
[Federal Register Volume 80, Number 201 (Monday, October 19, 2015)]
[Notices]
[Pages 63264-63267]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-26427]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-76128; File No. SR-OCC-2015-016]


Self-Regulatory Organizations; the Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change To Modify the Options Clearing 
Corporation's Margin Methodology by Incorporating Variations in Implied 
Volatility

October 13, 2015
    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 October 5, 2015, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by OCC.\3\ The Commission is publishing this notice 
to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ OCC also filed this proposal as an advance notice pursuant 
to Section 802(e)(1) of the Payment, Clearing, and Settlement 
Supervision Act of 2010 and Rule 19b-4(n)(1) under the Act. 15 
U.S.C. 5465(e)(1) and 17 CFR 240.19b-4(n)(1). See File No. SR-OCC-
2015-804.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    This proposed rule change by The Options Clearing Corporation 
(``OCC'') would modify OCC's margin methodology by incorporating 
variations in implied volatility for ``shorter tenor'' options within 
the System for Theoretical Analysis and Numerical Simulations 
(``STANS'').

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, OCC 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. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

1. Purpose
    The proposed rule change would modify OCC's margin methodology by 
more broadly incorporating variations in implied volatility within 
STANS. As explained below, OCC believes that expanding the use of 
variations in implied volatility within STANS for substantially all \4\ 
option contracts available to be cleared by OCC that have a residual 
tenor \5\ of less than three years (``Shorter Tenor Options'') would 
enhance OCC's ability to ensure that option prices and the margin 
coverage related to such positions more appropriately reflect possible 
future market value fluctuations and better protect OCC in the event it 
must liquidate the portfolio of a suspended Clearing Member.
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    \4\ OCC is proposing to exclude: (i) Binary options, (ii) 
options on energy futures, and (iii) options on U.S. Treasury 
securities. These relatively new products were introduced as the 
implied volatility margin methodology changes were in the process of 
being completed by OCC. Subsequent to the implementation of the 
revised implied volatility margin methodology discussed in this 
filing, OCC would plan to modify the margin methodology to 
accommodate the above new products. In addition, due to de minimus 
open interest in those options, OCC does not believe there is a 
substantive risk if the products would be excluded from the implied 
volatility margin methodology modifications at this time.
    \5\ The ``tenor'' of an option is the amount of time remaining 
to its expiration.
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Implied Volatility in STANS Generally

