[Federal Register Volume 59, Number 55 (Tuesday, March 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6602]


[[Page Unknown]]

[Federal Register: March 22, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 33766; File No. SR-Amex-93-37]

 

Self-Regulatory Organizations; American Stock Exchange Inc.; 
Order Approving and Filing and Order Granting Accelerated Approval to 
Amendment Nos. 1, 2, and 3 to a Proposed Rule Change by the American 
Stock Exchange, Inc. Relating to the Listing of Options on the Amex 
Broker/Dealer Index

March 15, 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 Broker/Dealer Index (``Broker/
Dealer Index'' or ``Index''). Notice of the proposed rule change 
appeared in the Federal Register on December 15, 1993.\3\ No comment 
letters were received on the proposed rule change. The Exchange 
subsequently submitted Amendment Nos. 1, 2, and 3 to the proposed rule 
change.\4\ This order approves the Exchange's proposal, as amended.
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    \1\U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\See Securities Exchange Act Release No. 33305 (December 9, 
1993), 58 FR 65605 (December 15, 1993).
    \4\In Amendment No. 1, the Exchange proposes to provide that: 
(1) If the number of components in the Index increases or decreases 
by more than 33\1/3\% from the current number of components (i.e., 
9) the Exchange will provide written notice to the Commission; (2) 
in no event will there be less than 9 components in the Index; and 
(3) the average monthly trading volume for up to two of the 
component securities can be not less than 500,000 shares. 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 December 31, 1993 (``Amendment No. 1''). On 
February 2, 1994, the Exchange filed Amendment No. 2 to provide 
update component information, to add Alex Brown, Inc. as an Index 
component, and to delete Primerica Corp. and Raymond James 
Financial, Inc. as Index components. 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 1, 1994. Finally, on February 22, 1994, the Exchange 
submitted Amendment No. 3. to provide that: (1) The position and 
exercise limits for the Index options would be 7,500 contracts on 
the same side of the market; and (2) contrary to Amendment No. 1, if 
the Amex decides to increase or decrease the number of components in 
the Index by more than 33\1/3\%, the Exchange would be required to 
submit a rule filing pursuant to Section 19(b) of the Act. 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. 
3'').
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II. Description of Proposal

A. General

    The Amex proposes to trade options on the Broker/Dealer Index, a 
new stock index developed by the Amex based on stocks of securities 
broker/dealer organizations which are traded on the Amex, the New York 
Stock Exchange, Inc. (``NYSE''), or are national market system stocks 
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.\5\ 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 Broker/
Dealer Index (``Broker/Dealer LEAPS'' or ``Index LEAPS'').\6\ Broker/
Dealer LEAPS will trade independent of and in addition to regular 
Broker/Dealer 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\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.
    \6\LEAPS is an acronym for Long-Term Equity Anticipation 
Securities.
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B. Composition of the Index

