draft 12727-76 statement of joseph w. sullivan

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DRAFT 12727-76

STATEMENT PRESIDENT, REGARDING

The

failure

number of small

their

accounts,

Street

under the

would

severely

system,

to allow

disadvantages

which

relative

depends to

the

on a large

large Wall

subject

effectively

Street

his p o s i t i o n

IBM stock at 260.

The

short

Yet u n d e r

be subject

$520,000 m a r k e t essentially

by going

long option

stock

serves

the FRB's

to a $260,0.00 m a r g i n value

riskless

of the

2,000

short p o s i t i o n

on

2,000

each)

can

shares

of

any risk of the short

to reduce

proposal,

are

a long p o s i t i o n

shares

short

the

pQsitions,

assumes

removes

of w h o m

requirement

long o p t i o n

(of i00

that

By contrast, most

to a 50% m a r g i n

contracts

to any charges

position

stock.

who

risk on the long

a CBOE m a r k e t - m a k e r

requirement

shares

on

Rule when the

CBOE m a r k e t - m a k e r s ,

hedging

their own

requirements

subject

by a long o p t i o n

a CBOE m a r k e t - m a k e r

hedge

(and the

nor are they

broker,

260 o p t i o n

and carry

SEC's Net C a p i t a l

stock positions

of 20 IBM A p r i l

clear

risk on the short

by a c l e a r i n g

For example,

would

PROPOSAL

from any FRB m a r g i n

is h e d g e d

any m a r k e t

short

option).

EXCHANGE

Board proposal

houses w h i c h

stock p o s i t i o n s ;

FRB p r o p o s a l

stock

Reserve

traders,

are exempt

stock p o s i t i o n

eliminates

their

OPTIONS

houses.

short

carried

SULLIVAN

BOARD M A R G I N

stock hedges

individual

on such p o s i t i o n s short

RESERVE

market-maker

The large Wall trading

BOARD

of the F e d e r a l

competitive

trading

CHICAGO

FEDERAL

for long o p t i o n / s h o r t CBOE's

OF J O S E P H W.

sold

whereas

(50% of the

short)

a large

on an

trading

-

firm that clears

2

-

for itself would be exempt from any requirement

on the same position. For other securities or convertible

into an underlying

any margin requirement short stock p o s i t i o n convertible

yet the FRB

on all investors

and dealers

alike on a in the

just the same as any other c o n v e r t i b l e s e c u r i t y ,

has failed to apply the same m a r g i n principles stock hedge

in

in any brokerage

even the account of an options market-maker.

Thus,

the CBOE's many

who are vital

smaller,

precluded

stock by margin requinements to the risks

non-clearing

market-makers

to the strength of i t s c o m p e t i t i v e

systems are v i r t u a l l y

purpose

the FRB has long waived

An option covers the risk of a short

the case of a long option/short account,

stock,

that are exchangeable

that is hedged by a long position

security.

stock position

such as a warrant

involved.

from hedging

market-making

in the underlying

that are totally d i s p r o p o r t i o n a t e

As a result, m a r g i n requirements

whose

is supposedly risk control are having the exact opposite

effect of exposing option m a r k e t - m a k e r s thereby impairing their market-making

to much greater risk,

cap&bilties

to the

detriment of all investors. There are two possible explanations unintended

irony.

of the Federal functions

for this hopefully

One is a lack of u n d e r s t a n d i n g

on the part

Reserve Board as to how the Options market

and the purposes

by large Wall Street

it serves.

specialist

firms

the CBOE at a severe disadvantage New York competitors.

The other

is maneuvering

and other dealers to put

to its p r e s e n t

and prospective