
[Federal Register Volume 76, Number 26 (Tuesday, February 8, 2011)]
[Notices]
[Pages 6838-6839]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-2645]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63819; File No. SR-CBOE-2010-106]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change, as Modified by 
Amendment No. 1, To Amend Margin Requirements for Credit Options

February 2, 2011.

I. Introduction

    On December 1, 2010, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change as described below. On December 
14, 2010, the Exchange filed Amendment No. 1 to the proposed rule 
change.\3\ The proposed rule change was published for comment in the 
Federal Register on December 21, 2010.\4\ The Commission received no 
comment letters on the proposed rule change. This order approves the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 to SR-CBOE-2010-106 replaced and superseded 
the original rule filing in its entirety.
    \4\ See Securities Exchange Act Release No. 63546 (December 15, 
2010), 75 FR 80099 (December 21, 2010) (``Notice'').
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II. Description of the Proposal

    The Exchange proposes to amend Rule 12.3(l), Margin Requirements, 
to make CBOE's margin requirements for Credit Options consistent with 
FINRA Rule 4240, Margin Requirements for Credit Default Swaps. CBOE's 
Credit Options consist of two variations--Credit Default Options and 
Credit Default Basket Options. Credit Default Options and Credit 
Default Basket Options are also referred to as ``Credit Event Binary 
Options.'' Effectively, both contracts operate in the same manner as 
credit default swap contracts.
    As with a credit default swap contract, the buyer of a Credit 
Option contract is buying protection from the seller of the Credit 
Option. This protection is in the form of a monetary payment from the 
Credit Option seller to the Credit Option buyer in the event that the 
issuer of debt securities, or Reference Entity, specified as underlying 
the Credit Option contract has a Credit Event,\5\ consequently 
defaulting on the payment of principal and interest on its debt 
securities. When a Credit Option buyer and seller initially open their 
positions via a transaction consummated on the Exchange, the Credit 
Option buyer's account is charged (debited) for the cost of the 
protection. The Credit Option seller's account is credited. For the 
protection, there is only a one-time debit and credit to the buyer and 
seller, respectively. If, prior to expiration of the Credit Option, a 
Credit Event \6\ occurs, the Credit Option contract is settled with a 
credit to the Credit Option buyer's account for a predetermined payout 
amount (e.g., $1,000), based on the Exchange's contract specifications. 
The Credit Option seller's account is debited (charged) for the payout 
amount.
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    \5\ See Securities Exchange Act Release No. 63352 (November 19, 
2010), 75 FR 73155 (November 29, 2010) (order approving SR-CBOE-
2010-046). CBOE amended its rules to permit it to, among other 
things, list credit options designating a single credit event, such 
as failure-to-pay default, another event of default, or a 
restructuring. See also CBOE Rules 29.2 and 29.2A.
    \6\ Id.
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    Credit Default Options have a single Reference Entity. Credit 
Default Basket Options have multiple Reference Entities. If a Credit 
Default Basket

[[Page 6839]]

Option is specified as having a single payout, settlement is triggered 
when any one of the component Reference Entities has a Credit Event and 
thereafter the option ceases to exist. The payout is the settlement 
amount attached to that one Reference Entity. If a Credit Default 
Basket Option is specified as having multiple payouts, a settlement is 
triggered when any one of the component Reference Entities has a Credit 
Event,\7\ but the option continues to exist until its expiration. 
Therefore, additional settlements would be triggered if, and as, any 
Credit Events occur in respect of the remaining Reference Entity 
components. The payout is the settlement amount attached to each 
particular Reference Entity.
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    \7\ Id.
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    CBOE notes that the current Exchange margin requirements for Credit 
Options were established before FINRA implemented margin requirements 
for credit default swaps (FINRA Rule 4240). In order to be consistent 
with FINRA margin requirements and establish a level playing field for 
similar instruments, CBOE's proposed amendments adopt the FINRA 
requirements to a large extent. For Credit Default Options, which 
overlie a single Reference Entity, CBOE proposes to adopt FINRA's 
margin percentage table for credit default swaps. With respect to 
Credit Default Basket Options, CBOE is adopting the margin percentage 
table that FINRA requires for CDX indices because, like an index, a 
Credit Default Basket Option involves multiple component Reference 
Entities. CBOE proposes to revise the FINRA column headings to fit 
Credit Options. FINRA Rule 4240 requires the percentage to be applied 
to the notional amount of a credit default swap. CBOE's proposed rules 
would require that the percentage be applied to the settlement value of 
a Credit Option to arrive at a margin requirement because the 
settlement value of a Credit Option is analogous to the notional amount 
of a credit default swap. CBOE's proposed rules incorporate all other 
relevant aspects of FINRA 4240, such as risk monitoring procedures and 
guidelines, and concentration charge (net capital) requirements.
    CBOE's proposed rules would require no margin in the case of a 
spread (i.e., long and short Credit Options with the same underlying 
Reference Entity or Entities.) This differs from FINRA Rule 4240, which 
requires margin of 50% of the margin required on the long or short 
(credit default swap), whichever is greater. CBOE is proposing no 
margin because the long and short are required to have the same 
underlying Reference Entity. Moreover, Credit Options are standardized 
and are settled through The Options Clearing Corp.
    CBOE's proposed rules would also require no margin on a short 
Credit Default Option that is offset with a short position in a debt 
security issued by the Reference Entity underlying the option. This 
language differs from the debt security offset allowed under FINRA Rule 
4240. However, applicable margin must still be collected on the short 
position in a debt security as prescribed pursuant to applicable margin 
rules. Rule 4240 requires no margin for a long credit default swap 
contract that is paired with a long position in the underlying debt 
security. However, CBOE believes this type of offset does not appear to 
be workable in respect of a Credit Default Option.
    The proposal will become effective on a pilot basis to run a 
parallel track with FINRA Rule 4240. FINRA Rule 4240 operates on an 
interim pilot basis which is currently scheduled to expire on July 16, 
2011.\8\ If the Exchange were to propose an extension of the Credit 
Option Margin Pilot Program or should the Exchange propose to make the 
Pilot Program permanent, then the Exchange would submit a filing 
proposing such amendments to the Pilot Program.
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    \8\ See Securities Exchange Act Release No. 63391 (November 30, 
2010), 75 FR 75718 (December 6, 2010) (notice of filing for 
immediate effectiveness extending FINRA Rule 4240 margin interim 
pilot program to July 16, 2011).
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III. Discussion and Commission's Findings

    After careful consideration, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\9\ In particular, the 
Commission finds that the proposal is consistent with Section 6(b)(5) 
of the Act,\10\ which requires, among other things, that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, remove impediments to and perfect the mechanism of a free and 
open market and a national market system, and, in general, protect 
investors and the public interest. In the Commission's view, because it 
is consistent with FINRA Rule 4240, the proposed rule change will 
provide for a more uniform application of margin requirements for 
similar products.
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    \9\ 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).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission further believes that it is appropriate to approve 
the proposal on a pilot basis to expire on July 16, 2011. In 
particular, the Commission notes that CBOE's proposed pilot program 
will parallel FINRA's pilot program. This will allow the Commission and 
CBOE to monitor the effects of the pilot on the markets and investors 
and consider appropriate adjustments, as necessary.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-CBOE-2010-106), as modified 
by Amendment No. 1, is approved.
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    \11\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-2645 Filed 2-7-11; 8:45 am]
BILLING CODE 8011-01-P


