Full text of Federal Reserve Bank of New York Circulars : 7107. Margin Regulations

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FED ER AL RESERVE BANK
O F N EW YORK

TC ircular No. 7107~|
[_February 27, 1973J

MARGIN REGULATIONS
Treatment of Puts, Calls, and Combinations thereof

To AH Persons Ext ending Securities Credit
in the Second Federal Reserve District:

Printed below is the text o f proposed am endm ents to margin Regulations G, T, and U o f the Board o f
Governors o f the Federal Reserve System, together with the text o f an interpretation ot its Regulation T,
“ Credit by Brokers and Dealers.”
The proposed amendments would provide that any put, call, or com bination thereof that is written on
an equity security, even if such option is itself registered as a security on a national securities exchange,
shall have no loan value for the purposes o f the margin regulations. Comments on the proposed am end­
ments should be submitted by March 16 and may be sent to our Regulations and Bank Analysis D epart­
ment.
The interpretation o f Regulation T, adopted February 20 by the Board o f Governors, relates to the
treatment o f put and call options and com binations thereof as securities.
Additional copies o f this circular will be furnished upon request.
Alfred Hayes,
President.

Proposed Amendments to Margin Regulations G, T, and U
The Board of Governors proposes to amend Parts
207, 220 and 221 (Regulations G, T, and U) in order to
provide that any put, call or combination thereof which
is written on an equity security, even if such option is
itself registered as a security on a national securities ex­
change, shall have no loan value for the purposes of
§207.1, §220.3 and § 221.1 (Regulations G ,T,and U); to
clarify that the customer’s adjusted debit balance in a
general account under Regulation T must include the
amount of margin required in connection with the
issuance, endorsement or guarantee o f any put, call or
combination thereof whether or not such obligations are
assumed by the creditor; and to conform the definition of
“ stock” in Regulation U to the statutory definition of
“ equity security.”




PART 207 — SECURITIES CREDIT BY PERSONS
OTHER THAN BANKS, BROKERS OR DEALERS
1. Section 207.5(a) (the Supplement to Regulation G)
would be amended as set forth below:
Section 207.5 SUPPLEMENT
(a)
Maximum loan value o f margin securities. For
the purpose of § 207.1, the maximum loan value of any
margin security, except convertible securities subject to
§ 207.1 (d) and any put, call or combination thereof, shall
be 35 per cent of its current market value, as determined
by any reasonable method. No put, call or combination
thereof shall have any loan value for the purposes of this
part.

PART 220 — CREDIT BY BROKERS AND DEALERS

nature and consider necessary or appropriate, by such
rules and regulations as it may prescribe in the public
interest or for the protection of investors, to treat as an
equity security such as any certificate of interest or parti­
Section 220.3 GENERAL ACCOUNTS
cipation in any profit sharing agreement, preorganiza­
*
*
*
*
*
tion certificate or subscription, transferable share,
(d)
Adjusted debit balance. For the purpose of this
limited partnership interest, interest in a joint venture, or
part, the adjusted debit balance of a general account,
certificate of interest in a business trust; or any put, call,
special bond account, or special convertible debt security
straddle, or other option or privilege of buying such a
account shall be calculated by taking the sum o f the
security from or selling such a security to another without
following items:
being bound to do so.
* * * (5) the amount of any margin required in
(b)
Section 221.4(a) (the Supplement to Regulation
connection with the issuance, endorsement or guarantee
U) would be amended to read as follows:
o f any put, call or combination thereof.
Section 221.4 SUPPLEMENT
(b)
Section 220.8(a)(1) and (f) (the Supplement to
(a)
Maximum loan value o f stocks. For the pur­
Regulation T) is amended to read as follows:
pose of § 221.1, the maximum loan value of any stock
Section 220.8 SUPPLEMENT
except puts, calls and combinations thereof, whether or
(a)
Maximum loan value fo r general accounts. The not registered on a national securities exchange shall be
maximum loan value of securities in a general account
35 per cent of its current market value, as determined by
subject to §220.3 shall be:
any reasonable method. Puts, calls and combinations
thereof shall have no loan value.
(1) o f a registered non-equity security held in the
The purpose of the proposed changes in Regulations
account on March 11, 1968, and continuously there­
G, T,and U is to indicate that puts, calls and combina­
after, and of a margin equity security (except as provided
tions thereof are to be given no loan value as collateral
in § 220.3(c) and paragraphs (b), (c) and (f) o f this sec­
even if they become registered as securities on a national
tion), 35 per cent of the current market value of such
securities exchange. Clarifying changes are proposed in
securities.
*
*
*
*
*
§ 220.3(dX5) to indicate that any margin required in
(f)
Securities having no loan value in a general connection with the issuance, endorsement or guarantee
of any put, call or combination thereof must be added to
account. No securities other than an exempted security
the adjusted debit balance of a general account and in
or registered non-equity security held in the account on
§ 221.1 (3)(/> to designate specific securities which are to
March 11, 1968, and continuously thereafter, and a
be treated as stock.
margin security, shall have any loan value in a general
account except that a margin security eligible for the
Because of the limited life of puts and calls and the
special convertible debt security account pursuant to
availability of credit if they are exercised the Board
§ 220.4(j) shall have loan value only if held in the account
deems it necessary, in order to prevent the excessive use
on March 11, 1968, and continuously thereafter; and no
of credit to finance transactions in securities, to propose
put, call or combination thereof shall have loan value in a
these amendments to Regulations G, T,and U under the
general account.
authority of section 7(b) of the Securities Exchange Act
2a. Section 220.3(d)(5) would be amended as set
forth below:

