[Federal Register Volume 60, Number 124 (Wednesday, June 28, 1995)]
[Notices]
[Pages 33440-33442]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-15810]



=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35874; File No. SR-NASD-94-60]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change by the National Association 
of Securities Dealers, Inc. Relating to Applicable Position Limits for 
OTC Collar Transactions

June 21, 1995.

I. Introduction

    On October 27, 1994, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') submitted to 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 proposed rule change 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 
(``OTC Collar Aggregation Exemption'').\3\ The NASD filed Amendment No. 
1 to the proposed rule change on December 14, 1994 (``Amendment No. 
1'').\4\ Notice of the proposal and Amendment No. 1 appeared in the 
Federal Register on December 29, 1994.\5\ No comment letters were 
received on the proposed [[Page 33441]] rule change. On May 19, 1995, 
the NASD filed Amendment No. 2 (``Amendment No. 2'') to the proposal to 
clarify in the language of the proposed exemption the maximum number of 
contracts that may comprise a collar that is governed by the OTC Collar 
Aggregation Exemption.\6\ The effect of Amendment No. 2 is to clarify 
that the exemption from aggregation only applies to the hedge exemption 
portion of the position limit. This order approves the NASD's proposal, 
as amended.

    \1\ 15 USC Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1992).
    \3\ 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.
    \4\ See Letter from Thomas R. Gira, Assistant General Counsel, 
NASD, to Stephen M. Youhn, Derivative Products Regulation, SEC, 
dated Dec. 14, 1994. See infra note. 8.
    \5\ Securities Exchange Act Release No. 35134 (Dec. 21, 1994), 
59 FR 67359.
    \6\ See Letter from Thomas R. Gira, Assistant General Counsel, 
NASD, to Stephen M. Youhn, Derivative Products Regulation, SEC, 
dated May 19, 1995.
---------------------------------------------------------------------------

II. Description of Proposal

    An OTC collar transaction involves the purchase (sale) of a put and 
the sale (purchase) of a call on the same underlying security to hedge 
a long (short) stock position. The proposal would amend Section 33 of 
the NASD Rules of Fair Practice, the NASD's position limit rule for 
standardized and conventional options, in the following manner:

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 established pursuant to the position 
limit hedge exemption in subsection (A)(5) need not be aggregated for 
position limit purposes, provided the following conditions are 
satisfied: \7\

    \7\ See Amendment No. 2.

    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. neither side of the transaction can be in-the-money when the 
collar is established.\8\

    \8\ The NASD originally proposed that one side of the collar 
could be in-the-money when the collar was established. Amendment No. 
1 changes this requirement by stating that neither side of a 
particular OTC collar may be in-the-money at the time the collar 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.
    Nothing in this subsection (6) changes the applicable position 
limit for a particular equity security.
    According to the NASD, market participants typically establish OTC 
collars to hedge price exposure to long stock positions. However, the 
NASD states that the current position limit aggregation rules constrain 
members 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., 4,500 short calls and 4,500 long puts).\9\ As a result, 
the remaining 450,000 shares of XYZ would remain unhedged.

    \9\ In this instance, 4,500 of the 9,000 contracts are 
permissible under the basic position limit contained 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).
---------------------------------------------------------------------------

    Accordingly, in order to facilitate the needs of market 
participants seeking to hedge their long stock positions with OTC 
collars, the NASD proposes to waive the position limit aggregation 
rules for certain OTC collar transactions meeting specific criteria. 
Specifically, the OTC Collar Aggregation Exemption will provide that 
puts and calls on the same side of the market (e.g., short calls and 
long puts) which are established pursuant to Section 33(b)(3)(A)(5), 
the equity option position limit hedge exemption rule (``equity option 
position limit hedge exemption'') are not required to be aggregated for 
position limit purposes if they are part of an OTC collar transaction 
meeting all of the conditions of proposed Section 33(b)(3)(A)(6) 
above.\10\

    \10\ Under Section 33(b)(3)(A)(5), the Equity Hedge Exemption 
rule, the hedge exemption may not exceed twice the position limit 
established under NASD rules. Position limits are set at either 
4,500, 7,500 or 10,500 contracts on the same side of the market, 
depending on the characteristics of the stock.
---------------------------------------------------------------------------

    Consistent with the NASD's equity option position limit hedge 
exemption rule, to the extent that the size of the controversial 
options involved in a particular OTC collar exceed the size of the 
applicable basic position limit for that option, the proposed 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 and 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.
    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.
    The following examples are intended to illustrate the operation of 
the OTC Collar Aggregation Exemption (assume a position limit of 4,500 
contracts and an applicable hedge exemption of 4,500 contracts):

