[Federal Register Volume 67, Number 250 (Monday, December 30, 2002)]
[Notices]
[Pages 79676-79680]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32921]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47080; File No. SR-NASD-2002-134]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Exemptions From Options Position and Exercise Limits

December 23, 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 October 1, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by NASD. 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

    NASD is proposing to amend Rule 2860(b)(3)(A) of the Conduct Rules 
of NASD, relating to options position and exercise limits for positions 
entered into under certain enumerated hedge strategies.
    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *
2860. Options
    (a) No Change
    (b) Requirements
    (1) and (2) (No Change)
    (3) Position Limits \3\
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    \3\ The Commission notes that it made typographical changes to 
the rule text submitted in the proposed rule change. NASD has 
committed to submitting an amendment reflecting those changes. 
Telephone conversation between Gary Goldsholle, Office of General 
Counsel, NASD and Tim Fox, Law Clerk, Division of Market Regulation 
(``Division''), Commission on December 20, 2002.
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    (A) Stock Options--Except in highly unusual circumstances, and with 
the prior written approval of [the Association] NASD pursuant to the 
Rule 9600 Series for good cause shown in each instance, no member shall 
effect for any account in which such member has an interest, or for the 
account of any partner, officer, director or employee thereof, or for 
the account of any customer, non-member broker, or non-

[[Page 79677]]

member dealer, an opening transaction through Nasdaq, the over-the-
counter market or on any exchange in a stock option contract of any 
class of stock options if the member has reason to believe that as a 
result of such transaction the member or partner, officer, director or 
employee thereof, or customer, non-member broker, or non-member dealer, 
would, acting alone or in concert with others, directly or indirectly, 
hold or control or be obligated in respect of an aggregate equity 
options position in excess of:
    (i) 13,500 option contracts of the put class and the call class on 
the same side of the market covering the same underlying security, 
combining for purposes of this position limit long positions in put 
options with short positions in call options, and short positions in 
put options with long positions in call options; or
    (ii) 22,500 option[s] contracts of the put class and the call class 
on the same side of the market covering the same underlying security, 
providing that the 22,500 contract position limit shall only be 
available for option contracts on securities [which] that underlie 
Nasdaq or exchange-traded options qualifying under applicable rules for 
a position limit of 22,500 option contracts; or
    (iii) 31,500 option contracts of the put class and the call class 
on the same side of the market covering the same underlying security 
providing that the 31,500 contract position limit shall only be 
available for option contracts on securities [which] that underlie 
Nasdaq or exchange-traded options qualifying under applicable rules for 
a position limit of 31,500 option contracts; or
    (iv) 60,000 option[s] contracts of the put and the call class on 
the same side of the market covering the same underlying security, 
providing that the 60,000 contract position limit shall only be 
available for option contracts on securities [which] that underlie 
Nasdaq or exchange-traded options qualifying under applicable rules for 
a position limit of 60,000 option contracts; or
    (v) 75,000 option[s] contracts of the put and the call class on the 
same side of the market covering the same underlying security, 
providing that the 75,000 contract position limit shall only be 
available for option contracts on securities [which] that underlie 
Nasdaq or exchange-traded options qualifying under applicable rules for 
a position limit of 75,000 option contracts; or
    (vi) such other number of stock option[s] contracts as may be fixed 
from time to time by [the Association] NASD as the position limit for 
one or more classes or series of options provided that reasonable 
notice shall be given of each new position limit fixed by [the 
Association] NASD.
    (vii) Equity Option Hedge Exemptions
    a. The following qualified hedge strategies and positions described 
in subparagraphs 1. through 5. below shall be exempt from the 
established position limits under this rule for standardized options. 
Hedge strategies and positions described in subparagraphs 6. and 7. 
below in which one of the option components consists of a conventional 
option, shall be subject to a position limit of five times the 
established position limits contained in subparagraphs (i) through (vi) 
above. Hedge strategies and positions in conventional options as 
described in subparagraphs 1. through 5. below shall be subject to a 
position limit of five times the established limits contained in 
subparagraphs (i) through (vi) above. Options positions limits 
established under this subparagraph shall be separate from limits 
established in other provisions of this rule. 
    1. 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, 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 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 underlying security.
    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 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 underlying security. 
    4. Collars--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 strike price of 
the long put position 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 underlying 
security. Neither side of the short call/long put position can be in-
the-money at the time the position is established. 
    5. Box Spreads--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. 
    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. 
    7. For reverse conversion, conversion and collar strategies set 
forth above in subparagraphs 2., 3. and 4., 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. 
    [a. The following positions, where each option contract is 
``hedged'' by 100 shares of stock or securities readily convertible 
into or economically equivalent to such stock, or, in the case of an 
adjusted option contract, the same number of shares represented by the 
adjusted contract, shall be exempted from established limits contained 
in paragraphs (i) through (vi) above:]
    [1. long call and short stock;]
    [2. short call and long stock;]
    [3. long put and long stock;]
    [4. short put and short stock.]
    [b. Except as provided under OTC Collar Exemption contained in 
subparagraph (b)(3)(A)(viii), in no event may the maximum allowable 
position, inclusive of options contracts hedged pursuant to the equity 
option position limit hedge exemption in subparagraph a. above, exceed 
three times the applicable position limit established in subparagraph 
(b)(3)(A)(i) through (v) with respect to standardized equity options, 
or paragraph (b)(3)(A)(ix) with respect to conventional equity 
options.]
    [(viii) OTC Collar Aggregation Exemption]
    [a. For purposes of this paragraph (b), the term OTC collar shall 
mean a conventional equity option position comprised of short (long) 
calls and long (short) puts overlying the same security that hedge a 
corresponding long (short) position in that security.]
    [b. Notwithstanding the aggregation provisions for short (long) 
call positions and long (short) put positions contained in 
subparagraphs (b)(3)(A)(i) through (v) above, the conventional options 
positions involved in a particular OTC collar transaction need not be

