The Securities and Exchange Commission has issued an order approving a rule change proposed by the Chicago Board Options Exchange Incorporated (CBOE) to list and trade options on corporate debt securities (CDSOs), thus providing an exchange-traded equivalent to the over-the-counter market in CDSOs. According to CBOE, the main advantages of exchange-listed as opposed to over-the-counter CDSOs would be greater contract term standardization and resulting liquidity, reduced counterparty credit risk, and increased transparency due to data provided by CBOE.
The initial listing standards for a CDSO include (i) original public sale of the underlying corporate debt security (CDS) in a principal amount of atleast $250 million, (ii) trading volume of the CDS over the preceding 6 months of at least $100 million in notional value, (iii) minimum aggregate par value or "float" of the CDS of at least $200 million, (iv) at least 360 holders of the CDS, (v) at least one class of common or preferred equity securities of the issuer of the CDS (or its parent) registered under Section 12(b) of the Securities Exchange Act of 1934, and other requirements.
CDSOs will be European-style and physically settled, and their option premium will be quoted in points each equal to $1,000. The position limits established by CBOE will be tiered so that all positions, if exercised, would not exceed 10% of the total float of the underlying bond (the lowest CBOE position limit for equity options is 19.28% of the minimum float of the underlying equity security—a difference which CBOE believes is justified by the differences in liquidity between the equity and debt markets). The CDSOs will be subject to margin requirements (both initial and maintenance margin), determined through CBOE's formula for all other option classes but adjusted for market factors specific to the debt rating and type of underlying CDS. CBOE's surveillance plan for CDSO trading includes monitoring for insider trading, mini-manipulation, manipulation, frontrunning, and capping and pegging.