[Federal Register Volume 60, Number 177 (Wednesday, September 13, 1995)]
[Notices]
[Pages 47637-47639]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-22655]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36194; File No. SR-PHLX-95-16]


Self-Regulatory Organization; Order Approving Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc., Relating to 
Modifications of the Position and Exercise Limits for Narrow-Based 
Index Options

September 6, 1995.

I. Introduction

    On March 6, 1995, the Philadelphia Stock Exchange, Inc. (``PHLX'' 
or ``Exchange'') filed with 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 PHLX Rule 1001A, 
``Position Limits,'' to increase the position and exercise limits \3\ 
for narrow-based (or industry) index options from the current levels of 
5,500, 7,500, or 10,500 contracts to 6,000, 9,000, or 12,000 contracts.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ Position limits impose a ceiling on the number of option 
contracts which an investor or group of investors acting in concert 
may hold or write in each class of options on the same side of the 
market (i.e., aggregating long calls and short puts or long puts and 
short calls). Exercise limits prohibit an investor or group of 
investors acting in concert from exercising more than a specified 
number of puts or calls in a particular class within five 
consecutive business days. PHLX Rule 1002A, ``Exercise Limits,'' 
states that for the purposes of determining compliance with PHLX 
Rule 1002, ``Exercise Limits,'' exercise limits for index option 
contracts shall be equivalent to the position limits described in 
PHLX Rule 1001A.
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    Notice of the proposed rule change appeared in the Federal Register 
on May 16, 1995.\4\ No comments were received on the proposal.

    \4\ See Securities Exchange Act Release No. 35694 (May 9, 1995), 
60 FR 26067.
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II. Background and Description

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
option contracts that a member or customer can hold or exercise. These 
rules are intended to prevent the establishment of large options 
positions that can be used or might create incentives to manipulate or 
disrupt the underlying market so as to benefit the options position. At 
the same time, the Commission has recognized that option position and 
exercise limits must not be established at levels that are so low as to 
discourage participation in the options market by institutions and 
other investors with substantial hedging needs or to prevent 
specialists and market makers from adequately meeting their obligations 
to maintain a fair and orderly market.\5\

    \5\ See, e.g., Securities Exchange Act Release No. 33285 
(December 3, 1993), 58 FR 65201 (December 13, 1993) (order approving 
File No. SR-Amex-93-27) (increasing position and exercise limits for 
equity options and narrow-based index options).
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    In 1983, the PHLX set position and exercise limits for narrow-based 
index options at 4,000 contracts.\6\ In 1993, the Commission approved a 
PHLX proposal to amend PHLX Rule 1001A to increase the position limits 
for narrow-based index options to the current levels of 5,500, 7,500, 
or 10,500 contracts.\7\ The PHLX proposes to amend Exchange Rule 
1001A(b)(1) to increase the position and exercise limits for industry 
index options from 5,500, 7,500, or 10,500 contracts to 6,000, 9,000 or 
12,000 contracts.\8\

    \6\ See Securities Exchange Act Release No. 20437 (December 2, 
1983), 48 FR 55229 (December 9, 1983) (order approving File No. SR-
PHLX-83-17).
    \7\ See Securities Exchange Act Release No. 33288 (December 3, 
1993), 58 FR 65221 (December 13, 1993) (order approving File No. SR-
PHLX-93-07) (``1993 Approval Order''). Specifically, PHLX Rule 
1001A(b)(1) currently provides the following position limits for 
industry index options: (i) 5,500 contracts for an index where a 
single component stock accounted, on average, for 30% or more of the 
index value during the 30-day period immediately preceding the 
Exchange's semi-annual review of industry index option position 
limits; (ii) 7,500 contracts for an index where a single component 
stock accounted, on average, for 20% or more of the index value or 
any five component stocks together accounted, on average, for more 
than 50% of the index value but no single component stock accounted, 
on average, for 30% or more of the index value during the 30-day 
period immediately preceding the Exchange's semi-annual review of 
industry index option position limits; or (iii) 10,500 contracts 
where the conditions requiring a limit of 5,500 contracts or 7,500 
contracts have not occurred.
    \8\ The PHLX currently trades options on the following narrow-
based indexes: (1) the Gold/Silver Index (``XAU'') 5,500 contracts; 
(2) the Utility Index (``UTY'') (10,500 contracts); (3) the PHLX/KBW 
Bank Index (``KBX'') (10,500 contracts); (4) the Phone Index 
(``PNX'') (5,500 contracts); (5) the Semiconductor Index (``SOX'') 
(7,500 contracts); and (6) the Airline Sector Index (``PLN'') 
(10,500 contracts).
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    The Exchange believes that its proposal is consistent with the Act 
for several reasons. First, the Exchange notes that the current 
industry index option position limits have been in place since 1993 and 
that there have been no further increases in position limits for 
narrow-based index options since that time, despite substantial changes 
in the marketplace. Most notable among these changes, according to the 
PHLX, is an appreciable growth in index options trading. The PHLX 
states that this marked increase in index options volume has 
significantly increased liquidity in PHLX-traded index options.\9\