[[Page 79678]]

aggregated for position limit purposes, provided the following 
conditions are satisfied:]
    [1. the conventional options can only be exercised if they are in-
the-money;]
    [2. neither conventional option can be sold, assigned, or 
transferred by the holder without the prior written consent of the 
writer;]
    [3. the conventional options must be European-style (i.e., only 
exercisable upon expiration) and expire on the same date;]
    [4. the strike price of the short call can never be less than the 
strike price of the long put; and]
    [5. neither side of any particular OTC collar transaction can be 
in-the-money when that particular OTC collar is established.]
    [6. the size of the conventional options in excess of the 
applicable basic position limit for the options established pursuant to 
subparagraph (b)(3)(A)(ix) must be hedged on a one-to-one basis with 
the requisite long or short stock position for the duration of the 
collar, although the same long or short stock position can be used to 
hedge both legs of the collar.]
    [c. For multiple OTC collars on the same security meeting the 
conditions set forth in subparagraph b. above, all of the short (long) 
call options that are part of such collars must be aggregated and all 
of the long (short) put options that are part of such collars must be 
aggregated, but the short (long) calls need not be aggregated with the 
long (short) puts.]
    [d. Except as provided above in subparagraphs b. and c., in no 
event may a member fail to aggregate any conventional options contract 
of the put class and the call class overlying the same equity security 
on the same side of the market with conventional option positions 
established in connection with an OTC collar.]
    [e. Nothing in this subparagraph (b)(3)(A)(viii) changes the 
applicable position limit for a particular equity security.]
    [(ix)](viii) Conventional Equity Options
    a. For purposes of [sub]paragraph (b), standardized equity 
option[s] contracts of the put class and call class on the same side of 
the market overlying the same security shall not be aggregated with 
conventional equity option[s] contracts or FLEX Equity Option[s] 
contracts overlying the same security on the same side of the market. 
Conventional equity option[s] contracts of the put class and call class 
on the same side of the market overlying the same security shall be 
subject to a position limit equal to the greater of:
    1. the basic limit of 13,500 contracts, or
    2. any standardized equity options position limit as set forth in 
[sub]paragraphs (b)(3)(A)(ii) through (v) for which the underlying 
security qualifies or would be able to qualify.
    a. In order for a security not subject to standardized equity 
options trading to qualify for an options position limit of more than 
13,500 contracts, a member must first demonstrate to NASD's [the 
Association's] Market Regulation Department that the underlying 
security meets the standards for such higher options position limit and 
the initial listing standards for standardized options trading.
    (B) No Change
    (4) through (24) No Change
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD 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. NASD 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 proposed rule change amends NASD's options position and 
exercise limits. Earlier this year, the Commission approved changes to 
the rules of the options exchanges that eliminated standardized equity 
option \4\ position and exercise limits for certain qualified hedge 
strategies and established position and exercise limits of five times 
the standard limit for certain of those strategies when they include an 
over-the-counter (OTC) option contract.\5\ NASD is proposing changes to 
substantially conform its rules to those of the options exchanges.
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    \4\ A standardized equity option contract is any equity options 
contract issued, or subject to issuance by, the Options Clearing 
Corporation that is not a FLEX Equity Option. NASD Rule 
2860(b)(2)(vv).
    \5\ See Securities Exchange Act Release No. 45603 (March 20, 
2002), 67 FR 14751 (March 27, 2002) (CBOE-2000-12); Securities 
Exchange Act Release No. 45650 (March 26, 2002), 67 FR 15638 (Apr. 
2, 2002) (AMEX-2001-71); Securities Exchange Act Release No. 45737 
(April 11, 2002), 67 FR 18975 (Apr. 17, 2002) (PCX-2000-45); 
Securities Exchange Act Release No. 45899 (May 9, 2002), 67 FR 34980 
(May 16, 2002) (PHLX-2002-33); and Securities Exchange Act Release 
No. 46228 (July 18, 2002), 67 FR 48689 (July 25, 2002) (ISE-2002-
15).
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    The proposed rule change establishes six qualified hedge 
strategies:
    1. Where each option contract is ``hedged'' or ``covered'' by 100 
shares of the underlying \6\ security 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.
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    \6\ NASD represents that the phrase ``securities convertible 
into the underlying security'' does not include single stock futures 
products. Telephone Conversation between Gary Goldsholle, Office of 
General Counsel, NASD and Tim Fox, Law Clerk, Division, Commission 
on December 6, 2002.
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    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 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 underlying security.
    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 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 underlying security.
    4. Collars--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 strike price of the long 
put position and where each short call and long put position is hedged 
with 100 shares (or other adjusted number of shares) of such the 
underlying security or securities convertible into such underlying 
security. Neither side of the short call/long put position can be in-
the-money at the time the position is established.
    5. Box Spreads--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.
    6. Back-to-Back Options--A listed option position hedged on a one-
for-one basis with an 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

