------------------------------------------
\10\ This release (Release No. 34-51614) seeks comment on the
proposed rule change, as amended, by Amendment Nos. 1 and 2.
Therefore, the language of the proposed rule change, as amended, is
set forth in the release in its entirety.
---------------------------------------------------------------------------
1. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The CBOE proposes to amend its rules, for certain customer
accounts, to allow member organizations to margin listed, broad-based,
market index options, index warrants and related exchange-traded funds
according to a portfolio margin methodology as an alternative to the
current strategy-based margin methodology. The proposed rule change
also will provide for cross-margining by allowing broad-based index
futures and options on such futures to be included with listed, broad-
based index options, index warrants and related exchange-traded funds
for portfolio margin treatment, in a separate cross-margin account. The
text of the proposed rule change is below. Additions are in italics.
Deletions are in brackets.
* * * * *
CHAPTER XII
Margins
[Covered Options Contracts]
Portfolio Margin and Cross-Margin for Index Options
Rule 12.4. [Deleted January 15, 1975.] As an alternative to the
transaction/position specific margin requirements set forth in Rule
12.3 of this Chapter 12, members may require margin for listed, broad-
based U.S. index options, index warrants and underlying instruments (as
defined below) in accordance with the portfolio margin requirements
contained in this Rule 12.4.
In addition, members, provided they are a Futures Commission
Merchant (``FCM'') and are either a clearing member of a futures
clearing organization or have an affiliate that is a clearing member of
a futures clearing organization, are permitted under this Rule 12.4 to
combine a customer's related instruments (as defined below) and listed,
broad based U.S. index options, index warrants and underlying
instruments and compute a margin requirement (``cross-margin'') on a
portfolio margin basis. Members must confine cross-margin positions to
a portfolio margin account dedicated exclusively to cross-margining.
Application of the portfolio margin and cross-margining provisions
of this Rule 12.4 to IRA accounts is prohibited.
(a) Definitions.
(1) The term ``listed option'' shall mean any option traded on a
registered national securities exchange or automated facility of a
registered national securities association.
(2) The term ``unlisted option'' means any option not included in
the definition of listed option.
(3) The term ``options class'' refers to all options contracts
covering the same underlying instrument.
(4) The term ``portfolio'' means options of the same options class
grouped with their underlying instruments and related instruments.
(5) The term ``option series'' relates to listed options and means
all option contracts of the same type (either a call or a put) and
exercise style, covering the same underlying instrument with the same
exercise price, expiration date, and number of underlying units.
(6) The term ``related instrument'' within an option class or
product group means futures contracts and options on futures contracts
covering the same underlying instrument.
(7) The term ``underlying instrument'' means long and short
positions in an exchange traded fund or other fund product registered
under the Investment Company Act of 1940 that holds the same
securities, and in the same proportion, as contained in a broad based
index on which options are listed. The term underlying instrument shall
not be deemed to include, futures contracts, options on futures
contracts, underlying stock baskets, or unlisted instruments.
(8) The term ``product group'' means two or more portfolios of the
same type (see subparagraph (a)(9) below) for which it has been
determined by Rule 15c3-1a under the Securities Exchange Act of 1934
that a percentage of offsetting profits may be applied to losses at the
same valuation point.
(9) The term ``theoretical gains and losses'' means the gain and
loss in the value of individual option series and related instruments
at 10 equidistant intervals (valuation points) ranging from an assumed
movement (both up and down) in the current market value of the
underlying instrument. The magnitude of the valuation point range shall
be as follows:
------------------------------------------------------------------------
Up/down market
Portfolio type move (high & low
valuation points)
------------------------------------------------------------------------
Non-high capitalization, broad based U.S. market +/-10%
index option \1\\1\................................
High capitalization, broad based U.S. market index +6%/-8%
option \1\.........................................
------------------------------------------------------------------------
\1\ In accordance with sub-paragraph (b)(1)(i)(B) of Rule 15c3-1a under
the Securities Exchange Act of 1934.
(b) Eligible Participants. The application of the portfolio margin
provisions of this Rule 12.4, including cross-margining, is limited to
the following:
(1) any broker or dealer registered pursuant to Section 15 of the
Securities Exchange Act of 1934;
(2) any member of a national futures exchange to the extent that
listed index
[[Page 22937]]
options hedge the member's index futures; and
(3) any other person or entity not included in (b)1 through (b)2
above that has or establishes, and maintains, equity of at least 5
million dollars. For purposes of this equity requirement, all
securities and futures accounts carried by the member for the same
customer may be combined provided ownership across the accounts is
identical. A guarantee by any other account for purposes of the minimum
equity requirement is not to be permitted.
(c) Opening of Accounts.
(1) Only customers that, pursuant to Rule 9.7, have been approved
for options transactions, and specifically approved to engage in
uncovered short option contracts, are permitted to utilize a portfolio
margin account.
(2) On or before the date of the initial transaction in a portfolio
margin account, a member shall:
A. furnish the customer with a special written disclosure statement
describing the nature and risks of portfolio margining and cross-
margining which includes an acknowledgement for all portfolio margin
account owners to sign, and an additional acknowledgement for owners
that also engage in cross-margining to sign, attesting that they have
read and understood the disclosure statement, and agree to the terms
under which a portfolio margin account and the cross-margin account,
respectively, are provided [see Rule 9.15(d)], and
B. obtain a signed acknowledgement(s) from the customer, both of
which are required for cross-margining customers, and record the date
of receipt.
(d) Establishing Account and Eligible Positions.
(1) Portfolio Margin Account. For purposes of applying the
portfolio margin requirements provided in this Rule 12.4, members are
to establish and utilize a dedicated securities margin account, or sub-
account of a margin account, clearly identified as a portfolio margin
account that is separate from any other securities account carried for
a customer.
