9826 Federal Register / Vol. 72, No. 42 / Monday, March 5, 2007 / Notices 

6 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2File No. SR–CBOE–2006–84, Securities 

Exchange Act Release No. 55251 (February 7, 2007), 

72 FR 7091 (February 14, 2007) (notice of filing of 

proposed rule change). 

3The Commission has modified the text of the 

summaries prepared by OCC. 

4 ‘‘Binary’’ options (also sometimes referred to as 

‘‘digital’’ options) are ‘‘all-or-nothing’’ options that 

pay a fixed amount if automatically exercised and 

otherwise pay nothing. 

5File No. SR–OCC–2004–21. 

6File Nos. SR–Amex–2004–27 and SR–CBOE–

2006–105. 

dividends, stock distributions, and stock 

splits consistent with the adjustment 

rules for stock options with respect to 

stock dividends, stock distributions, and 

stock splits and thus should protect 

investors and the public interest. 

IV. Conclusion 

On the basis of the foregoing, the 

Commission finds that the proposed 

rule change is consistent with the 

requirements of the Act and in 

particular Section 17A of the Act and 

the rules and regulations thereunder. In 

approving the proposed rule change, the 

Commission considered the proposal’s 

impact on efficiency, competition and 

capital formation. 

It is therefore ordered, pursuant to 

section 19(b)(2) of the Act, that the 

proposed rule change (File No. SR–

OCC–2006–08) be and hereby is 

approved. 

For the Commission by the Division of 

Market Regulation, pursuant to delegated 

authority.6

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. E7–3747 Filed 3–2–07; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–55362; File No. SR–OCC–

2007–01] 

Self-Regulatory Organizations; The 

Options Clearing Corporation; Notice 

of Filing of Proposed Rule Change 

Relating to Credit Default Options 

February 27, 2007. 

Pursuant to Section 19(b)(1) of the 

Securities Exchange Act of 1934 

(‘‘Act’’),1 notice is hereby given that on 

February 13, 2007, The Options Clearing 

Corporation (‘‘OCC’’) filed with the 

Securities and Exchange Commission 

(‘‘Commission’’) the proposed rule 

change described in Items I, II, and III 

below, which items have been prepared 

primarily by OCC. The Commission is 

publishing this notice to solicit 

comments on the proposed rule change 

from interested parties. 

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

The proposed rule change would 

permit OCC to clear and settle credit 

default options (‘‘CDOs’’), which are 

options related to the creditworthiness 

of an issuer or guarantor of one or more 

specified debt securities. Credit default 

options are proposed to be traded by the 

Chicago Board Options Exchange 

(‘‘CBOE’’).2

II. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

In its filing with the Commission, 

OCC included statements concerning 

the purpose of and basis for the 

proposed rule change and discussed any 

comments it received on the proposed 

rule change. The text of these statements 

may be examined at the places specified 

in Item IV below. OCC has prepared 

summaries, set forth in sections (A), (B), 

and (C) below, of the most significant 

aspects of these statements.3

(A) Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

The purpose of this rule change is to 

permit OCC to clear and settle CDOs, 

which are options related to the 

creditworthiness of an issuer or 

guarantor (‘‘reference entity’’) of one or 

more specified debt securities 

(‘‘reference obligation(s)’’). CDOs are 

binary options that pay a fixed amount 

to the holder of the option upon the 

occurrence of a ‘‘credit event’’ affecting 

the reference obligations.4

Characteristics of CDOs are described 

below, followed by an explanation of 

the specific rule changes being proposed 

to clear them. 

Description of Credit Default Options 

CDOs are structured as binary options 

that are automatically exercised and the 

exercise settlement amount payable if a 

‘‘credit event’’ occurs at any time prior 

to the last day of trading. A ‘‘credit 

event’’ is generally defined as any 

failure to pay on any of the reference 

obligations or any other occurrence that 

would constitute an ‘‘event of default’’

or ‘‘restructuring’’ under the terms of 

any of the reference obligations and that 

the listing exchange has determined 

would be a credit event for purposes of 

the CDO. Under CBOE’s current 

proposal, the payout or ‘‘settlement 

amount’’ for a single exercised option 

would be $100,000. 

