[Federal Register Volume 59, Number 47 (Thursday, March 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5480]


[[Page Unknown]]

[Federal Register: March 10, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33700; File No. SR-PSE-93-07]

 

Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment Nos. 1 and 
2 to a Proposed Rule change by the Pacific Stock Exchange, Inc. 
Relating to the Listing and Trading of Quarterly Index Expiration 
Options Based on the Wilshire Small Cap Index

March 2, 1994.
    On April 21, 1993, the Pacific Stock Exchange, Inc. (``PSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to provide for the listing and 
trading of options on the Wilshire Small Cap Index (``Wilshire Index'') 
that will expire on the last business day of each calendar quarter 
(``Quarterly Index Expirations'' or ``QIXs'').\3\ Currently, Wilshire 
Index options traded on the Exchange expire on the Saturday immediately 
following the third Friday of the expiration month. The PSE intends to 
trade Wilshire Index QIXs in addition to the existing Wilshire Index 
options expiring at the middle of the month. Notice of the proposed 
rule change appeared in the Federal Register on June 23, 1993.\4\ No 
comments were received on the proposed rule change. On December 28, 
1993, the Exchange filed Amendment No. 1 to the proposed rule 
change.\5\ On February 8, 1994, the Exchange filed Amendment No. 2 to 
the proposed rule change.\6\ This order approves the proposal.
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    \1\15 U.S.C. 78s(b)(1) (1982).
    \2\17 CFR 240.19b-4 (1993).
    \3\The Wilshire Small Cap Index is a broad-based, 
capitalization-weighted index of domestic equity securities traded 
on the New York Stock Exchange, Inc. (``NYSE''), American Stock 
Exchange, Inc. (``Amex''), and as national market securities traded 
through the facilities of the National Association of Securities 
Dealer's Automated Quotation system. The Index is composed of 250 
domestic equity securities, and is designed to reflect the 
characteristics and market performance of small stocks generally.
    \4\See Securities Exchange Act Release No. 32485 (June 17, 
1993), 58 FR 26013 (June 23, 1993).
    \5\In Amendment No. 1, the PSE proposes to add subparagraph (u) 
to Rule 7.1 to include a definition of QIX options. See Letter from 
Michael Pierson, Senior Attorney, Market Regulation PSE, to Richard 
Zack, Branch Chief, Office of Derivatives and Equity Regulation, 
Division of Market Regulation, Commission, dated December 28, 1993.
    \6\In Amendment No. 2, the PSE proposes (1) to adopt Rule 7.8(d) 
specifying the terms of QIX options; and (2) to change a reference 
in proposed Rule 7.6(d)(2) from ``Exchange'' to ``Board.'' In 
Amendment No. 2, the Exchange also agrees that: (1) the use of any 
multiplier with respect to QIX options other than 100 will require 
Commission approval pursuant to Section 19(b) of the Act; (2) any 
proposal to list and trade QIX options with more than twelve months 
to expiration will require Commission approval pursuant to Section 
19(b) of the Act; and (3) QIX options will be subject to the same 
rules that presently govern the trading of existing Wilshire Small 
Cap Index options contracts, including sales practice rules, margin 
requirements, and floor trading procedures. See Letter from Michael 
Pierson, Senior Attorney, Market Regulation, PSE, to Brad Ritter, 
Attorney, Office of Derivatives and Equity Regulation, Division of 
Market Regulation, Commission, dated February 7, 1994 (``February 7 
Letter'').
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    The Exchange proposes to add subparagraph (d) to Rule 7.8 to 
provide for the listing of up to eight near-term quarterly expirations 
for trading on Wilshire Index options. The PSE would be permitted at 
any one time to have up to eight QIX Wilshire Index options open for 
trading with expiration dates on the last business day of a calendar 
quarter.\7\ Accordingly, Wilshire Index QIXs will have expirations 
approximately two weeks apart from existing Wilshire Index option 
expirations in the quarterly month expiration.
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    \7\Presently, options traded at the PSE expire on the Saturday 
following the third Friday of the expiration month. The PSE trades 
index options with expirations of up to one year in length that 
expire at three month intervals. The Exchange allows for up to six 
expiration months with none farther out than twelve months. The PSE 
is not now proposing to list or trade Wilshire Index QIX options 
with more than twelve months to expiration. Any such proposal would 
be filed with the Commission for review under Section 19(b) of the 
Act. Id.
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    The proposed QIX options will trade simultaneously with, not 
independent of, currently listed and traded Wilshire Index options. The 
proposed QIX options will be subject to the same rules that presently 
govern the trading of existing Wilshire Index options contracts, 
including sales practice rules, margin requirements, and floor trading 
procedures.\8\ Contract terms for the QIX options will be similar, for 
the most part, to the corresponding Wilshire Index options that 
presently trade on the Exchange. For example, Wilshire Index QIXs will 
