Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices 71151

8NASD Code of Conduct, Section VIII, Paragraph

C.

9NASD Code of Conduct, Section IX, Paragraph

B.1.

10 In approving this proposal, the Commission has

considered the proposed rule’s impact on

efficiency, competition, and capital formation. 15

U.S.C. 78c(f). 11 15 U.S.C. 78f. 12 15 U.S.C. 78f(b)(5).

13See SR–NASD–00–58.

14 15 U.S.C. 78s(b)(2).

15 17 CFR 200.30–3(a)(12).

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

2 17 CFR 240.19b–4.

brokerage agreements. Consistent with

existing NASD Code of Conduct

provisions, the prohibition on member

loans to Exchange employees in new

Amex Rule 417(b) would not apply to

loans that are clearly motivated by a

family or personal relationship. Thus,

for example, a registered representative

would not be precluded from making a

personal loan to an adult child who

works at the Amex.

B. Brokerage Accounts of Exchange

Employees

The NASD Code of Conduct requires

disclosure of all security and

commodity accounts that an employee

maintains and accounts in which an

employee has a financial interest or

controls trading.8 Employees are

required to instruct the institutions

where such accounts are maintained to

provide duplicate account statements

(but not confirmations) to the NASD

Office of General Counsel, which

records transaction information in a

database

Commentary .01 to Amex Rule 416

currently requires members to obtain

the Exchange’s prior written approval

before opening an account for an

Exchange employee and to provide

duplicate confirmations and statements

to the Exchange. To conform Amex

rules to the NASD Code of Conduct, the

Exchange approval requirement for the

opening of accounts and the

requirement to furnish duplicate

confirmations are being deleted. The

requirement to provide duplicate

statements to the Exchange is being

retained. The Amex also proposes to

adopt new Amex Rule 417(a), which

provides that when a member has actual

notice that an Exchange employee has a

financial interest in an account or

controls trading in an account, duplicate

account statements shall be provided by

the member to the Exchange.

C. Member Gifts to Exchange Employees

Currently under Amex Rule 348,

Amex members must obtain approval

from the Corporate Secretary’s Office

before giving an Exchange employee

gifts valued at over $50 per year. The

Secretary’s Office does not approve gifts

that exceed the $50 threshold for

employees in the Exchange’s Member

Firm Regulation area. There is no such

pre-approval mechanism, however,

under the NASD Code of Conduct.9

To conform Amex rules to the NASD

Code of Conduct, Amex Rule 348

(Gratuities to Employees of Exchange)

would be deleted and replaced with

new Amex Rule 417(c), a provision that

parallels the NASD Code of Conduct.

New Amex Rules 417(c) permits

members to give non-cash business gifts

with an aggregate annual value of $100

to Exchange employees when no

conflict of interest exists, but prohibits

members from giving business gifts or

courtesies of more than nominal value

to any Exchange employee who has

responsibility for a specific regulatory

matter that involves the member. A

‘‘regulatory matter’’ would include such

matters as examinations, disciplinary

proceedings, membership applications,

listing applications, delisting

proceedings, and dispute resolution

proceedings involving the member. The

proposed rule would permit members to

give items of nominal value to

employees responsible for regulatory

matters affecting the member.

III. Discussion

The Commission has reviewed

carefully the Amex’s proposed rule

change and believes, for the reasons set

forth below,10 the proposal is consistent

with the requirements of Section 6 of

the Act 11 and the rules and regulations

thereunder applicable to a national

securities exchange. Specifically, the

Commission believes the proposal is

consistent with Section 6(b)(5) of the

Act.12 Section 6(b)(5) requires that the

rules of an exchange be designed to

promote just and equitable principles of

trade, to prevent fraudulent and

manipulative acts and practices, to

remove impediments to and perfect the

mechanism of a free and open market,

and, in general, to protect investors and

the public interest. The proposed rule

change is based upon recommendations

made by SEC staff following an

inspection of the ethical conduct and

conflicts of interest rules, policies, and

procedures of the Exchange. The

amendments to the rules are designed to

promote a high level of professional and

personal ethical conduct by Exchange

members and employees and to ensure

that Exchange members and employees

do not place their own personal and

financial interests above the regulatory

interests of the Exchange. The proposal

also helps to bring the Amex’s conflict

of interest and ethical conduct

provisions in line with those of the

NASD and helps eliminate any

confusion regarding the application of

these provisions to employees of both

self-regulatory organizations.

