[Federal Register Volume 61, Number 4 (Friday, January 5, 1996)]
[Notices]
[Pages 434-436]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-169]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36657; File No. SR-NASD-95-56]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc., Relating to an Extension and 
Expansion of the NASD's Equity Option Position Limit Hedge Exemption 
Pilot Program

December 29, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 21, 1995, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by the self-regulatory 
organization. The NASD has requested accelerated approval for the 
proposal. This order approves the NASD's proposal on an accelerated 
basis and solicits comments from interested persons.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.18b-4 (1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to amend Article III, Section 33(b)(3)(A)(5) 
of the NASD Rules of Fair Practice to extend, until December 31, 1997, 
the NASD's equity option position limit hedge exemption pilot program. 
The NASD is also proposing to expand the hedge exemption pilot program 
to permit the establishment of hedged positions up to three times the 
applicable basic position limit.
    In addition, the NASD is requesting that the Commission find good 
cause, pursuant to Section 19(b)(2) of the Act, to approve the proposed 
rule change prior to the thirtieth day after publication in the Federal 
Register.

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 NASD included statements 
concerning the purpose of and 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 III below. The NASD 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
    On February 9, 1990, the Commission approved a NASD proposal \3\ to 
implement a two-year pilot program during which certain fully hedged 
equity option positions would be automatically exempt from established 
position \4\ and exercise limits.\5\ On March 18, 1994, the Commission 
extended the NASD's hedge exemption pilot program through December 31, 
1995.\6\

    \3\ See Securities Exchange Act Release No. 27697 (February 9, 
1990), 55 FR 5535 (February 15, 1990).
    \4\ Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market (i.e., 
aggregating long calls and short puts and long puts and short calls) 
that can be held or written by an investor or group of investors 
acting in concert. Article III, Section 33(b)(3)(A) of the NASD 
Rules of Fair Practice currently provides that equity option 
position limits are 4,500, 7,500, or 10,500 contracts, depending 
upon the trading volume and number of outstanding shares of the 
underlying stock. In addition, the NASD has recently submitted to 
the Commission a rule proposal that would add a 20,000-contract 
position limit tier and a 25,000-contract position limit tier. See 
File No. SR-NASD-95-55.
    \5\ Exercise limits restrict the number of options contracts 
which an investor or group of investors acting in concert can 
exercise within five consecutive business days. Under NASD Rules, 
exercise limits correspond to position limits, such that investors 
in options classes on the same side of the market are allowed to 
exercise, during any five consecutive business days, only the number 
of options contracts set forth as the applicable position limit for 
those options classes. See Article III, Section 33(b)(4) of the NASD 
Rules of Fair Practice.
    \6\ See Securities Exchange Act Release No. 33783 (March 18, 
1994), 59 FR 14229 (March 25, 1994).
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    The NASD's hedge exemption provides for an automatic exemption from 
equity option position limits for accounts that have established one of 
the four most commonly used hedged positions \7\ and where each option 
contract is either (i) hedged by 100 shares of stock, (ii) hedged by 
securities that are readily convertible into, or economically 
equivalent to, such stock,\8\ or (iii) in the case of an adjusted 
options contract, hedged by the number of shares represented by the 
adjusted contract.

    \7\ The four exempted hedge positions are: (1) Long stock and 
short calls; (2) long stock and long puts; (3) short stock and long 
calls; and (4) short stock and short puts.
    \8\ The Commission notes that the NASD determines on a case-by-
case basis whether an instrument that is being used as the basis for 
the underlying hedged positions is readily convertible into, or 
economically equivalent to, the security underlying the 
corresponding option position. In this regard, the NASD generally 
finds that an instrument that is not presently convertible into a 
security, but which will be at a future date, is not a 
``convertible'' security for purposes of the hedge exemption. In 
addition, the NASD notes that if a convertible security used to 
hedge an option position is called for redemption by the issuer, the 
security would have to be converted into the underlying security 
immediately or the corresponding option position would have to be 
reduced accordingly.
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    Under the NASD's current hedge exemption, the largest options 
position (combining hedged and unhedged positions) that may be 
established may not exceed twice the basic position limit (i.e., 9,000, 
15,000, or 21,000 contracts, respectively). In addition, the hedge 
exemption does not change the exercise limits contained in Article III, 
Section 33(b)(4) of the NASD Rules of Fair Practice. Therefore, market 
participants are allowed to exercise, during any five consecutive 
business days, the same number of options contracts as set forth in the 
position limit for that option, including those options positions that 
are hedged (i.e., if the position limit for an option is 10,500 
contracts and an investor has established a position of 21,000 
contracts (10,500 unhedged and 10,500 hedged), the investor may 
exercise all 21,000 contracts during five consecutive business days).
    The NASD is currently proposing two amendments to its hedge 
exemption pilot program. First, the NASD is 

[[Page 435]]
proposing to extend the pilot program until December 31, 1997. Second, 
the NASD is proposing to modify the hedge exemption to permit the 
establishment of hedged equity option positions up to three times the 
applicable basic position limit (i.e., 13,500, 22,500, or 31,500 
contracts).\9\ As noted above, the hedge exemption rule currently 
permits the establishment of hedged equity option positions up to twice 
the applicable basic position limit.

