Options Clearing Corporation Assignment Procedure

Assignment runs through three layers. The exchange sends the trade to the clearing corporation, the clearing corporation assigns an exercise notice to a clearing member, and the clearing member then allocates that assignment to a specific customer. Each layer has its own rule, and the exam tests where one stops and the next begins.

How Does an Options Trade Reach the Clearing Corporation?

The Options Clearing Corporation (OCC) stands at the centre of options clearing, and the Cboe OCC trade reporting rule puts every exchange trade into its system. All transactions made on the Exchange shall be submitted for clearance to the Clearing Corporation, and all such transactions are subject to its Rules.

Each Trading Permit Holder (TPH) shall file trade information with, or at the direction of, the Exchange for each Exchange transaction for which that Trading Permit Holder is responsible.

The Exchange then does the matching. On each business day, at or prior to a time prescribed by the Clearing Corporation, the Exchange submits to the Clearing Corporation a report of each Clearing TPH's trades matched in accordance with the Rules.

The rule then limits the Exchange's own exposure. The Exchange assumes no responsibility with respect to any unmatched trade, nor for any delays or errors in the reporting to it of trade information.

Matching can also move. The Exchange may delegate its responsibility in respect of trade matching to the Clearing Corporation or another facility, in which case Clearing TPHs must abide by the procedures established by that facility in the filing of trade information, the reconciliation of unmatched trades, and other actions pertinent to trade comparison.

Exam Tip: Gotchas

• The Exchange disclaims responsibility for unmatched trades. Its report covers matched trades only, and it assumes no responsibility for delays or errors in the trade information reported to it.
• Delegation of matching moves the procedures a Clearing TPH must follow. Where the Exchange delegates, the Clearing TPH abides by the delegate facility's procedures for filing, reconciliation and other trade-comparison actions.

How Does the Clearing Corporation Assign an Exercise Notice?

The OCC assignment rule states the core duty in one sentence. Exercise notices accepted by the Corporation shall be assigned in accordance with the Corporation's procedures to Clearing Members with open short positions in the series of options involved.

That sentence carries two provisos, and they run in opposite directions.

• The Corporation may assign an exercise notice to a Clearing Member in respect of an opening writing transaction made by that Clearing Member on the day on which the exercise notice was accepted by the Corporation.
• The Corporation shall not assign an exercise notice in respect of any open short position after it has received confirmed trade information for a closing purchase transaction which, upon acceptance, will eliminate that short position, unless and until that closing purchase transaction is rejected by the Corporation.

Timing and dating are stated separately, and they are two different dates. Subject to the provisions of the By-Laws, exercise notices accepted by the Corporation shall be assigned at or before 8:00 a.m. Central Time (CT), which is 9:00 a.m. Eastern Time (ET), on the following business day. Assignments shall be dated and effective as of the date the applicable exercise notices were accepted.

Two notifications follow. The Assigned Clearing Member shall be notified as soon as practicable after the notice is assigned. And, if applicable, the Clearing Member submitting an exercise notice shall, subject to the provisions of another OCC rule that sentence names, be notified of the identity of the Assigned Clearing Member, either through the transmission of Delivery Advices or as soon as practicable after the notice is assigned.

An interpretation fixes the level at which assignment lands. The Corporation assigns exercise notices in respect of positions in a particular account of the Clearing Member or, where the account is divided into sub-accounts, a particular sub-account.

For short positions in over-the-counter options in a Clearing Member's securities customers' account for which the Corporation has a customer ID, the Corporation assigns exercise notices to specific customer IDs.

Exam Tip: Gotchas

• The assignment date and the assignment moment are different dates. The assignment is made at or before 8:00 a.m. CT on the following business day, and it is dated and effective as of the date the exercise notice was accepted.
• A pending closing purchase blocks assignment only once confirmed trade information arrives. The bar runs from the Corporation's receipt of that information, and it lifts if the closing purchase is rejected.
• The rule itself names no selection method. It says assignment is made in accordance with the Corporation's procedures, which is why the method has to be read out of a separate document.

What Method Do the Standard Assignment Procedures Use?

The Corporation's method sits in its Standard Assignment Procedure. An assignment "wheel" is created for each option series for which there is an exercise, and all short positions of that series are placed on the wheel.

Positions go on the wheel in sequential order based on a unique data base identification code given to a position account, meaning an account or sub-account that can hold positions. A position account of a clearing member added after the initial allocation of those codes may not be clustered on the wheel adjacent to the other position accounts of that clearing member.

Each sub-account is treated as a separate position account. The Corporation therefore assigns exercise notices directly to short positions held in a sub-account established by a clearing member for a single beneficial owner, including for individual market makers in a combined market-makers' account.

The number of contracts exercised for the series is then totaled, and the total decides which of two paths runs.