    STANS is OCC's proprietary risk management system that calculates 
Clearing Members' margin requirements in accordance with OCC's 
Rules.\6\ The STANS methodology uses Monte Carlo simulations to 
forecast price movement and correlations in determining a Clearing 
Member's margin requirement. Under STANS, the daily margin calculation 
for each Clearing Member account is constructed to comply with 
Commission Rule 17Ad-22(b)(2),\7\ ensuring OCC maintains sufficient 
financial resources to liquidate a defaulting member's positions, 
without loss, within the liquidation horizon of two business days.
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    \6\ Pursuant to OCC Rule 601(e)(1), however, OCC uses the 
Standard Portfolio Analysis of Risk Margin Calculation System 
(``SPAN'') to calculate initial margin requirements for segregated 
futures accounts. No changes are proposed to OCC's use of SPAN 
because the proposed changes do not concern futures. See Securities 
Exchange Act Release No. 72331 (June 5, 2014), 79 FR 33607 (June 11, 
2014) (SR-OCC-2014-13).
    \7\ 17 CFR 240.17Ad-22(b)(2). As a registered clearing agency 
that performs central counterparty services, OCC is required to 
``use margin requirements to limit its credit exposures to 
participants under normal market conditions and use risk-based 
models and parameters to set margin requirements and review such 
margin requirements and the related risk-based models and parameters 
at least monthly.''
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    The STANS margin requirement for an account is composed of two 
primary components: \8\ A base component and a stress test component. 
The base component is obtained from a risk measure of the expected 
margin shortfall for an account that results under Monte Carlo price 
movement simulations. For the exposures that are observed regarding the 
account, the base component is established as the estimated average of 
potential losses higher than the 99% VaR \9\ threshold to help ensure 
that OCC continuously meets the requirements of Rule 17Ad-22(b)(2).\10\ 
In addition, OCC augments the base component using the stress test 
component. The stress test component is obtained by considering 
increases in the expected margin shortfall for an account that would 
occur due to (i) market movements that are especially large and/or in 
which certain risk factors would exhibit perfect or zero correlations 
rather than correlations otherwise estimated using historical data or 
(ii) extreme and adverse idiosyncratic movements for individual risk 
factors to which the account is particularly exposed.
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    \8\ The two primary components referenced relate to the risk 
calculation and are associated with the 99% two-day expected 
shortfall (i.e., ES) and the concentration/dependence margin add-on 
(i.e., Add-on Charge). When computing the ES or Add-on Charges, 
STANS computes the theoretical value of an option for a given 
simulated underlying price change using the implied volatility 
reflected in the prior day closing price. Under the proposed change, 
STANS would use a modeled implied volatility intended to simulate 
the estimated change in implied volatilities given the simulated 
underlying price change in STANS.
    \9\ The term ``value at risk'' or ``VaR'' refers to a 
statistical technique that, generally speaking, is used in risk 
management to measure the potential risk of loss for a given set of 
assets over a particular time horizon.
    \10\ 17 CFR 240.17Ad-22(b)(2).
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    Including variations in implied volatility within STANS is intended 
to ensure that the anticipated cost of liquidating each Shorter Tenor 
Option position in an account recognizes the possibility that implied 
volatility could change during the two business day liquidation time 
horizon in STANS and lead to corresponding changes in the market prices 
of the options. Generally speaking, the implied volatility of an option 
is a measure of the expected future volatility of the value of the 
option's annualized standard deviation of the price of the underlying 
security, index, or future at exercise, which is reflected in the 
current option premium in the market. The volatility is

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``implied'' from the premium for an option \11\ at any given time by 
calculating the option premium under certain assumptions used in the 
Black-Scholes options pricing model and then determining what value 
must be added to the known values for all of the other variables in the 
Black-Scholes model to equal the premium. In effect, the implied 
volatility is responsible for that portion of the premium that cannot 
be explained by the then-current intrinsic value \12\ of the option, 
discounted to reflect its time value. OCC currently incorporates 
variations in implied volatility as risk factors for certain options 
with residual tenors of at least three years (``Longer Tenor 
Options'').\13\
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    \11\ The premium is the price that the holder of an option pays 
and the writer of an option receives for the rights conveyed by the 
option.
    \12\ Generally speaking, the intrinsic value is the difference 
between the price of the underlying and the exercise price of the 
option.
    \13\ See Securities Exchange Act Release Nos. 68434 (December 
14, 2012), 77 FR 57602 [sic] (December 19, 2012) (SR-OCC-2012-14); 
70709 [sic] (October 18, 2013), 78 FR 63267 [sic] (October 23, 2013) 
[sic] (SR-OCC-2013-16).
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Implied Volatility for Shorter Tenor Options

