[Federal Register Volume 64, Number 7 (Tuesday, January 12, 1999)]
[Notices]
[Pages 1842-1845]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-594]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40875; File Nos. SR-CBOE-98-25; Amex-98-22; PCX-98-33;
and Phlx-98-36]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Changes by the Chicago Board Options Stock Exchange,
Inc., American Stock Exchange, Inc., Pacific Exchange, Inc., and
Philadelphia Stock Exchange, Inc.; Notice of Filing and Order Granting
Accelerated Approval to Amendment Nos. 1 and 2 by the Chicago Board
Options Exchange; Notice of Filing and Order Granting Accelerated
Approval to Amendment No. 1 by the American Stock Exchange; Notice of
Filing and Order Granting Accelerated Approval to Amendment No. 1 by
the Pacific Exchange; Notice of Filing and Order Granting Accelerated
Approval to Amendment Nos. 1 and 2 by the Philadelphia Stock Exchange;
Relating to an Increase in Position and Exercise Limits for
Standardized Equity Options
December 31, 1998.
I. Introduction
On June 8, 1998, the Chicago Board Options Exchange, Inc.
(``CBOE''); on June 24, 1998, the American Stock Exchange, Inc.
(``Amex''); July 1, 1998, the Pacific Exchange, Inc. (``PCX''); and on
August 14, 1998, the Philadelphia Stock Exchange, Inc. (``Phlx'')
(collectively, the ``Exchanges''); submitted to the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to section
19(b)(1) of the Securities Exchange Act of 1934 (``Exchange Act'' or
``Act'') 1 and Rule 19b-4 thereunder,2 proposed
rule changes to increase position and exercise limits for standardized
equity options to three times their current levels.
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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 changes were published for comment in the Federal
Register on July 9, 1998, July 9, 1998, July 14, 1998, and September
11, 1998.3 CBOE filed two amendments to its proposed rule
change, respectively on November 12 and November 18, 1998.4
Amex filed an amendment to its proposed rule change on November 23,
1998.5 PCX filed and amendment to its proposed rule change
on December 14, 1998.6 Phlx filed two amendments to its
proposed rule change on September 15 and December 4, 1998.7
One comment was received on the CBOE's proposal.8 This order
approves the proposals, as amended.
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\3\ See Exchange Act Release Nos. 40160 (July 1, 1998), 63 FR
37155 (July 9, 1998) (CBOE); 40159 (July 1, 1998), 63 FR 37151 (July
9, 1998) (Amex); 40172 (July 6, 1998), 63 FR 37913 (July 14, 1997)
(PCX); and 40400 (September 3, 1998), 63 FR 48777 (September 11,
1998) (Phlx).
\4\ See Letter to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, from Timothy Thompson,
CBOE, dated November 10, 1998 (``CBOE Amendment No. 1''). CBOE
Amendment No. 1, in addition to making certain non-substantive
changes, implements a new hedge reporting requirement with respect
to customer accounts holding an equity option position in excess of
10,000 contracts on the same side of the market. See also Letter to
Michael Walinskas, Deputy Associate Director, Division of Market
Regulation, Commission, from Timothy Thompson, CBOE, dated November
17, 1998 (``CBOE Amendment No. 2''). CBOE Amendment No. 2 clarifies
that the 10,000 contract reporting requirement does not apply to
CBOE market-maker accounts. The amendment provides that the Exchange
has the authority to impose additional margin on the clearing firm
carrying the subject customer account in the event an under-hedged
equity option position in excess of 10,000 contracts is noted. CBOE
Amendment No. 2 also clarifies that the reporting threshold for FLEX
equity options will remain unchanged upon the Commission's approval
of the current proposed rule change.
\5\ See Letter to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, from Scott G. Van Hatten,
Legal Counsel, Amex, dated November 20, 1998 (``Amex Amendment No.
1''). Amex Amendment No. 1 implements a new hedge reporting
requirement on members, other than exchange market-makers, with
respect to customer accounts holding an equity option position in
excess of 10,000 contracts on the same side of the market. The
amendment provides that the Exchange has the authority to impose
additional margin on the clearing firm carrying the subject customer
account in the event an under-hedged equity option position in
excess of 10,000 contracts is noted. Amex Amendment No. 1 also
clarifies that the reporting threshold for FLEX equity options will
remain unchanged upon the Commission's approval of the current
proposed rule change.
\6\ See Letter to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, from Robert Pacileo,
Staff Attorney, PCX, dated December 14, 1998 (``PCX Amendment No.
