[Federal Register Volume 72, Number 109 (Thursday, June 7, 2007)]
[Notices]
[Pages 31636-31642]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-10970]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55843; File No. SR-Amex-2004-27]


Self-Regulatory Organizations; American Stock Exchange LLC; 
Notice of Filing of a Proposed Rule Change as Modified by Amendment 
Nos. 2 and 3 Thereto Relating to the Listing and Trading of Fixed 
Return Options

 June 1, 2007.
    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 April 29, 2004, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission

[[Page 31637]]

(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been substantially prepared by Amex. 
Amex filed Amendment No. 1 to the proposed rule change on September 26, 
2006.\3\ Amex filed Amendment No. 2 to the proposed rule change on 
April 19, 2007.\4\ Amex filed Amendment No. 3 to the proposed rule 
change on May 23, 2007.\5\ 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 replaces the original filing in its 
entirety.
    \4\ Amendment No. 2 replaces the original filing and Amendment 
No. 1 in their entirety.
    \5\ Amendment No. 3 made changes to the proposed rule text 
relating to minimum margin requirements.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to list and trade options having a fixed 
return in cash based on a set strike price (``Fixed Return Options'' or 
``FROs'').
    The text of the proposed rule change is available at Amex, from the 
Commission's Public Reference Room, and on Amex's Web site at http://www.amex.com.

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

    In its filing with the Commission, Amex 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
Introduction
    The Exchange proposes to list and trade options, called Fixed 
Return Options, having a fixed return in cash based on a set strike 
price.\6\ The proposed Fixed Return Options would initially consist of 
two types as follows: (1) ``Finish High''\SM\--Each contract returns 
$100 if the underlying settlement value is above the strike price at 
expiration and (2) ``Finish Low''\SM\--Each contract returns $100 if 
the underlying settlement value is below the strike price at 
expiration. The Finish High and Finish Low FROs are similar to existing 
long calls and long puts traded on the Exchange.
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    \6\ Patent Pending. The contract specifications for a FRO are 
set forth in Exhibit A to the proposal.
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    The structure of the FRO is commonly referred to as a ``binary'' 
option.\7\ Although FROs would be based on the same underlying 
securities and in the same framework as existing standardized options 
traded on Amex and the other options exchanges, the amount of the 
payout or profit of an FRO is based on whether the option is in the 
money, not by the degree it is in the money. As a result, the payout at 
expiration is an ``all-or-nothing'' occurrence. As with a standard 
European-style option, the payoff is based on the price of the 
underlying asset at expiration. However, unlike standard options 
currently traded on the Exchange, the payoff would be a fixed amount as 
of the writing of the option contract. In addition, an FRO would be 
automatically exercised at expiration if the price of the underlying 
security settles above the pre-defined strike price, in the case of a 
Finish High, or below the pre-defined strike price, in the case of a 
Finish Low.\8\
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    \7\ A ``binary option'' is an option with a fixed, pre-
determined payoff if the underlying security or index is in the 
money at expiration. The value of the payoff is not affected by the 
magnitude of the differenfce between the underlying and the strike 
price. A binary option is characterized by a discontinuous or non-
linear payoff (i.e., an ``all-or-nothing'' feature).
    \8\ Currently, the Exchange lists and trades Index Flex Options 
that are automatically exercised pursuant to Rule 1804(c) of The 
Options Clearing Corporation (``OCC''). Automatic exercise in this 
context refers to the fact that all in the money options are 
automatically exercised with the holder of such option having no 
choice to not exercise. This differs significantly from the ``Ex-by-
Ex'' procedure (often inaccurately referred to as ``automatic 
exercise'') employed by OCC in OCC Rule 805, which always allows an 
OCC Clearing Member to effect a choice not to exercise an option 
that is in the money by the exercise threshold amount or more, or to 
exercise an option which has not reached the exercise threshold 
amount. The exercise threshold amount set forth in OCC Rule 805 is 
$0.25 per share in the money for customer accounts and $0.15 per 
share in the money for firm and market maker accounts. The exercise 
threshold amount employed in the ``Ex-by-Ex'' procedure triggers the 
automatic exercise only in the absence of contrary instructions from 
the Clearing Member. See also Amex Rule 980.
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    Binary options have been traded in the over-the-counter (``OTC'') 
market for many years.\9\ However, OTC binary options have certain 
disadvantages. OTC binary options are typically offered by an 
institution on a non-fungible basis so the customer can purchase the 
option from or close out the option with only the particular 
institution that issued the option. As a result, OTC binary options 
lack both a trading market (liquidity) as well as transparency. The 
Exchange proposal to list and trade FROs is intended to provide the 
market for binary options with a standardized, fungible product without 
the credit risk of an individual issuer. By providing a listed or 
standardized market for a class of binary options named FROs, the 
Exchange seeks to attract investors who desire a binary option but at 
the same time prefer the certainty and safeguards of a regulated and 
standardized marketplace.
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    \9\ As reported by the Bank for International Settlements 
(``BIS''), the worldwide OTC equity-linked derivatives market was 
estimated on a notional amount basis to be $6.8 trillion as of June 
2006. As of the same time period, OTC equity-based options were 
estimated on a notional amount basis to amount to $5.3 trillion. See 
BIS, OTC Derivatives Market Activity in the First Half of 2006 
(November 2006).
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    The FROs that the Exchange proposes to list and trade would be 
European-style \10\ with expirations based on existing option cycles. 
Strike prices would be quoted based on existing intervals with minimum 
price variations (``MPVs'') expected to be $0.05 (except for those 
option classes that are part of the Penny Quoting Pilot Program, where 
the MPV would be $0.01). Strike prices initially would be established 
at approximate levels up to 20% above and below the price of the 
underlying asset. The Exchange is proposing in this filing to allow 
individual stocks and exchange-traded fund shares (``ETFs'') that meet 
the listing criteria set forth below to underlie an FRO.
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    \10\ A ``European style'' option is an option where the holder 
may exercise the contract only on the last business day prior to 
expiration.
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Benefits and Uses
    FROs are designed to be a simplified version of traditional, 
exchange-traded options. The inherent benefit of FROs is largely 
associated with the certainty provided writers and purchasers, i.e., a 
known maximum payout or liability at the time the contract is entered 
into. For investors, Amex believes that three positive attributes 
relating to FROs are apparent: (i) Simplicity; (ii) risk transparency; 
and (iii) liquidity. First, an FRO is easier to understand and utilize 
than a traditional equity option largely based on the certain payment 
amount and cash settlement. Second, unlike traditional options where a 
writer has unlimited risk, the maximum obligation in connection with an 
FRO is known at $100. Third, as an exchange-traded option, the FRO 
would have the advantage of liquidity provided by specialists and 
market makers; therefore, spreads should be tighter than exists in the 
OTC market. In addition,

