[Federal Register Volume 59, Number 164 (Thursday, August 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20896]


[[Page Unknown]]

[Federal Register: August 25, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34546; File No. SR-Phlx-94-02]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc., Relating to the 
Listing and Trading of Options and Long-Terms Options on the Phlx 
Semiconductor Index

August 18, 1994.

I. Introduction

    On January 5, 1994, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
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 Phlx Semiconductor Index 
(``Semiconductor Index'' or ``Index''). The Exchange filed Amendment 
No. 1 to the proposed rule change on January 14, 1994,\3\ Amendment No. 
2 on April 26, 1994,\4\ and Amendment No.; 3 on May 20, 1994.\5\ Notice 
of the proposal, as amended, appeared in the Federal Register on July 
12, 1994.\6\ 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\In Amendment No. 1, the Phlx proposes: (1) To correct the 
description of the formula for calculating the value of the Index; 
(2) to set the exercise prices at 5 point intervals instead of 2\1/
2\ point intervals; (3) to provide that if the number of components 
in the Index increases to more than 21 components or decreases to 
less than 11 components, the Exchange shall submit a rule filing to 
the Commission pursuant to Section 19(b)(4) of the Act; (4) to 
require that the components of the Index will be required to be 
listed for trading on the New York Exchange (``NYSE'') or the 
American Stock Exchange (``Amex'') (non-ECM), or traded as National 
Market (``NM'') securities through the facilities of the National 
Association of Securities Dealers, Inc. (``NASD'') Automated 
Quotation system (``NASDAQ''); and (5) to list long-term options on 
the Index that expire 12 to 36 months from the date of issuance 
(``LEAPS''). See Letter from William Uchimoto, General Counsel, 
Phlx, to Richard Zack, Branch Chief, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Division''), SEC, dated 
January 14, 1994.
    \4\In Amendment No. 2, the Phlx proposes to: (1) Provide that 
the index will be updated during the trading day at least once every 
15 seconds, rather than once every minute; (2) specify that the 
expiration cycle applicable to options of the index will be three 
expiration months from the March, June, September, December cycle 
plus two additional near-term months; (3) provide that additional 
exercise prices will be added pursuant to Rule 1101A rather than 
Rule 1012; and (4) clarify the Exchange's obligations with respect 
to delisting and replacing components of the components of the 
Index. See Letter from Michele R. Weisbaum, Associate General 
Counsel, Phlx, to Michael Walinskas, Branch Chief, OMS, Division, 
SEC, dated April 26, 1994.
    \5\In Amendment No. 3 to the proposal, the Exchange provides 
that the Index will be maintained so that if any time, less than 90% 
of the component issues by weight are eligible for exchange options 
trading, the Exchange will submit a Rule 19b-4 filing to the 
Commission before opening any new series of options on the Index for 
trading. See Letter from Michele R. Weisbaum, Associate General 
Counsel, Phlx, to Brad Ritter, Attorney, OMS, Division, SEC, dated 
May 20, 1994.
    \6\See Securities Exchange Act Release No. 34307 (July 5, 1994), 
59 FR 35549 (July 12, 1994).
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II. Description of Proposal

A. General

    The Phlx proposes to list for trading options on the Phlx 
Semiconductor Index, a new securities index developed by the Phlx and 
based on U.S. stocks representing the semiconductor industry that are 
traded on the NYSE or the AMEX, or are NM securities traded through the 
facilities of NASDAQ. The Phlx also proposes to list LEAPS on the full-
value Index (``Index LEAPS''). Semiconductor Index LEAPS will trade 
independent of and in addition to regular Semiconductor Index options 
traded on the Exchange; however, as discussed below, position and 
exercise limits of Index LEAPS and regular Index options will be 
aggregated. The Phlx will use a price-weighted methodology to calculate 
the value of the Index.\7\
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    \7\See infra Section II.E, entitled ``Calculation of the 
Index,'' for a description of this calculation method.
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B. Composition of the Index

