[Federal Register Volume 61, Number 50 (Wednesday, March 13, 1996)]
[Notices]
[Pages 10417-10420]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-5966]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36935; File No. SR-Phlx-95-92]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc., Relating to the Listing and Trading of Options on the 
Phlx OTC Industries Average Index

March 6, 1996.

I. Introduction

    On December 21, 1995, the Philadelphia Stock Exchange, Inc., 
(``Phlx'' or ``Exchange'') filed a proposed rule change 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\ to provide for the listing 
and trading of index options on the Phlx OTC Industrial Average Index 
(``OTC Industrial Index'' or ``Index''). The Exchange filed with the 
Commission Amendment No. 1 to the proposal on December 27, 1995.\3\ The 
Exchange filed with the Commission Amendment No. 2 to the proposal on 
February 28, 1996.\4\

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Exchange amended the proposed rule change to indicate 
that the Index will be treated as a narrow based index. See Letter 
from Nandita Yagnik, New Product Development, Phlx, to John Ayanian, 
Attorney, Office of Market Supervision (``OMS''), Division of Market 
Regulation (``Market Regulation''), Commission, dated December 27, 
1995 (``Amendment No. 1'').
    \4\ The Exchange proposed additional maintenance standards to 
the Index, as described more fully herein. See Letter from Nandita 
Yagnik, New Products Development, Phlx, to John Ayanian, Attorney, 
OMS, Market Regulation, Commission, dated February 28, 1996 
(``Amendment No. 2'').
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    Notice of the proposal, as amended, was published for comment and 
appeared in the Federal Register on January 26, 1996.\5\ No comment 
letters were received on the proposed rule change. This order approves 
the Exchange's proposal, as amended.

    \5\ See Securities Exchange Act Release No. 36744 (January 19, 
1996), 61 FR 2562
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II Description of the Proposal

A. General

    The Exchange proposes to list and trade options on the Phlx OTC 
Industrial Average Index, a price-weighted \6\ index developed by the 
Phlx based on some of the largest stocks, by capitalization, traded 
through the National Association of Securities Dealers Automated 
Quotations system and are reported national market system securities 
(``NASDAQ/NMS'').

    \6\See infra Section II.E, entitled ``Calculation of the 
Index,'' for a description of this calculation methodology.
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B. Composition of the Index

    The Index was designed by the Exchange and is currently composed of 
ten of the most highly capitalized and widely held common stocks of 
U.S. companies. The Index is composed entirely of NASDAQ/NMS 
securities. Currently, the Index represents diversified industries 
including Telecommunications, Pharmaceuticals, Semiconductors, and Data 
Processing.\7\ All component stocks are ``reported securities,'' as 
that term is defined in Rule 11a3-1 of the Act.\8\ The Index is price-
weighted and will be calculated on a real-time basis using last sale 
prices.

    \7\ The component's of the Index are: Amgen, Inc.; Applied 
Materials; Bay Networks, Inc.; CISCO Systems; Intel Corp.; Microsoft 
Corp.; MCI Communications; Oracle Corp.; Sun Microsystems; and Tele 
Communications, Inc.
    \8\ See 17 CFR 240.11Aa3-1. A ``reported security'' is defined 
in paragraph (a)(4) of this rule as ``any listed equity security or 
NASDAQ security for which transaction reports are required to be 
made on a real-time basis pursuant to an effective transaction 
reporting plan.''
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    As of the close of trading on January 4, 1996, the Index was valued 
at 279.27. As of November 9, 1995, the market capitalizations of the 
individual securities in the Index ranged from a high of $57.5 billion 
to a low of $8.2

[[Page 10418]]
billion, with the mean being $22.4 billion. The market capitalization 
of all the securities in the Index was $224.5 billion. The total number 
of shares outstanding on that date for the stocks in the Index ranged 
from a high of 821.2 million shares to a low of 90.9 million shares.\9\ 
Also on that date, the price per share in the U.S. of the securities in 
the Index ranged from a high of $85.375 to a low of $18.250. The 
average daily trading volume for the six month period from August 1, 
1995 to February 1, 1996 ranged from a high of 18.7 million shares to a 
low of 1.29 million shares.\10\ The average daily trading volume for 
all of the components of the Index for the same period was 
approximately 63.4 million shares.\11\ Lastly, no one component 
accounted for more than 15.59% of the Index's total vale and the 
percentage weighting of the five largest issues in the Index accounted 
for 67.35% of the Index's value. The percentage weighting of the lowest 
weighted component was 3.31% of the Index.

