Proposed Rulemaking Permitting Future-Style Margining of Commodity Options

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 33

Proposed Rulemaking Permitting Future-Style Margining of

Commodity Options

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of Proposed Rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is

proposing the repeal of Commission Regulation 33.4(a)(2) which requires

the full upfront payment of commodity option premiums. The effect of

the repeal would be to permit the futures-style margining of commodity

options traded on regulated futures exchanges. Futures-style margining

offers several potential benefits over the current margining system,

including the possibility for more efficient cash flows across markets.

The Commission is publishing notice of the proposed rulemaking and

requesting public comment.

DATES: Comments on the proposed rulemaking must be received by February

2, 1998.

ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street, NW, Washington, D.C. 20581; transmitted by facsimile to (202)

418-5521; or transmitted electronically to ([email protected]).

FOR FURTHER INFORMATION CONTACT: Thomas Smith, Attorney, Division of

Trading and Markets, Commodity Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone

(202) 418-5495.

SUPPLEMENTARY INFORMATION:

I. Introduction

The Commission is proposing the repeal of Commission Regulation

33.4(a)(2). Regulation 33.4(a)(2) requires that, when a commodity

option is purchased, each clearing member must pay to the

clearinghouse, each member must pay to the clearing member, and each

option customer must pay to the futures commission merchant (``FCM'')

the full option premium.\1\ The Commission is considering repealing

this regulation in order to permit the ``futures-style margining'' of

commodity options.

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\1\ Regulation 33.4 in pertinent part states:

Sec. 33.4 Designation as a contract market for the trading of

commodity options.

The Commission may designate any board of trade * * * as a

contract market for the trading of options on contracts of sale for

future delivery * * * when the applicant complies with and carries

out the requirements of the Act (as provided in Sec. 33.2), these

relations, and the following conditions and requirements with

respect to the commodity option for which the designation is sought:

(a) Such board of trade * * *

(2) Provides that the clearing organization must receive from

each of its clearing members, that each clearing member must receive

from each other person for whom its clears commodity option

transactions, and that each futures commission merchant must receive

from each of its option customers, the full amount of each option

premium at the time the option is purchased.

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A futures-style margining system for options would include two

components: Original margin, set according to the underlying risk, and

variation margin, reflecting the daily change in the value of the

option premium. Consistent with the current treatment of futures

positions, long and short option positions would be marked-to-market,

and gains and losses would be paid and collected daily. Futures-style

margining may benefit market participants by improving cash flow in

futures and options markets generally, thereby increasing liquidity and

efficiency.

II. Background

A. Option Pilot Program

In 1981 the Commission instituted a pilot program for exchange-

traded options on non-agricultural futures contracts. 46 FR 54500

(November 3, 1981). Concurrently, the Commission adopted Part 33 of its

regulations, including the full-payment-of-premium requirement of

Regulation 33.4(a)(2).

In approving the pilot program, the Commission was cognizant of the

history of fraudulent practices associated with the offer and sale of

commodity options to the general public. In this connection, the

Commission proceeded cautiously by, among other things, prohibiting the

margining of option premiums. The Commission viewed the full payment of

option premiums ``as essential to the protection of option purchasers

who otherwise could reasonably expect that an initial payment of margin

on an option contract constituted the full

[[Page 66570]]

extent of their obligations on the option.'' 46 FR 54504.

The pilot program was made permanent effective August 1, 1986. 51

FR 17464 (May 13, 1986). Subsequently, the Commission approved trading

of options involving agricultural futures contracts and options

involving non-agricultural physicals on designated contract markets. 52

FR 777 (January 9, 1987). The proposed futures-style margining would

apply to each of these exchange-traded commodity option categories.

B. Previous Commission Considerations of Futures-Style Margining of

Commodity Options

In June 1982 the Coffee, Sugar & Cocoa Exchange, Inc. (``CSCE'')

petitioned the Commission to repeal Regulation 33.4(a)(2). The

Commission denied CSCE's petition, but resolved to reconsider margining

of option premiums ``after the Commission and industry ha[d] gained

some experience with the trading of options under the pilot program.''

\2\

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\2\ Letter dated July 2, 1982, from Jane K. Stuckey, Secretary,

Commodity Futures Trading Commission, to Bennett J. Corn, President,

CSCE.

