[Federal Register Volume 59, Number 48 (Friday, March 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5675]


[[Page Unknown]]

[Federal Register: March 11, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33720; File No. SR-Amex-93-36]

 

Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Order Approving and Notice of Filing and Order Granting Accelerated 
Approval to Amendment Nos. 1 and 2 to a Proposed Rule Change by the 
American Stock Exchange, Inc. Relating to the Listing of Options on the 
Amex Natural Gas Index

March 7, 1994.

I. Introduction

    On November 12, 1993, the American Stock Exchange, Inc. (``Amex'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), 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 index options on the Amex Natural Gas Index (``Natural Gas 
Index'' or ``Index''). Notice of the proposed rule change appeared in 
the Federal Register on December 16, 1993.\3\ This order approves the 
Exchange's proposal. No comment letters were received on the proposed 
rule change. The Exchange subsequently submitted Amendments Nos. 1 and 
2 to the proposed rule change.\4\
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\See Securities Exchange Act Release No. 33312 (December 9, 
1993), 58 FR 65740 (December 16, 1993).
    \4\In Amendment No. 1, the Exchange proposes to provide that the 
number of components in the Index will not increase or decrease by 
more than 33\1/3\% from the current number of components (i.e., 15) 
and in no event will there be less than 9 components in the Index. 
See Letter from Claire McGrath, Managing Director and Special 
Counsel, Derivative Securities, Amex, to Richard Zack, Branch Chief, 
Office of Derivatives and Equity Regulation, Division of Market 
Regulation, Commission, dated January 14, 1994 (``Amendment No. 
1''). In order to increase or decrease the number of components in 
the Index beyond this range, the Exchange would be required to 
submit a rule filing to the Commission pursuant to section 19(b) of 
the Act. On February 22, 1994, the Exchange filed Amendment No. 2 to 
clarify that the position and exercise limits for the Index options 
would be 10,500 contracts on the same side of the market. See Letter 
from Claire McGrath, Managing Director and Special Counsel, 
Derivative Securities, Amex, to Sharon Lawson, Assistant Director, 
Office of Derivatives and Equity Regulation, Division of Market 
Regulation, Commission, dated February 18, 1994 (``Amendment No. 
2'').
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II. Description of Proposal

A. General

    The Amex proposes to trade options on the Natural Gas Index, a new 
stock index developed by the Amex based on natural gas industry stocks 
or American Depositary Receipts (``ADRs'')\5\ thereon which are traded 
on the Amex, the New York Stock Exchange, Inc. (``NYSE''), or are 
national market system securities traded through the facilities of the 
National Association of Securities Dealers Automated Quotation System 
(``NASDAQ-NMS''). In addition, the Amex proposes to amend Rule 901C, 
Commentary .01 to reflect that 90% of the Index's numerical index value 
will be accounted for by stocks that meet the current criteria and 
guidelines for securities underlying options set forth in Rule 915.\6\ 
The Amex also proposes to list either long-term options on the Index or 
long-term options on a reduced-value Index that will be computed at 
one-tenth of the value of the Natural Gas Index (``Natural Gas LEAPS'' 
or ``Index LEAPS'').\7\ Natural Gas LEAPS will trade independent of and 
in addition to regular Natural Gas Index options traded on the 
Exchange, however, as discussed below, position and exercise limits of 
Index LEAPS and regular Index options will be aggregated.
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    \5\An ADR is a negotiable receipt which is issued by a 
depositary, generally a bank, representing shares of a foreign 
issuer that have been deposited and are held, on behalf of holders 
of the ADRs, at a custodian bank in the foreign issuer's home 
country. See discussion of standards for ADR components, infra note 
31.
    \6\The Amex's options listing standards, which are uniform among 
the options exchanges, provide that a security underlying an option 
must, among other things, meet the following requirements: (1) The 
public float must be at least 7,000,000 shares; (2) there must be a 
minimum of 2,000 stockholders; (3) trading volume must have been at 
least 2.4 million over the preceding twelve months; and (4) the 
market price must have been at least $7.50 for a majority of the 
business days during the preceding three calendar months. See Amex 
Rule 915.
    \7\LEAPS is an acronym for Long-Term Equity Anticipation 
Securities.
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B. Composition of the Index

