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[Federal Register Volume 65, Number 230 (Wednesday, November 29, 2000)]
[Notices]
[Pages 71151-71160]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30378]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43582; File No. SR-Amex-99-27]

Self-Regulatory Organizations; American Stock Exchange LLC; Order 
Approving Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval of Amendment Nos. 1 and 2 to the Proposed Rule 
Change Relating to Amex Rule 462, ``Minimum Margins''

November 17, 2000.

I. Introduction

    On July 23, 1999, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Amex Rule 462, ``Minimum 
Margins,'' to revise the margin requirements for stock options and 
stock index options. The proposed rule

[[Page 71152]]

change was published for comment in the Federal Register on September 
8, 1999.\3\ No comments were received on the notice of the proposed 
rule change. The Exchange filed Amendment Nos. 1 \4\ and 2 \5\ to the 
proposal on June 1, 2000, and September 25, 2000, respectively. This 
order approves the proposed rule change and grants accelerated approval 
to Amendment Nos. 1 and 2.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 41808 (August 30, 
1999), 64 FR 48882.
    \4\ See letter from Scott G. Van Hatten, Attorney, Amex, to Jack 
Drogin, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated May 31, 2000 (``Amendment No. 
1''). Among other things, Amendment No. 1 revises the proposal to: 
(1) Add a definition of ``OTC Margin Bond'' to Amex Rule 462(d) to 
account for the Federal Reserve Board's removal of the definition 
from Section 220 of Regulation T of the Federal Reserve Board; (2) 
add a definition to Amex Rule 462(d) of ``escrow agreement'' with 
respect to cash settled options or warrants; (3) remove a reference 
to packaged vertical spreads and packaged butterfly spreads as the 
Exchange currently does not have Commission approval to trade these 
products; (4) remove certain margin provisions relating to unit 
investment trusts from proposed Amex Rule 462(d)(2)(I)(ii)(a)(2) and 
proposed Amex Rule 462(d)(10)(B)(iii) and (iv) as eligible 
securities to serve as a cover for index call options as a result of 
the approval of SR-Amex-98-33 which addressed such positions; (5) 
make certain other non-substantive revisions to correct 
typographical errors and to make the filing consistent; (6) move the 
definition of ``cash equivalent'' from Commentary .03(c) of Amex 
Rule 462 to proposed Amex Rule 462(d); (7) add citations to more 
clearly indicate the removal and insertion of various provisions of 
the Rule (for example, Amex is removing paragraphs (E) through (I) 
of Amex Rule 462(d)(2) as these paragraphs will be covered by 
proposed Amex Rule 462(d)(10)(B)); (8) remove Commentaries .06-.08 
of Amex Rule 462 because the Amex has rephrased and updated these 
margin provisions and has relocated them to other sections of the 
same rule. Specifically, the Amex proposes to delete the margin 
provisions relating to capped style options in Commentaries .06 and 
.07 because the Amex has proposed new provisions relating to these 
options in Amex Rule 462(d)(10)(B). The Amex also proposes to delete 
Commentary .08 of Amex Rule 462 and current Amex Rule 462(d)(2)(O) 
concerning margin provisions relating to debit put spread positions 
in broad based European style index options because the Amex has now 
proposed new margin for spread provisions in Amex Rule 462(d)(2)(J); 
(9) delete the current provision in Commentary .09 of Amex Rule 462 
relating to a margin rule regarding offset margin treatment for 
currency warrants, currency index warrants and listed options under 
a pilot program that has expired and therefore is no longer 
necessary; (10) revise and move provisions regarding straddle/
combination from Amex Rule 462(d)10(B)(v) to proposed Amex Rule 
462(d)(10)(B)(vi); and (11) move the rule text of Amex Rule 
462(d)(2)(H)(iv) and current Commentary .10 of the same rule 
concerning margin for certain short index options positions covered 
by positions in Portfolio Depositary Receipts or Index Fund Shares 
to proposed Amex Rule 462(d)(10)(B)(ii)(c) and proposed Commentary 
.06 of the same rule to reflect the rule language as approved in the 
filing SR-Amex-98-33.
    \5\ See letter from Scott G. Van Hatten, Attorney, Amex, to Jack 
Drogin, Assistant Director, Division, Commission, dated September 
22, 2000 (``Amendment No. 2''). Amendment No. 2 revises the proposal 
to: (1) Provide a technical correction to the proposed rule text for 
OTC options and warrants with expirations exceeding nine months 
(``long term''); (2) add the word ``aggregate'' in appropriate 
places in the definitions of ``butterfly spread'' and ``box 
spread;'' and delete the word ``aggregate'' in proposed Amex Rule 
462(d)(10)(B)(iv) relating to ``Exceptions'' referring to the 
general maintenance margin requirement provision for certain hedged 
option or warrant strategies; and (3) change the term ``deliver'' to 
``pay'' in the definition of ``escrow agreement'' in connection with 
cash settled options or warrants to more accurately reflect that a 
bank is obligated to pay to the creditor in the case of an option 
the exercise settlement amount (in the event an option) is assigned 
an exercise notice or (in the case of a warrant) the funds 
sufficient to purchase a warrant sold short in the event of a buy-
in.
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II. Description of the Proposal

A. Background

    Until several years ago, the margin requirements governing listed 
options were set forth in Regulation T, ``Credit by Brokers and 
Dealers.'' \6\ However, Federal Reserve Board amendments to Regulation 
T that became effective June 1, 1997, modified or deleted certain 
margin requirements regarding options transactions in favor of rules to 
be adopted by the options exchanges, subject to approval by the 
Commission.\7\
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    \6\ 12 CFR 220 et seq. The Board of Governors of the Federal 
Reserve System (``Federal Reserve Board'') issued Regulation T 
pursuant to the Act.
    \7\ See Board of Governors of the Federal Reserve System Docket 
No. R-0772 (Apr. 24, 1996), 61 FR 20386 (May 6, 1996) (permitting 
the adoption of margin requirements ``deemed appropriate by the 
exchange that trades the option, subject to the approval of the 
Securities and Exchange Commission'').
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    At the present time, the Exchange seeks to further revise its 
margin rules to implement enhancements long desired by Exchange members 
and member firms, public investors, and the Exchange staff. The 
Exchange believes that certain multiple options position strategies and 
other strategies that combine stock with option positions warrant more 
equitable margin treatment. The Exchange further believes that the 
offset in risk that results if the stock and options position are 
viewed collectively is not reflected in the current maintenance margin 
requirements. The Exchange believes that market participants should 
have the ability to use these strategies for the least amount of margin 
necessary. In addition, the Exchange believes it is appropriate for 
member firms to extend credit on certain types of long term options.
    In its proposal, the Exchange reviewed all of its margin rules with 
a view toward updating or improving margin provisions as necessary. The 
Exchange also found it necessary to propose minor changes to certain 
rules because they are closely related to, and will be impacted by, the 
more substantive proposals.
    In sum, the proposed revisions to the Exchange's margin rules 
would: (1) Permit the extension of credit on certain long term options 
and warrants with over nine months until expiration, and on certain 
long box spreads comprised entirely of European-style options; (2) 
recognize butterfly and box spread strategies for purposes of margin 
treatment and establish appropriate margin requirements for them; (3) 
recognize various strategies involving stocks (or other underlying 
instruments) paired with a long option, and provide for lower 
maintenance margin requirements on such hedged stock positions; (4) 
expand the types of short options positions that would be considered 
``covered'' in a cash account, specifically, certain short positions 
that are components of limited risk spread strategies (e.g., butterfly 
and box spreads); (5) allow a bank issued escrow agreement that 
conforms to Exchange standards to serve as cover for certain spread 
positions held in a cash account; and (6) update and improve, as 
necessary, Exchange current margin rules.