C. Maintenance

    The Phlx has retained Bridge Data, Inc. to compute and do all 
necessary maintenance of the Index. The Index value will be updated 
dynamically at least once every 15 seconds during the trading day. 
Pursuant to Phlx rule 1100A, updated Index values will be disseminated 
and displayed by means of primary market prints reported by the 
Consolidated Tape Association and over the facilities of the Options 
Price Reporting Authority. The Index value will also be available on 
broker/dealer interrogation devices to subscribers of the option 
information.
    In accordance with Phlx rule 1009A, if any change in the nature of 
any stock in the Index occurs as a result of delisting, merger, 
acquisition or otherwise, the Exchange will take appropriate steps to 
delete that stock from the Index and replace it with another stock 
which the Exchange believes would be compatible with the intended 
market character of the Index. In making replacement determinations, 
the Exchange will also take into account the capitalization, liquidity, 
and volatility of a particular stock.
    The Exchange represents that component stocks constituting the top 
90% of the Index by weight, must have a minimum market capitalization 
of $75 million and the component stocks constituting the bottom 10% of 
the Index, by weight, must have a minimum market capitalization of $50 
million. Additionally, the Phlx provides that the Index must meet the 
criteria that no single component represents more than 25% of the 
weight of the Index and that the five highest weighted components 
represent no more than 75% of the Index as of the first day of January 
and July in each year. Moreover, the Phlx represents that the monthly 
trading volume of each component security shall be at least 500,000 
shares, or for each of the lowest weighted components in the Index that 
in the aggregate account for no more than 10% of the weight of the 
Index, the monthly trading volume must be at least 400,000 shares.\12\ 
Finally, the Exchange represents that all of the stocks comprising the 
Index are options eligible \13\ and have overlying options currently 
trading. At least 90% of the component issues, by weight, and 80% of 
the number of stocks, must be options eligible at all times.\14\ If at 
any time the Index does not meet any of these maintenance requirements, 
the Exchange will submit a Rule 19b-4 filing to the Commission before 
opening any new series of options on the Index for trading. 
Additionally, if at any time, the Exchange determines to increase to 
more than thirteen or decrease to fewer than seven, the number of 
component issues in the Index, the Exchange will submit a new Rule 19b-
4 filing.options exchanges, provide that a security underlying an 
option must, among other things, meet the following requirements: (1) 
the public float must be at least 7,000,000 shares; (2) there must be a 
minimum of 2,000 stockholders; (3) trading volume in the U.S. must have 
been at least 2.4 million over the preceding twelve months; and (4) the 
U.S. market price must have been at least $7.50 for a majority of the 
business days during the preceding three calendar months. See Phlx Rule 
1009, Commentary .01.

D. Applicability of Phlx Rules Regarding Index Options

    Except as modified by this order, Phlx Rules 1000A through 1103A, 
in particular, and Phlx Rules 1000 through 1070, in general, will be 
applicable to OTC Industrial Index options. Those rules address, among 
other things, the applicable position and exercise limits, policies 
regarding trading halts and suspensions, and margin treatment for 
narrow-based index options.

E. Calculation of the Index

    The Phlx OTC Industrial Index is a price-weighted index and 
reflects changes in the prices of the Index component securities 
relative to the Index's base date of November 1, 1995. The formula for 
calculating the OTC Industrial Index is as follows:
[GRAPHIC] [TIFF OMITTED] TN13MR96.000

SP=the stock price of each component.