    The Index is comprised of fifteen securities of highly-capitalized 
companies in the natural gas industry. Included in this group are 
companies in the U.S. which are involved in natural gas exploration and 
production, natural gas transmission, or natural gas distribution.\8\ 
The Exchange will use an ``equal dollar-weighted'' method to calculate 
the Index.\9\ The Index was initialized at a level of 300 at the close 
of trading on October 15, 1993.
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    \8\The current component securities of the Index are Apache 
Corp.; Anadarko Petroleum Corp.; Burlington Resources; Consolidated 
Natural Gas; Cabot Oil and Gas Corporation (Class A); Enron Corp.; 
Ensearch Corp.; Louisiana Land and Exploration; Mitchell Energy and 
Development; Noble Affiliates, Inc.; Oryx Energy; Parker and Parsley 
Petroleum; Pogo Producing Co.; Seagull Energy Corp.; and Sonat Inc.
    \9\See infra Section II.D entitled ``Calculation of the Index'' 
for a description of this calculation method.
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    As of the close of trading on February 8, 1994, the Index was 
valued at 276.69. The market capitalizations of the individual stocks 
in the Index on that date ranged from a high of $8.13 billion (Enron 
Corp.) to a low of $470 million (Cabot Oil and Gas Corp. (Class A)), 
with the man and median being $2.35 billion and $1.37 billion, 
respectively. The market capitalization of all the stocks in the Index 
was $35.32 billion. The total number of shares outstanding for the 
stocks in the Index ranged from a high 238.97 million shares (Enron 
Corp.) to a low of 20.56 million shares (Cabot Oil and Gas Corp. (Class 
A)). In addition, the average daily trading volume of the stocks in the 
Index, for the six-month period from August 8, 1993 through February 8, 
1994, ranged from a high of 522,510 shares per day (Enron Corp.) to a 
low of 36,520 shares per day (Cabot Oil and Gas Corp. (Class A)), with 
the mean and median being 226,080 and 159,000 shares, respectively. 
Lastly, no one stock comprised more than 7.31% of the Index's total 
value and the percentage weighting of the five largest issues in the 
Index accounted for 34.92% of the Index's value. The percentage 
weighting of the lowest weighted stock was 6.08% of the Index and the 
percentage weighting of the five smallest issues in the Index accounted 
for 31.73% of the Index's value.

C. Eligibility and Maintenance Standards for the Inclusion of Component 
Stocks in the Index

    Exchange Rule 901C specifies criteria for the inclusion of stocks 
in an index on which options will be traded on the Exchange. 
Specifically, rule 901C states that an index must have a minimum of 
five stocks, and any index with less than 25 component stocks may not 
include stocks traded on the Amex.\10\ If, however, the Exchange 
determines to increase or decrease the number of Index component stocks 
by 33\1/3\% or more from its current level of 15 components, the Amex 
will submit a rule filing with the Commission pursuant to section 19(b) 
of the Act.\11\ The Exchange also notes that component stocks may be 
replaced in the event of certain corporate events, such as takeovers or 
mergers, that change the nature of the security. Furthermore, the Amex 
will be required to ensure that each of the components of the Index is 
subject to last sale reporting requirements in the U.S.
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    \10\Accordingly, the Natural Gas Index as currently constituted 
does not include Amex-traded stocks. The Amex, however, has 
submitted a proposal, that, among other things, revises Amex Rule 
901C to remove the limitation on the number of Amex stocks that can 
be included in an index which underlies a stock index option traded 
on the Exchange. Specifically, the proposal would allow, among other 
things, Amex-listed stocks to be included in Amex-traded index 
options that are comprised of less than 25 stocks. See Securities 
Exchange Act Release No. 30356 (February 12, 1992), 57 FR 5497 
(February 14, 1992).
    \11\See Amendment No. 1, supra note 4.
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    In addition, the Exchange will require, as reflected in amended 
Commentary .01 to Exchange Rule 901C, that at least 90% of the Index's 
numerical value, after each quarterly rebalancing of the Index, will be 
accounted for by stocks that meet the Exchange's options listing 
standards.
    In choosing among natural gas industry stocks that meet the minimum 
criteria set forth in Rule 901C, the Exchange will focus only on stocks 
that are traded on either the NYSE, Amex (subject to the limitations of 
Rule 901C) or traded through NASDAQ-NMS. In addition, the Exchange 
intends to select stocks that (1) have a minimum market value (in U.S. 
dollars) of at least $75 million, and (2) have an average monthly 
trading volume in the U.S. markets over the previous six month period 
of not less than one million shares except that component stocks 
accounting for not more than 10% of the Index value at each quarterly 
rebalancing may have an average monthly trading volume of not less than 
500,000 shares.
    The Index currently has fifteen component stocks, all of which are 
eligible for standardized options trading and thirteen of the fifteen 
are currently the subject of standardized options trading. However, to 
address concerns about the possibility of manipulation of an index 
containing a large percentage of stocks that do not meet the 
eligibility standards applicable to stocks eligible for standardized 
options trading, at each quarterly rebalancing, stocks that meet the 
then current criteria for standardized options trading set forth in 
Exchange Rule 915 will be required to account for at least 90% of the 
Index's numerical value, and this requirement will be reflected in 
commentary to Exchange Rule 901C.