    A. An investor has no established conventional or standardized 
option position. The investor may establish an OTC collar consisting 
of 6,750 short calls and 6,750 long puts. Pursuant to proposed 
Section 33(b)(3)(A)(6)(b)(6), the options [[Page 33442]] comprising 
the collar in excess of the applicable basic position limit (i.e., 
4,500) must be hedged on a one-for-one basis with 450,000 shares. 
The total number of allowable option contracts on the same side of 
the market in this example would be 13,500.
    B. An investor is short 1,000 calls. The investor may establish 
an OTC collar consisting of 6,250 short calls and 6,250 long puts. 
Pursuant to proposed Section 33(b)(3)(A)(6)(b)(6), the options 
comprising the collar in excess of the applicable basic position 
limit (i.e., 4,500) must be hedged on a one-for-one basis with 
450,000 shares. The total number of allowable option contracts on 
the same side of the market in this example would be 13,500.
    C. An investor is short 6,500 calls (4,500 pursuant to the 
position limit and 2,000 pursuant to the hedge exemption) and long 
200,000 shares of stock. An OTC collar consisting of 2,500 short 
calls and 2,500 long puts may be established. Pursuant to proposed 
Section 33(b)(3)(A)(6)(b)(6), the options comprising the collar in 
excess of the applicable basic position limit (i.e., 4,500) must be 
hedged on a one-for-one basis with an additional stock position of 
250,000 shares. The total number of allowable option contracts on 
the same side of the market in this example would be 11,500.
    D. An investor is short 9,000 calls (4,500 pursuant to the 
position limit and 4,500 pursuant to the hedge exemption) and long 
450,000 shares of stock. An OTC collar may not be established since 
the investor has already reached the maximum allowable position 
limit.
III. Commission Findings and Conclusions

    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) of the Art. 
Specifically, the Commission believes the conditions and limitations 
contained in the 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 the equity option position limit rules. In 
particular, because the conditions and limitations for the OTC Collar 
Aggregation Exemption effectively provide that neither leg of the OTC 
collar can be in-the-money at the time the collar is established and 
that no more than one leg of the collar can ever be exercised 
throughout the term of the collar, the Commission does not believe that 
the larger options position resulting from the proposed non-aggregation 
of short (long) calls and long (short) puts for the hedge exemption 
portion of the position limit pursuant to the OTC Collar Aggregation 
Exemption will increase the potential for market manipulation or 
disruption.\11\

    \11\ Furthermore, in order to ensure that the positions covered 
by this proposal are maintained in a collar transaction, the 
proposal requires that all of the conventional options comprising 
the OTC collar must be European-style and expire on the same date.
---------------------------------------------------------------------------

    In addition, even though the conventional options positions 
involved in a particular OTC collar transaction do not have to be 
aggregated (if the collar meets the standards for the aggregation 
exemption), the collar position must be aggregated with all other 
standardized and conventional options on the same side of the market 
overlying the same security. In this respect, the Commission notes that 
while the NASD's proposal does not change the recognized position limit 
levels (i.e., 4,500, 7,500, 10,500), it does alter the manner in which 
contracts are aggregated for position limits purposes, with the net 
result being an increase in certain situations in the number of 
contracts an investor may hold on the same side of the market from 
9,000 to 13,500 (assuming a position limit of 4,500). While the maximum 
number of contracts an investor may hold is effectively increased, the 
proposal's requirements ensure that the amount of stock that may be 
controlled by an investor's option position is not increased. Instead, 
the proposal merely facilitates the use of an OTC collar by not 
aggregating the positions for determining the number of contracts 
pursuant to the hedge exemption. To the extent that investors have 
greater latitude to use a collar for hedging purposes, the proposal 
will enhance investors' risk management of stock positions.\12\

    \12\ As noted above, the non-aggregation of collar positions 
only applies to positions established pursuant to the existing hedge 
exemption. See supra note 10.
---------------------------------------------------------------------------

    The Commission also 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 Commission notes 
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.
    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 2 has the effect of limiting and clarifying the maximum 
number of contracts that may comprise a particular OTC collar 
established pursuant to the OTC Collar Aggregation Exemption, and as a 
result, should further reduce any speculative or manipulative impact 
caused by the net increase in the number of options held by an 
investor. Therefore, the Commission believes there is good cause to 
approve Amendment No. 2 to the proposal on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2. 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 July 19, 1995.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
\13\ that the proposed rule change (SR-NASD-94-60) is approved, as 
amended.

    \13\ 15 USC 78s(b)(2) (1988).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\

    \14\ 17 CFR 200.30-3(a)(12) (1994).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-15810 Filed 6-27-95; 8:45 am]
BILLING CODE 8010-01-M