of 1934 (15 U.S.C. 78g).
PART 221 — CREDIT BY BANKS FOR THE
PURPOSE OF PURCHASING OR CARRYING
MARGIN STOCKS

4a. The Board is affording interested persons an
opportunity to submit relevant data, views, or arguments
concerning the proposed amendment. Any such material
3a. Section 221.3(7) would be amended as set forth
should be submitted in writing to the Secretary, Board of
below:
Governors of the Federal Reserve System, Washington,
Section 221.3 MISCELLANEOUS PROVISIONS
D.C. 20551, to be received not later than March 16, 1973.
Such material will be made available for inspection and
(1)
Stock. The term stock includes any security copying upon request, except as provided in § 261.6(a) of
commonly known as a stock; any voting trust certificate
the Board’s Rules Regarding Availability of Information.
or other instrument representing such a security; and any
b. This notice is published pursuant to section
security convertible, with or without consideration,
553(b) of Title 5, United States Code, and § 262.2(a) of
presently or in the future, into such security, certificate,
the Rules of Procedure of the Board of Governors o f the
or other instrument, or carrying any warrant or right to
Federal Reserve System (12 C.F.R. 262.2(a)).
subscribe to or purchase such a security; or any such war­
By order of the Board of Governors, February 20,
rant or right; or any other security which the Securities
1973.
and Exchange Commission shall deem to be of similar




