[Federal Register Volume 63, Number 176 (Friday, September 11, 1998)]
[Notices]
[Pages 48777-48779]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-24371]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40400; File No. SR-Phlx-98-36]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Philadelphia Stock Exchange, Inc. Relating to an Increase
in Position and Exercise Limits for Standardized Equity Options
September 3, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on August 14, 1998, the Philadelphia Stock
Exchange, Inc. (``Phlx'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the self-regulatory organization. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The Phlx proposes to amend Exchange Rule 1001, Position Limits, to
increase position and exercise limits \3\ for standardized equity
options to three times their current levels. Corresponding changes are
also being made to the equity option hedge exemption contained in
Commentary .07 to Rule 1001.
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\3\ Position limits impose a ceiling on the number of option
contracts in each class on the same side of the market relating to
the same underlying security that can be held or written by an
investor or group of investors acting in concert.
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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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in Sections A, B, and C below, of the
most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Phlx is proposing to increase the position and exercise limits
for equity options traded on the Exchange to three times their current
levels. Currently, Phlx Rule 1001 subjects equity options to one of the
five different position limits depending on the trading volume and
outstanding shares of the underlying security. Rule 1002 establishes
corresponding exercises limits.\4\ The limits are: 4,500; 7,500;
10,500; 20,000; and 25,000 contracts on the same side of the market.
Under the proposed changes the new limits will be: 13,500; 22,500;
31,500; 60,000; and 75,000 contracts. Corresponding changes are also
being proposed to the equity option hedge exemption contained in
Commentary .07 of Rule 1001 so that the example in the Commentary
reflects the proposed position and exercise limits. The Exchange
believes sophisticated surveillance techniques at options exchanges
adequately protect the integrity of the markets for the options that
will be subject to these increased position and exercise limits.
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\4\ Rule 1002 states ``. . . no member or member organization
shall exercise, for any account in which such member or member
organization has an interest or for the account of any partner,
officer, director or employee thereof or for the account of any
customer, a long position in any option contract of a class of
options dealt in on the Exchange (or, respecting an option not dealt
in on the Exchange, another exchange if the member or member
organization is not a member of that exchange) if as a result
thereof such member or member organization, or partner, officer,
director or employee thereof or customer, acting alone or in concert
with others, directly or indirectly, has or will have exercised
within any five (5) consecutive business days aggregate long
positions in that class (put or call) as set forth in the position
limit in Rule 1001, in the case of options on a stock, on a foreign
currency or cross rate currency options, or stock index warrants;
without regard to the exchange on which the options were purchased.
Whether option or warrant positions should be aggregated under this
rule shall be determined in the manner described in the Commentary
to Exchange Rule 1001. Index option position and exercise limits are
governed by Rules 1001A and 1002A.''
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Manipulation
The Phlx believes that position and exercise limits, at their
current levels, no longer serve their stated purpose. The Commission
has stated that:
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-manipulations and for corners or
squeezes of the underlying market.\5\
\5\ Exchange Act Release No. 39489 (December 24, 1997), 63 FR
276 (January 5, 1998).
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At this time in 1998, noting the twenty-fifth anniversary of listed
options trading, the Exchange believes that the existing surveillance
procedures and reporting requirements at options exchanges and clearing
firms that have been developed over the years are able to properly
identify unusual and illegal trading activity. In addition, routine
oversight inspections of Phlx's regulatory programs by the commission
have not uncovered any material inconsistencies or shortcomings in the
manner in which the Exchange's market surveillance reviews position
limits.
[[Page 48778]]
These procedures entail a daily monitoring of market movements
automated to identify unusual activity in both the options and
underlying stock. Further, the significant increases in unhedged
options capital charges resulting from the September 1997 adoption of
risk-based haircuts and the Exchange margin requirements applicable to
these products under Exchange rules serves as a more effective
protection than position limits.\6\
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\6\ See Exchange Act Release No. 38248 (February 6, 1997), 62 FR
6474 (February 12, 1997) (adopting Risk-Based Haircuts) and Phlx
rule 722.
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Further, large stock holdings must be disclosed to the Commission
by way of Schedules 13D or 13G.\7\ Options positions are part of any
reportable positions and cannot be legally hidden. In addition,
Exchange Rule 1003--which requires members to file reports with the
Exchange for any customer who held aggregate long or short positions of
200 or more option contracts of a put class and call class on the same
side of the market covering the same underlying security--will remind
unchanged and an important part of the Exchanges's surveillance
efforts.
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\7\ Exchange Act Rule 13d-1.
