[Federal Register Volume 68, Number 121 (Tuesday, June 24, 2003)]
[Notices]
[Pages 37594-37597]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-15835]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48045; File No. SR-PCX-2003-28]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change and Amendments 
No. 1 and 2 by the Pacific Exchange, Inc. To Initiate a Pilot Program 
That Allows the Listing of Strike Prices at One-Point Intervals for 
Certain Stocks Trading Under $20

June 17, 2003.
    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 13, 2003, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I and II 
below, which Items have been prepared by the Exchange. The PCX filed 
Amendments No. 1 and 2 to the proposal on June 16, 2003.\3\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons and to grant 
accelerated approval to the proposed rule change, as amended, through 
June 5, 2004.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Mai Shiver, Senior Attorney, Regulatory 
Policy, PCX, to Nancy J. Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated June 13, 2003 
(``Amendment No. 1''). Amendment No. 1 revises the text of the 
proposed rule to state that the pilot program will expire on June 5, 
2004. In addition, Amendment No. 1 revises the proposal's 
description of the Exchange's current strike price intervals for 
equity options. See also letter from Mai Shiver, Senior Attorney, 
Regulatory Policy, PCX, to Nancy J. Sanow, Assistant Director, 
Division, Commission, dated June 16, 2003 (``Amendment No. 2''). 
Amendment No. 2 corrects a typographical error in the text of the 
proposed rule by replacing a reference to the interval of ``stock'' 
prices in the first sentence of proposed PCX Rule 6.4, Commentary 
.04 with a reference to the interval of ``strike'' prices.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to initiate a pilot program (``Pilot 
Program'') that will allow the Exchange to list options on selected 
stocks trading below $20 at one-point intervals. The text of the 
proposed rule change appears below. Additions are in italics; deletions 
are in brackets.

4745 Series of Options Open for Trading

    Rule 6.4(a)-(e)--No change.
    Commentary .01-.03--No change.
    .04 The Exchange may select a limited number of its listed options 
on individual stocks for which the interval of strike prices will be 
$1.00 (``$1 strike prices'') provided the strike price is $20.00 or 
less, but not less than $3. The listing of $1 strike prices will be 
limited to options issues overlying no more than five (5) individual 
stocks (the ``$1 Strike Pilot Program'') as specifically designated by 
the Exchange. The Exchange may list $1 strike prices on any other 
option issues if those issues are specifically designated by other 
securities exchanges that employ a $1 Strike Pilot Program under their 
respective rules. To be eligible for inclusion into the $1 Strike Pilot 
Program, an underlying stock must close below $20 in its primary market 
on the previous trading day. After a stock is added to the $1 Strike 
Pilot Program, the Exchange may list $1 strike prices from $3 to $20 
that are no more than $5 from the closing price of the underlying on 
the preceding day. For example, if the underlying stock closes at $13, 
the Exchange may list strike prices from $8 to $18. The Exchange may 
not list series with $1.00 intervals within $0.50 of an existing $2.50 
strike price (e.g., $12.50, $17.50) in the same series, and may not 
list $2.50 intervals (e.g. $12.50, $17.50) below $20 under Commentary 
.03 of this Rule for any issue included within the $1 Strike Pilot 
Program if the addition of $2.50 intervals would cause the issue to 
have strike price intervals that are $.50 apart. Additionally, the 
Exchange may not list long-term option series (``LEAPS'') at $1 strike 
price intervals for any option class selected for the $1 Strike Pilot 
Program. A stock shall remain in the $1 Strike Pilot Program until 
otherwise designated by the Exchange. The $1 Strike Pilot Program shall 
expire on June 5, 2004.
    [.04] .05--No change.