    \9\ The PHLX states that index options volume increased 450% 
(from 354,614 contracts to 1,957,171 contracts in 1994 as compared 
to 1993.
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    Second, the Exchange believes that the proposed increases are 
reasonable and consistent with the gradual, evolutionary approach 
adopted previously by the Commission and the options exchanges when 
increasing position and exercise limits.\10\ Accordingly, the PHLX 
proposes a 9% increase in the lowest tier (from 5,000 to 6,000 
contracts); a 20% increase for options currently at the 7,500 contract 
limit (increased to 9,000 contracts); and a 15% increase in the highest 
tier, currently at 10,500 contracts (increased to 12,000 contracts).

    \10\ According to the PHLX, the most recent position limit 
changes in 1993 represented changes of 38% (from 4,000 to 5,500 
contracts); 25% (from 6,000 to 7,500 contracts); and 31% (from 8,000 
to 10,500 contracts).
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    Third, the Exchange believes that the proposed increases are needed 
by traders and investors. According to the PHLX, Exchange members and 
customers have asked the Exchange to propose an increase in position 
limits, primarily because interested trading 

[[Page 47638]]
participants have not been able to meet their investment needs at 
current position limit levels. Specifically, the PHLX notes that 
certain institutional traders handling industry funds deal in 
securities valued many times higher than the maximum permissible 
position under PHLX rules. Based on such member and customer requests, 
the Exchange believes that the current position limit levels discourage 
market participation by large investors and the institutions that 
compete to facilitate the trading interests of large investors. 
Accordingly, the PHLX proposes to raise position and exercise limits 
for narrow-based index options to accommodate the liquidity and hedging 
needs of large investors and the facilitators of those investors.
    Fourth, the Exchange believes that the proposal should increase the 
depth and liquidity of the markets for index options. The PHLX also 
believes that higher position limits would further accommodate the 
hedging needs of Exchange market makers and specialists, who are also 
restricted by current levels.
    The PHLX notes that it continues to monitor the markets for 
evidence of manipulation or disruption caused by investors with 
positions at or near current position or exercise limits and that the 
new limits will not diminish the surveillance function in this regard. 
Additionally, the PHLX states that its surveillance procedures have 
become increasingly sophisticated and automated.
    For these reasons, the Exchange believes that the proposal to 
increase narrow-based index option position limits is consistent with 
Section 6 of the Act, in general, and, in particular, with Section 
6(b)(5), in that it is designed to promote just and equitable 
principles of trade and to prevent fraudulent and manipulative acts and 
practices, as well as to protect investors and the public interest. The 
Exchange believes that the proposal should remove impediments to and 
perfect the mechanism of a free and open market by providing market 
opportunity to investors constricted by current position limit levels. 
The PHLX also believes that by stimulating market participation and 
thereby increasing option market depth and liquidity, the proposed rule 
change should promote just and equitable principles of trade.

III. Discussion

    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).\11\ Specifically, the 
Commission finds that the proposed position and exercise limits for 
narrow-based index options should accommodate the needs of investors 
and market participants and should increase the potential depth and 
liquidity of the options market as well as the underlying cash market 
without significantly increasing concerns regarding intermarket 
manipulations or disruptions of the market for the options or the 
underlying securities.

