New Rule
Rule from SEC will require quick adjustments by traders
The Securities and Exchange Commission adopted a new rule Wednesday that will make it more difficult for options market makers to sell stock without owning it first -- a move that could change the way the market operates.
The SEC's new rule, slated to go into effect Thursday morning, prompted immediate and widespread concern within the options market.
Some market makers said the rule will lead to wider spreads on options prices, making it more expensive for all investors to trade the contracts. Others said the rule will force them to stop trading options in certain companies altogether.
Market makers prepared for a long night during which they would digest the new policy before Thursday's session opened.
"We might have to be here until midnight," said Thomas Peterffy, chief executive of Interactive Brokers.
Market makers grease the wheels of the options market by taking the other side of investors' orders to buy and sell options. In that role, they routinely engage in short selling in an effort to hedge their positions.
The SEC's rule will eliminate an exemption that had been granted to options market makers under Regulation SHO. That 2005 rule aimed to curb abusive short selling by enforcing deadlines under which sellers of stock had to deliver shares to buyers of stock.
Under Regulation SHO, sellers had 13 days to deliver shares known as "threshold securities" -- stocks in which there had already been a high level of delivery failures. If 13 days lapsed, then the rule forced sellers to buy back the stock.
The SEC had granted market makers an exemption from the rule, after market makers pointed out that they did not take short positions to speculate on future moves. As a result, market makers could maintain short positions indefinitely, as long as they had established their positions before the stocks appeared on the threshold list.
Because of the way the rule was written, it is likely some market makers thought the exemption granted them broader flexibility than the SEC had intended.
The new rule forces market makers to deliver stock within three days of conducting the sale. Some could elect to pre-borrow stock, and that will drive up the prices of the contracts.
The SEC's new rule comes at an especially busy time. On Wednesday, there were more than 26 million options that changed hands, setting a record for the number of trades in one day, according to the Options Clearing Corp. The previous record was set on July 15.
The SEC proposed to eliminate the market-maker exemption in July. Nevertheless, industry experts said they were troubled by the commission's decision to implement it just one day after announcing its adoption.
"We're not surprised they eliminated the market-maker exemption. They made it clear in the proposal that they were strongly inclined to do that," said Susan Milligan, executive director of the Options Industry Council. "We are shocked they eliminated it as of tomorrow, with no time to buy in fail positions that have existed for long periods of time."
(Published by The Wall Street Journal - September 18, 2008)