[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

[[Page 51476]]

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