B. Definitions

    Currently, Amex Rule 462 defines the ``current market value'' or 
``current market price'' of an option, currency warrant, currency index 
warrant, or stock index warrant as the total cost or net proceeds of 
the option contract or warrant on the day it was purchased or sold. The 
Amex proposes to revise the definition to indicate that the current 
market value or current market price of an option, currency warrant, 
currency index warrant, or stock index warrant are as defined in 
Section 220.2 of Regulation T of the Federal Reserve Board.
    The Exchange also proposes to establish definitions for ``butterfly 
spread'' \8\ and ``box spread'' \9\ options

[[Page 71153]]

strategies. The definitions are important elements of the Exchange's 
proposal to recognize and specify cash and margin account requirements 
for butterfly and box spreads. The definitions will specify what 
multiple option positions, if held together, qualify for classification 
as butterfly or box spreads, and consequently are eligible for the 
proposed cash and margin treatment.
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    \8\ The proposal defines ``butterfly spread'' as:
    [A]n aggregation of positions in three series of either put or 
call options all having the same underlying component or index and 
time of expiration, and based on the same aggregate current 
underlying value, where the interval between the exercise price of 
each series is equal, which positions are structured as either (A) a 
``long butterfly spread'' in which two short options in the same 
series are offset by one long option with a higher exercise price 
and one long option with a lower exercise price, or (B) a ``short 
butterfly spread'' in which two long options in the same series 
offset one short option with a higher exercise price and one short 
option with a lower exercise price. See Amendment No. 2, supra note 
5.
    \9\ The proposal defines ``box spread'' as:
    [A]n aggregation of positions in a long call option and short 
put option with the same exercise price (``buy side'') coupled with 
a long put option and short call option with the same exercise price 
(``sell side'') all of which have the same underlying component or 
index and time of expiration, and are based on the same aggregate 
current underlying value, and are structured as either: (A) a ``long 
box spread'' in which the sell side exercise price exceeds the buy 
side exercise price, or (B) a ``short box spread'' in which the buy 
side exercise price exceeds the sell side exercise price. See 
Amendment No. 2, supra note 5.
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    The proposal would define the term ``OTC margin bond.'' \10\ The 
definition is necessary because the Exchange's margin rules currently 
cross-reference the Regulation T definition of ``OTC margin bond,'' 
which was eliminated by the Federal Reserve Board as of April 1, 
1998.\11\
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    \10\ The proposal defines ``OTC margin bond'' as:
    (1) Any debt securities not traded on a national securities 
exchange that meet all of the following requirements (a) at the time 
of the original issue, a principal amount of not less than 
$25,000,000 of the issue was outstanding; (b) the issue was 
registered under Section 5 of the Securities Act of 1933 and the 
issuer either files periodic reports pursuant to the Act or is an 
insurance company under Section 12(g)(2)(G) of the Act; or (c) at 
the time of the extension of credit the creditor has a reasonable 
basis for believing that the issuer is not in default on interest or 
principal payments; or (2) any private pass-through securities (not 
guaranteed by a U.S. government agency) that meet all of the 
following requirements: (a) an aggregate principal amount of not 
less than $25,000,000 was issued pursuant to a registration 
statement filed with the Commission; (b) current reports relating to 
the issue have been filed with the Commission; and (c) at the time 
of the credit extension, the creditor has a reasonable basis for 
believing that mortgage interest, principal payments and other 
distributions are being passed through as required and that the 
servicing agent is meeting its material obligations under the terms 
of the offering. See Amendment No. 1, supra note 4.
    \11\ See Board of Governors of the Federal Reserve System Docket 
Nos. R-0905, R-0923, and R-0944 (Jan. 8, 1998), 63 FR 2806 (Jan. 16, 
1998).
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    The Amex proposes to define an ``escrow agreement,'' when used in 
connection with cash settled calls, puts, currency warrants, currency 
index warrants or stock index warrants, carried short, any agreement 
issued in a form acceptable to the Exchange under which a bank holding 
cash, cash equivalents, one or more qualified equity securities or a 
combination thereof is obligated in the case of a call option or 
warrant; or cash, cash equivalents or a combination thereof in the case 
of a put option or warrant is obligated to pay to the creditor (in the 
case of an option) the exercise settlement amount in the event an 
option is assigned an exercise notice or (in the case of a warrant) the 
funds sufficient to purchase a warrant sold short in the event of a 
buy-in.\12\ The Exchange also proposes to revise the definition of 
``escrow agreement,'' when used in connection with non-cash settled 
call or put options carried short, as any agreement issued in a form 
acceptable to the Exchange under which a bank holding the underlying 
security (in the case of a call option) or required cash, cash 
equivalents, or a combination thereof (in the case of a put option), is 
obligated to deliver to the creditor (in the case of a call option) or 
accept from the creditor (in the case of a put option) the underlying 
security against payment of the exercise price in the event the call or 
put is assigned an exercise notice.
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    \12\ See Amendment No. 2, supra note 5.
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    The Exchange also seeks to define the term ``listed.'' \13\ Because 
the term ``listed'' is frequently used in the Exchange's margin rules, 
the Exchange believes that it would be more efficient to define the 
term once rather than specifying the meaning of the term each time it 
is used.
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    \13\ The proposal defines the term ``listed'' as a security 
traded on a registered national securities exchange or automated 
facility of a registered national securities association.
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    The Exchange would also define the term ``underlying stock 
basket.'' \14\
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    \14\ The proposal defines ``underlying stock basket'' as:
    [A] group of securities which includes each of the component 
securities of the applicable index and which meets the following 
conditions: (i) The quantity of each stock in the basket is 
proportional to its representation in the index; (ii) the total 
market value of the basket is equal to the underlying index value of 
the index options or warrants to be covered; (iii) the securities in 
the basket cannot be used to cover more than the number of index 
options or warrants represented by that value; and (iv) the 
securities in the basket shall be unavailable to support any other 
option or warrant transaction in the account.
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C. Extension of Credit on Long Term Options and Warrants

