[Federal Register Volume 67, Number 7 (Thursday, January 10, 2002)]
[Notices]
[Pages 1378-1380]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-635]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45236; File No. SR-Amex-2001-42]


Self-Regulatory Organizations; Notice of Proposed Rule Change by 
American Stock Exchange LLC To Increase Position and Exercise Limits 
for Nasdaq-100 Index Tracking Stock Options

January 4, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934,\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that on 
June 27, 2001, the American Stock Exchange LLC (the ``Amex'' or the 
``Exchange'') filed with the Securities and Exchange Commission (the 
``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. On 
December 26, 2001, the Exchange filed Amendment No. 1 to the proposed 
rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 supersedes and replaces the original 19b-4 
filing in its entirety.
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    The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Amex proposed to increase position and exercise limits for 
Nasdaq-100 Index Tracking Stock (``QQQ'') options to 300,000 contracts 
on the same side of the market. In order to codify the financial 
requirements imposed by the Exchange and the Commission, the Amex also 
proposes to add Commentary .11 to Exchange Rule 904.
    The text of the proposed rule change is available at the Office of 
the Secretary, Amex and at the Commission.

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 Amex 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 Amex 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 increase position and exercise limits 
for QQQ options up to 300,000 contracts on the same side of the market. 
The Exchange will continue to require that member organizations report 
all QQQ options positions exceeding 200 contracts pursuant to Exchange 
Rule 906. Moreover, for accounts holding positions in excess of 10,000 
contracts on the same side of the market, the Exchange will also 
continue to require information concerning the extent to which such 
positions are hedged. The Amex believes that increasing position and 
exercise limits from 75,000 to 300,000 contracts for QQQ options will 
provide greater flexibility for market participants attempting to hedge 
their market risks.\4\ In addition, Exchange staff will be able to re-
focus efforts and resources to other notable areas.
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    \4\ Although the current position limit is 75,000 contracts, due 
to a 50% reduction in the value of the underlying QQQ on March 20, 
2000, the limit was adjusted to 150,000.
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Manipulation

    Position limits restrict the number of options contracts that an 
investor, or a group of investors acting in concert, may own or 
control. Similarly, exercise limits prohibit the exercise of more than 
specified a number of contracts on a particular instrument within five 
(5) business days. The Commission by imposing these limits on exchange-
traded options has sought to: (1) Minimize the potential for mini-
manipulations,\5\ as well as other forms of market manipulations; (2) 
impose a ceiling on the position that investor with inside corporate or 
market information can establish; and (3) reduce the possibility of 
disruption in the options and underlying cash markets.\6\ The Amex 
believes that the structure of the QQQ option and the tremendous 
liquidity of both the underlying cash and option market for QQQs should 
allay regulatory concerns of potential manipulation. The Amex further 
believes that QQQ options are not readily susceptible to manipulation 
based largely on the liquidity and

[[Page 1379]]

