Options: Margin & Escrow Receipts, Overview of Margin Requirements for Options...
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>>>Following is a brief summary of the margin requirements and escrow receipt program that apply to options traded on the Chicago Board Options Exchange (CBOE). This is only a brief summary and should only serve as a supplement to careful review of relevant CBOE rules and federal securities laws dealing with margin requirements. For more information on margin requirements for options, please contact CBOE's Department of Financial and Sales Practice Compliance at (312) 786-7718. In addition please see the discussion of margins in the Characteristics and Risks of Standardized Options publication, Chapter 12 of the rules of the CBOE, and also the 41-page CBOE Margin Manual.
Recent Changes to Options Margin Rules Approved by the SEC
The SEC recently approved changes to options margin rules. of the CBOE and NYSE. Some of the changes include:
Loan Value for Long-Term Listed Options and for Certain Long Box Spreads. Member firms may now lend up to 25% of the current market value of a listed option that has more than 9 months until expiration. Thus, the initial and maintenance margin is 75%. Member firms may lend up to 50% of the difference in the aggregate exercise prices on a long box spread if it is comprised of European style options.
Reduced Maintenance Margin Requirements for Stock Positions Hedged With Options. These include protective puts, protective calls, conversions, reverse conversions and collars.
Recognition of Certain Long and Short Butterfly Spreads; and Long and Short Box Spreads. Eligible long butterfly and box spreads will pay in full the net debit incurred (i.e., the maximum risk). Eligible short (credit) butterfly and box spreads will pay the difference between the exercise prices. Net credit received may be applied.
Minimum Margin on Short, Uncovered Puts. The minimum requirement is now calculated using the exercise price of the put rather than the current market value of the underlying.
Provisions allowing certain spreads, including certain butterfly and box spreads, in cash accounts if they are comprised of European style index options.
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The SEC's multi-page approval of changes to NYSE margin rules (with a list of 17 people who commented on changes), effective in January 2000
The changes approved in 1999 represent just one phase of changes, and contain a number of strategy-based enhancements and new capabilities for margin and cash accounts. Another phase of change, which may begin in late 2000, is a portfolio margin approach, including a cross-margin capability, which will be an alternative to strategy-based margin requirements for broad based index options products.
Overview of Margin Requirements for Options
In the stock market, "margin" refers to buying stock or selling stock short on credit. A margin customer pays for half (50%) of the cost of buying stock (the margin) and the brokerage firm lends the customer the balance. Margin customers are required to keep securities on deposit with their brokerage firms as collateral for their borrowings. Buyers of options can now buy equity options and equity index options on margin, provided the option has more than nine (9) months until expiration. The initial(maintenance) margin requirement is 75% of the cost(market value) of a listed, long term equity or equity index put or call option. One who takes a "long" position in a non-marginable put option or call option is required to pay the premium amount in full.
In the options market, "margin" also means the cash or securities required to be deposited by an option writer with his brokerage firm as collateral for the writer's obligation to buy or sell the underlying interest, or in the case of cash-settled options to pay the cash settlement amount, if assigned an exercise. Minimum margin requirements currently are imposed by the options markets and other self-regulatory organizations, and higher margin requirements may be imposed either generally or for certain positions by the various brokerage firms.
Uncovered writers may have to meet calls for substantial additional margin in the event of adverse market movements. Even if a writer has enough equity in his account to avoid a margin call, increased margin requirements on his option positions will make that equity unavailable for other purposes.
If a holder of a physical delivery call option exercises and wishes to purchase the underlying interest on credit, the holder may be required to deposit margin with the holder's brokerage firm. Holders of physical delivery options on a foreign currency should be aware that, at the date of this booklet, foreign currency has no value for margin purposes except to the extent that credit has been extended on the same foreign currency.
Certain limited risk spreads, butterfly spreads and box spreads (collectively referred to as "spreads") may now be established and carried in a cash account. Provided the spread is composed of European style, cash settled index options that all expire at the same time, it may be effected in the cash account. Butterfly spreads and box spreads must meet the definition contained in Exchange's Rule 12.3(a). The requirement for debit (or long) spreads is to pay for the net debit in full. For credit (or short) spreads, cash or cash equivalents equal to the maximum risk (less the net credit received for selling the spread) must be deposited and held in the account.
Exchange rules also provide for lower maintenance margin requirements for the underlying instrument in certain strategies that employ a long American style option as a hedge.
Margin requirements for option writers are complex and are not the same for every type of underlying interest. Margin requirements are subject to change, and may vary from brokerage firm to brokerage firm. However, margin requirements can have an important effect on an option writer's risks and opportunities. Persons considering writing options (whether alone or as part of multiple position strategies, such as spreads or straddles) should determine the applicable margin requirements from their brokerage firms and be sure that they have sufficient liquid assets to meet those requirements in the event of adverse market movements.
Escrow Receipts
Many institutional accounts maintain their assets at a custodian bank, not at a broker-dealer. Exchange margin rules allow a broker-dealer to accept an "escrow agreement" in respect of short options, in lieu of cash or securities. An escrow agreement (also escrow receipt or option guarantee letter) is a document that, according to Exchange Rules, must be issued by a bank and be in a form which is acceptable to the Exchange. Broker-dealers may require that an escrow agreement be in a form that will be accepted by the Options Clearing Corporation.
In respect of an escrow agreement for a short equity call option, the issuing bank promises to deliver the underlying stock to the broker-dealer in the event the customer's account is assigned. In issuing an escrow agreement for a short equity put option, the bank promises to deliver cash in the amount of the aggregate put exercise price in the event the customer's account is assigned.
Exchange Rules also allow bank issued escrow agreements to be accepted for short index option positions. In issuing an escrow agreement for a short index call option, a bank attests that it will hold cash, cash equivalents, at least one marginable equity security, or a combination of the three. The total value of the assets held by the bank must equal the aggregate underlying index value on the trade date. As with short equity put options, an escrow agreement respecting a short index put option must be backed by cash or cash equivalents at the bank which equal the aggregate put exercise amount. In the case of both index calls and puts, the bank issuing the escrow agreement promises to deliver the in-the-money amount to the broker-dealer in the event the customer's account is assigned. The escrow agreement must give the bank the authority to liquidate assets held under the agreement if necessary to meet an assignment
For more information on current margin requirements for options, please contact CBOE's Department of Financial and Sales Practice Compliance, (312) 786-7718.
Investor Protection
Virtually all CBOE options contracts are issued by the Options Clearing Corporation, a clearinghouse with a triple-A credit rating from the Standard & Poor's Corporation. Click here for more details on Investor Protection.<<< |
