[Federal Register Volume 59, Number 197 (Thursday, October 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25277]


[[Page Unknown]]

[Federal Register: October 13, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34791; International Series Release No. 723; File No. 
SR-Amex-94-18]

 

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 American Stock Exchange, Inc., Relating to the 
Listing and Trading of Options on the Israeli Index

October 5, 1994.
    On May 31, 1994, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to list and trade options on the 
Israeli Index (``Israeli Index'' or ``Index''). On August 2, 1994, the 
Exchange filed Amendment No. 1 to the proposed rule change, the subject 
matter of which supersedes the original proposal.\3\ On August 8, 1994, 
the Exchange filed Amendment No. 2 (``Amendment No. 2'') to the 
proposal to clarify how the index will be weighted when the composition 
of the Index changes from its current number of eleven components.\4\ 
On September 28, 1994, the Exchange filed Amendment No. 3 (``Amendment 
No. 3'') to the proposal to extend the trading hours of the Index 
options by five minutes, to 4:15 p.m., and to reduce the index value in 
half by doubling the size of the divisor.\5\
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    \1\15 U.S.C. 78s(b)(1) (1982).
    \2\17 CFR 240.19b-4 (1991).
    \3\In the original proposal, the Amex originally sought approval 
of a narrow-based, capitalization-weighted index comprised of ten 
components.
    \4\See Letter from Nathan Most, Senior Vice President, New 
Products Development, Amex, to Michael Walinskas, Derivative 
Products Regulation, SEC, dated August 5, 1994.
    \5\See Letter from Nathan Most, Senior Vice President, Amex, to 
Michael Walinskas, Derivative Products Regulation, SEC, dated 
September 28, 1994.
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    Notice of the proposed rule change was published for comment in 
Securities Exchange Act Release No. 34554 (Aug. 19, 1994) and appeared 
in the Federal Register, 59 FR 44198 (Aug. 26, 1994). No comments were 
received on the proposal. This order approves the proposal, as amended.

I. Description of the Proposal

    The Amex has developed a new index called The Amex/Oscar Gruss 
Israel Index, based entirely on shares of widely held Israeli stocks 
and American Depositary Receipts (``ADRs'') traded on the NYSE, Amex, 
or that are National Market (``NM'') securities traded through the 
National Association of Securities Dealers. Automated Quotation system 
(``NASDAQ''). The Index contains securities of highly capitalized 
companies with major business interests in Israel. These include 
companies which are incorporated in Israel, whose offices are located 
in Israel, or whose research and development activities are 
concentrated in Israel.