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The following year, the Commission solicited comments concerning

``[t]he advantages and disadvantages of permitting margining of option

premiums paid by floor traders.'' 48 FR 10857, 10858 (March 15, 1983).

After considering comments made in response to the Federal Register

release, the Commission published a ``Notice of Proposed Rulemaking''

in which it proposed to allow contract markets to adopt rules

permitting their members to make a deposit with respect to option

premium. 49 FR 8937 (March 9, 1984). However, the intervening

circumstances of the margin default in the gold futures option market

on the Commodity Exchange, Inc. raised concerns about option margining

which caused the Commission to defer further consideration of futures-

style margining.\3\

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\3\ See Report on Volume Investors Corporation, Division of

Trading and Markets, July 1986.

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In July 1988 the Chicago Board of Trade (``CBT'') and the Chicago

Mercantile Exchange filed separate petitions with the Commission

requesting repeal of Regulation 33.4(a)(2). The petitioners noted that,

as a result of a study of the October 1987 market break, the

President's Working Group on Financial Markets recommended that market

participants and regulators study the potential for improving liquidity

through the use of futures-style margining of options.\4\ The petitions

were published, and the public was invited to file written comments. 54

FR 11233 (March 17, 1989). The Commission received numerous comments

supporting and opposing the proposal. Futures exchanges and futures

clearing organizations favored it. Securities exchanges and securities

clearing organizations opposed it. FCMs and introducing brokers

(``IBs'') expressed varying views, with some in support and some in

opposition. With a few exceptions, commenters from the agricultural

industry generally opposed the proposal. The Commission took no further

action on the petitions.

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\4\ Interim Report of the Working Group on Financial Markets,

submitted to the President of the United States, May 1988.

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Since 1988, a great deal of experience has been gained with option

trading in numerous products. Industry officials have continued to

indicate to the Commission that implementation of futures-style

margining might be beneficial. The Commission notes that futures-style

margining has been in place at the London International Financial

Futures and Options Exchange (``LIFFE'') for over ten years. Moreover,

LIFFE contracts executed in Chicago pursuant to the CBT/LIFFE link have

been subject to futures-style margining since May 1997 with no adverse

consequences.

III. Comparison of Option Margining Systems

Under the current ``stock-style'' option margining system, the

option buyer or ``long'' must pay the entire premium when the

transaction is initiated. No further payments are required. The premium

is credited to the account of the option seller or ``short,'' who must

keep it posted as margin. The option seller also must put up risk

margin to cover potential adverse market moves in his obligation. If

the option increases in value, the short must deposit additional funds

into the account. These funds, however, are not transferred to the

long, who must exercise or offset the option in order to realize any

increase in its value. By contrast, if the option value decreases, the

short may withdraw any excess funds from its account.

Under the proposed ``futures-style'' margining system, both the

long and short position holders would post risk-based original margin

upon entering into their option positions. During the life of the

option, the option value would be marked-to-market daily. Any increase

in value would result in a credit to the long option holder's account

and a corresponding debit against the short's account. Conversely, any

decrease in value would result in a credit to the short's account and a

corresponding debit to the long's account. Thus the cash flows in

option contracts would be symmetric, as is the case for futures. The

change in the margin system, however, would not alter the fundamental

nature of each party's overall obligation. A long's potential for loss

would remain limited to the full option premium and transaction costs.

As is the case now, a short's potential for loss would not be so

limited.

The difference between the current stock-style margining system and

the proposed futures-style margining system are illustrated by the

following examples. In each example assume that an at-the-money call

option with an exercise price of 270 and sixty days to expiration is

purchased for a premium of $5,000. Further assume that the minimum

price tick in both the futures and the option is $500.

Example 1: Option Value Decreases

At expiration the futures price has fallen below the exercise

price, and the option expires out-of-the-money. Under both stock-

style and futures-style margining, the long's loss is limited to the

$5,000 option premium. Only the timing of the payments differs.

[[Page 66571]]

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Long Short

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Stock-Style Margining

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Day 1--Pays full premium of $5,000..................... Day 1--Posts full $5,000 premium received from long

plus initial margin.

