Discussion in 'Options' started by demoship, Jul 20, 2007.
I don't understand the logic behind this rule.
Im not sure you are right but if you are its probably due lobby
Yes they can. I trade foreign equities everyday...
equity or index OPTIONS.
You can trade foreign equities.
Maybe it's considered unpatriotic for US citizens to trade options on non US markets .
I din't know about that rule.
Usually it means the foreign product is better and cheaper.
If you really want to trade these options you have either to move out of the US or open an offshore institutional account.
Trading Foreign Options: Rules of the Game
by Anthony Leitner and Edward Rosen
The hypothetical scenario described in this article is intended to illustrate some of the differences between the two regimes in the United States that regulate trading in foreign listed options. For reasons of space, the discussion only touches the high points of these differences.
Mary Jane is an investment adviser registered with the Securities and Exchange Commission and a commodity trading advisor registered with the Commodity Futures Trading Commission. She manages money for a large pension fund and for several very wealthy investors.
To diversify her clientsâ investments she acquired a portfolio of European stocks and bonds. She now believes that European interest rates will rise over the short term, causing the value of the bond portfolio to fall. She decides to use options to hedge the interest rate risk in the bond portfolio. She also feels that since stocks in the portfolio generally are likely to trade in a narrow range, it would be a good time to sell out-of-the-money call options to enhance the income of the stock portfolio. She is also considering buying call options on certain of her foreign stocks that she believes will outperform the portfolio.
She sees that the Euronext.liffe exchange in London offers options on the Euribor futures contract and on the London-traded stocks in her clientsâ portfolios. She also sees that the Eurex exchange in Frankfurt offers equity options. She calls Ted, a broker at the broker-dealer that helped her acquire her portfolio, to discuss her order. Ted tells her that, as a futures commission merchant, his firm would be happy to open futures accounts for her clients, and in these accounts she can trade Euribor options. But he will have to preclear with his legal or compliance departments whether his firm can execute the equity option trades for her clients on Euronext.liffe and Eurex.
The equity options, he informs her, will have to be booked in securities accounts. Any margin required for the derivatives will be computed and collected separately in each account, without any netting between the accounts.
She is not happy, and asks why it is so complicated to trade these options. Knowing he is out of his depth, Ted conferences in Bob, his in-house lawyer. Bob immediately thinks "Oh no, not again!" but agrees to try and answer Mary Janeâs questions.
"Mary Jane, the simple answer is that the Euribor options are products regulated by the Commodity Futures Trading Commission and equity options are securities regulated by the Securities and Exchange Commission," Bob explains. "The governing laws and regulatory schemes have taken very different approaches to these two types of options products and the foreign exchanges on which they trade. These differences affect whether and how U. S. investors and their brokers can access these foreign products.
"We can offer you direct trading in foreign listed options on interest rate futures because they are exclusively regulated under the Commodity Exchange Act and neither the CEA nor CFTC rules restrict a U.S. FCM from offering these products to U.S. clients. On the other hand, the CFTC has no jurisdiction over options on securities or equity indices. The SEC has jurisdiction over these products, so the federal and state securities laws apply."
Mary Jane is curious. "Bob, I just donât understand why this is so. Options are exchange products. Arenât all foreign exchanges treated the same?"
"Unfortunately no," Bob replies. "The CFTC has taken a number of steps that make it easier for U.S. investors to trade foreign futures and options, and has allowed a number of foreign exchanges to promote certain of their products to U.S. investors. The CFTC also has granted permission to several foreign exchanges to make their trading systems available in the U.S. Eurex, then known as DTB, was granted this right in 1996, and Euronext.liffe, then Liffe, in 1999. That makes it easy for our firm to execute your Euribor options order because we have Liffeâs trading terminals right here in Chicago and you can even place your orders electronically from your own office.
"Itâs a very different situation for equity options. The federal securities laws regulate not only the exchanges that promote the trading of these products to U.S. investors but also the offer and sale in the U.S. of any product that is a securityâand options on securities and equity index options are securities. So if foreign exchanges want to promote their equity options products to U.S. investors, they face having to register as exchanges with the SEC. No foreign exchangeâas far as I knowâhas registered with the SEC. In addition, they have to either register the offer of options or find an exemption from that requirement."
