70854 Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices

9 15 U.S.C. 78o(b)(6).

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. 78o–3(b)(6).

12See Securities Exchange Act Release No. 43587

(November 17, 2000) (Order approving SR–Amex–

00–23).

13 15 U.S.C. 78s(b)(2).

14 17 CFR 200.30–3(a)(12).

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

2 17 CFR 240.19b–4.

3See letter from Alden S. Adkins, Senior Vice

President and General Counsel, NASD Regulation,

to Jack Drogin, Assistant Director, Division of

Market Regulation (‘‘Division’’), Commission, dated

July 28, 2000 (‘‘Amendment No. 1’’); and see letter

from Alden S. Adkins, Senior Vice President and

General Counsel, NASD Regulation, to Jack Drogin,

Assistant Director, Division, dated September 11,

2000 (‘‘Amendment No. 2’’). Among other things,

Amendment No. 1 revises the proposal to: (1)

Provide technical corrections for various provisions

within NASD Rules 2520 and 2522; (2) revise the

cash account provisions of NASD Rule

2520(f)(2)(M)(ii)d to indicate that a long warrant or

option that is not listed must be guaranteed by the

carrying broker-dealer to serve as an offset for a

short position, or the short position will not be

eligible for the cash account and must be margined

separately pursuant to NASD Rule 2520(f)(2)(D); (3)

amend NASD Rule 2520(f)(2) to provide that the

margin for a long over-the-counter (‘‘OTC’’) option

or warrant with over nine months until expiration

will be 75% of the option’s or warrant’s in-themoney amount; (4) amend NASD Rules

2520(f)(2)(D)(i) and 2520(f)(2)(G)(v) to clarify that

the minimum amount of margin that must be

maintained on certain positions is a percentage of

the aggregate exercise price; (5) provide definitions

of ‘‘stock index warrant’’ and ‘‘escrow agreement’’

in connection with cash-settled options or warrants;

2. Statutory Basis

NASD Regulation believes that the

proposed rule change is consistent with

the provisions of section 15A(b)(6) of

the Act,9 which requires, among other

things, that the Association’s rules be

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.

Specifically, the NASD believes that, by

assisting the NASD in ensuring

employee compliance with NASD

ethical standards, the proposed rule

change serves the public interest.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

NASD Regulation does not believe

that the proposed rule change will

impose any burden on competition that

is not necessary or appropriate in

furtherance of the purposes of the Act.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

NASD Regulation did not solicit or

receive written comments on the

proposed rule change.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Interested persons are invited to

submit written data, views, and

arguments, concerning the foregoing,

including whether the proposed rule

change is consistent with the Act.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, NW.,

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 at

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the Exchange. All

submissions should refer to File No.

SR–NASD–00–58 and should be

submitted by December 19, 2000.

IV. Commission’s Findings and Order

Granting Accelerated Approval of

Proposed Rule Change

The Commission finds that the

proposed rule change is consistent with

the requirements of the Act and the

rules and regulations thereunder

applicable to a national securities

association,10 and in particular, the

requirements of section 15A(b)(6) 11 of

the Act, because it is designed to foster

cooperation and coordination with

persons engaged in processing

information with respect to securities, to

remove impediments to and perfect the

mechanism of a free and open market

and a national market system, and, in

general, to protect investors and the

public interest.

The proposed rule change is based

upon recommendations made by SEC

staff to the SROs. The amendments to

the rules are designed to promote a high

level of professional and personal

ethical conduct by NASD members and

employees and to ensure that NASD

members and employees do not place

their own personal and financial

interests above the regulatory interests

of the NASD. The proposal also helps to

bring the NASD’s conflict of interest and

ethical conduct provisions in line with

those of the NASD Code of Conduct and

the Amex (a subsidiary of the NASD)

and helps eliminate any confusion

regarding the application of these

provisions to employees of both selfregulatory organizations.

The Commission finds good cause for

approving the proposed rule change

(SR–NASD–00–58) prior to the thirtieth

day after the date of publication of

notice thereof in the Federal Register.

The Commission approved a proposal

by the Amex to adopt Amex Rule 417,

which is virtually identical to new

NASD Rule 3090.12

It Is Therefore Ordered, pursuant to

section 19(b)(2) of the Act,13 that the

proposed rule change (SR–NASD–00–

58) is hereby approved on an

accelerated basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.14

Jonathan G. Katz,

Secretary.

[FR Doc. 00–30195 Filed 11–27–00; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43581; File No. SR–NASD–

00–15]

Self-Regulatory Organizations;

National Association of Securities

Dealers, Inc.; Notice of Filing and

Order Granting Accelerated Approval

of Proposed Rule Change and

Amendment Nos. 1 and 2 to the

Proposed Rule Change Relating to

NASD Rule 2520, ‘‘Margin

Requirements’’

November 17, 2000.

