[Federal Register Volume 61, Number 192 (Wednesday, October 2, 1996)]
[Notices]
[Pages 51474-51476]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-25153]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37726; File No. SR-Amex-96-29; SR-CBOE-96-56; and SR-
PSE-96-31]
Self-Regulatory Organizations; Proposed Rule Changes: American
Stock Exchange, Inc., et al.
September 25, 1996
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval
of Amendment No. 1 by the American Stock Exchange, Inc., Relating to
Restrictions on the Available Exercise Prices for FLEX Equity Call
Options and Elimination of the Requirement that Members Sign the
Trade Sheet to Create a Binding FLEX Contract and Notice of Filing
and Order Granting Accelerated Approval of Proposed Rule Changes, as
Amended, by Chicago Board Options Exchange, Incorporated and Pacific
Stock Exchange, Inc. Relating to Restrictions on the Available
Exercise Prices for FLEX Equity Call Options
I. Introduction
On July 29, August 20, and August 26, 1996, the American Stock
Exchange, Inc. (``Amex''), the Chicago Board Options Exchange, Inc.
(``CBOE''), and the Pacific Stock Exchange, Inc. (``PSE'')
(collectively the ``Exchanges'') respectively filed proposed rule
changes 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
restrict the available exercise prices for FLEX equity call options.
The Amex further proposes to eliminate the requirement that members
sign the Trade Sheet when creating a binding FLEX contract.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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Notice of the Amex's proposal was published for comment and
appeared in the Federal Register on August 9, 1996.\3\ No comment
letters were received on the Amex's proposed rule change. The CBOE
submitted to the Commission Amendment No. 1 on August 30, 1996.\4\ The
Amex submitted to the Commission Amendment No. 1 on August 29, 1996.\5\
The Commission is approving the Amex's and CBOE's proposal, as amended,
and the PSE's proposal. The Commission is also publishing this notice
to solicit comments on the CBOE's proposed rule change, as amended,
PSE's proposed rule change, and Amex's Amendment No. 1 to its proposed
rule change from interested persons, and granting accelerated approval
to the foregoing.
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\3\ See Securities Exchange Act Release No. 37522 (August 9,
1996), 61 FR 41669.
\4\ In Amendment No. 1, the CBOE clarifies in Interpretation .01
to CBOE Rule 24A.4(c)(2) that the available exercise price intervals
for FLEX equity call options are limited to the same exercise price
intervals that are available for Non-FLEX equity call options
pursuant to Rule 5.5 and Interpretations and Policies thereunder.
See Letter from Michael Meyer, Attorney, Schiff Hardin & Waite, to
John Ayanian, Attorney, Office of Market Supervision (``OMS''),
Division of Market Regulation (``Market Regulation''), Commission,
dated August 28, 1996 (``CBOE Amendment No. 1'').
\5\ In Amendment No. 1, the Amex proposed a technical
clarification to its proposed rule change. Specifically, the
Exchange makes clear that the available exercise prices available
for FLEX equity call options, are those available pursuant to Amex
Rule 903 for Non-FLEX equity call options. See Letter from Claire
McGrath, Managing Director and Special Counsel, Derivative
Securities, Amex, to Ivette Lopez, Assistant Director, OMS, Market
Regulation, Commission, dated August 28, 1996 (``Amex Amendment No.
1'').
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II. Description of the Proposal
On February 14, 1996 \6\ and June 19, 1996,\7\ the Exchanges
received approval to list and trade flexible options on individual
stocks known as FLEX equity options. Similar to the FLEX index options,
investors will be able to set the specific terms of each FLEX equity
option contract. Among the terms that can be specified are: (1) The
expiration date of the option; (2) the exercise price of the option;
and (3) the exercise style of the option (American or European). The
Exchanges, however, impose some limitations on these flexible terms.
For example, the Exchange does not permit the expiration date of a FLEX
option to be any business day that falls on or within two business days
of the expiration date for standardized non-FLEX equity options.
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\6\ See Securities Exchange Act Release No. 36841 (February 14,
1996), 61 FR 6666 (February 21, 1996) (order approving SR-CBOE-95-43
and SR-PSE-95-24).
\7\ See Securities Exchange Act Release No. 37336 (June 19,
1996), 61 FR 33558 (June 27, 1996) (order approving SR-Amex-95-57).