    The Index is comprised of nine stocks of highly-capitalizing 
companies in the broker/dealer industry. Included in this group are 
companies in the U.S. which provides securities brokerage service, 
market-making services, U.S. Treasury primary dealer functions, and 
other functions dealing with U.S. and international securities of all 
types.\7\ The Exchange will use an ``equal dollar-weighted'' method to 
calculate the Index.\8\ The Index was initialized at a level of 300 at 
the close of trading on October 15, 1993.
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    \7\The current component securities of the Index are Alex Brown, 
Inc.; A.G. Edwards Inc.; Bear Stearns Companies, Inc.; Dean Witter 
Discover and Co.; Merrill Lynch and Co.; Morgan Stanley Group Inc.; 
Paine Webber Group Inc.; Salomon Inc.; and Charles Schwab Corp.
    \8\ 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 266.51. The market capitalizations of the individual stocks 
in the Index as of the close of trading on January 27, 1994 ranged from 
a high of $8.89 billion (Merrill Lynch and Co.) to a low of $416.70 
million (Alex Brown, Inc.), with the mean and median being $3.77 
billion and $2.74 billion, respectively. The market capitalization of 
all the stocks in the Index was $33.97 billion. The total number of 
shares outstanding for the stocks in the Index ranged from a high of 
209.73 million shares (Merrill Lynch and Co.) to a low of 15.95 million 
shares (Alex Brown, Inc.). In addition, the average monthly trading 
volume of the stocks in the Index, for the six-month period from July 
27, 1993 through January 27, 1994, ranged from a high of 23.65 million 
shares per month (Merrill Lynch and Co.) to a low of 1.37 million 
shares per month (Alex Brown, Inc.), with the mean and median being 
7.77 million and 5.04 million shares, respectively. Lastly, no one 
stock comprised more than 11.60% of the Index's total value and the 
percentage weighting of the five largest issues in the Index accounted 
for 56.36% of the Index's value. The percentage weighting of the lowest 
weighted stock was 10.76% of the Index and the percentage weighting of 
the five smallest issues in the Index accounted for 54.69% 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,\9\ 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 9 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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    \9\Notwithstanding Rule 901C, the Exchange must maintain the 
Index with no less than nine stocks. See Amendment No. 1, supra note 
4.
    \10\Accordingly, the Broker/Dealer 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. 3, 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 broker/dealer 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 two 
component stocks may have an average monthly trading volume of not less 
than 500,000 shares.\12\
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    \12\See Amendment No. 1, supra note 4.
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    The Index currently has nine component stocks, all of which are 
subject to 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 stocks 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 broker/dealer 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 broker/dealer industry, Merrill Lynch and Co. currently represents 
over 26% of the aggregate market value of the Index. In addition, while 
currently there is no extreme 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-weighting index.\13\
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    \13\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 stock 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 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 stocks 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.\14\
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    \14\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.\15\ 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 Broker/Dealer 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 Broker/Dealer LEAPS 
until their time to expiration is less than twelve months.\16\
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    \15\A European-style option can be exercised only during a 
specified period before the option expires.
    \16\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 
Broker/Dealer 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 
Broker/Dealer 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 Broker/Dealer 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 266.46 would be 26.65 for the Index LEAPS and 266.43 would 
become 26.64. 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 
Broker/Dealer 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,\17\ 
position and exercise limits,\18\ and trading halt procedures\19\ 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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    \17\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.
    \18\Pursuant to Amex rules 904C and 905C, respectively, the 
position and exercise limits for the Index options will be 7,500 
contracts, unless the Exchange determines, pursuant to rules 904C 
and 905C, that a lower limit is warranted. See Amendment No. 3, 
supra note 4.
    \19\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 Index options and 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.\20\
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    \20\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. Findings 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).\21\ Specifically, the 
Commission finds that the trading of Broker/Dealer Index options, 
including full-value and reduced-value Broker/Dealer 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 stocks in the broker/dealer 
industry.\22\
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    \21\15 U.S.C. 78f(b)(5) (1988).
    \22\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 Broker/Dealer Index will provide investors 
with a hedging vehicle that should reflect the overall movement of 
the stocks comprising the broker/dealer 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 broker/dealer 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 Broker/
Dealer Index, will serve the needs of broker/dealer 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 Broker/Dealer 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. Broker Design and Structure

