[Federal Register Volume 62, Number 179 (Tuesday, September 16, 1997)]
[Notices]
[Pages 48683-48686]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-24443]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39032; File Nos. SR-Amex-96-19; SR-DBOE-96-79; SR-PCX-
97-09]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval to Amendment No. 1 to Proposed Rule Change by the
American Stock Exchange, Inc. and the Chicago Board Options Exchange,
Inc., and Order Granting Approval to Proposed Rule Change by the
Pacific Exchange, Inc., Relating to the Elimination of Position and
Exercise Limits for FLEX Equity Options
September 9, 1997.
I. Introduction
On May 21, 1996, December 27, 1996, and April 1, 1997,
respectively, the American Stock Exchange, Inc. (``Amex''), the Chicago
Board Options Exchange, Inc. (``CBOE''), and the Pacific Exchange, Inc.
(``PCX'') (collectively the ``Exchanges''), 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\ proposed rule changes to eliminate position and exercise
limits \3\ for FLEX Equity options under a two-year pilot program.\4\
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\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4.
\3\ Position limits impose a ceiling on the aggregate number of
option contracts on the same-side of the market that an investor, or
group of investors acting in concern, may hold or write. Exercise
limits impose a ceiling on the aggregate long positions in option
contracts that an investor, or group of investors acting in concert,
can or will have exercised within five consecutive business days.
\4\ In general, FLEX Equity options provide investors with the
ability to customize basic option features including size,
expiration date, exercise style, and certain exercise prices. (See
Securities Exchange Act Release No. 37726 (September 25, 1996), 61
FR 51474 (October 2, 1996), regarding restrictions on the available
exercise prices for FLEX Equity call options (File Nos. SR-Amex-96-
29, SR-CBOE-96-56, and SR-PSE-96-31)).
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Notice of the proposed rule changes appeared in the Federal
Register on June 12, 1996, January 17, 1997, and May 20, 1997,
respectively.\5\ No comments were received on the proposed rule
changes. The Amex subsequently filed Amendment No. 1 to its proposed
rule change on February 3,
[[Page 48684]]
1997.\6\ The CBOE subsequently filed Amendment No. 1 to its proposed
rule change on May 13, 1997.\7\ This order approves the Exchanges'
proposals, as amended, and solicits comments on Amex Amendment No. 1
and CBOE Amendment No. 1.
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\5\ See Securities Exchange Act Release Nos. 37280 (June 5,
1996), 61 FR 29774 (June 12, 1996) (File No. SR-Amex-96-19); 38152
(January 10, 1997), 62 FR 2702 (January 17, 1997) (File No. SR-CBOE-
96-79); and 38616 (May 12, 1997), 62 FR 27642 (May 20, 1997) (File
No. SR-PCX-97-09).
\6\ See letter from Claire P. McGrath, Managing Director and
Special Counsel, Derivative Securities, Amex, to Lvette Lopez,
Assistant Director, Office of Market Supervision, Division of Market
Regulation (``Division''), Commission, dated February 3, 1997
(``Amex Amendment No. 1''). In Amex Amendment No. 1, the Amex
amended its rule filing to eliminate position and exercise limits
for FLEX Equity options under a two-year pilot program and revised
the proposed text of Amex Rule 906G to include a reporting
requirement and the ability of the Amex to impose higher margin
requirements and/or to assess capital charges.
\7\ See letter from Timothy H. Thompson, Senior Attorney, CBOE,
to Sharon Lawson, Division, Commission, dated May 13, 1997 (``CBOE
Amendment No. 1''). In CBOE Amendment No. 1, the CBOE amended its
rule filing to eliminate position and exercise limits for FLEX
Equity options under a two-year pilot program and revised the
proposed text of CBOE Rule 24A.7 to include a reporting requirement
and the ability of the CBOE to impose higher margin requirements
and/or to assess capital charges.
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II. Background
On February 14, 1996 and June 19, 1996, the Commission approved the
Exchanges' proposals to list and trade FLEX Equity options on specified
equity securities.\8\ According to the Exchanges, those proposals were
designed to provide investors with the ability, within specified
limits, to designate certain terms of the options. In support of their
proposals, the Exchanges stated that in recent years, an over-the-
counter (``OTC'') market in customized equity options had developed
which permitted participants to designate the basic terms of the
options including size, term to expiration, exercise style, exercise
price, and exercise settlement value. According to the Exchanges,
participants in this OTC market were typically institutional investors,
who bought and sold options in large-size transactions through a
relatively small number of securities dealers. To compete with this
growing OTC market in customized equity options, the Exchanges proposed
to expand their FLEX options rules \9\ to permit the introduction of
trading in FLEX options on specified equity securities that satisfied
the Exchanges' listing standards for equity options.\10\ The Exchanges'
proposals allowed FLEX Equity option market participants to designate
the following contract terms: (1) Certain exercise prices; (2) exercise
style (i.e., American, European, or capped); \11\ (3) expiration
date;\12\ and (4) option type (i.e., put, call, or spread). In
addition, the Exchanges set position and exercise limits for FLEX
Equity options at three times the position limits for the corresponding
Non-FLEX Equity options on the same underlying security.\13\ The
Exchanges now propose to eliminate position and exercise limits for
FLEX Equity options.
