[Federal Register Volume 70, Number 47 (Friday, March 11, 2005)]
[Notices]
[Pages 12260-12263]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1018]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51322; File No. SR-Phlx-2005-17]


Self-Regulatory Organizations; Philadelphia Stock 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 4, 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 March 3, 2005, the Philadelphia Stock Exchange, Inc. (``Phlx'' 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 the Phlx. On March 3, 2005 
the Phlx 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 Phlx proposes to amend Exchange Rule 1001 to increase the 
standard position and exercise limits for equity options contracts and 
options on the Nasdaq-100 Index Tracking Stock (``QQQQ'') on a six 
month pilot basis beginning on the effective date of the proposed rule 
change. The text of the proposed rule change is available on the Phlx's 
Web site (http://www.phlx.com), at the Phlx'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 Phlx 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 Phlx 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 purpose of the proposed rule change is to amend Exchange Rule 
1001, Position Limits, to establish increased position and exercise 
limits for equity options and options overlying QQQQ, on a six-month 
pilot basis. Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market relating to the 
same underlying security that can be held or written by an investor or 
group of investors acting in concert. Exchange Rule 1002 (not proposed 
to be amended herein) establishes corresponding exercise limits.\6\ 
Exercise limits prohibit an investor or group of investors acting in 
concert from exercising more than a specified number of puts or calls 
in a particular class within five consecutive business days.
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    \6\ As clarified by the Phlx, although the proposed rule change 
would not amend the text of Exchange Rule 1002 itself, the proposed 
amendment to Exchange Rule 1001 would have the effect of increasing 
the exercise limits established in Exchange Rule 1002 for the same 
six-month pilot period. Telephone conversation between Richard S. 
Rudolph, Vice President and Counsel, Phlx, and Ira L. Brandriss, 
Assistant Director, Division of Market Regulation, Commission, on 
March 4, 2005. See also infra, note 7 and accompanying text.
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    Exchange Rule 1001 subjects equity options to one of five different 
position limits depending on the trading volume and outstanding shares 
of the underlying security. Exchange Rule 1002 establishes exercise 
limits for the corresponding options at the same levels as the 
corresponding security's position limits.\7\
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    \7\ Exchange Rule 1002 states, in relevant part, ``* * * no 
member of member organization shall exercise, for any account in 
which such member or member organization has an interest of for the 
account of any partner, officer, director or employee thereof or for 
the account of any customer, a long position in any option contract 
of a class of options dealt in on the Exchange (or, respecting an 
option not dealt in on the Exchange, another exchange if the member 
or member organization is not a member of that exchange) if as a 
result thereof such member or member organization, or partner, 
officer, director or employee thereof or customer, acting alone or 
in concert with others, directly or indirectly, has or will have 
exercised within any five (5) consecutive business days aggregate 
long positions in that class (put or call) as set forth as the 
position limit in Exchange Rule 1001, in the case of options on a 
stock or an Exchange-Traded Fund Share. * * *''

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[[Page 12261]]

    Standard Position and Exercise Limits. The Exchange proposes to 
adopt a pilot program for a period of six months during which the 
standard position and exercise limits for equity options traded on the 
Exchange and for options overlying QQQQ 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
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    In 1998, the Commission approved an Exchange proposal (and similar 
proposals of other options exchanges) to increase standard option 
position and exercise limits to their current levels.\8\ 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 member 
organizations have petitioned the Exchange 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 options subject to the 60,000 and 75,000 tier limits. 
There also has been an increase in the number of accounts that maintain 
sizable 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 over the past 
twenty years justifies the proposed increases in the position and 
exercise limits.
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    \8\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (Order approving SR-Phlx-98-36; 
SR-Amex-98-22; SR-CBOE-98-25; and SR-PCX-98-33).
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    The proposal would also adopt a new equity hedge exemption to the 
existing exemptions currently provided under Commentary .07 to Exchange 
Rule 1001. Specifically, new Commentary .07(5) to Rule 1001 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 Commentary .07(4) to Exchange 
Rule 1001, which provides for an exemption for a ``collar,'' and 
Commentary .07(2) and (3), which allow for a hedge exemption for 
``reverse conversions'' and ``conversions,'' respectively.
    Manipulation. The Exchange 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.\9\

    \9\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998) (SR-CBOE-97-11).
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    As the anniversary of listed options trading approaches its thirty-
fifth year, the Exchange believes that the existing surveillance 
procedures and reporting requirements at the Phlx, 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 the Exchange'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, the 
significant increases in unhedged options capital charges resulting 
from the September 1997 adoption of risk-based haircuts in combination 
with the Exchange margin requirements applicable to these products 
under Exchange rules, serve as a more effective protection than do 
position limits.\10\
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    \10\ See Securities Exchange Act Release No. 38248 (February 6, 
1997), 62 FR 6474 (February 12, 1997) (File No. S7-7-94) (adopting 
Risk-Based Haircuts).
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    Furthermore, large stock holdings must be disclosed to the 
Commission by way of Schedules 13D or 13G.\11\ Options positions are 
part of any reportable positions and, thus, cannot be legally hidden. 
In addition, Exchange Rule 1003, 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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    \11\ 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 equity 
market. In addition, the Exchange has found that restrictive limits and 
narrow hedge exemption relief restrict member firms 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 a

[[Page 12262]]

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. 
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 should also be noted that the 
Exchange has the authority under Exchange Rule 722(d)(1), (d)(4) and 
(i)(8) to impose a higher margin requirement upon a member or member 
organization when the Exchange determines a higher requirement is 
warranted. In addition, the Commission's net capital rule, Rule 15c3-1 
under the Act,\12\ imposes a capital charge on members to the extent of 
any margin deficiency resulting from the higher margin requirement.
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    \12\ 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,\13\ in general, and furthers the objectives of Section 
6(b)(5) of the Act,\14\ in particular, in that it is designed to 
perfect the mechanisms of a free and open market and the national 
market system, protect investors and the public interest and promote 
just and equitable principles of trade, by establishing higher equity 
option position limits on a six-month pilot basis.
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    \13\ 15 U.S.C. 78f(b).
    \14\ 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 inappropriate burden on competition.

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

    No written comments were either solicited or received.

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

    The proposed rule change has been designated by the Phlx as a 
``non-controversial'' rule change pursuant to Section 19(b)(3)(A) of 
the Act \15\ and subparagraph (f)(6) of Rule 19b-4 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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    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 
\17\ and Rule 19b-4(f)(6) thereunder.\18\
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    \17\ 15 U.S.C. 78s(b)(3)(A).
    \18\ 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 Exchange 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.\19\ The Phlx 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.\20\ Waiving the pre-filing requirement and 
accelerating the operative date will allow the Phlx to immediately 
conform its position and exercise limits and its equity hedge exemption 
strategies to those of another exchange, which were recently approved 
by the Commission.\21\
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    \19\ 17 CFR 240.19b-4(f)(6)(iii).
    \20\ 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).
    \21\ 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.

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-Phlx-2005-17 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-Phlx-2005-17. 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 Phlx. All 
comments received will be posted without change;

[[Page 12263]]

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-Phlx-
2005-17 and should be submitted on or before April 1, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-1018 Filed 3-10-05; 8:45 am]
BILLING CODE 8010-01-P