Day 2-59--Pays no additional funds..................... Day 2-59--May withdraw amount equal to decrease in

value of option position since day of purchase. Total

amount withdrawn may not exceed $5,000 premium.

Day 60--Option expires valueless. Nothing is returned.. Day 60--Option expires valueless. Initial margin is

returned.

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Futures-Style Margining

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Day 1--Posts initial margin............................ Day 1--Posts initial margin.

Day 2-59--Pays aggregate variation of $5,000........... Day 2-59--Collects aggregate settlement variation

settlement of $5,000.

Day 60--Option expires valueless. Initial margin is Day 60--Option expires valueless. Initial margin is

returned. returned.

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Example 2: Option Value Increases

By expiration the futures price has risen above the exercise

price to 285. The option is in the money by 15 points, and the

premium is $7,500 ($500 X 15 points) per contract. Under both

systems, the long's profits are the same. Again, only the timing of

the payments differs.

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Long Short

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Stock-Style Margining

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Day 1--Pays full premium of $5,000..................... Day 1--Posts full $5,000 premium received from long

plus initial margin.

Day 2-59--Collects nothing over life of option......... Day 2-59--Posts additional funds equal to the increase

in value of option position over the life of the

option.

Day 60--Liquidates position by selling the option for Day 60--Liquidates position by buying the option for

$7,500 for a gain of $2,500. $7,500 for a loss of $2,500. Total margin payments are

returned.

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Futures-Style Margining

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Day 1--Posts initial margin............................ Day 1--Posts initial margin.

Day 2-59--Over life of option collects pays aggregate Day 2-59--Over life of option pays aggregate settlement

settlement variation of $2,500.. variation of $2,500.

Day 60--Liquidates position. Initial margin is Day 60--Liquidates position. Initial margin is

returned.. returned.

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The long also may choose to exercise the in-the-money call

instead of liquidating the option position. Exercising a futures-

style option is analogous to taking delivery on a futures position.

In order to receive a cash commodity by taking delivery on a futures

contract, the long must pay the settlement price of the futures

contract prevailing at the time of delivery. Similarly, in order to

obtain a futures position by exercising an option, the long must pay

the settlement of the option prevailing at the time of exercise. In

other words, the long must pay the full premium marked-to-market on

the day of exercise. Under a futures-style margining system, this

payment is offset by the variation payments received by the long

during the life of the option. The difference between this procedure

and the exercise of stock-style options are demonstrated in a final

example.

Example 3: Exercise of In-The-Money Option.

As in Example 2, the futures price has risen to 285 by

expiration. The long option holder decides to exercise the call.

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Long Short

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Stock-Style Margining

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Exercises option....................................... Option is exercised.

Receives long futures position at strike price of 270. Receives short futures position at strike price of 270.

Futures position is marked-to-market by the Futures position is marked-to-market market by the

clearinghouse, and the long is credited $7,500 ((285- clearinghouse, and short is debited $7,500.

270)X $500.

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Futures-Style Margining

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Exercises option....................................... Option is exercised.

Clearinghouse debits account for premium settlement Clearinghouse credits short with $7,500 settlement of

price of $7,500. premium.

Receives long futures position at option strike price Receives short futures position at option price of 270.

of 270. Futures position is marked-to-market by the Futures position is marked-to-market by the

clearinghouse, and the long is credited with $7,500 clearinghouse, and the short is debited $7,500.

((285-270)X $500.

Option position is closed through exercise, but risk Option position is closed through exercise, but risk

margin is retained until the futures position is marign is retained until the futures position is

offset. offset.

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IV. Potential Benefits and Costs of Futures-Style Margining

A. Potential Benefits

Futures-style margining of options could enhance financial

integrity and market liquidity by providing for more efficient cash

flows across markets. Currently, certain spread or risk neutral

positions can give rise to substantial funds requirements due to

asymmetrical cash flows. The problem arises, for example, where a short

futures position is hedged with a long call option. If the price of the

futures position increases, the value of the call also increases.

However, the trader cannot apply the increased option value toward the

[[Page 66572]]

corresponding loss in the futures position.\5\ Instead, the trader must

put up funds to pay the futures variation requirement. Similar cash

flow shortages can arise for traders holding arbitrage positions such

as conversions, reverse conversions, and box spreads. Such problems may

be particularly acute when there are major market moves.