1''). PCX Amendment No. 1, in addition to making technical language
changes, implements a new hedge reporting requirement on members,
other than exchange market-makers, with respect to customer accounts
holding an equity option position in excess of 10,000 contracts on
the same side of the market. The amendment provides that the
Exchange has the authority to impose additional margin on the
clearing firm carrying the subject customer account in the event an
under-hedged equity option position in excess of 10,000 contracts is
noted. PCX Amendment No. 1 also clarifies that the reporting
threshold for FLEX equity options will remain unchanged upon the
Commission's approval of the current proposed rule change.
\7\ See Letter to Michael Walinskas, Deputy Associate Director,
Division of Market Regulation, Commission, from Linda S. Christie,
Counsel, Phlx, dated September 14, 1998 (``Phlx Amendment No. 1'').
Phlx Amendment No. 1 makes minor technical changes by clarifying the
new position limits in the examples presented in Commentary .08(a)
of Phlx Rule 1001. See also Letter to Michael Walinskas, Deputy
Associate Director, Division of Market Regulation, Commission, from
John Dayton, Phlx, dated December 3, 1998 (``Phlx Amendment No.
2''). Phlx Amendment No. 2, in addition to making certain non-
substantive changes, implements a new hedge reporting requirement on
members, other than exchange market-makers, with respect to customer
accounts holding an equity option position in excess of 10,000
contracts on the same side of the market. The amendment provides
that the Exchange has the authority to impose additional margin on
the clearing firm carrying the subject customer account in the event
an under-hedged equity option position in excess of 10,000 contracts
is noted. Phlx Amendment No. 2 also clarifies that the reporting
threshold for FLEX equity options will remain unchanged upon the
Commission's approval of the current proposed rule change.
\8\ See Letter to Jonathan G. Katz, Secretary, Commission, from
Kathryn V. Natale, Deputy General Counsel/Director of Compliance-
Americas, Credit Suisse First Boston, dated September 23, 1998
(``CSFB Letter''). The CSFB Letter generally supported the position
and exercise limit increase.
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II. Description
The Exchanges propose to increase position and exercise limits for
standardized equity options \9\ to three times their current
levels.\10\ The current position and exercise limits subject
standardized equity options to one of five different position limits
depending on the trading volume and outstanding share for the
underlying security. 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. The Exchanges believe sophisticated surveillance techniques at
options exchanges adequately protect the
[[Page 1843]]
integrity of the markets for the options that will be subject to these
increased position and exercise limits. The proposed rule change also
will implement a new hedge reporting requirement on members, other than
exchange market-makers, with respect to customer accounts holding an
equity option position in excess of 10,000 contracts on the same side
of the market.
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\9\ Standardized 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.
\10\ Position limits impose a ceiling on the aggregate number of
option contracts on the same side of the market (i.e., aggregating
long calls and short puts or long puts and short calls) that an
investor, or a group of investors acting in concert, 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.
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III. 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 of the Act. \11\
Specifically, the Commission believes that the proposed rule changes
are designed to prevent fraudulent and manipulative acts and practices,
to promote just and equitable principles of trade, and to protect
investors and the public interest. The Commission also believes that
the proposed rule changes are consistent with section 11A of the Act
\12\ in that they will enhance competition by allowing the Exchanges to
compete better with the growing over-the-counter (OTC) market in
customized equity options and with entities not subject to position
limit rules.\13\
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\11\ See 15 U.S.C. 78f(b). In approving this rule change, the
Commission notes that it has considered the proposal's impact on
efficiency, competition, and capital formation, consistent with
section 3 of the Act. Id. at 78c(f).
\12\ See 15 U.S.C. 78k-1.
\13\ In approving this rule change, the Commission notes that it
has considered the proposal's impact on efficiency, competition, and
capital formation, consistent with Section 3 of the Act. Id., at
78c(f).
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The Commission notes that the Exchanges believe that position and
exercise limits, at their current levels, no longer serve their stated
purpose. In the past, 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
manipulative 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. In addition, such
limits serve to reduce the possibility for disruption of the options
market itself, especially in illiquid options classes.\14\
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\14\ See e.g., Exchange Act Release No. 33283 (December 3,
1993), 58 FR 65204 (December 13, 1993) (CBOE-93-43) (order approving
an increase in position and exercise limits for standardized equity
options).