"Wait a minute, Bob," says Mary Jane, "Iâve heard that some foreign exchanges have gotten permission from the SEC to sell equity options in the U.S."
"Youâre right, Mary Jane," Bob replies. "The SECâs Division of Market Regulation granted no-action letters to several foreign options exchanges relieving them from the exchange registration requirement. Euronext.liffe obtained a no-action letter but Eurex has not. These letters establish a number of conditions. For example, the division allowed the exchanges and their members to make available information about themselves, their clearinghouses and their products to eligible investors, which the SEC defines as QIBs, but only if they have prior experience in trading options. The exchanges also may allow their members to accept orders from QIBs, but they are required to send their own options disclosure statement to the QIBs before their members can take an order."
"What is a QIB?" asks Mary Jane.
"A QIB is a âqualified institutional buyerâ defined in SEC Rule 144A and includes a range of institutional investors, such as mutual funds, insurance companies, pension funds and trusts, that own and invest at least $100 million in securities. As a registered investment adviser you qualify if you manage at least $100 million in securities, but each account for which you trade options must also be a QIB. Unfortunately, individual investors donât qualify as a QIB no matter how rich or experienced they are," Bob explains.
"Well, I guess I personally qualify, and the pension fund I manage has more than $100 million in securities, but the rest of my clients are wealthy individuals," replies Mary Jane. "Does that mean I canât even use options for conservative strategies like writing covered calls or hedging with put options for my individual clients?"
"Unfortunately, youâre right, that wonât work under the no-action letters," Bob answers.
Mary Jane is stunned. "Let me get this straight. If I happened to be a professional options trader with a net worth of $10 million, I canât trade the foreign equity options for my own account? Even Warren Buffet canât trade foreign equity options? Not even as a hedge?"
"Thatâs right, at least not under the no-action letters," Bob replies. "But keep in mind that the SEC doesnât actually forbid U.S. investors from trading. The SEC simply insists that the foreign exchanges must make sure that when their members take orders from U.S. investors, those orders are coming only from QIBs. But the result is the same if everyone is abiding by the terms of the letters.
"You could consider trading options for your high net worth clients in the over-the-counter market as an alternative. Of course, OTC options raise a number of additional considerations. We would have to set up additional documentation and you would have to consider a number of issues such as credit and liquidity risk."
Mary Jane is exasperated. "Why has the SEC made it so difficult for me to trade foreign equity options for my high-net worth clients?"
"Thatâs a tough question," Bob responds. "I guess that one of the reasons the SEC used the institutional QIB approach was to avoid undercutting the policies underlying the federal securities laws. As I said before, unlike the CFTC, the SEC regulates the offer and sale of options and of the equity security underlying the option. Specifically, the offer and sale of any security to a U.S. person is regulated by the Securities Act of 1933, as amended. This law basically requires that the offer and sale to the public of any security must be done pursuant to a registration statement that the SEC declares effective, and a prospectus must be delivered to purchasers before the trade unless there is an exemption available.
"Yes, but you were able to execute my trades in foreign stocks and bonds. How is that different from foreign options?" Mary Jane asks.
"We were able to sell the foreign stocks and bonds in your portfolio because none of these were involved in a distribution at the time and exemptions from registration were available. But options are unusual animals. The SEC considers that options are âcontinuously offered.â With respect to options traded on U.S. exchanges, the SEC dealt with that by adopting a rule under which the Options Clearing Corp is considered the issuer of every option and the OCCâs Options Disclosure Statement is considered to be in the nature of a prospectus.
"Foreign exchanges have not sought to register their options. Thus, the risk disclosure statement that must be delivered to potential U.S. investors under the no-action letters does not have the same status as the OCC Risk Disclosure Statement. That means that for purposes of the Securities Act, anyone offering or selling these options to you must rely on an exemption from registration."
"So what you are saying is that you need an exemption in order to offer foreign equity options to me?" Mary Jane asks.
"Thatâs right. Rule 144A is a limited exemption from registration that allows securities to be offered to QIBs as long as the securities are not being offered in a public distribution. Our firm is prepared to rely on Rule 144A to trade foreign index options for the accounts that are QIBs.