    The proposal would allow extensions of credit on certain long 
listed and OTC \15\ options (i.e., put or call options on a stock or 
stock index) and warrant products (i.e., stock index warrants, but not 
traditional stock warrants issued by a corporation on its own 
stock).\16\ The proposal provides no loan value for long term foreign 
currency options. Only long term options or warrants with expirations 
exceeding nine months will be eligible for credit extension.\17\ For 
long term listed options and warrants, the proposal requires initial 
and maintenance margin of not less than 75 percent of the current 
market value of the option or warrant. Therefore, Amex member firms 
would be able to loan up to 25 percent of the current market value of a 
long term listed option or warrant.\18\
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    \15\ Unlike listed options, OTC options are not issued by The 
Options Clearing Corporation (``OCC''). OTC options and warrants are 
not listed or traded on a registered national securities exchange or 
through the automated quotation system of a registered securities 
association.
    \16\ Throughout the remainder of this approval order, the term 
``warrant'' means this type of warrant.
    \17\ For any stock option, stock index option, or stock index 
warrant, carried long in a customer's account, that expires in nine 
months or less, initial margin must be deposited and maintained 
equal to at least 100% of the purchase price of the option or 
warrant.
    \18\ For example, if an investor purchased a listed call option 
on stock XYZ that expired in January 2001 for approximately $100 
(excluding commissions), the investor would be required to deposit 
and maintain at least $75. The investor could borrow the remaining 
$25 from its broker. Under the Amex's current margin rules, the 
investor would be required to pay the entire $100. See Securities 
Exchange Act Release No. 41658 (July 27, 1999), 64 FR 42736 (August 
5, 1999) (``COBE Approval Order''), at footnote 18.
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    The proposal would permit the extension of credit on certain long 
term OTC options and warrants. Specifically, an Amex member firm could 
extend credit on a OTC put or call option on a stock or stock index, 
and on an OTC stock index warrant. In addition to being more than nine 
months from expiration, a marginable OTC option or warrant must: (1) Be 
in-the-money and valued at all time for margin purposes at an amount 
not to exceed the in-the-money amount; (2) be guaranteed by the 
carrying broker-dealer, and (3) have an American-style \19\ exercise 
provision.\20\ The proposal requires an initial and maintenance margin 
of 75 percent of the long term OTC option's or warrant's in-the-money 
amount (i.e., its intrinsic value).
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    \19\ American-style options are exercisable on any business day 
prior to its expiration date and on its expiration date.
    \20\ See Amendment No. 2, supra note 5.
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    When the time remaining until expiration for an option or warrant 
(listed or OTC) on which credit has been extended reaches nine months, 
the maintenance margin requirement would become 100 percent of the 
current market value. Options or warrants expiring in less than nine 
months would have no loan value under the proposal because of the 
leverage and volatility of those instruments.

D. Extension of Credit on Long Box Spread in European-Style Options

    The proposal also would permit the extension of credit on a long 
box spread composed entirely of European-style options \21\ that are 
listed or guaranteed by the carrying broker-dealer. A long box spread 
is a strategy that is composed of four option positions and

[[Page 71154]]

is designed to lock in the ability to buy and sell the underlying 
component or index for a profit, even after netting the cost of 
establishing the long box spread. The two exercise prices embedded in 
the strategy determine the buy and the sell price.\22\
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    \21\ A European-style option may be exercised only at its 
expiration pursuant to the rules of The OCC. See Amex Rule 900C(20).
    \22\ For example, an investor might be long 1 XYZ Jan 50 Call @ 
7 and short 1 XYZ Jan 50 Put @ 1 (``buy side''), and short 1 XYZ Jan 
60 Call @ 2 and long 1 XYZ Jan 60 Put @ 5\1/2\ (``sell side''). As 
required by the Exchange's proposed definition of ``long box 
spread,'' the sell exercise price exceeds the buy side exercise 
price. In this example, the long box spread is a riskless position 
because the net debit ((2 + 1) - (7 + 5\1/2\) = net debit of 9\1/2\) 
is less than the exercise price differential (60 - 50 = 10). Thus, 
the investor has locked in a profit of $50 (\1/2\  x  100). See CBOE 
Approval Order, supra note 18, at footnote 22.
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    For long box spreads made up of European-style options, the 
proposal would require initial and maintenance margin of 50 percent of 
the aggregate difference in the two exercise prices (buy and sell), 
which results in a margin requirement slightly higher than 50 percent 
of the net debit typically incurred.\23\ Under the proposal, a long box 
spread would be allowed market value for margin equity purposes of not 
more than 100 percent of the aggregate difference in exercise prices of 
the options.
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    \23\ In the example appearing in the preceding footnote, the 
margin required (50%  x  (60 - 50) = 5) would be slightly higher 
than 50% of the net debit (50%  x  9\1/2\ = 4\3/4\). See CBOE 
Approval Order, supra note 18, at footnote 23.
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E. Cash Account Treatment of Butterfly Spreads and Box Spreads, Other 
Spreads, and Short Options

    The proposal would permit butterfly spreads and box spreads in 
cash-settled, European-style options eligible for the cash amount. A 
butterfly spread is a pairing of two standard spreads, one bullish and 
one bearish. To qualify for carrying in the cash account, the butterfly 
spreads and box spreads must meet the specifications contained in the 
proposed definition section,\24\ and must be comprised of options that 
are listed or guaranteed by the carrying broker-dealer. In addition, 
the long options must be held in, or purchased for, the account on the 
same day.
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    \24\ See supra notes 8 and 9 (definitions of butterfly and box 
spreads).
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    For long butterfly spreads and long box spreads, the proposal would 
require full payment of the net debit that is incurred when the spread 
strategy is established. According to the Amex, full payment of the net 
debit incurred to establish a long butterfly or box spread will cover 
any potential risk to the carrying broker-dealer.\25\
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    \25\ For example, to create a long butterfly spread, which is 
comprised of call options, an investor may be long 1 XYZ Jan 45 Call 
@ 6, short 2 XYZ Jan 50 Calls @ 3 each, and long 1 XYZ Jan 55 Call @ 
1. The maximum risk for this long butterfly spread is the net debit 
incurred to establish the strategy ((3 + 3) - (6 + 1) = net debit of 
1). Under the proposal, therefore, the investor would be required to 
pay the net debit, or $100 (1  x  100) See CBOE Approval Order, 
supra note 18, at footnote 25.
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    Shortly butterfly spreads generate a credit balance when 
established (i.e., the proceeds from the sale of short option 
components exceed the cost of purchasing long option components). 
However, in the worst case scenario where all options are exercised, a 
debit (loss) greater than the initial credit balance received would 
accrue to the account. To eliminate the risk to the broker-dealer 
carrying the short butterfly spread, the proposal will require that an 
amount equal to the maximum risk be held or deposited in the account in 
the form of cash or cash equivalents.\26\ The maximum risk potential in 
a short butterfly spread comprised of call options is the aggregate 
difference between the two lowest exercise prices.\27\ With respect to 
short butterfly spreads comprised of put options, the maximum risk 
potential is the aggregate difference between the two highest exercise 
prices. The net credit received from the sale of the short option 
components could be applied towards the requirement. Short box spreads 
also generate a credit balance when established. This credit is nearly 
equal to the total debit (loss) that, in the case of a short box 
spread, will accrue to the account if held to expiration. The proposal 
will require that cash or cash equivalents covering the maximum risk, 
which is equal to the aggregate difference in the two exercise prices 
involved, be held or deposited.\28\ The net credit received from the 
sale of the short option components may be applied towards the 
requirement; if applied, only a small fraction of the total requirement 
need to be held or deposited.\29\
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    \26\ An escrow agreement could be used as a substitute for cash 
or equivalents if the agreement satisfies certain criteria. For 
short butterfly spreads, the escrow agreement must certify that the 
bank holds for the account of the customer as security for the 
agreement (1) cash, (2) cash equivalents, or (3) a combination 
thereof having an aggregate market value at the time the positions 
are established of not less than the amount of the aggregate 
difference between the two lowest exercise prices with respect to 
short butterfly spreads comprised of call options or the aggregate 
difference between the two highest exercise prices with respect to 
short butterfly spreads comprised of put options and that the bank 
will promptly pay the member organization such amount in the event 
the account is assigned an exercise notice on the call (put) with 
the lowest (highest) exercise price.
    \27\ For example, an investor may be short 1 XYZ Jan 45 Call @ 
6, long 2 XYZ Jan 50 Calls @ 3 each, and short 1 XYZ Jan 55 Call @ 
1. Under the proposal, the maximum risk for this short butterfly 
spread, which is comprised of call options, is equal to the 
difference between the two lowest exercise prices (50 - 45 = 5). If 
the net credit received from the sale of short option components ((6 
+ 1) - (3 + 3) = net credit of 1) is applied, the investor is 
required to deposit an additional $400 (4  x  100). Otherwise, the 
investor would be required to deposit $500 (5  x  100). See CBOE 
Approval Order, supra note 18, at footnote 27.
    \28\ As a substitute for cash or cash equivalents, an escrow 
agreement could be used if it satisfies certain criteria. For short 
box spreads, the escrow agreement must certify that the bank holds 
for the account of the customer as security for the agreement (1) 
cash, (2) cash equivalents, or (3) a combination thereof having an 
aggregate market value at the time the positions are established of 
not less than the amount of the aggregate difference between the 
exercise prices, and that the bank will promptly pay the member 
organization such amount in the event the account is assigned an 
exercise notice on either short option.
    \29\ To create a short box spread, an investor may be short 1 
XYZ Jan 60 Put @ 5\1/2\ and long 1 XYZ Jan 60 Call @ 2 (``buy 
side''), and short 1 XYZ Jan 50 Call @ 7 and long 1 XYZ Jan 50 Put @ 
1 (``sell side''). As required by the Exchange's proposed definition 
of ``short box spread'' (supra note 9), the buy side exercise price 
exceeds the sell side exercise price. In this example, the maximum 
risk for the short box spread is equal to the difference between the 
two exercise prices (60 - 50 = 10). If the net credit received from 
the sale of short option components ((5\1/2\ + 7) - (2 + 1) = net 
credit of 9\1/2\) is applied, the investor is required to deposit an 
additional $50 (\1/2\ - 100). Otherwise, the investor would be 
required to deposit $1,000 (10  x  100). See CBOE Approval Order, 
supra note 18, at footnote 29.
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    In addition to butterfly spreads and box spreads, the proposal will 
permit investors to hold in their cash accounts other spreads made up 
of European-style, cash-settled stock index options, stock index 
warrants, or currency index warrants. A short position would be 
considered covered, and thus eligible for the cash account, if a long 
position in the same European-style, cash-settled index option, stock 
index warrant, or currency index warrant was held in, or purchased for, 
the account on the same day.\30\ The long and short positions making up 
the spread must expire concurrently, and the long position must be paid 
in full. Lastly, the cash account must contain cash, cash equivalents, 
or an escrow agreement equal to at least the aggregate exercise price 
differential.
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    \30\ Under the proposal, a long warrant may offset a short 
option contract and a long option contract may offset a short 
warrant provided they have the same underlying component or index 
and equivalent aggregate current underlying value.
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    The proposal also would establish requirements for the following 
types of options and warrants carried short in the cash account: equity 
options, index options, capped-style index options, stock index 
warrants, and currency index warrants. For each of these securities, 
the proposal specifies certain criteria that must be satisfied for the 
short position to be deemed a covered position, and thus considered 
eligible

