[Federal Register: October 4, 2006 (Volume 71, Number 192)]
[Notices]
[Page 58656-58658]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04oc06-103]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-54514; File No. SR-OCC-2006-05]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of a Proposed Rule Change Relating to
Expiration Date Exercise Procedures
September 26, 2006.
I. Introduction
On April 6, 2006, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') proposed
rule change SR-OCC-2006-05 pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'').\1\ Notice
[[Page 58657]]
of the proposal was published in the Federal Register on August 18,
2006.\2\ No comment letters were received. For the reasons discussed
below, the Commission is granting approval of the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 54306, (August 11,
2006), 71 FR 47853.
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II. Description
The proposed rule change will amend OCC Rule 805, Expiration Date
Exercise Procedure, to reduce the threshold amounts used to determine
which equity options are in the money for purposes of ``exercise by
exception'' processing. A conforming change would also be made to OCC
Rule 1106, Open Positions, which concerns the treatment of open
positions following the suspension of a clearing member.
OCC has for years maintained an ``exercise by exception''
procedure. Under that procedure, options that are in the money at
expiration by more than a specified threshold amount are exercised
automatically unless the clearing member carrying the position
instructs OCC otherwise. Equity options are determined to be in the
money or not in the money based on the difference between the exercise
price and the closing price of the underlying equity interest on the
last trading day before expiration. In September 2004, in order to
streamline expiration processing, OCC reduced the threshold amounts
from $.75 to $.25 for equity options in a clearing member's customers'
account and from $.25 to $.15 for equity options in any other account
(i.e., firm and market makers' accounts).\3\ The September 2004 change,
which was implemented at the request of the OCC Roundtable,\4\
immediately yielded significant benefits to both OCC and clearing
members as evidenced by the fact that the time for submitting exercise
instructions was reduced by one to three hours on an average expiration
weekend.
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\3\ Securities Exchange Act Release No. 50178 (August 10, 2004),
69 FR 51343 (August 18, 2004) [File No. SR-OCC-2004-04].
\4\ The OCC Roundtable is an OCC sponsored advisory group
comprised of representatives from OCC's participant exchanges, OCC,
a cross-section of OCC clearing members, and industry service
bureaus. The OCC Roundtable considers operational improvements that
may be made to increase efficiencies and lower costs in the options
industry.
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Increasing options volumes in 2004 and 2005 prompted the OCC
Roundtable to review the threshold amounts used for equity options in
an effort to further reduce operational risks and improve expiration
processing. Initially, the OCC Roundtable proposed that the threshold
amount for all account types be set at $.01, but an OCC survey of
clearing members found that while 65% of responding clearing members
supported such a change, 35% were against it. A second OCC survey
determined that 75% of responding clearing members were in favor of and
25% were opposed to changing the threshold amount change to $.05 for
all account types. The OCC Roundtable then requested that OCC establish
$.05 as the threshold amount applicable to equity options exercises for
all account types.
In response to this request, OCC analyzed equity options exercise
information from the June 2004 through December 2005 expirations. OCC
analysis determined from its members that 70% of equity option
contracts carried in clearing members' customers' accounts that were in
the money by amounts of $.05 to $.24 (i.e., the proposed change to the
``in-the-money'' amount represented by the proposed threshold change)
were exercised. OCC analysis also determined from its members that
exercise activity in other account types supported the proposed
threshold amount change.
OCC surveyed all clearing members to obtain their views and
comments on the proposed change to $.05 as the threshold amount for
equity options for all account types. Survey results demonstrated
strong support across the membership for the change. Eighty-seven
clearing members responded to the survey with sixty-five clearing
members (75%) being in favor of the threshold change and 22 clearing
members (25%) being opposed.\5\ Clearing members supporting the change
confirmed the OCC Roundtable's view that such a change would
significantly reduce the number of instructions clearing members are
currently required to submit at expiration and thereby would shorten
the time frame for completing their instructions to OCC.
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\5\ OCC contacted clearing members that did not respond to its
survey. These firms expressed no opinion on the matter.
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OCC contacted each firm that expressed opposition to the $.05
threshold amount change. These firms are generally midsize to small
retail clearing members. Their opposition to the change reflected their
principal concern that they would have to submit more ``do not
exercise'' instructions. Some indicated concerns about the need to
educate customers and about the possibility that commission costs could
make an exercise unprofitable.\6\ However, all of these firms indicated
that they could adapt to a $.05 threshold amount if it was supported by
the majority of clearing members. OCC further reviewed the positions
carried by these firms and determined that, on average, they generally
carry positions in fewer than 10 expiring series per expiration that
are below the current threshold amount of $.25. This review led OCC to
conclude that the threshold amount change to $.05 would result in only
a slight increase in processing time for these firms and that they
would not be unduly burdened by its implementation.
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\6\ As noted, clearing members are able to instruct OCC not to
exercise an expiring equity option.
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OCC's survey of clearing members also asked firms to provide an
estimate of the time they would need to accommodate the threshold
change based upon supplied time frames (e.g., 0-3 months or 4-6
months). The majority of firms indicated that they could complete the
necessary systems development and customer notifications within six
months. OCC contacted every firm that commented on the proposed time
frames, and all expressed the view that their efforts would be
completed in the six month time period.
The OCC Roundtable has recommended that this change be implemented
for the October 2006 expiration. Therefore, OCC requests that the
Commission approve the proposed rule change with an effective date of
October 1, 2006, and that the Commission authorize OCC to implement the
threshold change thereafter based upon its assessment of clearing
member readiness. OCC would provide at least ten days advance notice to
clearing members of the effective date for the new threshold amounts by
information memoranda and by other forms of electronic notice such as
e-mail. Additionally, OCC would allow clearing members additional time
to complete preparations for the threshold change if necessary.
III. Discussion
Section 17A(b)(3)(F) of the Act requires, among other things, that
the rules of a clearing agency be designed to promote the prompt and
accurate clearance and settlement of securities transactions.\7\ OCC
Rule 805 is based on the assumption that when an option is in-the-money
by at least a minimum fixed threshold level, most OCC members and their
customers would choose to exercise the option. The rule has the effect,
therefore, of reducing the number of exercise instructions that must be
submitted to and processed by OCC. As OCC notes in its description of
the proposed rule change, if a threshold
[[Page 58658]]
amount is set too low, the result could be that some members would have
to submit a greater number of ``do not exercise'' instructions than
they would have to submit if the threshold amount was set at a higher
amount. However, the Commission is satisfied that by consulting with an
industry advisory group, by surveying its clearing members, and by its
analysis, OCC has made a reasoned determination in deciding to set the
threshold amount for equity options in all account types at $.05.
Furthermore, we note that OCC consulted with its clearing members to
ensure that even those that did not actively support the proposed rule
change would not be adversely affected in a significant manner by the
new threshold amount. Accordingly, because the proposed rule change is
designed to reduce the amount of processing required for in-the-money
equity options, we find that it is designed to promote the prompt and
accurate clearance and settlement of securities transactions.
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\7\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular Section 17A of the Act and the rules and regulations
thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-2006-05) be and hereby
is approved.
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\8\ 17 CFR 200.30-3(a)(12).
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\8\
Nancy M. Morris,
Secretary.
[FR Doc. E6-16332 Filed 10-3-06; 8:45 am]
BILLING CODE 8010-01-P