(2) Cross-Margin Account. For purposes of combining related
instruments and listed, broad-based U.S. index options, index warrants
and underlying instruments and applying the portfolio margin
requirements provided in this Rule 12.4, members are to establish and
utilize a portfolio margin account, clearly identified as a cross-
margin account, that is separate from any other securities account or
portfolio margin account carried for a customer.
A margin deficit in either the portfolio margin account or the
cross-margin account of a customer may not be considered as satisfied
by excess equity in the other account. Funds and/or securities must be
transferred to the deficient account and a written record created and
maintained.
(3) Portfolio Margin Account--Eligible Positions
(i) A transaction in, or transfer of, a listed, broad-based U.S.
index option or index warrant may be effected in the portfolio margin
account.
(ii) A transaction in, or transfer of, an underlying instrument may
be effected in the portfolio margin account provided a position in an
offsetting listed, broad-based U.S. index option or index warrant is in
the account or is established in the account on the same day.
(iii) If, in the portfolio margin account, the listed, broad-based
U.S. index option or index warrant position offsetting an underlying
instrument position ceases to exist and is not replaced within 10
business days, the underlying instrument position must be transferred
to a regular margin account, subject to Regulation T initial margin and
the margin required pursuant to the other provisions of this chapter.
Members will be expected to monitor portfolio margin accounts for
possible abuse of this provision.
(iv) In the event that fully paid for long options and/or index
warrants are the only positions contained within a portfolio margin
account, such long positions must be transferred to a securities
account other than a portfolio margin account or cross-margin account
within 10 business days, subject to the margin required pursuant to the
other provisions of this chapter, unless the status of the account
changes such that it is no longer composed solely of fully paid for
long options and/or index warrants.
(4) Cross-Margin Account--Eligible Positions
(i) A transaction in, or transfer of, a related instrument may be
effected in the cross-margin account provided a position in an
offsetting listed, U.S. broad based index option, index warrant or
underlying instrument is in the account or is established in the
account on the same day.
(ii) If the listed, U.S. broad-based index option, index warrant or
underlying instrument position offsetting a related instrument ceases
to exist and is not replaced within 10 business days, the related
instrument position must be transferred to a futures account. Members
will be expected to monitor cross-margin accounts for possible abuse of
this provision.
(iii) In the event that fully paid for long options and/or index
warrants (securities) are the only positions contained within a cross-
margin account, such long positions must be transferred to a securities
account other than a portfolio margin account or cross-margin account
within 10 business days, subject to the margin required pursuant to the
other provisions of this chapter, unless the status of the account
changes such that it is no longer composed solely of fully paid for
long options and/or index warrants.
(e) Initial and Maintenance Margin Required. The amount of margin
required under this Rule 12.4 for each portfolio shall be the greater
of:
(1) the amount for any of the 10 equidistant valuation points
representing the largest theoretical loss as calculated pursuant to
paragraph (f) below or
(2) $.375 for each listed index option and related instrument
multiplied by the contract or instrument's multiplier, not to exceed
the market value in the case of long positions in listed options and
options on futures contracts.
(f) Method of Calculation.
(1) Long and short positions in listed options, underlying
instruments and related instruments are to be grouped by option class;
each option class group being a ``portfolio''. Each portfolio is
categorized as one of the portfolio types specified in paragraph (a)(9)
above.
(2) For each portfolio, theoretical gains and losses are calculated
for each position as specified in paragraph (a)(9) above. For purposes
of determining the theoretical gains and losses at each valuation
point, members shall obtain and utilize the theoretical value of a
listed index option, underlying instrument or related instrument
rendered by a theoretical pricing model that, in accordance with
paragraph (b)(1)(i)(B) of Rule 15c3-1a under the Securities Exchange
Act of 1934, qualifies for purposes of determining the amount to be
deducted in computing net capital under a portfolio based methodology.
(3) Offsets. Within each portfolio, theoretical gains and losses
may be netted fully at each valuation point.
Offsets between portfolios within the High Capitalization, Broad
Based Index Option product group and the Non-High Capitalization, Broad
Based Index Option product group may then be applied as permitted by
Rule 15c3-1a under the Securities Exchange Act of 1934.
(4) After applying paragraph (3) above, the sum of the greatest
loss from
[[Page 22938]]
each portfolio is computed to arrive at the total margin required for
the account (subject to the per contract minimum).
(g) Equity Deficiency. If, at any time, equity declines below the 5
million dollar minimum required under Paragraph (b)(4) of this Rule
12.4 and is not brought back up to at least 5 million dollars within
three (3) business days (T+3) by a deposit of funds or securities, or
through favorable market action; members are prohibited from accepting
opening orders starting on T+4, except that opening orders entered for
the purpose of hedging existing positions may be accepted if the result
would be to lower margin requirements. This prohibition shall remain in
effect until such time as an equity of 5 million dollars is
established.
(h) Determination of Value for Margin Purposes. For the purposes of
this Rule 12.4, all listed index options and related instrument
positions shall be valued at current market prices. Account equity for
the purposes of this Rule 12.4 shall be calculated separately for each
portfolio margin account by adding the current market value of all long
positions, subtracting the current market value of all short positions,
and adding the credit (or subtracting the debit) balance in the
account.
(i) Additional Margin.
(1) If at any time, the equity in any portfolio margin account,
including a cross-margin account, is less than the margin required,
additional margin must be obtained within one business day (T+1). In
the event a customer fails to deposit additional margin within one
business day, the member must liquidate positions in an amount
sufficient to, at a minimum, lower the total margin required to an
amount less than or equal to account equity. Exchange Rule 12.9--
Meeting Margin Calls by Liquidation shall not apply to portfolio margin
accounts. However, members will be expected to monitor the risk of
portfolio margin accounts pursuant to the risk monitoring procedures
required by Rule 15.8A. Guarantees by any other account for purposes of
margin requirements are not to be permitted.