Index Calculation and Maintenance

    The Index is calculated using a ``modified'' equal dollar weighting 
methodology. Five of the eleven component securities have been given a 
higher weighting in the Index in order to more closely approximate the 
weight the industry represented by that component has in the Israeli 
stock market. For example, ECI Telecom Ltd. and Teva Pharmaceutical 
Industries, which are the largest capitalized components in the Index, 
will have a higher weight in the Index, but not as high as if the Index 
were capitalization weighted. The Amex believes that this ``modified'' 
equal dollar weighting methodology allows the Index to be a more 
accurate reflection of the Israeli market since it provides a higher 
weighting for the larger capitalized components, yet does not permit 
those stocks to dominate the Index.
    The following is a description of how the ``modified'' equal dollar 
weighting calculation method works. As of the market close on June 17, 
1994, a $100,000 portfolio comprised of eleven Israeli component 
securities was established representing a hypothetical ``investment'' 
(rounded to the nearest whole share) of $12,000 in the five largest 
capitalized Index components and $6,667 in each of the six remaining 
Index components. The value of the Index equals the current market 
value (i.e., based on U.S. primary market prices) of the sum of the 
assigned number of shares of each of the Index components divided by 
the Index divisor. The Index divisor was initially determined to yield 
the benchmark value of 213.00 at the close of trading on June 17, 1994, 
however, the Amex has since doubled the Index divisor in order to 
reduce the Index level.\6\ Each quarter thereafter, following the close 
of trading on the third Friday of March, June, September and December, 
the Index components will be ranked in descending market capitalization 
order and the Index portfolio adjusted by changing the number of whole 
shares of each component stock so that the five largest capitalized 
stocks in the Index represent 60% of the Index value, and the remaining 
40% of the Index value is evenly distributed over the remaining 
securities. If the number of components in the Index changes from 
eleven securities, the Amex will continue to weigh the five components 
with the highest market capitalizations 12%. The remaining components 
will then be weighted equally.\7\ For example, if two new components 
are added to the Index, the five securities with the highest market 
capitalizations will be assigned 12% weightings while the remaining 
eight securities in the Index would be weighted 5%.
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    \6\See Amendment No. 3.
    \7\See Amendment No. 2.
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    The Exchange has chosen to rebalance following the close of trading 
on the quarterly expiration cycle because it allows an option contract 
to be held for up to three months without a change in the Index 
portfolio while at the same time, maintaining the ``modified'' equal 
dollar weighting feature of the Index. If necessary, a divisor 
adjustment is made at the rebalancing 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.
    Adjustments to the Index are done on a regular basis and timely, 
proper and adequate notice is given to investors. An information 
circular is distributed to all Exchange members notifying them of the 
quarterly changes. This circular is also sent by facsimile 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 ``modified'' equal dollar weighting 
methodology.
    As noted above, the number of shares of each component stock in the 
Index portfolio remains 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, a stock distribution, 
stock splits, reverse stock splits, a rights offering distribution, 
reorganization, recapitalization, or similar event with respect to the 
component stocks. In a merger or consolidation of an issuer of a 
component stock, if the stock remains in the Index, the number of 
shares of that security in the portfolio may be adjusted, to the 
nearest whole share, to maintain the components's relative weight in 
the Index at the level immediately prior to the corporate action. In 
the event of a stock replacement, the average dollar value of the 
remaining portfolio components in the same weighting tier as the stock 
being replaced will be calculated and that amount ``invested'' in the 
stock of the new component, to the nearest whole share. In all cases, 
the divisor will be adjusted, if necessary, to ensure Index continuity.
    The Amex will calculate and maintain the Index, and pursuant to 
Exchange Rule 901C(b) may at any time or from time to time substitute 
stocks, or adjust the number of stocks included in the Index, based on 
changing conditions in Israel. However, the Exchange will not decrease 
the number of Index component stocks to less than nine or increase the 
number of component stocks to greater than fourteen without prior 
Commission approval.
    The value of the Index will be calculated continuously and 
disseminated every 15 seconds over the Consolidated Tape Association's 
Network B.

Expiration and Settlement

    The Exchange proposes to trade cash-settled, European-style Index 
options (i.e., exercises are permitted to expiration only). The 
Exchange also proposes that Israeli Index options will have trading 
hours from 9:30 a.m. to 4:15 p.m. EST.\8\ As with other index options 
traded on the Amex, the options on the Index will expire on the 
Saturday following the third Friday of the expiration month 
(``Expiration Friday''), The last trading day in an option series will 
normally be the second to last business day preceding the Saturday 
following the third Friday of the expiration month (normally a 
Thursday). Trading in expiring options will cease at the close of 
trading on the last trading day.
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    \8\See Amendment No. 3.
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    The Index value for purposes of settling a specific Israeli Index 
option will be calculated based upon the primary exchange regular way 
opening sale prices for the component securities.\9\ In the case of NM 
securities, the first reported sale price will be used. As trading 
begins in each of the Index's component securities, its opening sale 
price is used in the calculation. Once all of the component stocks have 
opened, the value of the Index is determined and that value is used as 
the settlement value of the option. If any of the component stocks do 
not open for trading on the last trading day before expiration, then 
the prior day's last sale price is used in the calculation.
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    \9\In the case of ADRs, the primary exchange refers tot he 
primary exchange for the ADR and not the underlying security. 
Telephone conversation between Claire McGrath, Special Counsel, 
Derivative Securities, Amex, and Stephen Youhn, Derivative Products 
Regulation, SEC, on Aug. 19, 1994.
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    The Exchange plans to list options series with expirations in the 
three near-term calendar months and in the two additional calendar 
months in the March cycle. In addition, longer term option series 
having up to thirty-six months to expiration may be traded. In lieu of 
such long-term options on a full-value Index level, the Exchange may 
instead list long-term, reduced-value put and call options based on 
one-tenth (\1/10\th) the Index's full-value. In either event, the 
interval between expiration months for either a full-value or reduced-
value long-term option will not be less than six months.