• Full assignment. Where the number of contracts being exercised equals the number of open short positions, the entire open interest for that series is assigned automatically.
• Partial assignment. Where the number exercised is less than the contracts held in open short positions, exercises are assigned in standard assignment increments of 25 contracts.

On the partial path the system calculates a random starting point on the wheel for the first assignment increment, and the first 25 contracts are assigned starting at that randomly chosen position. An initial skip interval is then calculated from the total number of contracts on the wheel and the number of exercise increments to be assigned.

Decimals from the resulting total are truncated to determine the first skip interval and stored to calculate the second. After skipping that interval, the next 25 contracts are assigned, and each later skip interval adds the initial skip interval, including its decimals, to the remaining decimal from the previous truncation. The process continues until all exercises have been assigned.

This standard methodology applies to all classes of options other than those classes which are subject to the pro rata assignment methodology.

Exam Tip: Gotchas

• Only the starting point is random. The system randomises where the first increment of 25 contracts begins. Every increment after that moves by a calculated skip interval, so the process is not a repeated random draw.
• A sub-account is a position account in its own right. That is why the Corporation can assign directly to a sub-account a clearing member established for a single beneficial owner.

How Does a Clearing Member Allocate an Assigned Exercise?

The OCC exercise allocation rule moves the duty to the clearing member. Except as provided in its last sentence, each Clearing Member shall establish fixed procedures for the allocation of exercises assigned in respect of short positions in its accounts to specific option contracts included in those short positions.

The allocation shall be made in accordance with the requirements set forth in Exchange Rules and any applicable rules of any self-regulatory organization of which the Clearing Member is a member. An interpretation adds that where an account is divided into sub-accounts, the procedures must allocate to specific option contracts in short positions maintained in the sub-account to which the exercise notice was assigned.

The last sentence takes over-the-counter options out. The foregoing provisions shall not apply to the allocation of exercises of over-the-counter options, and where the Corporation has assigned exercises to a particular customer ID, the Clearing Member shall allocate the exercise only to the customer associated with that customer ID.

The customer-level allocation methods a member may choose among sit in the Cboe exercise notice allocation rule, which is covered in the unit on options trading.

Exam Tip: Gotchas

• Over-the-counter options are carved out of the fixed-procedures requirement. Where the Corporation assigned to a customer ID, the clearing member allocates to that customer alone, with no allocation method to choose.

What Feeds the Assignment at Expiration?

The OCC expiration exercise procedure produces the notices the Corporation then assigns. At or before such time and date as the Corporation shall from time to time specify with respect to each expiration date, it makes an Expiration Exercise Report available to each Clearing Member, and the member may submit exercise instructions in response.

The procedure then deems the Clearing Member to have properly and irrevocably tendered an exercise notice on two categories: each contract in that report the member instructed the Corporation to exercise, and every contract in that report in the money against the closing price by $0.01 or more, unless the member duly instructed the Corporation to exercise none, or fewer than all, of that series in that account.

Exercise by exception itself, including the closing price definition, the Corporation's discretion where no last sale price is available, the suspension of the deeming branch and the two interpretations, is covered in the unit on options trading.

What Must a Firm Collect After an Exercise or an Assignment?

The Cboe delivery and payment rule puts two duties on the TPH organization, and it states them on different timing words.

As promptly as possible after the exercise of an option contract by a customer, the TPH organization shall require that customer to make full cash payment of the aggregate exercise price on a call, to deposit the underlying security on a put, or to make the required margin deposit where the transaction is effected in a margin account. All of that is in accordance with the Rules of the Exchange and the applicable regulations of the Federal Reserve Board.

As promptly as practicable after the assignment to a customer of an exercise notice, the TPH organization shall require that customer to deposit the underlying security on a call if the underlying security is not carried in the customer's account, to make full cash payment of the aggregate exercise price on a put, or in either case to deposit the required margin where the transaction is effected in a margin account. That duty carries the same Exchange-rules and Federal Reserve Board standard.

The rule ends with a scope limit. It does not apply to binary options.

Exam Tip: Gotchas

• The two collection duties run on different timing words. Collection after a customer's own exercise is due as promptly as possible; collection after an assignment to a customer is due as promptly as practicable.
• The call and put duties swap sides between exercise and assignment. On an exercise the customer pays cash on a call. On an assignment the customer deposits the underlying on a call, and pays cash on a put.

What Should You Check on Exam Day?

• Separate the three layers. The exchange submits matched trades, the clearing corporation assigns to a clearing member, and the clearing member allocates to a customer.
• On a timing question, confirm the assignment is made at or before 8:00 a.m. CT on the following business day but dated as of the day the notice was accepted.
• Confirm only the wheel's starting point is random. Later increments of 25 contracts move by a calculated skip interval.
• On an expiration question, confirm whether the contract is in the money by $0.01 or more and whether the clearing member gave contrary instructions.
• On a collection question, read whether the customer exercised or was assigned. The call and put duties reverse between the two.