

[Federal Register: December 20, 2005 (Volume 70, Number 243)]
[Notices]               
[Page 75523-75525]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20de05-97]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52951; File No. SR-NYSE-2004-39]

 
Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Approving a Proposed Rule Change and Partial Amendment No. 1 To 
Amend Exchange Rule 431 (Margin Requirements)

December 14, 2005.

I. Introduction

    On July 12, 2004, the New York Stock Exchange, Inc. (the 
``Exchange'' or ``NYSE'') filed with the Securities and Exchange 
Commission (``SEC'' or the ``Commission'') a proposed rule change to 
amend specified provision of Exchange Rule 431 (margin requirements) 
pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 1934 
(the ``Exchange Act'') \2\ and Rule 19b-4 thereunder.\3\ On September 
29, 2005, the Exchange filed a partial amendment to its proposed rule 
change.\4\ The proposed rule change, as amended, was published for 
comment in the Federal Register on November 10, 2005.\5\ The Commission 
received no comments on the proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 15 U.S.C. 78a et seq.
    \3\ 17 CFR 240.19b-4.
    \4\ SR-NYSE-2004-39: Amendment No. 1. The NYSE, in coordination 
with the Chicago Board Options Exchange, Incorporated (``CBOE''), 
filed the partial amendment to conform the complex options spreads 
strategies to which its rule amendments apply to those of the CBOE.
    \5\ See Securities Exchange Act Release No. 52738 (Nov. 4, 
2005); 70 FR 68501 (Nov. 10, 2005).
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II. Description

    The Exchange has proposed amendments to Rule 431 (margin 
requirements) that will recognize specific additional complex option 
spread strategies and set margin requirements commensurate with the 
risk of such spread strategies. These complex spread strategies are a 
combination of two or more basic option spreads that are already 
covered under Exchange Rule 431. In addition, the Exchange has proposed 
the elimination of the two-dollar standard exercise price interval 
limitation for listed options and certain terminology with respect to 
``permitted offsets,'' as defined in its Rule. The proposed amendments 
described below have been developed in conjunction with the Chicago 
Board Options Exchange (``CBOE'').

A. Complex Option Spreads

    As noted, the Exchange has proposed amendments to Rule 431 to 
recognize

[[Page 75524]]

certain additional complex option spread strategies that are the net 
result of combining two or more spread strategies that are currently 
recognized in the Exchange's margin rules. The netting of contracts in 
option series common to each of the currently recognized spreads in an 
aggregation reduces it to the complex spread strategies outlined below.
    The Exchange states that basic option spreads can be paired in such 
ways that they offset each other in terms of risk. The total risk of 
the combined spreads is less than the sum of the risk of both spread 
positions if viewed as stand-alone strategies. The specific complex 
spread strategies listed below are structured using the same principles 
as, and are essentially expansions of, the advanced spreads currently 
allowed in Rule 431.
    Currently, Rule 431 recognizes and prescribes margin requirements 
for advanced spread strategies known as the ``butterfly spread'' and 
the ``box spread.'' However, the Exchange noted that these option 
spreads are limited in scope and that its proposal expands upon the 
types of pairings that would qualify for butterfly spread and box 
spread treatment.
    Exchange Rule 431(f)(2)(G)(i) recognizes ``calendar spreads,'' also 
known as ``time spreads,'' but these spreads are not identified as 
such. The Exchange has proposed to define this term as ``the sale of 
one option and the simultaneous purchase of an option with a more 
distant expiration date, both specifying the same underlying component 
with the same exercise price where the long options do not expire 
before the short option with the longest term expiration'' in the 
definition section of the Rule (NYSE 431(f)(2)(C)) because some of the 
complex spreads recognized in this proposal will include this component 
of spread strategies.
    The Exchange noted that to be eligible for the margin requirements 
in the proposal, a complex spread must be consistent with one of the 
seven patterns specified below. The expiration months and the sequence 
of the exercise prices must correspond to the same pattern, and the 
intervals between the exercise prices must be equal.
    Under the proposal, members and member organizations will be 
required to obtain initial and maintenance margin for the subject 
complex spreads, whether established outright or through netting, of 
not less than the sum of the margin required on each basic spread in 
the equivalent aggregation.
    The Exchange noted that the basic requirements for complex options 
spreads are as follows: (a) The complex spreads must be carried in a 
margin account; (b) European-style options are prohibited for complex 
spread combinations having a long option series that expires after the 
other option series. Only American-style options may be used in these 
combinations. Additionally, the intervals between exercise prices must 
be equal, and each complex spread must comprise four option series, 
with the exception of a Long Calendar Butterfly Spread, which must 
comprised of three option series.
    According to the Exchange, the sum of the margin required on each 
currently recognized spread in each of the applicable aggregations 
renders a margin requirement for the subject complex spread strategies 
as stated below. The additional complex option strategies and 
maintenance margin requirements are as follows: (1) A Long Condor 
Spread comprised of two long Butterfly Spreads; (2) a Short Iron 
Butterfly Spread comprised of one long Butterfly Spread and one short 
Box Spread; (3) a Short Iron Condor Spread comprised of two long 
Butterfly Spreads and one short Box Spread; (4) a Long Calendar 
Butterfly Spread comprised of one long Calendar Spread and one long 
Butterfly Spread; (5) a Long Calendar Condor Spread comprised of one 
long Calendar Spread and two long Butterfly Spreads; (6) a Short 
Calendar Iron Butterfly Spread comprised of one long Calendar Spread 
plus one long Butterfly Spread and one short Box Spread; and (7) a 
Short Calendar Iron Condor Spread comprised of one Long Calendar Spread 
plus two long Butterfly Spreads and one short Box Spread.
    The Exchange stated that the purpose and benefit of the proposal is 
to set levels of margin that more precisely represent the actual net 
risk of the option positions in the account and to enable customers to 
implement these strategies more efficiently.