[[Page 71155]]

for the cash account. For example, a short put warrant on a market 
index would be deemed covered if, at the time the put warrant is sold 
or promptly thereafter, the cash account holds cash, cash equivalents, 
or an escrow agreement equal to the aggregate exercise price.

F. Margin Account Treatment of Butterfly and Box Spreads

    The Exchange's margin rules presently do not recognize butterfly 
spreads for margin purposes. Under the Exchange's current margin rules, 
the two spreads (bullish and bearish) that make up a butterfly spread 
each must be margined separately. The Exchange believes that the two 
spreads should be viewed in combination, and that commensurate with the 
lower combined risk, investors should receive the benefit of lower 
margin requirements.
    The Exchange's proposal would recognize as a distinct strategy 
butterfly spreads held in margin accounts,and specify requirements that 
are the same as the cash account requirements for butterfly 
spreads.\31\ Specifically, in the case of a long butterfly spread, the 
net debit must be paid in full. For short butterfly spreads comprised 
of call options, the initial and maintenance margin must equal at least 
the aggregate difference between the two lowest exercise prices. For 
short butterfly spreads comprised of put options, the initial and 
maintenance margin must equal at least the aggregate difference between 
the two highest exercise prices. The net credit received from the sale 
of the short option components may be applied towards the margin 
requirement for short butterfly spreads.
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    \31\ See supra, Section II.E., ``Cash Account Treatment of 
Butterfly Spreads and Box Spreads, Other Spreads, and Short 
Options.'' The margin requirements would apply to butterfly spreads 
where all option positions are listed or guaranteed by the carrying 
broker-dealer.
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    The proposed requirements for box spreads held in a margin account, 
where all option positions making up the box spread are listed or 
guaranteed by the carrying broker-dealer, also are the same as those 
applied to the cash account. With respect to long box spreads, where 
the component options are not European-style, the proposal would 
require full payment of the net debit that is incurred when the spread 
strategy is established.\32\ For short box spreads held in the margin 
account, the proposal would require that cash or cash equivalents be 
deposited and maintained, covering the maximum risk, which is equal to 
the aggregate difference in the two exercise prices involved. The net 
credit received from the sale of the short option components may be 
applied towards the margin requirement. Generally, long and short box 
spreads would not be recognized for margin equity purposes; however, 
the proposal would allow loan value for one type of long box spread 
where all component options have a European-style exercise provision 
and are listed or guaranteed by the carrying broker-dealer.
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    \32\ As discussed above in Section II.D., ``Extension of Credit 
on Long Box Spread in European-Style Options,'' the margin 
requirement for a long box spread made up of European-style options 
is 50% of the aggregate differrence with the two exercise prices.
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G. Maintenance Margin Requirements for Stock Positions Held With 
Options Positions