Although the Commission does not agree with the Exchanges that
position and exercise limits no longer serve their intended purpose,
the Commission believes that it is appropriate at this time to allow
for an increase in position and exercise limits. In making this
determination, the Commission has been careful to balance two competing
concerns when considering the appropriate level at which to set equity
option position and exercise limits. 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.\15\
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\15\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. At 189-91
(Comm. Print 1978).
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In general, the Commission has taken a gradual, evolutionary
approach toward expansion of position and exercise limits. At this
time, the Commission believes that an increase in position and exercise
limits is appropriate for several reasons. First, the attributes of the
exchange options markets include, among other things, 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. The high level of price and
transaction transparency in the centralized exchange setting helps to
deter illegal and manipulative trading activity. Furthermore, because
OCC serves as the counter-party guarantor in every exchange-traded
transaction, the potential for disruption to the market as a result of
a customer acquiring and exercising a number of options contracts
disproportionate to the deliverable supply is substantially reduced.
Second, an increase in position and exercise limits could bring
additional depth and liquidity to the listed options markets without
significantly increasing concerns regarding intermarket manipulations
or disruptions of the options or the underlying securities.
Third, the Exchanges' surveillance programs and enhanced reporting
procedures should detect and deter trading abuses that could arise from
the tripling of the current limits. Currently, the Exchanges' member
firms are required to report to the exchanges those accounts that, on
the previous business day, maintained aggregate long or short positions
on the same side of the market of 200 or more contracts of any single
class of options, identify the number of option contracts comprising
each position and, in the case of short positions, state whether they
are covered or uncovered (referred to as the ``Large Options Position
Report'' or ``LOPR''). The submission of specific information relating
to hedged positions currently is not required but can be obtained upon
request. In order to better monitor potentially large unhedged options
positions that will be subject to significantly higher position limits,
the Exchanges are adopting an additional reporting requirement and
position monitoring program. The Exchanges have proposed to implement a
new reporting requirement with respect to customer accounts holding an
equity option position in excess of 10,000 contracts on the same side
of the market.\16\ Member firms will be required to report and update
hedging information concerning the position, including a detailed
description of the hedge employed. The Commission believes that this
reporting requirement provides an additional flag to the Exchanges
concerning accounts maintaining large positions. Receipt and review of
this information will enable the Exchanges to better assess whether the
account is properly hedged, whether additional margin should be
imposed, or whether other regulatory action by the Exchange is
necessary. Furthermore, large stock holdings must be disclosed to the
Commission by way of Schedule 13D or 13G.\17\ Options positions are
part of any reportable positions and cannot be legally hidden.
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\16\ The Amex requested that the reporting level being adopted
be revised from 10,000 contracts to in excess of 13,500 contracts.
The Amex believes that the reporting obligations and the requisite
analyses at the 10,000 contract reporting level will require the
Amex to analyze positions in a large number of accounts holding
between 10,000 and 13,500 contracts, but that in nearly every case
could permissibly hold at least 25,000 unhedged option contracts.
See Letter to Michael Walinskas, Deputy Associate Director, Division
of Market Regulation, Commission, from Scott G. Van Hatten, Legal
Counsel, Amex, dated December 4, 1998. The Commission has determined
that the 10,000 contract reporting level is appropriate at this
time.
\17\ Exchange Act Rule 13d-1.
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Fourth, the Commission believes that financial requirements imposed
by each Exchange and by the Commission
[[Page 1844]]
adequately address concerns that a member or its customer may 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. The Exchanges also have the
authority under their respective rules to impose a higher margin
requirement upon the member or member organization when the Exchange
determines a higher requirement is warranted. In addition, the
Commission's net capital rule, Rule 15c3-1 under the Exchange Act,
imposes a capital charge on members to the extent of any margin
deficiency resulting from the higher margin requirement. 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 an additional form of protection.\18\
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\18\ See Exchange Act Release No. 38248 (February 6, 1997), 62
FR 6474 (February 12, 1997) (adopting Risk Based Haircuts); and CBOE
Rule 12.3 Margins.
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Fifth, an increase in position and exercise limits should attract
business back from the less-transparent OTC market to the Exchanges
where the trades will be subject to reporting requirements and
surveillance. Exchange member firms have repeatedly expressed their
belief 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.\19\ The increase in
position and exercise limits for standardized equity options should
allow the Exchanges to better compete with the growing OTC market in
customized equity options, thereby encouraging fair competition among
brokers and exchange markets.
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\19\ See, e.g., CSFB Letter.