    OCC is proposing certain modifications to STANS to more broadly 
incorporate variations in implied volatility for Shorter Tenor Options. 
Consistent with its approach for Longer Tenor Options, OCC would model 
a volatility surface \14\ for Shorter Tenor Options by incorporating 
into the econometric models underlying STANS certain risk factors 
regarding a time series of proportional changes in implied volatilities 
for a range of tenors and absolute deltas. Shorter Tenor Option 
volatility points would be defined by three different tenors and three 
different absolute deltas, which produce nine ``pivot points.'' In 
calculating the implied volatility values for each pivot point, OCC 
would use the same type of series-level pricing data set to create the 
nine pivot points that it does to create the larger number of pivot 
points used for Longer Tenor Options, so that the nine pivot points 
would be the result of a consolidation of the entire series-level 
dataset into a smaller and more manageable set of pivot points before 
modeling the volatility surface.
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    \14\ The term ``volatility surface'' refers to a three-
dimensional graphed surface that represents the implied volatility 
for possible tenors of the option and the implied volatility of the 
option over those tenors for the possible levels of ``moneyness'' of 
the option. The term ``moneyness'' refers to the relationship 
between the current market price of the underlying interest and the 
exercise price.
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    OCC partnered with an experienced vendor in this area to study 
implied volatility surfaces and to use back-testing of OCC's margin 
requirements to build a model that would be appropriately sophisticated 
and operate conservatively to minimize margin exceedances. The back-
testing results support that, over a look-back period from January 2008 
to May 2013,\15\ using nine pivot points to define the volatility 
surface would have resulted in a comparable number of instances in 
which an account containing certain hypothetical positions would have 
been under-margined compared to using a larger number of pivot points 
to define the volatility surface. Therefore, although OCC could create 
a more detailed volatility surface by increasing the number of pivot 
points, OCC has determined that doing so for Shorter Tenor Options 
would not be appropriate. Moreover, due to the significantly larger 
volume of Shorter Tenor Options, OCC also believes that relying on a 
greater number of pivot points could potentially lead to increases in 
the time necessary to compute margin requirements that would impair 
OCC's capacity to make timely calculations.
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    \15\ The look-back period was determined based on the 
availability of relevant data at the time of the back-testing. 
Relevant data in this case means data obtained from OCC's 
consultants, Finance Concepts. The back-testing was performed by 
Finance Concepts using data from their OptionMetrics Ivy source. The 
Ivy source maintains data from prior to 2008, but it is not clear 
that data from before the market dislocation in early August 2007 is 
as relevant to today's options markets.
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    Under OCC's model for Shorter Tenor Options, the volatility 
surfaces would be defined using tenors of one month, three months, and 
one year with absolute deltas, in each case, of 0.25, 0.5, and 0.75. 
This results in the nine implied volatility pivot points. Given that 
premiums of deep-in-the-money options (those with absolute deltas 
closer to 1.0) and deep-out-of-the-money options (those with absolute 
deltas closer to 0) are insensitive to changes in implied volatility, 
in each case notwithstanding increases or decreases in implied 
volatility over the two business day liquidation time horizon, those 
higher and lower absolute deltas have not been selected as pivot 
points. OCC believes that it is appropriate to focus on pivot points 
representing at- and near-the-money options because prices for those 
options are more sensitive to variations in implied volatility over the 
liquidation time horizon of two business days. Specifically, for SPX 
index options, four factors explain 99% variance of implied volatility 
movements: (i) A parallel shift of the entire surface, (ii) a slope or 
skewness with respect to Delta, (iii) a slope with respect to time to 
maturity; and, (iv) a convexity with respect to the time to maturity. 
The nine correlated pivot points, arranged by delta and tenor, give OCC 
the flexibility to capture these factors.
    In the proposed approach to computing margin for Shorter Tenor 
Options under STANS, OCC would first use its econometric models to 
simulate implied volatility changes at the nine pivot points that would 
correspond to underlying price simulations used by STANS.\16\ For each 
Shorter Tenor Option in the account of a Clearing Member, changes in 
its implied volatility would then be simulated according to the 
corresponding pivot point and the price of the option would be computed 
to determine the amount of profit or loss in the account under the 
particular STANS price simulation. Additionally, as OCC does today, it 
would continue to use simulated closing prices for the assets 
underlying options in the account of a Clearing Member that are 
scheduled to expire within the liquidation time horizon of two business 
days to compute the options' intrinsic value \17\ and use those values 
to help calculate the profit or loss in the account.\18\
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    \16\ STANS relies on 10,000 price simulation scenarios that are 
based generally on a historical data period of 500 business days, 
which is updated monthly to keep model results from becoming stale.
    \17\ Generally speaking, the intrinsic value is the difference 
between the price of the underlying and the exercise price of the 
option.
    \18\ For such Shorter Tenor Options that are scheduled to expire 
on the open of the market rather than the close, OCC would use the 
relevant opening price for the underlying assets.
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Effects of the Proposed Change and Implementation

