[Federal Register Volume 61, Number 213 (Friday, November 1, 1996)]
[Notices]
[Pages 56599-56601]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-28006]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37863; File No. SR-Phlx-96-33]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating
to an Increase in Narrow-Based Index Option Position and Exercise
Limits
October 24, 1996.
I. Introduction
On August 2, 1996, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to amend Exchange Rules 1001A(b)(1) and 1002A to
increase the position and exercise limits for narrow-based index
options from 6,000, 9,000, or 12,000 contracts to 9,000, 12,000, or
15,000 contracts.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4.
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The proposed rule change appeared in the Federal Register on
September 10, 1996.\3\ No comments were received on the proposed rule
change. This order approves the Phlx's proposal.
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\3\ See Securities Exchange Act Release No. 37629 (September 3,
1996), 61 FR 47775 (September 10, 1996).
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II. Background and Description
According to the Phlx, the purpose of the proposed rule change is
to increase narrow-based index option position and exercise limits \4\
in order to attract additional trading interest and, thus, promote
depth and liquidity in Phlx index options. The Exchange believes that
the current limits constrain certain investors from trading index
options.
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\4\ Position limits impose a ceiling on the number of option
contracts which an investor or group of investors acting in concert
may hold or write in each class of options on the same side of the
market (i.e., aggregating long calls and short puts or long puts and
short calls). Exercise limits prohibit an investor or group of
investors acting in concert from exercising more than a specified
number of puts or calls in a particular class within five
consecutive business days.
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Currently, Exchange Rules 1001A(b)(1) and 1002A establish the
following position and exercise limits for narrow-based (industry)
index options: (i) 6,000 contracts for an index where a single
component stock accounted, on average, for 30% or more of the index
value during the 30-day period immediately preceding the Exchange's
semi-annual review of narrow-based index option position limits; (ii)
9,000 contracts for an index where a single component stock accounted,
on average, for 20% or more of the index value or any five component
stocks together accounted, on average, for more than 50% of the index
value but no single component stock accounted, on average, for 30% or
more of the index value during the 30-day period immediately preceding
the Exchange's semi-annual review of narrow-based index option position
limits; and (iii) 12,000 contracts where the conditions requiring a
limit of 6,000 contracts or 9,000 contracts have not occurred. The Phlx
proposes to amend Exchange Rules 1001A(b)(1) and 1002A to increase the
position and exercise limits for narrow-based index options from 6,000,
9,000, or 12,000 contracts to 9,000, 12,000, or 15,000 contracts.\5\
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\5\ The Phlx trades options on the following seven narrow-based
indexes, with their current position limits noted: (1) Gold/Silver
Index (``XAU'') 6,000 contracts; (2) Utility Index (``UTY'') 12,000
contracts; (3) Phlx/KBW Bank Index (``BKX'') 12,000 contracts; (4)
Phone Index (``PNX'') 6,000 contracts; (5) Semiconductor Index
(``SOX'') 12,000 contracts; (6) Airline Sector Index (``PLN'')
12,000 contracts; and (7) Forest/Paper Products (``FPP'') 12,000
contracts.
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The Exchange believes that the proposed increase is appropriate in
light of the Exchange's more than ten years experience trading index
options. In 1983, the Gold/Silver Index (``XAU'') was the first narrow-
based index option to be traded on the Phlx, listed with a position
limit of 4,000 contracts.\6\ Since that time, the Exchange has honed
its experience in monitoring and surveilling index options trading by
developing and implementing an increasingly sophisticated regulatory
program. This program has benefitted from technological advances and
has matured alongside index options trading. Moreover, the market for
index options has also evolved, as more investors are familiar with the
product and its uses. This is reflected in the appreciable growth in
index options volume not only since 1983 but in more recent years as
well.\7\
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\6\ See Securities Exchange Act Release No. 20437 (December 2,
1983), 48 FR 55229 (December 9, 1983) (File No. SR-Phlx-83-17).
\7\ According to the Phlx, index options volume increased 48%
(from 998,780 contracts to 1,483,585 contracts) from the period
January-June 1995 to January-June 1996.