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\5\ Of course, the trader may obtain the excess funds by

exercising or offsetting the option, but this would eliminate the

original hedge strategy or require reestablishing the option with

the potential for a less favorable price and additional transaction

costs.

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With futures-style margining of options, these asymmetrical cash

flows could be reduced. Each increase in an option position's value

(long or short) would result in a related variation payment which would

be accessible to the option trader. The trader could in turn use the

option gains to contribute to margin payments on other positions with

losses.

Futures-style margining also may reduce financing requirements for

market participants and, thus, financing risk for FCMs and

clearinghouses. Under the current margining system, financing risk is

created because long option equity cannot be used to make variation

margin payments on short option or futures positions. Moreover,

financing based on option equity may not be readily available to market

participants because banks may be reluctant to provide such financing.

Futures-style margining of options, with its variation pay and collect

feature, would reduce the need for market participants to borrow

against their long option equity. Thus, FCMs no longer would be exposed

to the resulting credit risk beyond their control.

Market liquidity may increase under a futures-style margining

system for two reasons. First, the ability of traders to participate in

option markets could be less dependent on their ability to obtain

financing. Second, the incentive for early exercise of options could be

reduced. Under the present system, an option purchaser can realize

increases in the value of an option only by offsetting or exercising

that option. Thus, some long option holders may choose to exercise

their options early in order to obtain the option profits. This

possibility of early exercise may act as a disincentive to writing

options due to the uncertainty it creates. The daily pay and collect

feature of the futures-style system could reduce the incentive for

early exercise.

B. Potential Costs

Futures-style margining would increase leverage in the option

markets. A long would be required to put up a smaller initial payment

to purchase a given option than he or she would under the current

system. This would introduce a risk of default that does not exist

today. The Commission notes, however, that futures and short options

currently may be margined. It is anomalous that long options, which

entail less risk, are subject to a more stringent standard. Under

futures-style margining, the total risk of a long option would still be

fixed at the time of purchase. Moreover, FCMs would remain free to

require an initial payment equal to the value of the option premium.

Over the years, the Commission has brought enforcement actions

involving the fraudulent offer and sale of options on exchange-traded

futures contracts to unsophisticated retail customers. Futures-style

margining may provide unscrupulous individuals with an additional

opportunity to mislead unsophisticated option customers. Such customers

may not fully understand that they are liable for the full premium

payment if the market moves against their option position. In addition,

less well-capitalized customers could be persuaded to invest since the

initial margin would be lower than currently required. Institution of

futures-style margining would require efforts to educate market

participants. Of course, consistent with Commission Regulation 1.55,

full and accurate disclosure of potential liability also would be

necessary at the time an option position was entered in order to ensure

investor protection. The Commission welcomes comments on what measures

might be appropriate to address these concerns.

Implementation of futures-style margining would alter option

pricing which could adversely affect certain market participants.

Option premiums potentially would be higher under a futures-style

margining system because shorts likely would demand a higher price to

compensate for the loss of interest income on the full premium and

longs would be willing to pay a higher price because they would be

gaining such interest income. Some market participants believe that

this could affect various trading strategies by potentially diminishing

the usefulness of certain option writing strategies.

Implementation of futures-style margining might also create issues

for participants in the securities markets. To the extent the latter

retained the current system, customer confusion could result.\6\ In

addition, certain intermarket strategies such as ``buy-write'' might be

less useful because option grantors would not receive the full option

premium upfront.

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\6\ In May 1996 the Board of Governors of the Federal Reserve

amended Regulation T to allow securities exchanges to adopt,

pursuant to Securities and Exchange Commission approval, rules

permitting the margining of options on securities. 61 FR 20386 (May

6, 1996). To date, no exchange has submitted such a rule.

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Finally, there could be costs to the industry in making a

transition to futures-style margining. FCMs would have to adjust their

risk management systems to address the increased leverage and altered

cash flow features. Moreover, insofar as small retail firms currently

only handle long option positions, such firms would have to install

risk management systems if they planned to allow margining of premiums.