The Commission finds good cause for

approving the proposed rule change

(SR-Amex-00–23) prior to the thirtieth

day after the date of publication of

notice thereof in the Federal Register.

The Commission notes that Amex

employees have become subject to the

NASD Code of Conduct as of October

2000.13 The Commission has not

received any comments in response to

the filing of the proposed rule change.

IV. Conclusion

For the foregoing reasons, the

Commission finds that the proposal is

consistent with the requirements of the

Act and rules and regulations

thereunder.

It is therefore ordered, pursuant to

Section 19(b)(2) 14 of the Act, that the

proposed rule change (SR-Amex-00–23),

as amended, is hereby approved on an

accelerated basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority. 15

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–30377 Filed 11–28–00; 8:45 am]

BILLING CODE 8010–01–M

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

71152 Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices

3See Securities Exchange Act Release No. 41808

(August 30, 1999), 64 FR 48882.

4See 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.

5See 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. 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. 7See 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’’).

8The 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.

9The 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

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.

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

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

Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices 71153

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.

10The 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.

11See 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).

12See Amendment No. 2, supra note 5.

13The proposal defines the term ‘‘listed’’ as a

security traded on a registered national securities

exchange or automated facility of a registered

national securities association.

14The 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.

15Unlike 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.

16Throughout the remainder of this approval

order, the term ‘‘warrant’’ means this type of

warrant.

17For 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.

18For 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.

19American-style options are exercisable on any

business day prior to its expiration date and on its

expiration date.

20See Amendment No. 2, supra note 5.

21A European-style option may be exercised only

at its expiration pursuant to the rules of The OCC.

See Amex Rule 900C(20).

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.

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

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.

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.

The Exchange would also define the

term ‘‘underlying stock basket.’’ 14

C. Extension of Credit on Long Term

Options and Warrants

The proposal would allow extensions

of credit on certain long listed and

OTC15 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

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-themoney 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 inthe-money amount (i.e., its intrinsic

value).

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

71154 Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices

22For 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 @ 51⁄2 (‘‘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 + 51⁄2) = net debit of 91⁄2)

is less than the exercise price differential (60 ¥ 50

= 10). Thus, the investor has locked in a profit of

$50 (1⁄2 × 100). See CBOE Approval Order, supra

note 18, at footnote 22.

23 In the example appearing in the preceding

footnote, the margin required (50% × (60 ¥ 50) =

5) would be slightly higher than 50% of the net

debit (50% × 91⁄2 = 43⁄4). See CBOE Approval Order,

supra note 18, at footnote 23.

24See supra notes 8 and 9 (definitions of butterfly

and box spreads).

25For 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 × 100) See CBOE Approval

Order, supra note 18, at footnote 25.

26An 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.

27For 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 × 100).

Otherwise, the investor would be required to

deposit $500 (5 × 100). See CBOE Approval Order,

supra note 18, at footnote 27.

28As 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.

29To create a short box spread, an investor may

be short 1 XYZ Jan 60 Put @ 51⁄2 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 ((51⁄2 + 7) ¥ (2 + 1) = net credit of 91⁄2)

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 × 100). See

CBOE Approval Order, supra note 18, at footnote

29.

30Under 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.

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

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.

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 brokerdealer. In addition, the long options

must be held in, or purchased for, the

account on the same day.

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

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

In addition to butterfly spreads and

box spreads, the proposal will permit

investors to hold in their cash accounts

other spreads made up of Europeanstyle, 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.

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

Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices 71155

31See 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.

32As 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.

33The 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.

34For 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%×50)+(100%×2)=7) or (25%×52=13).

Therefore, the investor would be required to

maintain margin equal to at least $700 (7×100). See

CBOE Approval Order, supra note 18, at footnote

34.

35For 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%×50)+(100%×2)=7) or (30%×48=14.4).

Therefore, the investor would be required to

maintain margin equal to at least $700 (7×100). See

CBOE Approval Order, supra note 18, at footnote

35.