(2) The day trading requirements of Exchange Rule 12.3(j) shall not
apply to portfolio margin accounts, including cross-margin accounts.
(j) Cross-Margin Accounts--Requirement to Liquidate.
(1) A member is required immediately either to liquidate, or
transfer to another broker-dealer eligible to carry cross-margin
accounts, all customer cross-margin accounts that contain positions in
futures and/or options on futures if the member is:
(i) insolvent as defined in section 101 of title 11 of the United
States Code, or is unable to meet its obligations as they mature;
(ii) the subject of a proceeding pending in any court or before any
agency of the United States or any State in which a receiver, trustee,
or liquidator for such debtor has been appointed;
(iii) not in compliance with applicable requirements under the
Securities Exchange Act of 1934 or rules of the Securities and Exchange
Commission or any self-regulatory organization with respect to
financial responsibility or hypothecation of customers' securities; or
(iv) unable to make such computations as may be necessary to
establish compliance with such financial responsibility or
hypothecation rules.
(2) Nothing in this paragraph (j) shall be construed as limiting or
restricting in any way the exercise of any right of a registered
clearing agency to liquidate or cause the liquidation of positions in
accordance with its by-laws and rules.
* * * * *
Chapter XIII
Net Capital
Customer Portfolio Margin Accounts
Rule 13.5. (a) No member organization that requires margin in any
customer accounts pursuant to Rule 12.4--Portfolio Margin and Cross-
Margin for Index Options, shall permit gross customer portfolio margin
requirements to exceed 1,000 percent of its net capital for any period
exceeding three business days. The member organization shall, beginning
on the fourth business day of any non-compliance, cease opening new
portfolio margin accounts until compliance is achieved.
(b) If, at any time, a member organization's gross customer
portfolio margin requirements exceed 1,000 percent of its net capital,
the member organization shall immediately transmit telegraphic or
facsimile notice of such deficiency to the Securities and Exchange
Commission, 450 Fifth Street NW., Washington, DC 20549; to the district
or regional office of the Securities and Exchange Commission for the
district or region in which the member organization maintains its
principal place of business; and to its Designated Examining Authority.
* * * * *
Chapter XV
Records, Reports and Audits
Risk Analysis of Portfolio Margin Accounts
Rule 15.8A. (a) Each member organization that maintains any
portfolio margin accounts for customers shall establish and maintain
written procedures for assessing and monitoring the potential risk to
the member organization's capital over a specified range of possible
market movements of positions maintained in such accounts. Current
procedures shall be filed and maintained with the Department of
Financial and Sales Practice Compliance. The procedures shall specify
the computations to be made, the frequency of computations, the records
to be reviewed and maintained, and the position(s) within the
organization responsible for the risk function.
(b) Upon direction by the Department of Financial and Sales
Practice Compliance, each affected member organization shall provide to
the Department such information as the Department may reasonably
require with respect to the member organization's risk analysis for any
or all of the portfolio margin accounts it maintains for customers.
(c) In conducting the risk analysis of portfolio margin accounts
required by this Rule 15.8A, each affected member organization is
required to follow the Interpretations and Policies set forth under
Rule 15.8--Risk Analysis of Market-Maker Accounts. In addition, each
affected member organization shall include in written procedures
required pursuant to paragraph (a) above the following:
(1) Procedures and guidelines for the determination, review and
approval of credit limits to each customer, and across all customers,
utilizing a portfolio margin account.
(2) Procedures and guidelines for monitoring credit risk exposure
to the member organization, including intra-day credit risk, related to
portfolio margin accounts.
(3) Procedures and guidelines for the use of stress testing of
portfolio margin accounts in order to monitor market risk exposure from
individual accounts and in the aggregate.
(4) Procedures providing for the regular review and testing of
these risk analysis procedures by an independent unit such as internal
audit or other comparable group.
* * * * *
[[Page 22939]]
Chapter 9
Doing Business with the Public
Delivery of Current Options Disclosure Documents and Prospectus
Rule 9.15. (a) no change
(b) no change
(c) no change
(d) The special written disclosure statement describing the nature
and risks of portfolio margining and cross-margining, and
acknowledgement for customer signature, required by Rule 12.4(c)(2)
shall be in a format prescribed by the Exchange or in a format
developed by the member organization, provided it contains
substantially similar information as the prescribed Exchange format and
has received prior written approval of the Exchange.
Sample Risk Description for Use by Firms to Satisfy Requirements of
Exchange Rule 9.15(d)
Portfolio Margining and Cross-Margining Disclosure Statement and
Acknowledgement
For a Description of the Special Risks Applicable to a Portfolio Margin
Account and its Cross-Margining Features, See the Material Under Those
Headings Below.
Overview of Portfolio Margining
1. Portfolio margining is a margin methodology that sets margin
requirements for an account based on the greatest projected net loss of
all positions in a ``product class'' or ``product group'' as determined
by an options pricing model using multiple pricing scenarios. These
pricing scenarios are designed to measure the theoretical loss of the
positions given changes in both the underlying price and implied
volatility inputs to the model. Portfolio margining is currently
limited to product classes and groups of index products relating to
broad-based market indexes.
2. The goal of portfolio margining is to set levels of margin that
more precisely reflect actual net risk. The customer benefits from
portfolio margining in that margin requirements calculated on net risk
are generally lower than alternative ``position'' or ``strategy'' based
methodologies for determining margin requirements. Lower margin
requirements allow the customer more leverage in an account.
