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F ed e r a l Re s e r v e Ba n k DALLAS. TEXAS of Dallas 75222 C i r c u l a r No. 76-178 D e c e m b e r 29, 1976 American Revolution Bicentennial PROPOSED AMENDMENT TO REGULATION T C r e d i t to E x c h a n g e S p e c i a l i s t s in O p tio n s TO ALL BANKS, BROKERS/DEALERS, REGULATION G REGISTRANTS, AND OTHERS CONCERNED IN THE ELEVENTH FEDERAL RESERVE DISTRICT: T h e B o a r d of G o v e r n o r s o f th e F e d e r a l R e s e r v e S y s te m fo r c o m m e n t a p r o p o s e d a m e n d m e n t to its R e g u l a ti o n T ( C r e d i t b y D e a l e r s ) to p e r m i t r e g i s t e r e d m a r k e t m a k e r s o r s p e c i a l i s t s in t h e to o b ta in s t o c k , in c e r t a i n lim ited c i r c u m s t a n c e s , on a 25 p e r c e n t m e n t. has p u b lish e d B rokers and options m a rk e t m argin r e q u i r e T h e B o a r d r e q u e s t e d co m m e n t on th e p r o p o s e d a m e n d m e n t t h r o u g h J a n u a r y 17, 1977. On som e e x c h a n g e s , m a r k e t s in o p ti o n s a r e m a d e b y " r e g i s t e r e d m a r k e t m a k e r s " w h i l e on o t h e r e x c h a n g e s " s p e c i a l i s t s " p e r f o r m th i s f u n c t i o n . U n d e r th e p r o p o s a l , s u c h o p tio n s p e c i a l i s t s c o u l d p u r c h a s e a n d c a r r y s t o c k , a s a h e d g e in t h e i r o p t i o n s o p e r a t i o n s , u n d e r s p e c i f i e d lim ita tio n s , a t th e lo w e r m a r g i n r a t h e r th a n th e c u r r e n t 50 p e r c e n t m a r g i n r e q u i r e d w h e n s t o c k s a r e b o u g h t o r c a r r i e d on c r e d it. T h e p u r p o s e of th e p r o p o s a l is to f a c i l i t a t e t h e m a k in g o f m a r k e t s in o p t i o n s —t h a t is , m a i n t e n a n c e of c o n t i n u o u s a n d n a r r o w d i f f e r e n c e s b e t w e e n b id a n d a s k p r i c e s for o p t i o n s . A n o p tio n is a n a g r e e m e n t , w h i c h is it s e lf d e f i n e d a s a s e c u r i t y , u n d e r w h i c h th e h o l d e r h a s th e r i g h t to p u r c h a s e o r sell a p a r t i c u l a r s to c k a t a n a g r e e d p r i c e d u r i n g a s p e c i f i e d tim e p e r i o d . O p tio n m a r k e t m a k e r s m a y n e e d a t ti m e s , to a v o i d u n d u e r i s k , to p u r c h a s e o f f s e ttin g h o l d i n g s in th e s to c k i n v o l v e d . T h i s w o u ld n o t c h a n g e c u r r e n t p r o v i s i o n s p e r m i t t i n g s p e c i a l i s t s to r e c e i v e g o o d fa ith loan v a l u e on s t o c k s th e y h o ld a s i n v e n t o r y o r a s c o l la t e r a l in t h e i r o p t i o n s a c c o u n t s . This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) - 2 - T h e p r o p o s a l w o u ld a l s o p e r m i t s p e c i a l i s t s to u s e a n a l t e r n a t e m a r g i n c o m p u ta t io n from t h a t p r o v i d e d b y th e B o a r d ' s u n ifo rm m a r g i n r u l e fo r th e w r i t i n g of o p t i o n s , w h i c h is to b e c o m e e f fe c tiv e J a n u a r y 1, 1977. In a r e l a t e d d e v e l o p m e n t , th e B o a r d h a s b e e n a d v i s e d b y th e S e c u r i t i e s a n d E x c h a n g e C o m m is s io n t h a t it d o e s n o t p r o p o s e to t a k e a n y a c t io n if e x c h a n g e s p e c i a l i s t s a n d m a r k e t m a k e r s do n o t e n g a g e in f u t u r e t r a n s a c t i o n s in s e c u r i t i e s u n d e r l y i n g e x c h a n g e - l i s t e d o p t i o n s o t h e r w i s e th a n in c o m p lia n c e w ith t h e a m e n d m e n ts th e F e d e r a l R e s e r v e B o a r d p r o p o s e d . In a d d i t i o n , t h e C o m m issio n will r e q u i r e t h a t e x c h a n g e s p e c i a l i s t s a n d m a r k e t m a k e r s r e d u c e a n y d e f i c i e n c y in t h e i r e x i s t i n g m a r g i n p o s i t i o n s , c a l c u l a t e d in a c c o r d a n c e w ith th e p r o p o s e d r u l e a m e n d m e n t , so t h a t , b y F e b r u a r y 1, 1977, a n y s u c h d e f i c i e n c y s h a ll h a v e b e e n r e d u c e d to 50 p e r c e n t , a n d , b y May 1, 1977, a n y s u c h d e f i c i e n c y sh a ll h a v e b e e n e l im i n a te d c o m p le t e ly . F o r y o u r r e v i e w a n d c o m m e n t, th e B o a r d ' s p r o p o s a l is c o n t a i n e d in t h e e x t r a c t from th e F e d e r a l R e g i s t e r w h i c h is p r i n t e d o n t h e fo llo w in g p a g e s . C om m ents s h o u l d b e s u b m it te d in w r i t i n g to th e S e c r e t a r y , B o a r d of G o v e r n o r s o f t h e F e d e r a l R e s e r v e S y s t e m , W a s h in g to n , D . C . 20551, to be r e c e i v e d n o t la te r t h a n J a n u a r y 17, 1977. All m a t e r i a l s s h o u l d i n c l u d e th e D o cket N u m b e r R -0 0 5 4 . S in ce rely y o u rs , R o b e r t H . B o y k in F i r s t V ic e P r e s i d e n t E x t r a c t F rom FEDERAL REGISTER VOL. 41, NO. 246 T u e s d a y , D e c e m b e r 21, 1976 p p . 