In addition, if all exchanges were not ready or willing to switch from

stock-style option margining to futures-style margining at the same

time, FCMs might incur operational costs in order to maintain multiple

option margining systems and to comply with different disclosure

requirements for different exchanges. Furthermore, even if all

exchanges introduced futures-style margining simultaneously, there

would be a necessary transition period during which exchanges and

market participants would be required to deal with both margining

systems.

In addition, because of the impact of the futures-style margining

on option pricing, only a newly-issued option series could be margined

in the proposed manner. Any previously issued option series would

require margining under the existing stock-style system. Thus, a change

to futures-style margining would necessitate the maintenance of a two-

tiered margining system for a period of time.

VI. Proposed Regulatory Changes

A. Repeal of Commission Regulation 33.4(a)(2)

The Commission believes that futures-style margining could provide

substantial benefits to the marketplace and that steps are available to

minimize the potential costs. Accordingly, the Commission is proposing

to delete Regulation 33.4(a)(2) which requires full payment of the

option premium at the time of purchase. This would not impose future-

style margining on the industry but would merely make it available. Any

exchange or clearinghouse that wished to implement it would be required

to submit appropriate rule changes to the Commission pursuant to

Section

[[Page 66573]]

5a(a)(12)(A) of the Act and Commission Regulation 1.41. The Commission

would review any such proposal to ensure that adequate safeguards were

in place. In particular, the Commission would reemphasize the need to

use systems and procedures that took into account the unique risk

characteristics of options. Moreover, as previously mentioned, exchange

margin requirements are minimums. Any FCM would remain free to collect

the full premium at the time of purchase just as it is currently free

to collect more than the exchange minimum margin on futures positions.

B. Amendment of Commission Regulations 1.55 and 33.7

The Commission is proposing several amendments to the language of

the generic futures and option risk disclosure statement set forth in

Appendix A of Commission Regulation 1.55(c) and the more detailed

domestic exchange-traded option disclosure statement set forth in

Regulation 33.7. The proposed amendments would inform potential

investors that option transactions may be subject to either a stock-

style or futures-style margining system. The proposed amendments would

not relieve an FCM or IB from any other disclosure obligation it may

have under applicable law.

C. Technical Amendments

Implementation of futures-style margining will require changes to

other Commission requirements to provide for appropriate accounting

treatment of options. See, Financial and Segregation Interpretation No.

8, Comm. Fut. L. Rep., (CCH) para. 7118 (August 12, 1982), relating to

the proper accounting, segregation and net capital treatment of

options, and Commission Regulation 1.17 relating to minimum financial

requirements for FCMs and IBs. The Commission requests comments on the

appropriate technical amendments to these provisions. The Commission

also request comments on any other technical changes to its regulatory

requirements.

VII. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,

requires that agencies, in proposing rules, consider the impact on

small businesses. The rules discussed herein will affect FCMs and IBs.

The Commission has already established certain definitions of ``small

entities'' to be used by the Commission in evaluating the impact of its

rules on such small entities in accordance with the RFA. FCMs have been

determined not to be small entities under the RFA.

With respect to IBs, the Commission has stated that it is

appropriate to evaluate within the context of a particular rule

proposal whether some or all IBs should be considered to be small

entities and, if so, to analyze that economic impact on such entities

at that time. The proposed rule amendments would not require any IB to

alter its current method of doing business as FCMS have the

responsibility of administering customer funds. Further, these rule

amendments, as proposed should, impose no additional burden or

requirements on IBs and, thus, if adopted would not have a significant

economic impact on a substantial number of IBs.

Therefore, the Chairperson, on behalf of the Commission, hereby

certifies pursuant to 5 U.S.C. 605(b), that the action taken herein

would not have a significant economic impact on a substantial number of

small entities. The Commission nonetheless invites comments from any

person or entity which believes that the proposal would have a

significant impact on its operations.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 \7\ imposes certain

requirements on federal agencies (including the Commission) in

connection with their conducting or sponsoring any collection of

information as defined by the Paperwork Reduction Act.

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\7\ Pub. L. 104-13 (May 13, 1995).

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While proposed Rule 1.55 has no burden, the group of rules (3038-

0024), which Rule 1.55 is a part, has the following burden:

Average burden hours per response: 128.

