[Federal Register Volume 59, Number 104 (Wednesday, June 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-13215]


[[Page Unknown]]

[Federal Register: June 1, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34103; File No. SR-Amex-93-18]

 

Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 3 to a 
Proposed Rule Change by the American Stock Exchange, Inc., Relating to 
Position Limits on Options on the S&P MidCap Index

May 24, 1994.
    On April 20, 1993, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``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 relating to options on its S&P MidCap Index 
(``MID''). Notice of the proposal appeared in the Federal Register on 
June 22, 1993.\3\ No comment letters were received on the proposed rule 
change. The Amex subsequently filed Amendment No. 1 to the proposed 
rule change on January 7, 1994, Amendment No. 2 on May 5, 1994, and 
Amendment No. 3 on May 19, 1994.\4\ This order approves the Exchange's 
proposal, as amended.
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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. 32472 (June 16, 
1993), 58 FR 33960 (June 22, 1993).
    \4\In Amendment Nos. 1 and 2, the Amex proposed changes to the 
position and exercise limits and hedge exemptions for MID options 
proposed in the original filing. See Letter from Claire McGrath, 
Managing Director and Special Counsel, Derivative Securities, Amex, 
to Richard Zack, Branch Chief, Office of Derivatives and Equity 
Oversight (``ODEO''), Division of Market Regulation (``Division''), 
Commission, dated January 7, 1994; and Letter from Claire McGrath, 
Managing Director and Special Counsel, Derivative Securities, Amex, 
to Michael Walinskas, Branch Chief, ODEO, Division, Commission, 
dated May 5, 1994. The changes proposed in Amendment Nos. 1 and 2, 
however, were withdrawn and superseded by the changes proposed in 
Amendment No. 3. Specifically, in Amendment No. 3 the Amex proposes 
to: (1) Raise position and exercise limits fro MID options to 45,000 
contracts on the same side of the market with no more than 25,000 
contracts in series with the near-term month; (2) provide that no 
more than 25,000 MID options contracts may be used for purposes of 
taking advantage of any differential in price between the MID and 
the securities underlying the MID; (3) eliminate its earlier 
proposal seeking a hedge exemption of 75,000 contracts on the same 
side of the market; (4) limit the customer facilitation exemption 
for member organizations to a maximum of 75,000 MID options 
contracts on the same side of the market; (5) eliminate its earlier 
proposal seeking a money manager exemption for MID options 
positions; and (6) amend Rule 904C, Commentary .02, to set forth the 
index options and the contract limits for which facilitation 
exemptions have been approved by the Commission. See Letter from 
Claire McGrath, Managing Director and Special Counsel, Derivative 
Securities, Amex, to Michael Walinskas, Branch Chief, ODEO, 
Division, Commission, dated May 19, 1994 (``Amendment No. 3'').
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    Since the inception of standardized options trading, the options 
exchanges have had in place rules imposing limits on the aggregate 
number of options contracts of the same class that a market participant 
or market participants acting in concert could hold or exercise. 
Specifically, these restrictions are known as position and exercise 
limits.\5\ These rules are intended to, among other things, prevent the 
establishment of large options positions that can be used to manipulate 
or disrupt the underlying market so as to benefit the holder of an 
options position.
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    \5\Position limits impose a ceiling on the number of options 
contracts relating to an underlying instrument which an investor, or 
group of investors acting in concert, may own or control. Exercise 
limits prohibit the exercise by an investor, or group of investors 
acting in concert, of more than a specified number of option 
contracts on a particular underlying security within five 
consecutive business days.
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    According to the Amex, active participants in the MID options 
market have included institutional and professional investors with 
large stock portfolio holdings who use MID options as a mechanism to 
hedge those holdings. With trading interest continuing to grow, the 
Exchange has received some complaints from member firms that current 
MID position limits are too restrictive and have caused some users to 
utilize the over-the-counter derivatives market to fashion contracts to 
meet their needs.\6\ The Exchange believes that increasing position and 
exercise limits for MID options from current limits and allowing a 
customer facilitation exemption from position and exercise limits will 
increase institutional use of this product which will benefit not only 
the beneficiaries of assets managed by these institutions but also the 
market as a whole through increased liquidity.
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    \6\See Letter from Bruce Hackett, Managing Director and Member 
of Executive Committee, Salomon Brothers, to Howard Baker, Vice 
President, Amex, dated April 12, 1993; Letter from William S. 
Diskin, Managing Director, Furman Selz Incorporated, to Howard 
Baker, Vice President, Amex, dated March 19, 1993; Letter from Tom 