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\8\ See Securities Exchange Act Release Nos. 36841 (February 14,
1996), 61 FR 6666 (February 21, 1996) (File Nos. SR-CBOE-95-43 and
SR-PSE-95-24), and 37336 (June 19, 1996), 61 FR 33558 (June 27,
1996) (File No. SR-Amex-95-57).
\9\ See, e.g., Amex Rules 900G through 909G. At the time of
their FLEX Equity option proposals, the Amex and the CBOE had
already secured Commission approval to list and trade FLEX options
on several broad-based market indexes market indexes composed of
equity securities (``FLEX Index options''). See, e.g., Securities
Exchange Act Release Nos. 32781 (August 20, 1993), 58 FR 45360
(August 27, 1993) (Order approving the trading of FLEX Index options
on the Major Market, Institutional, and S&P MidCap Indexes) (File
No. SR-Amex-93-05), and 34052 (May 12, 1994), 59 FR 25972 (May 18,
1994) (order approving the trading of FLEX Index options on the
Nasdaq 100 Index) (File No. SR-CBOE-93-46).
\10\ See, e.g., Amex Rule 915 which contains initial listing
standards for a security to be eligible for options trading. In
addition, the Exchanges may trade FLEX options on any options-
eligible security regardless of whether standardized Non-FLEX
options overlie that security and regardless of whether such Non-
FLEX options trade on the Exchanges.
\11\ An American-style option is one that may be exercised at
any time on or before the expiration date. A European-style option
is one that may be exercised only during a limited period of time
prior to expiration of the option. A capped-style option is one that
is exercised automatically prior to expiration 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.
\12\ The expiration date of a FLEX Equity option cannot,
however, fall on a day that is on, or within two business days of,
the expiration date of a Non-FLEX Equity option.
\13\ Position and exercise limits for FLEX Equity options are
set forth below as compared to existing limits for Non-FLEX Equity
options on the same underlying security.
Non-FLEX Equity position limit
4,500 contracts.
7,500 contracts.
10,500 contracts.
20,000 contracts.
25,000 contracts.
FLEX Equity position limit
13,500 contracts.
22,500 contracts.
31,500 contracts.
60,000 contracts.
75,000 contracts.
The Commission notes that there is no aggregation of positions
or exercises in FLEX Equity options with positions or exercises in
Non-FLEX Equity options for purposes of the limits.
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III. Description
The Exchanges believe that the elimination of position and exercise
limits for FLEX Equity options is appropriate given the institutional
nature of the market for this derivative product. The Exchanges also
believe that large investors currently find the use of exchange-traded
options impractical because of the constraints imposed by position
limits. According to the Exchanges, with no position limits, additional
investors will be attracted to exchange-traded options, thereby
reducing transaction costs as well as improving price efficiency for
all exchange-traded option market participants.
In addition, the Exchanges believe that FLEX Equity options,
unconstrained by position limits, may become an important part of large
investors' investment strategies. For instance, according to the
Exchanges, in the absence of position limits, investors will be able to
use exchange-traded options to implement specific viewpoints regarding
the underlying common stock; viewpoints that take into account specific
near- and long-term expectations for the underlying stock price as well
as judgments on price volatility. Similarly, in the Exchanges' view,
the ability to execute large exchange-traded option transactions will
permit large investors to implement transactions that reflect the
strength of their interest in buying or selling the underlying shares,
as well as their specific viewpoints on the purchase or sale of the
underlying shares.
In further support for their proposals, the Exchanges note that
issuers of stocks underlying FLEX Equity options will be able to use
such options, primarily through the sale of puts, as part of their
stock repurchase programs.\14\ While the Exchanges do not expect that
corporate issuers will use the sale of put options to buy all the
securities that are covered by their repurchase programs, the Exchanges
believe that FLEX Equity options without position limits will at least
provide issuers with a meaningful alternative.
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\14\ The Commission notes that issuers would, of course, need to
comply with all applicable provisions of the federal securities laws
in conducting their share repurchase programs.