D. Calculation of the Index

    The Index will be calculated using an ``equal dollar-weighting'' 
methodology designed to ensure that each of the component securities 
are represented in approximately ``equal'' dollar amounts in the Index. 
The Exchange believes that this method of calculation is important 
since even among the largest companies in the natural gas industry 
there is a great disparity in size. For example, although the stocks 
included in the Index represent many of the most highly capitalized 
companies in the natural gas industry, Enron Corp. currently represents 
over 23% of the aggregate market value of the Index. In addition, while 
currently there is not much disparity in the prices of the stocks 
included in the Index, using a price-weighted method to calculate the 
Index's value is not the Exchange's preferred method since the prices 
of such stocks can fluctuate significantly as a result of a corporate 
action (e.g., a stock split or distribution), rather than as a result 
of stock performance, causing the relative weightings of the stocks 
within the Index to fluctuate significantly.
    In calculating the initial ``equal dollar-weighting'' of component 
stocks, the Amex, using closing prices on October 15, 1993, calculated 
the number of shares that would represent an investment of $10,000 in 
each of the stocks contained in the Index (to the nearest whole share). 
The value of the Index equals the current market value (i.e., based on 
U.S. primary market prices) of the assigned number of shares of each of 
the stocks in the Index portfolio divided by the current Index divisor. 
The Index divisor was initially calculated to yield a benchmark value 
of 300.00 at the close of trading on October 15, 1993. Each quarter 
thereafter, following the close of trading on the third Friday of 
January, April, July and October, the Index portfolio is adjusted by 
changing the number of shares of each component stock so that each 
company is again represented in $10,000 ``equal'' dollar amounts. If 
necessary, a divisor adjustment is made to ensure continuity of the 
Index's value. The newly adjusted portfolio becomes the basis for the 
Index's value on the first trading day following the quarterly 
adjustment.
    The Exchange represents that it has had experience making regular 
quarterly adjustments to certain of its indexes (e.g., the Amex 
Institutional Index) and has not encountered investor confusion 
regarding the adjustments because they are done on a regular basis and 
timely, proper, and adequate notice is given in the form of an 
information circular distributed to all Exchange members notifying them 
of the quarterly changes. This circular is also sent to the Exchange's 
contacts at the major options firms, mailed to recipients of the 
Exchange's options related information circulars, and made available to 
subscribers of the Options News Network. In addition, the Exchange will 
include in its promotional and marketing materials for the Index, a 
description of the equal dollar-weighting methodology. The Exchange 
states that this procedure has been used for the Exchange's 
Biotechnology Index, another equal dollar-weighted index.\12\
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    \12\See Securities Exchange Act Release No. 31245 (September 28, 
1992), 57 FR 45844 (October 5, 1992).
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    The number of shares of each component stock in the Index portfolio 
will remain fixed between quarterly reviews except in the event of 
certain types of corporate actions, such as the payment of a dividend, 
other than an ordinary cash dividend, stock distributions, stock 
splits, reverse stock splits, rights offerings, or a distribution, 
reorganization, recapitalization, or some such similar event with 
respect to an Index component stock. The number of shares will also be 
adjusted in the event of a merger, consolidation, dissolution or 
liquidation of an issuer of a component stock. When the Index is 
adjusted between quarterly reviews, the number of shares of the 
relevant security in the portfolio will be adjusted, to the nearest 
whole share, to maintain the component's relative weight in the Index 
at the level immediately prior to the corporate action. In the event of 
a stock replacement, the average dollar value of the remaining 
portfolio components will be calculated and that amount invested in the 
new component stock to the nearest whole share. In both cases, the 
divisor will be adjusted, if necessary, to ensure Index continuity.
    Similar to other stock index values published by the Exchange, the 
value of the Index will be calculated continuously and disseminated 
every 15 seconds over the Consolidated Tape Association's Network B and 
to the Options Price Reporting Authority (``OPRA'').
    The Index value for purposes of settling outstanding Index options 
and Index LEAPS contracts upon expiration will be calculated based upon 
the regular way opening sale prices for each of the Index's component 
stocks in their primary market on the last trading day prior to 
expiration. In the case of securities traded through the NASDAQ-NMS 
system, the first reported sale price will be used. Once all of the 
component stocks have opened, the value of the Index will be determined 
and that value will be used as the final settlement value for expiring 
Index options contracts. If any of the component stocks do not open for 
trading on the last trading day before expiration, then the prior 
trading day's (i.e., Thursday's) last sale price will be used in the 
Index calculation. In this regard, before deciding to use Thursday's 
closing value of a component stock for purposes of determining the 
settlement value of the Index, the Amex will wait until the end of the 
trading day on expiration Friday.\13\
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    \13\For purposes of the daily dissemination of the Index value, 
if a stock included in the Index has not opened for trading, the 
Amex will use the closing value of that stock on the prior trading 
day when calculating the value of the Index, until the stock opens 
for trading.
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E. Contract Specifications

