[Federal Register Volume 63, Number 34 (Friday, February 20, 1998)]
[Notices]
[Pages 8723-8725]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-4257]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39464; File No. SR-Amex-97-44]


Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to 
Institutional Index Option Position Limits

February 11, 1998.

I. Introduction

    On November 4, 1997, the American Stock Exchange, Inc. (``Amex'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities and 
Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to increase both position and 
exercise limits, as well as the firm facilitation exemption, for its 
Institutional Index Options (``XII'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4
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    The proposed rule change was published for comment in the Federal 
Register on November 17, 1997.\3\ No comments were received on the 
proposal. This order approves the proposal, as amended.
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    \3\ Exchange Act Release No. 39313 (November 7, 1997), 62 FR 
61418 (November 17, 1997).
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II. Description

A. Increase XII Position and Exercise Limits

    The Amex is proposing to increase XII position and exercise limits 
to 100,000 contracts on the same side of the market. Existing Exchange 
rules provide for XII position and exercise \4\ limits of 45,000 
contracts on the same side of the market of which no more than 25,000 
contracts may be used for purposes of realizing any differential in 
price between XII and the securities underlying XII. In July of 1992, 
the Exchange increased position and exercise limits for XII to their 
current levels.\5\ Since that time, options on XII continue to be 
traded primarily by institutional and professional investors and member 
firms, each often needing to hedge large asset quantities.
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    \4\ The exercise limit for XII, which is equal to XII's position 
limit, is determined under Exchange Rules 905C and 905.
    \5\ See Exchange Act Release No. 31330 (Oct. 16, 1992) 57 FR 
30516 (Oct. 23, 1992).
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    The Exchange believes that increasing the position and exercise 
limits for XII options to 100,000 contracts will allow increased 
institutional use of XII and allow it to be more competitive with 
alternative products. In addition, the Exchange believes that an 
increase in XII position and exercise limits will benefit not only the 
beneficiaries of assets managed by various institutions, but also the 
marketplace in general through increased liquidity.
    These proposed changes are intended to result in little or no 
attendant risk to the marketplace as XII is composed of seventy-five of 
the most widely-held stocks in institutional portfolios that have a 
market value of more than one hundred million in investment funds.\6\ 
Thus the component issues are extremely liquid and the overall index 
less volatile than individual stocks. Lastly, XII options are European-
style and therefore can only be exercised at expiration.
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    \6\ To qualify for inclusion in XII, stocks must be held by a 
minimum of 200 of the reporting institutions filing Section 13(f) 
reports and must have traded at least 7 million shares in each of 
the two preceding calendar quarters.
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    To enhance its ability to monitor unhedged positions, the Amex will 
add a reporting requirement (new Commentary .03 to Exchange Rule 904(C) 
for accounts having a position in excess of 45,000 a.m.-settled, 
European-style XII option contracts on the same-side of the market. 
Specifically, new Commentary .03 to Exchange Rule 904C states that if a 
member or member organization, other than an Exchange Specialist or 
Registered Options Trader, maintains a position in excess of 45,000 
a.m.-settled, European-style XII option contracts on the same-side of 
the market on behalf of its own account or for the account of a 
customer, it must report information as to whether those positions are 
hedged and provide documentation as to how such contracts are hedged, 
in the manner and form required by the Exchange. In addition, to 
address the Commission's concerns with respect to the ability of the 
Exchange to monitor customer accounts that maintain large unhedged 
positions, the Amex will add a margin and clearing firm requirement. 
Pursuant to new Commentary .04 to Exchange Rule 904C, whenever the 
Exchange determines that additional margin is warranted in light of the 
risks associated with an under-hedged option position in excess of 
45,000 contracts, the Exchange may impose additional margin upon the 
account maintaining such under-hedged position, or assess capital 
charges upon the clearing firm carrying the account to the extent of 
any margin deficiency resulting from the higher margin requirement.