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Postion and Exercise Limits Restrict Legitimate Options Use
Equity option position limits prevent large customers such as
mutual funds and pension funds from using options to gain meaningful
exposure to individual stocks, resulting in lost liquidity in both the
options market and the stock market. Equity option position limits also
act as a barrier to the use of options by corporations wishing to
implement options strategies with their own stock. For example,
existing equity option position limits could restrict the number of put
options that could be sold under a corporate buyback program.\8\
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\8\ 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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Financial Requirements
The Exchange believes that financial requirements imposed by the
Exchange and by the Commission adequately address concerns that a
member or its customer could try to maintain an inordinately large
unhedged position in an equity option. Current margin, and risk-based
haircut methodologies serve to limit the size of positions maintained
by any one account by increasing the margin and/or capital that a
member must maintain for a large position held by itself or by its
customer. It should also be noted that the Exchange has the authority
under Rule 722(d)(1), (d)(4) and (i)(8) to impose a higher margin
requirement upon a member or member organization when the Exchange
determines a higher requirement is warranted. In addition, the
Commission's net capital rule, Rule 15c3-1, imposes a capital charge on
members to the extent of any margin deficiency resulting from the
higher margin requirement.
Past Increases Have Had No Adverse Consequences
Equity option position limits have been gradually expanded from
1,000 contracts in 1973 to the current level of 25,000 contracts for
the largest and most active stocks. In 1998, the Commission approved
the elimination of position and exercise limits in FLEX equity options
under a two-year pilot program.\9\ To date, the Exchange does not
believe that there have been adverse effects on the market as a result
of the past increases in the limits for equity options or the
elimination of position and exercise limits for FLEX equity options.
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\9\ See Exchange Act Release No. 39549 (January 14, 1998) (SR-
Phlx-96-38).
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Changes Will Allow Options Exchanges To Compete More Fairly With
OTC Markets
The Commission has stated 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.'' \10\
However, in today's market, equity option position limits place listed
options at a competitive disadvantage to over-the-counter (``OTC'')
derivatives. OTC dealers can execute options trades through overseas
subsidiaries not subject to National Association of Securities Dealers
(``NASD'') regulation, and therefore not subject to position limits. As
a result, the largest trades can go unobserved and unmonitored for
regulatory and oversight purposes. Member firms continue to express
concern to options Exchanges that position limits are an impediment to
their business and that they have no choice but to move their business
to off-shore markets where position limits are not an issue.
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\10\ See H.R. Rep. No. IFC-3 96th Cong., 1st Sess. At 189-91
(Comm. Print 1978).
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In addition, the Commission has recently approved the NASD's
proposed rule change to raise position limits for conventional equity
options (i.e., those options not issued, or subject to issuance by The
Options Clearing Corporation) to three times their current levels and
three times the levels established by current Exchange rules for
standardized options.\11\ Because conventional options often have
nearly the identical terms as standardized, exchange-traded options,
the Exchange believes the position limits for standardized options
should be at least as high as those for conventional options. This is
critical for listed options to compete with a growing OTC market, thus
promoting fair competition. The proposed rule change should help to
attract business back to the Exchange where the trades will be subject
to reporting requirements and surveillance. In releases respecting FLEX
equity option's, which have no position limits, the Commission noted
that the elimination of position limits will allow the listed options
markets to better compete with the OTC market.\12\
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\11\ The NASD's position limit filing established position and
exercise limits for conventional equity options identical to those
being proposed by Phlx in this filing. See Exchange Act Release No.
40087 (June 12, 1998), 63 FR 33746 (June 19, 1998) (SR-NASD-98-23).
\12\ See, e.g., Exchange Act Release No. 39549 (January 14,
1998), 63 FR 3601 (January 23, 1998) (SR-Phlx-96-38).
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It should also be noted that individual stocks are not subject to
position limits. Investors can theoretically hold 100% of a company's
shares outstanding as long as they file the appropriate Schedule 13D or
13G. The Exchange believes the increase in the position and exercise
limits will better enable the Exchange to compete against the OTC
markets and is an appropriate and responsible increase given the nature
of the Exchange's surveillance.
2. Statutory Basis
The Exchange represents that the proposed rule change is consistent
with Section 6(b) \13\ of the Act, in general, and Section 6(b)(5) of
the Act,\14\ in particular, in that it is designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in facilitating transactions in securities, to
remove impediments to and perfect the mechanism of a free and open
market and a national market system, to protect investors and the
public interest and is not designed to permit unfair discrimination
between customer, issuers, brokers, or dealers.
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\13\ 15 U.S.C. 78f(b).
\14\ 15 U.S.C. 78f(b)(5).
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[[Page 48779]]
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule chnage will
impose any inappropriate burden on competition.
C. Self-Regulatory Organizations Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the publication of this notice in the Federal
Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 at the
Commission's Public Reference Room. Copies of such filing with also be
available for inspection and copying at the principal office of the
Exchange. All submissions should refer to File No. SR-Phlx-98-36 and
should be submitted by October 2, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ CFR 200.30-(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-24371 Filed 9-10-98; 8:45 am]
BILLING CODE 8010-01-M