Number of Respondents: 3,148.

Frequency of responses: 36.

While proposed Rule 33.7 has no burden, the group of rules (3038-

0007), which Rule 33.7 is a part, has the following burden:

Average burden hours per response: 50.57.

Number of Respondents: 190,422.

Frequency of responses: 1,111.

Copies of the OMB approved information collection package

associated with these rules may be obtained from Desk Officer, CFTC,

Office of Management and Budget, Room 10202, NEOB, Washington DC 20503,

(202) 395-7340.

List of Subjects

17 CFR Part 1

Commodity Futures, Domestic exchange-traded commodity option

transactions.

17 CFR Part 33

Commodity Futures, Domestic exchange-traded commodity option

transactions.

In consideration of the foregoing, and pursuant to the authority

contained in the Commodity Exchange Act and, in particular, sections

2(a)(1), 4b, 4c, and 8a thereof, 7 U.S.C. 2a, 6b, 6c, and 12a, the

Commission hereby proposes to amend Chapter I of Title 17 of the Code

of Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for Part 1 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 2a 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,

6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 9, 12, 12a, 12c,

13a, 13a--, 16, 16a, 19, 21, 23, 24.

2. Section 1.55(c) is amended by revising section 3 of Appendix A

to read as follows: \8\

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\8\ The Commission will republish the entire appendix in the

final rule.

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Appendix A to CFTC Rule 1.55(c)--Generic Risk Disclosure Statement

Risk Disclosure Statement for Futures and Options

* * * * *

Options

3. Variable degree of risk.

Transactions in options carry a high degree of risk. Purchasers

and sellers of options should familiarize themselves with the type

of option (i.e. put or call) which they contemplate trading and the

associated risks. You should calculate the extent to which the value

of the options must increase for your position to become profitable,

taking into account the premium and all transaction costs.

The purchaser of options may offset or exercise the options or

allow the options to expire. The exercise of an option results

either in a cash settlement or in the purchaser acquiring or

delivering the underlying interest. If the option is on a future,

the purchaser will acquire a futures position with associated

liabilities for margin (see the section on Futures above). If the

purchased options expire worthless, you will suffer a total loss of

your investment which will consist of the option premium plus

transaction costs. If you are contemplating purchasing deep-out-of-

the-money options, you should be aware that the chance of such

options becoming profitable ordinarily is remote.

[[Page 66574]]

Selling (``writing'' or ``granting'') an option generally

entails considerably greater risk than purchasing options. Although

the premium received by the seller is fixed, the seller may sustain

a loss well in excess of that amount. The seller will be liable for

additional margin to maintain the position if the market moves

unfavorably. The seller will also be exposed to the risk of the

purchaser exercising the option, and the seller will be obligated to

either settle the option in cash or to acquire or deliver the

underlying interest. If the option is on a future, the seller will

acquire a position in a future with associated liabilities for

margin (see the section on Futures above). If the position is

``covered'' by the seller holding a corresponding position in the

underlying interest or a future or another option, the risk may be

reduced. If the option is not covered, the risk of loss can be

unlimited.

Certain exchanges, domestic and foreign, permit deferred payment

of the option premium, exposing the purchaser to liability for

margin payments not exceeding the amount of the premium. The

purchaser is still subject to the risk of losing the premium and

transaction costs. When the option is exercised or expires, the

purchaser is responsible for any unpaid premium outstanding at that

time.

* * * * *

PART 33--REGULATION OF DOMESTIC EXCHANGE TRADED COMMODITY OPTION

TRANSACTIONS

3. The authority citation for Part 33 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 12c, 13a, 13a-

1, 13b, 19, and 21.

Sec. 33.4 [Amended]

4. Section 33.4 is amended by removing and reserving paragraphs

(a)(2).

5. The disclosure statement in paragraph (b) of Sec. 33.7 is

amended by revising the text preceding paragraph (1) and paragraph

(2)(v), (4) and (5) to read as follows:

Sec. 33.7 Disclosure.

