The Options Clearing Corp. plans to begin processing over-the-counter equity derivatives based on the Standard & Poor's 500 index beginning in the middle of 2011, reducing trading firms' risks on the securities linked to the benchmark measure of U.S. stocks.
Dealers will be able to clear the contracts on the S&P 500, S&P MidCap 400 and S&P SmallCap 600 indexes through Chicago-based OCC, which handles all exchange-listed U.S. equity options, Mike McClain, OCC's executive vice president of business development and operations, said in an interview Sept. 20. Regulatory approval from the Securities and Exchange Commission is pending.
The move will bring a segment of the OTC options business into the clearing system for the first time, reducing the financial risk trading parties face if the other side defaults, and potentially lowering costs for firms that transact a large number of contracts at a time. More than $1.1 trillion is directly indexed to the S&P 500 while $4.83 trillion in assets are benchmarked to it, according to OCC and S&P.
“OCC clearing of OTC options is a meaningful change,” said Eric Magac, head of business development at Chicago-based Gladius Investment Group, a hedge fund focused on derivatives. “This will allow clients to retain the attractive aspects of OTC structures, such as being able to tailor the expiration and strikes exactly to match their needs, while eliminating less-favorable attributes such as counterparty risk.”
OCC said for the first time last November that it was considering expansion into the over-the-counter equity options market as regulators began promoting the use of clearinghouses. By acting as the central counterparty to every buy and sell order they process, a clearinghouse reduces the risk that could result if a trading firm defaults on its obligation in a transaction. Clearinghouses are funded by their members, who must meet capital requirements and pass operational and technology tests.
The OCC would like to clear “all listed lookalike options, all other index and share options,” Mr. McClain said.
The OCC plans to use its existing guarantee fund to cover defaults in over-the-counter trades. It will likely charge a similar amount for OTC trades as for listed or exchange-traded contracts, the OCC said.