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Options clearing corporation occ

What Is Options Clearing Corporation (OCC)?

The Options Clearing Corporation (OCC) is the world's largest equity derivatives clearing house and a vital component of the financial market infrastructure. It acts as a central counterparty (CCP) for exchange-traded options contracts and futures contracts in the United States, guaranteeing the performance of cleared trades and facilitating settlement services. In this role, the OCC effectively becomes the buyer to every seller and the seller to every buyer, thereby eliminating counterparty risk between market participants. The OCC falls under the broader financial category of Financial Market Infrastructure and Derivatives Clearing.

History and Origin

The Options Clearing Corporation (OCC) was founded in 1973, marking a significant development in the evolution of the U.S. options markets. Prior to its establishment, clearing functions were often handled by individual exchanges, such as the Chicago Board Options Exchange (CBOE) Clearing Corporation. With significant encouragement from the Securities and Exchange Commission (SEC), the OCC was created to centralize the clearing process for listed equity options.

The formation of the OCC was crucial for fostering confidence and growth in the nascent listed options market by providing a single, reliable guarantor for all transactions. Over the decades, its clearing volumes have increased dramatically, reflecting the expanding use of equity derivatives. By 2011, the OCC had become the largest equity derivatives clearing organization in the U.S., and by 2020, it cleared a record 7.52 billion total contracts.9

Key Takeaways

  • The Options Clearing Corporation (OCC) serves as the central counterparty for all exchange-listed options and futures contracts traded in the United States.
  • By acting as the guarantor, the OCC assumes the counterparty risk between buyers and sellers, ensuring the fulfillment of contractual obligations even if one party defaults.
  • The OCC operates under the joint jurisdiction of the U.S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC).
  • It plays a critical role in market stability by managing systemic risk through robust risk management frameworks, including the collection of margin and collateral from its clearing members.
  • The OCC is designated as a Systemically Important Financial Market Utility (SIFMU) under the Dodd-Frank Act, highlighting its essential role in the financial system.

Interpreting the Options Clearing Corporation (OCC)

The significance of the Options Clearing Corporation (OCC) lies in its function as a central counterparty. Its role fundamentally transforms the landscape of derivatives trading by muting the impact of individual counterparty defaults. When a trade is executed on an exchange, the OCC steps in between the buyer and the seller. This means that neither the buyer nor the seller needs to assess the creditworthiness of their direct trading partner. Instead, both parties face the OCC, which has stringent risk management protocols in place, including capital requirements and the collection of initial and variation margin from its clearing members. This structure enhances market efficiency and liquidity by reducing perceived risk, thus encouraging greater participation in the options and futures markets.

Hypothetical Example

Consider a scenario where an investor, Alice, wants to buy 10 equity options on Company XYZ through her broker-dealer. Simultaneously, another investor, Bob, wants to sell 10 identical options on Company XYZ.

  1. Alice places a buy order, and Bob places a sell order.
  2. Their respective broker-dealers transmit these orders to an exchange.
  3. Once the orders match and a trade is executed, the Options Clearing Corporation (OCC) steps in.
  4. The OCC becomes the seller to Alice's broker-dealer and the buyer to Bob's broker-dealer.
  5. If, at expiration, Alice decides to exercise her options, the OCC guarantees that Bob's broker-dealer (on behalf of Bob) will fulfill the obligation, or the OCC itself will step in. Conversely, if Bob is obligated to deliver shares, the OCC ensures Alice's broker-dealer receives them.

This intervention by the OCC means Alice and Bob never directly face each other's credit risk. They only face the OCC, which is designed to withstand significant market stresses and member defaults.

Practical Applications

The Options Clearing Corporation (OCC) is integral to the functioning of U.S. financial markets, particularly in the realm of derivatives. Its practical applications are numerous:

  • Risk Mitigation: The primary application is the reduction of counterparty risk. By interposing itself between trading parties, the OCC absorbs the default risk of any single participant, thereby protecting the market as a whole. Its robust risk management framework, which includes demanding collateral from clearing members, is key to this function.7, 8
  • Market Efficiency and Liquidity: The guarantee provided by the OCC fosters trust and encourages greater participation in the options and futures markets. This increased participation contributes to tighter spreads and deeper liquidity, making it easier for investors to enter and exit positions. The OCC highlights its role as "the buyer to every seller and the seller to every buyer" as foundational for secure markets.6
  • Standardization and Settlement: The OCC standardizes the terms of options contracts and futures contracts for clearing, ensuring uniformity across various exchanges. It then handles the post-trade processing, including trade matching, clearing, and financial settlement, streamlining operations for market participants.
  • Regulatory Oversight: As a designated Systemically Important Financial Market Utility (SIFMU) under the Dodd-Frank Act, the OCC's operations are under the purview of multiple regulators, including the SEC, CFTC, and the Federal Reserve Board. This ensures a high level of scrutiny and adherence to sound financial practices. The Federal Reserve supervises SIFMUs due to their critical role in the financial system.4, 5

