[Federal Register Volume 63, Number 220 (Monday, November 16, 1998)]
[Notices]
[Pages 63764-63766]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-30549]


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SECURITIES AND EXCHANGE COMMISSION

[(Release No. 34-40652; File No. SR-NASD-98-78)]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to the Equity Option Hedge Exemption

November 9, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ notice is hereby given that on 
October 15, 1998, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary, 
NASD Regulation (``NASD Regulation''), 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 NASD Regulation. 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).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation proposes to amend Rule 2860(B)(3)(A)(vii) of the 
NASD, to make permanent the Equity Option Hedge Exemption, which has 
been operating as a pilot program since 1990. Below is the text of the 
proposed rule change. Deletions are bracketed.

Rule 2860. Options.

* * * * *
(b)(3)(A)(vii) Equity Option Hedge Exemption
    a. The following positions, where each option contract is 
``hedged'' by 100 shares of stock or securities readily convertible 
into or economically equivalent to such stock, or, in the case of an 
adjusted option contract, the same number of shares represented by the 
adjusted contract, shall be exempted from established limits contained 
in (i) through (vi) above:
    1. long call and short stock;
    2. short call and long stock;
    3. long put and long stock;
    4. short put and short stock.
    b. Except as provided under the OTC Collar Exemption contained in 
paragraph (b)(3)(A)(viii), in no event may the maximum allowable 
position, inclusive of options contracts hedged pursuant to the equity 
option position limit hedge exemption in subparagraph a. above, exceed 
three times the applicable position limit established in subparagraph 
(b)(3)(A)(i) through (v) with respect to standardized equity options, 
or subparagraph (b)(3)(A)(ix) with respect to conventional equity 
options.
    [c. The Equity Option Hedge Exemption is a pilot program authorized 
by the Commission through December 31, 1998.]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD Regulation 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. NASD Regulation 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
    Position limits impose a ceiling on the number of options contracts 
of each options class on the same side of the market that can be held 
or written by a member, an investor, or a group of investors acting in 
concert. NASD Rule 2860(b)(3) provides that the position limits for 
equity options are determined according to a five-tiered system in 
which more actively traded stocks with larger public floats are subject 
to higher position limits. Currently, the five tiers for standardized 
equity options \2\ are 4,500, 7,500, 10,500, 20,000 and 25,000 
contracts. The position limits for conventional equity options \3\ are 
three times the limits for standardized equity

[[Page 63765]]

options.\4\ NASD rules do not specifically govern how a particular 
equity option falls within one of the five position limit tiers. 
Rather, the NASD's position limit rule provides that the position limit 
established by an options exchange for a particular equity option is 
the applicable position limit for purposes of the NASD's rule.\5\
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    \2\ Standardized equity options are exchange-traded options 
issued by the Options Clearing Corporation (``OCC'') that have 
standard terms with respect to strike prices, expiration dates and 
the amount of the underlying security.
    \3\ A conventional option is any option contact not issued, or 
subject to issuance by, the OCC.
    \4\ See Exchange Act Release No. 40087 (June 12, 1998), 63 FR 
33746 (June 19, 1998).
    \5\ For equity options that do not trade on an options exchange, 
the NASD's position limit rule provides that the limit for 
conventional equity options shall be three times the basic limit of 
4,500 contracts, such as 13,500 contracts, unless the member can 
demonstrate to the Association that the underlying security meets 
the standards for higher limits and the initial listing standards 
for standardized options trading.
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    The NASD's Equity Option Hedge Exemption (``Hedge Exemption'') 
provides for an automatic, limited exemption from position limits for 
equity options that are hedged using one of the four most commonly used 
hedge positions: (1) long stock and short calls; (2) long stock and 
long puts; (3) short stock and long calls; and (4) short stock and 
short puts. The Hedge Exemption applies to accounts in which the option 
contract is either (i) hedged by 100 shares of stock, (ii) hedged by 
securities that are readily convertible into, or economically 
equivalent to, such stock, or (iii) in the case of an adjusted options 
contract, hedged by the number of shares represented by the adjusted 
contract.
    Under the Hedge Exemption, the largest standardized equity options 
position (combining hedged and unhedged positions) that may be 
established may not exceed three times the basic position limits, i.e., 
13,500, 22,500, 31,500, 60,000, or 75,000 contracts, depending on the 
basic position limits of the underlying security. Likewise, the largest 
conventional equity options position (combining hedged and unhedged 
positions) that may be established may not exceed three times the basic 
position limits on conventional equity options, i.e., 40,500, 67,500, 
94,500, 180,000, or 225,000 contracts.
    The Hedge Exemption has been operating as pilot program since its 
inception in 1990.\6\ The Commission recently extended the deadline of 
the pilot program until December 31, 1998, to give the NASD time to 
adopt it on a permanent basis.\7\
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    \6\ See Exchange Act Release No. 27697 (February 9, 1990), 55 FR 
5535 (February 15, 1990).
    \7\ See Exchange Act Release No. 39865 (April 14, 1998), 63 FR 
19992 (April 22, 1998).
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    NASD Regulation believes that the Hedge Exemption is an important 
component of the options position limit rules and should be continued 
on a permanent basis. NASD Regulation staff has over eight years 
experience administering the Hedge Exception and has concluded that it 
is both an important and necessary tool for market participants to 
manage their market exposure by allowing them the flexibility to hold 
larger options positions in cases where such positions are hedged. In 
addition, NASD Regulation believes that the Hedge Exemption should be 
made permanent to achieve parity with the other options self-regulatory 
organizations which have in effect a permanent, substantively identical 
equity option hedge exemption.\8\
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    \8\ See American Stock Exchange Rule 904; Chicago Board Options 
Exchange Rule 4.11; Philadelphia Stock Exchange Rule 1001; Pacific 
Exchange Rule 6.8.
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    Finally, NASD Regulation believes that continuing the Hedge 
Exemption on a permanent basis will not pose any risk to the options or 
underlying equity market. NASD rules require each member to report 
options positions of any account which has established an aggregate 
position of 200 or more option contracts of the put class and the call 
class on the same side of the market covering the same underlying 
security.\9\
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    \9\ See Rule 2860(b)(5).
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2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\10\ 
which requires, among other things, that the Association's rules must 
be designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. The NASD believes that 
making the Hedge Exemption permanent will maintain the depth and 
liquidity of the options markets by permitting investors to hedge 
greater amounts of stock than would otherwise be permitted under NASD 
rules. Making the Hedge Exemption permanent also will promote 
consistency among the rules of the NASD and the other options self-
regulatory organizations. NASD Regulation notes that the higher 
position limits currently available under the Hedge Exemption have not 
resulted in disruptions of the underlying equities market, and it will 
continue monitoring the market effects, if any, from the Hedge 
Exemption. Lastly, NASD Regulation will continue to monitor use of the 
Hedge Exemption to ensure that members are complying with all 
applicable requirements.
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    \10\ 15 U.S.C. 78o(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectivess of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of 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 its 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 such 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 there 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 Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-98-78 and should 
be submitted by December 7, 1998.


[[Page 63766]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc 98-30549 Filed 11-13-98; 8:45 am]
BILLING CODE 8010-01-M