have European-style\9\ exercise. The daily exercise settlement value of 
the index will be based, however, on the value of closing prices of 
component stocks, rather than opening prices.\10\
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    \8\Id.
    \9\A European-style option is one that may be exercised only 
during a specified period prior to the expiration of the option.
    \10\Regular options on the Wilshire Index are settled based on 
the opening prices of the component securities. See Securities 
Exchange Act Release No. 31397 (November 3, 1992), 57 FR 53368 
(November 9, 1992) (``Exchange Act Release No. 31397'').
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    With regard to position and exercise limits,\11\ the PSE is 
proposing to amend Rule 7.6 to provide that Wilshire Index QIXs will be 
subject to the 37,500 contract limit currently specified for Wilshire 
Index options, but without the 22,500 contract limit or ``telescoping 
requirement'' for the series with the nearest expiration date 
applicable for regular Wilshire Index options.\12\ For the purpose of 
this test, regular Wilshire Index options would be aggregated with the 
Wilshire Index QIXs, however, in the case of regular Wilshire Index 
options, the 22,500 contract telescoping requirement continues to 
apply.
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    \11\Position limits are the maximum number of option contracts 
permitted on the same side of the market with respect to a single 
underlying interest that may be held or written by a single investor 
or group of investors acting in concert. Exercise limits are the 
maximum number of option contracts on the same underlying interest 
that a single investor or group of investors acting in concert may 
exercise during any five consecutive business days.
    \12\See Securities Exchange Act Release No. 32554 (June 29, 
1993), 58 FR 36492 (July 7, 1993).
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    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of Section 6(b)(5).\13\ In particular, the 
Commission believes that the proposed rule change is designed to 
provide investors with a tailored quarterly portfolio hedge that may be 
more suitable to their investment needs. Specifically, by providing 
investors with the ability to use Wilshire Index QIX options that 
settle based on the value of component stocks on the last business day 
of the calendar quarter, the PSE proposal will allow investors 
increased flexibility to tailor their portfolio positions to satisfy 
their investment objectives. For instance, according to the PSE, the 
performance of portfolio managers and institutional investors is judged 
on a quarterly basis.\14\ Therefore, in the past, these investors have 
been forced to pursue ``quarterly hedges'' in the over-the-counter 
(``OTC'') market employing forwards, options, and/or swaps. 
Accordingly, the Commission believes the PSE proposal is a reasonable 
response by the Exchange to meet the demands of sophisticated portfolio 
managers and other institutional investors who are increasingly using 
the OTC market in order to satisfy their hedging needs, and will 
thereby promote competition among these markets.\15\
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    \13\15 U.S.C. 78f(b)(5) (1982).
    \14\In addition, many investment strategies employed by these 
portfolio managers converge at the calendar quarter. Hence, 
traditional exchange-type expirations provide a less than perfect 
hedge for many institutions.
    \15\Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option proposal upon a finding that 
the introduction of such new derivative instrument is in the public 
interest. Such a finding would be difficult for a derivative 
instrument that served no hedging or other economic function, 
because any benefits that might be derived by market participants 
likely would be outweighed by the potential for manipulation, 
diminished public confidence in the integrity of the markets, and 
other valid regulatory concerns.
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    In addition, the Commission believes that the PSE proposal will 
help promote the maintenance of a fair and orderly market because the 
purpose of the proposal is to extend the benefits of a listed, exchange 
market in Wilshire Index options to quarterly calendar expirations. The 
attributes of the Exchange's Wilshire Index options market versus an 
OTC market include, but are not limited to, a centralized market 
center, an auction market with posted market quotations and transaction 
reporting, standardized contract specifications, parameters and 
procedures for clearance and settlement, and the guarantee of the 
Options Clearing Corporation (``OCC'') for all contracts traded on the 
Exchange.\16\
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    \16\See Securities Exchange Act Release No. 31898 (February 22, 
1993), 58 FR 11878 (March 1, 1993).
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    The Commission also notes that the Exchange's existing rules 
applicable to stock index options, including among others, strike price 
interval, bid/ask differential, price continuity, and sales practice 
rules and position and exercise limits will apply to QIX options.\17\ 
In particular, Wilshire Index QIXs will be subject to a 37,500 contract 
