Notice2023-04683
Self-Regulatory Organizations; Cboe Exchange, Inc.; Order Approving a Proposed Rule Change To Amend Rule 10.3 Regarding Margin Requirements
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Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
March 8, 2023
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 88 Issue 45 (Wednesday, March 8, 2023)</title>
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[Federal Register Volume 88, Number 45 (Wednesday, March 8, 2023)]
[Notices]
[Pages 14416-14419]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-04683]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-97019; File No. SR-CBOE-2022-058]
Self-Regulatory Organizations; Cboe Exchange, Inc.; Order
Approving a Proposed Rule Change To Amend Rule 10.3 Regarding Margin
Requirements
March 2, 2023.
I. Introduction
On November 14, 2022, Cboe Exchange, Inc. (the ``Exchange'' or
``Cboe'') filed with the Securities and Exchange Commission (the
``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend Cboe Rule 10.3 regarding
margin requirements related to cash-settled index options written
against exchange-traded funds (``ETF(s)'') that track the same index
underlying the option. The proposed rule change was published for
comment in the Federal Register on December 2, 2022.\3\ On January 10,
2023, the Exchange consented to an extension of the time period in
which the Commission must approve the proposed rule change, disapprove
the proposed rule change, or institute proceedings to determine whether
to approve or disapprove the proposed rule change to March 2, 2023. The
Commission received no comment letters on the proposal. 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\ See Exchange Act Release No. 96395 (Nov. 28, 2022), 87 FR
74199 (Dec. 2, 2022) (``Notice'').
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II. Description of the Proposed Rule Change
The Exchange proposed to amend Cboe Rule 10.3, which sets forth
margin requirements, and certain exceptions to those requirements,
applicable to security positions of Trading Permit Holders' (``TPHs'')
customers. Specifically, the Exchange stated that Cboe Rule 10.3(c)(5)
generally requires TPHs to obtain from a customer, and maintain, a
margin deposit for short cash-settled index options in an amount equal
to 100% of the current market value of the option plus 15% (if
overlying a broad-based index) or 20% (if overlying a narrow-based
index) of the amount equal to the index value multiplied by the index
multiplier minus the amount, if any, by which the option is out-of-the-
money.\4\ The minimum margin required for such an option is 100% of the
option current market value plus 10% of the index value multiplied by
the index multiplier for a call or 10% of the exercise price multiplied
by the index multiplier for a put.\5\
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\4\ See Notice at 74201. According to the Exchange, the out-of-
the-money amount for a call is any excess of the aggregate exercise
price of the option or warrant over the product of the current (spot
or cash) index value and the applicable multiplier. The out-of-the-
money amount for a put is any excess of the product of the current
(spot or cash) index value and the applicable multiplier over the
aggregate exercise price of the option or warrant. See id. at 74201,
n.8.
\5\ See id. at 74201.
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By contrast, Rule 10.3(c)(5)(C)(iii) provides that no margin is
required for a call (put) option contract or warrant carried in a short
position where there is carried in the same account a long (short)
position in equivalent units of the underlying security,\6\ and no
margin is required for a call (put) index option contract or warrant
carried in a short position where there is carried in the same account
a long (short) position in an (1) underlying stock basket,\7\ (2) index
mutual fund, (3) index portfolio receipt (``IPR''),\8\ or (4) index
portfolio
[[Page 14417]]
share (``IPS''),\9\ that is based on the same index underlying the
index option or warrant and having a market value at least equal to the
aggregate current index value.
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\6\ The Exchange states that in computing margin on a position
in the underlying security, (a) in the case of a call, the current
market value to be used must not be greater than the exercise price
and (b) in the case of a put, margin will be the amount required by
Cboe Rule 10.3(b)(2), plus the amount, if any, by which the exercise
price of the put exceeds the current market value of the underlying.
See id. at 74201, n.3.
\7\ The Exchange defines ``underlying stock basket'' to mean a
group of securities that includes each of the component securities
of the applicable index and which meets the following conditions:
(a) the quantity of each stock in the basket is proportional to its
representation in the index, (b) the total market value of the
basket is equal to the underlying index value of the index options
or warrants to be covered, (c) the securities in the basket cannot
be used to cover more than the number of index options or warrants
represented by that value and (d) the securities in the basket shall
be unavailable to support any other option or warrant transaction in
the account. See Cboe Rule 10.3(a)(7). See also Notice at 74201,
n.4.