"There is, however, an additional issue for single stock options. The SEC has said that options are deemed the equivalent of a purchase (long call, short put) or a sale (short call, long put) of the underlying security. That means that we need an exemption from the registration requirements for both the sale of the option and for the sale of the underlying security.
"Accordingly, there may be times when our firm must restrict your options trading because our firm is engaged in an investment banking transaction with the issuer of that stock. This is no different than when we restrict trading in a stock and its options in the U.S."
"If your firm restricts my trading in an option, I can just go to a broker in London to place my order, right?" asks Mary Jane.
Bob, grimacing, answers, "Mary Jane, I canât tell you what a broker in London will or wonât do, but technically the foreign exchanges agreed in their representations to the SEC, and their no-action letters are based upon, undertakings that any actual options transactions will be done pursuant to SEC rule 15a-6 and in conformity with other applicable U.S. securities laws. That rule generally requires that these trades be effected through a U.S. broker acting as agent for the foreign broker. So unless the foreign broker considered your order to be completely unsolicited, the foreign broker would still need to go through a U.S. broker to accept your equity option orders.
"The CFTCâs rules here are quite different. Under Part 30, the CFTC has recognized âcomparableâ regulatory regimes and doing so has allowed foreign FCMs to deal directly with futures customers in the U.S."
"So I pay two commissions for an equity option trade and just one for a Euribor trade?" asks Mary Jane.
"Thatâs correct," says Bob. "The SEC has specifically prohibited foreign exchanges from putting their trading screens in the U.S., so our firm has to send your order to our London affiliate for execution and that will add costs to the transaction. European regulators have asked the SEC to allow them to put their trading screens here but have not been successful. But, as I said before, the CFTC allows us to have direct access to Liffeâs futures and options on futures so you pay one commission."
Totally exasperated, Mary Jane says, "Well maybe Iâll just trade the single stock futures that Liffe offers."
"Ummm," says Bob, wishing this was over. "Itâs true that the Commodity Futures Modernization Act removed the prohibition against trading single stock futures in the U.S., but foreign single stock futures, and narrow-based index futures for that matter, are still prohibited. Nobody is supposed to sell these to you."
"I still donât understand. Why does the SEC make it so difficult for U.S. investors to manage the risks on their foreign equity portfolios and take advantage of listed products that have an active market?"
"There are a number of policy reasons that inform the SECâs views," Bob explains. "These include accounting disclosure for foreign issuers, general disclosure and anti-fraud concerns and investor protection. While there may be alternatives to the current state of affairs, the SEC has a lot on its plate right now, and the fact is that because they arenât under pressure from people like you to address these rules they have no incentive to move the bar."
"Thanks, Bob," Mary Jane replies. "Unfortunately, I also have more pressing issues than lobbying the SEC on foreign stock options. Iâll follow up with Ted, or maybe Iâll just move to London!"
The foreign exchanges listed below have received no-action letters from the Securities and Exchange Commission, under which they and their members may offer option products to "qualified institutional buyers" (a term defined in SEC Rule 144A) in the U.S.
EDX London and OM London Exchange Oct. 23, 2003
Tokyo Stock Exchange Nov. 15, 2002
Paris Bourse Dec. 6, 1999
Tokyo Stock Exchange Jul. 27, 1999
Osaka Securities Exchange Jul. 23, 1999
Monep Oct. 26, 1998
Borsa Italiana Sep. 1, 1998
SociÃ©tÃ© de Compensation des Marches Conditionnels Jun. 17, 1996
London Internatâl Financial Futures and Options Exchange Mar. 6, 1996
Hong Kong Futures Exchange Sep. 26, 1995
London International Financial Futures Exchange May 1, 1992
London Traded Options Market Oct. 30, 1990
Source: Cleary, Gottlieb, Steen & Hamilton
Don't ya luv it when you guvmint does such a stellar job of protecting you from the evils of furrin options markets!
Afterall you could get hurt. Sure, and Enron, 911, etc etc etc didn't hurt us. Howz about we are each responsible for ourselves. No, I guess thats simply too radical an idea.
I guess the SEC wants people to keep their money in the US, so we can get screwed by our own fraudulent shit (REITs and subprime bonds anyone?)
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