B. Increase XII Firm Facilitation Exemption

    The Exchange is proposing to increase the XII firm facilitation 
exemption \7\ from 100,000 contracts to 400,000 contracts in order to 
accommodate the needs of investors as well as market participants. The 
Exchange believes that this increase should not substantially increase 
concerns regarding the potential for manipulation and other trading 
abuses.\8\ Furthermore, the Exchange believes that proposed rule change 
will further enhance the potential depth and liquidity of the options 
market as well as the underlying

[[Page 8724]]

markets by providing Exchange members greater flexibility in executing 
large customer orders, which the Exchange's existing safeguards 
applicable to current facilitation exemptions continue to serve to 
minimize any potential disruption or manipulation concerns.
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    \7\ The Amex defines a facilitation order as an order which is 
only executed in whole or in part, in a cross transaction with an 
order for a public customer of the member organization. See Amex 
Rule 950 (e)(iv).
    \8\ The Exchange notes that the XII firm facilitation exemption 
is in addition to the standard limit and other exemptions under 
Exchange rules, commentaries and policies.
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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).\9\ Specifically, 
the Commission believes that the proposed increase in the XII position 
and exercise limits, as well as the firm facilitation exemption, will 
enhance the depth and liquidity of the market for both members and 
investors. Accordingly, the Commission believes that these changes are 
consistent with, and further the objectives of, Section 6(b)(5)\10\ of 
the Act in that they would remove impediments to and perfect the 
mechanism of a free and open market in a manner consistent with the 
protection of investors and the public interest.\11\
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    \9\ 15 U.S.C. 78f(b)(5).
    \10\ 15 U.S.C. 78f(b)(5).
    \11\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. Sec. 78c(f).
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A. Increase XII Position and Exercise Limits

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate or 
disrupt the underlying market so as to benefit the options position. In 
particular, position and exercise limits are designed to minimize the 
potential for mini-manipulation \12\ and for corners or squeezes of the 
underlying market. In addition, they serve to reduce the possibility 
for disruption of the options market itself, especially in illiquid 
options classes.
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    \12\ Mini-manipulation is an attempt to influence, over a 
relatively small range, the price movement in a stock to benefit a 
previously established derivatives position.
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    The Commission has been careful to balance two competing concerns 
when considering an SRO's position and exercise limits. First, the 
Commission has recognized that the limits must be sufficient to prevent 
investors from disrupting the market for the underlying security by 
acquiring and exercising a number of options contracts disproportionate 
to the deliverable supply and average trading volume of the underlying 
security. At the same time, the Commission has realized that 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.\13\
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    \13\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. at 189-91 
(Comm. Print 1978) (``Options Study'').
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    The Commission believes that the proposed increase in XII position 
and exercise limits to 100,000 contracts will expand the depth and 
liquidity of the XII market without significantly increasing concerns 
regarding intermarket manipulations or disruptions of the options or 
the underlying securities.\14\ As previously noted by the Commission, 
markets with active and deep trading interest, as well as with broad 
public ownership, are more difficult to manipulate or disrupt than less 
active and deep markets with smaller public floats. In this regard, the 
XII market is composed of seventy-five of the most widely-held stocks 
in institutional portfolios that have a market value of more than one 
hundred million in investment funds.
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    \14\ See Amex Rule 904C(a).
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    Moreover, the Amex has adopted important safeguards that will allow 
it to monitor large unhedged positions (those in excess of 45,000 
contracts) in order to identify instances of potential risk \15\ and to 
assess additional margin or capital charges against the clearing firm, 
if necessary.\16\
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    \15\ Under new Commentary .03 to Exchange Rule 904C, each member 
or member organization, other than an Exchange Specialist or 
Registered Options Trader, that maintains a position in excess of 
45,000 A.M.-settled, European-style XII option contracts on the same 
side of the market on behalf of its own account or for the account 
of a customer will report information as to whether those positions 
are hedged and provide documentation as to how such contracts are 
hedged, in the manner and form required by the Exchange.
    \16\ Under new Commentary .04 Exchange Rule 904C, whenever the 
Exchange determines that additional margin is warranted in light of 
the risks associated with an under-hedged XII option position in 
excess of 45,000 contracts, the Exchange may impose additional 
margin upon the account maintaining such under-hedged position, or 
assess capital charges upon the clearing firm carrying the account 
to the extent of any margin deficiency resulting from the higher 
margin requirement.
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    Accordingly, given the size and breadth of the XII, along with the 
new XII reporting requirement set forth in Commentary .03 to Exchange 
Rule 904C and the new margin and clearing firm requirements set forth 
in Commentary .04 to Exchange Rule 904C, the Commission believes that 
increasing the XII position and exercise limits to 100,000 contracts 
should not increase any manipulative concerns. Finally, the Exchange's 
surveillance program will continue to detect and deter trading abuses 
arising from the increased position and exercise limits.\17\
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    \17\ The Exchange has represented that it intends to implement 
increased surveillance and reporting procedures to ensure a thorough 
understanding of the uses and risks of the underlying strategies 
supported by the increased position limits. The Exchange also has 
represented that it intends to provide reports regarding position 
limits to the Commission's Division of Market Regulation on a 
periodic basis and at appropriate thresholds of activity.
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B. Increase XII Firm Facilitation Exemption