    The Exchange proposes to recognize, and establish reduced 
maintenance margin requirements for five options strategies that are 
designed to limit the risk of a position in the underlying component. 
The strategies are: (1) Long Put/Long Stock; (2) Long Call/Short Stock; 
(3) Conversion; (4) Reverse Conversion; and (5) Collar. Although the 
five strategies are summarized below in terms of a stock position held 
in conjunction with an overlying option (or options), the proposal is 
structured to also apply to components that underlie index options and 
warrants. For example, these same maintenance margin requirements will 
apply when these strategies are utilized with a stock basket underlying 
index options or warrants. Proposed Exchange Rule 462(d)(10)(B)(iv), 
``Exceptions,'' will define the five strategies and set forth the 
respective maintenance requirements for the stock component of each 
strategy.\33\
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    \33\ The Exchange's proposal provides maintenance margin relief 
for the stock component (or other underlying instrument) of the five 
identified strategies. A reduction in the initial margin for the 
stock component of these strategies is not currently possible 
because the 50% initial margin requirement under Regulation T of the 
Federal Reserve Board continues to apply, and the Exchange does not 
possess the independent authority to lower the initial margin 
requirement for stock. See CBOE Approval Order, supra note 18, at 
footnote 33.
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1. Long Put/Long Stock
    The Long Put/Long Stock hedging strategy requires an investor to 
carry in an account a long position in the component underlying the put 
option, and a long put option specifying equivalent units of the 
underlying component. The maintenance margin requirement for the Long 
Put/Long Stock combination would be the lesser of: (i) 10 percent of 
the put option aggregate exercise price, plus 100 percent of any amount 
by which the put option is out-of-the-money; or (ii) 25 percent of the 
current market value of the long stock position.\34\
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    \34\ For example, if an investor is long 100 shares of XYZ @ 52 
and long one XYZ Jan 50 Put @ 2, the required margin would be the 
lesser of ((10% x 50)+(100% x 2)=7) or (25% x 52=13). Therefore, the 
investor would be required to maintain margin equal to at least $700 
(7 x 100). See CBOE Approval Order, supra note 18, at footnote 34.
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2. Long Call/Short Stock
    The Long Call/Short Stock hedging strategy requires an investor to 
carry in an account a short position in the component underlying the 
call option, and a long call option specifying equivalent units of the 
underlying component. For a Long Call/Short Stock combination, the 
maintenance margin requirement would be the lesser of: (i) 10 percent 
of the call option aggregate exercise price, plus 100 percent of any 
amount by which the call option is out-of-the-money; or (ii) the 
maintenance margin requirement of the short stock position as specified 
in Amex Rule 462(b).\35\
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    \35\ For each stock carried short that has a current market 
value of less than $5 per share, the maintenance margin is $2.50 per 
share or 100% of the current market value, whichever is greater. For 
each stock carried short that has a current market value of $5 per 
share or more, the maintenance margin is $5 per share or 30% of the 
current market value, whichever is greater. See Amex Rule 462(b). 
For example, for an investor who is short 100 shares of XYZ @ 48 and 
long 1 XYZ Jan 50 Call @ 1, the required margin would be the lesser 
of ((10% x 50)+(100% x 2)=7) or (30% x 48=14.4). Therefore, the 
investor would be required to maintain margin equal to at least $700 
(7 x 100). See CBOE Approval Order, supra note 18, at footnote 35.
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3. Conversion (Long Stock/Long Put/Short Call)
    A ``Conversion'' is a long stock position held in conjunction with 
a long put and a short call. For a Conversion to qualify as hedged, the 
long put and short call must have the same expiration date and exercise 
price. The short call is covered by the long stock and the long put is 
a right to sell the stock at a predetermined price--the exercise price 
of the long put. Thus, regardless of any decline in market value, the 
stock position, in effect, is worth no less than the exercise price of 
the put.
    Current Amex margin rules specify that no maintenance margin would 
be required on the short call option because it is covered, but the 
underlying long stock position would be margined according to the 
present maintenance margin requirement (i.e., 25 percent of the current 
market value).\36\ Under the

[[Page 71156]]

proposal, the maintenance margin for a Conversion would be 10 percent 
of the aggregate exercise price.\37\
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    \36\ Suppose an investor who is long 100 shares of XYZ @ 48, 
long one XYZ Jan 50 Put @ 2, and short one XYZ Jan 50 Call @ 1, the 
present maintenance margin on the long stock position would be 
$1,200 ((25%  x  48)  x  100). However, if the price of the stock 
increased to 60, the Amex currently specifies that the stock may not 
be valued at more than the short exercise price. Thus, the 
maintenance margin on the long stock position would be $1,250 ((25% 
x  50)  x  100). The writer of the call option cannot receive the 
benefit (i.e., greater loan value) of a market value that is above 
the call exercise price because, if assigned an exercise, the 
underlying component would be sold at the exercise price, not the 
market price of the long position. See CBOE Approval Order, supra 
note 18, at footnote 36.
    \37\ For the example in the preceding footnote, where the 
investor was long 100 shares of XYZ @ 48, long 1 XYZ Jan 50 Put @ 2, 
and short 1 XYZ Jan 50 Call @ 1, the proposed maintenance margin 
requirement for the Conversion strategy would be $500 ((10%  x  50) 
x  100). See CBOE Approval Order, supra note 18, at footnote 37.
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4. Reverse Conversion (Short Stock/Short Put/Long Call)
    A ``Reverse Conversion'' is a short stock position held in 
conjunction with a short put and a long call. As with the Conversion, 
the short put and long call must have the same expiration date and 
exercise price. Regardless of any rise in market value, the stock can 
be acquired for the call exercise price, in effect, the short position 
is valued at no more than the call exercise price. The maintenance 
margin requirement for a Reverse Conversion would be 10 percent of the 
aggregate exercise price, plus any in-the-money amount (i.e., the 
amount by which the aggregate exercise price of the short put exceeds 
the current market value of the underlying stock position).\38\
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    \38\ The seller of a put option has an obligation to buy the 
underlying component at the put exercise price. If assigned an 
exercise, the underlying component would be purchased (the short 
position in the Reverse Conversion effectively closed) at the 
exercise price, even if the current market price is lower. To 
recognize the lower market value of a component, the short put in-
the-money amount is added to the requirement. For example, an 
investor holding a Reverse Conversion may be short 100 shares of XYZ 
@ 52, long 1 XYZ Jan 50 Call @ 2\1/2\, and short 1 XYZ Jan 50 Put @ 
1\1/2\. If the current market value of XYZ stock drops to 30, the 
maintenance margin would be $2,500 ((10  x  50) + (50 - 30))  x  
100). See CBOE Approval Order, supra note 18, at footnote 38.
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5. Collar (Long Stock/Long Put/Short Call)
    A ``Collar'' is a stock position held in conjunction with a long 
put and a short call. A Collar differs from a Conversion in that the 
exercise price of the long put is lower than the exercise price of the 
short call. Therefore, the options positions in a Collar do not 
constitute a pure synthetic short stock position. The maintenance 
margin for a Collar would be the lesser of: (i) 10 percent of the long 
put aggregate exercise price, plus 100 percent of any amount by which 
the long put is out-of-the-money; or (ii) 25 percent of the short call 
aggregate exercise price.\39\ Current Amex margin requirements specify 
that the stock may not be valued at more than the call exercise price.
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    \39\ To create a Collar, an investor may be long 100 shares of 
XYZ @ 48, long 1 XYZ Jan 45 Put @ 4, and short 1 XYZ Jan 50 Call @ 
3. The maintenance margin requirement would be the lesser of ((10% 
x  45) + 3 = 7\1/2\) or (25%  x  50 = 12\1/2\). Therefore, the 
investor would need to maintain at least $750 (7\1/2\  x  100) in 
margin. See CBOE Approval Order, supra note 18, at footnote 39.
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H. Restructuring

    The Exchange proposes to update other margin provisions with Amex 
Rule 462 to make its margin rule consistent with the 431 Committee's 
(which is comprised of industry representatives with diverse areas of 
expertise) recommendations. Specifically, the proposal would make some 
minor corrections to the table in Exchange Rule 462 that displays the 
margin requirements for short OTC options. The proposal also would 
revise and update provisions regarding straddle/combination in Amex 
Rule 462(d)10(B)(v) and would move those provisions to proposed Amex 
Rule 462(d)(10)(B)(vi)(c).\40\ The proposal also would delete 
Commentaries .06-.08 of Amex Rule 462 because these provisions have 
been updated and relocated to other sections of the same rule.\41\ 
Specifically, the Amex proposes to delete the margin provisions 
relating to capped style options in Commentaries .06 and .07 of Amex 
Rule 462 because the Amex has proposed new provisions relating to these 
options in Amex Rule 462(d)(10)(B).\42\ The Amex also proposes to 
delete the Commentary .08 of Amex Rule 462 and current Amex Rule 
462(d)(2)(O) concerning margin provisions relating to debit put spread 
positions in broad based European style index options because the Amex 
has now proposed new margin for spread provisions in Amex Rule 
462(d)(2)(J).\43\ Moreover, the Exchange proposes to delete the current 
provision in Commentary .09 of Amex Rule 462 relating to a margin rule 
regarding offset margin treatment for currency warrants, currency index 
warrants and listed options under a pilot program that has expired and 
therefore is not longer necessary.\44\ The Amex also would move the 
rule text concerning margin fro certain short index options positions 
covered by positions in Portfolio Depositary Receipts or Index Fund 
Shares from current Amex Rule 462(d)(2)(H)(iv) and current Commentary 
.10 of the same rule to proposed Amex Rule 462(d)(10)(B)(ii)(c) and 
proposed Commentary .06 of the same rule to reflect the text language 
that was approved by the Commission in SR-Amex-98-33.\45\ The Exchange 
also proposes to move the definition of ``cash equivalent'' from 
Commentary .03(c) of Amex Rule 462 to proposed Amex rule 462(d).\46\
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    \40\ See Amendment No. 1, supra, note 4.
    \41\ Id.
    \42\ Id.
    \43\ Id.
    \44\ Id.
    \45\ See Securities Exchange Act Release No. 42605 (March 31, 
2000), 65 FR 18395 (April 7, 2000) (SR-Amex-98-33).
    \46\ Id.
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I. Effect of Mergers and Acquisitions on the Margin Required for Short 
Options

