December 12, 2006
December 11, 2006
Nancy M. Morris
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
Re: Comments on SR-OCC-2006-01
We appreciate the opportunity to comment on the Options Clearing Corporations (OCC) proposal to change the Option adjustment methodology to eliminate rounding error. We also hope you will allow us to offer an alternative solution.
Although we have not asked for permission to speak for retail investors and their Financial Advisors, we believe that we do represent their best interest. Retail order flow has always been considered to be a vital portion of Option volume. We believe that will continue to be so as long as we do not create problems for them.
We wholeheartedly support taking steps to eliminate the inequities created by the rounding effect in the current adjustment method. However, we believe that the suggested change will create too much confusion within the retail community. Indeed, the OCC memo itself (# 22232 dated October 30, 2006) recognizes this problem. In order to continue the progress achieved in bringing retail customers into the Options marketplace, we need to minimize confusion caused by changes to our rules while addressing legitimate problems.
The current method provides some important advantages over the new proposal. First, the strike price correlates with the adjusted price of the underlying equity, while the new method keeps the strike price the same. The result will be that strike prices are disconnected from the current price of the stock. The OCC memo addresses the problem created by this disparity as well. Secondly, in the current method the multiplier is identical to the number of shares represented in the contract which correlates to the number of shares required for delivery and to the premium which is quoted on a per share basis. The new method does not have that correlation. This disparity creates another problem for the customer to understand.
The basic purpose of this process is to provide the purchaser of the stock the same percentage ownership in the underlying company as represented prior to the adjustment. Ideally, the cost (dollar amount exchanged at exercise) would also be identical to the original contracted amount. The fact that this second statement is not currently correct, of course, is the root of the problem.
The problem with the current method, we believe, is not the adjustment formula. Instead the problem is created by what is left out of the final deliverable – a cash component. After the adjustment the net dollars exchanged between the contracting parties is not the same as in the original contract. Instead, the simple formula adjusted strike price times the number of shares disadvantages one party while unjustly rewarding the other.
By adding a cash adjustment into the final delivery requirement, this inequity can be corrected while retaining the simplicity and familiarity which the current method provides. This cash adjustment will either add to or subtract from the calculation (strike price times number of shares) in order to adjust the dollar amount exchanged at exercise back to the original contracted amount. Indeed, the proposed method actually uses this same idea in the case of a 4 for 3 split to cover the remaining amount of the inequity created in the adjustment.
The proposed method also does not apply to a 2 for 1 or 4 for 1 split, further exacerbating the confusion.
And one last problem: When we resolve the problems associated with our current symbology, the OCC suggests that we revert to the current adjustment method. This will require reeducating the same retail clients.
In summary, we believe that this proposal creates an inordinate burden upon the retail client – the most unsophisticated participant in the Options marketplace. While resolving the issue, it creates confusion and ignores a much simpler method to accomplish the same objective.
We would, respectfully, request that this rule change be rejected.
Vice President, Manager
Options Trading and Strategies
Raymond James Associates
Gary M. Franklin
Manager of Option Trading
Managing Director / Senior Options Principal
Morgan Keegan Co.
Mgr. - Options Dept.
J.J.B. Hilliard, W.L. Lyons, Inc.