[Federal Register Volume 64, Number 224 (Monday, November 22, 1999)]
[Notices]
[Pages 63837-63839]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-30321]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42132; File Nos SR-Amex-98-39; SR-Phlx-98-39]


Self-Regulatory Organizations; American Stock Exchange, Inc.; 
Philadelphia Stock Exchange; Order Approving Proposed Rule Change and 
Notice of Filing and Order Granting Accelerated Approval to Amex 
Amendment No. 1 and Phlx Amendment No. 2 Thereto Relating to an 
Increase in Position and Exercise Limits for Narrow-Based Index Options

November 12, 1999.

I. Introduction

    On October 13, 1998, and on September 3, 1998, the American Stock 
Exchange, Inc. (``Amex'') and the Philadelphia Stock Exchange, Inc. 
(``Phlx'') (collectively, the ``Exchanges'') respectively 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 
narrow-based index options.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    The proposed rule changes were published for comment in the Federal 
Register on December 14, 1998, and December 17, 1998, respectively.\3\ 
No comments were received on the proposal. Amex and Phlx filed 
amendments to the proposed rule changes on September 2, 1999, and July 
16, 1999, respectively.\4\ This order approves the proposals, as 
amended.
---------------------------------------------------------------------------

    \3\ See Exchange Act Release Nos. 40756 (December 7, 1998), 63 
FR 68809 (December 14, 1998); 40757 (December 7, 1998), 63 FR 69704 
(December 17, 1998). Phlx Amendment No. 1 was published for comment 
in the Notice. See Letter to Michael Walinskas, Deputy Associate 
Director, Division of Market Regulation, Commission, from Nandita 
Yagnik, Attorney, Phlx, dated September 25, 1998.
    \4\ See Letter from Scott G. VanHatten, Legal Counsel, Amex, to 
Richard Strasser, Assistant Director, Division of Market Regulation, 
Commission, dated September 2, 1999 (``Amex Amendment No. 1''); and 
Letter from Nadita Yagnik, Phlx, to Michael Walinskas, Associate 
Director, Division of Market Regulation, Commission, dated July 156 
1999 (``Phlx Amendment No. 2''). These amendments propose to set the 
position and exercise limits at 18,000, 24,000, and 31,500 
contracts, rather than the originally proposed tripled limits.
---------------------------------------------------------------------------

II. Description

    The Exchanges propose to increase position and exercise limits for 
narrow-based index options traded on each Exchange.\5\ Specifically, 
the Exchanges' rules provide three different position limits depending 
on index components' relative weightings in the index.\6\ The current 
limits for narrow-based index options are 9,000, 12,000 and 15,000 
contracts on the same side of the market. Under the proposed changes, 
the new limits will be 18,000, 24,000, and 31,500.
---------------------------------------------------------------------------

    \5\ Amex trades options on the following narrow-based indices: 
Airline, Biotechnology, Computer Hardware, Computer Technology, de 
Jager Year 2000, Disk Drive, Inter@ctive Week Internet, Morgan 
Stanley Commodity Related, Morgan Stanley High-Technology 35, 
Natural Gas, Networking, North American Telecommunications, Oil, 
Pharmaceutical, Securities Broker/Dealer, CSFB Technology Index, 
Deutsche Bank Energy Index, TheStreet.com E-Commerce Index, and 
TheStreet.com E-Finance Index.
    Phlx trades options on the following narrow-based indices: Gold/
Silver Index (``XAU''); Utility Index (``UTY''); Phlx/KBW Bank Index 
(``BKX''); Semiconductor Index (``SOX''); Forest and Paper 
(``FPP''); Box Maker Index (``BMX''); OTC Prime Index (``OTX''); Oil 
Service Index (``OSC''); and TheStreet.com Internet Index (``DOT'').
    \6\ See Amex Rule 904C. Amex Rule 905C establishes exercise 
limits for the corresponding options at the same levels. See Phlx 
Rule 1001A. Phlx Rule 1002A establishes exercise limits for the 
corresponding option at the same levels.
---------------------------------------------------------------------------

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.\7\ 
Specifically, the Commission believes the proposed rule changes are 
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, and to remove impediments to and perfect the mechanism of a 
free and open market and a national market system.
---------------------------------------------------------------------------

    \7\ 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).
---------------------------------------------------------------------------

    Position limits serve as a regulatory tool designed to address 
potential manipulative schemes and adverse market impact surrounding 
the use of options. 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 manipulate 
or disrupt the underlying market

[[Page 63838]]

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.\8\
---------------------------------------------------------------------------