\8\ The Exchange defines IPRs as securities that (a) represent
an interest in a unit investment trust (``UIT'') which holds the
securities that comprise an index on which a series of IPRs is
based; (b) are issued by the UIT in a specified aggregate minimum
number in return for a ``Portfolio Deposit'' consisting of specified
numbers of shares of stock plus a cash amount; (c) when aggregated
in the same specified minimum number, may be redeemed from the UIT,
which will pay to the redeeming holder the stock and cash then
comprising the Portfolio Deposit; and (d) pay holders a periodic
cash payment corresponding to the regular cash dividends or
distributions declared and paid with respect to the component
securities of the stock index on which the IPRs are based, less
certain expenses and other charges as set forth in the UIT
prospectus. IPRs are ``UIT interests'' within the meaning of the
Cboe's rules. See Cboe Rule 1.1. See also Notice at 74201, n.5. The
Exchange defines a UIT Interest as any share, unit, or other
interest in or relating to a unit investment trust, including any
component resulting from the subdivision or separation of such an
interest. See Cboe Rule 1.1. See also Notice at 74201, n.5.
\9\ The Exchange defines IPSs as securities that (a) are issued
by an open-end management investment company based on a portfolio of
stocks or fixed income securities designed to provide investment
results that correspond generally to the price and yield performance
of a specified foreign or domestic stock index or fixed income
securities index; (b) are issued by such an open-end management
investment company in a specified aggregate minimum number in return
for a deposit of specified number of shares of stock and/or a cash
amount, or a specified portfolio of fixed income securities and/or a
cash amount, with a value equal to the next determined net asset
value; and (c) when aggregated in the same specified minimum number,
may be redeemed at a holder's request by such open-end management
investment company, which will pay to the redeeming holder stock
and/or cash, or a specified portfolio of fixed income securities
and/or cash with a value equal to the next determined net asset
value. See Cboe Rule 1.1. See also Notice at 74201, n.6.
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The Exchange stated that, in order for these exceptions to apply,
in computing margin on positions in the underlying security, underlying
stock basket, index mutual fund, IPR or IPS, as applicable, (1) in the
case of a call, the current market value to be used must not be greater
than the exercise price, and (2) in the case of a put, margin is the
amount required by subparagraph (b)(2) of Rule 10.3, plus the amount,
if any, by which the exercise price exceeds the current market
value.\10\
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\10\ See Notice at 74201.
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The Exchange proposed to amend this exception to margin
requirements applicable to short option positions or warrants on
indexes that are offset by positions in an underlying stock basket,
non-leveraged index mutual fund, or non-leveraged ETF (each, the
``protection'') that is based on the same index as the option, as well
as move it within Cboe Rule 10.3 to Rule 10.3(c)(5)(C)(iv)(e).
Specifically, the proposed rule change provides that the margin
requirement for an uncovered, short index option or warrant does not
apply to a ``protected option or warrant position.'' The proposed rule
change identifies a ``protected option'' as a strategy of writing an
index option against a holding in an ETF based on the same index as the
index option, and differentiates it from a ``covered call,'' which is a
strategy of writing an option against a position in an underlying
security.\11\ The proposed rule change also limits the margin exception
to index options written against an underlying stock basket, non-
leveraged index mutual fund or non-leveraged ETF (compared to
underlying stock basket, index mutual fund, IPR, or IPS under the
current rule). The Exchange stated that it proposed to add the non-
leveraged limitation to clarify that the exception is not intended to,
and does not apply to leveraged instruments.\12\ Additionally, the
Exchange proposed to not include specific references to IPRs and IPSs
in the proposed margin exception for protected options and
warrants.\13\
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\11\ See id. at 74201, n.12.
\12\ See id. at 74201, n.11.
\13\ See id. According to the Exchange, IPRs and IPSs are
commonly referred to as ETFs. See id. at n.7.
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The Exchange also proposed certain conditions that must be met in
order for the proposed margin exception to apply. The first proposed
condition to qualify for the exception is that the TPH must carry or
establish in the same account as the protected option or warrant
position protection with an absolute value of not less than 100% of the
aggregate underlying index value at either the time the order that
created the protected option or warrant position was entered or
executed, or the close of business on the trading day the protected
option or warrant position was created.\14\ The Exchange stated that
the aggregate underlying index value used would be that which existed
at the same point in time that the clearing broker selects to value the
protection.\15\ According to the Exchange, this first condition
corresponds to the concept of covered writing (such as writing a
covered call).\16\
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\14\ See proposed Cboe Rule 10.3(c)(5)(C)(iv)(e)(1).
\15\ See Notice at 74202.
\16\ See id.