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The Exchanges believe that making the exchange-traded options
market more accessible to large investors will create more ``complete''
markets and thereby better serve investors and issuers. In addition,
the Exchanges believe that institutional investors, large individual
investors, and corporate issuers repurchasing their own shares will
find FLEX Equity options without position limits extremely attractive.
Moreover, the Exchanges note that such activity will occur in the
regulated, transparent domestic FLEX Equity options markets rather than
in the less transparent OTC market or an offshore
[[Page 48685]]
market which do not come under Commission oversight.
Finally, the Exchanges have represented that they intend to
implement increased surveillance and reporting procedures in order to
ensure an enhanced monitoring of the uses and risks associated with
both the elimination of position limits and the underlying strategies
resulting in such increased positions. Specifically, whenever a member
files a report with an exchange (indicating that an account is carrying
a position in excess of three times the standardized option position
limit or that class), the Options Clearing Corporation (``OCC'') will
be asked to perform a risk evaluation of the account and its position.
If OCC's risk evaluation indicates a cause for concern, the exchange
will notify the member carrying the account and assess the
circumstances of the transactions along with the firm's view of the
exposure of the account, as well as determine whether the account is
approved and suitable for the strategies being utilized. According to
the Exchanges, this monitoring of accounts should provide the
information necessary to determine whether additional margin and/or
capital charges should be imposed. Similarly, the adoption of the
Exchanges' proposals under a two-year pilot period, with a status
report provided to the Commission after one-and-a-half years, should
enable the Commission to assess the effects on the markets of the
elimination of position and exercise limits on FLEX Equity options.
IV. Discussion
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, with the requirements of Section 6(b) (5). Specifically,
the Commission believes that the rule proposals are designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, and are not designed to permit unfair
discrimination between customers, issuers, brokers, or dealers.
The Commission also believes that the proposed rule changes are
consistent with Section 11A of the Act in that the elimination of
position and exercise limits for FLEX Equity options allows the
Exchange to better compete with the growing OTC market in customized
equity options, thereby encouraging fair competition among brokers and
dealers and exchange markets. The attributes of the Exchanges' options
markets versus an OTC market include, but are not limited to, a
centralized market center, an auction market with posted transparent
market quotations and transaction reporting, parameters and procedures
for clearance and settlement, and the guarantee of the OCC for all
contracts traded on the Exchanges.
While the Commission has generally taken a gradual, evolutionary
approach toward expansion of position and exercise limits, the
Commission is willing to approve the two-year pilot program for FLEX
Equity options for several reasons. First, the FLEX Equity options
market is characterized by large, sophisticated institutional investors
(or extremely high net worth individuals), who have both the experience
and ability to engage in negotiated, customized transactions. For
example, with a required minimum size of 250 contracts to open a
transaction in a new series, FLEX Equity options are designed to appeal
to institutional investors, and it is unlikely that many retail
investors would be able to engage in options transactions at that size.
Second, all of the Exchanges' other current rules and provisions
governing FLEX Equity options remain applicable.\15\ Third, the OCC
will serve as the counter-party guarantor in every exchange-traded
transaction. Fourth, the proposed eliminated of position and exercise
limits for FLEX Equity options could potentially expand the depth and
liquidity of the FLEX equity market without significantly increasing
concerns regarding intermarket manipulations or disruptions of the
options or the underlying securities. Finally, the Exchanges'
surveillance programs will be applicable to the trading of FLEX Equity
options and should detect and deter trading abuses arising from the
elimination of position and exercise limits.
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\15\ See, e.g., Amex Rules 900G through 909G.
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As described above, the Exchanges have adopted important safeguards
that will allow them to monitor large positions in order to identify
instances of potential risk and to assess additional margin and/or
capital charges, if necessary. The Exchanges require each member or
member organization (other than a Specialist, a Registered Options
Trader, a Market Maker, or a Designated Primary Market Maker) that
maintains a position on the same-side of the market in excess of three
times the position limit level established pursuant to the applicable
exchange rule for Non-FLEX Equity options of the same class, to report
information to the exchange regarding the FLEX Equity option position,
positions in any related instrument, the purpose or strategy for the
position, and the collateral used by the account.\16\ By monitoring
accounts in excess of three times the Non-FLEX Equity option position
limit in this manner, the Exchanges should be provided with the
information necessary to determine whether to impose additional margin
and/or whether to assess capital charges upon a member organization
carrying the account. In addition, this information should allow the
Exchanges to determine whether a large position could have an undue
effect on the underlying market and to take the appropriate action.