activity of the underlying QQQ as well as the securities comprising the 
QQQ. Therefore, the Exchange submits that increasing position and 
exercise limits to 300,000 contracts may generate greater order flow 
for the Amex and provide members with greater flexibility in fulfilling 
their obligations to customers and the market.
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    \5\ Mini-manipulation is an attempt to influence, over a 
relatively small range, the price movement in a stock to benefit a 
previously established options position.
    \6\ See Becker and Burns, Regulation of Exchange-Traded Options 
in The Handbook of Derivatives and Synthetics (1994), Probus 
Publishing Company and Regulating the Options Market, Institutional 
Investor Forum (November 1991).
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    Although the QQQ options is not itself an index option product, it 
nonetheless is designed to closely track the price and yield 
performance of the Nasdq-100 index.\7\ Therefore, we believe that in 
evaluating this proposal to increase position and exercise limits for 
QQQ options, the Commission should apply an analysis similar to what 
was used in connection with broad-based index options.\8\
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    \7\ QQQ represents ownership in the Nasdaq-100 Trust, a long-
term unit investment trust established to accumulate and hold a 
portfolio of the equity securities that comprise the Nasdaq-100 
Index. The Nasdaq-100 Index includes 100 of the largest non-
financial companies listed on the Nasdaq National Market. The 
Nasdaq-100 reflects Nasdaq's largest growth companies across major 
industry groups with all index components having a market 
capitalization of at least $500 million and an average daily trading 
volume of at 100,000 shares. QQQ is intended to provide investment 
results that generally correspond to the Nasdaq-100 Index with an 
initial market value approximated at \1/40\th the value of the 
underlying Nasdaq-100 Index. A description and analysis of the 
Nasdaq-100 Index is set forth by the Commission in Securities 
Exchange Act Release No. 33428 (January 4, 1994), 59 FR 1576 
(January 11, 2994) (order approving trading of Nasdaq-100 options by 
CBOE). As of November 30, 2001, the market capitalization of the 
securities underlying the Nasdaq-100 Index was approximately $1.875 
trillion while the QQQ had net assets of $23.96 billion and 559.1 
million shares outstanding. By far the largest economic sector 
represented is technology amounting to 68.91%. The top QQQ holding 
is Microsoft accounting for 11.97% while the top ten holdings 
constitute 43.22%.
    \8\ See Securities Exchange Act Release Nos. (February 1, 1999), 
64 FR 6405 (February 9, 1999) (order approving the elimination of 
position and exercise limits for XMI and XII options on a two-year 
pilot basis) and 40969 (January 22, 1999), 64 FR 4911 (February 1, 
1999) (order approving the elimination of position and exercise 
limits for SPX, OEX, DJX and related FLEX options on a two-year 
pilot basis).
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    The Amex believes in connection with QQQ options that the 
restrictive position and exercise limits no longer serve their stated 
purpose. 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 of 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 so as to benefit the options position. In 
particular, position and exercise limits are designed to minimize the 
potential for mini-manipulations and for concerns or squeezes of the 
underlying market. In addition such limits such to reduce the 
possibility for disruption of the options market itself, especially in 
illiquid options classes.\9\
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    \9\ Securities Exchange Act Release No. 39489 (December 24, 
1997), (63 FR 276 (January 5, 1998).
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    The Exchange believes that both the size and breadth of the market 
for QQQs dispels concerns regarding market manipulation and disruption. 
The average daily trading volumes for the QQQs and QQQ options from 
January 1, 2001 to November 30, 2001 were 71.21 million shares and 
148,181 contracts, respectively. the QQQ option is by far the most 
actively-traded option product in the U.S., and therefore, the most 
liquid. The underlying QQQ is the most actively-traded equity security 
in the U.S. with greater trading volume than both Microsoft and 
Intel.\10\ Accordingly, the Exchange believes that the tremendous 
liquidity of the QQQ option and the underlying cash market for QQQs 
severly minimizes the potential for manipulations in both the options 
and underlying cash market.
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    \10\ For the period of January 1, 2001 to November 30, 2001, 
Microsoft and Intel had average daily trading volumes of 39.38 and 
53.98 million shares, respectively, compared to the QQQ with an 
average daily trading volume of 71.21 million shares.
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    To date, there has not been a single disciplinary action involving 
manipulation or potential manipulation in the QQQ or the QQQ option on 
the Exchange. We further believe that our extensive experience 
conducting surveillance of derivative products and program trading 
activity is sufficient to identify improper activity. Routine oversight 
inspections of Amex's regulatory programs by the Commission have not 
uncovered any inconsistencies or shortcomings in the manner in which 
derivative and options surveillance is conducted. These procedures 
entail a daily monitoring of market movements via automated 
surveillance techniques to identify unusual activity in both the 
options and underlying cash markets.