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Although the Exchanges have received approval to trade these
products, they have not done so due to a concern that the flexible
exercise price feature could result in an available call option that
would not be eligible to be a qualified covered call (``QCC'') under
Section 1092(c)(4) of the Internal Revenue Code, thus jeopardizing a
modest tax benefit currently enjoyed by writers of standardized non-
FLEX equity call options. Under the straddle rules of Section 1092 of
the Internal Revenue Code, a loss on one position in a straddle is
taken into account for tax purposes only to the extent that the amount
of the loss exceeds unrecognized gain on the other position(s) in the
straddle. In addition, if a taxpayer has held stock for less than the
long-term holding period at the time the taxpayer acquires an
offsetting position with respect to the stock, the taxpayer's holding
period in the stock is forfeited until disposing of the position
offsetting the stock.
Although stock and an offsetting option (e.g., a short call)
constitute a straddle for purposes of Section 1092, a straddle
consisting solely of stock and a QCC has been exempted from these rules
provided, among other things, that the call option is not ``deep-in-
the-money.'' Under certain conditions a ``deep-in-the-money'' call
option is defined to mean an option having an exercise price lower than
the highest
[[Page 51475]]
available exercise price which is less than the previous day's closing
price of the stock. For example, using standardized options, if stock
XYZ closed yesterday at $54 and opened at that price today, the
standardized exercise price of $50 for a call option would not be
``deep-in-the-money'' because $50 would be the highest available
exercise price that is less than the applicable stock price. A
standardized exercise price of $45, however, would be ``deep-in-the-
money'' and would not be a QCC. Thus, if a FLEX equity call option were
written with an exercise price of $53, the standardized exercise price
of $50 might be considered ``deep-in-the-money'' because the FLEX
equity call option with an exercise price of $53 could be considered
the highest available exercise price and the only qualified covered
call for that option. Another interpretation might consider any call
option struck at or below $53\3/4\ ``deep-in-the-money'' because FLEX
Equity Call Option strikes of $53\7/8\ and $53\3/4\ could be created.
While the Exchanges hope to petition the Treasury Department for
relief from these latter interpretations of the straddle rules, in the
interim, the Exchanges propose to go forward with the FLEX equity
option program by prohibiting the writing of FLEX equity call options
with exercise prices other than those exercise prices allowed for
standardized non-FLEX equity call options.\8\
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\8\ The Exchanges' proposals provide that exercise prices for
FLEX equity call options may be fixed only at prices that are
integer multiples of the applicable minimum interval, in order to
assure that exercise prices for FLEX equity call options coincide
with exercise prices for non-FLEX equity call options fixed by the
Exchanges pursuant to their rules. For example, where 2\1/2\ point
minimum intervals apply, exercise prices may be fixed only at
numbers evenly divisible by 2\1/2\, such as 17\1/2\, 20, 22\1/2\,
and 25. See Amex Amendment No. 1, supra note 5.
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Although this proposal will place limitations on a product designed
to be flexible and free of such standardized terms, the Exchanges
believe that the proposed limitations appropriately balance the needs
of investors with concerns that flexible exercise prices for FLEX
equity call options could disrupt the existing framework for
determining whether a standardized option is a qualified covered call.
FLEX equity put options would have no restrictions placed on exercise
prices because the exemption from the straddle rules is available only
for call options. In addition, the Exchanges anticipate that they will
seek to eliminate the proposed restriction on the exercise prices of
FLEX equity call options when it receives guidance and relief from the
Treasury Department.
The Amex further proposes to eliminate the requirement that
acceptance of the best bid or offer will take place only when each
party to the FLEX transaction signs a trade sheet, thus creating a
binding contract. Since the Amex began trading FLEX Index Options in
1993, the fully manual process for executing transactions has been
automated. Currently, trade information is input into the Amex's Intra-
Day Comparison (IDC) System for FLEX Index Options after completion of
a trade in a manner similar to that for non-FLEX options. IDC input
results in the immediate comparison of FLEX option trades. The Exchange
believes that requiring signed trade sheets is unnecessary and time
consuming.
