[Federal Register Volume 59, Number 190 (Monday, October 3, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-24304]


[[Page Unknown]]

[Federal Register: October 3, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34712; International Series Release No. 717; File No. 
SR-PHLX-93-13]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 3 to the Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc., Relating to Modifications of the Position and Exercise 
Limits for Foreign Currency Options

September 23, 1994.
    On March 29, 1993, the Philadelphia Stock Exchange, Inc. (``PHLX'' 
or ``Exchange'') filed with 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 proposal to amend PHLX Rules 1001, ``Position 
Limits'', and 1002,'' ``Exercise Limits,''\3\ to increase the position 
and exercise limits for foreign currency options (``FCOs'') from 
100,000 contracts to 150,000 contracts for FCOs with annual trading 
volume of at least 3,500,000 contracts, based on the previous year's 
trading volume.\4\
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    \1\15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
    \3\Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market (i.e., 
aggregating long calls and short puts or long puts and short calls) 
that can be held or written by an investor or group of investors 
acting in concert. Exercise limits prohibit an investor or group of 
investors acting in concert from exercising more than a specified 
number of puts or calls in a particular class within five 
consecutive business days. Throughout this approval order, the terms 
``position limits'' or ``limits'' will be used to refer to both 
position and exercise limits.
    \4\On July 19, 1994, the PHLX amended its proposal to establish 
an FCO position limit of 150,000 contracts for FCOs with annual 
trading volume of at least 4,000,000 contracts. See Letter from 
Gerald D. O'Connell, First Vice President, Regulation and Trading 
Operations, PHLX, to Michael Walinskas, Branch Chief, Options 
Regulation, Division of Market Regulation (``Division''), 
Commission, dated July 19, 1994 (``Amendment No. 1''). In addition, 
the PHLX submitted information concerning the implementation and 
effective date of the proposal. See Letter from Edith Hallahan, 
Attorney, Market Surveillance, PHLX, to Richard Zack, Branch Chief, 
Options Branch, Division, Commission, dated July 27, 1993 (``July 27 
Letter''). On July 26, 1994, the PHLX amended the proposal to 
provide that FCOs with annual trading volume of 3,500,000 contracts 
would be eligible for a position limit of 150,000 contracts and to 
indicate that the PHLX plans a one-time immediate review to 
implement the higher position limit for FCOs which meet the annual 
trading volume requirement. See Letter from Gerald D. O'Connell, 
First Vice President, Regulation and Trading Operations, PHLX, to 
Michael Walinskas, Branch Chief, Options Regulation, Division, 
Commission, dated July 26, 1994 (``Amendment No. 2''). On September 
22, 1994, the PHLX amended its proposal to revise the effective date 
of a change to a lower FCO position limit. Specifically, if the 
PHLX's beginning-of-the-year review of FCO trading volume indicates 
that the position limit for an FCO must be lowered from 150,000 to 
100,000 contracts, the PHLX will promptly advise FCO participants 
that all series in that FCO will be subject to the lower limit 
effective the Monday following the mid-month June expiration. See 
Letter from Gerald D. O'Connell, First Vice President, Regulation 
and Trading Operations, PHLX, to Michael Walinskas, Branch Chief, 
Options Regulation, Division, Commission, dated September 22, 1994 
(``Amendment No. 3'').
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    Notice of the proposal appeared in the Federal Register on August 
18, 1994.\5\ No comments were received on the proposal.
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    \5\See Securities Exchange Act Release No. 34525 (August 11, 
1994), 59 FR 42620 (August 18, 1994).
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    Currently, PHLX Rule 1001 establishes a position limit of 100,000 
contracts for FCOs traded on the PHLX. The PHLX proposes to amend 
Exchange Rules 1001 and 1002 to increase the position and exercise 
limits for FCOs, including cross-rate FCOs.\6\ Specifically, under 
proposed Commentary .05(b) to PHLX rule 1001, the PHLX proposes to 
establish a position limit of 150,000 contracts for FCOs with annual 
trading volume of at least 3,500,000 contracts, based upon the previous 
year's volume. At the beginning of each calendar year, the PHLX will 
review FCO volume information from the previous year to determine which 
limit will apply; a higher limit will be effective on the date set by 
the Exchange, and a lower limit will take effect on the Monday 
following the mid-month June expiration. If the PHLX's beginning-of-
the-year FCO trading volume review indicates that the position limit 
for an FCO must be lowered from 150,000 contracts to 100,000 contracts, 
the PHLX will promptly notify FCO participants that the lower limit 
will be effective for all series in that option on the Monday following 
the mid-month June expiration, and FCO participants will be required to 
comply with the lower limit.\7\ In addition, the PHLX's Market 
Surveillance Department plans to monitor trading volume on a monthly 
basis, so that FCOs will be eligible immediately for a higher position 
limit when annual trading volume, as measured from the beginning of the 
calendar year, exceeds the levels established in the proposal.