B. Permitted Offsets

    Currently, Exchange Rule 431(f)(2)(J) limits permitted offsets \6\ 
for specialists and market makers in options to option series that are 
``in-or-at-the-money.'' \7\ Recently, various options exchanges have 
provided for the listing of options with one-dollar strike intervals in 
a number of classes. The Exchange stated that as a result, the use of 
securities to hedge option series that have one-dollar strike intervals 
has unintentionally become more restrictive.
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    \6\ NYSE Rule 431(f)(2)(J) defines a permitted offset position 
as, in the case of an option in which a specialist makes a market, a 
position in the underlying asset or other related assets, and in the 
case of other securities in which a specialist makes a market, a 
position in options overlying the securities in which a specialist 
makes a market.
    \7\ NYSE Rule 431(f)(2)(J) defines the term ``in or at the 
money'' as the current market price of the underlying security is 
not more than two standard exercise intervals below (with respect to 
a call option) or above (with respect to a put option) the exercise 
price of the option.
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    The Exchange has proposed a rule change to eliminate the two-dollar 
standard exercise price interval limitation for listed options and the 
definition of ``in-or-at-the-money.'' As proposed, Rule 431(f)(2)(J) 
would require permitted offset transactions be effected for specialist 
or market-making purposes such as hedging, risk reduction, rebalancing 
of positions, liquidation, or accommodation of customer orders, or 
other similar specialist or market-making purposes, while prohibiting 
trading in an underlying security that is not related to specialist or 
market making option activities, or that does not constitute a 
reasonable hedge.
    Because clearing firms have risk monitoring systems that alert them 
to unhedged positions and haircut requirements pursuant to Rule 15c3-1 
\8\ of the Exchange Act \9\ perform a similar function as NYSE margin 
requirements relative to providing adequate risk coverage to broker-
dealers, the Exchange believes that the elimination of the two-dollar 
standard exercise price limitation and definition of ``in-or-at-the-
money'' will not diminish the ``safety and soundness'' protections that 
Rule 431 provides.
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    \8\ 17 CFR 240.15c3-1.
    \9\ 15 U.S.C. 78a.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\10\ In particular, the Commission believes that 
the proposed rule change is consistent with Section 6(b)(5) of the 
Exchange Act,\11\ which requires that the rules of the exchange be 
designed, among other things, to remove impediments to and perfect the 
mechanisms of a free and open market, and, in general, to protect 
investors and the public interest. The Commission finds that amending 
the rules to permit complex option spread strategies that are the net 
result of combining two or more spread strategies that are currently 
recognized in the Exchange's margin rules is consistent

[[Page 75525]]

with the requirements of Section 6(b)(5) because the amendments will 
allow the Exchange to set levels of margin that more precisely 
represent the actual net risk of the option positions in the account 
and enable customers to implement these strategies more efficiently.
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    \10\ In approving this proposed rule change, the Commission 
notes that it 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(b)(5).
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    The Commission further finds elimination of the two-dollar standard 
exercise price interval limitation for listed options and elimination 
of the definition of ``in-or-at-the-money'' are consistent with the 
requirements of Section 6(b)(5). The rules changes should allow 
specialists and market makers to hedge risk related to their options 
positions while prohibiting trading in an underlying security that is 
not related to specialist or market making option activities, or that 
does not constitute a reasonable hedge.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (File No. SR-NYSE-2004-39), as 
amended, be, and it hereby is, approved.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-7525 Filed 12-19-05; 8:45 am]

BILLING CODE 8010-01-P