Eligibility Standards for Index Components

    The Index's component securities all have major business interests 
in Israel, and have been selected on the basis of their market 
capitalization, trading liquidity, and representation of Israeli 
business industries. The Amex believes the components represent the 
largest and most liquid of all Israeli securities trading in the U.S., 
and that the Index tracks closely the performance of larger broad 
market Israeli indexes, such as the Oscar Gruss Israel Index, which 
contains all of the more than 50 Israeli securities currently traded in 
the U.S. this index is carried in the Israeli press as well as by 
Bloomberg L.P., a major U.S. data vendor.
    In choosing among Israeli stocks that meet the minimum criteria set 
forth in Exchange Rule 901C, the Exchange will select stocks that: (1) 
Have a minimum market value in U.S. dollars of at least $75 million, 
except that for each of the lowest weighted component securities in the 
Index that in the aggregate account for no more than 10% of the weight 
of the Index, the market value may be at least $50 million; (2) have an 
average monthly trading volume in the U.S. markets over the previous 
six month period of not less than 500,000 shares (or ADRs); (3) have at 
least 85% of the numerical Index value and at least 80% of the total 
number of component securities meeting the current criteria for 
standardized option trading set forth in Exchange Rule 915; and (4) are 
reported securities that trade on either the NYSE, Amex (subject to the 
limitations of Rule 901C), or are NM securities.
    The Amex will ensure that not more than 20% of the weight of the 
Index is represented by ADRs overlying foreign securities that are not 
subject to comprehensive surveillance sharing agreements.\10\ Currently 
no Index components have the majority of their trading volume occurring 
on an exchange with which the Amex does not currently have in place an 
effective surveillance sharing agreement.
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    \10\See Amendment No. 2.
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Exchange Rules Applicable to Stock Index Options

    Amex Rules 900C through 980C will apply to the trading of regular 
and long-term contracts based on the Index. These Rules cover issues 
such as surveillance, exercise prices, and position limits. 
Surveillance procedures currently used to monitor trading in each of 
the Exchange's other index options will also be used to monitor trading 
in options on the Index. The Index is deemed to be a Stock Index option 
under Rule 901C(a) and a Stock Index Industry Group under Rule 
900C(b)(1). With respect to Rule 903C(b), the Exchange proposes to list 
near-the-money (i.e., within ten points above or below the current 
index value) options series on the Index at 2\1/2\ point strike 
(exercise) price intervals when the value of the Index is below 200 
points. In addition, the Exchange proposes to establish, pursuant to 
Rule 904C(c), a position limit of 7,500 contracts on the same side of 
the market.
    The Exchange seeks to have the ability to utilize its Auto-Ex 
system for orders in Index options of up to 50 contracts. Auto-Ex is 
the Exchange's automated execution system which provides for the 
automatic execution of market and marketable limit orders at the best 
bid or offer at the time the order is entered. The Amex represents that 
it has the necessary systems capacity to support new series that would 
result from the introduction of Israeli Index Options.\11\
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    \11\See Letter from Warren I. Kaiser, Senior vice President, 
Information Technology, Amex, to Michael Walinskas, Derivative 
Products Regulation, SEC, dated August 8, 1994. Additionally, the 
Options Price reporting Authority (``OPRA'') has stated that it has 
the necessary systems capacity to support those new series of index 
options that would result from the introduction of Index options an 
Index LEAPS. See Memorandum from Joe Corrigan, Executive Director, 
OPRA, to Charles Faurot, Managing Director, Market Data Services, 
Amex, dated August 8, 1994.
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II. Discussion