[[Page 37595]]

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 III 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
    PCX policy establishes the guidelines regarding the addition of 
series for trading on the Exchange.\4\ The Exchange may list $2.50 
intervals for strike prices at $25 or less, $5.00 intervals for strikes 
over $25 but less than $200, and $10 intervals for strikes at or above 
$200.\5\ The PCX currently lists options on more than 400 stocks 
trading under $20, including Cisco, Sun Microsystems, Lucent, JDS 
Uniphase, Nextel, AT&T, Motorola, Intel, Apple, Tyco, AOL Time Warner, 
and Calpine. These stocks are among the most widely held and actively 
traded equities listed on the New York Stock Exchange, Inc. (``NYSE'') 
or Nasdaq and the options overlying these stocks also trade actively.
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    \4\ See Securities Exchange Act Release No. 21985 (April 25, 
1985), 50 FR 18595 (May 1, 1985) (order approving File Nos. SR-PSE-
85-9 and PHLX-85-9) (``1985 Order'').
    \5\ See 1985 Order, supra note 4. Additionally, PCX Rule 6.4, 
Commentary .03 establishes guidelines for listing $2.50 strikes for 
a set number of issues with series trading between $25 and $50.
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    When a stock underlying an option trades at a lower price, it takes 
a larger percentage gain in the stock for an option to become in-the 
money. For example, when a stock trades at $8 an investor who wants to 
buy a slightly out-of-the-money call option would have to buy the call 
with a $10 strike price. At these levels, the stock price would need to 
register a 25% change before it reached $10 (i.e., in-the-money 
status). A 25% gain in the underlying is especially large given the 
lessened degree of volatility that has accompanied many stocks and 
options over the past several months. Due to the recent preponderance 
of low priced stocks, Member Firms have expressed an interest in 
listing additional strike prices on these classes so that they can 
provide their customers with greater flexibility in their investment 
choices. For this reason, the Exchange proposes to implement a Pilot 
Program, as described below.

Pilot Program Eligibility

    The Exchange proposes to amend PCX Rule 6.4 in order to list series 
with $1 strike price intervals on equity option issues that overlie up 
to five individual stocks, provided that the strike prices are $20 or 
less, but not less than $3. The PCX's Options Listing Committee would 
make the determination of which underlying stocks are to be included in 
the Pilot Program. An issue becomes eligible for inclusion in the Pilot 
Program when the underlying stock closes below $20 in its primary 
market on the previous business day. Underlying stocks trading under 
$20 that are not a part of the Pilot Program would continue to be 
eligible for trading in $2.50 and $5.00 intervals. Although the PCX may 
select only up to five individual stocks to be included in the Pilot 
Program, the Exchange would not be precluded from also listing options 
on other individual stocks at $1 strike price intervals if other 
options exchanges listed those series pursuant to their respective $1 
strikes pilot programs.

Procedures for Adding $1 Strike Price Intervals

    The Exchange proposes to amend Rule 6.4 to specify the standards 
that will apply when adding additional $1 strike price intervals under 
the Pilot Program. Under the proposal, the closing price of the 
underlying stock serves as the reference point for determining which $1 
strike prices the Exchange may open for trading. Specifically, the 
Exchange will only list $1 strike prices that fall within a $5 range of 
the underlying stock price, and no strike prices will be added outside 
of the $5 range. For example, if the underlying stock trades at $6, the 
Exchange could list $1 strikes from $3 to $11.\6\ The Exchange believes 
that this proposed range-format will significantly restrict the number 
of series that may be added at any one time.
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    \6\ As indicated above, strike prices for options included in 
the Pilot Program may not be greater than $20 or less than $3.
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    The Exchange may currently list strike prices with $2.50 intervals 
when an underlying stock trades below $25.\7\ Accordingly, several 
option issues have $7.50, $12.50, and $17.50 strike prices (the ``$2.50 
series'' or ``$2.50 intervals''). To further avoid the proliferation of 
series, the Exchange does not intend to list $1 strike prices at levels 
that ``bracket'' existing $2.50 intervals (e.g., $7 and $8 strikes 
around a $7.50 strike). Accordingly, the Exchange does not intend to 
list $7, $8, $12, $13, $17, and $18 levels in an expiration month where 
there is a corresponding $2.50 level. As the $2.50 intervals are 
``phased-out,'' as described below, the Exchange would introduce the $1 
levels that bracket the phased-out price. For example, when the $7.50 
series expires, the Exchange would replace it by issuing a new month 
with $7 and $8 intervals.
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    \7\ See 1985 Order, supra note 4.
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Procedures for Phasing-out $2.50 Strike Price Intervals

    When a stock becomes part of the Pilot Program, the Exchange will 
begin the corresponding process of phasing-out the existing $2.50 
intervals on the same stock in favor of $1 intervals. To phase out the 
$2.50 intervals, the Exchange would first delist those $2.50 series for 
which there is no open interest. Second, the Exchange would no longer 
add new expiration months at $2.50 intervals below $20 when the 
existing months expire. This would cause the $2.50 strike price 
intervals below $20 to be phased-out when the farthest-out month with a 
$2.50 interval eventually expires.