III. Commission Finding and Conclusions
The Commission finds that the proposed rule changes are 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 Act.\9\
Specifically, the Commission finds that the Exchanges' proposals strike
a reasonable balance between the Commission's mandates under section
6(b)(5) to remove impediments to and perfect the mechanism of a free
and open market and a national market system, while protecting
investors and the public interest.
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\9\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the Exchanges' proposals to restrict
exercise prices as described above, reasonably balances the desire of
sophisticated portfolio managers and other institutional investors to
trade flexible equity options products, with the need to eliminate the
potential that the trading of such options could inadvertently impact a
tax benefit currently provided to writers of standardized call options
that qualify as QCCs.\10\ In approving the Exchanges' proposals, the
Commission recognizes that the Exchanges will restrict the flexibility
of investors in determining an essential term of FLEX equity call
options contracts (i.e., the exercise price). Nevertheless, investors
will still be able to designate contract terms for exercise style
(i.e., American, European, or capped) and expiration date.\11\ Based on
this and the current tax framework for QCCs, the Commission believes
the limitations imposed by the proposals are appropriate and should
still provide investors with a more flexible product than one with
standardized option terms while protecting investors in the
standardized equity call options market.\12\
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\10\ The Commission notes that the Exchanges must file a
proposed rule change with the Commission, pursuant to section 19(b)
of the Act, to withdraw or modify this exercise price policy
regarding FLEX equity call options.
\11\ Of course, investors will also be able to designate
exercise price for FLEX equity put options.
\12\ The Commission notes that The Options Clearing Corporation
must submit to the Commission a supplement to its Options Disclosure
Document (``ODD'') that will inform investors of the limitation of
exercise price intervals when writing FLEX equity call options.
Accordingly, the Exchanges will only be allowed to trade FLEX equity
call options pursuant to this proposal when the proposed supplement
to the ODD becomes effective pursuant to Rule 9b-1 under the Act.
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The Commission also believes that in light of Amex's development of
the IDC system for FLEX options, as described above, it is reasonable
for the Amex to eliminate the current requirement that each party to a
FLEX transaction sign a trade sheet to create a binding FLEX contract.
The Commission finds good cause for approving the CBOE's proposed
rule change, as amended, and PSE's proposed rule changes prior to the
thirtieth day after the date of publication of notice thereof in the
Federal Register. Specifically, the Commission believes that the CBOE's
and PSE's proposals conform its rules concerning available exercise
prices for FLEX equity call options to the proposed rule change of the
Amex and raises no new regulatory issues. Additionally, the Amex
proposal was subject to a full notice and comment period, and no
comments were received. Accordingly, the Commission believes,
consistent with section 6(b)(5) of the Act, that good cause exists, to
approve the CBOE's proposed rule change, as amended, and PSE's proposed
rule change, on an accelerated basis.
The Commission finds good cause for approving Amendment No. 1 to
Amex's proposed rule changes prior to the thirtieth day after the date
of publication of notice thereof in the Federal Register. Specifically,
the Amex proposes to amend the proposed rule by clarifying that
exercise price intervals available to Non-FLEX equity call options
pursuant to Amex Rule 903, will be available for FLEX equity call
options. The Commission believes that the Amex's amendment clarifies
the scope of the proposed rule change and raises no new regulatory
issues. Accordingly, the Commission believes, consistent with Section
6(b)(5) of the
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Act, that good cause exists, to approve Amendment No. 1 to Amex's
proposed rule change on an accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the CBOE's and PSE's proposed rule changes and
CBOE Amendment No. 1 and Amex Amendment No. 1. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 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 Section, 450 Fifth Street,
NW., Washington, DC 20549. Copies of such filing will also be available
for inspection and copying at the principal offices of the Exchanges.
All submissions should refer to File Nos. SR-Amex-96-29, SR-CBOE-96-56,
or SR- PSE-96-31 and should be submitted by October 23, 1996.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\13\ that the Amex's proposed rule change (File No. SR-Amex-96-29),
as amended, is approved, and the CBOE's and PSE's proposed rule changes
(File Nos. SR-CBOE-96-56 (as amended) and SR-PSE-96-31) are approved on
an accelerated basis.\14\
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\13\ 15 U.S.C. 78s(b)(2).
\14\ See supra note 12.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 96-25153 Filed 10-1-96; 8:45 am]
BILLING CODE 8010-0-M