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

Securities Exchange Act of 1934

(‘‘Act’’) 1 and Rule 19b–4 thereunder,2

notice is hereby given that on March 31,

2000, the National Association of

Securities Dealers, Inc. (‘‘NASD’’),

through its wholly owned subsidiary,

NASD Regulation, Inc. (‘‘NASD

Regulation’’) filed with the Securities

and Exchange Commission (‘‘SEC’’ or

‘‘Commission’’), the proposed rule

change as described in Items I and II

below, which Items have been prepared

by NASD Regulation. NASD Regulation

amended its proposal on July 31, 2000,

and September 13, 2000.3 The

Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices 70855

and (6) clarify the purpose of NASD Regulation’s

proposed definitions of ‘‘current market value,’’

‘‘butterfly spread,’’ and ‘‘box spread.’’ Amendment

No. 2: (1) Deletes an incorrect reference to currency

index warrants in Amendment No. 1 and clarifies

that a description in Amendment No. 1 refers to

NASD Rule 2520(f)(2)(M)(ii)d rather than NASD

Rule 2520(f)(2)(L)(ii)d; (2) provides a revised

definition of ‘‘escrow agreement;’’ (3) clarifies the

definition of American-style options to indicate that

American-style options are exercisable at any time

up to and including the day of expiration; and (4)

adds a comma in the title of NASD Rule 2522 after

the word ‘‘Options.’’

4Listed options are issued by The Options

Clearing Corporation (‘‘OCC’’), a clearing agency

registered pursuant to Section 17A of the Act.

5 12 CFR 220 et seq. The Board of Governors of

the Federal Reserve System (‘‘Federal Reserve

Board’’) issued Regulation T pursuant to the Act.

6See Board of Governors of the Federal Reserve

System Docket No. R–0772 (April 24, 1996), 61 FR

20386 (May 6, 1996).

7See Securities Exchange Act Release Nos. 41658

(July 27, 1999), 64 FR 42736 (August 5, 1999) (order

approving File No. SR–CBOE–97–67) (‘‘CBOE

Approval Order’’); and 42011 (October 14, 1999), 64

FR 57172 (October 22, 1999) (order approving SR–

NYSE–99–03) (‘‘NYSE Approval Order’’).

Commission is publishing this notice to

solicit comments on the proposed rule

change and Amendment Nos. 1 and 2

from interested persons, and

simultaneously is approving the

proposed rule change, as amended, on

an accelerated basis.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

NASD Regulation proposes to amend

NASD Rules 2520 ‘‘margin

Requirements,’’ and 2522 ‘‘Definitions

Related to Options, Currency Warrants,

Currency Index Warrants, and Stock

Index Warrants Transactions’’ to: (1)

Expand the types of short options

positions that would be considered

‘‘covered’’ and eligible for the cash

account to include short positions that

are components of certain limited risk

spread strategies (box spreads, butterfly

spreads, and debits and credit spreads),

provided that any potential risk to the

carrying broker-dealer is paid for in full

and retained in the account; (2) allow an

escrow agreement that conforms to

NASD standards to serve in lieu of cash

or cash equivalents for certain spread

positions held in a cash account; (3)

reduce the required margin for butterfly

and box spreads by recognizing butterfly

and box spreads as strategies (rather

than separate transactions) for purposes

of margin treatment; (4) recognize

various hedging strategies involving

stocks (or other underlying instruments)

paired with long options, and reduce

the required maintenance margin on

such hedged stock positions; (5) permit

the extension of credit on certain long

term options and warrants with over

nine months until expiration; (6) permit

the extension of credit on certain long

box spreads; and (7) provide that the

minimum margin requirements for a

short put on a listed option will be the

current value of the put plus a specified

percentage of the put option’s aggregate

exercise price, and the minimum margin

requirement for a short put on an overthe-counter (‘‘OTC’’) option will be a

specified percentage of the put option’s

aggregate exercise price.

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission,

NASD Regulation included statements

concerning the purpose of and basis for

the proposed rule change and discussed

any comments it received on the

proposed rule change. The text of these

statements may be examined at the

places specified in Item IV below.

NASD Regulation has prepared

summaries, set forth in Sections A, B,

and C below, of the most significant

aspects of such statements.

A. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

Purpose

NASD Regulation proposes to amend

NASD Rule 2520 to: (1) Expand the

types of short options positions that

would be considered ‘‘covered’’ and

eligible for the cash account to include

short positions that are components of

certain limited risk spread strategies

(box spreads, butterfly spreads, and

debit and credit spreads), provided that

any potential risk to the carrying brokerdealer is paid for in full and retained in

the account; (2) allow an escrow

agreement that conforms to NASD

standards to serve in lieu of cash or cash

equivalents for certain spread positions

held in a cash account; (3) reduce the

required margin for butterfly and box

spreads by recognizing butterfly and box

spreads as strategies (rather than

separate transactions) for purposes of

margin treatment; (4) recognize various

hedging strategies involving stocks (or

other underlying instruments) paired

with long options, and reduce the

required maintenance margin on such

hedged stock positions; (5) permit the

extension of credit on certain long term

options and warrants with over nine

months until expiration; (6) permit the

extension of credit on certain long box

spreads; and (7) provide that the

minimum margin requirement for a

short uncovered put on a listed option

will be the current value of the put plus

a specified percentage of the put

option’s aggregate exercise price, and

the minimum margin requirement for a

short uncovered put on an OTC option

will be a specified percentage of the put

option’s aggregate exercise price. In

addition, NASD Regulation proposes to

amend NASD Rule 2522 to include

certain new definitions relating to the

proposed rule change.

A. Background

Until several years ago, the margin

requirements governing listed options 4

were set forth in Regulation T, ‘‘Credit

by Brokers and Dealers.’’ 5 However,

Federal Reserve Board amendments to

Regulation T that became effective on

June 1, 1997, modified or deleted

certain margin requirements regarding

options transactions in favor of rules to

be adopted by the self-regulatory

organizations (‘‘SROs’’), subject to

approval by the Commission.6

Following the amendments to

Regulation T, an informal ad hoc

committee (the ‘‘431 Committee’’) was

formed to consider changes to the

margin rules of the New York Stock

Exchange (‘‘NYSE’’) and the NASD

(NYSE Rule 431 and NASD Rule 2520,

respectively). The 431 Committee

created various subcommittees,

including an Options Subcommittee

(‘‘Options Subcommittee’’), to ensure

that the NYSE’s and NASD’s margin

rules were consistent in order to prevent

confusion and avoid conferring

advantages on members that are

required to comply with one rule and

not the other. NASD Regulation

proposes to amend NASD Rules 2520

and 2522 based on recommendations by

the 431 Committee and the Options

Subcommittee. The proposed

amendments to NASD Rules 2520 and

2522 are substantially identical to

amendments made in proposals filed by

the Chicago Board Options Exchange,

Inc. (‘‘CBOE’’) and the NYSE, which the

Commission approved.7

B. Definitions

Currently, NASD Rule 2520 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. NASD Regulation proposes to

revise the definition of ‘‘current market

value’’ or ‘‘current market price’’ to

indicate that the current market value or

current market price of an option,

currency warrant, currency index

70856 Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices

8See Amendment No. 1, supra note 3.

9The proposal defines ‘‘butterfly speread’’ as:

[A]n aggegation 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.

10The 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.

11See Amendment No. 1, supra note 3.

12The proposal defines a ‘‘stock index warrant’’

as a put or call warrant that overlies a broad index

stock group or an industry index stock group. See

Amendment No. 1, supra note 3.

13The proposal defines the term ‘‘escrow

agreement,’’ when used in connection with cash

settled calls, puts, currency warrants, currency

index warrants or stock index warrants carried

short as any agreement issued in a form acceptable

to the Association under which a bank holding

cash, cash equivalents, one or more qualified equity

securities or a combination thereof 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 (in the case of an option) to

pay the creditor 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 buyin. See Amendment No. 2, supra note 3. The

proposal defines the term ‘‘escrow agreement’’

when used in connection with non-cash settled put

or call options carried short as any agreement

issued in a form acceptable to the Association

under which a bank holding the underlying security

(in the case of a call option) or required cash or 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.

See Amendment No. 1, supra note 3.

14See Amendment No. 1, supra note 3.

15Unlike listed options, OTC options are not

issued by the 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 notice and

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

of warrant.

17For any stock option, stock index option, or

stock index warrant 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. See Amendment No.

1, supra note 3.

18An American-style option is exercisable on any

business day prior to its expiration date and on its

expiration date. See Amendment No. 2, supra note

3.

19A European-style option may be exercised only

at its expiration pursuant to the rules of the OCC.

See NASD Rule 2860(U).

20For 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 NASD Regulation’s proposed definition

of ‘‘long box spread,’’ the sell side 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 7, at footnote 22.

warrant, or stock index warrant are as

defined in Section 220.2 of Regulation

T.8 The revised definition appears in

NASD Rule 2522.

