EFTA01393139.pdf

based option can theoretically offset most of the risk of his writing position by acquiring Treasury securities of the designated maturity period on which the underly- ing yield is based. Offsetting risk in this way may be difficult to do in practice, however. While it is possible at any given time to calculate the principal amount of Treasury securities needed lo assure that the risk of the option position is offset, such calculations are based upon complex mathematical relationships. Moreover. the principal amount of Treasury securities needed to assure that the risk of an options position is fully offset will generally not remain constant throughout the life of the option, but instead will fluctuate as a result of changes in yields and remaining time to maturity. For a given percentage change in yield, this fluctuation will be greater for securities of longer maturity periods than for securities of shorter maturity periods. Furthermore, there can be no assurance that an option writer will be able to sell the Treasury securities that he holds at the option's expiration at the same average yield that is used in calculating the exercise settlement value of the option. Prices, and therefore yields, could differ from dealer to dealer. Moreover, when dealer quotations are averaged in obtaining a yield, they may result in a value which varies from the value that would be ob- tained by averaging yields representing actual transac- tions for the same securities during the same time period. 6. Investors in yield-based debt options run the risk that reported yields may be in error. The values dis- seminated by the designated reporting authority of the Options markets during trading and for exercise settle- ment purposes will ordinarily be averages or medians of dealer quotations or prices, and it is possible that errors could be made in the gathering or averaging of these values. A person who buys or sells an option at a premium based on an erroneous reported yield value is bound by the trade and has no remedy under the rules of the options markets. Similarly, persons who exercise options or are assigned exercises based on erroneous reported yields will ordinarily be required to make settlement based on the value as initially re- ported by the reporting authority, even if a corrected value is subsequently announced. In extraordinary cir- cumstances (e.g.. where a value as initially reported is obviously wrong and inconsistent with values previ- ously reported, and a corrected value is promptly an- nounced). OCC may direct that exercise settlements 81 CONFIDENTIAL - PURSUANT TOEFEESERM0S13566 P. 6(e) CONFIDENTIAL SDNY_GM_00244750 EFTA01393139