Peters, Managing Director, Susquehanna Investment Group, to Howard 
Baker, Vice President, Amex, dated March 22, 1993.
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    Currently, Exchange rules provide for MID position and exercise 
limits of 25,000 contracts on the same side of the market with a 
``telescoping'' provision that no more than 15,000 of such contracts 
may be held in series with the nearest expiration month. The Exchange 
now proposes to: (1) Increase MID position and exercise limits to 
45,000 contracts on the same side of the market with a telescoping 
provision of no more than 25,000 contracts on the same side of the 
market in series with the nearest expiration month; (2) provide that no 
more than 25,000 MID options contracts may be used for index arbitrage; 
and (3) provide an exemption from position and exercise limits for 
member firms of 75,000 MID contracts on the same side of the market for 
the facilitation of customer orders for MID options.\7\
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    \7\The Exchange also originally proposed a position limit hedge 
exemption for MID options. Amex's position limit hedge exemption for 
broad-based index options was approved as a one-year pilot program 
in 1988. See Securities Exchange Act Release No. 25938 (July 22, 
1988), 53 FR 28738 (July 29, 1988). The pilot was subsequently 
extended for one additional year. See Securities Exchange Act 
Release No. 27326 (October 2, 1989), 54 FR 423121 (October 13, 
1989). Because this pilot program lapsed in 1990, however, the 
Exchange has withdrawn this portion of the proposal. Telephone 
conversation between Claire McGrath, Managing Director and Special 
Counsel, Derivative Securities, Amex, and Brad Ritter, Attorney, 
ODEO, Division, Commission, on May 23, 1994; and see Amendment No. 
3, supra note 4.
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    As discussed below, the Commission believes that the Amex proposal 
is consistent with the requirements of Section 6 of the Act, in 
general, and section 6(b)(5)\8\ in particular, in that it should help 
to remove impediments to and perfect the mechanism of a free and open 
market, promote just and equitable principles of trade and protect 
investors and public interest.
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    \8\15 U.S.C. 78f(b)(5) (1988).
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    Initially, the Commission notes that in July and October of 1992, 
the Commission approved similar increases in position and exercise 
limits and approved customer facilitation exemptions for the Exchange's 
Institutional Index (``XII'') options\9\ and for the Chicago Board 
Options Exchange, Inc.'s (``CBOE'') Standard & Poor's 500 Index 
(``SPX'') options.\10\ To the Commission's knowledge, the increased 
position and exercise limits for XII and SPX options have not resulted 
in any problems. These increases were made in conjunction with options 
on both the XII and SPX moving from afternoon settlement (based on 
closing prices of component stocks) to morning settlement (based on 
opening prices of component stocks) (``A.M.-Settlement''). 
Specifically, the change to A.M.-Settlement for options on the XII and 
SPX were made in response to concerns about stock market volatility 
experienced on expiration Fridays and particularly on the four Fridays 
per year (each known as a ``triple witching day'') when individual 
stock options, stock index options, stock index futures, and options on 
such futures all expire together. The Commission notes, however, that 
since its introduction in February of 1992,\11\ the MID has always had 
an A.M.-Settlement feature, which, according to the Exchange, negates 
any ``triple witching day'' concerns which could be attributed to 
increased position limits.\12\ The Commission further notes that the 
proposed MID position limits would allow a significantly smaller 
portfolio to be fully hedged than that allowable pursuant to the 
position limits approved for options on the SPX and XII,\13\ thus 
further minimizing manipulative concerns. Accordingly, the Commission 
believes that the A.M.-Settlement of the MID is helpful in insuring 
that the increased position and exercise limits should not unduly 
disrupt the market in the securities underlying the MID.
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    \9\See Securities Exchange Act Release No. 31330 (October 16, 
1992), 57 FR 48408 (October 23, 1992) (``Exchange Act Release No. 
31330'').
    \10\See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
    \11\See Securities Exchange Act Release No. 30290 (January 27, 
1992), 57 FR 4072 (February 3, 1992).
    \12\The Commission continues to believe that basing the 
settlement of index options on opening, as opposed to closing prices 
on expiration Fridays, helps alleviate the stock market volatility 
once experienced on expiration Fridays. See Securities Exchange Act 
Release No. 24262 (March 27, 1987), 57 FR 10836 (April 3, 1987).
    \13\Based on the closing values of the various indexes on May 2, 
1994, the proposed MID position limits would allow a portfolio of 
approximately $781.695 million to be fully hedged, while the 
position limits approved for the XII and SPX (excluding applicable 
position limit hedge exemptions) would allow qualified portfolios of 
approximately $2.037 billion and $2.039 billion, respectively, to be 
fully hedged.
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1. Position and Exercise Limit Increase