55552 - 55553 FEDERAL RESERVE SYSTEM [12 CFR Part 220] [R eg. T ; D o c k e t N o. R -005 4] CREDIT BY BROKERS AND DEALERS Credit to Exchange Specialists in Options The Board of Governors of the Federal Reserve System, pursuant to authority contained In sections 7 and 23 of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78g and w ), proposes for comment an amendment to the pro visions in Regulation T which govern credit which a broker or dealer extends to exchange specialists. The purpose of this amendment It to provide 'appro priate relief to option specialists who, in furtherance of their obligation to promote an orderly and efficient market, are required to assume certain security positions. , Th* amendment Would permit a spe cialist in options, In certain limited cir cumstances, to purchase’or sell short In the specialist's account with a broker or dealer, securities underlying the options In which the specialist Is registered. It would also provide a reduced margin re quirement for such underlying securities a t any time when they serve as a hedge against a short option position which is not offset by a corollary long option posi tion. The proposed amendment would also provide an alternative method of calculating the adjusted debit balance in a specialist's account In order to provide relief for specialists with short security positions comparable to th at presently provided to specialists with long security positions. The existing rule for specialist credit was written before the advent of exchange-traded options and, therefore, the concessions which it grants are not specifically structured for the mechanics of the options markets. H ie proposed amendment is a response to a request for rulemaking made by the Chicago Board Options Exchange as well as a recognition by the Board of Gover nors th a t option specialists m ight need certain specific relief from the Board’s uniform margin rule for the writing of options which is scheduled to go into ef fect on January 1, 1977. The uniform rule was published In the F ed e r a l R e g i s t e r on October 5, 1976 (41 F R 43895). The Board's proposal would allow tne purchase and short sale of a security underlying a n option In a specialist’s account when the account has a short option position wbMh Is susceptible to exercise and the aeaount does not hold an offsetting position In a comparable "in-or-at-the-m oney” option on the same underlying seotirity. 'While the un derlying stock which has been purchased or sold short In the account serves as such a hedge, a margin of 25 per cent (instead of the current margin require ment of 50 per cent) will be required. If the underlying stock or short position is not liquidated when it no longer serves as an allowable hedge, the current m ar gin requirements will be operative. Any account which carries positions in under lying stock whloh were purchased or sold short under the terms of the proposed rule must be m aintained on a dally basis with no excess of the adjusted debit bal ance over the maximum loan value Of the securities in the account. . The amendment is not intended' to af fect specialists who are not option spe cialists. The proposed amended paragraph is set forth below: § 220.4 * Special Accounts. * * * * (g) Specialist’s account. (1) In a, spe cial account designated as a specialist’s account, a creditor may effect and fi nance, for any mem ber-tf a national securlties exobange who Is registered and acts as a specialist in securities on the exchange, such member’s transactions as a specialist in ouch securities, or effect and finance, for any Joint venture in which th e creditor participates, any transactions in any securities of an issue with respect to which all participants, or all participants other than the creditor, are registered and act on a national se curities exchange as specialists. (2) Such specialist’s account shall be subject to the same conditions to which it would be subject if it were a general account unless the specialist’s exchange is a national securities exchange which requires and submits to the Board of Governors of the Federal Reserve Sys tem reports suitable for supplying cur rent information regarding specialist’s use of credit pursuant to this paragraph (g), in which case, the following modi fications of and exceptions to the gen eral rule will apply: (I) The required calculations of § 220.3(b) (1) (11) to determine if an account Is an “account subject to $ 220.8(g) ’’ and the requirements of § 220.6(b) regarding joint ventures shall not apply. (II) The maximum loan value of regis tered securities In such account shall be: (a> Such maximum loan value as the Board shall prescribe from tim e to time in S 220.8 (the Supplement to Regula tion T) where (1) the security is identi fied as held for investment pursuant to a rule of the Commissioner of Internal