Customers Elibible for Portfolio Margining
3. To be eligible for portfolio margining, customers (other than
broker-dealers) must meet the basic standards for having an options
account that is approved for uncovered writing and must have and
maintain at all times account net equity of not less than $5 million,
aggregated across all accounts under identical ownership at the
clearing broker. The identical ownership requirement excludes accounts
held by the same customer in different capacities (e.g., as a trustee
and as an individual) and accounts where ownership is overlapping but
not identical (e.g., individual accounts and joint accounts).
Positions Eligible for a Portfolio Margin Account
4. All positions in broad-based U.S. market index options and index
warrants listed on a national securities exchange, and exchange traded
funds and other fund products registered under the Investment Company
Act of 1940 that are managed to track the same index that underlies
permitted index options, are eligible for a portfolio margin account.
Special Rules for Portfolio Margin Accounts
5. A portfolio margin account may be either a separate account or a
subaccount of a customer's regular margin account. In the case of a
subaccount, equity in the regular account will be available to satisfy
any margin requirement in the portfolio margin subaccount without
transfer to the subaccount.
6. A portfolio margin account or subaccount will be subject to a
minimum margin requirement of $.375 multiplied by the index multiplier
for every options contract or index warrant carried long or short in
the account. No minimum margin is required in the case of eligible
exchange traded funds or other eligible fund products.
7. Margin calls in the portfolio margin account or subaccount,
regardless of whether due to new commitments or the effect of adverse
market moves on existing positions, must be met within one business
day. Any shortfall in aggregate net equity across accounts must be met
within three business days. Failure to meet a margin call when due will
result in immediate liquidation of positions to the extent necessary to
reduce the margin requirement. Failure to meet an equity call prior to
the end of the third business day will result in a prohibition on
entering any opening orders, with the exception of opening orders that
hedge existing positions, beginning on the fourth business day and
continuing until such time as the minimum equity requirement is
satisfied.
8. A position in an exchange traded index fund or other eligible
fund product may not be established in a portfolio margin account
unless there exists, or there is established on the same day, an
offsetting position in securities options or other eligible securities.
Exchange traded index funds and/or other eligible funds will be
transferred out of the portfolio margin account and into a regular
securities account subject to strategy based margin if, for more than
10 business days and for any reason, the offsetting securities options
or other eligible securities no longer remain in the account.
9. When a broker-dealer carries a regular cash account or margin
account for a customer, the broker-dealer is limited by rules of the
Securities and Exchange Commission and of The Options Clearing
Corporation (``OCC'') in the extent to which the broker-dealer may
permit OCC to have a lien against long option positions in those
accounts. In contrast, OCC will have a lien against all long option
positions that are carried by a broker-dealer in a portfolio margin
account, and this could, under certain circumstances, result in greater
losses to a customer having long option positions in such an account in
the event of the insolvency of the customer's broker. Accordingly, to
the extent that a customer does not borrow against long option
positions in a portfolio margin account or have margin requirements in
the account against which the long option can be credited, there is no
advantage to carrying the long options in a portfolio margin account
and the customer should consider carrying them in an account other than
a portfolio margin account.
Special Risks of Portfolio Margin Accounts
10. Portfolio margining generally permits greater leverage in an
account, and greater leverage creates greater losses in the event of
adverse market movements.
11. Because the time limit for meeting margin calls is shorter than
in a regular margin account, there is increased risk that a customer's
portfolio margin account will be liquidated involuntarily, possibly
causing losses to the customer.
12. Because portfolio margin requirements are determined using
sophisticated mathematical calculations and theoretical values that
must be calculated from market data, it may be more difficult for
customers to predict the size of future margin calls in a portfolio
margin account. This is particularly true in the case of customers who
do not have access to specialized software necessary to make
[[Page 22940]]
such calculations or who do not receive theoretical values calculated
and distributed periodically by The OCC.
13. For the reasons noted above, a customer that carries long
options positions in a portfolio margin account could, under certain
circumstances, be less likely to recover the full value of those
positions in the event of the insolvency of the carrying broker.
14. Trading of securities index products in a portfolio margin
account is generally subject to all the risks of trading those same
products in a regular securities margin account. Customers should be
thoroughly familiar with the risk disclosure materials applicable to
those products, including the booklet entitled Characteristics and
Risks of Standardized Options.
15. Customers should consult with their tax advisers to be certain
that they are familiar with the tax treatment of transactions in
securities index products.
16. The descriptions in this disclosure statement relating to
eligibility requirements for portfolio margin accounts, and minimum
equity and margin requirements for those accounts, are minimums imposed
under exchange rules. Time frames within which margin and equity calls
must be met are maximums imposed under exchange rules. Broker-dealers
may impose their own more stringent requirements.
Overview of Cross-Margining
17. With cross-margining, index futures and options on index
futures are combined with offsetting positions in securities index
options and underlying instruments, for the purpose of computing a
margin requirement based on the net risk. This generally produces lower
margin requirements than if the futures products and securities
products are viewed separately, thus providing more leverage in the
account.
18. Cross-margining must be done in a portfolio margin account
type. A separate portfolio margin account must be established
exclusively for cross-margining.
19. When index futures and options on futures are combined with
offsetting positions in index options and underlying instruments in a
dedicated account, and a portfolio margining methodology is applied to
them, cross-margining is achieved.
Customers Eligible for Cross-Margining
20. The eligibility requirements for cross-margining are generally
the same as for portfolio margining, and any customer eligible for
portfolio margining is eligible for cross-margining.
21. Members of futures exchanges on which cross-margining eligible
index contracts are traded are also permitted to carry positions in
cross-margin accounts without regard to the minimum aggregate account
equity.
Positions Eligible for Cross-Margining
22. All securities products eligible for portfolio margining are
also eligible for cross-margining.
