SEC Considers Revising Shorting Ban in Options Market

SEC Considers Revising Shorting Ban in Options Market (Update2)
By Edgar Ortega and Michael Tsang
Sept. 19 (Bloomberg) -- The U.S. Securities and Exchange Commission may revise its ban on short sales to add financial companies and carve out an exemption for brokerages that pair off brokers in the $1.6 trillion U.S. options market.
The commission may add companies after firms such as M&T Bank Corp. were left off a list of 799 insurers, banks and securities institutions barred from short sales. The staff also will recommend that options market-makers be exempt from the ban, easing concern the rule would raise investor costs, the agency said in a statement today.
``If they don't fix it, there just won't be an options market on Monday,'' Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago-based online brokerage unit of options trading firm PEAK6 Investments LP. ``If they have an exemption for market-makers that they're allowed to sell stock short, then they can provide a market in the options.''
The SEC is prohibiting investors from betting against banks and brokerages to stem a sell-off that erased as much as $3.8 trillion from stocks globally after the collapse of Lehman Brothers Holdings Inc. and American International Group Inc. U.K regulators and attorneys general in New York, Texas and Connecticut, and the three largest U.S. pension funds are cracking down on short sellers.
Short sellers try to profit by betting stock prices will fall. In a short sale, traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and pocket the difference.
`Disastrous'
Options market makers would have been prohibited from making short sales starting next week under the ban adopted today to keep speculators from driving down stock prices. The Options Clearing Corp., which guarantees all trades exchange- listed options, said a ban would have proved ``disastrous.''
The list of companies for which short-selling is banned included Morgan Stanley, Wachovia Corp., Washington Mutual Inc., Goldman Sachs Group Inc. and Warren Buffett's Berkshire Hathaway Inc. Banks including Capital One Financial Corp. and Commerce Bancshares Inc. also were omitted. General Electric Co., which got about half its profit from financial units last year, was left off the list.
``The commission is willing to consider adding comparable financial companies as appropriate,'' SEC spokesman John Heine said in a statement today.
Interactive Brokers
Under rule announced today, market-makers such as Interactive Brokers Group Inc. and Susquehanna International Group LLP would be unable to short a stock to hedge their risks when clients buy or sell options on financial shares. Options give investors the right to buy or sell stocks at fixed prices in the future.
Market-makers, accounting for about 40 percent of trades, are obliged to quote prices at which they'll buy and sell securities so investors are able to complete trades.
The SEC staff will recommend an exemption for the duration of the ban, scheduled to expire Oct. 2, the agency said in the statement. Stocks surged in the biggest two-day global rally in 38 years as the crackdown took effect for speculators who drove down shares of financial companies.
Roughly 23 million contracts were traded on the seven U.S. option exchanges today, down from a record 30 million yesterday, according to OCC statistics.
``Either you had to change the rules or you had to halt options trading,'' said Henry Schwartz, president of Trade Alert LLC, a New York-based provider of options market analytics. ``This is the better choice. You couldn't have left it as it is because options market makers were refusing to quote without the ability to hedge.''
Option Prices
Prices for options today show that market-makers were already seeking to compensate for the added risk by widening the difference between their bids and offers, according to Peter Bottini, an executive vice president of Chicago-based online brokerage OptionsXpress Holdings Inc. The wider spreads make it more costly for investors to buy or sell options.
``For our retail customers, the costs of adjusting their portfolio has gone through the roof, because the bid-ask spreads have gone through the roof,'' said Bottoni, a former market maker at the Chicago Board Options Exchange.
The SEC's order comes in the midst of the biggest drop in financial-industry shares since at least 1962, according to data compiled by Birinyi Associates Inc., a Westport, Connecticut- based research and money-management firm. Goldman Sachs Group Inc. and Morgan Stanley, the remaining independent securities firms on Wall Street, plunged by the most ever this week, prompting Morgan Stanley Chief Executive Officer John Mack to say short sellers are using abusive tactics to attack companies