NASD Regulation also proposes to

define the ‘‘butterfly spread’’ 9 and ‘‘box

spread’’ 10 options strategies.11 The

definitions are important elements of

NASD Regulation’s proposal to

recognize and specify the 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 treatments.

In addition, NASD Regulation

proposes to define the terms ‘‘stock

index warrant’’ 12 and ‘‘escrow

agreement,’’ as used in connection with

cash-settled calls, puts, currency

warrants, currency index warrants or

stock index warrants carried short and

as used in connection with non-cash

settled put or call options carried

short.13

Finally, NASD Regulation proposes to

move the definitions of ‘‘exercise

settlement amount,’’ ‘‘aggregate exercise

price’’ and ‘‘aggregate current index

value’’ from NASD Rule 2520(f)(2)(C) to

NASD Rule 2522(a) for ease of reference

so that the definitions relating to

transactions in options, currency

warrants, currency index warrants and

stock index warrants will be located in

NASD Rule 2522.14

C. Extension of Credit on Long Term

Options and Warrants

The proposal would allow extensions

of credit on certain long listed and

OTC15options (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

foreign currency options. Only those

options or warrants with expirations

exceeding nine months (‘‘long term’’)

will be eligible for credit extension.17

For long term listed options and

warrants, the proposed rule change

requires initial and maintenance margin

of cost less than 75% of the current

market value of the option or warrant.

Therefore, NASD members would be

able to loan up to 25% of the current

market value of a long term listed option

or warrant. 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 the member. Under

the current margin rules, the investor

would be required to pay the entire

$100.

The proposal also would permit the

extension of credit on certain long term

OTC options and warrants. Specifically,

an NASD member firm could extend

credit on an 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 times 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 18 exercise provision.

The proposal requires initial and

maintenance margin of 75% of the long

term OTC option’s or warrant’s in-themoney 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% 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 long box spreads

composed entirely of European-style

options 19 that are listed or guaranteed

by the carrying broker-dealer. A long

box spread is a strategy composed of

four option positions and 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. The two

exercise prices embedded in the strategy

determine the buy and the sell price.20

For long box spreads made up of

European-style options, the proposal

would require initial and maintenance

Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices 70857

21Using the example 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

7, at footnote 23.

22See notes 9 and 10, supra.

23For example, to create a long butterfly spread

comprised of all 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

next debit incurred to establish the strategy ((3 + 3)

- (6 + 1) = net debit of 1). Under the proposed rule

change, the investor would be required to pay the

net debit, or $100 (1 × 100). See CBOE Approval

Order, supra note 7, at footnote 25.

24An escrow agreement could be used as a

substitute for cash or cash 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 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

differrence 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.

25For 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

proposed rule change, 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 = 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 7, at footnote 27.

29See supra, Section II.E., ‘‘Cash Account

Treatment of Butterfly Spreads, Box Spreads, and

Other Spreads.’’ The margin requirements would

apply to butterfly spreads where all option

positions are listed or guaranteed by the carrying

broker-dealer.

30As 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 difference in the two exercise

prices.

margin of 50% of the aggregate

difference in the two exercise prices

(buy and sell), which results in a margin

requirement slightly higher than 50% of

the debit typically incurred in

establishing such a position.21 Under

the proposal, a long box spread position

would be allowed market value for

margin equity purposes of not more

than 100% of the aggregate difference in

the exercise prices of the options.

E. Cash Account Treatment of Butterfly

Spreads, Box Spreads, and Other

Spreads

The proposal would make butterfly

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

proposal’s definitions of those terms,22

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.

For long butterfly spreads and long

box spreads, the proposal would require

full payment of the net nebit that is

incurred when the spread strategy is

established. According to NASD

Regulation, full payment of th enet debit

incurred to establish a long butterfly or

box spread will cover any potential risk

to the carrying broker-dealer.23

Short butterfly spreads generate a

credit balance when establish (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.24 The maximum potential

risk in a short butterfly spread

comprised of all options is the aggregate

difference be between the two lowest

exercise prices.25 With respect to short

butterfly spreads comprised of put

options, the maximum potential risk 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.

NASD Regulation’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.29 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 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 it incurred when the spread strategy

is established.30 For short box spreads

held in the margin account, the proposal

would require that cash or cash

equivalents covering the maximum risk,

which is equal to the aggregate

difference in the two exercise prices

involved, be deposited and maintained.

The net credit received from the sale of

the short option components may be

applied towards the requirement.

Generally, long and short box spreads

would not be recognized for margin

equity purposes; 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.