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    \6\Currently, the PHLX trades two cross-rate FCOs, the British 
pound/Deutsche mark and the Deutsche mark/Japanese yen.
    \7\See Amendment No. 3, supra note 4.
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    In order to implement the proposal prior to the end of 1994, the 
PHLX plans to conduct a one-time review of FCO volume, calculating 
volume for the 12-month period immediately preceding approval of the 
proposal, so that FCOs with annual trading volume during that period of 
at least 3,500,000 contracts will be eligible for the 150,000-contract 
limit immediately after approval of the proposal.\8\ The PHLX states 
that for the 12-month period from September 1993-August 1994, the 
Deutsche mark and the French franc would qualify for the higher 
limit.\9\
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    \8\See Amendment No. 2, supra note 4.
    \9\See Amendment No. 3, supra note 4.
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    The PHLX notes that the Exchange's exercise limits are established 
by reference to position limits, so that any increase in position 
limits will also increase exercise limits. Accordingly, the PHLX 
proposes to amend Exchange Rule 1002 to reflect the proposed amendment 
to Exchange Rule 1001.
    The Exchange views the current FCO position and exercise limits as 
too low in light of increased levels of trading activity in the 
underlying currency markets and the resultant growth in liquidity of 
PHLX FCOs in recent years. The PHLX's proposal is designed to identify 
and accommodate those active currencies where heavier trading and open 
interest warrant higher limits. The PHLX understands that if it were to 
begin trading a new currency, measurement of the new currency's trading 
volume for purposes of establishing its eligibility for the 150,000-
contract limit would be calculated from the beginning of the ``calendar 
year.''
    When FCOs began trading on the PHLX in 1982, FCO position limits 
were set at 10,000 contracts.\10\ Since that time the position limits 
have been changed three times, including an increase to the current 
level of 100,000 contracts in 1986.\11\ Since 1986, the PHLX has added 
several new products for which position limits are aggregated with 
other trading in the same underlying foreign currency.\12\ As a result, 
many traders have begun to regularly accumulate positions near existing 
limits, especially in certain more active currencies. In those active 
currencies, the PHLX believes that trading interest could migrate to 
the over-the-counter (``OTC'') market, hampering PHLX liquidity if 
large traders continue to be restricted by the current position limits.
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    \10\See Securities Exchange Act Release No. 19313 (December 8, 
1982) 47 FR 56591 (order approving File No. SR-PHLX-81-04).
    \11\See Securities Exchange Act Release No. 27310, supra note 2. 
See also Securities Exchange Act Release Nos. 21676 (January 18, 
1985) 50 FR 3859 (order approving File No. SR-PHLX-84-18) 
(increasing position limits from 10,000 to 25,000 contracts); and 
22479 (September 27, 1985), 50 FR 41276 (order approving File No. 
SR-PHLX-85-22) (increasing position limits to 50,000 contracts).
    \12\See e.g. Securities Exchange Act Release Nos. 24859 (August 
27, 1987) 52 FR 33493 (order approving File No. SR-PHLX-87-24) 
(aggregating European-style contracts); 30945 (July 21, 1992) 57 FR 
33381 ((order approving File No. SR-PHLX-92-13) (aggregating month-
end options); and 33732 (May 8, 1994), 59 FR 12023 (order approving 
File No. SR-PHLX-93-10) (aggregating cash-spot FCOs).
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    The PHLX notes that since the time of the most recent increase in 
position limits, the size of the underlying currency market has grown 
exponentially.\13\ Since 1986, average daily trading volume in PHLX 
FCOs has grown from 30,880 to 48,246 contracts in 1992.\14\ As of 
February 1993, average daily volume was 61,062 contracts. Monthly 
volume and open interest have also increased dramatically since 1986, 
especially in certain FCOs. Further, the highest monthly open interest 
in FCOs reached 995,941 in 1986; 1,188,570 contracts in 1987; 1,190,389 
contracts in 1992; and 1,338,458 in 1993. Total annual volume has 
increased from 7,905,239 contracts in 1986 to 12,158,069 contracts in 
1992 to 13,101,365 contracts in 1993. Total FCO trading volume as of 
July 1994 was 5,755,939 contracts.
