[Federal Register Volume 60, Number 27 (Thursday, February 9, 1995)]
[Notices]
[Pages 7805-7808]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3280]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35327; File No. SR-AMEX-94-56]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 to Proposed Rule Change by the American 
Stock Exchange, Inc., Relating to Buy-Write Options Unitary Derivatives 
(``BOUNDs'')

February 3, 1995.
    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 December 
12, 1994, the American Stock Exchange, Inc. (``Amex'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II 
and III below, which Items have been prepared by the self-regulatory 
organization. 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 Change

    The Amex, pursuant to Rule 19b-4 under the Act, proposes to amend 
its rules to permit trading in Buy-Write Options Unitary Derivatives 
(``BOUNDs''). As described in more detail below, BOUNDs are long term 
options which the Amex believes have the same economic characteristics 
as a covered call writing strategy. On December 23, 1994, the Exchange 
submitted Amendment No. 1 (``Amendment No. 1'') to the filing to 
provide that BOUNDs will be listed with a maximum expiration date 
corresponding to the longest prescribed long term equity options 
(``LEAPs'') then available for trading, which is currently 39 
months.\1\

    \1\Letter from William Floyd-Jones, Jr., Assistant General 
Counsel, Amex, to Michael Walinskas, Derivative Products Regulation, 
SEC, dated Dec. 23, 1994. The Amex originally proposed listing 
BOUNDs with 60 month expirations and extending the maximum duration 
of LEAPs from 39 months to 60 months.
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    The text of the proposed rule change and Amendment No. 1 are 
available at the Office of the Secretary, Amex and at the Commission.

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

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of, and statutory 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 self-regulatory organization 
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

(1) Purpose
    In 1986, the Exchange began listing 26 unit investment trusts, each 
of which held shares of a single ``blue-chip'' equity security. 
Investors were offered an opportunity to separate their ownership 
interests in these trusts into two distinct trading components 
representing different economic characteristics of the individual 
stocks held in the trusts. These separate trading components were known 
as PRIMEs and SCOREs. [[Page 7806]] 
    PRIMEs were the enhanced income/limited capital gain component. The 
holder of a PRIME retained the dividends on the stock held by the trust 
and participated in the underlying stock's appreciation up to a fixed 
dollar amount. SCOREs were the capital appreciation component. The 
holder of a SCORE had the right to all capital appreciation above a 
fixed dollar amount, but did not receive the dividends on the 
underlying stock.
    PRIMEs and SCOREs were extremely popular with investors, but the 
trusts from which they derived have now reached their five-year 
termination dates. Certain Internal Revenue Service regulations, 
moreover, effectively preclude the creation of new PRIMEs and SCOREs 
through the original trust mechanism.
    The Exchange, for some time, has sought a replacement for the 
expired PRIMEs and SCOREs. During this process, the Exchange and other 
options exchanges began to list and trade LEAPs. Like SCOREs, LEAPs 
enable investors to receive the benefits of a stock's price 
appreciation above a fixed dollar amount over a long period of time. 
Currently, however, there is no generally available replacement for 
PRIMEs.
    The Exchange, accordingly, proposes to list BOUNDs as a replacement 
for PRIMEs. The Options Clearing Corporation (``OCC'') will be the 
issuer of all BOUNDs traded on the Exchange. As with all OCC issued 
options, BOUNDs will be created when an opening buy and an opening sell 
order are executed. The execution of such orders will increase the open 
interest in BOUNDs. Except as described herein, BOUNDs will be subject 
to the rules governing standardized options.
    The Exchange anticipates listing BOUNDs with respect to those 
underlying securities that have listed LEAPs. The criteria for stocks 
underlying BOUNDs will be the same as the criteria for stocks 
underlying LEAPs.
    It is anticipated that the sum of the market prices of a LEAP and a 
BOUND on the same underlying stock with the same expiration and 
exercise price will closely approximate the market price for the 
underlying stock. If the combined price of the LEAP and BOUND diverge 
from that of the underlying common stock, there will be an arbitrage 
opportunity which, when executed, should bring the price relationships 
back into line.
    BOUNDs will have the same strike prices and expiration dates as 
their respective LEAPs except that the Exchange will list only a strike 
price that is at or very close to the price of the underlying stock at 
the time of listing, or that is below the price of the stock at that 
time. For example, at the time of initial listing, the strike prices 
for a BOUND with the underlying stock trading at $50 per share, would 
be set at $40 and $50. The Exchange would not list a BOUND with a 
strike price of $60 in this example.
    The Exchange anticipates that it will list new complementary LEAPs 
and BOUNDs on the same underlying securities annually, or at more 
frequent intervals, depending on market demand. The Exchange has the 
current authority to list LEAPs with up to 39 months until expiration 
and, therefore, seeks to introduce BOUNDs with up to the same 39 month 
duration.\2\