23. All broad-based U.S. market index futures and options on index
futures traded on a designated contract market subject to the
jurisdiction of the Commodity Futures Trading Commission are eligible
for cross-margining.
Special Rules for Cross-Margining
24. Cross-margining must be conducted in a portfolio margin account
type. A separate portfolio margin account must be established
exclusively for cross-margining. A cross-margin account is a securities
account, and must be maintained separate from all other securities
accounts.
25. Cross-margining is automatically accomplished with the
portfolio margining methodology. Cross-margin positions are subject to
the same minimum margin requirement for every contract, including
futures contracts.
26. Margin calls arising in the cross-margin account, and any
shortfall in aggregate net equity across accounts, must be satisfied
within the same time frames, and subject to the same consequences, as
in a portfolio margin account.
27. A position in a futures product may not be established in a
cross-margin account unless there exists, or there is established on
the same day, an offsetting position in securities options and/or other
eligible securities. Futures products will be transferred out of the
cross-margin account and into a futures account if, for more than 10
business days and for any reason, the offsetting securities options
and/or other eligible securities no longer remain in the account. If
the transfer of futures products to a futures account causes the
futures account to be undermargined, a margin call will be issued or
positions will be liquidated to the extent necessary to eliminate the
deficit.
28. According to the rules of the exchanges, a broker-dealer is
required to immediately liquidate, or, if feasible, transfer to another
broker-dealer eligible to carry cross-margin accounts, all customer
cross-margin accounts that contain positions in futures and/or options
on futures in the event that the carrying broker-dealer becomes
insolvent.
29. Customers participating in cross-margining will be required to
sign an agreement acknowledging that their positions and property in
the cross-margin account will be subject to the customer protection
provisions of Rule 15c3-3 under the Securities Exchange Act of 1934 and
the Securities Investor Protection Act, and will not be subject to the
provisions of the Commodity Exchange Act, including segregation of
funds.
30. In signing the agreement referred to in paragraph 29 above, a
customer also acknowledges that a cross-margin account that contains
positions in futures and/or options on futures will be immediately
liquidated, or, if feasible, transferred to another broker-dealer
eligible to carry cross-margin accounts, in the event that the carrying
broker-dealer becomes insolvent.
Special Risks of Cross-Margining
31. Cross-margining must be conducted in a portfolio margin account
type. Generally, cross-margining and the portfolio margining
methodology both contribute to provide greater leverage than a regular
margin account, and greater leverage creates greater losses in the
event of adverse market movements.
32. As cross-margining must be conducted in a portfolio margin
account type, the time required for meeting margin calls is shorter
than in a regular securities margin account and may be shorter than the
time ordinarily required by a futures commission merchant for meeting
margin calls in a futures account. As a result, there is increased risk
that a customer's cross-margin positions will be liquidated
involuntarily, causing possible loss to the customer.
33. As noted above, cross-margin accounts are securities accounts
and are subject to the customer protections set-forth in Rule 15c3-3
under the Securities Exchange Act of 1934 and the Securities Investor
Protection Act. Cross-margin positions are not subject to the customer
protection rules under the segregation provisions of the Commodity
Exchange Act and the rules of the Commodity Futures Trading Commission
(``CFTC'') adopted pursuant to the Commodity Exchange Act.
34. Trading of index options and futures contracts in a cross-
margin account is generally subject to all the risks of trading those
same products in a futures account or a regular securities margin
account, as the case may be. Customers should be thoroughly familiar
with the risk disclosure materials applicable to those products,
including the booklet entitled
[[Page 22941]]
Characteristics and Risks of Standardized Options and the risk
disclosure document required by the CFTC to be delivered to futures
customers. Because this disclosure statement does not disclose the
risks and other significant aspects of trading in futures and options,
customers should review those materials carefully before trading in a
cross-margin account.
35. Customers should bear in mind that the discrepancies in the
cash flow characteristics of futures and certain options are still
present even when those products are carried together in a cross-margin
account. Both futures and options contracts are generally marked to the
market at least once each business day, but the marks may take place
with different frequency and at different times within the day. When a
futures contract is marked to the market, the gain or loss is
immediately credited to or debited from, respectively, the customer's
account in cash. While an increase in value of a long option contract
may increase the equity in the account, the gain is not realized until
the option is sold or exercised. Accordingly, a customer may be
required to deposit cash in the account in order to meet a variation
payment on a futures contract even though the customer is in a hedged
position and has experienced a corresponding (but as yet unrealized)
gain on a long option. On the other hand, a customer who is in a hedged
position and would otherwise be entitled to receive a variation payment
on a futures contract may find that the cash is required to be held in
the account as margin collateral on an offsetting option position.
36. Customers should consult with their tax advisers to be certain
that they are familiar with the tax treatment of transactions in index
products, including tax consequences of trading strategies involving
both futures and option contracts.
37. The descriptions in this disclosure statement relating to
eligibility requirements for cross-margining, and minimum equity and
margin requirements for cross-margin accounts, are minimums imposed
under exchange rules. Time frames within which margin and equity calls
must be met are maximums imposed under exchange rules. The broker-
dealer carrying a customer's portfolio margin account, including any
cross-margin account, may impose its own more stringent requirements.
* * * * *
Acknowledgement for Customers Utilizing a Portfolio Margin Account--
Cross-Margining and non Cross-Margining
Rule 15c3-3 under the Securities Exchange Act of 1934 requires that
a broker or dealer promptly obtain and maintain physical possession or
control of all fully-paid securities and excess margin securities of a
customer. Fully-paid securities are securities carried in a cash
account and margin equity securities carried in a margin or special
account (other than a cash account) that have been fully paid for.