$1 Strikes for LEAPS

    The Exchange will not list long-term options (also known as 
``LEAPS'') in equity option classes at $1 strike price intervals.

Procedures for Adding Expiration Months

    PCX Rule 6.4 will govern the addition of expiration months for the 
Pilot Program. Pursuant to this rule, the Exchange generally opens up 
to four expiration months for each class upon initial listing of an 
options class for trading, and upon expiration of the near-term month, 
the Exchange lists an additional expiration month. With respect to 
options in the Pilot Program, the Exchange may list an additional 
expiration month for a $1 strike series provided that the underlying 
strike price closes blow $20 on its primary market on expiration 
Friday. If the underlying closes at or above $20 on expiration Friday, 
the Exchange would not list an additional month for $1strike series 
until the stock again closes below $20.

Procedures for Deleting $1 Strike Price Intervals

    At any time, the Exchange may cease trading options series, 
including series

[[Page 37596]]

with $1 strike prices, by submitting a cessation notice to the Options 
Clearing Corporation (``OCC'').\8\ As discussed above, if the 
underlying closes at or above $20 on expiration Friday, the Exchange 
would not list any additional months with $1 strike prices until the 
stock subsequently closed below $20. If the underlying does not 
subsequently close below $20, thereby precluding the listing of 
additional strike prices and months, the existing $1 series will 
eventually expire. When the near-term month is the only series 
available for trading, the Exchange may submit a cessation notice to 
OCC. Upon submission of that notice, the underlying stock would no 
longer count towards the five stock Pilot Program, thereby allowing the 
Exchange to list issues on an additional stock. Once the Exchange 
submits the cessation notice, it would not list any additional months 
for trading with $1 strikes below $20 (unless the underlying once again 
closed below $20).\9\
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    \8\ Among the reasons for submitting a cessation notice are the 
expiration of available $1 strikes (i.e., underlying stock price 
remains at or above $20), series proliferation concerns, and 
delisting because of low price, merger, takeover, or other events. 
In any event, with prior notice to the membership and customers, the 
PCX would continue to have the ability to cease trading series that 
become inactive and have no open interest.
    \9\ If the underlying stock trades below $20 after submission of 
the cessation notice by the Exchange, the PCX could list $1 strike 
prices again provided it included the class as one of the five 
classes permitted under the Pilot Program.
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Options Price Reporting Authority (``OPRA'') Capacity

    The PCX believes that OPRA has the capacity to accommodate the 
increase in the number of series added pursuant to the Pilot Program. 
The Pilot Program is limited to only five underlying securities, and 
the Pilot Program will result in an increase of between seven and 14 
additional strikes for each underlying (depending on the number of 
existing $2.50 strikes listed). Thus, the Pilot Program will result in 
a maximum of 70 additional series, which is a small increase in the 
59,000 series currently traded on the PCX. Currently, OPRA's one-minute 
peak has been less than one-third its total capacity.
2. Basis
    The Exchange believes that the addition of $1 strike prices would 
stimulate customer interest in options overlying lower-priced stocks by 
creating greater trading opportunities and flexibility. The Exchange 
further believes that $1 strike prices would provide customers with the 
ability to more closely tailor investment strategies to the precise 
movement of the underlying security. For these reasons, the Exchange 
believes the proposed rule change is consistent with the Act and the 
rules and regulations thereunder and, in particular, the requirements 
of section 6(b) of the Act.\10\ Specifically, the Exchange believes the 
proposed rule change is consistent with section 6(b)(5)\11\ 
requirements that the rules of an exchange be designed to promote just 
and equitable principles of trade, to prevent fraudulent and 
manipulative acts, to remove impediments to and perfect the mechanism 
for a free and open market and a national market system, and, in 
general, to protect investors and the public interest.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    Written comments on the proposed rule change were neither solicited 
nor received.

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 Room. Copies of such 
filings will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-PCX-2003-28 and should be submitted by July 15, 2003.