    The Exchange proposes to adopt proposed Commentary .10 to Exchange 
Rule 462 to provide an exception to the margin requirement for short 
equity options in the event trading in the underlying security ceases 
due to a merger or acquisition. Under this exception, if an underlying 
security ceases to trade due to a merger or acquisition, and a cash 
settlement price has been announced by the issuer of the option, margin 
would be required only for in-the-money options and would be set at 100 
percent of the in-the-money amount.

J. Determination of Value for Margin Purposes

    The proposal would revise Exchange Rule 462(d)1 to make it 
consistent with that portion of the Exchange's proposal that allows the 
extension of credit on certain long term options and warrants (i.e., 
stock options, stock index options, and stock index warrants). 
Currently, Exchange Rule 462(d)1 does not allow certain long term 
options or warrants to have market value for margin purposes. The 
revision would allow options and warrants eligible for loan value under 
proposed Exchange Rules 462 to have market value for margin purposes. 
The Exchange believes that this change is necessary to ensure that the 
value of the marginable option or warrant (the collateral) is 
sufficient to cover the debit carried in conjunction with the purchase.

III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations under the Act applicable to a national securities exchange. 
In particular, the Commission finds that the proposed rule change is

[[Page 71157]]

consistent with the Section 6(b)(5) \47\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, prevent fraudulent and manipulative acts and practices, and 
protect investors and the public interest. The Commission also finds 
that the proposal may serve to remove impediments to and perfect the 
mechanism of a free and open market by revising the Exchange's margin 
requirements to better reflect the risk of certain hedged options 
strategies.\48\
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    \47\ 15 U.S.C. 78f(b)(5).
    \48\ In approving the proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78f(c)(f).
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    The Commission believes that it is appropriate for the Exchange to 
allow member firms to extend credit on certain long term options and 
warrants, and that such practice is consistent with Regulation T of the 
Federal Reserve Board. In 1996, the Federal Reserve Board amended 
Regulation T to enable the self-regulatory organizations (``SROs'') to 
adopt rules permitting the margining of options.\49\ As noted above, 
the Amex rules approved in this order, which will permit the margining 
of options under the grant of authority from the Federal Reserve Board, 
are substantially identical to rules adopted recently by the CBOE and 
NYSE.\50\
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    \49\ See Board of Governors of the Federal Reserve System Docket 
No. R-0772 (April 24, 1996), 61 FR 20386 (May 6, 1996), and 12 CFR 
220.12(f).
    \50\ See Securities Exchange Act Release No. 42011 (October 14, 
1999), 64 FR 57172 (October 22, 1999) (order approving SR-NYSE-99-
03) (``NYSE Approval Order''); and See CBOE Approval Order, supra 
note 18.
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    The Commission believes that it is reasonable for the Exchange to 
restrict the extension of credit to long term options and warrants. The 
Commission believes that by limiting loan value to long term options 
and warrants, the proposal will help to ensure that the extension of 
credit is backed by collateral (i.e., the long term option or warrant) 
that has sufficient value.\51\ Because the expiration dates attached to 
options and warrants make such securities wasting assets by nature, it 
is important that the Exchange restrict the extension of credit to only 
those options and warrants that have adequate value at the time of the 
purchase, and during the term of the margin loan.\52\
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    \51\ The value of an option contract is made up of two 
components: intrinsic value and time value. Intrinsic value, or the 
in-the-money-amount, is an option contract's arithmetically 
determinable value based on the strike price of the option contract 
and the market value of the underlying security. Time value is the 
portion of the option contract's value that is attributable to the 
amount of time remaining until the expiration of the option 
contract. The more time remaining until the expiration of the option 
contract, the greater the time value component.
    \52\ For similar reasons, the Commission believes that it is 
appropriate for the Exchange to permit the extension of credit on 
long box spreads comprised entirely of European-style options that 
are listed or guaranteed by the carrying broker-dealer. Because the 
European-style long box spread locks in the ability to buy and sell 
the underlying component or index for a profit, and all of the 
component options must be exercised on the same expiration day, the 
Commission believes that the combined positions have adequate value 
to support an extension of credit.
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    The Commission believes that the proposed margin requirements for 
eligible long term options and warrants are reasonable. For long term 
listed options and warrants, the proposal requires that an investor 
deposits and maintains not less than 75 percent of the long term OTC's 
option's or warrant's current market value. For long term OTC options 
and warrants, an investor must deposit and maintain margin of not less 
than 75 percent of the option's or warrant's in-the-money amount (i.e., 
its intrinsic value).\53\ The Commission notes that the proposed margin 
requirements are more stringent than the current Regulation T margin 
requirements for equity securities (i.e., 50 percent initial margin and 
25 percent maintenance margin).
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    \53\ See Amendment No. 2, supra note 5.
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    The Commission recognizes that because current Exchange rules 
prohibit loan value for options, increases in the value of long term 
options cannot contribute to margin equity (i.e., appreciated long term 
options cannot be used to offset losses in other positions held in a 
margin account). Consequently, some customers may face a margin call or 
liquidation for a particular position even though they concurrently 
hold a long term option that has appreciated sufficiently in value to 
obviate the need for additional margin equity. The Exchange's proposal 
would address this situation by allowing loan value for long term 
options and warrants.
    The Commission believes that it is reasonable for the Exchange to 
afford long term options and warrants loan value because mathematical 
models for pricing options and evaluating their worth as loan 
collateral are widely recognized and understood.\54\ Moreover, some 
broker-dealers and The OCC, extend credit on options as part of their 
current business.\55\ The Commission believes that because options 
market participants possess significant experience in assessing the 
value of options, including the use of sophisticated models, it is 
appropriate for them to extend credit on long term options and 
warrants.
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    \54\ For example, the Black-Scholes model and the Cox Ross 
Rubinstein model are often used to price options. See F. Black and 
M. Scholes, The Pricing of Options and Corporate Liabilities, 81 
Journal of Political Economy 637 (1973), and J. C. Cox, S. A. Ross, 
and M. Rubinstein, Option Pricing: A Simplified Approach, 7 Journal 
of Financial Economics 229 (1979).
    \55\ In this regard, the Commission notes that the CBOE, in its 
options margin proposal, stated that ``[t]he fact that market-maker 
clearing firms and the Options Clearing Corporation extend credit on 
long options demonstrates that long options are acceptable 
collateral to lenders. In addition, banks have for some time loaned 
funds to market-maker clearing firms through the Options Clearing 
Corporation's Market Maker Pledge Program.'' See CBOE Approval 
Order, supra note 18.
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    Furthermore, since 1998, lenders other than broker-dealers have 
been permitted to extend 50 percent loan value against long listed 
options under Regulation U.\56\ The Commission understands that the 
current bar preventing broker-dealers from extending credit on options 
may place some Amex member firms at a competitive disadvantage relative 
to other financial service firms. By permitting Exchange members to 
extend credit on long term options and warrants, the proposal should 
enable Exchange members to better serve customers and offer additional 
financing alternatives.
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    \56\ See Board of Governors of the Federal Reserve System Docket 
Nos. R-0905, R-0923, and R-0944 (January 8, 1998), 63 FR 2806 
(January 16, 1998). In adopting the final rules that permitted non-
broker-dealer lenders to extend credit on listed options, the 
Federal Reserve Board stated that it was:
    [A]mending the Supplement to Regulation U to allow lenders other 
than broker-dealers to extend 50 percent loan value against listed 
options. Unlisted options continue to have no loan value when used 
as part of a mixed-collateral loan. However, banks and other lenders 
can extend credit against unlisted options if the loan is not 
subject to Regulation U [12 CFR 221 et seq.].
    The Federal Board first proposed margining options in 1995. See 
Board of Governors of the Federal Reserve System Docket No. R-0772 
(June 21, 1995), 60 FR 33763 (June 29, 1995) (``[T]he Board is 
proposing to treat long positions in exchange-traded options the 
same as other registered equity securities for margin purposes.'').
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    The Commission believes that it is appropriate for the Exchange to 
recognize the hedged nature of certain combined options strategies and 
prescribe margin and cash account requirements that better reflect the 
true risk of the strategy. Under current Exchange rules, the multiple 
positions comprising an option strategy such as a butterfly spread must 
be margined separately. In the case of a butterfly spread, the two 
component spreads (bull spread and bear spread) are margined without 
regard to the risk profile of the entire strategy. The net debit 
incurred on the bullish spread must be paid in full, and margin equal