Excess margin securities are a customer's margin securities having a
market value in excess of 140% of the total of the debit balances in
the customer's non-cash accounts. For the purposes of Rule 15c3-3,
securities held subject to a lien to secure obligations of the broker-
dealer are not within the broker-dealer's physical possession or
control. The Commission staff has taken the position that all long
option positions in a customer's portfolio-margining account (including
any cross-margining account) may be subject to such a lien by OCC and
will not be deemed fully-paid or excess margin securities under Rule
15c3-3.
The hypothecation rules under the Securities Exchange Act of 1934
(Rules 8c-1 and 15c2-1), prohibit broker-dealers from permitting the
hypothecation of customer securities in a manner that allows those
securities to be subject to any lien or liens in an amount that exceeds
the customer's aggregate indebtedness. However, all long option
positions in a portfolio-margining account (including any cross-
margining account) will be subject to OCC's lien, including any
positions that exceed the customer's aggregate indebtedness. The
Commission staff has taken a position that would allow customers to
carry positions in portfolio-margining accounts (including any cross-
margining account), even when those positions exceed the customer's
aggregate indebtedness. Accordingly, within a portfolio margin account
or cross-margin account, to the extent that you have long option
positions that do not operate to offset your aggregate indebtedness and
thereby reduce your margin requirement, you receive no benefit from
carrying those positions in your portfolio margin account or cross-
margin account and incur the additional risk of OCC's lien on your long
option position(s).
BY SIGNING BELOW, THE CUSTOMER AFFIRMS THAT THE CUSTOMER HAS READ
AND UNDERSTOOD THE FOREGOING DISCLOSURE STATEMENT AND ACKNOWLEDGES AND
AGREES THAT LONG OPTION POSITIONS IN PORTFOLIO-MARGINING ACCOUNTS AND
CROSS-MARGINING ACCOUNTS WILL BE EXEMPTED FROM CERTAIN CUSTOMER
PROTECTION RULES OF THE SECURITIES AND EXCHANGE COMMISSION AS DESCRIBED
ABOVE AND WILL BE SUBJECT TO A LIEN BY THE OPTIONS CLEARING CORPORATION
WITHOUT REGARD TO SUCH RULES.
CUSTOMER NAME:---------------------------------------------------------
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BY:--------------------------------------------------------------------
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(signature/title)
DATE:------------------------------------------------------------------
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* * * * *
ACKNOWLEDGEMENT FOR CUSTOMERS ENGAGED IN CROSS-MARGINING
As disclosed above, futures contracts and other property carried in
customer accounts with Futures Commission Merchants (``FCM'') are
normally subject to special protection afforded under the customer
segregation provisions of the Commodity Exchange Act (``CEA'') and the
rules of the CFTC adopted pursuant to the CEA. These rules require that
customer funds be segregated from the accounts of financial
intermediaries and be separately accounted for, however, they do not
provide for, and regular futures accounts do not enjoy the benefit of,
insurance protecting customer accounts against loss in the event of the
insolvency of the intermediary carrying the accounts.
As also has been discussed above, cross-margining must be conducted
in a portfolio margin account dedicated exclusively to cross-margining,
and cross-margin accounts are not treated as a futures account with an
FCM. Instead, cross-margin accounts are treated as securities accounts
carried with broker-dealers. As such, cross-margin accounts are covered
by Rule 15c3-3 under the Securities Exchange Act of 1934, which
protects customer accounts. Rule 15c3-3, among other things, requires a
broker-dealer to maintain physical possession or control of all fully-
paid and excess margin securities and maintain a special reserve
account for the benefit of their customers. However, in respect of
cross-margin accounts, there is an exception to the possession or
control requirement of Rule 15c3-3 that permits The Options Clearing
Corporation to have a lien on long positions. This aspect is outlined
in a separate
[[Page 22942]]
acknowledgement form that must be signed prior to or concurrent with
this form. Additionally, the Securities Investor Protection Corporation
(``SIPC'') insures customer accounts against the financial insolvency
of a broker-dealer in the amount of up to $500,000 to protect against
the loss of registered securities and cash maintained in the account
for purchasing securities or as proceeds from selling securities
(although the limit on cash claims is $100,000). According to the rules
of the exchanges, a broker-dealer is required to immediately liquidate,
or, if feasible, transfer to another broker-dealer eligible to carry
cross-margin accounts, all customer cross-margin accounts that contain
positions in futures and/or options on futures in the event that the
carrying broker-dealer becomes insolvent.
BY SIGNING BELOW, THE CUSTOMER AFFIRMS THAT THE CUSTOMER HAS READ
AND UNDERSTOOD THE FOREGOING DISCLOSURE STATEMENT AND ACKNOWLEDGES AND
AGREES THAT: 1) POSITIONS AND PROPERTY IN CROSS-MARGINING ACCOUNTS,
WILL NOT BE SUBJECT TO THE CUSTOMER PROTECTION RULES UNDER THE CUSTOMER
SEGREGATION PROVISIONS OF THE COMMODITY EXCHANGE ACT (``CEA'') AND THE
RULES OF THE COMMODITY FUTURES TRADING COMMISSION ADOPTED PURSUANT TO
THE CEA, AND 2) CROSS-MARGINING ACCOUNTS THAT CONTAIN POSITIONS IN
FUTURES AND/OR OPTIONS ON FUTURES WILL BE IMMEDIATELY LIQUIDATED, OR,
IF FEASIBLE, TRANSFERED TO ANOTHER BROKER-DEALER ELIGIBLE TO CARRY
CROSS-MARGIN ACCOUNTS, IN THE EVENT THAT THE CARRYING BROKER-DEALER
BECOMES INSOLVENT.