    The Index was designed by the Exchange and is presently composed of 
16 highly capitalized and widely held common stocks of U.S. companies 
that are primarily involved in the design, manufacture, sale, and 
distribution of semiconductors used in computer and other electronic 
device manufacturing. Six of these securities currently trade through 
NASDAQ as NM securities, and ten trade on the NYSE. All component 
stocks are ``reported securities,'' as that term is defined in Rule 
11a3-1 of the Act.\8\ The Index is price-weighted and will be 
calculated on a real-time basis using last sale prices.
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    \8\See 17 CFR 240.11Aa3-1. A ``reported security'' is defined in 
paragraph (a)(4) of this rule as ``any listed equity security or 
NASDAQ security for which transaction reports are required to be 
made on a real-time basis pursuant to an effective transaction 
reporting plan.'' A ``transaction reporting plan'' is defined in 
paragraph (a)(2) of this rule as ``any plan for collecting, 
processing, making available or disseminating transaction reports 
with respect to transactions in reported securities filed with the 
Commission pursuant to, and meeting the requirements of, this 
section.''
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    As of the close of trading on July 21, 1994, the Index was valued 
at 237.19. As of July 8, 1994, the market capitalizations of the 
individual securities in the Index ranged from a high of $25.0 billion 
to a low of $317.8 million, with the mean being $4.8 billion. The 
market capitalization of all the securities in the Index was $76.8 
billion. The total number of shares outstanding on that date for the 
stocks in the Index ranged from a high of 557.2 million shares to a low 
of 15.7 million shares. Also on that date, the price per share in the 
U.S. of the securities in the Index ranged from a high of $83.88 to a 
low of $14.50. In addition, the average daily trading volume in the 
U.S. of the stocks in the Index, for the six-month period from January 
1, 1994, through June 30, 1994, ranged from a high of 2.7 million 
shares per day to a low of 107,000 shares per day. Lastly, no one 
component accounted for more than 15.79% of the Index's total value and 
the percentage weighting of the five largest issues in the Index 
accounted for 51.01% of the Index's value. The percentage weighting of 
the lowest weighted component was 2.73% of the Index and the percentage 
weighting of the five smallest issues in the Index accounted for 17.41% 
of the Index's value.

C. Maintenance

    The Index will be maintained by the Phlx. The Phlx may change the 
composition of the Index at any time, subject to compliance with the 
maintenance criteria discussed herein, to reflect the conditions in the 
semiconductor industry. In accordance with Phlx rule 1009A, if it 
becomes necessary to replace a security in the Index, the Exchange 
represents that it will be replaced with a stock which the Exchange, in 
its discretion, believes would be compatible with the intended market 
character of the Index.\9\ In making replacement determinations, the 
Exchange will also take into account a security's capitalization, 
liquidity, volatility, and name recognition of the proposed 
replacement. Further, securities may be replaced in the event of 
certain corporate events, such as takeovers or mergers, that change the 
nature of the security. If, however, the Exchange determines to 
increase the number of Index component securities to greater than 21 or 
reduce the number of index component securities to fewer than 11, the 
proposal provides that the Phlx will submit a rule filing with the 
Commission pursuant to Section 19(b) of the Act. In addition, in 
choosing replacement securities for the Index, the Phlx will be 
required to ensure that at least 90% of the weight of the Index 
continues to be made up of stocks that are eligible for standardized 
options trading.\10\
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    \9\The Exchange represents that any future replacement or added 
component securities will be listed and traded on either the NYSE or 
the Amex, or quoted on and traded through NASDAQ as NM securities.
    \10\The Phlx'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 in the 
U.S. must have been at least 2.4 million over the preceding twelve 
months; and (4) the U.S. market price must have been at least $7.50 
for a majority of the business days during the preceding three 
calendar months. See Phlx Rule 1009, Commentary .01. With respect to 
ADRs, in addition to the above standards: (1) the Exchange must have 
in place of a comprehensive surveillance agreement with the primary 
exchange in the home country where the security underlying the ADR 
is traded; or (2) the trading volume for the three month period 
preceding the date of listing in the U.S. markets for ADRs overlying 
any class of the foreign issuer's common stock (on a share-
equivalent basis) is at least 50% of the sum of the (i) combined 
world wide trading volume for all classes of the foreign issuer's 
common stock, and (ii) combined trading volume for all ADRs 
overlying any of these classes of stock; or (3) the SEC must 
otherwise authorize the listing. In addition, the percentage of the 
world-wide trading volume for the security underlying an ADR that 
occurs in the U.S. ADR market must meet a maintenance standard of 
30% or more in order for options on that particular ADR to continue 
to be traded on the Phlx. See, e.g., Securities Exchange Act Release 
No. 33554 (January 31, 1994), 59 FR 5622 (February 7, 1994).

D. Applicability of Phlx Rules Regarding Index Options

    Except as modified by this order, Phlx Rules 1000A through 1103A, 
in particular, and Phlx Rules 1000 through 1070, in general, will be 
applicable to Semiconductor Index options and Index LEAPS. Those rules 
address, among other things, the applicable position and exercise 
limits, policies regarding trading halts and suspensions, and margin 
treatment for narrow-based index options.