G. Margin Requirements for Short Put

Options

NASD Rule 2520(f)(2)(D)(i) currently

provides that the minimum required

margin for a short listed put option is an

amount equal to the option premium

plus a percentage of the current value of

the underlying instrument. The

minimum required margin for a short

OTC put option is an amount equal to

a percentage of the current value of the

underlying component. According to

NASD Regulation, the NASD’s current

rule creates a margin requirement for a

short put option even when the price of

the underlying instrument rises above

the exercise price of the put and the risk

associated with the put option has

decreased because the option is out-ofthe-money. NASD Regulation proposes

to amend the margin requirement for

short put options to provide a minimum

margin requirement more in line with

the risk associated with the option.

Specifically, NASD Regulation proposes

to amend NASD Rule 2520(f)(2)(D) to

provide the minimum margin

requirement for a short listed put option

will be an amount equal to the current

value of the option plus a percentage of

the option’s aggregate exercise price.

The minimum margin required for a

short OTC put option would be an

amount equal to a specified percentage

of the options’ aggregate exercise price.

Short box spreads also generate a

credit balance when established. This

credit is nearly equal to the total debit

70858 Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices

26As 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 such amount in the event

the account is assigned an exercise notice on either

short option.

27For example, to 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 NASD Regulation’s

proposed definition of ‘‘short box spread (supra

note 10),’’ 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 7,

at footnote 29.

28Under 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. If the

long position is not listed, it must be guaranteed by

the carrying broker-dealer; otherwise the short

position is not eligible for the cash account and

must be margined separately pursuant to NASD

Rule 2520(f)(2)(D). See Amendment No. 1, supra

note 3.

31 Generally, NASD Rule 2520(c) requires

maintenance margin of 25% for all securities ‘‘long’’

in an account. 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.

32NASD Regulation’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 continues

to apply, and the NASD does not possess

independent authority to lower the initial margin

requirement for the stock.

33For 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 7, at footnote 34.

34As discussed in note 29, supra, NASD Rule

2520(c) provides a maintenance margin requirement

of the greater of $2.50 per share or 100% of the

current market value for each stock carried short

that has a current market value of less than $5 per

share. 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. Thus,

for an investor who is short 100 shares of XYZ @

48 and long 1 XYZ Jan 50 Call @ 1, the proposed

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 7, at footnote 35.

(loss) that, in the case of a short box

spread, will accrue to the account if

held to expiration. The proposed rule

change 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.26 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 be held or

deposited.27

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 or

stock 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 or stock index

warrant was held in, or purchased for,

the account on the same day.28 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.

F. Margin Account Treatment of

Butterfly and Box Spreads

The NASD’s margin rules presently

do not recognize butterfly spreads for

margin purposes. Under NASD’s current

margin rules, the two spreads (bullish

and bearish) that make up a butterfly

spread each must be margined

separately. NASD Regulation 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.

H. Maintenance Margin Requirements

for Stock Positions Held With Options

Positions

NASD Regulation proposes to

recognize, and establish reduced

maintenance margin requirements for

five options strategies designed to limit

the risk of a position in the underlying

component.31 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 stock positions held in

conjunction with an overlying option

(or options), the proposal is structured

to apply also to components that

underlie index options and warrants.

For example, these same maintenance

margin requirements will apply when

these strategies are used with a stock

basket underlying index options or

warrants. Proposed NASD Rule

2520(f)(2)(G)(v) will define the five

strategies and set forth the respective

maintenance margin requirements for

the stock component of each strategy.32

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. This strategy is designed to

limit downside risk in the underlying

stock while the put is held. The put

holder retains the right to sell stock at

the strike price through the expiration of

the put. The maintenance margin

requirement for the Long Put/Long

Stock combination would be the lesser

of: (a) 10% of the put option aggregate

exercise price, plus 100% of any

amount by which the put option is outof-the-money; or (b) 25% of the current

market value of the long stock

position.33

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 the

equivalent units of the underlying

component. This strategy is designed to

limit the risk associated with upside

appreciation in the underlying stock

during the life of the call. The call

holder retains the right to buy the stock

at the strike price through the expiration

of the call. For a Long Call/Short Stock

combination, the maintenance margin

requirement would be the lesser of: (a)

10% of the call option aggregate

exercise price, plus 100% of any

amount by which the call option is outof-the-money; or (b) the maintenance

margin requirement on the short stock

position as specified in NASD Rule

2520(c).34

3. Conversion (Long Stock/Long Put/

Short Call)

A ‘‘Conversion’’ is a long stock

position in conjunction with a long put

and a short call. For a Conversion to

qualify as hedged, the long put and the

short call must have the same expiration

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

Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices 70859

35For example, for 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 current

maintenance margin on the long stock position

would be $1,200 ((25%×48)×100). However, if the

price of the stock increased to 60, NASD rules

currently specify that the stock may not be valued

at more than the short call 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 7,

at footnote 36.