IV. Commission's 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.\12\ In particular, the Commission finds that the proposed 
rule change is consistent with section 6(b)(5) of the Act,\13\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest. Specifically, 
the Commission believes that the proposed listing of one point strike 
price intervals in selected equity options on a pilot basis should 
provide investors with more flexibility in the trading of equity 
options overlying stocks trading at more than $3 but less than $20, 
thereby furthering the public interest by allowing investors to 
establish equity options positions that are better tailored to meet 
their investment objectives. The Commission also believes that the 
Exchange's limited Pilot Program strikes a reasonable balance between 
the Exchange's desire to accommodate market participants by offering a 
wide array of investment opportunities and the need to avoid 
unnecessary proliferation of options series. The Commission expects the 
Exchange to monitor the applicable equity options activity closely to 
detect any proliferation of illiquid options series resulting from the 
narrower strike price intervals and to act promptly to remedy this 
situation should it occur. In addition, the Commission requests that 
the PCX monitor the trading volume associated with the additional 
options series listed as a result of the Pilot Program and the effect 
of these additional series on market fragmentation and on the capacity 
of the Exchange's, OPRA's, and vendors' automated systems.
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    \12\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \13\ 15 U.S.C. 78f(b)(5).
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    As noted above, the Commission is approving the PCX's proposal on a 
pilot basis. In the event that PCX proposes to extend the Pilot Program 
beyond June 5, 2004, expand the number of options eligible for 
inclusion in the Pilot Program, or seek permanent approval of the Pilot 
Program, it should submit a Pilot Program report to the Commission

[[Page 37597]]

along with the filing of such proposal.\14\ The report must cover the 
entire time the Pilot Program was in effect, and must include: (1) Data 
and written analysis on the open interest and trading volume for 
options (at all strike price intervals) selected for the Pilot Program; 
(2) delisted options series (for all strike price intervals) for all 
options selected for the Pilot Program; (3) an assessment of the 
appropriateness of $1 strike price intervals for the options the PCX 
selected for the Pilot Program; (4) an assessment of the impact of the 
Pilot Program on the capacity of the PCX's, OPRA's, and vendors' 
automated systems; (5) any capacity problems or other problems that 
arose during the operation of the Pilot Program and how the PCX 
addressed them; (6) any complaints that the PCX received during the 
operation of the Pilot Program and how the PCX addressed them; and (7) 
any additional information that would help to assess the operation of 
the Pilot Program.
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    \14\ The Commission expects the PCX to submit a proposed rule 
change at least 60 days before the expiration of the Pilot Program 
in the event the PCX wishes to extend, expand, or seek permanent 
approval of the Pilot Program.
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    The Commission finds good cause for approving the proposal prior to 
the thirtieth day after the date of publication of notice of filing 
thereof in the Federal Register. The PCX's Pilot Program is identical 
to a CBOE pilot program (``CBOE Pilot'') that the Commission 
approved.\15\ Notice of the CBOE Pilot was published for comment \16\ 
and the Commission received one comment letter, which supported the 
CBOE's proposal. Accordingly, the Commission believes that the PCX's 
Pilot Program proposal raises no issues of regulatory concern. 
Amendment No. 1 to the proposal clarifies the proposal by specifying 
the date on which the Pilot Program will expire and describing the 
PCX's current strike price intervals for equity options. Amendment No. 
2 corrects a typographical error in the text of the proposed rule. For 
these reasons, the Commission believes that there is good cause, 
consistent with sections 6(b)(5) and 19(b) of the Act,\17\ to approve 
the PCX's proposal, as amended, on an accelerated basis.
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    \15\ See Securities Exchange Act Release No. 47991 (June 5, 
2003), 68 FR 35243 (June 12, 2003) (order approving File No. SR-
CBOE-2001-60).
    \16\ See Securities Exchange Act Release No. 47753 (April 29, 
2003), 68 FR 23784 (May 5, 2003).
    \17\ 15 U.S.C. 78f(b)(5) and 78s(b).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-PCX-2003-28) and Amendments 
No. 1 and 2, are hereby approved, on an accelerated basis and as a 
pilot program, through June 5, 2004.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-15835 Filed 6-23-03; 8:45 am]
BILLING CODE 8010-01-P