OCC does not currently clear any 

binary options although OCC has filed 

a rule change 5 seeking to clear binary 

options on securities and securities 

indexes that have been proposed for 

trading by CBOE and the American 

Stock Exchange (‘‘Amex’’).6 The binary 

options rule filings of OCC, Amex, and 

CBOE are still pending approval by the 

Commission, and OCC expects to amend 

its binary options rule filing in the near 

future in order to conform it to the 

changes made in this filing and to make 

any additional changes necessary to 

accommodate the Amex and CBOE 

products. Under the binary options rule 

filings, binary options are proposed to 

be traded on the price of single 

securities or on the price of indexes of 

securities where the option is exercised 

if the closing value of the underlying 

interest meets the specified criterion for 

automatic exercise, which could be 

defined as ‘‘at or above’’ a certain value, 

‘‘below’’ a certain value, or in other 

ways. In other words, the underlying 

interest is a continuous measure that 

could have a wide range of positive 

values. CDOs, on the other hand, are 

options for which the payout is 

determined by the occurrence or nonoccurrence of a discrete credit event 

affecting underlying securities. The 

rules proposed in the current rule filing 

for CDOs are intended to be sufficiently 

generic to be the basis for clearing CDOs 

as well as other binary options although 

certain provisions specific to other 

binary options proposals will be filed 

separately. 

By-Law and Rule Amendments 

Applicable to CDOs 

In order to accommodate trading in 

CDOs and to provide a framework of 

rules that can accommodate other 

binary option products as well, OCC 

proposes to add a new By-Law Article 

and a new Chapter to its Rules to 

incorporate several new defined terms 

and procedures for clearing and settling 

binary options generally and CDOs 

specifically. 

1. Terminology—Article I, Section 1 and 

Article XIV, Section 1 of the By-Laws 

‘‘Binary Option’’ is defined in Article 

XIV, Section 1 of the By-Laws, and that 

definition is cross-referenced in Article 

I of the By-Laws. The definition of 

‘‘expiration time’’ in Article I is 

modified to be a default provision, 

permitting the expiration time to be 

defined differently for different classes 

of options. The definition of ‘‘option 

contract’’ in Article I of the By-Laws is 

amended to include a binary option and 


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Federal Register / Vol. 72, No. 42 / Monday, March 5, 2007 / Notices 9827 

to provide a more generic definition of 

‘‘cash-settled option.’’

‘‘Adjustment event’’ is defined in 

Article XIV by reference to the rules of 

the listing exchange. Similarly, ‘‘credit 

event’’ is defined by reference to 

exchange rules. The terms ‘‘credit event 

confirmation’’ and ‘‘credit event 

confirmation deadline’’ are used, 

respectively, to refer to the notice that 

must be provided by the listing 

exchange or other reporting authority to 

OCC that a credit event has occurred 

(and that a CDO will therefore 

automatically be exercised) and to the 

deadline for receipt of such notice if it 

is to be treated as having been received 

on the business day on which it is 

submitted. Credit event confirmations 

received after the deadline on the 

expiration date but before the expiration 

time will be given effect but may result 

in delayed exercise settlement. 

The definition of ‘‘exercise price’’ in 

Article I is replaced with respect to 

CDOs with a revised definition in 

Article XIV, Section 1 which recognizes 

that binary options will be settled by a 

fixed cash payment. The ‘‘exercise 

price’’ of a binary option is not, as 

defined in Article I, an amount that is 

paid in exchange for an underlying 

interest and is not used to determine the 

exercise settlement amount as in the 

case of other cash-settled options. In the 

case of a binary option other than a 

CDO, the exercise price is simply a 

defined value or range of values for the 

underlying interest. If the underlying 

interest falls within the defined range at 

expiration of the option, the option will 

be automatically exercised. Otherwise, 

it will expire unexercised. A CDO is 

said to have no exercise price. 

OCC is also redefining the term 

‘‘exercise settlement amount’’ in Article 

XIV for purposes of binary options. The 

exercise settlement amount of a binary 

option is the amount specified by the 

exchange on which the option is traded 

that will be paid in settlement of an 

automatically exercised option. CBOE 

has specified the exercise settlement 

amount for a single CDO as $100,000. 

OCC’s proposed definition would 

permit an exchange to specify a 

different exercise settlement amount. 

The exercise settlement amount will be 

determined by the exchange at the time 

of listing when the exchange fixes the 

other variable terms for the options of a 

particular class or series. 

OCC is replacing the definitions of 

‘‘variable terms,’’ ‘‘premium,’’ and 

‘‘multiplier’’ in Article I with revised 

definitions in Article XIV, Section 1 that 

are applicable to binary options 

generally. The term ‘‘class’’ is also 

redefined in Article XIV, Section 1. This 

new definition of ‘‘class’’ does not apply 

to binary options other than CDOs and 

will need to be supplemented for other 

binary options. To be within the same 

class, CDOs must have the same 

reporting authority, which OCC 

anticipates will ordinarily be the listing 

exchange. This is necessary because of 

the degree of discretion that the 

reporting authority will have in 

determining whether a credit event has 

occurred. 