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The Commission observes that CSFB, the sole commenter on the
proposals, generally favors the increase in position and exercise
limits. CSFB believes, however, that the current five-tier position
limit system should be consolidated into a three-tier system. CSFB
believes that consolidation of the position limit tiers would simplify
the monitoring of options positions and reduce confusion for options
traders and compliance personnel. The Commission notes that the
Exchanges' proposed rule changes did not propose to consolidate the
position limit tiers. Specifically, the Exchanges did not seek to amend
their respective proposals in response to the comment letter.
Nevertheless, the Commission recognizes that the comment may have merit
and that the Exchanges may consider to incorporate the views contained
in the comment letter in future rule proposals.
The Commission finds good cause to approve Phlx Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. Phlx
Amendment No. 1 corrects a rule language oversight in Phlx's filing.
Specifically, Phlx Amendment No. 1 makes minor technical changes by
clarifying the new position limits in the examples presented in
Commentary .08(a) of Phlx Rule 1001. Accordingly, the Commission
believes that it is consistent with section 6(b) of the Act to approve
Phlx Amendment No. 1 to the proposed rule change on an accelerated
basis.
The Commission finds good cause to approve Amex Amendment No. 1,
PCX Amendment No. 1, and Phlx Amendment No. 2 to the proposed rule
changes prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. Amex Amendment No. 1,
PCX Amendment No. 1, and Phlx Amendment No. 2 implement a new hedge
reporting requirement on members, other than exchange market-makers,
with respect to customer accounts holding an equity option position in
excess of 10,000 contracts on the same side of the market. The
amendments provide that the Exchanges have the authority to impose
additional margin on the clearing firm carrying the subject customer
account in the event an under-hedged equity option position in excess
of 10,000 contracts is noted. These amendments also clarify that the
reporting threshold for FLEX equity options will remain unchanged upon
the Commission's approval of the current proposed rule changes. The
Commission believes that receipt and review of this hedging information
at the 10,000 contract threshold will enable the Exchanges to better
assess whether an account is properly hedged, whether additional margin
should be imposed, or whether other regulatory action by the Exchange
is necessary. Furthermore, the clarification as to the reporting
threshold for FLEX equity options helps to avoid an inadvertent
increase in this threshold as a result of approving the current
proposed rule changes. Accordingly, the Commission believes that it is
consistent with section 6(b) of the Act to approve Amex Amendment No.
1, PCX Amendment No. 1, and Phlx Amendment No. 2 to the proposed rule
changes on an accelerated basis.
The Commission finds good cause to approve CBOE Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. CBOE
Amendment No. 1, in addition to making certain non-substantive changes,
implements a new hedge reporting requirement with respect to customer
accounts holding an equity option position in excess of 10,000
contracts on the same side of the market. The Commission believes that
receipt and review of this hedging information at the 10,000 contract
threshold will enable the Exchange to better assess whether an account
is properly hedged, whether additional margin should be imposed, or
whether other regulatory action by the Exchange is necessary.
Accordingly, the Commission believes that it is consistent with section
6(b) of the Act to approve CBOE Amendment No. 1 to the proposed rule
change on an accelerated basis.
The Commission finds good cause to approve CBOE Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. CBOE
Amendment No. 2 clarifies that the 10,000 contract reporting
requirement does not apply to CBOE market-maker accounts. This
clarification is consistent with the rules of other exchanges. The
amendment provides that the Exchange has the authority to impose
additional margin on the clearing firm carrying the subject customer
account in the event an under-hedged equity option position in excess
of 10,000 contracts is noted. CBOE Amendment No. 2 also clarifies that
the reporting threshold for FLEX equity options will remain unchanged
upon the Commission's approval of the current proposed rule change.
This clarification helps to avoid an inadvertent increase in the FLEX
equity reporting threshold as a result of approving the current
proposed rule change. Accordingly, the Commission believes that it is
consistent with section 6(b) of the Act to approve CBOE Amendment No. 2
to the proposed rule change on an accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposal is
consistent with the Act. Persons making written submissions should file
six
[[Page 1845]]
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 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 will also be available for
inspection and copying at the principal office of the Exchange. All
submissions should refer to File Nos. SR-CBOE-98-25; Amex-98-22; PCX-
98-33; and/or Phlx-98-36 and should be submitted by February 2, 1999.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule changes (SR-CBOE-98-25; SR-AMEX-98-22;
SR-PCX-98-33; and SR-Phlx-98-36) are approved, as amended.
\20\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 99-594 Filed 1-11-99; 8:45 am]
BILLING CODE 8010-01-M