36Suppose an investor who is long 100 shares of

XYZ @ 48, long one XYZ Jan 50 Put @ 2, and short

Continued

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.

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 Europeanstyle exercise provision and are listed or

guaranteed by the carrying brokerdealer.

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

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

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 outof-the-money; or (ii) the maintenance

margin requirement of the short stock

position as specified in Amex Rule

462(b).35

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

71156 Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices

one XYZ Jan 50 Call @ 1, the present maintenance

margin on the long stock position would be $1,200

((25% × 48) × 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%

× 50) × 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.

37For 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% × 50) × 100). See CBOE Approval Order,

supra note 18, at footnote 37.

38The 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 @ 21⁄2,

and short 1 XYZ Jan 50 Put @ 11⁄2. If the current

market value of XYZ stock drops to 30, the

maintenance margin would be $2,500 ((10 × 50) +

(50 ¥ 30)) × 100). See CBOE Approval Order, supra

note 18, at footnote 38.

39To 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%

× 45) + 3 = 71⁄2) or (25% × 50 = 121⁄2). Therefore,

the investor would need to maintain at least $750

(71⁄2 × 100) in margin. See CBOE Approval Order,

supra note 18, at footnote 39.

40See Amendment No. 1, supra, note 4.

41 Id.

42 Id.

43 Id.

44 Id.

45See Securities Exchange Act Release No. 42605

(March 31, 2000), 65 FR 18395 (April 7, 2000) (SRAmex–98–33).

46 Id.

proposal, the maintenance margin for a

Conversion would be 10 percent of the

aggregate exercise price.37

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-themoney 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

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.

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

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

Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices 71157

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).

49See 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).

50See 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.

51The 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.

52For 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.

53See Amendment No. 2, supra note 5.

54For 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.

56See 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 nonbroker-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.’’).

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

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

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

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).

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.

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.

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

71158 Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices

57However, for long box spreads made up of

European-style options, the margin requirement is

50% of the aggregate difference in the two exercise

prices.

58For 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% × 50) + (100% × 2) = 7)

or (25% × 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.

59See CBOE Approval Order, supra note 18.

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.

61See supra note 8.

62See supra note 9.

63See Amendment No. 2, supra note 5.

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.

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.

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.

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.

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.

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

Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices 71159

64 Id.

65See supra note 14.

66See proposed Amex Rules 462(d)(I)(ii)(a),

462(d)(10)(B)(iii) and (iv).

67See supra note 13.

68See CBOE Approval Order, supra note 18, and

see NYSE Approval Order, supra note 50.

69 15 U.S.C. 78s(b).

revise the definition of ‘‘escrow

agreement’’ in connection with noncash 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).

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-themoney 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.

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.

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

71160 Federal Register / Vol. 65, No. 230 / Wednesday, November 29, 2000 / Notices

70 15 U.S.C. 78s(b)(2).

71 17 CFR 200.30–3(a)(12).

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

2 17 CFR 240.19b–4.

3The National Association of Securities Dealers,

Inc., through its wholly owned subsidiary The

Nasdaq Stock Market, Inc., filed a similar proposed

rule change (SR–NASD–00–50). See Securities

Exchange Act Release No. 43420 (Oct. 6, 2000), 65

FR 61011 (Oct. 13, 2000).

4The Amex filed its proposed rule change on

August 16, 2000. On September 29, 2000, the Amex

filed Amendment No. 1 that entirely replaced the

original rule filing. See Letter from Michael J. Ryan,

Senior Vice President, Chief of Staff and Senior

Legal Officer, Amex, to Katherine A. England,

Assistant Director, Division of Market Regulation

(‘‘Division’’), Commission (September 29, 2000)

(‘‘Amendment No. 1’’). In Amendment No. 1, the

Amex also designated SR–Amex–00–46 as a

proposed rule change under Section 19(b)(2) of the

Act. 15 U.S.C. 78s(b)(2).

5Securities Exchange Act Release No. 43419 (Oct.

6, 2000), 65 FR 61206 (Oct. 16, 2000).

6Amendment No. 2 made a minor technical

change to the proposal. See Letter from Claudia

Crowley, Assistant General Counsel, Amex, to

Florence Harmon, Esq., Senior Special Counsel,

Division, SEC (Oct. 10, 2000). Because the

amendment is technical, it does not need to be

published for comment.