    The Commission believes that the proposed increase of the XII firm 
facilitation exemption from 100,000 contracts to 400,000 contracts will 
accommodate the needs of investors as well as market participants 
without substantially increasing concerns regarding the potential for 
manipulation and other trading abuses.\18\ The Commission also believes 
that the proposed rule change will further enhance the potential depth 
and liquidity of the options market as well as the underlying market by 
providing Exchange members greater flexibility in executing large 
customer orders.\19\
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    \18\ The Commission notes that the XII firm facilitation 
exemption is in addition to the Standard limit and other exemptions 
under Exchange rules, commentaries and policies.
    \19\ When initially approving the firm facilitation exemption 
for XII options, the Commission stated that providing member 
organizations with an exemption for the purpose of facilitating 
large customer orders would better serve the needs of the investing 
public. At that time, the Commission also noted that safeguards were 
built into the exemption to minimize any potential disruption or 
manipulation concerns. The Commission currently believes that these 
same benefits and assurances are also applicable with respect to the 
increased firm facilitation exemption. See Exchange Act Release No. 
31330 (October 16, 1992), 57 FR 48408 (October 23, 1992).
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    The Amex's existing safeguards that apply to the current 
facilitation exemption will continue to serve to minimize any potential 
disruption or manipulation concerns. First, the facilitation firm must 
receive approval from the Exchange prior to executing facilitating 
trades. Second, a facilitation firm must, within five business days 
after the execution of a facilitation exemption order, hedge all exempt 
options positions that have not previously been liquidated, and furnish 
to the Exchange documentation reflecting the resulting hedged

[[Page 8725]]

positions.\20\ Third, the facilitation exemption member is required to 
provide the Exchange with any information or document requested 
concerning the exempted options positions and the positions hedging 
them. Fourth, a facilitation exemption member is not permitted to use 
the facilitation exemption for the purpose of engaging in index 
arbitrage. Fifth, neither the member's nor the customer's order may be 
contingent upon ``all or none'' or ``fill or kill'' instructions and 
the orders may not be executed until the XII specialist has announced 
the orders to the entire crowd and crowd members have been given a 
reasonable time to participate in the trade. Finally, once liquidated 
or reduced, the member organization may not increase the exempted 
option positions without receiving approval from the Exchange again. 
The Commission believes that these requirements will help to ensure 
that the facilitation exemption will not have an undue market impact on 
the options or on any underlying stock positions.
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    \20\ In meeting this requirement, the facilitation firm must 
liquidate and establish its customer's and its own options and stock 
positions or their equivalent in an orderly fashion, and not in a 
manner calculated to cause unreasonable price fluctuations or 
unwarranted price changes.
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    In summary, the Commission continues to believe that the safeguards 
built into the facilitation exemptive process will serve to minimize 
the potential for disruption and manipulation concerns, while at the 
same time benefiting market participants by allowing member firms 
greater flexibility to facilitate large customer orders. The Commission 
also believes that the Amex has adequate surveillance procedures to 
surveil for compliance with the rule's requirements. Based on these 
reasons, the Commission believes that it is appropriate to increase the 
XII firm facilitation exemption to 400,000 contracts.

IV. Conclusion

    Based on the above, the Commission believes that the proposed rule 
change will serve to provide market participants with greater 
flexibility without significantly increasing concerns regarding 
intermarket manipulations or disruptions of either the options market 
or the underlying stock market.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-Amex97-44) is approved.

    \21\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-4257 Filed 2-19-98; 8:45 am]
BILLING CODE 8010-01-M