[Federal Register Volume 61, Number 175 (Monday, September 9, 1996)]
[Notices]
[Pages 47535-47536]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-22937]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37630; File No. SR-OCC-96-03]


Self-Regulatory Organizations; the Options Clearing Corporation; 
Order Approving a Proposed Rule Change Relating to the Clearance and 
Settlement of Flexibly Structured Equity Options

September 3, 1996.
    On April 30, 1996, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') a proposed 
rule change (File No. SR-OCC-96-03) under Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ to enable OCC to clear 
and settle flexibly structured equity options. Notice of the proposal 
was published in the Federal Register on June 25, 1996.\2\ No comment 
letters were received. For the reasons discussed below, the Commission 
is approving the proposed rule change.
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    \1\ 15 U.S.C. 78(b)(1) (1988).
    \2\ Securities Exchange Act Release No. 37318 (June 18, 1996), 
61 FR 32873.
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I. Description

    OCC is modifying its existing by-laws and rules to allow for the 
clearance and settlement of flexibly structured options on individual 
equity securities as proposed for trading by the American Stock 
Exchange, Inc. (``AMEX''), the Chicago Board Options Exchange, 
Incorporated (``CBOE''), the Philadelphia Stock Exchange, Inc. 
(``PHLX''), and the Pacific Stock Exchange, Inc. (``PSE''-- 
(collectively, ``Exchange'' or ``Exchanges'').\3\ Flexibly structured 
equity options will allow the parties to each flexibly structured 
equity option trade to customize certain terms of the option within 
specified limits established by the Exchange. Specifically, for each 
flexibly structured equity option trade the parties may establish the 
exercise price, the exercise style (i.e., American,\4\ European \5\ or 
capped) \6\ the cap interval in the case of a capped-style option, the 
expiration date, and the option type (i.e., put or call).\7\ In 
addition to customization, flexibly structured equity option trades 
will require a minimum transaction size of 250 contracts in opening 
trades in currently unopened series and 100 contracts in the case of 
opening and most closing trades in currently open series. Flexibly 
structured equity options thus will differ from existing Exchanged-
traded equity options both in terms of customization and size.
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    \3\ For a complete description of flexibly structured equity 
options, refer to Securities Exchange Act Release Nos. 36841 
(February 14, 1996), 61 FR 6666 [File Nos. SR-CBOE-95-43 and SR-PSE-
95-24] (order approving the trading of flexibly structured equity 
options by the CBOE and PSE) and 37366 (June 19, 1996), 61 FR 33558 
[File No. SR-AMEX-95-57] (order approving the trading of flexibly 
structured equity options by the AMEX). The PHLX filed and 
subsequently withdrew a proposed rule change regarding the trading 
of flexibly structured equity options. The Commission anticipates 
that the PHLX will refile in the near future.
    \4\ An American-style equity option may be exercised at any time 
prior to its expiration date.
    \5\ A European-style equity option may be exercised only during 
a specified period before the option expires.
    \6\ A capped-style equity option will be exercised automatically 
prior to expiration if the options market on which the option is 
trading determines that the value of the underlying interest at a 
specified time on a trading day ``hits the cap price'' for the 
option (i.e., when the cap price is less than or equal to the 
closing price of the underlying security for calls or when the cap 
price is greater than or equal to the closing price of the 
underlying security for puts).
    \7\ Although the rules of the Exchanges provide for capped-style 
flexibly structured equity options, the Exchanges advised OCC that 
they do not intend to provide a market in capped-style equity 
options at the outset. Accordingly, this proposed rule change does 
not include the rules that would be required for the clearance and 
settlement of such options. The commencement of trading in capped-
style flexibly structured equity options will require that OCC file 
and that the Commission approve another proposed rule change filed 
by OCC under Section 19(b)(1) of the Act.
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    From a clearance and settlement prospective, flexibility structured 
equity options will be treated and processed in virtually all respects 
like any other equity option. While Exchange rules permit a Request for 
Quotes \8\ to specify a quote either as a dollar amount or as a 
percentage of the underlying stock price, the option premium always 
will be expressed as a dollar amount when a trade is reported to OCC. 
Therefore, when a flexibly structured equity option trade is reported 
to OCC by one of the Exchanges, all of the terms of that option will 
have been established in the Exchange's report, and the terms will 
correspond to existing equity options term categories. As a result, on 
receipt of a matched trade report from an Exchange, OCC will establish 
long and short flexibility structured equity option positions in 
clearing member accounts in precisely the same way it does for existing 
equity options. Furthermore, flexibly structured equity option 
positions should exhibit virtually the