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    \13\In 1989, total gross global foreign exchange turnover was 
estimated to be $932 billion per day and net global turnover was 
estimated to be $640 billion per day. See Bank for International 
Settlements (``BIS'') Survey of Foreign Exchange Market Activity, 
April 1989. In 1992, total gross global foreign exchange turnover 
was estimated to be $1,354 billion per day, a 35% increase since 
April 1989. After allowing for the elimination of local and cross-
border double-counting and estimated gaps in reporting (e.g., 
exchange-traded options and futures and countries not providing 
counterparty information for over-the-counter transactions), global 
``net-net'' exchange market turnover in spot, forward and derivative 
contracts may be estimated at $880 billion per day during April 
1992. See BIS Central Bank Survey of Foreign Exchange Market 
Activity in April 1992, March 1993.
    \14\Average daily volume in foreign currency options was 14,829 
contracts in 1985 and 30,880 contracts in 1986.
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    In light of these market changes, the PHLX believes that increased 
position and exercise limits are necessary to add depth and liquidity 
to the market. Because of the large size of the underlying market in 
foreign currencies, the PHLX does not believe that higher position and 
exercise limits will increase manipulative concerns. Moreover, the 
Exchange believes that these increases are particularly appropriate 
because the FCO market attracts a large number of institutional and 
corporate investors who have substantial hedging needs and execute 
block-sized\15\ transactions in FCOs.
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    \15\For the purposes of this proposal, the PHLX defines ``block-
sized orders'' as orders of 100 contracts or more. See July 27 
Letter, supra note 4.
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    Although the Exchange may grant position limit exemptions in the 
interest of fair and orderly markets, the Exchange believes that it is 
more direct and logical to establish more appropriate position limits 
for all investors.
    The PHLX believes that the proposed rule change is consistent with 
Section 6 of the Act, in general, and, in particular, with Section 
6(b)(5), in that it is designed to promote just and equitable 
principles of trade as well as to protect investors and the public 
interest. The PHLX believes that the increased depth and liquidity of 
the FCO market should promote just and equitable principles of trade. 
In addition, the PHLX believes that the proposed approach to FCO 
position limits should ensure that the applicable limit is reasonably 
related to trading volume. The PHLX believes that this, in turn, should 
result in position limit levels that serve the purposes of protecting 
investors and the public interest as well as preventing unfair acts and 
practices, such as manipulation.
    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).\16\ Specifically, the 
Commission believes that the proposal to raise the position limit for 
only those FCOs with annual trading volume of at least 3,500,000 
contracts should help to accommodate the needs of investors and market 
participants while ensuring that the increased limits are only 
available for those currencies with extremely large and liquid markets.
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    \16\15 U.S.C. Sec. 78f(b)(5) (1982).
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    In this regard, the Commission believes, as it has stated in the 
past, that although position and exercise limits for FCOs must be 
sufficient to protect the options and related markets from disruptions 
by manipulation, the limits must not be established at levels that are 
so low as to discourage participation in the options market by 
institutions and other investors with substantial hedging needs or to 
prevent market makers from adequately meeting their obligations to 
maintain a fair and orderly market.\17\ In its proposal, the PHLX 
states that the FCO market attracts a large number of institutional and 
corporate investors who have substantial needs and who execute block-
sized transactions in FCOs. In addition, the PHLX believes that trading 
in active currencies could migrate to the OTC market if traders 
continue to be restricted by the PHLX's current FCO position limits. In 
light of the size of the FCO market and the needs of FCO investors and 
market makers, the Commission believes that the PHLX's proposal is a 
reasonable effort to accommodate the needs of market participants and 
to help the Exchange remain competitive with the OTC market for FCOs.
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    \17\See Securities Exchange Act Release No. 22479, supra note 
11.
