he Chicago Mercantile Exchange and the Chicago Board of Trade are petitioning T the Commodity Futures Trading Commission (CFTC) to repeal a long-standing regulation requiring an investor to pay the total value of an option premium when purchasing a commodity option. Under the current "stock-style" option system the option buyer or "long" must pay the entire premium when the transaction is initiated. No further payments are required. The premium is credited to the account of the option seller or "short" who must keep it posted as margin. The option seller also must put up risk margin to cover potential adverse market moves in his obligation. If the option increases in value, the short must deposit additional funds into the account. These funds, however, are not transferred to the long, who must exercise or sell the option to realize any increase in its value. By contrast, if the option value decreases, the short may withdraw any excess funds from its account.
Under the proposed futures-style margin system, both the long and the short position holders would post risk-based original margin upon entering their option positions. During the life of the option, the option value would be marked to market daily, and gains and losses would be paid and collected on a daily basis just like futures positions are maintained today. I
The CFTC published a notice of petition for rulemaking in the Federal Register2 of March 17, 1989. In the Federal Register, the CFTC identified a number of benefits arising from futures-style margining of options. The CFTC also raised some concerns with respect to futures-style margining. A significant source of confusion, the C R C pointed out, could be the differences in option pricing which could result from futures-style margining. Option premiums potentially would be higher under a futures-style system because shorts would demand a higher price to compensate for the loss of interest on the full premium and longs would be willing to pay a higher price because they would be gaining such interest income. But exactly how the proposed system would change the equilibrium option pricing formula is unclear. I am grateful to Todd E. Petzel, Warren Bailey, Hong-Ming Shaw and the referee of this Journal for helpful comments. ' However, a futures-style option is unlike a futures contract in that the long side of the option position can exercise the option either on any business day (if American) or at option expiration (if European). 'The proposed rule change affects only options on futures contracts. Options on physical (cash) are not affected. The CFTC rule change should be distinguished from the proposed SEC rule change on equity options that was published in the Federal Register of