E. Calculation of the Index

    The Phlx Semiconductor Index is a price-weighted index and reflects 
changes in the prices of the Index component securities relative to the 
Index's base date of December 1, 1993. Specifically, the Index value is 
calculated by adding the prices of the component stocks, dividing this 
summation by a divisor that is equal to the number of the components of 
the Index to get the average price, and multiplying the resulting 
number by 100. To maintain the continuity of the Index, the divisor 
will be adjusted to reflect non-market changes in the prices of the 
component securities as well as changes in the composition of the 
Index. Changes that may result in divisor adjustments include, but are 
not limited to, stock splits and dividends, spin-offs, certain rights 
issuances, and mergers and acquisitions.
    The Index value will be updated dynamically at least once every 15 
seconds during the trading day. The Phlx has retained Bridge Data, Inc. 
to compute the value of the Index. Pursuant to Phlx Rule 1100A, updated 
Index values will be disseminated and displayed by means of primary 
market prints reported by the Consolidated Tape Association and over 
the facilities of the Options Price Reporting Authority (``OPRA''). The 
Index value will also be available on broker/dealer interrogation 
devices to subscribers of the option information.
    The Index value for purposes of settling outstanding regular 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 securities in their primary market on the last trading day 
prior to expiration. In the case of securities traded on and through 
NASDAQ, 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 and Index LEAPS 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., normally 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 security for purposes of 
determining the settlement value of the Index, the Phlx will wait until 
the end of the day on the last trading day before expiration.

F. Contract Specifications

    The proposed options on the Index will be cash-settled, European-
style options.\11\ Standard options trading hours (9:30 a.m. to 4:10 
p.m. Eastern Standard time) will apply to the contracts. The Index 
multiplier will be 100. The strike price interval will be $5.00 for 
Index options with a duration of one year or less to expiration. In 
addition, pursuant to Phlx Rule 1012(a), there may be up to six 
expiration months outstanding at any given time. Specifically, there 
may be up to three expiration months from the March, June, September, 
and December cycle plus up to three additional near-term months so that 
the two nearest term months will always be available. The Exchange also 
intends to list several Index LEAPS series that expire from 12 to 36 
months from the date of issuance pursuant to Phlx Rule 1101A(b)(iii).
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    \11\A European-style option can be exercised only during a 
specified period before the option expires.
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G. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Because the Index is classified as an ``industry index'' under Phlx 
rules,\12\ Exchange rules that are applicable to the trading of options 
on narrow-based indexes will apply to the trading of Semiconductor 
Index options and Index LEAPS. Specifically, Exchange rules governing 
margin requirements,\13\ position and exercise limits,\14\ and trading 
halt procedures\15\ that are applicable to the trading of narrow-based 
index options will apply to options traded on the Index. Positions in 
Index LEAPS will be aggregated with positions in regular Index options 
on a one-for-one basis for purposes of position and exercise limits.
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    \12\See Phlx Rule 1000A(11).
    \13\Pursuant to Phlx Rule 722, the margin requirements for the 
Index options will be: (1) for 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.
    \14\Pursuant to Phlx Rules 1001A and 1002A, respectively, the 
position and exercise limits for the Index options will be 7,500 
contracts, unless the Exchange determines, pursuant to those rules 
that a higher or lower limit is warranted.
    \15\Pursuant to Phlx Rule 1047A, the trading on the Phlx of 
Index options may 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 Index LEAPS. These procedures include 
complete access to trading activity in the underlying securities. 
Further, the Intermarket Surveillance Group Agreement, dated July 14, 
1983, as amended on January 29, 1990, will be applicable to the trading 
of options on the Index.\16\
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    \16\The Intermarket Surveillance Group (``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. (``NASD''); the NYSE; the Pacific Stock 
Exchange, Inc.; and the Phlx. 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).\17\ Specifically, the 
Commission finds that the trading of Semiconductor Index options, 
including Index 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 of hedging exposure to market risk 
associated with securities representing the semiconductor industry.\18\
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    \17\15 U.S.C. Sec. 78f(b)(5) (1988).
    \18\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 Index options and Index LEAPS will provide investors with a 
hedging vehicle that should reflect the overall movement of stocks 
representing the semiconductor industry.
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    The trading of options of LEAPS on the Semiconductor Index, 
however, raises several concerns, namely issues related to index 
design, customer protection, surveillance, and market impact. The 
Commission believes, however, for the reasons discussed below, that the 
Phlx adequately has addressed these concerns.