    The proposed options on the Index will be cash-settled, European-
style options.\14\ Standard options trading hours (9:30 a.m. to 4:10 
p.m. New York time) will apply to the contracts. The options on the 
Index will expire on the Saturday following the third Friday of the 
expiration month. Under Amex Rule 903C, the Exchange intends to list up 
to three near-term calendar months and two additional calendar months 
in three month intervals in the January cycle. The Exchange also 
intends to list Natural Gas LEAPS, having up to thirty-six months to 
expiration. Strike price interval, bid/ask differential and price 
continuity rules will not apply to the trading of Natural Gas LEAPS 
until their time to expiration is less than twelve months.\15\
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    \14\A European-style option can be exercised only during a 
specified period before the option expires.
    \15\See Securities Exchange Act Release No. 25041 (October 16, 
1987), 52 FR 40008 (October 26, 1987) (order approving SR-Amex-87-
22).
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    The options on the Index will expire on the Saturday following the 
third Friday of the expiration month (``Expiration Friday''). Since 
options on the Index will settle based upon the opening prices of the 
component stocks on the last trading day before expiration (normally a 
Friday), the last trading day for an expiring Index option series will 
normally be the second to the last business day before expiration 
(normally a Thursday).

F. Listing of Long-Term Options on the Full Value or Reduced Value 
Natural Gas Index

    The proposal provides that the Exchange may list long-term index 
options that expire from 12 to 36 months from listing on the full-value 
Natural Gas Index or a reduced-value Index that will be computed at 
one-tenth the value of the full-value Index. The current and closing 
Index value for reduced-value Natural Gas LEAPS will be computed by 
dividing the value of the full-value Index by 10 and rounding the 
resulting figure to the nearest one-hundredth. For example, an Index 
value of 276.46 would be 27.65 for the Index LEAPS and 276.43 would 
become 27.64. The reduced-value Index LEAPS will have a European-style 
exercise and will be subject to the same rules that govern the trading 
of all the Exchange's index options, including sales practice rules, 
margin requirements and floor trading procedures. The strike price 
interval for the reduced-value Index LEAPS will be no less than $2.50 
instead of $5.00.
    In addition, the proposal provides that full-value or reduced-value 
Natural Gas LEAPS will be issued at no less than six month intervals 
and that new strike prices will either be near or bracketing the 
current Index value.

G. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Because the Index is a Stock Index Option under Amex Rule 901C(a) 
and a Stock Index Industry Group under Rule 900C(b)(1), the proposal 
provides that Exchange rules that are applicable to the trading of 
narrow-based index options will apply to the trading of options on the 
Index. Specifically, Exchange rules governing margin requirements,\16\ 
position and exercise limits,\17\ and trading halt procedures\18\ that 
are applicable to the trading of narrow-based index options will apply 
to options traded on the Index. The proposal further provides that, for 
purposes of determining whether a given position in reduced-value Index 
LEAPS complies with applicable position and exercise limits, positions 
in reduced-value Index LEAPS will be aggregated with positions in the 
full-value Index options. For aggregation purposes, ten reduced-value 
contracts will equal one full-value contract.
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    \16\Pursuant to Amex Rule 462(d)(2)(D)(iv), the margin 
requirements for the Index options will be: (1) For each short 
options positions, 100% of the current market value of the options 
contract plus 20% of the underlying aggregate Index value, less any 
out-of-the-money amount, with a minimum requirement of the options 
premium plus 10% of the underlying Index value; and (2) for long 
options positions, 100% of the options premium paid.
    \17\Pursuant to Amex Rules 904C and 905C, respectively, the 
position and exercise limits for the Index options will be 10,500 
contracts, unless the Exchange determines, pursuant to Rules 904C 
and 905C, that a lower limit is warranted. See Amendment No. 2, 
supra note 4.
    \18\Pursuant to Amex Rule 918C, the trading of Index options 
will be halted or suspended whenever trading in underlying 
securities whose weighted value represents more than 20% of the 
Index value are halted or suspended.
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H. Surveillance

    Surveillance procedures currently used to monitor trading in each 
of the Exchange's other index options will also be used to monitor 
trading in full-value and reduced-value Index LEAPS. These procedures 
include complete access to trading activity in the underlying 
securities. Further, the Intermarket Surveillance Group (``ISG'') 
Agreement, dated July 14, 1983, as amended on January 29, 1990, will be 
applicable to the trading of options on the Index.\19\
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    \19\ISG was formed on July 14, 1983 to, among other things, 
coordinate more effectively surveillance and investigative 
information sharing arrangements in the stock and options markets. 
See Intermarket Surveillance Group Agreement, July 14, 1983. The 
most recent amendment to the ISG Agreement, which incorporates the 
original agreement and all amendments made thereafter, was signed by 
ISG members on January 29, 1990. See Second Amendment to the 
Intermarket Surveillance Group Agreement, January 29, 1990. The 
members of the ISG are: the Amex; the Boston Stock Exchange, Inc.; 
the Chicago Board Options Exchange, Inc.; the Chicago Stock 
Exchange, Inc.; the National Association of Securities Dealers, 
Inc.; the NYSE; the Pacific Stock Exchange, Inc.; and the 
Philadelphia Stock Exchange, Inc. Because of potential opportunities 
for trading abuses involving stock index futures, stock options, and 
the underlying stock and the need for greater sharing of 
surveillance information for these potential intermarket trading 
abuses, the major stock index futures exchanges (e.g., the Chicago 
Mercantile Exchange and the Chicago Board of Trade) joined the ISG 
as affiliate members in 1990.
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III. Finding and Conclusions

    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).\20\ Specifically, the 
Commission finds that the trading of Natural Gas Index options, 
including full-value and reduced-value Natural Gas LEAPS, will serve to 
promote the public interest and help to remove impediments to a free 
and open securities market by providing investors with a means to hedge 
exposure to market risk associated with securities in the natural gas 
industry.\21\
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    \20\15 U.S.C. 78f(b)(5) (1988).
    \21\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. In this regard, the trading of 
listed options on the Natural Gas Index will provide investors with 
a hedging vehicle that should reflect the overall movement of the 
stocks comprising the natural gas industry in the U.S. stock 
markets. The Commission also believes that these Index options will 
provide investors with a means by which to make investment decisions 
in the natural gas industry sector of the U.S. stock markets, 
allowing them to establish positions or increase existing positions 
in such markets in a cost effective manner. The Commission also 
believes that the trading of the Index options and Index LEAPS will 
allow investors holding positions in some or all of the underlying 
securities in the Index to hedge the risks associated with their 
portfolios more efficiently and effectively. Moreover, the 
Commission believes that the reduced-value Index LEAPS, that will be 
traded on an index computed at one-tenth the value of the Natural 
Gas Index, will serve the needs of natural gas industry investors by 
providing them with the opportunity to use a long-term option to 
hedge their portfolios from long-term market moves at a reduced 
cost.
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    The trading of options on the Natural Gas Index and on a reduced-
value Index, however, raises several concerns, namely issues related to 
index design, customer protection, surveillance, and market impact. The 
Commission believes, for the reasons discussed below, that the Amex 
adequately has addressed these concerns.