CUSTOMER NAME:---------------------------------------------------------
-----------------------------------------------------------------------
BY:--------------------------------------------------------------------
-----------------------------------------------------------------------
(signature/title)
DATE:------------------------------------------------------------------
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* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the CBOE included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The CBOE has prepared summaries, set forth in Sections
A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
a. Introduction
The CBOE proposes to expand its margin rules by providing a
portfolio margin methodology for listed, broad-based market index
options, index warrants and related exchange-traded funds that clearing
member organizations may extend to eligible customers as an alternative
to the current strategy-based option margin requirements. The proposed
rule change would also allow broad-based index futures and options on
such futures to be included in a separate portfolio margin account,
thus providing a cross-margin capability. The CBOE seeks to introduce
the proposed new rule as a two-year pilot program that would be made
available to member organizations on a voluntary basis.
The proposed rule change would permit self-clearing member
organizations to apply a prescribed portfolio margin methodology to an
account \11\ of another broker-dealer and an account of a member of a
national futures exchange who is a futures floor trader. Any other
customers or affiliates of the clearing member would be required to
have account equity of at least $5 million to be eligible for portfolio
margin treatment. This circumscribes the number of accounts able to
participate and adds safety in that such accounts are more likely to be
of significant financial means and investment sophistication.
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\11\ An account dedicated to portfolio margining.
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The Exchange submitted this partial amendment, constituting
Amendment No. 2, pursuant to the request of Commission staff.
Specifically, the Exchange proposes to amend the proposed rule (Rule
12.4) to remove the provision in current paragraph (b)(2) that makes
``any affiliate of a self-clearing member organization'' eligible for
portfolio margining. Removal of this provision would not exclude an
affiliate of a self-clearing member organization from participation,
but would necessitate that such entities have minimum account equity of
five million dollars in order to participate, as required under current
paragraph (b)(4). Current paragraph (b)(3) would be renumbered (b)(2),
and current paragraph (b)(4) would be renumbered (b)(3).
In relation to the change noted above, the Exchange also proposes
in Amendment No. 2 to revise paragraph number 3 of the Sample Risk
Description for Use by Firms To Satisfy Requirements of Exchange Rule
9.15(d) to remove the words ``and certain non-broker-dealer affiliates
of the carrying broker-dealer'' in the first sentence. This change to
the notice would reflect that non-broker-dealer affiliates would be
subject to the $5 million equity requirement. With the exception of
these changes, the rest of the proposed rule changes, as contained in
the Original Proposal, as amended by Amendment No. 1,\12\ remain
unchanged.
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\12\ A number of revisions contained in Amendment No. 1 were
deemed warranted, or requested or recommended by staff of the
Commission. In either case, the reason for these revisions was to
make corrections or clarifications to the proposed rule, or to
reconcile differences between the proposed rule and a parallel
filing by the NYSE. See, supra notes 7 and 8.
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Portfolio margining is most effective when applied to larger
accounts with diverse option positions and related securities, and any
related futures contracts. It is expected that institutional customers
will be the primary participants. Whether the account equity
requirement should be lowered to allow participation of more customers
will be assessed at the end of the pilot program period. Application of
portfolio margin, including cross-margin, to an IRA account would be
prohibited under the proposed rule change.
The proposed portfolio margin and cross-margin rules have been
developed by the CBOE in cooperation with The Options Clearing
Corporation (``The OCC''), the New York Stock Exchange, Inc.
(``NYSE''), the American Stock Exchange LLC, the Board of Trade of the
City of Chicago, Inc., and the Chicago Mercantile Exchange Inc.
(``CME''). The CBOE intends to provide a written overview describing
the operational details of the portfolio margin and cross-margin pilot
program to potential member organization participants to introduce and
explain the pilot program.
A committee of representatives from the member organizations
identified as potential participants, and staff of the sponsoring
exchanges and The OCC (the ``Portfolio Margin Committee'') was formed
and met several times in 1999 and 2000 to refine the portfolio margin
and cross-margin pilot program. This
[[Page 22943]]
group has recommended adoption of the portfolio margin and cross-margin
pilot program, as finalized by the group, and the related rule
proposals. In addition, the portfolio margin and cross-margin pilot
program has been presented to the NYSE's Rule 431 Committee \13\ on two
occasions, with draft rules included on the second occasion, and has
received the NYSE's Rule 431 Committee's support.
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\13\ The NYSE Rule 431 Committee is comprised of securities
industry representatives, primarily representatives of NYSE member
organizations. NYSE Rule 431 contains the NYSE's margin rules. The
function of the NYSE Rule 431 Committee is to assess the adequacy of
NYSE Rule 431 on an ongoing basis, review proposals for changes to
NYSE Rule 431, and recommend changes that are deemed appropriate.
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b. Overview--Portfolio Margin Computation
(1) Portfolio Margin
Under a portfolio margin system, margin is required based on the
greatest loss that would be incurred in a portfolio if the value of
components (underlying instruments in the case of options) move up or
down by a predetermined amount (e.g., +/-5%). Under the Exchange's
proposed portfolio margin rule, listed index options and underlying
instruments (also related instruments \14\ in the case of a cross-
margin account) would be grouped by class \15\ (e.g., S&P 500, S&P 100,
etc.), each class group being a portfolio.\16\ The gain or loss on each
position in a portfolio would be calculated at each of 10 equidistant
points (``valuation points'') set at and between the upper and lower
market range points. A theoretical options pricing model would be used
to derive position values \17\ at each valuation point for the purpose
of determining the gain or loss. Gains and losses would then be netted
for positions within the class or portfolio at each valuation point.
