[Federal Register Volume 67, Number 63 (Tuesday, April 2, 2002)]
[Notices]
[Pages 15638-15641]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-7870]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45650; File No. SR-Amex-2001-72]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to Proposed Rule Change and Amendment 
Nos. 1 and 2 by the American Stock Exchange LLC Relating to an 
Expansion of the Hedge Exemption From Position and Exercise Limits

March 26, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934,\1\ notice is hereby given that on September 6, 2001, the American 
Stock Exchange LLC (``Amex'' or ``Exchange'') filed with the Securities 
and Exchange Commission (``SEC'' or ``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 \2\ with the Commission, and on February 4, 2002, the 
Exchange filed Amendment No. 2 \3\ with the Commission. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change and Amendment Nos. 1 and 2 from interested persons. The 
Commission is also granting accelerated approval to the proposed rule 
change, including Amendment Nos. 1 and 2.
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    \1\ 15 U.S.C 78s(b)(1).
    \2\ See Letter to Sharon Lawson, Senior Special Counsel, 
Division of Market Regulation (``Division''), Commission, from 
Jeffrey P. Burns, Senior Counsel, Amex, dated December 21, 2001 
(``Amendment No. 1''). In Amendment No. 1, Amex amended the proposed 
rule change to state that for back-to-back options or where one of 
the option components of a qualified hedge consists of an over-the-
counter (``OTC'') option, the hedge exemption is limited to five 
times the established position limit.
    \3\ See Letter to Sharon Lawson, Senior Special Counsel, 
Division, Commission, from Jeffrey P. Burns, Senior Counsel, Amex, 
dated February 1, 2002 (``Amendment No. 2''). Amendment No. 2 is a 
technical amendment whereby the Exchange moved language regarding 
the establishment of position and exercise limit of five times the 
standard limit for those strategies that include an OTC option 
contract to the beginning to Commentary .09 to Amex Rule 904.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange is proposing to amend Commentary .09 to Amex Rule 904 
to eliminate position and exercise limits for certain qualified hedge 
strategies relating to stock and Exchange-Traded Fund (``ETF'') Share 
options and to establish a position and exercise limit of five times 
the standard limit for those strategies that include an OTC option

[[Page 15639]]

contract. The current reporting procedures that serve to identify and 
document hedged positions will continue to apply.

