SEC OKs OCC to Margin and Clear Binary Options

The SEC approved rule changes allowing the Options Clearing Corporation ("OCC") to begin clearing "European-style" binary options. The amendments add a margining mechanism for the products to OCC's risk model.

In the Order, the SEC approved amendments to OCC's System for Theoretical Analysis and Numerical Simulation, or STANS - the methodology OCC uses to set Clearing Member margin requirements. The OCC said it previously cleared binary options and maintained rules addressing them, though its margin methodology had no mechanism to calculate margin requirements for the products. The OCC explained that its Participant Exchanges had expressed interest in listing binary options for trading. The OCC said it initially plans to clear only binary options on equity indexes that fall within the definition of a "security," while anticipating that exchanges will expand their offerings over time.

Under the approved approach, OCC will price binary options within a Black-Scholes framework, using the forward price of the underlying asset and the implied volatility of a corresponding vanilla option, plus an adjustment term to align theoretical prices with observed market prices and account for illiquidity at launch. The amendments (i) add binary options to the list of options within the STANS Methodology Description, (ii) define them as "European-style" contracts paying a fixed amount at expiration, and (iii) add a new section describing the pricing process.

The SEC found the change consistent with SEA Section 17A(b)(3)(F) ("National system for clearance and settlement of securities transactions") which requires clearing agency rules to safeguard securities and funds in the agency's control, and with Rule 17ad-22(e)(6)(i) ("Standards for Clearing Agencies") which requires a covered clearing agency to maintain a risk-based margin system producing margin levels commensurate with each product's risks. Absent the change, the SEC said, OCC might not collect sufficient margin collateral to cover binary options positions in a Clearing Member default.