Competition

    The Commission has stated 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.'' \11\ 
Based on the large trading volume apparent in both the underlying QQQ 
and QQQ options, the Exchange believes that current position and 
exercise limits of the QQQ option are too restrictive and may adversely 
affect the Amex's ability to compete with the OTC market. The Exchange 
believes that investors who trade listed options on the QQQ at the Amex 
may be placed at a serious disadvantage in comparison to certain 
Nasdaq-100 index derivative products traded in the OTC market where 
some index-based derivatives are not currently subject to position and 
exercise limits.\12\ Member firms also continue to express their 
concern that position limits on popular, actively-traded products, such 
as QQQ options, are an impediment to business development on the 
Exchange. Accordingly, a portion of this business is believed to have 
moved to the OTC market where some index-based derivative products are 
not subject to position limit requirements. In addition, current base 
limits for the QQQ option may not be adequate in many instances for the 
hedging needs of certain institutions which engage in trading 
strategies differing from those covered under the current index hedge 
exemption policy (e.g., delta hedges; OTC vs. listed hedges).\13\
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    \11\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. At 189-91 
(Comm. Print 1978).
    \12\ The Commission notes, however, that as an equity product, 
options on the QQQ are subject to position limits in the OTC market. 
See NASD Rule 2860.
    \13\ The current limit for QQQ options is 150,000 contracts due 
to the 50% reduction in the underlying value of the QQQ that 
occurred on March 20, 2000. At this limit, the QQQ options equate to 
15,000,000 QQQ shares or an aggregate value of $59.47 billion as of 
November 30, 2001. At the time of approval of QQQ options, position 
and exercise limits were set at 25,000 (250,000 QQQ shares) equating 
to an aggregate value of $2,500,000 as of March 9, 1999 
(commencement of trading ). When QQQs commenced trading, the volume 
was 10.4 million shares with an opening price of $100.00 per share. 
The average daily trading volumes for the QQQ during 1999, 2000 and 
year-to-date 2001 were 13.9 million, 30.9 million and 71.21 million 
shares respectively, while for the same periods the average daily 
trading contract volume for the QQQ option were 9,206, 91,656, and 
148,181. As of November 30, 2001, the price of a single QQQ was 
$39.65.
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Financial Requirements

    The Exchange believes that financial requirements imposed by the 
Exchange and by the Commission adequately address concerns that a 
member or its customer may try to maintain an inordinately large 
unhedged position in QQQ options. 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. It should also be noted that the Exchange has the

[[Page 1380]]

authority under paragraph (d)(2)(k) of Rule 462 to impose a higher 
margin requirement upon the member or member organization when the 
Exchange determines a higher requirement is warranted. Proposed 
Commentary .11 to Exchange Rule 904 codifies these financial 
requirements imposed by the Exchange and the Commission.

Reporting Requirements

    Consistent with Amex Rule 906(b), the Amex will continue to require 
that each member or member organization that maintains a position on 
the same side of the market in excess of 10,000 contracts in the QQQ 
option, for its own account or for the account of a customer report 
certain information. This data includes, but is not limited to, the 
option position, whether such position is hedged and if so, a 
description of the hedge and if applicable, the collateral used to 
carry the position. Exchange market-markers are exempt from this 
reporting requirement as market-maker information can be accessed 
through the Exchange's market surveillance systems. Once the 10,000 
contract reporting threshold is attained, the Amex requires members and 
member organizations to similarly report each increase of 2,500 
contracts on the same side of the market for customer accounts and each 
increase of 5,000 contracts on the same side of the market for 
proprietary accounts. The Exchange believes that the reporting level of 
10,000 contracts on the same side of the market for members other than 
Exchange market-makers is consistent with the designation of the QQQ as 
an equity option, and therefore, the existing regulatory regime. 
Pursuant to Rule 906(a), the general reporting requirement for customer 
accounts that maintain a position in excess of 200 contracts will 
remain at this level for QQQ options. Lastly, the Amex believes that 
the 10,000 contract reporting requirement is above and beyond what is 
currently required in the OTC market. According to the Amex, NASD 
member firms are only required to report options positions in excess of 
200 contracts and are not required to report any related hedging 
information.
2. Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \14\ in general and furthers the 
objectives of section 6(b)(5) \15\ in particular in that it is 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.
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    \14\ 15 U.S.C. 78f(b).
    \15\ 15 U.S.C. 78f(b)(5).
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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.

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

    No written comments were 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 Amex 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 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 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 Section. Copies of such filing will also 
be available for inspection and copying at the principal office of the 
Amex. All submissions should refer File No. SR-AMEX-2001-42 and should 
be submitted by January 31, 2002.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority. \16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-635 Filed 1-9-02; 8:45 am]
BILLING CODE 8010-01-M