[Federal Register Volume 60, Number 46 (Thursday, March 9, 1995)]
[Notices]
[Pages 12998-13001]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-5704]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35436; File No. SR-PSE-95-01]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Stock Exchange, Inc., Relating to Buy-Write 
Options Unitary Derivatives (``BOUNDs'')

March 2, 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 February 
6, 1995, the Pacific Stock Exchange, Inc. (``PSE'' 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 [[Page 12999]] 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 PSE, pursuant to Rule 19b-4 under the Act, proposes to amend 
its rules to permit trading in Buy-Write Options Unitary Derivatives 
(``BOUNDs'').\1\ As described in more detail below, BOUNDs are long 
term options which the PSE believes have the same economic 
characteristics as a covered call writing strategy.

    \1\The PSE notes that BOUNDs is a service mark of The American 
Stock Exchange, Inc.
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    The text of the proposed rule change is available at the Office of 
the Secretary, PSE 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 section (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 Exchange is proposing to list for trading BOUNDs. 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.
    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.
    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.
    The Exchange believes the settlement of the LEAP and BOUND at 
expiration are equally well harmonized from the perspective of the 
writer. For example, 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 [[Page 13000]] 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 
BOUNDs are European-style.\2\ 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.

    \2\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 set forth in Rule 
9.
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 6.8. 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 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 price 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.
    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 PSE does not believe that the proposed rule change will impose 
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

    Written comments were neither solicited nor 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 NW., [[Page 13001]] 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 in 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 March 30, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\3\

    \3\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-5704 Filed 3-8-95; 8:45 am]
BILLING CODE 8010-01-M