The greatest net loss among the 10 valuation points would be the margin
required on the portfolio or class. The margin for all other portfolios
within an account would be calculated in a similar manner. Broad-based
index classes (portfolios) that are highly correlated would be allowed
offsets such that, at the same valuation point, for example, 90% of a
gain in one class may reduce or offset a loss in another class. The
amount of offset allowed between portfolios would be the same amount
that is permitted under the risk-based haircut methodology set forth in
Appendix A of the Commission's net capital rule.\18\ A per contract
minimum would be established and would override if a lesser requirement
is rendered by the portfolio margin computation.\19\ Member
organizations would not be permitted to use any theoretical pricing
model to generate the prices used to calculate theoretical profits and
losses. Under the proposed rule change, the theoretical prices used for
computing profits and losses must come from a theoretical pricing model
that, pursuant to the Commission's net capital rule,\20\ qualifies for
purposes of determining the amount to be deducted in computing net
capital under a portfolio-based methodology. CBOE believes that
delineating acceptable theoretical pricing models is best achieved by
applying the Commission's net capital rule by reference. In this way,
consistency with the Commission's net capital rule is maintained. In
addition, since theoretical pricing models must be approved by a
Designated Examining Authority and reviewed by the Commission to
qualify, uniformity across models can be assured. As a result,
portfolio margin and cross-margin requirements will not vary materially
from firm to firm. Currently, the theoretical model used by The OCC is
the only model qualified pursuant to the Commission's net capital rule.
Consequently, all member organizations participating in the pilot
program would, at least for the foreseeable future, obtain their
theoretical values from The OCC.
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\14\ Under the proposed rule change, the term ``related
instrument'' would mean, with respect to an options class or product
group, futures contracts and options on futures contracts covering
the same underlying instrument.
\15\ Under the proposed rule change, the term ``options class''
would refer to all options contracts covering the same underlying
instrument.
\16\ CBOE's pilot program would permit an exchange-traded fund
structured to replicate the composition of the index to be included;
however, stock baskets would not be permitted at this time.
\17\ Position values would represent the difference between the
position closing price and the theoretical value at each valuation
point.
\18\ Rule 15c3-1a under the Act, 17 CFR 240.15c3-1a.
\19\ The proposed rules set a per contract minimum of $37.50.
\20\ See Rule 15c3-1a(b)(1)(i)(B) under the Act, 17 CFR
240.15c3-1a(b)(1)(i)(B).
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The Exchange's proposed rule would propose a market range of +/-10%
for computing theoretical gains and losses in broad-based, non-high
capitalization index portfolios. A market range of +6% /-8% is proposed
for broad-based, high capitalization index portfolios.\21\ These are
the same ranges currently applied to options market makers for the
purpose of computing portfolio or risk-based haircuts. On a historical
basis, these ranges cover one day moves at a very high level of
confidence, and would be competitive with the market range coverage
applied for performance bond (margin) purposes in the futures industry
on comparable index futures. The proposed rule change requires that a
separate securities margin account (or subaccount of a securities
margin account) be used for portfolio margining.
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\21\ CBOE believes that it is imperative that these market move
ranges be competitive with the range used in the futures industry
for computing margin (performance bond) on broad-based index
futures. The proposed ranges accomplish this goal. Customer
performance bond in the futures industry is computed using a
portfolio margining system known as the Standard Portfolio Analysis
of Risk (``SPAN''). The terms ``high capitalization'' and ``non-high
capitalization'' have the same meaning as they do for the purposes
of risk-based haircuts (Rule 15c3-1 under the Act, 17 CFR 240.15c3-
1).
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Amendment No. 1 to the proposed rule change also adds rule language
that requires fully paid for long options (and/or index warrants) to be
transferred out of the portfolio margin account and/or cross-margin
account and into a securities account that is not a portfolio margin
account, in the event that such long positions are the only components.
(2) Cross-Margining
The proposed rule permits related index futures and options on such
futures to be carried in a separate portfolio margin account, thus
affording a cross-margin capability. Amendment No. 1 contains changes
that primarily relate to the addition of rule language (i.e., Rule
12.4(j)) that, pursuant to agreement between Commission staff, the
Exchange and The OCC, requires cross-margin positions to be liquidated
or transferred in the event the carrying broker-dealer becomes
insolvent. The Original Proposal allowed cross-margining to be
commingled with other, non-cross margin portfolio margin positions in
the same account. However, the proposal of Amendment No. 1 to require
liquidation or transfer of the cross-margin account necessitates that
cross-margining be conducted in an account separate from non-cross-
margining activity. Therefore, Amendment No. 1 contains a number of
proposed revisions that relate to isolation of cross-margin positions
in a separate account.
In a portfolio margin account, including one that is used
exclusively for cross-margining, constituent portfolios may be formed
containing index options, index warrants and exchange-traded funds
structured to replicate the composition of the index underlying a
particular portfolio, as well as related index futures and options on
such futures. Cross-margining would operate similar to the cross-margin
program that was approved by the
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Commission and the Commodity Futures Trading Commission (``CFTC'') for
listed options market-makers and proprietary accounts of clearing
member organizations. For determining theoretical gains and losses, and
resultant margin requirements, the same portfolio margin computation
program will be applied to portfolio margin accounts, as well as cross-
margin accounts.
c. Margin or Minimum Equity Deficiency
Under proposed CBOE Rule 12.4(h), positions in a portfolio margin
account would be valued at current market prices, as currently defined
in the Exchange's margin rules. Under the proposed rule change, account
equity would be calculated and maintained separately for each portfolio
margin account. For purposes of the $5 million minimum account equity
requirement, all accounts owned by an individual or entity may be
combined. Proposed CBOE Rule 12.4(i) requires that additional margin
must be obtained within one business day (T+1) whenever equity is below
the margin required, regardless of whether the deficiency is caused by
the addition of new positions, the effect of u
