[Federal Register Volume 70, Number 44 (Tuesday, March 8, 2005)]
[Notices]
[Pages 11292-11295]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-969]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51295; File No. SR-ISE-2005-14]


Self-Regulatory Organizations; International Securities Exchange, 
Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule 
Change and Amendment No. 1 Thereto Relating to Position Limits and 
Exercise Limits

March 2, 2005.
    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 February 25, 2005, the International Securities Exchange, Inc. 
(``ISE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by ISE. On March 
1, 2005 the ISE filed Amendment No. 1 to the proposed rule change.\3\ 
The Exchange has filed the proposal as a ``non-controversial'' rule 
change pursuant to Section 19(b)(3)(A) of the Act\4\ and Rule 19b-
4(f)(6) thereunder,\5\ which renders it effective upon filing with the 
Commission. The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 made certain technical changes to Exhibit 5 
to the filing.
    \4\ 15 U.S.C. 78s(b)(3)(A).
    \5\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The ISE proposes to amend ISE Rules 412, 413, and 414 to increase 
the standard position and exercise limits for equity options contracts 
and options on the Nasdaq-100 Index Tracking Stock (``QQQQ''). The text 
of the proposed rule change is available on the ISE's Web site (http://www.iseoptions.com), at the ISE's Office of the Secretary, and at the 
Commission's Public Reference Room.

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 ISE 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 several change to ISE Rule 412 (Position 
Limits), ISE Rule 413 (Exemptions from Position Limits), and ISE Rule 
414 (Exercise Limits). ISE Rule 412 subjects equity options to one of 
five different position limits depending on the trading volume and 
outstanding shares of the underlying security. ISE Rule 413 establishes 
certain qualified hedging transactions and positions that are exempt 
from established options position limits as prescribed under ISE Rule 
412. ISE Rule 414 establishes exercise limits for the corresponding 
options at the same levels as the corresponding security's position 
limits. On February 23, 2005, the Commission granted accelerated 
approval of a rule change proposed by the Chicago Board

[[Page 11293]]

Options Exchange, Inc. (``CBOE'') relating to position and exercise 
limits.\6\
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    \1\ See Securities Exchange Act Release No. 51244 (February 23, 
2005), 70 FR 10010 (March 1, 2005) (SR-CBOE-2003-30).
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Standard Position and Exercise Limits
    The Exchange is proposing to adopt a pilot program for a period of 
six months during which the standard position and exercise limits for 
options on the QQQQ and for equity option classes traded on the 
Exchange would be increased to the following levels:

------------------------------------------------------------------------
   Current Equity Option Contract      Proposed Equity Option Contract
               Limit                                Limit
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                         13,500                               25,000
                         22,500                               50,000
                         31,500                               75,000
                         60,000                              200,000
                         75,000                              250,000
------------------------------------
                               Current QQQQ OptProposed QQQQ Option Contract Limit
------------------------------------
                        300,000                              900,000
------------------------------------------------------------------------

    The ISE's standard position limits have been in effect since the 
Exchange commenced trading in May 2000. These standard position limits 
are the same as the position limits at the other options exchanges at 
that time, which were last increased on December 31, 1998.\7\ Since 
that time, there has been a steady increase in the number of accounts 
that, (a) approach the position limit; (b) exceed the position limit; 
and (c) are granted an exemption to the standard limit. Several members 
have petitioned the options exchanges to either eliminate position 
limits, or in lieu of total elimination, increase the current levels 
and expand the available hedge exemptions. A review of available data 
indicates that the majority of accounts that maintain sizable positions 
are in those classes subject to the 60,000 and 75,000 tier limits. 
There also has been an increase in the number of accounts that maintain 
sizeable positions in the lower three tiers. In addition, overall 
volume in the options market has continually increased over the past 
five years. The Exchange believes that the increase in options volume 
and lack of evidence of market manipulation occurrences during that 
same period justifies the proposed increase in the position and 
exercise limits.
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    \7\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (SR-CBOE-98-25).
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    The Exchange also proposes the adoption of a new equity hedge 
exemption to the existing exemptions currently provided under ISE Rule 
413. Specifically, proposed ISE Rule 413(a)(5) would allow for a 
``reverse collar'' hedge exemption where a long call position is 
accompanied by a short put position where the long call expires with 
the short put and the strike price of the long call equals or exceeds 
the short put and where each long call and short put position is hedged 
with 100 shares of the underlying security (or other adjusted number of 
shares). Neither side of the long call short put can be in-the-money at 
the time the position is established. The Exchange believes this is 
consistent with existing ISE Rule 413(a)(4), which provides for an 
exemption for a ``collar'', and ISE Rules 413(a)(2) and 413(a)(3), 
which provide for a hedge exemption for reverse conversion and 
conversions, respectively.
Manipulation
    The ISE believes that position and exercise limits, at their 
current levels, no longer serve their stated purpose. The Commission 
has previously stated that:
    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate or 
disrupt the underlying market so as to benefit the options position. In 
particular, position and exercise limits are designed to minimize the 
potential for mini-manipulations and for corners or squeezes of the 
underlying market. In addition such limits serve to reduce the 
possibility for disruption of the options market itself, especially in 
illiquid options classes.\8\
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    \8\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998) (SR-CBOE-97-11).
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    The Exchange believes that the existing surveillance procedures and 
reporting requirements at the ISE, other options exchanges, and at the 
several clearing firms are capable of properly identifying unusual and/
or illegal trading activity. In addition, routine oversight inspections 
of ISE's regulatory programs by the Commission have not uncovered any 
material inconsistencies or shortcomings in the manner in which the 
Exchange's market surveillance is conducted. These procedures utilize 
daily monitoring of market movements via automated surveillance 
techniques to identify unusual activity in both options and in 
underlying stocks.
    Furthermore, large stock holdings must be disclosed to the 
Commission by way of Schedules 13D or 13G.\9\ Options positions are 
part of any reportable positions and, thus, cannot be legally hidden. 
In addition, ISE Rule 415, which requires members to file reports with 
the Exchange for any customer who held aggregate long or short 
positions of 200 or more option contracts of any single class for the 
previous day, will remain unchanged and will continue to serve as an 
important part of the Exchange's surveillance efforts.
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    \9\ 17 CFR 240.13d-1.
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    The Exchange believes that restrictive equity position limits 
prevent large customers, such as mutual funds and pension funds, from 
using options to gain meaningful exposure to individual stocks. This 
can result in lost liquidity in both the options market and the stock 
market. In addition, the Exchange has found that restrictive limits and 
narrow hedge exemption relief restrict members from adequately 
facilitating customer order flow and offsetting the risks of such 
facilitations in the listed options market. The fact that position 
limits are calculated on gross rather than a delta basis also is an 
impediment.
Financial Requirements
    The Exchange believes that the current financial requirements 
imposed by the Exchange and by the Commission adequately address 
concerns that a member or its customer may try to maintain an 
inordinately large unhedged position in an equity option.

