[Federal Register Volume 67, Number 143 (Thursday, July 25, 2002)]
[Notices]
[Pages 48689-48691]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-18839]



[[Page 48689]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46228; File No. SR-ISE-2002-15]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the International Stock 
Exchange, Inc. To Eliminate Position and Exercise Limits for Certain 
Qualified Hedge Strategies

July 18, 2002.
    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 June 26, 2002, the International Stock Exchange, Inc. (``ISE'' 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. The Commission is publishing this notice to solicit comments 
on 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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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend ISE Rule 413 to eliminate 
position and exercise limits when certain qualified hedge 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. The 
current reporting procedures that serve to identify and document hedged 
positions will continue to apply. The text of the proposed rule change 
is available at the Office of the Secretary, the Exchange, 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 Exchange 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 Exchange 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 
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. Current ISE Rule 413 provides position and 
exercise limits for stock 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. The 
existing hedge exemption 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.
    The ISE represents that the types of hedge strategies employed by 
market participants are becoming increasingly more diversified. The 
Exchange 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 ISE 
believes that listed options contracts are now employed to hedge a 
wider spectrum of securities.
    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 ISE proposes to expand the definition of a 
``qualified'' hedged position found in ISE Rule 413. 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.\3\
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    \3\ For reverse conversion, conversion, and collar 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 ISE 
Rule 412(c) and Supplementary Material .02 to Rule 412. 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.\4\
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    \4\ 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). Neither side of the short call/long 
put position can be in-the-money at the time the position is 
established.\5\
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    \5\ 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. The strike price of the listed 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.

[[Page 48690]]

    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 \6\ 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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    \6\ At or about the same time.
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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 remain 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 
hedge information each time the option position changes. Hedge 
information for member firm and customer accounts are electronically 
reported via the Large Options Positions Report. Market maker account 
information is also reported to the Exchange electronically by the 
member's clearing firm. The existing requirement imposed on a member 
firm 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 ISE believes that, with the exception of covered stock 
positions, all of the proposed qualified hedge strategies are market 
neutral.\7\ 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 ISE rules and the surveillance procedures for hedged positions 
will enable the Exchange to closely monitor sizable option positions 
and corresponding hedges.
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    \7\ 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. The ISE believes that, as the short option premium 
serves to mitigate the stock exposure, no limit should be imposed on 
this strategy.
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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 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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    \8\ 15 U.S.C. 78f(b).
    \9\ 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 Exchange has neither solicited nor received comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The foregoing rule change has become effective pursuant to section 
19(b)(3)(A) of the Act \10\ and Rule 19b-4(f)(6) \11\ thereunder 
because the proposal: (i) Does not significantly affect the protection 
of investors or the public interest; (ii) does not impose any 
significant burden on competition; and (iii) does not become operative 
prior to 30 days after the date of filing or such shorter time as the 
Commission may designate if consistent with the protection of investors 
and the public interest; provided that the Exchange has given the 
Commission notice of its intent to file the proposed rule change, along 
with a brief description and text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such short time as designated by the Commission. At any time 
within 60 days of the filing of such proposed rule change, the 
Commission may summarily abrogate such rule change if it appears to the 
Commission that such action is necessary or appropriate in the public 
interest, for the protection of investors or otherwise in furtherance 
of the purposes of the Act.
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    \10\ 15 U.S.C. 78s(b)(3)(A).
    \11\ 17 CFR 240.19b-4(f)(6).
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    The ISE has requested that the Commission waive the 30-day 
operative delay. The Commission believes waiving the 30-day operative 
delay is consistent with the protection of investors and the public 
interest. The Commission notes that the proposal is substantially 
identical to proposed rule changes submitted by other options 
exchanges, which the Commission has approved.\12\ The Commission also 
notes that these proposals were noticed for public comment and no 
comment was received. The Commission does not believe that the proposed 
rule change raises novel regulatory issues that were not already 
addressed in the approval orders to these proposed rule changes.\13\ 
For these reasons, the Commission designates the proposal to be 
effective and operative as of the date of this order.\14\
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    \12\ See Securities Exchange Act Release No. 45737 (April 11, 
2002), 67 FR 18975 (April 17, 2002) (SR-PCX-00-45); Securities 
Exchange Act Release No. 45650 (March 26, 2002), 67 FR 15638 (April 
2, 2002) (SR-Amex-2001-72); Securities Exchange Act Release No. 
44503 (March 20, 2002), 67 FR 14751 (March 27, 2002) (SR-CBOE-00-
12).
    \13\ Id.
    \14\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
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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

[[Page 48691]]

public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying at the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-ISE-2002-15 and should be 
submitted by August 15, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-18839 Filed 7-24-02; 8:45 am]
BILLING CODE 8010-01-P