[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

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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