
[Federal Register Volume 80, Number 221 (Tuesday, November 17, 2015)]
[Notices]
[Pages 71900-71903]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-29227]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-76421; File No. SR-OCC-2015-804]


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

November 10, 2015.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision Act of 2010 (``Payment, Clearing 
and Settlement Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the 
Securities Exchange Act of 1934,\2\ notice is hereby given that on 
October 5, 2015, The Options Clearing Corporation (``OCC'') filed with 
the Securities and Exchange Commission (``Commission'') the advance 
notice 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 advance notice from interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ OCC also filed a proposed rule change with the Commission 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
and Rule 19b-4 thereunder, seeking approval of changes to its rules 
necessary to implement the proposal. 15 U.S.C. 78s(b)(1) and 17 CFR 
240.19b-4, respectively. See SR-OCC-2015-016.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This advance notice is filed by The Options Clearing Corporation 
(``OCC'') in connection with a proposed change that 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 Advance Notice

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the advance notice and 
discussed any comments it received on the advance notice. 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) and (B) 
below, of the most significant aspects of these statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants or Others

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

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment, 
Clearing and Settlement Supervision Act

Description of the Proposed Change
    The proposed 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

[[Page 71901]]

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 ``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

[[Page 71902]]

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 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 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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Consistency With the Payment, Clearing and Settlement Supervision Act
    OCC believes that the proposed change regarding the incorporation 
of variations in implied volatility within STANS is consistent with 
Section 805(b)(1) of the Payment, Clearing and Settlement Supervision 
Act \23\ because the proposed procedures would promote robust risk 
management by more robustly computing Clearing Member margin 
requirements in order to ensure that OCC maintains adequate financial 
resources in the event of a Clearing Member default. As described 
above, OCC believes that the proposed change would enhance OCC's 
ability to ensure that margin requirements determined through STANS 
appropriately take 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. As a result, OCC 
would be better able to ensure that margin assets are sufficient to 
liquidate the accounts of a defaulted Clearing Member without incurring 
a loss and thereby promote robust risk management.
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    \23\ 12 U.S.C. 5464(b)(1).
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Anticipated Effect on and Management of Risk
    OCC believes that the proposed change would reduce OCC's overall 
level of risk because the proposed change makes it less likely that the 
amount of margin OCC collects from Clearing Members Clearing Fund would 
be insufficient should OCC need to use such margin in connection with a 
Clearing Member default. As described above, OCC is proposing certain 
modifications to STANS to more broadly incorporate variations in 
implied volatility for Shorter Tenor Options. Such modifications would

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result in OCC being able to better ensure that margin requirements 
computed by STANS because [sic] STANS would appropriately take 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. As a result, the proposed change 
would make it less likely that OCC would need to use additional 
financial resources, such as its clearing fund, in order to 
appropriately manage a clearing member default. Moreover, the proposed 
change is intended to measure the exposure associated with changes in 
option implied volatilities, thus mitigating credit risk presented by 
clearing members. Accordingly, OCC believes that the proposed changes 
would reduce risks to OCC and its participants. Moreover, and for the 
same reasons, the proposed change will facilitate OCC's ability to 
manage risk.

III. Date of Effectiveness of the Advance Notice and Timing for 
Commission Action

    The designated clearing agency may implement this change if it has 
not received an objection to the proposed change within 60 days of the 
later of (i) the date that the Commission receives the notice of 
proposed change, or (ii) the date the Commission receives any further 
information it requests for consideration of the notice. The designated 
clearing agency shall not implement this change if the Commission has 
an objection.
    The Commission may, during the 60-day review period, extend the 
review period for an additional 60 days for proposed changes that raise 
novel or complex issues, subject to the Commission providing the 
designated clearing agency with prompt written notice of the extension. 
The designated clearing agency may implement a change in less than 60 
days from the date of receipt of the notice of proposed change by the 
Commission, or the date the Commission receives any further information 
it requested, if the Commission notifies the designated clearing agency 
in writing that it does not object to the proposed change and 
authorizes the designated clearing agency to implement the change on an 
earlier date, subject to any conditions imposed by the Commission.
    The designated clearing agency shall post notice on its Web site of 
proposed changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.\24\
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    \24\ OCC also filed a proposed rule change with the Commission 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
and Rule 19b-4 thereunder, seeking approval of changes to its rules 
necessary to implement the proposal. 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. 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-2015-804 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-2015-804. 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 advance notice that are filed 
with the Commission, and all written communications relating to the 
advance notice 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 OCC and on OCC's Web site at http://www.optionsclearing.com/components/docs/legal/rules_and_bylaws/sr_occ_2015_804.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-2015-804 and should be submitted on or before December 2, 2015.

    By the Commission.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-29227 Filed 11-16-15; 8:45 am]
 BILLING CODE 8011-01-P


