[Federal Register Volume 67, Number 17 (Friday, January 25, 2002)]
[Notices]
[Pages 3752-3753]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-1903]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45312; File No. SR-Amex-2001-42]


Self-Regulatory Organizations; Order Granting Accelerated 
Approval To Proposed Rule Change by American Stock Exchange LLC To 
Increase Position And Exercise Limits For Nasdaq-100 Index Tracking 
Stock Options

January 18, 2002.

I. Introduction

    On June 27, 2001, the American Stock Exchange LLC (the ``Amex'' or 
``Exchnge'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934,\1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change relating to position and exercise limits for the Nasdaq-100 
Index Trading Stock (``QQQ'') options. On December 26, 2001, the 
Exchange filed Amendment No. 1 to the proposed rule change.
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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 change, as amended, was published for comment in 
the Federal Register on January 10, 2002.\3\ To date, no comment 
letters have been received. This order approves the proposal, as 
amended, on an accelerated basis.
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    \3\ See Securities Exchange Act Release No. 45236 (January 4, 
2002), 67 FR 1378.
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II. Description of Proposal

    The Exchange is proposing to increase position and exercise limits 
for QQQ options from 75,000 contracts 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. Finally, the Exchange will 
add a commentary to reiterate its authority under paragraph (d)(2)(K) 
of Rule 462 to impose a higher margin requirement upon a member or 
member organization when the Exchange determines that a higher 
requirement is warranted.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange. In 
particular, the Commission believes the proposal is consistent with the 
requirements of Section 6(b)(5) of the Act \4\ in that it is designed 
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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    \4\ 15 U.S.C. 78f(b)(5). 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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    Position and exercise 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 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 liquid options classes.\5\
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    \5\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998).

    In general, the Commission has taken a gradual, evolutionary 
approach toward expansion of position and exercise limits. The 
Commission has been careful to balance two competing concerns when 
considering the appropriate level at which to set 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 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.\6\
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    \6\ Id.
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    The Commission has carefully considered the Amex's proposal to 
increase position and exercise limits for QQQ options. At the outset, 
the Commission notes that it still believes the fundamental purpose of 
position and exercise limits are being served by their existence. 
However, given the surveillance capabilities of the Exchange, and the 
depth and liquidity in both the QQQ options and the underlying cash 
market in QQQs, the Commission believes it is permissible to 
significantly raise position limits for QQQ options without risk of 
disruption to options or underlying cash markets. Specifically, the 
Commission believes that it is appropriate to increase position and 
exercise limits from 75,000 contracts to 300,000 contracts for QQQ 
options for several reasons.
    First, the Commission believes that the structure of the QQQ 
options and the considerable depth and liquidity of both the underlying 
cash and options market for QQQ options lessens the opportunity for 
manipulation of this product and disruption in the underlying market 
that a lower position limit may protect against. In this regard, the 
Amex notes that 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 Amex also notes that 
the QQQ option is the most actively-traded option in the U.S. markets, 
and the underlying QQQ is the most actively-traded equity security in 
the U.S. markets.\7\ These factors provide support for higher limits 
for the QQQ options and differentiate them from other equity options.
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    \7\ The Amex has noted that the QQQ is designed to closely track 
the performance of the Nasdaq-100 Index. According to the Amex, as 
of November 30, 2001, the market capitalization of the securities 
underlying the Nasdaq-100 Index was $1.875 trillion. In its filing, 
the Amex stated that the Commission should apply an analysis similar 
to what was used in connection with broad-based index options. The 
Commission notes that the elimination of position and exercise 
limits for certain broad-based index options was based on many 
factors including the enormous capitalization's of the indexes. For 
example, the market capitalization of the SPX, OEX and DJX as of 
October 2001 was $9.81 trillion, $5.7 trillion and $3.23 trillion, 
respectively. See Securities Exchange Act Release No. 44994 (October 
26, 2001), 66 FR 55722 (November 2, 2001) (permanently approving the 
pilot to eliminate position and exercise limits for OEX, SPX and DJX 
Index options). In contrast, the market capitalization of the NASDAQ 
100 as of November 2001 was 1.875 trillion. The Commission further 
notes that options on QQQs physically settle in the underlying QQQs, 
which had net assets of $23.96 billion as of November 30, 2001. In 
contrast, index options are cash settled based on the underlying 
value of the index.
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    Second, the Commission notes that current margin and risk-based 
haircut methodologies serve to limit the size of positions maintained 
by any one account by increasing the margin and/

[[Page 3753]]

or capital that a member must maintain for a large position held by 
itself or by its customer. Further, the Amex, under its rules, may 
impose additional margin on options positions if it determines that 
this is warranted. The Commission believes that these financial 
requirements are sufficient to address concerns that a member or its 
customer may try to maintain an inordinately large unhedged position in 
QQQ options and will help to reduce risks if such a position is 
established.
    Finally, the Commission believes that the reporting requirements 
imposed by the Exchange will help protect against potential 
manipulation. Under Amex Rule 906(b), 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 is required to report certain 
information. The Exchange also requires members to report subsequent 
incremental increases in positions, thus assuring that positions are 
regularly monitored by the Exchange. In particular, information that 
must be reported includes, among other things, whether or not the 
options position is hedged, and if so, a description of the hedge. This 
information should help Amex to monitor accounts and determine whether 
it is necessary to impose additional margin for under-hedged position, 
as provided under its rules. In this regard, the Commission believes 
the Amex's adoption of Commentary .11 under Amex Rule 906 is 
appropriate and will reiterate its authority under Amex Rule 462 to 
require additional margin for under-hedged positions.
    In summary, the financial and reporting requirements noted above 
should allow the Exchange to detect and deter trading abuses arising 
from the increased position and exercise limits, and will also allow 
the Exchange to monitor large positions in order to identify instances 
of potential risk and to assess additional margin and/or capital 
charges, if deemed necessary. These requirements, coupled with the 
special trading characteristics of the QQQ options and the underlying 
QQQ noted above, warrant approval of the Exchange's proposal.\8\
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    \8\ Of course, the Commission expects that Amex will take prompt 
action, including timely communication with the Commission and other 
marketplace self-regulatory organizations responsible for oversight 
of trading in the underlying QQQ should any unanticipated adverse 
market effects develop due to the increased limits.
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    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of the 
notice of filing thereof in the Federal Register. The Commission notes 
that under the current Amex rules, the position and exercise limits 
applicable to QQQ options is 75,000 contracts. However, due to a 50% 
reduction in the value of the underlying QQQ on March 20, 2000, the 
limit was adjusted to 150,000 contracts. The position and exercise 
limits are scheduled to revert back to 75,000 contracts after the 
January options expiration occurring on January 18, 2002. The Exchange 
has represented to the Commission that limits of 75,000 contracts for 
the QQQ options could substantially reduce depth and liquidity in the 
QQQ market. The Exchange has further represented that increasing 
position and exercise limits from 75,000 contracts to 300,000 contracts 
for QQQ options will provide greater flexibility for market 
participants attempting to hedge their market risks. The Commission, 
therefore, believes for the reasons noted above that it is appropriate 
to approve this proposed rule change increasing the position and 
exercise limit to 300,000 contracts on January 18, 2002. Accordingly, 
the Commission finds that there is good cause, consistent with Section 
6(b)(5) of the Act,\9\ to approve the proposal on an accelerated basis.
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    \9\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (SR-AMEX-2001-42), as amended, 
is hereby approved on an accelerated basis.
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    \10\ 15 U.S.C. 78s(b)(2).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-1903 Filed 1-24-02; 8:45 am]
BILLING CODE 8010-01-M