[[Page 79679]]

of each other and no more than one expiration month apart.
    Under the proposed rule change, there would be no position and 
exercise limits when such qualified hedge strategies are effected 
solely with standardized equity options. In addition, the proposed rule 
change establishes standardized equity option position and exercise 
limits of five times the standard limit when one component of such 
strategies is an OTC option contract.
    Further, within the list of proposed hedge strategies, NASD 
proposes that the option component of a reversal, a conversion or a 
collar position can be treated as one contract rather than as two 
contracts. NASD believes that all three strategies serve to hedge a 
related stock portfolio. Because these strategies require the 
contemporaneous purchase/sale of both a call and put component, against 
the appropriate number of shares underlying the option (generally 100 
shares), NASD believes, like the options exchanges, that the position 
should be treated as one contract for hedging purposes.
    NASD currently establishes position and exercise limits on 
conventional \7\ equity options.\8\ The NASD's position limits for 
conventional equity options are identical to those for standardized 
options.\9\ Moreover, like position and exercise limits for 
standardized equity options, NASD recognizes certain hedge strategies 
under which persons can establish greater options positions. NASD 
currently has an equity option hedge exemption \10\ and an OTC collar 
aggregation exemption.\11\ Under the current equity option hedge 
exemption, a person can establish a conventional equity options 
position of three times the standard position limit. Under the OTC 
collar aggregation exemption, a person can establish a conventional 
equity options position of three times the standard position limit for 
each side of the OTC collar.
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    \7\ A ``conventional option'' is any option contract not issued, 
or subject to issuance, by the Options Clearing Corporation. NASD 
Rule 2860(b)(2)(N).
    \8\ NASD notes that the terms ``conventional'' and ``OTC'' 
options have identical meanings for the purposes of this proposed 
rule change. Telephone conference among Gary Goldsholle, Office of 
General Counsel, NASD, Susie Cho, Special Counsel, Division, 
Commission, and Tim Fox, Law Clerk, Division, Commission on November 
14, 2002.
    \9\ NASD Rule 2860(b)(3)(A)(ix).
    \10\ NASD Rule 2860(b)(3)(A)(vii).
    \11\ NASD Rule 2860(b)(3)(A)(viii).
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    The proposed rule change modifies the conventional equity options 
position and exercise limits in several respects. First, the proposed 
rule change expands the hedge exemption for conventional options to 
include all of the qualified hedge strategies. NASD believes that 
covered stock positions, conversions, reverse conversions, collars,\12\ 
and box spreads may all be effected with conventional options. 
Moreover, NASD believes that having one set of hedge strategies 
applicable to standardized and conventional options will simplify 
members' compliance burdens.
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    \12\ NASD Rule 2860(b)(3)(viii) currently provides for a collar 
exemption. For purposes of clarity and consistency, NASD proposes 
adopting the collar exemption developed by the Options Exchanges in 
place of its existing collar exemption.
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    Second, the proposed rule change increases the conventional equity 
options position and exercise limits for such qualified hedge 
strategies to five times the standard limits. NASD believes that this 
change makes NASD's conventional equity options position limits 
consistent with the limits for OTC options under the options exchange's 
hedge exemptions. NASD's increased conventional options position limits 
also will apply when not part of a standardized option hedge. According 
