[Federal Register Volume 59, Number 249 (Thursday, December 29, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31996]


[[Page Unknown]]

[Federal Register: December 29, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35134; File No. SR-NASD-94-60]

 

Self-Regulatory Organizations; Proposed Rule Change and Amendment 
No. 1 to Proposed Rule Change; National Association of Securities 
Dealers, Inc.

December 21, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on October 
27, 1994, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the NASD. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule

    The NASD proposes to amend Section 33 of the NASD Rules of Fair 
Practice, the NASD's position limit rule for standardized and 
conventional options, to add a new subsection governing the application 
of the NASD's aggregation rules for options positions to certain ``OTC 
collar'' transactions involving conventional equity options (``OTC 
Collar Aggregation Exemption'').

Section 33 of the NASD By-Laws

* * * * *
Section (b)(3) Position Limits
    (a)(1)-(5) No change.
    (a)(6) OTC Collar Aggregation Exemption.
    (a) For purposes of this subsection, the term OTC collar shall mean 
a conventional equity option position comprised of short (long) calls 
and long (short) puts overlying the same security that hedge a 
corresponding long (short) position in that security.
    (b) Notwithstanding the aggregation provisions for short (long) 
call positions and long (short) put positions contained in subsections 
(A)(1)-(A)(3) above, the conventional options positions involved in a 
particular OTC collar transaction need not be aggregated for position 
limit purposes, provided the following conditions are satisfied:
    1. the conventional options can only be exercised if they are in-
the-money;
    2. neither conventional option can be sold, assigned, or 
transferred by the holder without the prior written consent of the 
writer;
    3. the conventional options must be European-style (i.e., only 
exercisable upon expiration) and expire on the same date;
    4. the strike price of the short call can never be less than the 
strike price of the long put; and
    5. no more than one side of the transaction can be in-the-money 
when the color is established.
    6. the size of the conventional options in excess of the applicable 
basic position limit for the options established pursuant to 
subsections (A) (1)--(3) above must be hedged on a one-to-one basis 
with the requisite long or short stock position for the duration of the 
collar, although the same long or short stock position can be used to 
hedge both legs of the collar. (c) For multiple OTC collars on the same 
security meeting the conditions set forth in subsection (b) above, all 
of the short (long) call options that are part of such collars must be 
aggregated and all of the long (short) put options that are part of 
such collars must be aggregated, but the short (long) calls need not be 
aggregated with the long (short) puts.
    (d) Except as provided above in subsections (b) and (c), in no 
event may a member fail to aggregate any conventional or standardized 
options contract of the put class and the call class overlying the same 
equity security on the same side of the market with conventional option 
positions established in connection with an OTC collar.
    (e) Nothing in this subsection (6) changes the applicable position 
limit for a particular equity security.
    On December 14, 1994, the NASD amended the proposal (``Amendment 
No. 1'') to require that neither side of a particular OTC collar be in-
the-money at the time the collar is established.\1\
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    \1\Letter from Thomas R. Gira, Assistant General Counsel, NASD, 
to Stephen M. Youhn, Derivative Products Regulation, SEC, dated Dec. 
14, 1994.
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II. Self-Regulatory Organizations's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The NASD is proposing to amend its options position limit rule to 
provide that positions in conventional put and call options 
establishing OTC collars meeting certain qualifications need not be 
aggregated for position limit purposes.\2\ An OTC collar transaction 
involves the purchase (sale) of a long put and the sale (purchase) of a 
short call on the same underlying security to hedge a long (short) 
stock position. Market participants typically establish OTC collars to 
hedge price exposure to long stock positions. Because of the NASD's 
aggregation rules for options positions on the same side of the market, 
however, members have represented that they have been constrained when 
seeking to establish OTC collar positions for their customers. For 
example, if a customer wanted to hedge 900,000 shares in XYZ with an 
OTC collar (assuming XYZ is subject to a position limit of 4,500 
contracts), and if the calls and puts associated with the collar must 
be aggregated, the customer could only establish the collar for 450,000 
shares (i.e., 4500 short calls and 4,500 long puts).\3\ As a result, 
the remaining 450,000 shares of XYZ would remain unhedged.
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    \2\Section 33(b)(3) of the NASD Rules of Fair Practice provides 
that ``options contracts of the put and call class on the same side 
of the market covering the same underlying security'' are aggregated 
for position limit purposes. Accordingly, long calls and short puts 
are aggregated and short calls and long puts are aggregated.
    \3\In this instance, 4,500 of the 9,000 contracts are 
permissible under the basic position limit contained in Section 
33(b)(3) (A)(1) of the NASD Rules of Fair Practice and the remaining 
4,500 contracts are permissible because they are hedged by the 
900,000 shares of XYZ and, therefore, fall within the NASD's hedge 
exemption contained in Section 33(b)(3) (A)(5).
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    Accordingly in order to facilitate the needs of market participants 
seeking to hedge their long stock positions with OTC collars, while not 
compromising the market integrity and anti-manipulation concerns 
underlying the NASD's options position limit rule, the NASD proposes to 
waive the aggregation rules for certain OTC collar transactions meeting 
specific criteria. Specifically, under the proposal, puts and calls on 
the same side of the market would not have to be aggregated for 