    In analyzing and reviewing specific position and exercise limits 
proposed by the options exchanges, the Commission has attempted to 
balance two competing concerns. First, position limits must be 
sufficiently low to prevent investors from disrupting the underlying 
cash market. Second, limits must not be established at levels that are 
so low as to unnecessarily discourage participation in the options 
market by institutions and other investors with substantial hedging 
needs or to prevent specialists and market makers from adequately 
meeting their obligations to maintain fair and orderly markets.
    The Commission believes that the proposed position and exercise 
limits may increase the depth and liquidity of the MID options 
market\14\ without significantly increasing concerns regarding 
intermarket manipulations or disruptions of the markets for the options 
or the underlying securities. Specifically, the Commission notes that 
the MID is a broad-based index consisting of 400 domestic securities 
which are highly capitalized, and have large public floats and high 
trading volume. As the Commission has previously stated, markets that 
exhibit active and deep trading, as well as broad public ownership, are 
more difficult to manipulate or disrupt than less active markets with 
smaller public floats.\15\ Additionally, the proposed position limits 
include a 25,000 contract telescoping provision for near-term series 
which further minimizes the potential for manipulation of the MID and 
the securities underlying the MID as expiration of a particular series 
of MID options approaches. Finally, even with the position limit 
increased to 45,000 contracts, the proposal limits to 25,000 contracts 
the number of MID options positions that may be used for purposes of 
index arbitrage. This is consistent with the proposal previously 
approved by the Commission regarding options on the XII\16\ and serves 
to further minimize the potential for trading in MID options to disrupt 
the market for the securities underlying the index. Accordingly, given 
the size and breadth of the MID, the Commission does not believe that 
increasing the position and exercise limits for options on the MID as 
proposed herein will increase the MID's susceptibility to manipulation 
or increase the potential for disruption in the markets for the 
underlying securities.
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    \14\The increase in position limits may increase trading 
activity in MID options and may increase market depth and liquidity 
by giving market participants wider latitude in trading to manage 
their portfolios.
    \15\See e.g., Securities Exchange Act Release No. 25738 (May 24, 
1988), 53 FR 20201 (June 2, 1988).
    \16\See Exchange Act Release No. 31330, supra note 9.
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2. Customer Facilitation Exemption

    The proposal would also enable a member organization to obtain a 
position limit exemption of up to 75,000 contracts on the same side of 
the market in order to facilitiate the execution of large customer 
orders.\17\ The Commission believes that this customer facilitation 
exemption from MID option position and exercise limit rules for member 
organizations may further enhance the depth and liquidity of the 
options and underlying cash markets by providing members greater 
flexibility in executing large MID options customer orders.\18\
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    \17\A customer facilitation order is an order which is only 
executed, in whole or in part, in a cross transaction with an order 
for a public customer of the member organization. See Amex Rule 
950(e)(iv).
    \18\The proposed customer facilitation exemption for MID option 
positions is 25,000 contracts less than the level approved by the 
Commission for AMEX's XII options. See Exchange Act Release No. 
31330, supra note 9.
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    The Commission also believes that the Exchange has proposed several 
safeguards in connection with the customer facilitation exemption that 
will serve to minimize any potential disruption or manipulation 
concerns. First, the member organization must receive approval from the 
Exchange prior to executing customer facilitation trades. In this 
regard, the Commission believes that permitting the Amex to grant oral 
approval of customer facilitation exemptions will not result in trading 
abuses because of the follow-up documentation required. Second, a 
member granted a customer facilitation exemption must hedge all exempt 
options positions that have not been previously liquidated within five 
business days after the execution of the customer facilitation 
exemption order, and furnish to the Exchange documentation reflecting 
the resulting hedged positions. Third, a member granted a customer 
facilitation exemption is required to provide the exchange with any 
information or documents requested concerning the exempted options 
positions and the positions hedging them. Fourth, a member granted a 
customer facilitation exemption is not permitted to use the 
facilitation exemption for the purpose of engaging in index arbitrage. 
Thus, the Commission concludes that the member organization customer 
facilitation exemption from position and exercise limits is consistent 
with the Act and will promote fair and orderly markets.