    \9\ The NASD notes that if File No. SR-NASD-95-55 is approved by 
the Commission, market participants could establish hedged positions 
of up to 60,000 contracts or 75,000 contracts, respectively, in 
those securities that qualify for the 20,000-contract position limit 
tier or the 25,000-contract position limit tier. In addition, under 
the OTC Collar Exemption, market participants could establish OTC 
collars where each ``leg'' of the collar is 50,000 contracts, in the 
case of a security eligible for the 20,000-contract position limit, 
or 62,500 contracts, in the case of a security eligible for the 
25,000-contract position limit.
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2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act.\10\ Section 15A(b)(6) requires that the 
rules of a national securities association be 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 regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system and, in general, to 
protect investors and the public interest.

    \10\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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    In particular, the NASD believes that the proposed expansion of the 
equity option position limit hedge exemption pilot program is warranted 
for the following reasons. First, permitting market participants, 
particularly investors with sizeable holdings, accounts, or assets, to 
establish larger hedged equity option positions will afford them 
greater flexibility to employ larger options positions when effecting 
their hedging strategies. Second, the higher hedged position limit 
exemption will likely facilitate greater activity in exchange-listed 
options and conventional equity options, thereby enhancing liquidity in 
the markets for exchange-traded options, conventional equity options, 
and the securities underlying those options. Third, by conforming the 
NASD's equity option hedge exemption rule to the hedge exemption rules 
in place at the options exchanges, there will be no confusion by market 
participants concerning applicable position and exercise limits.\11\

    \11\ See Securities Exchange Act Release Nos. 36371 (October 13, 
1995), 60 FR 54269 (October 20, 1995) (order approving File No. SR-
CBOE-95-42); and 36409 (October 23, 1995), 60 FR 55399 (October 31, 
1995) (order approving File Nos. SR-NYSE-95-31, SR-PSE-95-25, SR-
Amex-95-42, and SR-Phlx-95-71).
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    In addition, the NASD believes that the proposed expansion of the 
equity option position limit hedge exemption will not compromise the 
integrity of the options markets or jeopardize the stability of the 
securities markets underlying exchange-traded equity options or 
conventional equity options. As options positions established pursuant 
to the hedge exemption pilot program will continue to be hedged on a 
one-for-one basis with the underlying stock, the NASD does not believe 
that the proposed expansion of the hedge exemption pilot program will 
have an adverse impact on the market. In this regard, the NASD notes 
that the higher position limits currently available by virtue of the 
NASD's hedge exemption pilot program have not resulted in disruptions 
of the underlying stock market. Moreover, the NASD will continue to 
monitor the use of the position limit hedge exemption to ensure that 
NASD members comply with the requirements of the exemption, as well as 
to monitor the exemption's effect, if any, on the market.\12\

    \12\ In addition, should the NASD seek permanent approval of its 
hedge exemption pilot program, the NASD is aware of and will comply 
with the Commission's request for a request on the operation of the 
program.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

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

    Comments were neither solicited nor received with respect to the 
proposed rule change.

III. 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 changes that are filed 
with the Commission, and all written communications relating to the 
proposed rule changes 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. Sec. 552, will be available for inspection and 
copying at the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. 20549. Copies of such filings also will be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-95-56 and should 
be submitted by January 26, 1996.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    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 association, and, in 
particular, with the requirements of Section 15A(b)(6). Specifically, 
the Commission believes that the proposed extension and expansion of 
the NASD's equity option position limit hedge exemption pilot program 
will accommodate the needs of investors and market participants while 
at the same time furthering investor protection and the public 
interest.
    The Commission also believes that the proposed rule change will 
increase the potential depth and liquidity of the equity 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.
    In addition, to the extent the potential for manipulation does 
increase due to the expanded hedge exemption, the Commission believes 
that the NASD's surveillance programs will be adequate to detect as 
well as to deter attempted manipulative activity. Moreover, the 
Commission will continue to monitor the NASD's surveillance programs to 
ensure that problems do not arise.
    The Commission finds good cause to approve the proposed rule 
changes prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. Specifically, by 
accelerating the approval of the NASD's rule proposal, the Commission 
is conforming the NASD's equity option hedge exemption to identical 
proposals that were recently approved for the options exchanges by the 

[[Page 436]]
Commission.\13\ Accelerated approval of the proposed rule change will 
thereby provide for the desired uniformity of equity option hedge 
exemptions within the exchange traded options market. Any other course 
of action could lead to unnecessary investor confusion. In addition, 
the Chicago Board Options Exchange, Inc.'s (``CBOE'') proposal was 
noticed for the entire twenty-one day comment period and generated no 
negative responses.\14\ Lastly, accelerated approval of the rule 
proposal will allow the NASD's hedge exemption pilot program to 
continue on an uninterrupted basis. Accordingly, the Commission 
believes that it is consistent with Section 15A(b)(6) of the Act to 
approve the proposed rule change on an accelerated bais.

    \13\ See supra note 11.
    \14\ Id.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) \15\ of the 
Act that the proposed rule change (File No. SR-BASD-85-56) is hereby 
approved on an accelerated basis, and, accordingly, the hedge exemption 
pilot program as expanded herein is extended until December 31, 1997.

    \15\ 15 U.S.C. Sec. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\

    \16\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-169 Filed 1-4-96; 8:45 am]
BILLING CODE 8010-01-M