SEC Approves CBOE'S New Portfolio Margining Rules To Benefit Customer Accounts

The Chicago Board Options Exchange (CBOE) announced today that the Securities and Exchange Commission (SEC) approved amendments to CBOE rules that allow for expanded portfolio margining for customer accounts.The effective date of the amendments is April 2, 2007.

Today's action expands the scope of products eligible for portfolio margining to include equities, equity options, narrow-based index options, certain security futures products (such as single stock futures), and unlisted derivatives. The SEC approved portfolio margining for broad-based index options in July 2005.U.S. futures markets and most European and Asian exchanges for many years have employed risk-based margining similar to CBOE's new rules.

"CBOE's portfolio margining rules makes the U.S. equity markets much more competitive in a world where the lines continue to blur between product classes, where cross-border trading is common, and where capital moves quickly to the most efficient markets," said CBOE Chairman and Chief Executive Officer William J. Brodsky. "True risk-based margining frees up a tremendous amount of capital, allowing investors to more appropriately allocate assets in their accounts. The benefits to customers from these changes are profound and will revolutionize our market place."

"Markets expand when new efficiencies are brought to bear, and today marks the beginning of a new era for the efficient use of capital and risk management for our markets," Brodsky added."CBOE has been a driving force behind moving this initiative through Congress, the CFTC and SEC, and it is extremely gratifying to see this finally approved."

The new portfolio margining rules will have the effect of aligning the amount of margin money required to be held in a customer's account to the risk of the portfolio as a whole, calculated through simulating market moves up and down, and accounting for offsets between and among all products held in the account that are highly correlated (for example, options on the S&P 500 Index, "SPX", can be offset against options on the S&P 500 Depositary Receipts, "SPY", or options on DIAMONDS (DIA) can be offset against SPX options). Current practice is to require margin based on set formulas for various strategies (i.e. some spread strategies require a certain minimum margin), regardless of what other offsetting positions were held in the account and regardless of potential market moves. For some positions the margin requirements may not change significantly, but for other positions, such as owning a protective put against a long stock position, the difference may be sizable. This is appropriate in that the margin calculation accounts for the fact that the risk of one position (long stock) is offset by the other (long put).

The New York Stock Exchange, which is the Designated Examining Authority for most CBOE member firms, submitted similar rules that also were approved concurrently by the SEC.

Some of the features of the new portfolio margining rules include:
- Expands the scope of products eligible for portfolio margining to include equities, equity options, narrow-based index options, security futures products and unlisted derivatives; whereas previously only broad-based index options and related products were permitted.

- Eliminates the five million dollar minimum account equity requirement, except for portfolio margin accounts that carry unlisted derivatives.

- Provides that cross-margining can be conducted in a portfolio margin account instead of a separate cross-margin account as previously required.

- In the case of a broad-based index option, removes the prohibition against an unhedged position in a related exchange traded fund (and imposes no hedging requirement on positions in equity securities).

- Requires a margin deficiency to be resolved within three business days instead of within one business day under the previous rule.

- Brokerage firms must be approved by their Designated Examining Authority (DEA) in order to offer portfolio margining to customers.

Margin Calculation:
- Positions are allocated to separate portfolios according to underlying security.

- As with the previous rule, a margin requirement is computed by "stressing" a portfolio at ten equidistant intervals (valuation points) representing assumed market moves, both up and down, in the current value of the underlying security or index. Gains and losses at each valuation point are netted and the greatest net loss among the valuation points is the margin requirement for that portfolio.

- The total margin requirement is the sum of the margin requirements for each portfolio.

- For equities, equity options, narrow-based indices and security futures products, the amendments require assumed up/down moves of +/-15% as the end points.

- For broad-based index portfolios, the assumed up/down moves remain the same (-8%/+6% for high capitalization indices; +/-10% for non-high capitalization indices).

Further details of the new portfolio margining rules, including sample calculations, can be found at http://www.cboe.com/SECMargin.