    \9\ See Letter from Nandita Yagnik, New Products Development, 
Phlx, to John Ayanian, Attorney, OMS, Market Regulation, Commission, 
dated February 23, 1996 (``Trading Data Letter'').
    \10\ Id.
    \11\Id.
    \12\ See Amendment No. 2, supra note 4.
    \13\ The Phlx's options listing standards, which are uniform 
among the
    \14\ Telephone conversation between Michele Weisbaum, Associate 
General Counsel, Phlx, and John Ayanian, Attorney, OMS, Market 
Regulation, Commission, on January 18, 1996.
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    The current price of each component issue is added and multiplied 
by 100 shares to determine the current aggregate market value of the 
issues in the Index. To compute the current Index value, the aggregate 
market value is divided by the divisor. The Index value was set at a 
starting value of 150 as of November 1, 1995.
    In order to maintain continuity in the value of the Index, the 
Index divisor will be adjusted for changes in capitalization of any of 
the component issues resulting from, among other things, mergers, 
acquisitions, delistings, and substitutions. Adjustments in the value 
of the Index which are necessitated by the addition and/or the deletion 
of an issue from the Index are made by adding and/or subtracting the 
market value (price times shares outstanding) of the relevant issues. 
The value of the Index as of the close of trading on Friday, January 4, 
1996 was 279.27.
    The settlement value for the Index options will be based on the 
opening values of the component securities on the date prior to 
expiration. Index options will expire on the Saturday following the 
third Friday of the expiration month, and the last day for trading in 
an expiring series will be the second business day (ordinarily a 
Thursday) preceding the expiration

[[Page 10419]]
date. If any of the component stocks do not open for trading on the 
last trading day before expiration, then the prior trading day's (i.e., 
normally Thursday's) last sale price will be used in the Index 
calculation.
F. Contract Specifications
    The proposed Index options will be cash-settled, European-style 
options. As with the Exchange's other indexes, the multiplier for 
options on the OTC Industrial Index will be 100. The OTC Industrial 
Index options will trade from 9:30 a.m. to 4:10 p.m. eastern time. 
Exercise prices will be initially set at 5 point intervals and 
additional exercise prices will be added in accordance with Phlx Rule 
1101A(a).
    The Phlx will trade consecutive and cycle month series pursuant to 
Phlx Rule 1101A. Specifically, there will be three expiration months 
from the March, June, September, December cycle plus two additional 
near-term months so that the three nearest term months will always be 
available.
G. Position and Exercise Limits, Margin Requirements, and Trading Halts
    Because the Index is classified as an ``industry index'' under Phlx 
rules, Exchange rules that are applicable to the trading of options on 
narrow-based indexes will apply to the trading of OTC Industrial Index 
options. Specifically, Exchange rules governing position and exercise 
limits,\15\ margin requirements,\16\ and trading halt procedures \17\ 
that are applicable to the trading of the Exchange's other industry 
index options will apply to options traded on the Index.

    \15\ Pursuant to Phlx Rules 1001A and 1002A, respectively, the 
position and exercise limits for the Index options will be 9,000 
contracts. See Amendment No. 1, supra note 3.
    \16\ Pursuant to Phlx Rule 722, the margin requirements for the 
Index options will be: (1) for short options positions, 100% of the 
current market value of the options contract plus 20% of the 
underlying aggregate Index value, less any out-of-the-money amount, 
with a minimum requirement of the options premium plus 10% of the 
underlying Index value; and (2) for long options positions, 100% of 
the options premium paid. See Amendment No. 1, supra note 3.
    \17\ Pursuant to Phlx Rule 1047A, the trading on the Phlx of 
Index options may be halted or suspended whenever trading in the 
underlying securities whose weighted value represents more than 10% 
of the Index value are halted or suspended.
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H. Surveillance
    The Exchange notes that procedures currently used to monitor 
trading in each of the Exchange's other index options will also be used 
to monitor the trading of options on the OTC Industrial Index. These 
procedures included having complete access to trading activity in the 
underlying securities which are all traded through NASDAQ via the 
Intermarket Surveillance Group Agreement (``ISG Agreement'') dated July 
14, 1983, as amended on January 29, 1990.\18\