7The Commission believes that this activity is not

appropriate under Section 5 of the Securities Act

of 1933. See 15 U.S.C. 77e.

8 15 U.S.C. 78f(b).

9 15 U.S.C. 78f(b)(5).

10 In approving the proposal, the Commission has

considered the rule’s impact on efficiency,

competition, and capital formation. 15 U.S.C. 78c(f).

11 15 U.S.C. 78s(b)(2).

12 17 CFR 200.30–3(a)(12).

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.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.71

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–30378 Filed 11–28–00; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43588; File No. SR–Amex–

00–46]

Self-Regulatory Organizations; Order

Approving a Proposed Rule Change by

the American Stock Exchange LLC

Adopting Commentary to Section 713

that Defines ‘‘Public Offering’’ for

Purposes of Shareholder Approval

Rules

November 17, 2000.

On August 16, 2000, the American

Stock Exchange LLC (‘‘Amex’’ or

‘‘Exchange’’) filed with 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 3

adopting commentary to Section 713

that defines ‘‘Public Offering’’ for

purposes of shareholder approval rules.4

The proposed rule change was noticed

in the Federal Register.5 On October 13,

2000, the Amex filed Amendment No. 2

to the proposed rule change.6 No

comments were received on the

proposed rule change. This order

approves the proposed rule change, as

amended.

I. Background

Section 713 of the Amex Company

Guide requires shareholder approval for

stock issuances of 20 percent or more of

an issuer’s total shares outstanding,

offered at less than the greater of book

or market value. The applicable rules

further provide, however, that

shareholder approval is not required for

a ‘‘public offering,’’ although that term

is not defined in the rules. The

Exchange proposes to adopt

Commentary .01 to Section 713, to

clarify the definition of ‘‘public

offering’’ for issuers and interested

parties. According to the Amex, a

number of issuers have recently

inquired as to whether certain large,

below-market offerings were ‘‘public

offerings’’ because the transactions were

registered with the Commission prior to

closing the transactions.7 The Exchange

notes that historically, for purposes of

assessing the applicability of the

shareholder approval rules, it has

interpreted ‘‘public offering’’ as a

broadly distributed, registered offering

based on a firm commitment

underwriting. Conversely, the Exchange

does not consider a transaction to be a

‘‘public offering’’ for these purposes

when the transaction is of limited

distribution and/or is not based on a

firm commitment underwriting, even if

the offering was registered. Because the

offerings described above had limited

distributions and, in some cases,

offerees that were pre-determined by the

issuer, the Exchange believes that these

transactions were not ‘‘public offerings’’

for purposes of the shareholder approval

rules.

The Amex expects that proposed

Commentary .01 will help to ensure

issuer understanding of how Amex

determines whether a transaction is a

‘‘public offering’’ for purposes of

shareholder approval rules. The

proposed Commentary identifies a

number of factors that will be

considered in establishing the existence

of a ‘‘public offering.’’ Such factors

include the type of offering; the

marketing of the offering; the extent of

the offering’s distribution; the offering

price; and the extent to which the issuer

controls the offering and its distribution.

Decisions as to whether a transaction is

a ‘‘public offering’’ for purposes of these

rules will be based on the facts and

circumstances surrounding each

particular transaction.

II. Discussion

The Commission finds that the

proposed rule change is consistent with

Section 6(b) of the Act 8 in general, and

furthers the objectives of Section

6(b)(5) 9 in particular, in that it is

designed to prevent fraudulent and

manipulative acts and practices, to

promote just and equitable principles of

trade, and, in general, to protect

investors and the public interest.10 The

Commission believes that the proposed

Commentary to Section 713 is designed

to educate issuers and other interested

parties as to how the Exchange defines

a ‘‘public offering’’ and ensure that

issuers recognize which transactions

require shareholder approval under the

Exchange’s rules, thus promoting just

and equitable principles of trade and

protecting investors and the public

interest.

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,11 that the

proposal, SR–Amex–00–46, as

amended, be and hereby is approved.

For the Commission, by the Division of

Market Regualtion, pursuant to delegated

authority.12

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–30381 Filed 11–28–00; 8:45 am]

BILLING CODE 8010–01–M