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\16\ The Exchanges also require that an updated report be filed
when a change in the options position occurs or when a significant
change in the hedge of that position occurs.
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Given the size and sophisticated nature of the FLEX Equity options
market, along with the new reporting and margin requirements, the
Commission believes that eliminating position and exercise limits for
FLEX Equity options for a two-year pilot period should not
substantially increase manipulative concerns. Nevertheless, the
Commission will be able to assess the effects on the markets of the
Exchanges' proposals during the two-year pilot period. If problems were
to arise during such pilot period, the Commission believes that the
enhanced market surveillance of large positions should help the
Exchanges to take the appropriate action in order to avoid any
manipulation or market risk concerns.
Preliminarily, the Commission believes that it is reasonable to
treat FLEX Equity options differently than regular standardized
options. FLEX options compete directly with OTC options. The Commission
believes that it would be beneficial to attract OTC activity back to a
more transparent market with a clearinghouse guarantee. Hence, a
liberalization of position limits for FLEX Equity options is a measured
deregulatory means to enable the Exchanges to compete with the OTC
market while preserving important oversight safeguards.
In summary, because of the special nature of the Flex Equity
markets, the Commission believes that the Exchanges' proposals should
be approved. Nevertheless, because this is the first time the
Commission has agreed to eliminate position and exercise limits for a
derivative product, the Commission cannot rule out the potential for
adverse effects on the securities markets for the component securities
underlying FLEX Equity options. To address this concern, the
[[Page 48686]]
Commission has approved the proposals for a two-year pilot period. The
Exchanges will undertake to monitor, among other things, open interest
and potential adverse market effects and to report to the Commission on
the status of the program no later than eighteen months after the
order's date of effectiveness. The reporting of the Exchanges'
experiences should include, among other things, such information as:
(i) The type of strategies used by FLEX Equity options market
participants and whether FLEX Equity options are being used in lieu of
existing standardized equity options; (ii) the type of market
participants using FLEX Equity options both before and during the pilot
program, including how the utilization of FLEX Equity options has
changed; (iii) the average size of the FLEX Equity option contract both
before and during the pilot program, the size of the largest FLEX
Equity option contract on any given day both before and during the
pilot program, and the size of the largest FLEX Equity option held by
any single customer/member both before and during the pilot program;
and (iv) any impact on the prices of underlying stocks during the
establishment or unwinding of FLEX positions that are greater than
three times the standard position limit. Finally, the Commission
expects the Exchanges to take prompt action, including timely
communication with the Commission and other marketplace self-regulatory
organizations responsible for oversight of trading in component stocks,
should any unanticipated adverse market effects develop.
The Commission finds good cause to approve Amex Amendment No. 1 and
CBOE Amendment No. 1 to the proposed rule filings prior to the
thirtieth day after the date of publication of notice of filing thereof
in the Federal Register. Specifically, by restricting the elimination
of position and exercise limits for FLEX Equity options to a two-year
pilot period, as well as requiring members holding large positions to
report such positions to the Amex and to the CBOE, the proposed rule
changes are more restrictive than the original proposals, which are
published for the entire twenty-one day comment period and generated no
responses. In addition, by authorizing the Amex and the CBOE to impose
margin and/or assess capital charges, the Commission believes that the
Amex and the CBOE have established important safeguards to address
concerns regarding potential manipulation or other market disruptions.
Accordingly, the Commission believes that it is consistent with Section
6(b)(5) of the Act to approve Amex Amendment No. 1 and CBOE Amendment
No. 1 to the proposed rule changes on an accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amex Amendment No. 1 and CBOE Amendment No. 1 to
the rule proposals. 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 changes that are filed with the Commission, and all
written communications relating to the proposed rule changes 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. Sec. 552,
will be available for inspection and copying at the Commission's Public
Reference Section, 450 Fifth Street, NW., Washington, DC 20549. Copies
of such filings also will be available for inspection and copying at
the principal offices of the Amex and the CBOE. All submissions should
refer to File Nos. SR-Amex-96-19 and SR-CBOE-96-79 and should be
submitted by October 7, 1997.
V. Conclusion
For the foregoing reasons, the Commission finds that the Exchanges'
proposals to eliminate position and exercise limits for FLEX Equity
options for a two-year pilot period, as amended, 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,\17\ that the proposed rule changes (SR-Amex-96-19), SR-CBOE-96-79
and SR-PCX-97-09), as amended, are approved on a pilot basis until
September 9, 1999.
\17\ 15 U.S.C. 78s(b)(2) (1988).
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By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-24443 Filed 9-15-97; 8:45 am]
BILLING CODE 8010-01-M