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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Amex is proposing to eliminate position and exercise limits when 
certain qualified strategies are employed to establish a hedged equity 
option position and to establish a position and exercise limit of five 
times the standard limit for those strategies that include an OTC 
option contract. Position limits impose a ceiling on the aggregate 
number of options contracts (when long or short) of each class on the 
same side of the market that can be held or written by an investor or 
group of investors acting in concert. Exercise limits prohibit the 
exercise by an investor or group of investors acting in concert of more 
than a specified number of options contracts in a particular underlying 
security within five (5) consecutive business days. The Exchange 
believes that this proposal expands position and exercise limits to 
meet the needs of investors for market neutral strategies. This 
expansion of the Equity Hedge Exemption from position and exercise 
limits (the ``Equity Hedge Exemption'') is substantially identical to 
proposals recently filed by the Chicago Board Options Exchange, Inc. 
(``CBOE'') \4\ and the Pacific Stock Exchange, Inc. (``PCX'').\5\
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    \4\ See Securities Exchange Act Release No. 44681 (August 10, 
2001), 66 FR 43274 (August 17, 2001) (SR-CBOE-00-12). The CBOE's 
proposed qualified hedge strategies contain certain examples of the 
strategies. See Amendment No. 1 to SR-CBOE-00-12. The Amex 
represents that the CBOE's examples apply equally to the Amex's 
proposed qualified hedge strategies.
    \5\ See Securities Exchange Act Release No. 44680 (August 10, 
2001) 66 FR 43283 (August 17, 2001) (SR-PCX-00-45).
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    Current Commentary .07 to Amex Rule 904 provides position and 
exercise limits for stock and ETF Share options of 13,500, 22,500, 
31,500, 60,000 and 75,000 options contracts on the same side of the 
market depending on the level of underlying trading volume over a six-
month period.\6\ The existing hedge exemption found in Commentary .09 
to Amex Rule 904 provides an exemption to position and exercise limits 
of up to three (3) times the standard limit for certain qualified hedge 
strategies as follows: (i) Long call and short stock; (ii) short call 
and long stock; (iii) long put and long stock; and (iv) short put and 
short stock.\7\ Moreover, in 1993 the Amex expanded the definition of a 
qualified hedge position to allow for the use of convertible 
securities.\8\
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    \6\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999).
    \7\ See Securities Exchange Act Release No. 25738 (May 24, 
1988), 53 FR 20201 (June 2, 1988).
    \8\ See Securities Exchange Act Release No. 36409 (October 23, 
1995), 60 FR 55399 (October 31, 1995) and Securities Exchange Act 
Release No. 32902 (September 14, 1993), 58 FR 49066 (September 21, 
1993).
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    Since the inception of the Equity Hedge Exemption in 1988,\9\ the 
types of hedge strategies employed by market participants have become 
increasingly more diversified. Amex believes that, through its 
experience in administering and processing Equity Hedge Exemption 
information, it has learned that market participants no longer rely 
strictly on a stock-option hedge. Additionally, while traditional hedge 
strategies such as a covered call or reverse conversion strategy 
continue to be utilized, the Amex believes that listed options 
contracts are now employed to hedge a wider spectrum of securities.
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    \9\ See supra note 8.
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    In response to the Commission's liberalization in granting position 
limit relief for market neutral strategies, and to more fully 
accommodate the hedging needs of investors, the Exchange is proposing 
to eliminate position and exercise limits when certain qualified 
strategies are employed to establish a hedged equity options position. 
Accordingly, the Amex proposes to expand the definition of a 
``qualified hedged position'' found in Commentary .09 to Amex Rule 904. 
The proposed qualified hedged strategies are as follows:
    1. Where each option contract is ``hedged'' by the number of shares 
underlying the option contract or securities convertible into the 
underlying security or, in the case of an adjusted option, 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; or (d) short put and short stock.
    2. Reverse Conversions--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 the same, and where each 
long call and short put contract is hedged with 100 shares (or other 
adjusted number of shares) of the underlying security or securities 
convertible into such underlying security.\10\
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    \10\ For these strategies 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. Hedge 
transactions and positions established pursuant to these strategies 
are subject to a position limit equal to five times the standards 
limit established under Commentary .07 to Amex Rule 904. For 
purposes of this rule filing, an OTC option contract is defined as 
an option that is not listed on a National Securities Exchange or 
cleared at the Options Clearing Corporation.
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    3. Conversions--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 the same, and where each short 
call and long put contract is hedged with 100 shares (or other adjusted 
number of shares) of the underlying security or securities convertible 
into such underlying security.\11\
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    \11\ Id.
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    4. Collars--A short call position accompanied by a long put 
position, where the short call expires at the same time as the long put 
and the strike price of the short call equals or exceeds the strike 
price of the long put position and where each short call and long put 
position, is hedged with 100 shares of the underlying security (or 
other adjusted number of shares).\12\ Neither side of the short call/
long put position can be in-the-money at the time the position is 
established.
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    \12\ Id.
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    5. Box Spreads--A long call position accompanied by a short put 
position, where both the long call and short put have the same strike 
price, and a short call position accompanied by a long put position, 
where the short call and long put have the same strike price as each 
other, but a different strike price than the long call/short put 
position.
    6. Back-to-Back Options--A listed option position hedged on a one-
for-one basis with an over-the-counter (``OTC'') option position on the 
same underlying security. \13\ The strike price of the listed

[[Page 15640]]