[[Page 71158]]

to the exercise price differential must be deposited for the bearish 
spread.
    The Commission believes that the revised margin and cash account 
requirements for butterfly spread and box spread strategies are 
reasonable measures that will better reflect the risk of the combined 
positions. Rather than view the butterfly and box spread strategies in 
terms of their individual option components, the Exchange's proposal 
would take a broader approach and require margin that is commensurate 
with the risk of the entire hedged position. For long butterfly spreads 
and long box spreads, the proposal would require full payment of the 
net debit that is incurred when the spread strategy is established.\57\ 
For short butterfly spreads and short box spreads, the initial and 
maintenance margin required would be equal to the maximum risk 
potential. Thus, for short butterfly spreads comprised of call options, 
the margin must equal the aggregate difference between the two lowest 
exercise prices. For short butterfly spreads comprised of put options, 
the margin must equal the aggregate difference between the two highest 
exercise prices. For shore box spreads, the margin must equal the 
aggregate difference in the two exercise prices involved. In each of 
these instances, the net credit received from the sale of the short 
option components may be applied towards the requirement.
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    \57\ However, for long box spreads made up of European-style 
options, the margin requirement is 50% of the aggregate difference 
in the two exercise prices.
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    The Commission believes that the proposed margin and cash account 
requirements for butterfly spreads and box spreads are appropriate 
because the component options positions serve to offset each other with 
respect to risk. The proposal takes into account the defined risk of 
these strategies and sets margin requirements that better reflect the 
economic reality of each strategy. As a result, the margin requirements 
are tailored to the overall risk of the combined positions.
    For similar reasons, the Commission approves of the proposed cash 
account requirements for spreads made up of European-style cash-settled 
stock index options, stock index warrants, or currency index warrants. 
Under the proposal, a short position would be considered covered, and 
thus eligible for the cash account, if a long position in the same 
European-style cash-settled stock index option, stock index warrant, or 
currency index warrant was held in, or purchased for, the account on 
the same day. In addition, the long and short positions must expire 
concurrently, and the cash account must contain cash, cash equivalents, 
or an escrow agreement equal to at least the aggregate exercise price 
differential.
    The Commission believes that it is appropriate for the Exchange to 
revise the maintenance margin requirements for several hedging 
strategies that combine stock positions with option positions. The 
Commission recognizes that the hedging strategies such as the Long Put/
Long Stock, Long Call/Short Stock, Conversion, Reverse Conversion, and 
Collar are designed to limit the exposure of the investor holding the 
combined stock and option positions. The proposal would modify the 
maintenance margin required for the stock component of a hedging 
strategy. For example, the stock component of a Long Put/Long Stock 
combination currently is margined without regard to the hedge provided 
by the long put position (i.e., the 25 percent maintenance margin 
requirement for the stock component is applied in full). Under the 
proposal, the maintenance margin requirement for the Long Put/Long 
Stock combination strategy would be the lesser of: (1) 10 percent of 
the put option aggregate exercise price, plus 100 percent of any amount 
by which the put option is out-of-the money; or (2) 25 percent of the 
current market value of the long stock position. Although for some 
market values the proposed margin requirement would be the same as the 
current requirement, in many other cases it would be lower.\58\ The 
Commission believes that reduced maintenance margin requirements for 
the stock components of hedging strategies are reasonable given the 
limited risk profile of the strategies.
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    \58\ For example, for an investor who is long 100 shares of XYZ 
@ 52 and long 1 XYZ Jan 50 Put @ 2, the margin required under the 
proposal would be $700--the lesser of ((10%  x  50) + (100%  x  2) = 
7) or (25%  x  52 = 13). In contrast, the current margin requirement 
would be $1,300, a difference of $600. See CBOE Approval Order, 
supra note 18, at footnote 63.
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    The Commission notes that the proposed changes were reviewed 
carefully by the 431 Committee and the Options Subcommittee, which are 
comprised of industry participants who have extensive experience in 
margin and credit matters. In addition, as noted above, the Amex's 
proposal is substantially identical to rules adopted by the CBOE and 
the NYSE, which the Commission approved. In approving the CBOE's 
proposal, the Commission noted the CBOE's experience in monitoring the 
credit exposures of options strategies and the fact that the CBOE 
regularly examines the coverage of options margin as it relates to 
price movements in the underlying securities and index components.\59\ 
Therefore, the Commission is confident that the proposed margin 
requirements are consistent with investor protection and properly 
reflect the risks of the underlying options positions.
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    \59\ See CBOE Approval Order, supra note 18.
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    The Commission notes that the margin requirements approved in this 
order are mandatory minimums. Therefore, an Exchange member may freely 
implement margin requirements that exceed the margin requirements 
adopted by the Exchange.\60\ The Commission recognizes that the 
Exchange's margin requirements serve as non-binding benchmarks, and 
that Exchange members often establish different margin requirements for 
their customers based on a number of factors, including market 
volatility. The Commission encourages Exchange members to continue to 
perform independent and rigorous analyses when determining prudent 
levels of margin for customers.
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    \60\ In this regard, the Commission notes that proposed Amex 
Rule 462(F) (which is currently Amex Rule 462(K)) permits the 
Exchange, at any time, to impose higher margin requirements than 
those set forth in this rule in respect to any option position(s) 
when it deems such higher margin requirements are appropriate.
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    The Commission also believes that it is reasonable for the Exchange 
to define ``butterfly spread'' \61\ and ``box spread.'' \62\ These 
definitions will specify which multiple options positions, if held 
together, qualify for classification as butterfly or box spreads, and 
consequently are eligible for the proposed cash and margin treatments. 
The Commission believes that it is important for the Exchange to 
clearly define which options strategies are eligible for the proposed 
margin treatment.
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    \61\ See supra note 8.
    \62\ See supra note 9.
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    The Commission also believes that it is reasonable for the Amex to 
revise its definition of ``current market value'' and ``current market 
price'' in Amex Rule 462(d) to conform to Regulation T of the Federal 
Reserve Board. A linkage to the Regulation T definition should keep the 
Exchange's definition equivalent to Regulation T without requiring a 
rule filing if the Federal Reserve Board revises its definition of 
Regulation T of the Federal Reserve Board. In addition, the Commission 
believes that it is reasonable for the Amex to define an ``escrow 
agreement'' in respect of cash settled options or warrants,\63\ and to