    \11\ 15 U.S.C. 78f(b) (1988 & Supp. V 1993).
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    As noted above, the Commission believes that although the position 
and exercise limits for options must be sufficient to protect the 
options and related markets from disruptions by manipulation, the 
limits must not be established at levels that are so low as to 
discourage participation in the options market by institutions and 
other investors with substantial hedging needs or to prevent market 
makers from adequately meeting their obligations to maintain a fair and 
orderly market. In this regard, the PHLX has stated that the current 
position limits discourage market participation by certain large 
investors and the institutions that compete to facilitate their 
trading. In addition, the PHLX notes that index option trading volume 
has increased significantly since 1993, when the current industry index 
option position limits were established. In light of the increased 
volume of narrow-based index option trading and the needs of investors 
and market makers, the Commission believes that the PHLX's proposal is 
a reasonable effort to accommodate the needs of market participants.
    In addition, the Commission notes that the proposal, while 
increasing the positions limits for narrow-based index options, 
continues to reflect the unique characteristics of each index option 
and to maintain the structure of the current three-tiered system. 
Specifically, the lowest proposed limit, 6,000 contracts, will apply to 
narrow-based index options in which a single underlying stock accounts 
for 30% or more of the index value during the 30-day period immediately 
preceding the Exchange's semi-annual review of industry index option 
positions limits. A position limit of 9,000 contracts will apply if any 
single underlying stock accounts, on average, for 20% or more of the 
index value or any five underlying stocks account, on average for more 
than 50% of the index value, but no single stock in the group accounts, 
on average, for 30% or more of the index value during the 30-day period 
immediately preceding the Exchange's semi-annual review of industry 
index option position limits. The 12,000-contract limit will apply only 
if the Exchange determines that the conditions requiring either the 
6,000-contract limit or the 9,000-contract limit have not occurred. 
Accordingly, the proposal allows the Exchange to avoid placing 
unnecessary restraints on those narrow-based index options where the 
manipulative potential is the least and the need for increased 
positions, both by traders and institutional investors, may be the 
greatest.
    The Commission believes that the proposed increases for the three 
tiers of 9%, 20%, and 15%, for lowest to highest, respectively, appear 
to be appropriate and consistent with the Commission's evolutionary 
approach to position and exercise limits. In this regard, the absence 
of discernible manipulative problems under the current three-tiered 
position and exercise limit system for narrow-based index options leads 
the Commission to conclude that the modest increases proposed by the 
Exchange are warranted. The Commission recognizes that there are no 
ideal limits in the sense that options positions of any given size can 
be stated conclusively to be free of any manipulative concerns. 
However, based upon the absence of discernible manipulation or 
disruption problems under current limits, the Commission believes that 
the proposed limits can be safely considered. Accordingly, the 
Commission believes that the liberalization of existing position and 
exercise limits for narrow-based index options is now appropriate.\12\

    \12\ The Commission continues to believe that proposals to 
increase position limits and exercise limits must be justified and 
evaluated separately. After reviewing the proposed exercise limits, 
along with the eligibility criteria for each tier, the Commission 
has concluded that the proposed exercise limit increases for the 
three-tiered framework do not raise manipulation problems or 
increase concerns over market disruption in the underlying 
securities.
    The Commission notes that the Exchange has had considerable 
experience monitoring the current three-tiered framework in narrow-
based stock index options. The Commission has not found that differing 
position and exercise limit requirements based on the particular 
options product to have created programming or monitoring problems for 
securities firms, or to have led to significant customer confusion. 
Based on the current experience in handling position and exercise 
limits, the Commission believes that the proposed increase in position 
and exercise limits for narrow-based index 

[[Page 47639]]
options will not cause significant problems.
    Finally, the PHLX has indicated that its surveillance procedures 
have become increasingly sophisticated and automated. The Commission 
believes that the Exchange's surveillance programs are adequate to 
detect and deter violations of position and exercise limits as well as 
to detect and deter attempted manipulative activity and other trading 
abuses through the use of such illegal positions by market 
participants.\13\

    \13\ The Commission emphasizes that the PHLX must closely 
monitor compliance with position and exercise limits and to impose 
appropriate sanctions for failures to comply with the Exchange's 
position and exercise limit rules.
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposal 
to increase the position and exercise limits for narrow-based index 
options to 6,000, 9,000, or 12,000 contracts, depending on the 
percentage stock concentrations within the index, is consistent with 
the requirements of the Act and the rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-PHLX-95-16) is approved.

    \14\ 15 U.S.C. Sec. 78f(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\

    \15\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-22655 Filed 9-12-95; 8:45 am]
BILLING CODE 8010-01-M