36For 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 7, at footnote 37.

37The seller of a put option has an obligation to

buy the underlying component at the put exercise

price. If assigned an exercise, the underling

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 one XYZ Jan 50 Call @

2 1⁄2, and short one 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% × 50)

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

supra note 7, at footnote 38.

38To 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 ((100%

× 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 7, at footnote 39.

39See Amendment No. 1, supra note 3.

40 15 U.S.C. 78o–3(b)(6).

41 15 U.S.C. 78o–3(b)(6).

42 In approving the proposal, the Commission has

considered its impact on efficiency, competition,

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

43See note 6, supra.

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 NASD 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 current maintenance

margin requirement (i.e., 25% of the

current market value).35 Under the

proposed rule change, the maintenance

margin requirement for a Conversion

would be 10% of the aggregate exercise

price.36

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. Under the

proposed rule change, the maintenance

margin requirement for a Reverse

Conversion would be 10% of the

aggregate exercise price, plus any in-themoney amount (i.e., the amount by

which the exercise price of the short put

exceeds the current market value of the

underlying stock position).37

5. Collar (Long Stock/Long Put/Short

Call)

A ‘‘Collar’’ is a long stock position

held in conjunction with a long put and

a short call. In a Collar, as compared to

a Conversion, 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 under

the proposed rule change would be the

lesser of: (a) 10% of the long put

aggregate exercise price, plus 100% of

any amount by which the long put is

out-of-the-money; or (b) 25% of the

short call aggregate exercise price.38

Current NASD margin requirements

specify that the stock may not be valued

at more than the call exercise price.

I. Determination of Value for Margin

Purposes

The proposal would revise NASD

Rule 2520(f) to allow the extension of

credit on certain long-term options and

warrants (i.e., stock options, stock index

options, and stock index warrants that

are more than nine months from

expiration).39 Currently, NASD Rule

2520(f) does not allow certain long term

options or warrants to have market

value for margin equity purposes. The

revision would allow options and

warrants eligible for loan value under

proposed NASD Rule 2520(f) to have

market value for margin purposes. This

change is designed 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.

Statutory Basis

NASD Regulation believes that the

proposed rule change is consistent with

the provisions of Section 15A(b)(6) of

the Act,40 which requires, among other

things, that the rules of the Association

be 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. NASD

Regulation believes that the proposed

rule change will promote the safety and

soundness of member firms and is

consistent with the rules and

regulations of the Federal Reserve Board

because it is designed to prevent the

excessive use of credit for the purpose

or carrying of securities, pursuant to

Section 7(a) of the Act.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

NASD Regulation does not believe

that the proposed rule change will result

in any burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act, as amended.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

Written comments were neither

solicited nor received.

III. Commission’s Findings and Order

Granting Accelerated Approval of

Proposed Rule Change and Amendment

Nos. 1 and 2

For the reasons discussed below, the

commission finds the proposed rule

change, as amended, is consistent with

the Act and the rules and regulations

under the Act applicable to a national

securities association. In particular, the

commission finds that the proposed rule

change, as amended, is consistent with

the Section 15A(b)(6) 41 requirements

that the rules of a national securities

association 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 NASD

Regulation’s margin requirements to

better reflect the risk of certain hedged

options strategies.42

Specifically, the Commission believes

that it is appropriate for NASD

Regulation to allow member firms to

extend credit on certain long term

options and warrants, and that such

practice is consistent with Regulation T.

In 1996, the Federal Reserve Board

amended Regulation T to enable the

SROs to adopt rules permitting the

margining of options.43 As noted above,

the NASD rules approved in this order,

which will permit the margining of

options under the grant of authority

from the Federal Reserve Board, are

70860 Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices

44See CBOE Approval Order and NYSE Approval

Order, supra note 7.

45The 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.

46For similar reasons, the Commission believes

that it is appropriate for the NASD 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.

47See Amendment No. 1, supra note 3.

48For 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).

49 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 7.

50See 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 Reserve Board first proposed

margining listed 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’’).