[[Page 71159]]

revise the definition of ``escrow agreement'' in connection with non-
cash settled options,\64\ to establish clear requirements for these 
types of escrow agreements. The Commission also believes that it is 
reasonable for the Amex to define the term ``underlying stock basket'' 
\65\ so that Amex Rule 462 can clarify when an underlying stock basket 
may serve as an offset or as a cover for an option or warrant on a 
market index carried short in a customer account.\66\ It is also 
reasonable for the Exchange to codify a definition of ``OTC Margin 
Bond'' in its rule since this definition has been deleted from 
Regulation T by the Federal Reserve Board as of April 1, 1998. The 
Commission also believe that the Exchange's codification of the term 
``listed'' \67\ is appropriate in order to permit the Exchange to refer 
to this term, rather than specifying its meaning each time the term is 
used. It is also reasonable for the Exchange to move the definition of 
``cash equivalent'' from Commentary .03(c) of Amex Rule 462 to Amex 
Rule 462(d). The Commission believes that this will make it easier for 
Exchange members to refer to the definition section of the Exchange 
margin rule because all the definition provisions will be set forth in 
Amex Rule 462(d).
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    \63\ See Amendment No. 2, supra note 5.
    \64\ Id.
    \65\ See supra note 14.
    \66\ See proposed Amex Rules 462(d)(I)(ii)(a), 
462(d)(10)(B)(iii) and (iv).
    \67\ See supra note 13.
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    The Commission believes that it is appropriate for the Exchange to 
revise Exchange Rule 462, ``Determination of Value for Margin 
Purposes,'' to allow the market value of certain long term stock 
options, stock index options, and stock index warrants to be considered 
for margin equity purposes. Under the current terms of Exchange Rule 
462, options contracts are not deemed to have market value. Because the 
Exchange's proposal will allow extensions of credit on long term 
options and warrants, Exchange Rule 462 must be revised to permit such 
marginable options and warrants to have market value for margin 
purposes. The Commission notes that unless Exchange Rule 462 were 
revised to recognize the market value of the marginable options and 
warrants, the Exchange's loan value proposal would be ineffective 
(i.e., the market value of an appreciated marginable security would not 
be recognized or allowed to offset any loss in value of other 
securities held in the margin account.)
    The Commission believes that it is reasonable for the Exchange to 
codify as part of its rules the current margin requirements for short 
options on securities that have been delisted due to a merger or 
acquisition. Under the provision, if an underlying security ceases to 
trade due to a merger or acquisition, and a cash settlement price has 
been announced by the issuer of the option, margin would be required 
only for in-the-money options and would be set at 100 percent of the 
in-the-money amount. The Commission believes that it is appropriate for 
the Exchange not to require margin for out-of-the-money short options. 
Given that a fixed settlement price will have been announced by the 
issuer of the option (e.g., The OCC) and trading in the delisted 
security will have stopped, the Commission believes that margin for the 
out-of-the-money short option contract is unnecessary because the 
intrinsic value of the option contract will not appreciate or vary such 
that the seller risks assignments (i.e., the intrinsic value will 
remain nil). The Commission believes that because the intrinsic value 
of short in-the-money options will similarly remain fixed, it is 
reasonable to require margin that corresponds to 100 percent of the 
aggregate in-the-money amount.
    The Commission also believes that it is reasonable for the Exchange 
to update and reorganize its margin provisions within Exchange Rule 462 
so that Exchange members and other market participants will find the 
Exchange margin provisions easier to locate and use. The Commission 
believes that it is reasonable for the Exchange to rephrase and update 
some of the margin provisions that have been relocated. The margin 
revisions are designed to ensure consistency among exchanges margin 
rules (for example, between the Amex's, the CBOE's and the NYSE's 
margin rules). In some instances, changes proposed to one particular 
margin requirement impacted the requirements for other positions and 
products. In other instances, the Exchange simply revised language to 
clarify the meaning of a provision.
    The revisions to the Exchange's margin rules will significantly 
impact the way Exchange members calculate margin for options customers. 
The Commission believes that it is important for the Exchange to be 
adequately prepared to implement and monitor the revised margin 
requirements. To best accommodate the transition, the Commission 
believes that a phase-in period is appropriate. Therefore, the approved 
margin requirements shall not become effective until the earlier of 
February 27, 2001 or such date as the Exchange represents in writing to 
the Commission and to its members that the Exchange is prepared to 
fully implement and monitor the approved margin requirements.
    The Commission expects the Exchange to issue an information 
memorandum to members that discusses the revised margin provisions and 
provides guidance to members regarding their regulatory 
responsibilities. The Commission also believes that it would be helpful 
for the Exchange to publicly disseminate (i.e., via web site posting) a 
summary of the most significant aspects of the new margin rules and 
provide clear examples of how various options positions will be 
margined under the provisions.
    The Commission finds good cause for approving proposed Amendment 
Nos. 1 and 2 prior to the thirtieth day after the date of publication 
of notice of filing thereof in the Federal Register.
    Changes proposed in Amendment Nos. 1 and 2 will strengthen the 
proposal by making it consistent with the margin requirements supported 
by the 431 Committee. Because the changes conform the Amex's rule to 
existing rule recently adopted by the CBOE and NYSE,\68\ the changes 
raise no new material regulatory basis.
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    \68\ See CBOE Approval Order, supra note 18, and see NYSE 
Approval Order, supra note 50.
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    Based on the above, the Commission finds that good cause exists, 
consistent with Section 19(b) of the Act,\69\ to accelerate approval of 
Amendment Nos. 1 and 2 to the proposed rule change.
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    \69\ 15 U.S.C. 78s(b).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 2, including whether 
Amendment Nos. 1 and 2 are consistent with the Act. Persons making 
written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
DC 20549-0609. 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 Room. Copies of such 
filing will also be available for inspection and copying at

[[Page 71160]]

the principal office of the Amex. All submissions should refer to file 
number SR-Amex-99-27 and should be submitted by December 20, 2000.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\70\ that the proposed rule change (SR-Amex-99-27), as amended, is 
approved. The approved margin requirements shall become effective the 
earlier of February 27, 2001 or such date the Exchange represents in 
writing to the Commission that the Exchange is prepared to fully 
implement and monitor the approved margin requirements.
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    \70\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\71\
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    \71\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-30378 Filed 11-28-00; 8:45 am]
BILLING CODE 8010-01-M
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