* * * * *

(b) The disclosure statement must read as follows:

OPTION DISCLOSURE STATEMENT

BECAUSE OF THE VOLATILE NATURE OF THE COMMODITIES MARKETS, THE

PURCHASE AND GRANTING OF COMMODITY OPTIONS INVOLVE A HIGH DEGREE OF

RISK. COMMODITY OPTION TRANSACTIONS ARE NOT SUITABLE FOR MANY

MEMBERS OF THE PUBLIC. SUCH TRANSACTIONS SHOULD BE ENTERED INTO ONLY

BY PERSONS WHO HAVE READ AND UNDERSTOOD THIS DISCLOSURE STATEMENT

AND WHO UNDERSTAND THE NATURE AND EXTENT OF THEIR RIGHTS AND

OBLIGATIONS AND OF THE RISKS INVOLVED IN THE OPTION TRANSACTIONS

COVERED BY THIS DISCLOSURE STATEMENT.

BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE

PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS AN OPTION

WHICH, IF EXERCISED, RESULTS IN THE ESTABLISHMENT OF A FUTURES

CONTRACT (AN ``OPTION ON A FUTURES CONTRACT'') OR RESULTS IN THE

MAKING OR TAKING OF DELIVERY OF THE ACTUAL COMMODITY UNDERLYING THE

OPTION (AN ``OPTION ON A PHYSICAL COMMODITY''). BOTH THE PURCHASER

AND THE GRANTOR OF AN OPTION ON A PHYSICAL COMMODITY SHOULD BE AWARE

THAT, IN CERTAIN CASES, THE DELIVERY OF THE ACTUAL COMMODITY

UNDERLYING THE OPTION MAY NOT BE REQUIRED AND THAT, IF THE OPTION IS

EXERCISED, THE OBLIGATIONS OF THE PURCHASER AND GRANTOR WILL BE

SETTLED IN CASH.

BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW WHETHER THE

PARTICULAR OPTION IN WHICH THEY CONTEMPLATE TRADING IS SUBJECT TO A

``STOCK-STYLE'' OR ``FUTURES-STYLE'' SYSTEM OF MARGINING. UNDER A

STOCK-STYLE MARGINING SYSTEM, A PURCHASER IS REQUIRED TO PAY THE

FULL PURCHASE PRICE OF THE OPTION AT THE INITIATION OF THE

TRANSACTION. THE PURCHASER HAS NO FURTHER OBLIGATION ON THE OPTION

POSITION. UNDER A FUTURES-STYLE MARGINING SYSTEM, THE PURCHASER

DEPOSITS INITIAL MARGIN AND MAY BE REQUIRED TO DEPOSIT ADDITIONAL

MARGIN IF THE MARKET MOVES AGAINST THE OPTION POSITION. THE

PURCHASER'S TOTAL MARGIN OBLIGATION, HOWEVER, WILL NOT EXCEED THE

ORIGINAL OPTION PREMIUM. IF THE PURCHASER OR GRANTOR DOES NOT

UNDERSTAND HOW OPTIONS ARE MARGINED UNDER A STOCK-STYLE OR FUTURES-

STYLE MARGINING SYSTEM, HE OR SHE SHOULD REQUEST AN EXPLANATION FROM

THE FUTURES COMMISSION MERCHANT (``FCM'') OR INTRODUCING BROKER

(``IB'').

A PERSON SHOULD NOT PURCHASE ANY COMMODITY OPTION UNLESS HE OR

SHE IS ABLE TO SUSTAIN A TOTAL LOSS OF THE PREMIUM AND TRANSACTION

COSTS OF PURCHASING THE OPTION. A PERSON SHOULD NOT GRANT ANY

COMMODITY OPTION UNLESS HE OR SHE IS ABLE TO MEET ADDITIONAL CALLS

FOR MARGIN WHEN THE MARKET MOVES AGAINST HIS OR HER POSITION AND, IN

SUCH CIRCUMSTANCES, TO SUSTAIN A VERY LARGE FINANCIAL LOSS.