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The Exchange recognizes that the purposes of these limits are to
prevent manipulation and to protect against disruption of the markets
for both options as well as the underlying securities. The Exchange has
considered the effects of increased position limits on the marketplace
and believes that concerns regarding manipulation and disruption are
adequately addressed by the Phlx's regulatory program. The Phlx
continues to monitor the markets for evidence of manipulation or
disruption caused by investors with positions at or near current
position or exercise limits and the new limits will not diminish the
surveillance function in this regard.
The current levels for narrow-based index options have been in
place since September 1995.\8\ Since that time, however, index options
have continued
[[Page 56600]]
to experience heavy and steady volume, with a concomitant increase in
open interest. In this light, the Exchange believes that the proposed
limits of 9,000, 12,000, or 15,000 contracts should further increase
the depth and liquidity of the markets for index options by attracting
additional investor interest. The Phlx also believes that higher
position limits would further accommodate the hedging needs of Exchange
market makers and specialists, who are restricted by current levels.
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\8\ See Securities Exchange Act Release No. 36194 (September 6,
1995), 60 FR 47637 (September 13, 1995) (File No. SR-Phlx-95-16)
(increasing position and exercise limits for narrow-based index
options to 6,000, 9,000, or 12,000 contracts) (``Securities Exchange
Act Release No. 36194'').
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Further, the Exchange believes that the proposed increases are
reasonable. The Phlx states that in prior releases approving increased
position limits, the Commission has acknowledged that a gradual,
evolutionary approach has been adopted in increasing position and
exercise limits. Accordingly, the Phlx proposes a 25% increase in the
highest tier (from 12,000 to 15,000 contracts); a 33% increase in the
middle tier (from 9,000 to 12,000 contracts); and a 50% increase in the
lowest tier (from 6,000 to 9,000 contracts). The Exchange believes that
these proposed increases are consistent with the gradual evolution
cited by the Commission, as the proposed levels represent reasonable
increases which are in line with prior changes.\9\
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\9\ See, e.g., Securities Exchange Act Release No. 36194, supra
note 8, where the Phlx's narrow-based position limit changes
represented a 9% increase in the lowest tier (from 5,500 to 6,000
contracts); a 20% increase in the middle tier (from 7,500 to 9,000
contracts); and a 14% increase in the highest tier (from 10,500 to
12,000 contracts).
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The Exchange believes that the 1995 changes were so modest (20% or
less) that position limit increases are once again needed. Since the
1995 changes were implemented, the Exchange has been requested by its
members and customers to again propose an increase in position limits,
arguing that these limits hamper their ability to execute investment
strategies. In light of the large portfolios common to institutional
trading and the large-sized transactions that are required to execute
complicated, cross-market strategies, such requests emphasize that
institutional hedging needs and trading objectives may exceed current
limits. Floor members have also expressed the resulting deleterious
effect on index options trading in an exchange environment. Based on
such member and customer requests, the Exchange believes that the
current position limit levels continue to discourage market
participation by large investors and the institutions that compete to
facilitate the trading interests of large investors. Accordingly, this
proposal aims to accommodate the liquidity and hedging needs of large
investors as well as the facilitators of those investors.
Concurrent with the proposed increase in position limits, the
Exchange is also proposing a corresponding increase to narrow-based
index option exercise limits. The Exchange believes that this increase
is necessary and appropriate for the same reasons as the rationale
cited above for proposed increases in position limits. Furthermore,
exercise limits constrict trading strategies by preventing investors
from exercising positions larger than the limit within five consecutive
business days. The Exchange also notes that most of its index options
currently are or will become European-style, exercisable only during a
specified period at expiration, such that the manipulation and market
disruption concerns associated with large exercises will be
limited.\10\
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\10\ See, e.g., Securities Exchange Act Release No. 37575
(August 15, 1996), 61 FR 43289 (August 21, 1996), File No. SR-Phlx-
96-18) (order approving change in exercise style of Phlx's National
Over-the-Counter Index from American-style to European-style).
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III. Discussion
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, with the requirements of Section 6(b)(5),\11\ in that it is
designed to promote just and equitable principles of trade, prevent
fraudulent and manipulative acts and practices, as well as to protect
investors and the public interest. In addition, the Commission believes
that the proposal should remove impediments to and perfect the
mechanism of a free and open market by providing market opportunity to
investors constricted by current position limit levels.
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\11\ 15 U.S.C. Sec. 78f(b) (1988).