A. Index Design and Structure

    The Commission finds that the Natural Gas Index is a narrow-based 
index. The Natural Gas Index is comprised of only fifteen stocks, all 
of which are within one industry--the natural gas industry.\22\ 
Accordingly, the Commission believes it is appropriate for the Amex to 
apply its rules governing narrow-based index options to trading in the 
Index options.\23\
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    \22\The reduced-value Natural Gas Index, which is comprised of 
the same component securities as the Natural Gas Index and 
calculated by dividing the Natural Gas Index value by ten, is 
identical to the Natural Gas Index.
    \23\See supra Section II.G entitled ``Position and Exercise 
Limits, Margin Requirements, and Trading Halts.''
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    The Commission also finds that the large capitalizations, liquid 
markets, and relative weightings of the Index's component stocks 
significantly minimize the potential for manipulation of the Index. 
First, the stocks that comprise the Index are actively traded, with a 
mean and median average monthly trading volume of 4.75 million and 3.34 
shares, respectively.\24\ Second, the market capitalizations of the 
stocks in the Index are very large, ranging from a high of $8.13 
billion (Enron Corp.) to a low of $470 million (Cabot Oil and Gas 
Corporation (Class A)) as of February 8, 1994, with the mean and median 
being $2.35 billion and $1.37 billion, respectively. Third, although 
the Index is only comprised of fifteen stocks, no one particular stock 
or group of stocks dominates the Index. Specifically, no one stock 
comprises more than 7.31% of the Index's total value and the percentage 
weighting of the five largest issues in the Index accounts for 34.92% 
of the Index's value.\25\ Fourth, all of the component stocks in the 
Index currently are eligible for options trading,\26\ and all but two 
components have standardized options trading on them. Fifth, the Amex, 
prior to increasing or decreasing the number of component stocks by 
more than 33\1/3\%, will be required to seek Commission approval 
pursuant to section 19(b)(2) of the Act before effecting such 
change.\27\ This will help protect against material changes in the 
composition and design of the Index that might adversely affect the 
Amex's obligations to protect investors and to maintain fair and 
orderly markets in Natural Gas Index options. Sixth, the Amex will be 
required to ensure that each component of the Index is subject to last 
sale reporting requirements in the U.S. This will further reduce the 
potential for manipulation of the value of the Index. Finally, the 
Commission believes that the expense of attempting to manipulate the 
value of the Natural Gas Index in any significant way through trading 
in component stocks (or options on those stocks) coupled with, as 
discussed below, existing mechanisms to monitor trading activity in 
those securities, will help deter such illegal activity.
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    \24\In addition, for the six-month period between August 8, 1993 
and February 8, 1994, all of companies within the Index had an 
average daily trading volume greater than 226,000 shares.
    \25\For an index with a significantly greater number of stocks 
than fifteen issues, the Commission might come to a different 
conclusion if only a few stocks accounted for a significant portion 
of the index's weighting. Further, if an index contained only a few 
stocks, the Commission might question whether it can be traded as an 
index product.
    \26\See supra note 6.
    \27\See Amendment No. 1, supra note 4.
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    In addition, the Commission does not believe that the fact that the 
Index is equal dollar-weighted instead of market-weighted or price-
weighted results in the Index being readily susceptible to 
manipulation. Because the use of an equal dollar-weighting method could 
give securities with relatively small floats or prices a greater weight 
in the Index than if the Index were capitalization weighted or price 
weighted, the Commission is concerned that this calculation method 
could make the Index more readily susceptible to manipulation. The 
Amex, however, has developed several composition and maintenance 
criteria for the Index that the Commission believes will minimize the 
possibility that the Index could be manipulated through trading in less 
actively traded securities or securities with smaller prices or floats. 
First, after each quarterly rebalancing, the Amex proposal requires 
that 90% of the weighting of the Index be accounted for by stocks that 
are eligible for standardized options trading. The Commission believes 
that this requirement will ensure that the Index will be almost 
entirely made up of stocks with large public floats that are actively 
traded, thus reducing the likelihood that the Index could be 
manipulated by abusive trading in the smaller stocks contained in the 
Index. Second, the proposal provides that to be eligible for inclusion 
in the Index, component stocks must have an average monthly trading 
volume over the previous six-month period of not less than one million 
shares, except that component stocks accounting for not more than 10% 
of the value of the Index at rebalancing, may have an average monthly 
trading volume of less than one million shares but not less than 
500,000 shares. This trading volume requirement is considerably higher 
than the requirement contained in the options listing standards for 
individual equity options. Third, the Commission believes that the 
quarterly rebalancing of the Index will further serve to reduce the 
susceptibility of the Index to manipulation. Through the quarterly 