option position and corresponding OTC option position must be within 
one strike price interval of each other and no more than one expiration 
month apart.
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    \13\ Hedge transactions and positions established pursuant to 
this strategy are subject to a position limit equal to five times 
the standards limit established under Commentary .07 to Amex Rule 
904.
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    For reverse conversion, conversion and collar strategies, one of 
the option components can be an OTC option \14\ guaranteed or endorsed 
by the firm maintaining the proprietary position or carrying the 
customer account.
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    \14\ For the purpose of this ruling, an OTC option contract is 
defined as an option that is not listed on a national securities 
exchange or cleared at the Options Clearing Corporation.
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    Within the list of proposed hedge strategies eligible for the 
Equity Hedge Exemption, the Exchange proposes that the option component 
of a reversal, a conversion or a collar position can be treated as one 
contract rather than as two (2) contracts. All three strategies serve 
to hedge a related stock portfolio. Because these strategies require 
the contemporaneous \15\ 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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    \15\ At or about the same time.
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    With the exception of covered stock positions, Amex believes that 
all other proposed qualified strategies are market neutral,\16\that 
none of the proposed strategies lend themselves to market manipulation 
and, they therefore, should qualify for the Equity Hedge Exemption. In 
addition, the Exchange believes that the current reporting requirements 
under Amex Rule 906 and internal surveillance procedures for hedged 
positions will enable the Exchange to closely monitor sizable option 
positions and corresponding hedges.
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    \16\ Where covered stock transactions are not market neutral 
(i.e. long stock/short call; short stock/short put); the market 
exposure on such activity resides with the stock position where no 
limit is imposed. As the short option premium serves no mitigate the 
stock exposure, no limit should be imposed on this strategy.
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    Under the proposed rule change, the 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 
a qualified hedge strategy will be exempted from position limit 
calculations. The exemption will be automatic (i.e. does not require 
pre-approval 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 exempt 
positions remains intact and the Exchange is provided with any required 
supporting documentation. Procedures to demonstrate that the option 
position remains qualified are similar to those currently in place. 
Exchange procedures currently require a qualified account to report to 
the Exchange's Department of Market Surveillance all hedged positions 
together with the underlying stock positions that qualify the options 
position for the exemption. This report is filed with the Exchange no 
later than the close of business on the next day following the day on 
which the transaction or transactions that require the filing of such 
report occurred. Hedge information for member firm and customer 
accounts having 200 or more contracts are electronically reported via 
the Large Options Positions Report. Specialist and registered options 
trader account information is also reported to the Amex by such 
member's clearing firm. The existing requirement imposed on a member 
firms to report hedge information for proprietary and customer accounts 
that maintain an options position in excess of 10,000 contracts will 
continue to apply.
    The Amex believes that, with the exception of covered stock 
positions, all of the proposed qualified hedge strategies are market 
neutral. Therefore, none of the proposed strategies lend themselves to 
market manipulation and should be exempt from position limits. In 
addition, the Exchange believes that the current reporting requirements 
under Amex Rule 906 and the surveillance procedures for hedged 
positions will enable the Exchange to closely monitor sizable option 
positions and corresponding hedges.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \17\ in general and furthers the 
objectives of Section 6(b)(5) \18\ 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, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, to protect investors 
and the public interest and is not designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
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    \17\ 15 U.S.C. 78f(b).
    \18\ 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

    The Amex has neither solicited nor received written comments with 
respect to the proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, 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 Amex. All submissions should refer File No. SR-
Amex-2001-72 and should be submitted by April 23, 2002.

IV. Commission Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    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 \19\ 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,

[[Page 15641]]

and to remove impediments to and perfect the mechanism of a free and 
open market and a national market system.
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    \19\ 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, considered 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 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.\20\
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    \20\ Id.
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    The Commission has carefully considered the Amex's proposal to 
expand the hedge exemption from position and exercise limits. Given the 
market neutral characteristic of all the proposed qualified hedge 
strategies (except covered stock positions), the Commission believes it 
is permissible to expand the current equity hedge exemption without 
risk of disruption to the options or underlying cash markets. 
Specifically, the Commission believes that existing position and 
exercise limits, procedures for maintaining the exemption, and the 
reporting requirements imposed by the Exchange will help protect 
against potential manipulation. The Commission notes that the existing 
standard position and exercise limits will remain in place for unhedged 
equity option positions. To further ensure against market disruption, 
the Amex will establish a position and exercise limit equal to no 
greater than five times the standard limit for those hedge strategies 
that include an OTC option component.
    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. Although the exemption will 
be automatic (i.e., does not require pre-approval from the Exchange), 
the exemption will remain in effect only to the extent that the 
exempted position remains intact and that the Exchange is provided with 
any required supporting documentation.
    In addition, as described above, a qualified account must report 
hedge information each time the option position changes. Hedge 
information for member firm and customer accounts having 200 or more 
contracts are reported to the Exchange electronically, via the Large 
Options Position Report. Specialist and registered options trader 
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 Commission believes these reporting requirements will help the 
Amex to monitor options positions and ensure that only qualified hedges 
are being exempt from position and exercise limits. To the extent that 
any position raises concerns, the Commission believes that the Amex, 
through its monitoring, will be promptly notified, and the Commission 
would expect the Amex to take any appropriate action, as permitted by 
its rules.
    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 the proposal, as amended, is substantially identical to a proposed 
rule change submitted by the CBOE, which the Commission has 
approved.\21\ The Commission does not believe that the proposed rule 
changes raises novel regulatory issues that were not already addressed 
and should benefit Exchange members by permitting them greater 
flexibility in using hedge strategies advantageously, while providing 
an adequate level of protection against the opportunity for 
manipulation of these securities and disruption in the underlying 
market. Accordingly, the Commission finds that there is good cause, 
consistent with section 6(b)(5) of the Act,\22\ to approve the 
proposal, as amended, on an accelerated basis.
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    \21\ See Securities Exchange Act Release No. 44503 (March 20, 
2002) (SR-CBOE-00-12).
    \22\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\23\ that the proposed rule change (SR-Amex-2001-72), as amended, 
is hereby approved on an accelerated basis.
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    \23\ 15 U.S.C. 78s(b)(2).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-7870 Filed 4-1-02; 8:45 am]
BILLING CODE 8010-01-P