The Securities and Exchange Commission’s restrictions on short selling in September 2008 threw the options industry into a frenzy, so it wasn’t hard to imagine another battle after the SEC proposed new restrictions on short selling on April 10. However, options leaders are speaking out against parts of the proposal, and they think the SEC is listening.
There are two approaches to the SEC proposals. A market-wide, permanent approach includes a modified uptick rule, a market-wide short sale price test based on the national best bid and an uptick rule, a market-wide short sale price test based on the last sale price or tick. The second approach is a security-specific temporary approach, or circuit breaker approach. It includes a circuit breaker that would either ban short selling in a particular security for the remainder of the day, if there is a severe decline in that security’s price, or impose a short sale price test based on either the national best bid or the last sale price in a particular security for the remainder of the day if there is a severe decline in price.
If the SEC bans short selling and options market makers are not provided an exemption as in the past and aren’t allowed to short stock at all, “then you’re in a permanent state of really wide markets. It makes transacting a lot harder for options market makers without the ability to be short,” says George Ruhana, CEO of OptionsHouse. “If it’s structured wrong, you’ll get unintended consequences, especially on the total ban. If there’s a ban [on short selling] at 10%, once the stock’s down 5%, people who want to short stocks are going to try and do it before the ban” and therefore actually push the stocks down, he says. “They have to be careful how they structure this and what they’re looking for from an options market maker perspective.”
Options industry participants can weigh in during the SEC’s comment period, which lasts through June. At the annual Options Industry Conference in May, Chicago Board Options Exchange Chairman Bill Brodsky stressed the need for the SEC to allow an exemption for market makers. Not having an exemption would create a “draconian situation,” he said. He called the short sale rule “the most important issue facing the options industry in the United States.”
In an address at the conference, Elizabeth King, associate director of trading and markets at the SEC, was asked about the direction of the market maker exemption. “I don’t know what the likelihood is. I think it’s important that those of you here who are knowledgeable about the options business…comment on this proposal,” she said.
“In a crisis like this, the way the political system works, it doesn’t favor reflection, it favors doing something and being seen to be doing something. Going fast doesn’t tend to encourage in-depth analysis. It tends to be more looking for scapegoats,” says Will Easley, vice chairman of the Boston Options Exchange.
Easley thinks neither SEC staff nor most of the commissioners are “particularly enthusiastic” about short sale restrictions, in part because the SEC’s document requesting comment on the proposals contains 200 pages of questions. “There’s reason to be optimistic that we’ll be able to obtain the market maker exemption. The consequences to the options market are potentially disastrous and I don’t think that’s what anybody wants to happen,” he says. However, he adds, “there’s ultimately political pressure, and it’s up to the people in this industry, the exchanges and the dealers, to speak to Congressmen to educate them on it.”