rebalancing, any ``overweight'' stock\28\ will be brought back into 
line with the other stocks, thus ensuring that less capitalized stocks 
do not become excessively weighted. Fourth, because the Index is 
narrow-based, the applicable position and exercise limits and margin 
requirements will further reduce the susceptibility of the Index to 
manipulation. Lastly, the Amex represents that it will make every 
effort to add new stocks to the Index that are representative of the 
natural gas sector and, as discussed above,\29\ will take into account 
a stock's capitalization, liquidity, and volatility.
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    \28\A stock would be ``overweight'' if its weight in the Index 
were greater than the average weight of all of the stocks in the 
Index. This would occur, for example, if the price of a component 
stock significantly increased relative to the other stocks in the 
Index during a particular quarter and prior to the rebalancing.
    \29\See supra Section II.C entitled ``Eligibility and 
Maintenance Standards for the Inclusion of Component Stocks in the 
Index.''
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B. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as Natural Gas Index options 
(including full-value and reduced-value Natural Gas LEAPS), can 
commence on a national securities exchange. The Commission notes that 
the trading of standardized exchange-traded options occurs in an 
environment that is designed to ensure, among other things, that: (1) 
The special risks of options are disclosed to public customers; (2) 
only investors capable of evaluating and bearing the risks of options 
trading are engaged in such trading; and (3) special compliance 
procedures are applicable to options accounts. Accordingly, because the 
Index options and Index LEAPS will be subject to the same regulatory 
regime as the other standardized options currently traded on the Amex, 
the Commission believes that adequate safeguards are in place to ensure 
the protection of investors in Natural Gas Index options and full-value 
or reduced value Index LEAPS.
    The Commission also has some concern that the quarterly rebalancing 
of the Index could result in investor confusion because the number of 
stocks of each component issuer in the Index could fluctuate each 
quarter. Such fluctuation, among other things, could make it difficult 
for investors to maintain any corresponding cash positions in the 
stocks underlying the Index. The Commission, however, does not believe 
that the quarterly rebalancing will result in dramatic changes in the 
weightings of the component securities. Moreover, the Commission 
believes the benefits to be derived from using a quarterly rebalancing 
will more than offset the potential confusion for investors. 
Specifically, the Commission believes the quarterly rebalancing will 
ensure that no stock or group of stocks will have a disproportionate 
impact on the Index.
    Finally, the Amex has developed procedures to ensure that investors 
are adequately notified of any changes due to the quarterly rebalancing 
of the Index. In particular, the Amex represents that it will send 
informational circulars to its members notifying them of any changes to 
the Index as a result of the quarterly rebalancing prior to the 
implementation of those changes. In addition, the Amex has stated that 
it will include a description of the equal dollar-weighting methodology 
in all its promotional and marketing materials for the Index. The 
Commission believes these procedures should help to avoid any investor 
confusion, while providing important information about the special 
characteristics of the Index.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing to list a stock index derivative product 
and the exchange(s) trading the stocks underlying the derivative 
product is an important measure for surveillance of the derivative and 
underlying securities markets. Such agreements ensure the availability 
of information necessary to detect and deter potential manipulations 
and other trading abuses, thereby making the stock index product less 
readily susceptible to manipulation.\30\ In this regard, the NYSE, 
which currently is the primary market for all of the Index's component 
stocks, is a member of the Intermarket Surveillance Group (``ISG''), 
which provides for the exchange of all necessary surveillance 
information.\31\
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    \30\See Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \31\See supra note 19. Although the Index currently does not 
contain ADRs, the proposal provides that the Index could contain 
ADRs representing natural gas industry stocks. If the Amex were to 
change the composition of the Index so that greater than 20% of the 
Index by weight was represented by ADRs whose underlying securities 
were not subject to a comprehensive surveillance sharing arrangement 
with the Amex, then it would be difficult for the Commission to 
reach the conclusions reached in this order and the Commission would 
have to determine whether it would be suitable to continue to trade 
options on the Index. The Amex should, accordingly, notify the 
Commission immediately if more than 20% of the numerical value of 
the Index is represented by ADRs whose underlying securities are not 
subject to a comprehensive surveillance sharing agreement. Such a 
change in the composition of the Index may warrant the submission of 
a rule filing pursuant to Section 19 of the Act. In determining 
whether a particular ADR is subject to a comprehensive surveillance 
sharing agreement see, e.g., Securities Exchange Act Release Nos. 
31529 (November 27, 1992), 57 FR 57248 (December 3, 1992); and 33555 
(January 31, 1994), 59 FR 5619 (February 7, 1994).
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D. Market Impact