    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).\12\ Specifically, the 
Commission finds that the trading of Israeli Index options, including 
full-value and reduced-value 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 Israeli securities.\13\
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    \12\15 U.S.C. 78f(b)(5) (1988).
    \13\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 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 full-value Index LEAPS will provide investors with a 
hedging vehicle that should reflect the overall movement of Israeli 
stocks and ADRs in the U.S. securities markets. The Commission also 
believes that these Index options will provide investors with a 
means by which to make investment decisions regarding Israeli 
securities traded in the U.S. securities markets, allowing them to 
establish positions or increase existing positions in such markets 
in a cost effective manner. Moreover, the Commission believes that 
the reduced-value Index LEAPS, which will be traded on an index 
computed at one-tenth the value of the Israeli Index, will serve the 
needs of retail investors by providing them with the opportunity to 
use a long-term option to hedge their portfolios from long-term 
markets moves at a reduced cost.
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    The trading of options on the Israeli Index, including full-value 
and reduced-value Index LEAPS, however, raises several concerns, namely 
issues related to index design, customer protection, surveillance, and 
market impact. The Commission believes, for the reasons discussed 
below, that the Amex adequately has addressed these concerns.

A. Index Design and Structure

    The Commission finds that the Israeli Index is a narrow-based 
index. The Israeli Index is composed of only eleven securities, all of 
which represent Israeli companies.\14\ Accordingly, in light of the 
limited number of components in the Index, the Commission believes it 
is proper to classify the Israeli Index as narrow-based and apply 
Amex's rules governing narrow-based index options to trading in the 
Index options.
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    \14\The reduced-value Israeli Index, which is composed of the 
same component securities as the Index and calculated by dividing 
the Index value by ten, is identical to the Israeli Index.
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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, 1994 through June, 1994, ranging from a high of 
453,000 shares per day to a low of 32,000 shares per day. Second, the 
market capitalizations of the securities in the Index are very large, 
ranging, during the same period, from a high of $1.46 billion to a low 
of $80 million, with the mean and median being $487.7 million and 
$252.95 million, respectively. Third, although the Index is only 
comprised of eleven component securities, no one particular security or 
group of securities dominates the Index. Specifically, no one stock or 
ADR comprises more than 12% of the Index's total value and the 
percentage weighting of the five largest issues in the Index account 
for 60% of the Index's value. Fourth, at least 85% of the securities in 
the Index, by weight, and at least 80% of the number of components of 
the Index, must be eligible for standardized options trading. This 
proposed maintenance requirement will ensure that the Index is 
substantially comprised of options-eligible securities.\15\ Fifth, if 
the Amex increases the number of component securities to more than 
fourteen or decreases that number to less than nine, the Amex 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 
Israeli Index options and Index LEAPS. 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 Israeli Index options and Index 
LEAPS. Sixth, the Amex will be required to ensure that each component 
of the Index is subject to last sale reporting pursuant to Rule 11Aa3-1 
of the Act. This will further reduce the potential for manipulation of 
the value of the Index. Finally, the Commission believes that, as 
discussed below, the existing mechanisms to monitor trading activity in 
the underlying Index components (or options on those securities), will 
help deter such illegal activity.
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    \15\Currently, nine of the eleven Index components are options-
eligible securities while 89% of the Index, by weight, is comprised 
of options-eligible securities.
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    The Commission finds that the Exchange's requirements covering 
minimum capitalization, monthly trading volume, and relative weightings 
of component stocks are designed to ensure that the trading markets for 
component stocks are adequately capitalized and sufficiently liquid, 
and that no one stock or stock group dominates an index. Thus, the 
Commission believes these standards are reasonably designed to ensure 
the protection of investors and the public interest and that the 
satisfaction of these requirements significantly minimizes the 
potential for manipulation of the Index.