    \8\ Exchange Act Release Nos. 39489 (December 24, 1997), 63 FR 
276 (January 5, 1998) (SR-CBOE-97-11) (order approving an increase 
in OEX position and Exercise limits); 31330 (October 16, 1992), 57 
FR 48408 (October 23, 1992) (SR-Amex-92-13) (order approving an 
increase in Institutional Index Options position and exercise 
limits).
---------------------------------------------------------------------------

    In general, the Commission has taken a gradual, evolutionary 
approach toward the expansion of position and exercise limits.\9\ The 
Commission has been careful to balance two competing concerns when 
considering the appropriate level at which to set option position and 
exercise limits. The Commission has recognized that the limits must be 
sufficient to prevent investors from disrupting the market in the 
component securities comprising the indexes. At the same time, the 
Commission has determined that limits must 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\
---------------------------------------------------------------------------

    \9\ The Commission approved increases in position limits in 
1983, 1993, 1995, and 1996. See, e.g., Exchange Act Release No. 
37863 (October 24, 1996), 61 FR 56599 (November 1, 1996) (SR-Phlx-
96-33).
    \10\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. at 189-91 
(Comm. Print 1978).
---------------------------------------------------------------------------

    In this regard, the Exchanges have represented that the current 
position and exercise limits impede their members; ability to execute 
investment strategies. Given the Commission's traditional, gradual 
approach to position and exercise limits, and that three years have 
passed since these limits have been raised, the Commission believes 
that it is reasonable to allow for an increase in the limits for 
narrow-based index options to accommodate the needs of market 
participants.
    The Commission believes that an increase in position and exercise 
limits for narrow-based index options is appropriate for several 
reasons. First, the Commission believes that increasing position and 
exercise limits for narrow-based index options may bring additional 
depth and liquidity, in terms of both volume and open interest, to 
these index options classes without significantly increasing concerns 
regarding intermarket manipulations or disruptions of the index options 
or the underlying component securities.
    Second, increasing position and exercise limits for narrow-based 
index options should better serve the hedging needs of institutions 
that engage in trading strategies different from those covered under 
the index hedge exemption policy.
    Third, the Commission notes that the proposals, while increasing 
the position limits for narrow-based index options, continue to reflect 
the unique characteristic of each index option and to maintain the 
structure of the current three-tiered system. Specifically, the lowest 
proposed limit, 18,000 contract will apply to narrow-based index 
options in which a single underlying stock accounts for 30% or more of 
the index value during the 30-day period immediately preceding the 
Exchanges' semi-annual review of industry index option position limits. 
A position limit of 24,000 contracts will apply if any single 
underlying stock accounts, on average for 20% or more of the index 
value or any fire underlying stocks account, on average for more than 
50% of the index value, but no single value in the group account, on 
average, for 30% or more of the index value during the 30-day period 
immediately preceding the Exchange's semi-annual review of industry 
index option position limits. The 31,500 contract limit will apply only 
if the Exchanges respectively determine that the conditions requiring 
either the 18,000 contract limit or the 24,000 contract limit have not 
occurred.\11\
---------------------------------------------------------------------------

    \11\See Amex Rule 904C(c); Phlx Rule 1001A(b).
---------------------------------------------------------------------------

    Fourth, the Commission believes that financial requirements imposed 
by the Exchanges and by the Commission adequately address concerns that 
an Amex or Phlx member or their customer may try to maintain a large 
unhedged position in a narrow-based index 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.\12\ The Exchanges also have the authority under its rules 
to impose a higher margin requirement upon the member or member 
organization when it determines a higher requirement is warranted.\13\ 
Monitoring accounts maintaining large positions should provide the 
Exchanges with the information necessary to determine whether to impose 
additional margin and/or whether to assess capital charges upon a 
member organization carrying the account. 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 Exchanges' margin requirements applicable 
to these products under Exchange rules serves as an additional form of 
protection.\14\ The Commission also notes that The Options Clearing 
Corporation(``OCC'') will serve as the counter-party guarantor in every 
exchange-traded transaction.
---------------------------------------------------------------------------

    \12\ Exchange Act Rule 15c3-1 requires a capital charge equal to 
the maximum potential loss on a broke-dealer's aggregate index 
position over a  +  (-) 10% market move. Exchange margin rules 
require margin on naked index options, which are in, or at-the-money 
equal to a 15% move in the underlying index; and a minimum 10% 
charge for naked out-of-the money contracts. At an index value of 
9,000 this approximates of a $90,000 to $135,000 requirement per 
each unhedged contract.
    \13\ See Amex Rule 462(d)(2)(K); and Phlx Rule 722(i)(8).
    \14\ See Exchange Act Release No. 38248 (February 6, 1997), 62 
FR 6474 (February 12, 1997) (adopting Risk Based Haircuts); Phlx 
Rule 722; and Amex Rule 462.
---------------------------------------------------------------------------