[[Page 47536]]

same characteristics as existing equity options.
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    \8\ A Request for Quotes is the initial request by an exchange 
member to initiate flexibly structured option bidding and offering.
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    Because of the similarities between existing equity options and 
flexibly structured equity options, only a few of OCC's by-laws and 
rules need adjustment to accommodate flexibly structured equity 
options.\9\ OCC is amending Section 1 of Article I to add an all-
purpose definition of ``flexibly structured option.'' Thus, the 
definition of flexibly structured option set forth in Articles XV, 
XVII, and XXIII will be deleted. The definition of ``expiration date'' 
is being amended to make clear that flexibly structured equity options 
may expire on dates other than the Saturday following the third Friday 
of the expiration month. The expiration date of any such option will be 
the date reported to OCC by the Exchange, subject to such constraints 
on the range of possible expiration dates as set forth in the rules of 
the Exchanges.
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    \9\ The specific changes to OCC's by-laws and rules are set 
forth in OCC's proposed rule change, which is available for review 
at the principal office of OCC and at the Commission's Public 
Reference Room.
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    Section 11 of Article VI regarding adjustments to equity and index 
options also will apply to the adjustment of flexibly structured equity 
and index options.\10\ However, paragraph (j) has been amended to 
reserve to the Securities Committee \11\ the power to make special 
exceptions for flexibly structured options whenever it determines that 
such exceptions are appropriate. This is intended to give the 
Securities Committee the flexibility to deal with situations where a 
different adjustment for flexibly structured options is warranted.
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    \10\ Adjustments may be made to the number of option contracts, 
the unit of trading, the exercise price, and the underlying security 
with respect to all outstanding option contracts open for trading on 
an underlying security which is the subject of a dividend, stock 
dividend, stock distribution, stock split, reverse stock split, 
rights offering, distribution, reorganization, recapitalization, 
reclassification or similar event, or the merger, consolidation, 
dissolution, or liquidation of the issuer of the underlying 
security.
    \11\ The Securities Committee consists of one designated 
representative of each exchange and the Chairman of OCC.
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    OCC also is adding Interpretation and Policy .08 to Section 11. The 
interpretation provides that when a flexibly structured option with a 
European style exercise is adjusted to require the delivery upon 
exercise of a fixed amount of cash, such as would ordinarily occur in a 
merger where the underlying security is converted into a right to 
receive a fixed amount of cash, the expiration date of the option will 
ordinarily be accelerated so that the option will expire on or shortly 
after the date when the underlying stock is converted into the right to 
receive cash. Without this adjustment, the option position would have 
to be maintained until it could be exercised at its regular expiration 
even though the amount to be received on exercise had already been 
fixed. This special adjustment is being made to accommodate flexibly 
structured equity options because, unlike existing equity options, 
flexibly structured equity options may have European-style exercise 
features.
    The only change being made to OCC's rules is the addition of 
Interpretation and Policy .03 to Rule 805 which clarifies that OCC's 
exercise procedures as set forth in Rule 805 shall apply to the 
exercise of flexibly structured equity options. The new interpretation 
also gives OCC the flexibility, if necessary, to depart from regular 
expiration date procedures and deadlines in the case of flexibly 
structured options. Such departures are not currently anticipated and 
adequate notice will be given to all clearing members prior to such 
departures being made.

II. Discussion

    Sections 17A(b)(3) (A) and (F) \12\ of the Act require that a 
clearing agency be structured and its rules designed to facilitate the 
prompt and accurate clearance and settlement of securities transactions 
and to safeguard securities and funds in its custody or control or for 
which it is responsible. Because from a clearance and settlement 
perspective, OCC will process flexibly structured equity options like 
any other equity option, the Commission believes that OCC's proposed 
change is consistent with Sections 17A(b)(3) (A) and (F) of the Act 
because the proposed rule change establishes a framework in which 
existing, reliable OCC systems, rules, and procedures are extended to 
the processing of flexibly structured equity options. As a result, the 
proposed rule change should promote the prompt and accurate clearance 
and settlement of such options and should provide for the safeguarding 
of related securities and funds.
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    \12\ 15 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
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III. Conclusion

    The Commission finds that OCC's proposal is consistent with the 
requirements of the Act and particularly with Section 17A and the rules 
and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-96-03) be, and hereby 
is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12) (1996).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-22937 Filed 9-6-96; 8:45 am]
BILLING CODE 8010-01-M