CDOs will be a subcategory of binary 

options where exercise is triggered by a 

discrete event such as a ‘‘credit event’’

affecting the ‘‘reference obligations’’

issued by a ‘‘reference entity,’’ which 

terms are defined to have the meanings 

given to them in the rules of the listing 

exchange. The term ‘‘underlying 

interest’’ is defined in the case of CDOs 

to be the reference obligation(s) with 

respect to which the credit event will or 

will not occur. In the case of other 

binary options, ‘‘underlying interest’’ is 

defined as the underlying security, 

index, or measure whose underlying 

interest value is compared to the 

option’s exercise price to determine 

whether the option will be 

automatically exercised. ‘‘Underlying 

interest value’’ is defined to mean the 

value or level of the underlying interest 

used to determine whether a binary 

option will be automatically exercised. 

The term ‘‘underlying interest value’’ is 

not applicable to CDOs. 

2. Terms of Cleared Contracts—Article 

VI, Section 10(e) 

A new paragraph (e) is added to 

Article VI, Section 10 so that an 

exchange is required to designate the 

exercise settlement amount, expiration 

date, and exercise price for a series of 

binary options at the time the series is 

opened for trading. Section 10(e) also 

reminds the reader that binary options 

are subject to adjustment under Article 

XIV. 

3. Rights and Obligations—Article XIV, 

Section 2 

Article XIV, Section 2 defines the 

general rights and obligations of holders 

and writers of binary options. As noted 

above, the holder of a binary option that 

is automatically exercised has the right 

to receive the fixed exercise settlement 

amount from OCC, and the assigned 

writer has the obligation to pay that 

amount to OCC. 

4. Adjustments of Credit Default 

Options—Article XIV, Section 3; 

Determination of Occurrence of Credit 

Event—Article XIV, Section 4 

Article XIV, Section 3 provides for 

adjustment of CDOs in accordance with 

the rules of the listing exchange. CBOE’s 

proposed rules provide for adjustment 

of CDOs in the case of certain corporate 

events affecting the reference 

obligations, and OCC proposes simply 

to defer to those rules and to the 

determinations of CBOE pursuant to 

those rules. Accordingly, OCC will have 

no responsibility for adjustment 

determinations with respect to CDOs. 

Adjustment rules for other binary 

options will be supplied as necessary 

for other products. 

Similarly, Section 4 provides that the 

listing exchange for a class of CDOs will 

have responsibility for determining the 

occurrence of a credit event that will 

result in automatic exercise of the 

options of that class. The listing 

exchange has the obligation to provide 

a credit event confirmation to OCC in 

order to trigger the automatic exercise. 

New Article XIV, Section 5 provides, 

in essence, that the underlying interest 

value of a series of binary options other 

than CDOs will be determined by the 

exchange or exchanges on which such 

series is traded. OCC reserves the right 

to override that determination in certain 

circumstances. If a series of binary 

options is traded on more than one 

exchange, OCC may use the underlying 

interest value received from the 

exchange deemed by OCC to be the 

principal exchange, or OCC may employ 

a procedure to derive a single value 

based on some or all of the values 

received. 

5. Exercise and Settlement—Chapter XV 

of the Rules and Rule 801 

Binary options would not be subject 

to the exercise-by-exception procedures 

applicable to most other options under 

OCC’s Rules but would instead be 

automatically exercised at expiration if 

the specified criterion for exercise is 

met. The procedures for the automatic 

exercise of binary options, as well as 

their assignment and settlement 

(including during periods when a 

clearing member is suspended), are set 

forth in Rules 1501 through 1505 of new 

Chapter XV and in revised Rule 801(b). 

6. Special Margin Requirements—Rule 

601; Deposits in Lieu of Margin—Rule 

1506 

OCC will not initially margin CDOs 

through its usual ‘‘STANS’’ system. 

Because of CDOs’ fixed payout feature, 

further systems development is needed 

to accommodate these options in 

STANS. Until such development is 

completed, OCC has initially 

determined to require that writers of 

such options post margin in a fixed 

amount that will be set at 100% of the 

fixed exercise settlement amount 


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9828 Federal Register / Vol. 72, No. 42 / Monday, March 5, 2007 / Notices 

7 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

3 15 U.S.C. 78s(b)(3)(A)(ii). 

4 17 CFR 240.19b–4(f)(2). 

applicable to each series of CDOs. OCC 

would have discretion to reduce the 

requirement to something less than 

100% if research, analysis, and 

experience suggest that a lower 

percentage is sufficient. Initially, long 

positions in CDOs will be valued at zero 

and will provide no offset against 

margin requirements on the shorts. 

Again, based on research, analysis, and 

experience, OCC may determine to give 

some value to the longs. Ultimately, 

CDOs will be incorporated into the 

STANS system and valued and will be 

margined on a risk basis. 

OCC does not propose to accept 

escrow deposits in lieu of clearing 

margin for binary options. Therefore, 

Rule 1506 states that Rule 610, which 

otherwise would permit such deposits, 

does not apply to binary options. 