    Fifth, the Commission notes that the index options and other types 
of index-based derivatives (e.g., forwards and swaps) are not subject 
to position and exercise limits in the OTC market. The Commission 
believes that increasing position and exercise limits for narrow-based 
index options will better allow the Exchanges to compete with the OTC 
market.
    Sixth, the Commission notes that it recently approved rule filings 
increasing position and exercise limits for standardized equity 
options.\15\ The Commission also approved rule filings eliminating 
position and exercise limits for certain broad-based index options.\16\ 
Given these recent changes to the various exchanges' position limit 
rules, the Commission believes it is reasonable to allow for 
corresponding changes to the position and exercise limits for narrow-
based index options.\17\
---------------------------------------------------------------------------

    \15\ See Exchange Act Release No. 40875 (December 31, 1998), 64 
FR 1842 (January 12, 1999) (File Nos. SR-CBOE-98-25; Amex-98-22; 
PCX-98-33; and Phlx-98-36) (increasing position limits for 
standardized equity options to 13,500, 22,500, 31,500, 60,000, and 
75,000).
    \16\ See Exchange Act Release Nos. 40969 (January 22, 1999), 64 
FR 4911 (February 1, 1999) (File No. SR-CBOE-28-23); 41011 (February 
1, 1999), 64 FR 6405 (February 9, 1999) (File No. SR-Amex-98-38).
    \17\ The Commission notes that the trend toward increasing 
position and exercise limits for standardized equity options and 
eliminating them for certain broad-based index options, while a 
factor in considering increases for narrow-based index options, does 
not automatically dictate the need for or appropriateness of an 
increase in position and exercise limits for narrow-based index 
options. The fact that many narrow-based index options include non-
options eligible components requires that the Exchanges and the 
Commission give additional consideration to manipulation and other 
regulatory concerns prior to any increase. The Commission has 
considered these issues and believes that the proposed increases are 
appropriate at this time.

---------------------------------------------------------------------------

[[Page 63839]]

    Finally, the absence of any discernable manipulative problems for 
narrow-based index options at existing levels leads the Commission to 
conclude that the proposed increases are reasonable and that they can 
be safely implemented. The Commission believes that the Exchanges' 
surveillance programs are adequate to detect and deter violations of 
position and exercise limits, as well as to detect and deter attempted 
manipulation and other trading abuses through the use of such illegal 
positions by market participants.\18\
---------------------------------------------------------------------------

    \18\ The Commission emphasizes that the Exchanges must closely 
monitor compliance with position and exercise limits and impose 
appropriate sanctions for failures to comply with the Exchanges' 
position and exercise limit rules.
---------------------------------------------------------------------------

    The Commission finds good cause to approve Amex Amendment No. 1 and 
Phlx Amendment No. 2 to the proposed rule change prior to the 30th day 
after the date of publication of notice of filing thereof in the 
Federal Register. These amendments set the new position and exercise 
limits at 18,000, 24,000, and 31,500 contracts. In light of the 
Commission's traditional, gradual approach to position limits, the 
Commission believes that these limits are more appropriate than those 
initially proposed. The Commission also notes that the limits being 
approved reflect percent increases that more closely correspond to 
previous increases. Finally, the Commission notes that the higher 
limits were noticed for comment and no comments were received. Given 
that no regulatory issues were raised with the higher limits, the 
Commission believes approving the lower limits on an accelerated basis 
is appropriate under the Act. Accordingly, the Commission finds that, 
consistent with Sections 6(b) and 19(b)(2) of the Act, there is good 
cause to approve Amex Amendment No. 1 and Phlx Amendment No. 2 to the 
proposed rule changes on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amex Amendment No. 1 and Phlx Amendment No. 2, 
including whether the amendments are consistent with the Exchange 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. 20549-0609. 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, located at the above address. Copies of such filing 
will also be available for inspection and copying at the principal 
office of the self-regulatory organization. All submissions should 
refer to File No. SR-Amex-98-39 or SR-Phlx-98-39 and should be 
submitted by December 13, 1999.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule changes (SR-Amex-98-39; SR-Phlx-98-39) 
are approved, as amended.

    \19\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
---------------------------------------------------------------------------

    \20\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-30321 Filed 11-19-99; 8:45 am]
BILLING CODE 8010-01-M