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 Israeli Index options 
(including full-value and reduced-value Israeli 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 Israeli Index options and full-value and reduced-value 
Israeli Index LEAPS.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing the list a security index derivative 
product and the exchange(s) trading the 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.\16\ In this 
regard, the Amex, NYSE, and NASD are all members of the ISG, which 
provides for the exchange of all necessary surveillance 
information.\17\ Further, as to present and future ADR components of 
the Index, either the Exchange must have comprehensive surveillance 
sharing agreements with the primary foreign markets for the securities 
underlying the ADRs or the U.S. must be the relevant market for 
surveillance purposes.\18\ 
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    \16\Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \17\If the prices of the ADR components, or the composition of 
the Index, should change so that greater than 20% of the weight of 
the Index would be represented by ADRs whose underlying securities 
were not the subject of a comprehensive surveillance sharing 
agreement with the Amex, then it would be difficult for the 
Commission to reach the conclusions reached in this order and the 
Commission would have to determine whether it would be suitable for 
the Exchange to continue to trade options on this Index. The Amex 
should, accordingly, notify the Commission immediately if more than 
20% of the numerical value of the Index is represented by ADRs whose 
underlying securities are not subject to a comprehensive 
surveillance sharing agreement. Such a change in the current 
relative weights of the Index or in the composition of the Index 
will warrant the submission of a rule filing pursuant to Section 19 
of the Act. In determining whether a particular ADR is subject to a 
comprehensive surveillance sharing agreement, see, e.g., Securities 
Exchange Act Release Nos. 31531 (November 27, 1992), 57 FR 57250 
(December 3, 1992); and 33554 (January 31, 1994), 59 FR 5622 
(February 7, 1994).
    \18\See 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 Israeli 
Index options, including full-value and reduced-value Index LEAPS, on 
the Amex will not adversely impact the underlying securities markets. 
First, as described above, for the most part, no one security or group 
of securities dominates the Index. Second, because at least 85% of the 
numerical value of the Index and at least 80% of the components of the 
Index must be accounted for by securities that meet the Exchange's 
options listing standards, and because each of the component securities 
must be subject to last sale reporting pursuant to Rule 11Aa3-1 of the 
Act, 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.
    The Commission believes that settling expiring Israeli Index 
options (including full-value and reduced-value 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.\19\ Lastly, the Commission believes the ability to use Auto-
Ex for orders of up to 50 contracts will provide customers with liquid 
markets and efficient executions.
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    \19\See 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 No. 3 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice there in the Federal Register. The Commission 
believes that the Amex's doubling of the size of the Index divisor in 
order to reduce the value of the Index in half is consistent with the 
purposes of the Act. A lower Index should make the Index options more 
affordable and available to individual investors, thereby resulting in 
improved efficiency or liquidity in the execution of these Index 
options. Furthermore, the Commission believes the Amex's extension of 
its trading hours in the Index options by five minutes is non-
substantive and does not raise any new or unique regulatory issues. 
Both the Chicago Board Options Exchange, Inc. and Pacific Stock 
Exchange, Inc. currently trade a form of Index options on an Israeli 
Index and their trading hours extend until 4:15 p.m. The Amex's change 
simply brings the three Exchange's into conformity. 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.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 3. 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 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the Amex. All 
submissions should refer to File No. SR-Amex-94-18 and should be 
submitted by November 3, 1994.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (SR-Amex-94-18) is approved, as 
amended.
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    \20\15 U.S.C. 78s(b)(2) (1988).

    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. 94-25277 Filed 10-12-94; 8:45 am]
BILLING CODE 8010-01-M