51However, for long box spreads made up of

European-style options, the margin requirement is

50% of the aggregate difference in the two exercise

prices.

substantially identical to rules adopted

recently by the NYSE and the CBOE.44

The Commission believes that it is

reasonable for NASD Regulation 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.45 Because the expiration dates

attached to options and warrants make

such securities wasting assets by nature,

it is important that NASD Regulation

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.46

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 deposit and

maintain margin of not less than 75% of

the long term OTC 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% of the long term OTC

option’s or warrant’s in-the-money

amount (i.e., intrinsic value).47 The

Commission notes that the proposed

margin requirements are more stringent

than the current Regulation T margin

requirements for equity securities (i.e.,

50% initial margin and 25%

maintenance margin).

The Commission recognizes that

because current NASD 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 NASD’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 NASD 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.48 Moreover,

some creditors, such as OCC, extend

credit on options as part of their current

business.49 The Commission believes

that because option 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% loan value

against long listed options under

Regulation U.50 The Commission

understands that the current bar

preventing broker-dealers from

extending credit on options may place

some NASD member firms at a

competitive disadvantage relative to

other financial service firms. By

permitting NASD members to extend

credit on long term options and

warrants, the proposal should enable

NASD members to better serve

customers and offer additional financing

alternatives.

The Commission believes that it is

appropriate for NASD Regulation 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 NASD

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 to the aggregate 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 NASD’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.51 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 short 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

Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices 70861

52For 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 7, at footnote

63.

53See CBOE Approval Order and NYSE Approval

Order, supra note 7.

54See CBOE Approval Order, supra note 7.

55 In this regard, the Commission notes that

NASD Rule 2520(d). ‘‘Additional Margin,’’ requires

NASD members to: (1) review limits and types of

credit extended to all customers; (2) formulate their

own margin requirement; and (3) review the need

for instituting higher margin requirements, mark-tomarkets and collateral deposits than are required by

NASD Rule 2520 for individual securities or

customer accounts. 56See NYSE Rule 414(a).

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 and stock 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 or stock

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 NASD Regulation to

revise the maintenance margin

requirements for several hedging

strategies that combine stock positions

with options positions. The Commission

recognizes that 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

hedge provided by the long put position

(i.e., the 25% maintenance margin

requirement for the stock component is

applied in full). Under the proposal, the

maintenance margin requirement for the

stock component of a Long Put/Long

Stock strategy would be the lesser of: (1)

10% of the put option aggregate exercise

price, plus 100% of any amount by

which the put option is out-of-themoney; or (2) 25% 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

may other cases it would be lower.52

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, NASD Regulation’s proposal is

substantially identical to rules adopted

by the CBOE and the NYSE, which the

Commission approved.53 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.54 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 NASD member may freely

implement margin requirements that

exceed the margin requirements by

adopted by NASD Regulation.55 The

Commission recognizes that the NASD’s

margin requirements serve as nonbinding benchmarks, and that NASD

members often establish different

margin requirements for their customers

based on a number of factors, including

market volatity. The Commission

encourages NASD members to continue

to perform independent and rigorous

analysis when determining prudent

levels of margin for customers.

The Commission believes that it is

appropriate for the NASD to revise Rule

2520(f) (1) and (2) to allow the market

value of certain long term stock options,

stock index options, and stock index

warrants to have market value for

margin equity purposes. Under the

current terms of NASD Rule 2520(f) (1)

and (2), options contracts are not

deemed to have market value. Because

NASD Regulation’s proposal will allow

extensions of credit on certain long term

options and warrants, NASD Rule

2520(f) (1) and (2) must be revised to

permit such marginable options and

warrants to have market value for

margin purposes. The Commission

notes that unless NASD Rule 2520(f) (1)

and (2) are revised to recognize the

market value of the marginable options

and warrants, the NASD’s loan value

proposal will 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 also believes that it

is reasonable for the NASD Regulation

to define ‘‘butterfly spread’’ and ‘‘box

spread.’’ 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 NASD to clearly

define which options strategies are

eligible for the proposed margin

treatment.

Moreover, the Commission believes

that it is reasonable for NASD

Regulation to define the term ‘‘escrow

agreement,’’ when used in connection

with non cash-settled call or put options

carried short, and when used in

connection with cash-settled call or put

options carried short, to establish clear

requirements for both of these types of

escrow agreements. The Commission

believes that the proposed definitions

will help to clarify the requirements for

these types of escrow agreements.

The Commission also finds that the

NASD’s definition of the term ‘‘stock

index warrant’’ is reasonable because it

conforms an NASD rule to an existing

NYSE rule.56

The Commission also believes that it

is reasonable for NASD Regulation to

revise its definition of ‘‘current market

value’’ and ‘‘current market price’’ to

provide that the terms ‘‘current market

value’’ and ‘‘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. A linkage to the

Regulation T definition should keep the

NASD’s definition equivalent to

Regulation T without requiring a rule

filing if the Federal Reserve Board

revises its definition of Regulation T. In

70862 Federal Register / Vol. 65, No. 229 / Tuesday, November 28, 2000 / Notices

57See CBOE Rule 12.3(c)(5) and NYSE Rule

431(f)(2).