to NASD, this change avoids having different conventional equity 
options position and exercise limits apply depending on whether a 
position is hedged by a standardized or conventional option.
    Third, the proposed rule change provides that conventional equity 
options positions under the hedge strategies not be aggregated with 
other options positions similar to the way that positions under the 
current equity option hedge exemption and OTC collar aggregation 
exemption are not aggregated with other options positions.
    NASD believes that rationales articulated by the Commission in its 
prior approval of similar rule changes by the options exchanges apply 
equally to the proposed rule change.\13\ It is NASD's view that 
position and exercise limits serve as a regulatory tool designed to 
address potential manipulative schemes and adverse market impact 
surrounding the use of options. According to NASD, the Commission has 
taken a gradual, evolutionary approach toward expansion of position and 
exercise limits. NASD believes that the Commission has been careful to 
balance two competing concerns when considering the appropriate level 
at which to set position and exercise limits. According to NASD, the 
Commission has recognized that the limits must be sufficient to prevent 
investors from disrupting the market in the underlying securities. At 
the same time, it is NASD's view that 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. NASD believes that the 
proposed rule change is consistent with these Commission policies.
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    \13\ See supra note 4.
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    Under the proposed rule change, the standard position and exercise 
limits will remain in place for unhedged equity options positions. Once 
an account reaches the standard limit, positions identified as a 
qualified hedge strategy would be subject to the increased position 
limits, or exempted from position limit calculations, as appropriate. 
The exemption would be automatic (i.e., it will not require pre-
approval from NASD) to the extent that a member identifies that a pre-
existing qualified 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 NASD.\14\ The exemption would 
remain in effect to the extent that the exempted position remains 
intact and NASD is provided with any required supporting documentation.
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    \14\ Under the proposed rule change, the existing reporting 
procedures that serve to identify and document hedged positions 
above a certain threshold continue to apply. Paragraph (b)(5) of 
NASD Rule 2860 requires reporting to NASD of aggregate positions of 
200 more contracts of the put class and the call class on the same 
side of the market covering the same underlying security.
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2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A of the Act,\15\ in general and with Section 
15A(b)(6) of the Act,\16\ in particular, in that it is designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and, in general, to protect 
investors and the public interest. NASD also believes that the proposed 
rule change is necessary to keep NASD's rules consistent with similar 
rules of Options Exchanges approved by the Commission.
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    \15\ 15 U.S.C. 78o-3.
    \16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

[[Page 79680]]

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 NASD 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 Room. Copies of such filings will also be 
available for inspection and copying at the principal office of the 
NASD.
    All submissions should refer to File No. SR-NASD-2002-134 and 
should be submitted by January 21, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\

    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32921 Filed 12-27-02; 8:45 am]
BILLING CODE 8010-01-P