Interpretation of Regulation T
§220.126. Certain transactions in put and call options
and combinations thereof may be effected in the special
cash account; a put, call or combination thereof is not
considered an “ Unissued” security or a security “ ex­
changeable or convertible” into the underlying security.
(a) The Board has been asked several questions
about the treatment of put and call options and combin­
ations thereof (“ puts and calls” ) under Regulation T
(Part 220). These questions involve § 220.3(d) Adjusted
debit balance, § 220.3(h) Unissued securities, § 220.4(c)
Special cash account and § 220.4(d) Special arbitrage
account.
(b) The special cash account under § 220.4(c) may
be used only for those bona fide transactions in securities
in which the creditor accepts in good faith the customer’s
agreement, if he is a purchaser, that (if he does not
already have sufficient funds in the account) he will
promptly make full cash payment for the security and
does not contemplate selling it prior to making such
payment, and if he is a seller, that he or his principal
owns the security and (if it is not already held in the
account) it will be promptly deposited therein. It is the
Board’s view that subject to these requirements, a
creditor may effect in a special cash account (1) the
purchase or sale for cash of a put or call; (2) the exercise
o f a call, provided that full cash payment for the
purchased stock is deposited in the account promptly
and in any event prior to the release o f the proceeds of
any resale o f such security; and (3) the endorsement,
guarantee or issuance of a put or call if (in the case o f a
put) sufficient funds to purchase the underlying stock or
(in the case of a call) the underlying stock itself are held
in the account.
(c) Generally a put or call option refers to an agree­
ment to sell a security or to purchase a security, at some
future time. Although the agreement may itself be
deemed to be a security, it cannot be an “ unissued”
security, under § 220.3(h) or § 220.4(c)(3), for the reasons
set forth by the Board in discussing a similar question in
regard to mutual fund shares (1962 Bulletin 1427; 12
C.F.R. 220.118). Accordingly, in respect of a transaction
involving puts or calls, payment is required within the
period of time provided by § 220.3(b)(1) if the transaction
occurs in the general account (or if the transaction occurs
in a special cash account, by § 220.4(c)(2)) without
regard to whether there has been a delay in obtaining the
endorsement, or for any other reason the option has not
yet technically been issued.
(d) A question has been asked whether puts and
calls may be considered to be securities which are ex­
changeable or convertible into other securities, within 90
calendar days, without restriction other than the pay­
ment o f money. If held in a general account, such ex­




changeable or convertible securities are acceptable in
lieu o f the margin required in respect of a short sale
under § 220.3(d)(3). If held in a special arbitrage
account under § 220.4(d), exchangeable or convertible
securities will support the sale, for purposes o f bona fide
arbitrage, of the security into which they are so ex­
changeable or convertible. The Board concludes that
puts and calls may not be considered, for either purpose,
as securities that are exchangeable or convertible into
other securities. The Board’s view stems from the policies
underlying the sections in question.
(e) The margin restrictions in respect o f short sales
were imposed in order that
“ . . . traders on the short side o f the market
should not be in a position, with a given amount
of funds, to exert a greater influence on the
market than they could with the same amount
of funds if they were trading on the long side.”
(Annual Report, Board of Governors, 1937,
p. 208)
Permitting call options to be used in lieu o f the margin
required in respect of a short sale would be inconsistent
with that general policy (parallel considerations would
apply in the case of puts).
(f) The use of the special arbitrage account under
§ 220.4(d) is limited to the simultaneous purchase and
sale of the same or equivalent securities for the purpose
of taking advantage of a difference in price. Arbitrage is
permitted to be carried on without additional deposit of
margin because it tends to equalize prices between
markets and between equivalent securities. Because the
relatively high initial cost of a put or call option must be
deducted from the potential profit due to the disparity in
price between the two securities, it is not likely that true
arbitrage would take place between an option and an
underlying security. Such options would be used, rather,
for purposes of “ hedging” , that is to say, to protect an
investor against loss while he holds a security in the hope
of profiting by changes in its price. Such market
strategies may be beneficial to individual investors. How­
ever, they do not perform a comparable market function.
(g) Section 221.2 of this chapter provides that “ a
bank may extend and may maintain any credit for the
purpose specified in § 221.1, without regard to the limita­
tions prescribed therein, or in § 221.3(t), if the credit
comes within any of the following descriptions.” Subsec­
tion (j) contains the following description: “ (j) Any credit
extended to a member of a national securities exchange
for the purpose of financing his or his customers’ bona
fide arbitrage transactions in securities.” The Board has
concluded that a purchase of a put or call is not
embraced within the term in § 220.4(d) “ a purchase o f a
security which is, without restriction other than the

payment o f money exchangeable or convertible . . . into a
second security” so as to qualify such purchase, when
effected together with an offsetting sale o f the second
security, as a bona fide arbitrage transaction, and the
Board’s conclusion is also applicable to subsection (j) of
§ 221 .2 .




PART 221 — CREDIT BY BANKS FOR THE
PURPOSE OF PURCHASING OR
CARRYING MARGIN STOCKS
§ 221.122 Bona fid e arbitrage transactions.
For text of this interpretation, see § 220.126 o f this
subchapter.
(Interprets and applies 12 C.F.R. 220.4(c), 220.4(d)).