3. Conclusion

    In summary, the Commission believes that the increase in position 
and exercise limits as well as the addition of the customer 
facilitation exemption from position and exercise limits may benefit 
market participants by allowing them to take larger MID options 
positions in the context of an exchange-traded and regulated product 
without unnecessarily increasing manipulative concerns. In addition, 
the customer facilitation exemption is limited and positions 
established pursuant to it must be liquidated or fully hedged within 
five business days. Further, the Commission believes that the customer 
facilitation exemption is appropriate in light of the composition, 
depth, and liquidity of the S&P MidCap Index, making it less 
susceptible to manipulation.
    Nevertheless, as a result of the significant increase in MID 
options positions that may result from this proposed rule change, the 
Commission believes that the Amex should study the market impact of 
these changes. Specifically, the Commission expects the Amex to report 
on an annual basis for the next three years on the following matters:
    (1) the number of market participants that are at or near the 
45,000 contract position limit level;
    (2) any market impact concerns or issues raised by the large 
options positions, such as frontrunning, mini-manipulation, capping and 
pegging, and other similar trading abuses;
    (3) how often the customer facilitation exemption is utilized;
    (4) the frequency and size of the customer facilitation exemption 
utilized;
    (5) the number of position limit violations;
    (6) any disciplinary actions brought as a result of such 
violations; and
    (7) the number of oral exemption requests, the number of requests 
granted, and the number of times documentation was not timely filed.
    The Commission finds good cause for approving Amendment No. 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.\19\ 
Specifically, Amendment No. 3: (1) Raises position and exercise limits 
for MID options to 45,000 contracts on the same side of the market with 
no more than 25,000 contracts in series with the near-term month; (2) 
provides that no more than 25,000 MID options contracts may be used for 
purposes of index arbitrage; (3) reduces the proposed MID customer 
facilitation exemption to 75,000 contracts on the same side of the 
market; and (4) eliminates the requested position limit hedge exemption 
and money manager exemption for MID options positions. For the reasons 
stated above, the Commission believes that these proposals may increase 
the market depth and liquidity in MID options while not increasing the 
susceptibility of the MID to manipulation or the potential for 
disruption in the markets for the securities underlying the MID. 
Additionally, the changes proposed in Amendment No. 3 are more 
restrictive than the position limits and exemptions originally proposed 
and no comments were received by the Commission concerning the original 
proposal.
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    \19\As noted previously, Amendment No. 3 withdraws and 
supersedes Amendment Nos. 1 and 2. See Amendment No. 3, supra note 
4.
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    Finally, Amendment No. 3 would amend Rule 904C, Commentary .02, to 
set forth in the rule the specific indexes for which position limit 
customer facilitation exemptions have been approved, and the numerical 
levels of those exemptions. The Commission believes that this amendment 
will serve to minimize investor confusion as to the availability of the 
customer facilitation exemption for approved index options and, 
therefore, is consistent with the Act.
    Based on the foregoing, the Commission believes the changes 
proposed in Amendment No. 3 are designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and to facilitate transactions in securities. 
Therefore, it is consistent with Section 6(b)(5) of the Act to approve 
Amendment No. 3 to the Amex's proposal on an accelerated basis.
    Interested person are invited to submit written data, views and 
arguments concerning Amendment No. 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 File No. SR-Amex-93-18 and should be 
submitted by June 22, 1994.
    It is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-Amex-93-18), as amended, is 
approved.

    \20\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-13215 Filed 5-31-94; 8:45 am]
BILLING CODE 8010-01-M