    The Commission finds that the Broker/Dealer Index is a narrow-based 
index. The Broker/Dealer Index is comprised of only nine stocks, all of 
which are within on industry--the broker/dealer industry.\23\ 
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.\24\
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    \23\The reduced-value Broker/Dealer Index, which is comprised of 
the same component securities as the Broker/Dealer Index and 
calculated by dividing the Broker/Dealer Index value by ten, is 
identical to the Broker/Dealer Index.
    \24\See supra Section II.G entitled ``Position and Exercise 
Limits, Margin Requirements, and Trading Halts.''
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    The Commission 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 7.77 million and 5.04 
million shares, respectively.\25\ Second, the market capitalizations of 
the stocks in the Index are very large, ranging from a high of $8.89 
billion (Merrill Lynch and Co.) to a low of $416.70 million (Alex 
Brown, Inc.) as of January 27, 1994, with the mean and median being 
$3.77 billion and $2.74 billion, respectively. Third, although the 
Index is only comprised of nine stocks, no one particular stock or 
group of stocks dominates the Index. Specifically, no one stock 
comprises more than 11.60% of the Index's total value and the 
percentage weighting of the five largest issues in the Index accounts 
for 56.36% of the Index's value.\26\ Fourth, all of the component 
stocks in the Index currently have standardized options trading on 
them.\27\ 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.\28\ 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 Broker/Dealer 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 Broker/Dealer 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 stocks, will help deter such illegal 
activity.
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    \25\In addition, for the six-month period between July 27, 1993 
and January 27, 1994, all of the companies within the Index had an 
average daily trading volume greater than 370,000 shares.
    \26\For an index with a significantly greater number of stocks 
than nine issues, the Commission might come to a different 
conclusion if only a few stocks accounts for this level of the 
index's weighting. Further, if an index contained fewer than nine 
stocks, the Commission would question whether it can be traded as an 
index product. In this regard, the Amex must maintain the Index at 
nine or more components. See Amendment No. 1, supra note 4. If the 
Amex needs to replace a stock at a time when there are only nine 
components in the Index but cannot find one meeting the inclusion 
criteria, the Exchange shall immediately contact the Commission at 
which time a decision will be made as to whether the Exchange will 
be required to delist its Index options and Index LEAPS.
    \27\See supra note 5.
    \28\See Amendment No. 2, 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 floats that are actively traded, 
thus reducing the likelihood that the Index could be easily 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 two component stocks 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\29\ 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 
broker/dealer sector and, as discussed above,\30\ meet the inclusion 
criteria.
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    \29\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.
    \30\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 Broker/Dealer Index 
options (including full-value and reduced-value Broker/Dealer 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 Broker/Dealer 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 stocks. 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 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.\31\ 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.\32\
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    \31\See Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \32\See supra note 20. The Commission notes that the Index 
currently does not contain American Depositary Receipts (``ADRs''), 
nor does the proposal provide that the Index could contain ADRs 
representing broker/dealer industry stocks.
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D. Market Impact

    The Commission believes that the listing and trading of Broker/
Dealer Index options, including full-value and reduced-value Index 
LEAPS on the Amex will not adversely impact the underlying securities 
markets.\33\ 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 stocks generally will be actively traded, highly capitalized 
stocks. Third, the 7,500 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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    \33\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 Broker/
Dealer 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 stocks underlying options on the Index.\34\
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    \34\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, 2, 
and 3 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, as subsequently amended by Amendment No. 3, 
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.\35\ Amendment No. 1 
also provides that the average monthly trading volume for up to two of 
the component securities can be not less than 500,000 shares. While in 
other proposals recently approved by the Commission, components 
representing no more than 10% of the Index value by weight were 
eligible for this reduced trading volume requirement, the proposed 
requirement is still significantly higher than the trading volume 
requirement for listing options on individual equity options and should 
ensure that Index components have deep and liquid markets. Amendment 
No. 2 adds Alex Brown, Inc. and deletes Primerica, Corp. and Raymond 
James Financial, Inc. as components of the Index. Because Alex Brown, 
Inc. and the remaining components originally proposed satisfy the 
Exchange's listing and maintenance requirements discussed above,\36\ 
and the Commission has determined that nine components is adequate for 
the Index to trade as an index product pursuant to Amex's rules, the 
Commission believes this change is appropriate. Amendment No. 3, in 
addition to amending Amendment No. 1 as discussed above, merely states 
that the position and exercise limits for the proposed Index options 
will be set at 7,500 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.\37\ Therefore, the 
Commission believes it is consistent with section 6(b)(5) of the Act to 
approve Amendment Nos. 1, 2, and 3 to the Amex's proposal on an 
accelerated basis.
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    \35\See 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). The Commission 
notes that the Amex's proposal requires the Index to have a minimum 
of nine stocks. See Amendment No. 1, supra note 4.
    \36\See supra Section II.C entitled ``Eligibility and 
Maintenance Standards for the Inclusion of Component Stocks in the 
Index.''
    \37\See 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, 2, and 3 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 12, 1994.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\38\ that the proposed rule change (SR-Amex-93-37), as amended, is 
approved contingent upon the Exchange's submission to the Commission of 
adequate systems capacity representations.\39\

    \38\15 U.S.C. 78s(b)(2) (1988).
    \39\See supra note 33.
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\40\
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    \40\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-6602 Filed 3-21-94; 8:45 am]
BILLING CODE 8010-01-M