58See CBOE Approval Order and NYSE Approval

Order, supra note 7.

59 Id.

60 15 U.S.C. 78s(b).

61 15 U.S.C. 78s(b)(2).

62 17 CFR 200.30–3(a)(12).

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

addition, the Commission believes that

it is reasonable for NASD Regulation to

move its definitions of ‘‘current market

value,’’ ‘‘current market price,’’

‘‘exercise settlement amount,’’

‘‘aggregate exercise price,’’ and

‘‘aggregate current index value’’ from

NASD Rule 2520 to NASD Rule 2522 for

ease of reference purposes so that all the

definitions relating to transactions in

options, currency warrants, currency

index warrants and stock index

warrants will be located under NASD

Rule 2522. The Commission believes

that NASD members and other market

participants will find the consolidated

margin definitions easier to locate and

use.

Further, the Commission believes that

it is reasonable for NASD Regulation to

modify NASD Rule 2450(f)(2)(D) to

provide that the minimum customer

margin requirement for a short put on a

listed equity will be the current value of

the put plus 10% of the put’s aggregate

exercise price; and that the minimum

customer margin requirement for a short

put on an OTC equity will be 10% of the

put’s aggregate exercise price. The

proposed change will make NASD

Regulation’s treatment of short equity

put options consistent with the CBOE

and NYSE treatment of short equity put

options.57

The revisions to NASD margin rules

will significantly impact the way NASD

members calculate margin for options

customers. The Commission believes

that it is important for NASD Regulation

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 26, 2001 or

such date NASD Regulation represents

in writing to the Commission that NASD

Regulation is prepared to fully

implement and monitor the approved

margin requirements.

The Commission expects NASD

Regulations to issue a notice 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

NASD Regulation 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

new provisions.

The Commission finds good cause for

approving the proposal prior to the

thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register because the

proposal is substantially identical to

proposals filed by the CBOE and NYSE,

which the Commission approved

previously.58 The Commission also

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. Amendment

No. 1 strengthens NASD Regulation’s

proposal by, among other things,

clarifying the requirements for stock

index option and stock index warrant

spreads carried in a cash account.

Specifically, NASD Rule

2520(f)(2)(M)(ii)d, as amended, provides

that if the long stock index option or

warrant position is not listed, it must be

guaranteed by the carrying broker-dealer

or the offsetting short position would

not be eligible for the cash account and

would be margined separately pursuant

to NASD Rule 2520(f)(2)(D). Because

this change conforms the NASD’s rule to

the CBOE and NYSE rules that were

approved by the Commission,59 the

change raises no new material

regulatory issues. In addition,

Amendment No. 1 makes technical

corrections, clarifies the purpose of

proposed definitions, and indicates that

the minimum amount of margin that

must be maintained in various hedged

strategies is the aggregate exercise price

(rather than the exercise price).

Amendment No. 2 strengthens the

NASD’s proposal by making technical

corrections and by clarifying the

definitions of ‘‘American-style option,’’

and ‘‘escrow agreement,’’ as used in

connection with cash settled

instruments.

Based on the above, the Commission

finds that good cause exists, consistent

with Section 19(b) of the Act,60 to

accelerate approval of the proposal and

Amendment Nos. 1 and 2 to the

proposal.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing,

including whether the proposed rule

change and 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, NW., 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

the principal office of the NASD. All

submissions should refer to File No.

SR–NASD–00–15 and should be

submitted by December 19, 2000.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,61 that the

proposed rule change (SR–NASD–00–

15), as amended, is approved. The

approved margin requirements shall

become effective the earlier of February

26, 2001 or such date the Association

represents in writing to the Commission

that the Association is prepared to fully

implement and monitor the approved

margin requirements.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.62

Jonathan G. Katz,

Secretary.

[FR Doc. 00–30196 Filed 11–27–00; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43597; File No. SR–NSCC–

00–11]

Self-Regulatory Organizations;

National Securities Clearing

Corporation; Notice of Filing and Order

Granting Accelerated Approval of a

Proposed Rule Change Relating to

Automated Customer Account

Transfer Services Procedures

November 20, 2000.

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

Securities Exchange Act of 1934

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

August 28, 2000, the National Securities

Clearing Corporation (‘‘NSCC’’) filed

with the Securities and Exchange

Commission (‘‘Commission’’) and on

September 25, 2000, amended the

proposed rule change as described in