[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]
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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.
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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.
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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).
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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.
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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.
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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.
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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).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\14\
\14\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-15810 Filed 6-27-95; 8:45 am]
BILLING CODE 8010-01-M