    \2\See Amendment No. 1.
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    Like PRIMEs, BOUNDs will offer essentially the same economic 
characteristics as covered calls with the added benefits that BOUNDs 
can be traded in a single transaction and are not subject to early 
exercise. BOUND holders will profit from appreciation in the underlying 
stock's price up to the strike price and will receive payments 
equivalent to any cash dividends declared on the underlying stock. On 
the ex-dividend date for the underlying stock, OCC will debit all 
accounts with short positions in BOUNDs and credit all accounts with 
long positions in BOUNDs with an amount equal to the cash dividend on 
the underlying stock.
    Like regular options, BOUNDs will trade in standardized contract 
units of 100 shares of underlying stock per BOUND so that at 
expiration, BOUND holders will receive 100 shares of the underlying 
stock for each BOUND contract held if, on the last day of trading, the 
underlying stock closes at or below the strike price. However, if at 
expiration the underlying stock closes above the strike price, the 
BOUND contract holder will receive a payment equal to 100 times the 
BOUND's strike price for each BOUND contract held. BOUND writers will 
be required to deliver either 100 shares of the underlying stock for 
each BOUND contract or the strike price multiplied by 100 at 
expiration, depending on the price of the underlying stock at that 
time. This settlement design is similar to the economic result that 
accrues to an investor who has purchased a covered call (i.e., long 
stock, short call) and held that position to the expiration of the call 
option.
    For example, if the XYZ BOUND has a strike price of $50 and XYZ 
stock closes at $50 or less at expiration, the holder of the XYZ BOUND 
contract will receive 100 shares of XYZ stock. This is the same result 
as if the call option in a buy--write position had expired out of the 
money; i.e., the option would expire worthless and the writer would 
retain the underlying stock. If XYZ closes above $50 per share, then 
the holder of an XYZ BOUND will receive $5,000 in cash (100 times the 
$50 strike price). This mimics the economic result to the covered call 
writer when the call expires in the money, i.e., the writer would 
receive an amount equal to 100 shares times the strike price and would 
forfeit any appreciation above that price (because the stock would be 
delivered to satisfy the settlement obligations created upon the 
exercise of the call option).
    The settlement mechanism for the BOUNDs will operate in conjunction 
with that of LEAP calls. For example, if at expiration the underlying 
stock closes at or below the strike price, the LEAP call will expire 
worthless, and the holder of a BOUND contract will receive 100 shares 
of stock from the short BOUND. If on the other hand, the LEAP call is 
in the money at expiration, the holder of the LEAP call is entitled to 
100 shares of stock from a short LEAP upon payment of the strike price, 
and the holder of a BOUND contract is entitled to the cash equivalent 
of the strike price times 100 from the short BOUND. An investor long 
both a LEAP and a BOUND, where XYZ closes above the $50 strike price at 
expiration, would be entitled to receive $5,000 in cash from the short 
BOUND and, upon exercise of the LEAP, would be obligated to pay $5,000 
to receive 100 shares of XYZ stock.
    An investor long the underlying stock, and who writes both a LEAP 
and a BOUND, will be obligated to deliver the stock to the long LEAP 
call if the underlying stock closes above the strike price, and will 
receive in return payment of the strike price times 100, which amount 
will then be delivered to the long BOUND. Accordingly, the Exchange 
believes a covered writer's position is effectively closed upon the 
delivery of the underlying stock. If a writer of both instruments has 
deposited cash or securities other than the underlying stock as margin 
for a short LEAP call and BOUND, then the writer delivers 100 shares of 
stock (purchased on the open market) to the long LEAP call upon payment 
of the strike price times 100. The writer of the BOUND then delivers 
the cash value of 100 times the strike price to the holder of the long 
BOUND.
    It should be noted that LEAPs are American-style options whereas 
[[Page 7807]] BOUNDs are European-style.\3\ The Exchange believes that 
it would be inappropriate for the BOUND holder to have an American-
style exercise right since the BOUND will tend to trade at a discount 
to the stock and strike price.