A PERSON WHO PURCHASES AN OPTION SUBJECT TO STOCK-STYLE

MARGINING SHOULD BE AWARE THAT, IN ORDER TO REALIZE ANY VALUE FROM

THE OPTION, IT WILL BE NECESSARY EITHER TO OFFSET THE OPTION

POSITION OR TO EXERCISE THE OPTION. OPTIONS SUBJECT TO FUTURES-STYLE

MARGINING ARE MARKED-TO-MARKET, AND GAINS AND LOSSES ARE PAID AND

COLLECTED DAILY. IF AN OPTION PURCHASER DOES NOT UNDERSTAND HOW TO

OFFSET OR EXERCISE AN OPTION, THE PURCHASER SHOULD REQUEST AN

EXPLANATION FROM THE FCM OR IB. CUSTOMERS SHOULD BE AWARE THAT IN A

NUMBER OF CIRCUMSTANCES, SOME OF WHICH WILL BE DESCRIBED IN THIS

DISCLOSURE STATEMENT, IT MAY BE DIFFICULT OR IMPOSSIBLE TO OFFSET AN

EXISTING OPTION POSITION ON AN EXCHANGE.

THE GRANTOR OF AN OPTION SHOULD BE AWARE THAT, IN MOST CASES, A

COMMODITY OPTION MAY BE EXERCISED AT ANY TIME FROM THE TIME IT IS

GRANTED UNTIL IT EXPIRES. THE PURCHASER OF AN OPTION SHOULD BE AWARE

THAT SOME OPTION CONTRACTS MAY PROVIDE ONLY A LIMITED PERIOD OF TIME

FOR EXERCISE OF THE OPTION.

THE PURCHASER OF A PUT OR CALL SUBJECT TO STOCK-STYLE OR

FUTURES-STYLE MARGINING IS SUBJECT TO THE RISK OF LOSING THE ENTIRE

PURCHASE PRICE OF THE OPTION--THAT IS, THE PREMIUM CHARGED FOR THE

OPTION PLUS ALL TRANSACTION COSTS.

THE COMMODITY FUTURES TRADING COMMISSION REQUIRES THAT ALL

CUSTOMERS RECEIVE AND ACKNOWLEDGE RECEIPT OF A COPY OF THIS

DISCLOSURE STATEMENT BUT DOES NOT INTEND THIS STATEMENT AS A

RECOMMENDATION OR ENDORSEMENT OF EXCHANGE-TRADED COMMODITY OPTIONS.

* * * * *

(2) * * *

(v) An explanation and understanding of the option margining

system.

* * * * *

(4) Margin requirements. An individual should know and

understand whether the option he or she is contemplating trading is

subject to a stock-style or futures-style system of margining.

Stock-style margining requires the purchaser to pay the full option

premium at the time of purchase. The purchaser has no further

financial obligations, and the risk of loss is limited to the

purchase price and transaction costs. Futures-style margining

requires the purchaser to pay initial margin only at the time of

purchase. The option position is marked-to-market, and gains and

losses are collected and paid daily. The purchaser's risk of loss is

limited to the initial option premium and transaction costs.

An individual granting options under either a stock-style or

futures-style system of margining should understand that he or she

may be required to pay additional margin in the case of adverse

market movements.

(5) Profit potential of an option position. An option customer

should carefully calculate the price which the underlying futures

contract or underlying physical commodity would have to reach for

the option position to become profitable. Under a stock-style

margining system, this price would include the amount by which the

underlying futures contract or underlying physical commodity would

have to rise above or fall below the strike price to cover the sum

of the premium and all other costs incurred in entering into and

exercising or closing (offsetting) the commodity option position.

Under a future-style margining

[[Page 66575]]

system, option positions would be marked-to-market, and gains and

losses would be paid and collected daily, and an option position

would become profitable once the variation margin collected exceeded

the cost of entering the contract position.

Also, an option customer should be aware of the risk that the

futures price prevailing at the opening of the next trading day may

be substantially different from the futures price which prevailed

when the option was exercised. Similarly, for options on physicals

that are cash settled, the physicals price prevailing at the time

the option is exercised may differ substantially from the cash

settlement price that is determined at a later time. Thus, if a

customer does not cover the position against the possibility of

underlying commodity price change, the realized price upon option

exercise may differ substantially from that which existed at the

time of exercise.

* * * * *

Issued in Washington, D.C., on this 15th day of December, 1997,

by the Commodity Futures Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 97-33125 Filed 12-18-97; 8:45 am]

BILLING CODE 6351-01-P