The Securities and Exchange Commission has published for comment a Chicago Board Options Exchange proposal to list and trade options on credit defaults. Each option would specify an entity that could be the issuer or guarantor of a debt obligation and the reference obligation. Upon the occurrence of a failure to pay default on the reference obligation or any other debt referenced in the referenced obligation on or prior to the expiration date of the option, the holders with a long position would receive $100,000 per contract, and holders of short positions would pay $100,000 per contract. Other events of default would be specified by the CBOE when listing an option that would trigger such payments. Payments would be made by, and collected by, The Options Clearing Corporation. If an option expired prior to a default, the payment obligation would be $0.
Each option class could be for up to 10.25 years from the date trading starts. Expiration of a class would be on the third Friday of March, June, September or December.
For a credit default option to be listed, the obligor must be registered with the SEC under Section 12 of the Securities Exchange Act, and its stock must meet the eligibility requirements for options on it to be traded on the CBOE. Position limits for a credit default option would be 5,000 contracts (pay or receive $500,000,000). Margin would be 100% of the current market value for long positions and 100% of the settlement amount ($100,000) for short positions but only 20% in the case of a “qualified customer.” A “qualified customer” is a person or entity that owns and invests on a discretionary basis not less than $5,000,000 in investments. Margin may be satisfied by depositing cash, marginable securities or a bank issued, irrevocable letter of credit expiring no sooner than the expiration date for the option class being margined.
Credit default options would trade in increments of $.05 ($50 per contract).