    \3\A European-style option may only be exercised during a 
limited period of time before the option expires. An American-style 
option may be exercised at any time prior to its expiration.
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    Sales Practices. BOUNDs will be subject to the Exchange's sales 
practice and suitability rules applicable to standardized options.
    Adjustments. BOUNDs will be subject to adjustments for corporate 
and other actions in accordance with the rules of OCC.
    Position Limits. BOUNDs will be subject to the position limits for 
equity options set forth in Exchange Rule 904. In addition, BOUNDs will 
be aggregated with other equity options on the same underlying stock 
for purposes of calculating position limits. According to the Exchange, 
since a BOUND to the holder is a bullish position (i.e., the equivalent 
of a short put position where the strike price has been prepaid), the 
Exchange proposes that long BOUNDs be aggregated with long call and 
short put positions in the related equity options. Similarly, since the 
Exchange believes the BOUND, from the perspective of the seller, is a 
``bearish'' position (i.e., it is the equivalent of a long put position 
where the strike price has been prepaid), it proposes to aggregate 
short BOUNDs with short call and long put positions in the related 
equity options.
    Customer Margin. The Exchange proposes to apply options margin 
treatment to BOUNDs as follows:
    1. Long BOUND Positions: full payment required at the time of 
purchase. As described more fully below, however, there will be a 
credit for long BOUNDs in BOUND spread positions.
    2. Short BOUND Positions: the BOUND seller receives full value of 
the BOUND at the time of the initial sale and receives no further 
payment when the contract is settled either by payment of the strike 
price or delivery of the underlying stock. Short BOUND positions, 
therefore, will be margined in an amount equal to the current market 
price of the BOUND plus an amount equal to an ``add-on'' used to margin 
short call options times the market value of the BOUND. Since the 
maximum obligation of the seller of a BOUND cannot exceed the strike 
price, however, the amount of margin will never exceed the strike 
value. For example:
    A. Assume a stock rice of $50, an exercise price of $50, a margin 
add-on percent of 20% and the BOUND trading at $40. In this case, the 
short seller would have to pay $48 to margin the position, i.e., $40 
BOUND price plus 20% of $40.
    B. Assume a stock price of $40, an exercise price of $50, a margin 
add-on percent of 20% and the BOUND trading at $35. In this case, the 
margin would be $42, i.e., $35 BOUND price plus 20% of $35.
    3. Covered Positions: Short BOUND positions offset by the 
equivalent number of shares of the underlying stock will not require 
any additional margin since the seller's obligation to the buyer will, 
in all cases, be covered by the position in the underlying stock. 
Further, since the sum of the prices of a LEAP and a BOUND will be 
approximately equal to the price of the underlying stock, a long stock 
position is cover for both a short BOUND and a short LEAP position.
    4. Spread Positions. (i) Same Expiration--Different Strike Prices: 
There will be no margin requirement for BOUND positions which are long 
the higher strike price and short the lower strike price since the long 
BOUND more than covers the obligation of the short side of the 
position. For positions short the higher strike price and long the 
lower strike, a customer will be required to post the difference 
between the strike prices.
    (ii) Different Expiration--Same Strike Price: No margin will be 
required for positions long the nearest expiration and short the longer 
expiration since the value of the long BOUND will cover the obligation 
on the short leg of the position. Positions that are short the near 
expiration and long the distant expiration will require full margin on 
the short position less 80% of the market value of the long position.
    (iii) Different Expiration--Different Strike Prices: There will be 
no margin required for positions that are long the near expiration and 
short the distant expiration when the strike price on the near 
expiration is higher than the strike on the distant expiration. For 
positions which are long the near expiration and short the distant 
expiration where the strike price on the near expiration is lower than 
the strike on the distant contract, the margin will be the difference 
in the strike between the near term and distant strikes. For positions 
which are short the near expiration and long the distant expiration, 
full margin will be required on the short position less 80% of the 
market value of the long position.
(2) Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act, in general, and furthers the objectives 
of section 6(b)(5), in particular, in that it is 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 facilitating transactions in securities, and to 
remove impediments to and perfect the mechanism of a free and open 
market and the national market system.

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

    The Amex believes that the proposed rule change will impose no 
burden on competition.

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

    No written comments were either solicited or received with respect 
to the proposed rule change.

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 self-regulatory organization 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 [[Page 7808]] available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street 
NW., Washington, D.C. 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 March 2, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\4\

    \4\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-3280 Filed 2-8-95; 8:45 am]
BILLING CODE 8010-01-M