    OCC believes that the proposed rule change would enhance OCC's 
ability to ensure that in determining margin requirements STANS 
appropriately takes into account normal market conditions that OCC may 
encounter in the event that, pursuant to OCC Rule 1102, it suspends a 
defaulted Clearing Member and liquidates its accounts.\19\ Accordingly, 
the change would promote OCC's ability to ensure that margin assets are 
sufficient to liquidate the accounts of a defaulted Clearing Member 
without incurring a loss.
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    \19\ Under authority in OCC Rules 1104 and 1106, OCC has 
authority to promptly liquidate margin assets and options positions 
of a suspended Clearing Member in the most orderly manner 
practicable, which might include, but would not be limited to, a 
private auction.
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    OCC estimates that Clearing Member accounts generally would 
experience increased margin requirements as compared to those 
calculated for the same options positions in an account today. OCC 
estimates the proposed

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change would most significantly affect customer accounts and least 
significantly affect firm accounts, with the effect on Market Maker 
accounts falling in between.
    OCC expects customer accounts to experience the largest margin 
increases because positions considered under STANS for customer 
accounts typically consist of more short than long options positions, 
and therefore reflect a greater magnitude of direction risk than other 
account types. Positions considered under STANS for customer accounts 
typically consist of more short than long options positions because, to 
facilitate Clearing Members' compliance with Commission requirements 
for the protection of certain customer property under Rule 15c3-
3(b),\20\ OCC segregates long option positions in the securities 
customers' account of each Clearing Member and does not assign them any 
value in determining the expected liquidating value of the account.\21\
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    \20\ 17 CFR 240.15c3-3(b).
    \21\ See OCC Rule 601(d)(1). Pursuant to OCC Rule 611, however, 
a Clearing Member, subject to certain conditions, may instruct OCC 
to release segregated long option positions from segregation. Long 
positions may be released, for example, if they are part of a spread 
position. Once released from segregation, OCC receives a lien on 
each unsegregated long securities option carried in a customers' 
account and therefore OCC permits the unsegregated long to offset 
corresponding short option positions in the account.
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    While overall OCC expects an increase in aggregate margins by about 
$1.5 billion (9% of expected shortfall and stress-test add-on), OCC 
does anticipate a decrease in margins in certain clearing member 
accounts' requirements. OCC anticipates that such a decrease would 
occur in accounts with underlying exposure and implied volatility 
exposure in the same direction, such as concentrated call positions, 
due to the negative correlation typically observed between these two 
factors. Over the back-testing period, about 28% of the observations 
for accounts on the days studied had lower margins under the proposed 
methodology and the average reduction was about 2.7%. Parallel results 
will be made available to the membership in the weeks ahead of 
implementation.
    To help Clearing Members prepare for the proposed change, OCC has 
provided Clearing Members with an Information Memo explaining the 
proposal, including the planned timeline for its implementation,\22\ 
and discussed with certain other clearinghouses the likely effects of 
the change on OCC's cross-margin agreements with them. OCC is also 
publishing an Information Memo to notify Clearing Members of the 
submission of this filing to the Commission. Subject to all necessary 
regulatory approvals regarding the proposed change, for a period of at 
least two months beginning in October 2015, OCC intends to begin making 
parallel margin calculations with and without the changes in the margin 
methodology. The commencement of the calculations would be announced by 
an Information Memo, and OCC would provide the calculations to Clearing 
Members each business day. OCC believes that Clearing Members will have 
sufficient time and data to plan for the potential increases in their 
respective margin requirements. OCC would also provide at least thirty 
days prior notice to Clearing Members before implementing the change.
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    \22\ In addition to the proposal to introduce variations in 
implied volatility for Shorter Tenor Options, OCC is also 
contemporaneously proposing an additional change to its margin 
methodology that would use liquidity charges to account for certain 
costs associated with hedging in which OCC would engage during a 
Clearing Member liquidation and the reasonably expected effect that 
OCC's management of the liquidation would have on related bid-ask 
spreads in the marketplace. The Information Memo explained both of 
these proposed changes and their expected effects on margin 
requirements.
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2. Statutory Basis
    Section 17A(b)(3)(F) of the Securities Exchange Act of 1934, as 
amended (``Act''),\23\ requires that the rules of a clearing agency 
ensure the safeguarding of securities and funds in the custody and 
control of OCC and protect investors and the public interest. OCC has 
custody and control of margin deposits it requires members to post to 
limit credit exposure to members under normal market conditions. In the 
event of a member default, that member's margin deposits are the first 
pool of resources OCC would use to cover losses associated with the 
default. Appropriately robust and accurate margin resources help ensure 
that OCC does not have to access mutualized clearing fund deposits that 
are also in OCC's custody and control to cover losses associated with a 
member's default. By ensuring its margin methodology more accurately 
and appropriately measures its credit exposure to members under normal 
market conditions, OCC helps ensure that it is safeguarding of clearing 
fund resources in the custody and control of OCC.
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    \23\ 15 U.S.C. 78q-1(b)(3)(F).
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    The proposed rule is also consistent with Rule 17Ad-22(b)(2),\24\ 
which specifically requires that OCC use margin requirements to limit 
its credit exposures to Clearing Members under normal market conditions 
and use risk-based models and parameters to set margin requirements, in 
compliance with Rule 17Ad-22(b)(2). As explained directly above, OCC 
believes the proposed rule more accurately and appropriately measures 
OCC's credit exposures in normal market conditions and sets margin 
requirements commensurate with this more accurate and appropriate 
measure. Finally, the proposed rule change is not inconsistent with the 
existing rules of OCC, including any other rules proposed to be 
amended.
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    \24\ 17 CFR 240.17Ad-22(b)(2).
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(B) Clearing Agency's Statement on Burden on Competition