limit under Rule 7.6 without a telescoping provision, and will be 
aggregated with regular Wilshire Index contracts.\18\ Accordingly, all 
Wilshire Index options contract positions are limited in total to a 
37,500 position limit.
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    \17\See February 7 Letter, supra note 6.
    \18\Regular Index options will continue to be subject to limits 
of 37,500 contracts with a telescoping limit of 22,500 contracts in 
the near term series. In the aggregate, all Wilshire Index contracts 
are limited to the position limits of 37,500 contracts established 
for this particular contract, however, in the near-term series, no 
more than 22,500 of these contracts may be regular Index options.
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    The Commission notes that Wilshire Index QIXs will be treated like 
regular Wilshire Index options except for expiration settlement which 
will be based on the closing values of the component securities.\19\ 
Although the Commission continues to believe that basing the settlement 
of index products on opening, as opposed to closing prices on 
Expiration Fridays helps alleviate stock market volatility,\20\ these 
concerns are reduced in the case of Wilshire Index QIXs, since 
expiration of these stock index options will not correspond with the 
normal expiration of stock index options, stock index futures, and 
options on stock index futures. In particular, Wilshire Index QIXs will 
never expire on an ``Expiration Friday'' or any other ``Expiration 
Fridays'' in March, June, September, and December, thereby diminishing 
the impact that Wilshire Index QIXs could have on the market. 
Accordingly, the Commission believes that Wilshire Index QIX options 
will not compromise the protection of investors or have an adverse 
market effect. Of course, the Commission expects the PSE to monitor the 
actual effect of Wilshire Index QIXs once trading commences and take 
prompt action (including timely communication with marketplace self-
regulatory organizations responsible for oversight of trading in 
component stocks) should any unanticipated adverse market effects 
develop.
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    \19\See Exchange Act Release No. 31397, supra note 10.
    \20\See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
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    Lastly, based on representations from the PSE, the Commission 
believes that the PSE and the Options Price Reporting Authority 
(``OPRA'') will have adequate systems processing capacity to 
accommodate the additional options listed in connection with QIX 
options.\21\
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    \21\See Letter from Michael Pierson, Senior Attorney, PSE, to 
Brad Ritter, Attorney, Office of Derivatives and Equity Regulation, 
Division of Market Regulation, Commission, dated February 25, 1994, 
incorporating a memorandum from Joseph Corrigan, Executive Director, 
OPRA, to Kim Koppien, PSE, dated February 24, 1994.
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    The Commission finds good cause for approving Amendment Nos. 1 and 
2 to the proposed rule change prior to the thirtieth day after the date 
of publication of notice thereof in the Federal Register. The 
Commission finds that Amendment Nos. 1 and 2 more closely conform the 
Exchange's proposal to proposals previously approved by the Commission 
with respect to the listing and trading QIX options.\22\ Specifically, 
Amendment Nos. 1 and 2 provide definitions and additional listing and 
trading standards that are specifically tailored to Wilshire Index 
QIXs. The Commission believes that these additional standards 
strengthen the integrity of the security and may promote stability in 
the marketplace. Additionally, the Commission has not received any 
comments on this proposal. Therefore, the Commission believes it is 
consistent with sections 6(b)(5)\23\ and 19(b)(2)\24\ of the Act to 
approve Amendment Nos. 1 and 2 to the proposal on an accelerated basis.
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    \22\See, e.g., Securities Exchange Act Release No. 32693 (July 
29, 1993), 58 FR 41817 (August 5, 1993) (order approving the listing 
and trading of QIX options by the Chicago Board Options Exchange, 
Inc. on the Russell 200 Index).
    \23\15 U.S.C. 78f(b)(5) (1988).
    \24\15 U.S.C. 78s(b)(2) (1988).
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    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 1 and 2 to the proposed rule 
change. Persons making written submissions should file six copies 
thereof with the Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549. Copies of the submission, all 
subsequent amendments, all written statements with respect to the 
proposed rule change that are filed with the Commission, and all 
written communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Section, 450 Fifth Street NW., Washington, DC. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the PSE. All written submissions should refer to 
File No. SR-PSE-93-07 and should be submitted by March 31, 1994.
    It is therefore ordered, Pursuant to section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-PSE-93-07) is approved.

    \25\15 U.S.C. 78s(b)(2) (1982).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5480 Filed 3-9-94; 8:45 am]
BILLING CODE 8010-01-M