[Federal Register Volume 66, Number 160 (Friday, August 17, 2001)]
[Notices]
[Pages 43283-43285]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-20765]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44680; File No. SR-PCX-00-45]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to the Expansion of 
Equity Hedge Exemptions From Position and Exercise Limits

August 10, 2001.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 11, 2000, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') filed with the securities and Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I, II, and III below, which items have been prepared by the 
Exchange. 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 PCX proposes to expand its current equity hedge exemptions by 
eliminating position and exercise limits for certain designated hedge 
strategies. The current reporting procedures to identify and document 
hedged positions would remain in place. The text of the proposed rule 
change is set forth below. Proposed additions are italicized and 
proposed deletions are in brackets.
* * * * *
    para.4769--Position Limits
    Rule 6.8(a)--No change.
    Commentary:
    .01-.06--No change.
    .07--Equity Hedge Exemption. The following qualified hedging 
transactions and positions are exempt from the established position and 
exercise limits prescribed under Commentary .06 above.
    (a) Where each option contract is ``hedged'' or ``covered'' by 100 
shares of the underlying security or securities convertible into such 
underlying security, or, in the case of an adjusted option contract, 
the same number of shares represented by the adjusted contract: (i) 
long call and short stock; (ii) short call and long stock; (iii) long 
put and long stock; (iv) short put and short stock.
    (b) A long call position accompanied by a short put position, where 
the long call expires with the short put, and the strike price of the 
long call and short put is equal, and where each long call and short 
put position is hedged with 100 shares (or other adjusted number of 
shares) of the underlying security or securities convertible into such 
stock (``reverse conversion'').
    (c) A short call position accompanied by a long put position where 
the short call expires with the long put, and the strike price of the 
short call and long put is equal, and where each short call and long 
put position is hedged with 100 shares (or other adjusted number of 
shares) of the underlying security or securities convertible into such 
stock (``conversion'').
    (d) A short call position accompanied by a long put position, where 
the short call expires with the long put, and the strike price of the 
short call equals or exceeds the long put, and where each short call 
and long put position is hedged with 100 shares of the underlying 
security (or other adjusted number of shares). Neither side of the 
short call/long put position can be in-the-money at the time the 
position is established (``collar'').
    (e) A long call position accompanied by a short put position with 
the same

[[Page 43284]]

strike price and a short call position accompanied by a long put 
position with a different strike price (``box spread'').
    (f) A listed option position hedged on a one-for-one basis with an 
over-the-counter (``OTC'') option position on the same underlying 
security. The strike price of the listed option position and 
corresponding OTC option position must be within one strike of each 
other and no more than one expiration month apart.
    (g) For those strategies described under (b), (c) and (d) above, 
one component of the option strategy can be an OTC option contract 
guaranteed or endorsed by the firm maintaining the proprietary position 
or carrying the customer account.
    (h) An OTC option contract is defined as an option contract that is 
not listed on a National Securities Exchange or cleared at the Options 
Clearing Corporation.
    [The Exchange may exempt position and exercise limits for options 
on underlying stocks in the following positions where each option 
contract is ``hedged'' by 100 shares of the underlying stock or 
securities convertible into such stock or, in the case of an adjusted 
option contract, the same number of shares represented by the adjusted 
contract:

(i) Long Stock and Short Call
(ii) Long Stock and Long Put
(iii) Short Stock and Long Call
(iv) Short Stock and Short Put.

    Position limits for any class of options on underlying stocks may 
not exceed three times the established position limits for such class. 
This restriction also applies to positions for which an exemption has 
been granted pursuant to Rule 6.8 commentaries .03 or .04.]
* * * * *