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The second proposed condition to qualify for the exception is that
the absolute value of the protection must at no time be less than 95%
of the aggregate underlying index value associated with the protected
option or warrant position.\17\ According to the Exchange, this second
proposed condition is intended to correspond to covered writing by
requiring a market participant to maintain the protection in an amount
close to the aggregate underlying index value associated with the
protected option or warrant position.\18\ The Exchange stated that
because the value of the protection typically will not track exactly
the aggregate underlying index value (i.e., tracking error), the 95%
threshold will require the absolute value of the protection to remain
close to the aggregate underlying index value while effectively
imposing a cap of 5% on how much the two values may diverge (i.e., the
value of the protection may not be more than 5% less than the value of
the aggregate underlying index value).\19\ According to the Exchange,
if the absolute value of the protection falls below 95% of the
aggregate underlying index value associated with the protected option
or warrant position, the protected option or warrant position would be
deemed uncovered and thus no longer eligible for the exception from the
uncovered, short index option margin requirement.\20\ When that occurs,
the Exchange stated that a clearing broker must either collect the
required margin amount for the short index option or warrant position,
require that the value of the protection be increased to 100% of the
aggregate underlying index value, or liquidate the short index option
or warrant position.\21\
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\17\ See proposed Cboe Rule 10.3(c)(5)(C)(iv)(e)(2).
\18\ See Notice at 74202.
\19\ See id.
\20\ See id.
\21\ See id.
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The third proposed condition to qualify for the exception is to
maintain margin in an amount equal to the greater of: (a) the amount,
if any, by which the aggregate underlying index value associated with
the protected option or warrant position is above (below) the aggregate
exercise price of the protected call (put) option or warrant position;
or (b) the amount, if any, by which the absolute value of the
protection is below the aggregate current underlying index value
associated with the protected option or warrant (which would be subject
to the 95% threshold imposed by the second proposed condition, as
described above).\22\
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\22\ See proposed Cboe Rule 10.3(c)(5)(C)(iv)(e)(3); Notice at
74202.
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The Exchange stated that the proposed margin requirement to cover
any difference by which the underlying index value is above (below) the
exercise price of a call (put), in aggregate, would capture any amount
by which a protected option or warrant position is in-the-money (i.e.,
the amount the aggregate underlying index value exceeds the aggregate
exercise price for a short call).\23\ Pursuant to this
[[Page 14418]]
proposed requirement, margin equivalent to the in-the-money amount of
the protected option or warrant position would need to be held in the
account with that position, which would then be available to offset any
debit to that account in the event of an exercise of the protected
option or warrant.\24\ The Exchange stated that this corresponds to
current Cboe Rule 10.3(c)(5)(C)(iii)(c), which requires the value of
the protection or underlying stock to be capped at the exercise price
of a covered call for no additional margin to be required for that call
position and that both approaches prevent any in-the-money amount from
contributing equity to the account and being used to support other
positions.\25\
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\23\ See Notice at 74202.
\24\ See id.
\25\ See id.
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According to the Exchange, the proposed alternative margin
requirement to cover any difference by which the absolute value of the
protection is below the aggregate underlying index value associated
with the protected option or warrant would compensate for any tracking
error.\26\ Pursuant to this proposed requirement, margin equivalent to
the value of the divergence between the absolute value of the
protection and the aggregate underlying index value would need to be
maintained once a protected option or warrant position is created.\27\
However, the Exchange stated that this requirement would be rendered
moot if the absolute value of the protection fell below 95% of the
aggregate underlying index value associated with the protected option
or warrant position, because the position at that point would be
considered uncovered.\28\ To the extent equity is not available in the
margin account to meet this requirement, the Exchange stated that a TPH
can require its customer to deposit margin into the account.\29\ The
Exchange stated that it believes this is more practical than requiring
the value of the protection to be maintained at 100% of the aggregate
underlying index value in actual shares (or applicable units) of the
protection, as this would require continuous small transactions in the
protection instrument to offset tracking differences (which are
generally no larger than 2% according to the Exchange).\30\
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\26\ See id.
\27\ See id.
\28\ See id.
\29\ See id.
\30\ See id.
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Because there may be instances where margin requirements for the
in-the-money amount and the tracking error may be duplicative,\31\ the
Exchange proposed to require only the greater amount of the two to
avoid requiring an unnecessarily high amount of margin.\32\
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\31\ The Exchange stated that two out of a total of six possible
combinations of underlying index value, exercise price and
protection value would result in overlapping margin requirements as
proposed. For all other combinations, the Exchange stated that one
of the proposed margin requirement alternatives would be zero. See
id. at 74202, n.13.
\32\ See id. at 74202.