    \18\ The Intermarket Surveillance Group (``ISG'') was formed on 
July 14, 1983 to, among other things, coordinate more effectively 
surveillance and investigative information sharing arrangements in 
the stock and options markets. See Intermarket Surveillance Group 
Agreement, July 14, 1983. The most recent amendment to the ISG 
Agreement, which incorporates the original agreement and all 
amendments made thereafter, was signed by ISG members on January 29, 
1990. See Second Amendment to the Intermarket Surveillance Group 
Agreement, January 29, 1990. The members of the ISG are: the Amex; 
the Boston Stock Exchange, Inc.; the CBOE; the Chicago Stock 
Exchange, Inc.; the National Association of Securities Dealers, Inc. 
(``NASD''); the NYSE; the Pacific Stock Exchange, Inc.; and the 
Philadelphia Stock Exchange, Inc. Because of potential opportunities 
for trading abuses involving stock index futures, stock options, and 
the underlying stock and the need for greater sharing of 
surveillance information for these potential intermarket trading 
abuses, the major stock index futures exchanges (e.g., the Chicago 
Mercantile Exchange and the Chicago Board of Trade) joined the ISG 
as affiliate members in 1990.
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    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act in general and furthers the objectives of 
Sections 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 change, 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 a national market systems.

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).\19\ Specifically, the 
Commission finds that the trading of OTC Industrial Index options will 
serve to promote the public interest and help to remove impediments to 
a free and open securities market by providing investors with a means 
of hedging exposure to market risk associated with heavily traded 
industrial securities traded through NASQDAQ.\20\ The trading of 
options on the OTC Industrial Index, however, raises several issues 
related to index design, customer protection, surveillance, and market 
impact. The Commission believes, for the reasons discussed below, that 
the Phlx has adequately addressed these issues.

    \19\ 15 U.S.C. 78f(b)(5).
    \20\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option proposal upon a finding that 
the introduction of such new derivative instrument is in the public 
interest. Such a finding would be difficult for a derivative 
instrument that served no hedging or other economic function because 
any benefits that might be derived by market participants likely 
would be outweighed by the potential for manipulation, diminished 
public confidence in the integrity of the markets, and other valid 
regulatory concerns. In this regard, the trading of listed Index 
options will provide investors with a hedging vehicle that should 
reflect the overall movement of some of the most heavily traded 
industrial securities traded through NASDAQ.
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A. Index Design and Structure

    The Commission finds that the OTC Industrial Index is a narrow-
based index, because it is only composed of ten stocks, comprising some 
of the largest industrial securities traded through NASDAQ. 
Accordingly, the Commission believes it is appropriate for the Phlx to 
apply its rules governing narrow-based index options to trading in the 
Index options.\21\

    \21\ See supra Section II.G.
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    The Commission also finds that the large capitalizations, liquid 
markets, and relative weightings of the individual securities 
comprising the Index minimize the potential for manipulation of the 
Index. First, the securities comprising the Index are actively traded, 
with an average daily trading volume for all components for the period 
from August 1, 1995 through February 1, 1996, of approximately 63.4 
million shares per day. Second, as of November 9, 1995, the market 
capitalizations of the individual securities in the Index ranged from a 
high of $57.5 billion to a low of $8.2 billion, with the mean being 
$22.4 billion. Third, although the Index is composed of only 10 
securities, no particular component security or group of securities 
dominates the Index. Specifically, as of November 16, 1995, no 
component security contained in the Index accounted for more than 
15.59% of the Index's total value and the five highest weighted 
securities in the Index accounted for 67.35% of the Index's value.
    Fourth, the proposed maintenance criteria will serve to ensure 
that: (1) The Index remains composed substantially of liquid, highly 
capitalized securities; and (2) the Index is not dominated by any one 
security that does not satisfy the Exchange's options listing criteria. 
Specifically, in considering changes to the composition of the Index, 
90% of the weight of the Index and 80% of the number of components in 
the Index must comply with the listing criteria for standardized 
options trading set forth in

[[Page 10420]]
Phlx Rule 1009 (for securities that are not then the subject of 
standardized options trading) and Phlx Rule 1010 (for securities that 
are then the subject of standardized options trading).\22\ 
Additionally, the Phlx is required to review the composition of the 
Index at least quarterly to ensure that the Index continues to meet 
this 90%/80% criterion.

    \22\ Additionally, the securities contained in the Index must be 
``reported'' securities and must be Nasdaq/NM securities.
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    The Phlx will promptly notify the Commission staff at any time that 
the Phlx determines that the Index fails to satisfy any of the above 
maintenance criteria. Further, in such an event, the Exchange will not 
open for trading any additional series of Index options unless the 
Exchange determines that such failure is not significant, and the 
Commission staff affirmatively concurs in that determination, or unless 
the Commission specifically approves the continued listing of that 
class of Index options pursuant to a proposal filed in accordance with 
Section 19(b) of the Act.
    For the above reasons, the Commission believes that these criteria 
minimize the potential for manipulation of the Index and eliminate 
domination concerns.

B. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as OTC Industrial Index 
options, can commence on a national securities exchange. The Commission 
notes that the trading of standardized exchange-traded options occurs 
in an environment that is designed to ensure, among other things, that: 
(1) the special risks of options are disclosed to public customers; (2) 
only investors capable of evaluating and bearing the risks of options 
trading are engaged in such trading; and (3) special compliance 
procedures are applicable to options accounts. Accordingly, because the 
Index options will be subject to the same regulatory regime as the 
other standardized index options currently traded on the Phlx, the 
Commission believes that adequate safeguards are in place to ensure the 
protection of investors in OTC Industrial Index options.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing to list a stock index derivative product 
and the exchange(s) trading the stocks underlying the derivative 
product is an important measure for surveillance of the derivative and 
underlying securities markets. Such agreements ensure the availability 
of information necessary to detect and deter potential manipulations 
and other trading abuses, thereby making the stock index product less 
readily susceptible to manipulation.\23\ In this regard, the Commission 
notes that the NASD, the self-regulatory organization which oversees 
NASDAQ, the primary market for all of the Index's component securities, 
is a member of the ISG.\24\ The Commission believes that this 
arrangement ensures the availability of information necessary to detect 
and deter potential manipulations and other trading abuses, thereby 
making the Index option less readily susceptible to manipulation.

    \23\ See Securities Exchange Act Release No. 31243 (September 
28, 1992), 57 FR 45849 (October 5, 1992).
    \24\ See supra note 16.
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D. Market Impact

    The Commission believes that the listing and trading on the Phlx of 
OTC Industrial Index options will not adversely impact the markets for 
the securities contained in the Index.\25\ First, as described above, 
no one security or group of securities represented in the Index 
currently dominates the Index and the maintenance standards will 
continue to ensure that such domination does not occur. Second, the 
maintenance criteria for the Index ensure that the Index will be 
substantially comprised of securities that satisfy the Exchange's 
listing standards for standardized options trading and that the 
component stocks are actively-traded and well capitalized. Third, the 
9,000 contract position and exercise limits applicable to Index options 
will serve to minimize potential manipulation and market impact 
concerns.

    \25\ The Commission notes that trading of Phlx OTC Industrial 
Average Index options is contingent upon the Exchange submitting to 
the Commission's Division of Market Regulation, the letter from OPRA 
(``OPRA Capacity Letter'') to the Exchange indicating that the 
Exchange has adequate systems processing capacity to accommodate the 
listing of OTC Industrial Index options.
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    Lastly, the Commission believes that settling expiring OTC 
Industrial Index options based on the opening prices of the component 
securities is consistent with the Act.
    The Commission finds good cause for approving Amendment No. 2 to 
the proposal prior to the thirtieth day after the date of publication 
of notice of filing thereof in the Federal Register. Specifically, 
Amendment No. 2 provides objective maintenance criteria which, for the 
reasons stated above, minimize the potential for manipulation of the 
Index and the securities comprising the Index. Further, as discussed 
above, the Commission believes that these maintenance criteria 
significantly strengthen the customer protection and surveillance 
aspects of the proposal, as originally proposed.
    Based on the above, the Commission finds good cause for approving 
Amendment No. 2 to the proposed rule change on an accelerated basis and 
believes that the proposal, as amended, is consistent with Sections 
6(b)(5) and 19(b)(2) of the Act.

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 at the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. Copies of such filing will also be available for 
inspection and copying at the principal office of the Phlx. All 
submissions should refer to the File Number SR-Phlx-95-92 and should be 
submitted by April 1, 1996.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (File No. SR-Phlx-95-92), as 
amended, is approved.\27\

    \26\ 15 U.S.C. 78s(b)(2).
    \27\ As noted above, trading of OTC Industrial Index options is 
contingent upon the Exchange submitting the OPRA Capacity Letter to 
the Division of Market Regulation. See supra note 25.
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\

    \28\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-5966 Filed 3-12-96; 8:45 am]
BILLING CODE 8010-01-M