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 PCX 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 Exchange is proposing to eliminate position and exercise limits 
for certain qualified hedged equity option positions by expanding the 
definition of a ``qualified'' hedged position. The PCX believes that 
the proposed rule change expands position and exercise limits to meet 
the hedging needs of investors for market neutral strategies. The PCX 
represents that the proposal is in large part adopted from a proposed 
rule change by the Chicago Board Options Exchange, Inc. (``CBOE'').\3\ 
The following qualified hedge strategies are proposed to be exempt from 
the established position and exercise limits:
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    \3\ Securities Exchange Act Release No. 44681 (August 10, 2001) 
(File No. SR-CBOE-00-12). The CBOE's proposed qualified hedge 
strategies, which are identical to the PCX's proposal, contain 
examples of these strategies. See Amendment No. 1 to SR-CBOE-00-12. 
The PCX has represented that it agrees with those examples for its 
proposed qualified hedge strategies. Telephone conversation between 
Cindy Sink, Senior Attorney, Regulatory Policy, PCX, and Susie Cho, 
Special Counsel, Division of Market Regulation (``Division''), 
Commission, June 26, 2001.
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    (i) Where each option contract is ``hedged'' or ``covered'' by 100 
shares of the underlying security or securities convertible into the 
underlying security, or, in the case of an adjusted option contract, 
the same number of shares represented by the adjusted contract: (a) 
Long call and short stock; (b) short call and long stock; (c) long put 
and long stock; and (d) short put and short stock;
    (ii) A long call position accompanied by a short put position, 
where the long call expires with the short put, and the strike price of 
the long call and short put is equal, and where each long call and 
short put position is hedged with 100 shares (or other adjusted number 
of shares) of the underlying security or securities convertible into 
such stock (``reverse conversion''); \4\
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    \4\ For this strategy one of the option components can be an OTC 
option guaranteed or endorsed by the firm maintaining the 
proprietary position or carrying the customer account.
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    (iii) A short call position accompanied by a long put position 
where the short call expires with the long put, and the strike price of 
the short call and long put is equal, and where each short call and 
long put position is hedged with 100 shares (or other adjusted number 
of shares) of the underlying security or securities convertible into 
such stock (``conversion''); \5\
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    \5\ Id.
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    (iv) A short call position accompanied by a long put position, 
where the short call expires with the long put, and the strike price of 
the short call equals or exceeds the long put, and where each short 
call and long put position is hedged with 100 shares of the underlying 
security (or other adjusted number of shares). Neither side of the 
short call/long put position can be in-the-money at the time the 
position is established (``collar''); \6\
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    \6\ Id.
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    (v) A long call position accompanied by a short put position with 
the same strike price and a short call position accompanied by a long 
put position with a different strike price (``box spread''); and
    (vi) A listed option position hedged on a one-for-one basis with a 
over-the-counter (``OTC'') option position on the same underlying 
security. The strike price of the listed option position and 
corresponding OTC option position must be within one strike of each 
other and no more than one expiration month apart.
    Within the list of proposed hedge strategies eligible for an equity 
hedge exemption, the Exchange proposes that the option component of a 
reversal, conversion, or collar position be treated as one contract 
rather than as two contracts. All three strategies serve to hedge a 
related stock portfolio. Because these strategies require the 
contemporaneous \7\ purchase/sale of both a call and put component 
against the appropriate number of shares underlying the option 
(generally 100 shares), the Exchange believes that the position should 
be treated as one contract for hedging purposes.
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    \7\ At or about the same time.
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    Under the proposed rule change, the existing standard position and 
exercise limits will remain in place for unhedged equity option 
positions. Once an account nears or reaches the standard limit, 
positions identified as one or more of the proposed qualified hedge 
strategies will be exempted from limit calculations. The exemption will 
be automatic (i.e., does not require preapproval from the Exchange) to 
the extent that the member identifies that a pre-existing qualified 
hedge strategy is in place or is employed from the point that an 
account's position reaches the standard limit and provides the required 
supporting documentation to the Exchange.
    The exemption will remain in effect to the extent that the exempted 
position remains intact and that the Exchange is provided with any 
required supporting documentation. Procedures to

[[Page 43285]]

demonstrate that the option position remains qualified will be similar 
to those currently in place for equity hedge exemptions. Currently a 
qualified account must report hedge information each time the option 
position changes. Hedge information for member firm and customer 
accounts are reported to the Exchange electronically, via the Large 
Options Position Report. Market maker account information is also 
reported to the Exchange electronically by the member's clearing firm. 
For those option positions that do not change, a filing is generally 
required on a weekly basis. Finally, the existing requirement imposed 
on member firms to report hedge information for proprietary and 
customer accounts that maintain an options position in excess of 10,000 
contracts will remain in place.
    The Exchange believes that all of the proposed qualified strategies 
are market neutral with the exemption of covered stock positions. 
According to the Exchange, we covered stock transactions (long stock/
short call; short stock/short put) are not market neutral, the market 
exposure resides with the stock position where no limit is imposed. The 
Exchange believes that the short option premium mitigates the stock 
exposure and therefore no limit should be imposed on this strategy.
    The Exchange believes that the proposed strategies do not lend 
themselves to market manipulation and should be exempt from position 
limits. The Exchange represents that the reporting requirements under 
PCX Rule 6.6 and internal surveillance procedures for hedged positions 
will enable the Exchange to closely monitor sizable option position and 
corresponding hedge.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act,\8\ in general, and furthers the 
objectives of Section 6(b)(5),\9\ in particular, in that it is designed 
to promote just and equitable principles of trade and to protect 
investors and the public interest.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(4).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose 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's Participants, or Others

    Written comments were not solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness 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 it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange 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 proposal is 
consistent with the Act. The Commission is especially interested in 
receiving written, data, views and arguments concerning the use of a 
listed option position hedged on a one-for-one basis with an OTC option 
position on the same underlying security. In particular, the Commission 
staff has concerns that such exemption would grant members the ability 
to sell OTC options and hedge such positions on the exchange with 
listed options on an unlimited basis. This potentially raises 
manipulation concerns. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 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 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. 522, will be available for inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of such filing will also be available for 
inspection and copying at the principal office of the PCX. All 
submissions should refer to File No. SR-PCX-00-45 and should be 
submitted by September 7, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-20765 Filed 8-16-01; 8:45 am]
BILLING CODE 8010-01-M