A. Index Design and Structure

    The Commission finds that the Semiconductor Index is a narrow-based 
index. The Index is composed of only sixteen securities, all of which 
represent the semiconductor industry. Accordingly, in light of the 
limited number of stocks in the Index and that the Index represents one 
industry sector, the Commission believes it is proper to classify the 
Semiconductor Index as narrow-based and apply Phlx's rules governing 
narrow-based index options to trading in the Index options and Index 
LEAPS.\19\
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    \19\See supra notes 12 through 15, and accompanying text.
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    The Commission also finds that the large capitalizations, liquid 
markets, and relative weightings of the Index's component securities 
significantly minimize the potential for manipulation of the Index. 
First, the overwhelming majority of the components that comprise the 
Index are actively traded, with an average daily trading volume for the 
period from January 1, 1994 through June 30, 1994, ranging from a high 
of 2.7 million shares per day to a low of 107,000 shares per day. 
Second, the market capitalizations of the securities in the Index are 
very large, ranging from a high of $25.0 billion to a low of $317.8 
million as of July 8, 1994, with the mean being $4.86 billion. Third, 
although the Index is only comprised of sixteen component securities, 
no one particular security or group of securities dominates the Index. 
Specifically, as of July 8, 1994, no one stock accounted for more than 
15.79% of the Index's total value and the percentage weighting of the 
five largest issues in the Index accounted for 51.01% of the Index's 
value. Fourth, at least 90% of the securities in the Index, by weight, 
must be eligible for standardized options trading. This proposed 
maintenance requirement will ensure that the Index is substantially 
comprised of options eligible securities. Fifth, if the Phlx increases 
the number of component securities to more than 21 or decreases that 
number to less than 11, the Phlx will be required to seek Commission 
approval pursuant to Section 19(b)(2) of the Act before listing new 
strike price or expiration month series of Semiconductor Index options 
or Index LEAPS. This will help protect against material changes in the 
composition and design of the Index that might adversely affect the 
Phlx's obligations to protect investors and to maintain fair and 
orderly markets in Semiconductor Index options and Index LEAPS. 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 Semiconductor 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.

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 Semiconductor Index 
options and Index 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 Phlx, the Commission believes that 
adequate safeguards are in place to ensure the protection of investors 
in Semiconductor Index options and LEAPS.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing to list a security index derivative 
product and the exchange(s) trading to securities 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 security 
index product less readily susceptible to manipulation.\20\ In this 
regard, the Phlx, NYSE, Amex, and NASD are all members of the ISG, 
which provides for the exchange of all necessary surveillance 
information.\21\
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    \20\Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \21\See note 16, supra. If the composition of the Index should 
change so that greater than 10% of the weight of the Index would be 
represented by ADRs ineligible for standardized options trading in 
the U.S. either because the securities underlying the ADRs are not 
the subject of a comprehensive surveillance sharing agreement with 
the Phlx or because the U.S. market is not the primary market for 
the ADRs, 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 for the Exchange to continue 
to trade options on this Index. The Phlx should, accordingly, notify 
the Commission immediately if more than 10% of the numerical value 
of the Index is represented by ADRs not eligible for standardized 
options trading in the U.S. Such a change in the current relative 
weights of the Index or 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 eligible for standardized 
options trading see, e.g., Securities Exchange Act Release Nos. 
31531 (November 27, 1992), 57 FR 57250 (December 3, 1992); and 33554 
(January 31, 1994), 59 FR 5622 (February 7, 1994).
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D. Market Impact

    The Commission believes that the listing and trading of 
Semiconductor Index options and Index LEAPS on the Phlx will not 
adversely impact the underlying securities markets.\22\ First, as 
described above, for the most part, no one security or group of 
securities dominates the Index. Second, because (i) at least 90% of the 
numerical value of the Index must be accounted for by securities that 
meet the Exchange's options listing standards, (ii) each of the 
component securities must be traded on either the NYSE or the Amex, or 
as NM securities traded through NASDAQ, and (iii) the component 
securities must be subject to last sale reporting pursuant to Rule 
11Aa3-1 of the Act,\23\ the component securities generally will be 
actively-traded, highly-capitalized securities. Third, the 7,500 
contract position and exercise limits applicable to Index options and 
Index LEAPS will serve to minimize potential manipulation and market 
impact concerns.
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    \22\In addition, the Phlx has represented that the Phlx and the 
OPRA have the necessary systems capacity to support those new series 
of options that would result from the introduction of Index options 
and Index LEAPS. See Letter from Michele Weisbaum, Associate General 
Counsel, Phlx, to Thomas McManus, Attorney, OMS, Division, 
Commission, dated June 24, 1994; and Memorandum from Joe Corrigan, 
Executive Director, OPRA, to Richard Cangelosi, Assistant Vice 
President, New Product Development, Phlx, dated April 18, 1994.
    \23\See supra note 8.
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    Lastly, the Commission believes that settling expiring 
Semiconductor Index options and Index LEAPS based on the opening prices 
of component securities is 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.\24\
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    \24\See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-Phlx-94-02), as amended, is 
approved.
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    \25\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20896 Filed 8-24-94; 8:45 am]
BILLING CODE 8010-01-M