[[Page 11294]]

Current margin and risk-based haircut methodologies serve to limit the 
size of positions maintained by any one account by increasing the 
margin and/or capital that a member must maintain for a large position 
held by itself or by its customer. It also should be noted that the 
Exchange has the authority under ISE Rule 1204 to impose higher margin 
requirements upon a member when the Exchange determines that higher 
requirements are warranted. Also, the Commission's net capital rule, 
Rule 15c3-1 under the Act,\10\ imposes a capital charge on members to 
the extent of any margin deficiency resulting from the higher margin 
requirement.
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    \10\ 17 CFR 240.15c3-1.
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    Finally, equity position limits have been gradually expanded from 
1,000 contracts in 1973 to the current level of 75,000 contracts for 
the largest and most active stocks. To date, the Exchange believes that 
there have been no adverse affects on the market as a result of these 
past increases in the limits for equity option contracts.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \11\ in general, and furthers the objective of Section 
6(b)(5) of the Act \12\ in particular, in that it is designed to 
promote just and equitable principles of trade and to protect investors 
and the public interest.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not 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 not solicited, and does not intend to solicit, 
comments on this proposed rule change. The Exchange has not received 
any unsolicited written comments from members or other interested 
parties.

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

    The proposed rule change has been designated by the ISE as a ``non-
controversial'' rule change pursuant to Section 19(b)(3)(A) of the Act 
\13\ and subparagraph (f)(6) of Rule 19b-4 thereunder.\14\
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    \13\ 15 U.S.C. 78s(b)(3)(A).
    \14\ 17 CFR 240.19b-4(f)(6).
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    The foregoing rule change: (1) Does not significantly affect the 
protection of investors or the public interest, (2) does not impose any 
significant burden on competition, and (3) by its terms does not become 
operative for 30 days after the date of this filing, or such shorter 
time as the Commission may designate, if consistent with the protection 
of investors and the public interest. Consequently, the proposed rule 
change has become effective pursuant to Section 19(b)(3)(A) of the Act 
\15\ and Rule 19b-4(f)(6) thereunder.\16\
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    \15\ 15 U.S.C. 78s(b)(3)(A).
    \16\ 17 CFR 240.19b-4(f)(6).
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    Pursuant to Rule 19b-4(f)(6)(iii), a proposed ``non-controversial'' 
rule change does not become operative for 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, 
and the ISE gave the Commission written 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 shorter time as 
designated by the Commission.\17\ The ISE has requested that the 
Commission waive the five-day pre-filing notice requirement and the 30-
day operative delay. The Commission has determined that it is 
consistent with the protection of investors and the public interest to 
waive the five-day pre-filing notice requirement and the 30-day 
operative delay.\18\ Waiving the pre-filing requirement and 
accelerating the operative date will allow the ISE to immediately 
conform its position and exercise limits and its equity hedge exemption 
strategies to those of the CBOE, which were recently approved by the 
Commission.\19\
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    \17\ 17 CFR 240.19b-4(f)(6)(iii).
    \18\ For the 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). See Securities Exchange Act Release No. 51244 (February 23, 
2005).
    \19\ See Securities Exchange Act Release No. 51244 (February 23, 
2005), 70 FR 10010 (March 1, 2005) (SR-CBOE-2003-30).
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    At any time within 60 days of the filing of the 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 Act.\20\
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    \20\ For purpose of calculating the 60-day period within which 
the Commission may summarily abrogate the proposed rule change under 
Section 19(b)(3)(C) of the Act, the Commission considers that period 
to commence on March 1, 2005, the date that the ISE filed Amendment 
No. 1.
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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, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File No. SR-ISE-2005-14 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File No. SR-ISE-2005-14. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the ISE. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File No. SR-ISE-2005-14 and should be 
submitted on or before March 29, 2005.


[[Page 11295]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-969 Filed 3-7-05; 8:45 am]
BILLING CODE 8010-01-P