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    At the same time, the Commission does not believe that the proposal 
significantly increases concerns regarding intermarket manipulations or 
disruptions of the markets for FCOs or the underlying currencies. The 
Commission notes that the interbank foreign currency spot market is an 
extremely large, diverse market comprised of banks and other financial 
institutions worldwide.\18\ That market is supplemented by equally deep 
and liquid markets for standardized options and futures on foreign 
currencies and options on those futures. An active OTC market also 
exists in FCOs. Given the probable expense of attempting to affect the 
cash market for the currencies underlying the FCOs, the Commission 
believes that it would be difficult for a market participant to 
manipulate the underlying cash market to benefit a previously 
established FCO position.
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    \18\See Securities Exchange Act Release No. 31627 (December 21, 
1992), 57 FR 62399 (December 30, 1992) (order approving File No. SR-
Amex-92-36).
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    In addition, the Commission believes the proposal's requirement 
that FCOs have annual trading volume of 3,500,000 contracts to be 
eligible for the 150,000 contract limit further minimizes the potential 
for manipulations and helps to ensure that only consistently active 
currencies will be eligible for the higher position limit. In this 
regard, the Commission notes that if the PHLX's annual review of FCO 
trading volume indicates that an FCO is no longer eligible for the 
higher position limit, then the lower limit will be effective in all 
series of the FCO effective the Monday following the mid-month June 
expiration.\19\
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    \19\See Amendment No. 3, supra note 4.
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    The Commission believes that the proposal's two-tiered approach to 
FCO position limits is consistent with the three-tiered position limits 
for equity and narrow-based index options traded on the PHLX, and that 
tiering is consistent with the evolutionary approach that the 
Commission and the options exchanges have adopted in increasing 
position and exercise limits.\20\ The Commission believes that the PHLX 
has had considerable experience monitoring the tiered framework in 
equity options and narrow-based index options, and that differing 
position limits in those options have not created programming or 
monitoring problems for securities firms, or led to significant 
customer confusion.\21\ Based on the PHLX's experience with the three-
tiered approach in equity and narrow-based index options, the 
Commission believes the two-tiered approach for FCOs is appropriate.
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    \20\See Securities Exchange Act Release No. 33288 (December 3, 
1994), 58 FR 65221 (December 13, 1993) (order partially approving 
File No. SR-PHLX-93-07).
    \21\Id.
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    Moreover, the absence of discernible manipulative problems under 
the current FCO position limit leads the Commission to conclude that 
the proposed increase is warranted. The Commission recognizes, as it 
has stated in the past, that there are no ideal limits in the sense 
that options positions of any given size can be stated conclusively to 
be free of any manipulative concerns.\22\ The PHLX and the Commission, 
however, have relied largely on the absence of discernible manipulation 
or disruption problems under the current limit as an indicator that 
additional increases can be safely considered. The Commission believes 
for these reasons that the liberalization of existing FCO position and 
exercise limits under the condition specified is appropriate.\23\
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    \22\See Securities and Exchange Act Release No. 33288, supra 
note 20.
    \23\The Commission continues to believe that proposals to 
increase position and exercise limits must be justified and 
evaluated separately. After reviewing the proposed exercise limits, 
along with the eligibility criteria for the higher tier, the 
Commission has concluded that the exercise limit increase does not 
raise manipulation problems or increase concerns over market 
disruption in the underlying currencies.
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    In addition, the Commission believes that the PHLX's surveillance 
programs will be adequate to detect and deter the use of illegal 
position limits by market participants as well as detect and deter 
attempted manipulative activity and other trading abuses.
    The Commission believes that it is reasonable for the PHLX, on a 
timely basis, to review annual FCO volume during the year measured 
immediately prior to approval of the proposal in order to allow the 
Exchange to implement the higher position limit for eligible FCOs prior 
to the end of 1994.
    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 thereof in the Federal Register.
    The Commission believes that Amendment No. 3 strengthens the PHLX's 
proposal by requiring that lower position limits be implemented sooner 
than originally proposed, i.e., six months rather than up to two years, 
if an FCO's trading volume for the previous year is less than 3,500,000 
contracts, thereby helping to ensure that only actively traded 
currencies are eligible for the higher position limit. Accordingly, the 
Commission believes it is consistent with Sections 6(b)(5) and 19(b) of 
the Act to approve Amendment No. 3 to the proposed rule change on an 
accelerated basis.

IV. Solicitation of Comments

    Interested persons 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 at 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 October 24, 1994.
    It is therefore ordered, Pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-PHLX-93-13) is approved.

    \24\15 U.S.C. Sec. 78s(b)(2) (1982).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-24304 Filed 9-30-94; 8:45 am]
BILLING CODE 8010-01-M