7. Acceleration of Expiration Date—Rule 

1507 

This provision permits OCC to 

accelerate the expiration date of a binary 

option when the value of the underlying 

interest has become fixed (e.g., where a 

stock underlying a binary option has 

been converted by a merger into the 

right to receive a fixed amount of cash). 

If the value of the underlying interest 

does not meet the specified criterion for 

automatic exercise, it will expire 

unexercised. Otherwise, it will be 

automatically exercised. 

The proposed changes to OCC’s ByLaws and Rules are consistent with the 

purposes and requirements of Section 

17A of the Act, as amended, because 

they are designed to promote the 

prompt and accurate clearance and 

settlement of transactions in, including 

exercises of, credit default options and 

other binary options, and to foster 

cooperation and coordination with 

persons engaged in the clearance and 

settlement of such transactions, to 

remove impediments to and perfect the 

mechanism of a national system for the 

prompt and accurate clearance and 

settlement of such transactions, and, in 

general, to protect investors and the 

public interest. They accomplish these 

purposes by applying substantially the 

same rules and procedures to binary 

options and specifically CDOs as OCC 

applies to similar transactions in other 

cash-settled options. Other than as 

described in this Item II, the proposed 

rule change is not inconsistent with the 

existing rules of OCC, including rules 

proposed to be amended. 

(B) Self-Regulatory Organization’s 

Statement on Burden on Competition 

OCC does not believe that the 

proposed rule change would impose any 

burden on competition. 

(C) Self-Regulatory Organization’s 

Statement on Comments on the 

Proposed Rule Change Received From 

Members, Participants, or Others 

Written comments were not and are 

not intended to be solicited with respect 

to the proposed rule change, and none 

have been received. 

III. Date of Effectiveness of the 

Proposed Rule Change and Timing for 

Commission Action 

Within thirty-five days of the date of 

publication of this notice in the Federal 

Register or within such longer period: 

(i) As the Commission may designate up 

to ninety days of such date if it finds 

such longer period to be appropriate 

and publishes its reasons for so finding 

or (ii) as to which the self-regulatory 

organization consents, the Commission 

will: 

(A) By order approve such proposed 

rule change or 

(B) Institute proceedings to determine 

whether the proposed rule change 

should be disapproved. 

IV. Solicitation of Comments 

Interested persons are invited to 

submit written data, views, and 

arguments concerning the foregoing, 

including whether the proposed rule 

change is consistent with the Act. 

Comments may be submitted by any of 

the following methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/sro.shtml) or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number SR–OCC–2007–01 on the 

subject line. 

Paper Comments 

• Send paper comments in triplicate 

to Nancy M. Morris, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number SR–OCC–2007–01. This file 

number should be included on the 

subject line if e-mail is used. To help the 

Commission process and review your 

comments more efficiently, please use 

only one method. The Commission will 

post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/ 

rules/sro.shtml). Copies of the 

submission, all subsequent 

amendments, all written statements 

with respect to the proposed rule 

change that are filed with the 

Commission, and all written 

communications relating to the 

proposed rule change between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for inspection and copying in 

the Commission’s Public Reference 

Section, 100 F Street, NE., Washington, 

DC 20549. The text of the proposed rule 

change is available at OCC, the 

Commission’s Public Reference Room, 

and http://www.theocc.com/ 

publications/rules/proposed_changes/ 

sr_occ_07_01.pdf. All comments 

received will be posted without change; 

the Commission does not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. All submissions 

should refer to File Number SR–OCC–

2007–01 and should be submitted on or 

before March 26, 2007. 

For the Commission by the Division of 

Market Regulation, pursuant to delegated 

authority.7

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. E7–3773 Filed 3–2–07; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–55358; File No. SR–Phlx–

2007–14] 

Self-Regulatory Organizations; 

Philadelphia Stock Exchange, Inc.; 

Notice of Filing and Immediate 

Effectiveness of Proposed Rule 

Change Extending the Dividend, 

Merger, and Short Stock Interest 

Strategies Fee Cap Program 

February 27, 2007. 

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 

21, 2007, the Philadelphia Stock 

Exchange, Inc. (‘‘Phlx’’ or ‘‘Exchange’’) 

filed with the Securities and Exchange 

Commission (‘‘Commission’’) the 

proposed rule change as described in 

Items I, II, and III below, which Items 

have been substantially prepared by the 

Exchange. Phlx has designated this 

proposal as one establishing or changing 

a due, fee, or other charge imposed by 

a self-regulatory organization pursuant 

to Section 19(b)(3)(A)(ii) of the Act 3 and 

Rule 19b–4(f)(2) thereunder,4 which 


erjones on PRODPC74 with NOTICES