position limit purposes if they are part of an OTC collar transaction 
meeting the following characteristics: (1) the options can only be 
exercised if they are in-the-money; (2) neither option can be sold, 
assigned, or transferred by the holder without the prior written 
consent of the writer; (3) the options must be European-style (i.e., 
only exercisable upon expiration) and expire on the same date; (4) the 
strike price of the short call can never be less than the strike price 
of the long put; and (5) neither side of the transaction can be in-the-
money when the collar is established.\4\
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    \4\See Amendment No. 1.
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    In addition, consistent with the NASD'S position limit hedge 
exemption rule, to the extent that the size of the conventional options 
involved in an OTC collar exceed the size of the applicable basic 
position limit for that option, the OTC Collar Aggregation Exemption 
provides that such options positions must be hedged on a one-for-one 
basis with the corresponding long/short stock position for the duration 
of the collar. The NASD also notes that the OTC Collar Aggregation 
Exemption will not affect the NASD's other aggregation rules for 
options positions on the same side of the market. Thus, the NASD will 
aggregate all standardized an conventional options positions with 
options positions established pursuant to the OTC Collar Aggregation 
Exemption, as well as options positions established in multiple OTC 
collars on the same security. For example, if an investor establishes a 
short position in 1,000 standardized call options on XYZ, a long 
position in 1,000 standardized put options on XYZ, a short position in 
1,000 conventional call options on XYZ (not established as part of an 
OTC collar), a long position in 1,000 conventional put options on XYZ 
(not established as part of an OTC collar), and an OTC collar meeting 
the standards set forth above covering 500,000 shares of XYZ, the total 
options position for position limit purposes would be 9,000 
contracts.\5\ The proposal also contains provisions governing the 
aggregation of conventional options positions establishing multiple OTC 
collars. Specifically, for multiple OTC collars on the same security 
meeting the conditions for the OTC Collar Aggregation Exemption, all of 
the short (long) call options that are part of such collars must be 
aggregated and all of the long (short) put options that are part of 
such collars must be aggregated, but the short (long) calls need not be 
aggregated with the long (short) puts.
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    \5\See Amendment No. 1. This sentence was amended to correct a 
typographical error.
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    The NASD believes the conditions and limitations contained in the 
OTC Collar Aggregation Exemption proposal strike a reasonable balance 
between the need to facilitate legitimate hedging needs of market 
participants and the need to have rules in place that do not compromise 
the regulatory purposes served by equity option position limits. In 
particular, because the conditions and limitations for the OTC Collar 
Aggregation Exemption effectively provide that no more than one leg of 
the OTC collar can ever be in-the-money at any time during the term of 
the collar and no more than one leg of the collar can ever be exercised 
throughout the term of the collar, the NASD believes that the potential 
for market manipulation or disruption will not be increased by not 
requiring the aggregation of the short (long) calls and long (short) 
puts established pursuant to the OTC Collar Aggregation Exemption. In 
addition, even though the legs of an OTC collar do not have to be 
aggregated if the collar meets the standards for the aggregation 
exemption, the NASD notes that these positions must be aggregated with 
all other standardized and conventional options on the same side of the 
market overlying the same security.\6\ Accordingly, the NASD believes 
the proposal will not undermine the regulatory purposes served by 
equity option position limits.
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    \6\However, as noted above, if there are multiple OTC collars on 
the same security meeting the conditions for the aggregation 
exemption, then all of the short (long) call options that are part 
of the collars must be aggregated and all of the long (short) put 
options that are part of the collars must be aggregated, but the 
short (long) calls need not be aggregated with the long (short) 
puts.
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    The NASD believes the proposed rule change is consistent with 
Section 15A(b)(6) of the Act. Section 15A(b)(6) requires that the rules 
of a national securities association be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, to foster cooperation and coordination with 
persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system and, in general, to 
protect investors and the public interest. Specifically, the NASD 
believes that the OTC Collar Aggregation Exemption may increase the 
depth and liquidity of the options markets by permitting investors to 
hedge greater amounts of stock than would otherwise be the case without 
the exemption. In addition, to the extent that investors have greater 
assurance that they can hedge larger stock positions through the use of 
OTC collars, the NASD believes liquidity in the underlying cash market 
may be enhanced by the proposal. At the same time, the NASD believes 
that the larger options positions available by virtue of the proposal 
will not result in disruptions to the underlying stock market due to 
the conditions and limitations that must be met to be eligible for the 
aggregation exemption, and the NASD's surveillance program. In this 
connection, the NASD will monitor the use of the OTC Collar Aggregation 
Exemption to ensure that NASD members are complying with the 
requirements of the exemption.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD believes that the proposed rule change will not result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the NASD consents, the Commission will:
    A. by order approve such proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to the file number in the caption 
above and should be submitted by January 19, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-31996 Filed 12-28-94; 8:45 am]
BILLING CODE 8010-01-M