Revalue (Regs, section 1-1236-1 (d )), or (2) the security is an underlying security acquired in the account as permitted under paragraph (g) (3) of this section and held in th e account on any day when it is not eligible to be held pursuant to paragraph (g) (3) (1) of this section. (b) 75 per cent of the current m arket value of an underlying security th a t Is purchased in the account under the terms of paragraph (g) (3) of this section and held In the account on any day when it is eligible to be held pursuant to para graph (g) (3) (1) of this section. (c) The maximum loan value as deter mined by th e creditor in good faith for any other registered security. (iii) The amount to be included in the adjusted debit balance of th e account shall be: (o) The margin required for the writ ing of options may be either the amount; required by 5 220.3 (i) ajtid 220.8 (the Supplement to Regulation T> or 130 per cent of the current m arket value of each option held in a short position in the account which Is not offset by one of the positions which may be used in lieu ol’ margin under § 220.3(i)(l). (b) The margin required in connection with the sale of a security sold short in conformity witn tnis paragraph shall be the current m arket value of the security sold short plus either 25 per cent of such current m arket value on any day when the position Is eligible to be held pur suant to the conditions provided in para graph (g) (3) (1) of this section or such margin as the Board shall prescribe for short sales in 8 220.8 (the Supplement to Regulation T) for positions not so held. (It) At any time when a position in an underlying security which was pur chased or sold short in th e account under the term s of paragraph (g)(3) et this section Is held in the account, the ac count shall be maintained on a dally basis with no excess of th e adjusted debit balance over the maximum loan value of the securities in the account. (3) In this account, a specialist in op tions on a national securities exchange is permitted to purchase or sell short the securities underlying the options in which such member is registered and acts as a specialist only under one or more of the following conditions: (i) The account holds short positions in call options in which the member is registered and acts as a specialist which are “in or a t the money” but only to the extent the positions are not offset in the account by long positions in call options for an equal or greater number of shares of the same underlying securities which are “in or a t the money” and do not expire before the short positions in call options; « » * * • (ii) the account holds short positions in put options in which th e member Is registered and acts as a specialist which are “in or at the money” but only to the extent the positions are not offset In the account by long positions in put options for an equal or greater number of shares of the same underlying securities which are “in or at the money” and do not ex pire before the short positions in put op tions; (iii) The account held a short position in an option against which an exercise notice was tendered; or (iv) The account held a long position in an option which was exercised. (4) For the purpose of this paragraph: (i) The term “underlying security” means the security which will be deliv ered upon exercise of the option. (ii) The term “joint venture” does not include any account which, by written agreement with a credftpr, permits the commingling of th e security positions of a specialist or a specialist unit with those of other specialists or specialist units un less such agreement provides for a shar ing of profits and losses from the ac count on some predetermined ratio. (iii) The term “in or a t the money” means, with respect to a call, th at the current m arket pirce of the underlying security is not more than 5 per cent be low the exercise price of the option, and, with respect to a put, the current m ar ket price of the underlying security is not more than 5 per cent above the exer cise price of the option. To aid in the consideration of this m at ter by the Board interested persons are invited to submit relevant data, views, comments, or arguments. Any such m a terial should be submitted in writing to the Secretary, Board erf Governors of the Federal Reserve System, Washing ton, D.c. 20551, to be received not later than January 17, 1977. All m aterial should include the docket number R 0054. Such m aterial will be made avail able for inspection and copying upon request, except as provided In S 261.6(a) of Board’s rales regarding avaliabtnty of Information (12 CPR 361.6 (a )). This notice Is published pursuant to section 653(b) of Title 5 of the United States Code and 1262.2(a) of the Board’s Rules of Procedure (12 CFR 262.2(a)). By order of the Board of Governors. December 15, 1976. T h e o d o r* E . A llis o n , Secretary o f the Board. (P R Doc.70-37414 F iled 12-16-76; 1:63 pm ]