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Since the inception of standardized options trading, the options
exchanges have had rules imposing limits on the aggregate number of
option contracts that a member or customer can hold or exercise. These
rules are intended to prevent the establishment of large options
positions that can be used or might create incentives to manipulate or
disrupt the underlying market so as to benefit the options position. At
the same time, the Commission has recognized that option position and
exercise limits must not be established at levels that are so low as to
discourage participation in the options market by institutions and
other investors with substantial hedging needs or to prevent
specialists and market makers from adequately meeting their obligations
to maintain a fair and orderly market.
In this regard, the Phlx has stated that the current position
limits discourage market participation by certain large investors and
the institutions that compete to facilitate their trading. In addition,
the Phlx notes that index option trading volume has increased
significantly since 1995, when the current industry index option
position limits were established. In light of the increased volume of
narrow-based index option trading and the needs of investors and market
makers, the Commission believes that the Phlx's proposal is a
reasonable effort to accommodate the needs of market participants.
In addition, the Commission notes that the proposal, while
increasing the positions limits for narrow-based index options,
continues to reflect the unique characteristics of each index option
and to maintain the structure of the current three-tiered system.
Specifically, the lowest proposed limit, 9,000 contracts, will apply to
narrow-based index options in which a single underlying stock accounts
for 30% or more of the index value during the 30-day period immediately
preceding the Exchange's semi-annual review of industry index option
positions limits. A position limit of 12,000 contracts will apply if
any single underlying stock accounts, on average, for 20% or more of
the index value or any five underlying stocks account, on average for
more than 50% of the index value, but no single stock in the group
accounts, on average, for 30% or more of the index value during the 30-
day period immediately preceding the Exchange's semi-annual review of
industry index option position limits. The 15,000 contract limit will
apply only if the Exchange determines that the conditions requiring
either the 9,000 contract limit or the 12,000 contract limit have not
occurred.
The Commission believes that the proposed increases for the three
tiers of 25%, 33%, and 50%, for highest to lowest, respectively, appear
to be appropriate and consistent with the Commission's evolutionary
approach to position and exercise limits. In this regard, the absence
of discernible manipulative problems under the current three-tiered
position and exercise limit system for narrow-based index options leads
the Commission to conclude that the increases proposed by the Exchange
are warranted. The Commission recognizes that there are no ideal limits
in the sense that options positions of any given size can be stated
conclusively to be free of any
[[Page 56601]]
manipulative concerns. However, based upon the absence of discernible
manipulation or disruption problems under current limits, the
Commission believes that the proposed limits can be safely considered.
Accordingly, the Commission believes that the Phlx's proposed increases
of existing position and exercise limits for narrow-based index options
is now appropriate.\12\
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\12\ The Commission continues to believe that proposals to
increase position limits and exercise limits must be justified and
evaluated separately. After reviewing the proposed exercise limits,
along with the eligibility criteria for each tier, the Commission
has concluded that the proposed exercise limit increases for the
three-tiered framework do not raise manipulation problems or
increase concerns over market disruption in the underlying
securities.
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The Commission notes that the Exchange has had considerable
experience monitoring the current three-tiered framework in narrow-
based index options. The Commission has not found that differing
position and exercise limit requirements based on the particular
options product to have created programming or monitoring problems for
securities firms, or to have led to significant customer confusion.
Based on the current experience in handling position and exercise
limits, the Commission believes that the proposed increase in position
and exercise limits for narrow-based index options will not cause
significant problems.
Finally, the Phlx has indicated that its surveillance procedures
have become increasingly sophisticated and automated. The Commission
believes that the Exchange's surveillance programs are adequate to
detect and deter violations of position and exercise limits as well as
to detect and deter attempted manipulative activity and other trading
abuses through the use of such illegal positions by market
participants.\13\
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\13\ The Commission emphasizes that the Phlx must closely
monitor compliance with position and exercise limits and to impose
appropriate sanctions for failures to comply with the Exchange's
position and exercise limit rules.
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IV. Conclusion
For the foregoing reasons, the Commission finds that the Phlx's
proposal to increase the position and exercises limits for narrow-based
index options is consistent with the requirements of the Act and the
rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-Phlx-96-33) is approved.
\14\ 15 U.S.C. 78s(b)(2) (1988).
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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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-28006 Filed 10-31-96; 8:45 am]
BILLING CODE 8010-01-M