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PORTFOLIO MARGIN and CROSS-MARGIN. AN OVERVIEW OF THE BROAD BASED INDEX OPTION PILOT PROGRAMS FOR CUSTOMERS Richard Lewandowski - Chicago Board Options Exchange. Portfolio Margin and Cross-Margin Pilot Plan Proposal. History

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portfolio margin and cross margin

PORTFOLIO MARGIN and CROSS-MARGIN

AN OVERVIEW OF THE BROAD BASED INDEX

OPTION PILOT PROGRAMS FOR CUSTOMERS

Richard Lewandowski - Chicago Board Options Exchange

slide2

Portfolio Margin and Cross-Margin Pilot Plan Proposal

  • History
  • Past and current margining of listed options and securities underlying listed options .
  • Studies of the 1987 market crash advocate cross-margining.
    • “Report of the Presidential Task Force on Market Mechanisms” (the “Brady Commission”)
    • “The October 1987 Market Break” (SEC)
    • “Working Group on Financial Markets” (Dept. of the Treasury, FRB, SEC and CFTC)
  • Net Capital - haircuts on options strategy based prior to April 1994.
    • SEC no-action letter in April 1994 allows portfolio methodology.
    • SEC changes Net Capital Rule in Sept. 1997 to formally allow portfolio methodology as an alternative to strategy based requirements.
    • Proposed customer program will parallel haircut methodology.
slide3

Portfolio Margin and Cross-Margin Pilot Plan Proposal

History

  • Since April 1986, OCC has utilized portfolio margin.
  • Since 1988, Futures Commission Merchants (“FCM”) have applied a portfolio (SPAN) margin requirement.
  • Final changes to Reg. T (effective April 1, 1998)
    • Permit portfolio margining as an alternative to Reg. T.
    • Self-regulatory organization (“SRO”) rules needed to implement portfolio margining
    • SEC approval required.
  • Portfolio Margin Committee formed - recommendations made.
slide4

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Joint effort by CBOE, OCC, NYSE, AMEX, CME and CBOT to implement portfolio margin system for customers.
  • An alternative to the current “position” or “strategy” based margin.
  • Pilot program initially.
    • Limits a firm’s gross portfolio margin requirements to 1,000 percent of its net capital.
    • Firms can select accounts as they deem appropriate.
    • Participant criteria may be modified based on the pilot experience.
  • Plan also provides for cross-margin - margin requirement determined using the same portfolio margin facility.
  • Pilot will only permit portfolio margining of:
    • Broad based U.S. listed securities index options
    • Related exchange traded funds (i.e., SPDRS, DIAMONDS)
    • Related index futures and options on those futures.
  • No stock baskets permitted at this time.
slide5

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Portfolio margining objective - determine margin based on potential risk in a portfolio as a whole.
  • Margin required is derived based on the greatest projected net loss in an account given various scenarios of underlying price increases and decreases and implied volatility changes.
      • Positions grouped by class.
      • Gain or loss on each position is calculated for assumed moves in the underlying, both up and down.
      • Theoretical pricing formula is employed for options gains / losses.
      • Netting of gains / losses within class groups.
      • Offsets (gains) applied between classes, if eligible.
      • Greatest loss is the portfolio margin requirement for that class.
      • Total of class requirements is overall portfolio margin requirement.
      • Per contract minimum of $37.50 (.375 X $100 multiplier).
      • Firms can impose an “add-on” (house) requirement if desired.
slide6

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Option theoretical values supplied by The Options Clearing Corporation.
    • Provides for uniform margin requirements across broker-dealers.
  • Broker-dealers organize customer positions into a firm or vendor supplied spreadsheet.
  • Portfolio margin requirement calculated within the spreadsheet application using option theoretical values obtained from the OCC.
  • Process is the same as is currently in place for computing haircuts under the Securities & Exchange Commission’s capital rule.
  • Market ranges for computing gains and losses:
    • high-cap broad based indexes --- +6% / -8% of the closing price of the index
    • non-high- cap broad based indexes --- +/- 10% of the closing price of the index
slide7

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Portfolio margin computation done at close of each business day.
  • Portfolio margin requirement is both the initial and maintenance margin requirement - not necessary to determine whether an increase in the requirement is due to a new commitment or adverse market moves.
  • Margin call arises if requirement greater than net liquidating equity in the portfolio margin account (cross-margin account).
  • Margin call must be met by the end of business on T+1 (one day settlement).
slide8

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Liquidating or hedging to meet a margin call is allowed.
  • Minimum Equity Requirement.
    • Account equity of at least five million dollars.
    • Accounts may be aggregated if same owner.
    • Not applicable to a broker-dealer, an affiliate of the clearing broker-dealer, or to the cross-margining activity of a member of a national futures exchange.
    • Firms may impose a higher minimum equity (house) requirement if desired.
  • Equity call must be met by T+3 (three business day settlement).
    • If equity call not met, no new orders may be accepted (except opening orders that reduce margin requirement).
  • Account guarantees prohibited (for equity or margin).
slide9

Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • Required Disclosure
    • Firm must provide customer with a standard disclosure statement prior to opening a portfolio margin and/or cross-margin account.
    • Customers must sign an attestation acknowledging that they have received the disclosure document and are aware of the risks involved.
    • Not applicable to broker-dealers, affiliates of the clearing broker-dealer, and members of futures exchanges.
  • To offer cross-margining, a broker-dealer must:
    • also be an FCM and
    • either be a clearing FCM or have an affiliate that is a clearing FCM.
  • Cross-margin account would be a securities account.
    • SEC customer protection rules and SIPC coverage apply.
  • Internal risk analysis procedures required of each firm.
portfolio margin and cross margin pilot plan proposal
Portfolio Margin and Cross-Margin Pilot Plan Proposal

Plan Overview

  • CBOE filed a rule change with the SEC in January 2002 to go forward with the pilot.
  • NYSE filed a similar rule change with the SEC in May 2002.
  • Final work to be completed before the pilot can begin:
    • Customer Protection changes at the SEC and CFTC concerning cross-margin account
    • SIPC protection for non-securities products and balances in a cross-margin account
    • Hypothecation of customers’ long options positions at the clearing house level (SEC)