Limitations and Criticisms

Despite its critical role in market stability, the Options Clearing Corporation (OCC) has faced scrutiny and criticism, particularly concerning its risk management and governance. Following the 2008 financial crisis, there was increased regulatory focus on central counterparties. The SEC, in particular, has highlighted areas for improvement.

In 2013, the Securities and Exchange Commission (SEC) testified before the U.S. Senate, emphasizing the need for CCPs like the OCC to have robust risk management practices, sufficient financial resources, and effective governance. The testimony underscored that while CCPs reduce counterparty risk, they concentrate risk and therefore must be exceptionally resilient. This heightened attention has led to continuous efforts by the OCC to enhance its operational capabilities and financial safeguards.3

Furthermore, the dual jurisdiction of the SEC for options and the Commodity Futures Trading Commission (CFTC) for futures and options on futures, combined with its SIFMU designation under the Federal Reserve, means the OCC operates under complex regulatory oversight. While this provides multiple layers of supervision, it also presents challenges in coordinating regulatory expectations and implementing comprehensive frameworks that satisfy all governing bodies.

Options Clearing Corporation (OCC) vs. Office of the Comptroller of the Currency (OCC)

The acronym "OCC" can lead to confusion because it refers to two distinct and significant entities in the U.S. financial landscape: the Options Clearing Corporation and the Office of the Comptroller of the Currency.

The Options Clearing Corporation (OCC), as discussed, is a self-regulatory organization that acts as a central counterparty for exchange-traded derivatives, primarily options and futures. Its core function is to guarantee the performance of these contracts, thereby mitigating counterparty risk for market participants. It operates under the oversight of the SEC and CFTC.

In contrast, the Office of the Comptroller of the Currency (OCC) is an independent bureau within the U.S. Department of the Treasury. Its primary mission is to charter, regulate, and supervise all national banks and federal savings associations. The Office of the Comptroller of the Currency ensures that these institutions operate safely and soundly, provide fair access to financial services, and comply with applicable laws and regulations. While both entities play crucial roles in financial stability, their mandates, regulatory scope, and the types of institutions they oversee are entirely separate.

FAQs

What does the Options Clearing Corporation (OCC) do?

The Options Clearing Corporation (OCC) serves as the central counterparty for all exchange-traded options and futures contracts in the United States. It guarantees that the obligations of these contracts are fulfilled, effectively removing counterparty risk between trading parties.

Who regulates the Options Clearing Corporation (OCC)?

The Options Clearing Corporation (OCC) operates under the jurisdiction of two primary U.S. financial regulators: the Securities and Exchange Commission (SEC), which oversees options, and the Commodity Futures Trading Commission (CFTC), which oversees futures and options on futures. It is also designated as a Systemically Important Financial Market Utility (SIFMU) by the Financial Stability Oversight Council, meaning it is also supervised by the Federal Reserve Board.1, 2

Why is the Options Clearing Corporation (OCC) important to financial markets?

The Options Clearing Corporation (OCC) is crucial because it significantly reduces systemic risk in the derivatives markets. By guaranteeing trades and managing the default risk of its clearing members through robust risk management practices and the collection of margin, the OCC ensures that the failure of one market participant does not cascade and destabilize the broader financial system.

Does the Options Clearing Corporation (OCC) issue options?

Yes, the Options Clearing Corporation (OCC) is technically the issuer of all listed options contracts in the U.S. Once a trade is executed, the OCC creates the option contract and becomes the counterparty to both the buyer and the seller. This facilitates the fungibility and transferability of options.

Is the Options Clearing Corporation (OCC) a government agency?

No, the Options Clearing Corporation (OCC) is not a government agency. It is a privately owned self-regulatory organization (SRO) that provides clearing and settlement services. However, due to its critical role in the financial system, it is subject to extensive regulation and oversight by U.S. government agencies like the SEC, CFTC, and the Federal Reserve Board.