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The proposed rule change also deletes Cboe Rule
10.3(c)(5)(C)(iii)(b), as well as the cross-reference to such paragraph
and the references to underlying stock basket, index mutual fund, IPR
or IPS, as applicable, in current subparagraph (c), as those terms
relate specifically to current subparagraph (b). Because this would
leave only one section in Cboe Rule 10.3(c)(5)(C)(iii), the proposed
rule change deletes subparagraph lettering and combines current
subparagraph (iii)(a) and current subparagraph (iii)(c) into a single
provision as subparagraph (iii) and makes corresponding conforming
changes.\33\
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\33\ See id. at 74203.
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The proposed rule change also makes additional clarifying, non-
substantive changes in each subparagraph of Cboe Rule 10.3(c)(5)(C)(iv)
to conform language in those subparagraphs to language used throughout
Cboe Rule 10.3. Specifically, the proposed rule change amends the
provision of each subparagraph to state that the minimum amount of
required margin in the circumstances described in each subparagraph
applies when the applicable long position is carried ``in the same
account as'' the applicable short position, rather than ``also
carried.'' This language is consistent with the language in, for
example, current Cboe Rule 10.3(c)(5)(C)(iii), as margin requirements
are determined generally based on positions held in the same
account.\34\
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\34\ See id.
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III. Commission Discussion and Findings
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Exchange Act and the
rules and regulations thereunder applicable to a national securities
exchange.\35\ In particular, the Commission finds that the proposed
rule change is consistent with Section 6(b)(5) of the Exchange Act,\36\
which requires, among other things, that the rules of a national
securities exchange be designed to prevent fraudulent and manipulative
acts and practices, to promote just and equitable principles of trade,
to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect to,
and facilitating transactions in securities, to remove impediments to
and perfect the mechanism of a free and open market and a national
market system, and, in general, to protect investors and the public
interest. The Commission also finds that the proposed rule change is
consistent with Section 6(c)(3) of the Exchange Act,\37\ which
authorizes, among other things, a national securities exchange to
prescribe standards of financial responsibility or operational
capability.
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\35\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\36\ 15 U.S.C. 78f(b)(5).
\37\ 15 U.S.C. 78f(c)(3).
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The Commission believes that the proposed rule change would
establish a more tailored margin approach for protected options or
warrant positions that reflects the differences between protected
options and covered options, and that addresses the risks specific to
protected options or warrant positions. For example, while both the
protected option positions and covered option positions are subject to
the risk of exercise where the price or value of the underlying is
above (below) the exercise price for a call (put), covered options do
not face the risk of ``tracking error.'' Consequently, by providing for
margin requirements that are more tailored to the risks associated with
protected options or warrant positions, the Commission believes that
the proposed rule change will remove impediments to and perfect the
mechanism of a free and open market and a national market system.
More specifically, by revising the margin requirements for
protected option or warrant positions, including requiring that certain
conditions are met (as described above), and revising the types of
products permitted to be used as protection (i.e., permitting only
stock baskets, non-leveraged index mutual funds, and non-leveraged ETFs
to function as protection), the Commission believes the proposed rule
change will facilitate the use of protected options and warrants as the
cost and operational burdens associated with these products under the
current approach will be reduced. TPHs will no longer be required to
purchase and deposit additional shares related to the underlying index,
such as additional shares of an ETF, where the protection value is not
at least equal to the aggregate underlying index value. Instead, TPHs
will be permitted (subject
[[Page 14419]]
to the requirement that the deficiency not be greater than 5 percent)
to post margin in the form of available equity in the margin account or
cash or other marginable securities in order to remedy such a
deficiency. As a result, TPHs will benefit from a reduction in
transaction costs, and to the extent that equity in the margin account
is utilized, TPHs will also benefit from a more straightforward process
from an operational standpoint with respect to posting required margin.
Lastly, the Commission believes that by imposing the requirement to
post margin on protected options or warrant positions that equals the
greater of the in-the-money amount of the option or warrant, or the
amount by which the aggregate current underlying index value exceeds
the absolute value of the protection, while also implementing a
requirement that the protection be at all times at least 95% of the
aggregate current underlying index value, the proposed rule change
addresses the risks associated with protected options or warrant
positions (e.g., the risk of exercise of a short position when the
option or warrant is in-the-money and tracking error), and
appropriately protects investors and the public interest.
Accordingly, for the foregoing reasons, the Commission finds that
this proposed rule change is consistent with the Exchange Act.
IV. Conclusion
It is therfore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\38\ that the proposed rule change (SR-CBOE-2022-058) be,
and hereby is, approved.
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\38\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\39\
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\39\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-04683 Filed 3-7-23; 8:45 am]
BILLING CODE 8011-01-P
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