    The Commission believes that the listing and trading of Natural Gas 
Index options, including full-value and reduced-value Index LEAPS on 
the Amex will not adversely impact the underlying securities 
markets.\32\ First, as described above, due to the ``equal dollar-
weighting'' method, no one stock or group of stocks dominates the 
Index. Second, because 90% of the numerical value of the Index must be 
accounted for by stocks that meet the options listing standards, the 
component securities generally will be actively-traded, highly-
capitalized stocks. Third, the 10,500 contract position and exercise 
limits will serve to minimize potential manipulation and market impact 
concerns. Fourth, the risk to investors of contra-party non-performance 
will be minimized because the Index options and Index LEAPS will be 
issued and guaranteed by the Options Clearing Corporation just like any 
other standardized option traded in the United States.
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    \32\The Commission notes that prior to listing Index options or 
full-value or reduced-value Index LEAPS, the Exchange will be 
required to provide written representations that both the Exchange 
and OPRA have the necessary systems capacity to support those new 
series of Index options.
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    Lastly, the Commission believes that settling expiring Natural Gas 
Index options (including full-value and reduced-value Index LEAPS) 
based on the opening prices of component securities is reasonable and 
consistent with the Act. As noted in other contexts, valuing options 
for exercise settlement on expiration based on opening prices rather 
than closing prices may help reduce adverse effects on markets for 
securities underlying options on the Index.\33\
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    \33\Securities Exchange Act Release No. 30944 (July 21, 1992), 
57 FR 33376 (July 28, 1992).
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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 of filing thereof in the Federal Register. 
Amendment No. 1 provides that the Amex must submit a rule filing 
pursuant to section 19(b) of the Act if the number of components in the 
Index increases or decreases by more than 33\1/3\%. This amendment 
conforms the proposal to other proposals recently approved by the 
Commission for the listing and trading of options on narrow-based 
indexes.\34\ Amendment No. 2 merely states that the position and 
exercise limits for the proposed Index options will be set at 10,500 
contracts pursuant to Amex Rule 904C consistent with the Commission's 
recent approval order increasing the position and exercise limits for 
narrow-based index options.35 Therefore, the Commission believes 
it is consistent with section 6(b)(5) of the Act to approve Amendment 
Nos. 1 and 2 to the Amex's proposal on an accelerated basis.
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    \3\4See, e.g., Securities Exchange Act Release No. 33442 
(January 6, 1994), 59 FR 1973 (January 13, 1994) order approving the 
listing and trading of options on the CBOE Gaming Index).
    \3\5See, e.g., Securities Exchange Act Release No. 33285 
(December 3, 1993), 58 FR 65201 (December 13, 1993).
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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 above-mentioned self-regulatory organization. 
All submissions should refer to the file number in the caption above 
and should be submitted by April 1, 1994.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,36 that the proposed rule change (SR-Amex-93-36), as amended, 
is approved contingent upon the Exchange's submission to the Commission 
of adequate systems capacity representations.37
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    \36\15 U.S.C. 78s(b)(2) (1988).
    \37\See supra note 32.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.38
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    \38\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5675 Filed 3-10-94; 8:45 am]
BILLING CODE 8010-01-M