    OCC believes that the proposed rule change would increase margin 
requirements more significantly with respect to Clearing Member 
customer accounts than other accounts and would therefore impose a 
burden on competition.\25\ While the proposed rule change to include 
variations in implied volatility within STANS would be applied 
uniformly to all Clearing Members for Shorter Tenor Options, the 
disproportionate effect for customer accounts would result in a larger 
burden for Clearing Members that engage in more customer clearing than 
others. Although overall OCC expects an increase in aggregate margins 
by about $1.5 billion (9% of expected shortfall and stress-test add-
on), OCC does anticipate a decrease in margins in certain clearing 
member accounts' requirements, such as account with underlying exposure 
and implied volatility exposure in the same direction, such as 
concentrated call positions, due to the negative correlation typically 
observed between these two factors. Over the back-testing period, about 
28% of the observations for accounts on the days studied had lower 
margins under the proposed methodology and the average reduction was 
about 2.7%.
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    \25\ 15 U.S.C. 78q-1(b)(3)(I).
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    As discussed above, customer accounts experience higher margin 
requirements than would otherwise result because long option positions 
in securities customers' accounts of Clearing Members are generally 
segregated by OCC, pursuant to its own Rules, to facilitate compliance 
by Clearing Members with Commission Rule 15c3-3(b).\26\ However, such 
an effect is justified because the customer accounts are more 
directional: allowing offsets for long options positions in securities 
customers' accounts of Clearing Members in STANS would not

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accurately represent the conditions of a Clearing Member liquidation 
scenario since the positions are not eligible for use in this scenario 
under Commission rules. For the foregoing reasons, OCC believes that 
the proposed rule change is in the public interest, would be consistent 
with the requirements of the Act applicable to clearing agencies and 
would impose a burden on competition, with respect to more significant 
margin increases for customer accounts, that is necessary and 
appropriate in furtherance of the purposes of the Act.
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    \26\ 17 CFR 240.15c3-3(b).
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(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants, or Others

    Written comments on the proposed rule change were not and are not 
intended to be solicited with respect to the proposed rule change and 
none have been received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.\27\
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    \27\ OCC also filed this proposal as an advance notice pursuant 
to Section 802(e)(1) of the Payment, Clearing, and Settlement 
Supervision Act of 2010 and Rule 19b-4(n)(1) under the Act. See 
supra note 3.
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IV. Solicitation of Comments

    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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form
    (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2015-016 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2015-016. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549 on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available 
for inspection and copying at the principal office of OCC and on OCC's 
Web site at http://www.optionsclearing.com/components/docs/legal/rules_and_bylaws/sr_occ_15_016.pdf. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-OCC-2015-016 and should be submitted on 
or before November 9, 2015.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-26427 Filed 10-16-15; 8:45 am]
 BILLING CODE 8011-01-P