[[Page 31638]]

the structure of an FRO eliminates the potential counterparty risk 
inherent in OTC products.
    Amex believes that a significant benefit of an FRO is that the 
purchaser and writer of the FRO know the expected return at the time of 
purchase if the underlying security performs as expected. In contrast, 
the ``traditional'' option does not typically have a known return at 
the time of purchase, i.e., the return cannot be accurately determined 
until the option is nearing expiration due to price movements. In 
addition, because the return on the FRO is a fixed amount, a buyer of 
the FRO would not need to determine the absolute magnitude of the 
underlying security's price movement relative to the strike price, as 
is the case with traditional options. Yet another benefit of the FRO is 
the limited risk/return to the writer/purchaser because of the payout 
being a known, fixed dollar amount. A systemic benefit provided by the 
FRO versus its OTC counterpart is the ability of standardized clearing 
and settlement systems to be programmed to recognize FROs based on 
their unique underlying symbols and segregation for particular 
treatment by systems used for calculating permissible margin as well as 
final payout amounts due at settlement.
    Amex believes that investors will want to utilize FROs to earn 
additional income on securities they own. An ``FRO Call Writing'' 
strategy describes a situation where an investor is long stock and 
writes a Finish High FRO on that same security. In this instance, the 
writer has earned premium while risking a fixed and known portion of 
the upside should the stock close above the FRO strike price at 
expiration. The amount at risk is the difference between $100 and the 
premium received.
    In contrast, if a holder of a long stock position employs a ``Call 
Writing'' strategy by writing a traditional call covered by the 
corresponding long stock position, up to 100% of the potential upside 
may be given up if the stock moves up beyond the option strike price. A 
holder of stock, particularly stock that has depreciated, may lock in a 
loss by selling traditional ``covered calls''--there is no potential 
for upside, beyond the premium received, if the stock moves up and 
closes above the strike at expiration.
    With the ``FRO Call Writing'' strategy, an investor believing his 
long stock position would remain stagnant in the short term may further 
choose to write more than one Finish High FRO, increasing the short-
term return potential by receiving more premium for the additional 
calls sold. The investor by engaging in this FRO Call Writing strategy 
would maintain certainty of stock ownership while knowing the total 
capital or funds at risk if the stock exceeds the strike price of the 
Finish Highs sold.
    On the buy side, Amex believes that the decision process is made 
simpler for the investor with the advent of the FRO. To profit from 
buying a traditional call, an investor must be correct in his 
prediction that the underlying security will appreciate within a given 
period of time. In addition, due to the linear payoff nature of the 
traditional call, the investor must also be correct about the amount of 
time erosion or ``decay'' of the position in the time he holds the 
call. Thus, with a traditional long call purchase, if the investor is 
correct in his prediction that the stock will appreciate within a set 
period of time, there are still other factors, such as volatility and 
time premium, that could affect potential returns.
    If the purchaser of a long FRO position is correct about the 
prediction that the stock will appreciate and also correct about the 
timeframe within which this appreciation will occur, he then has a 
known risk/return profile, due to the non-linear relationship between 
the Fixed Return Option payoff amount and the price of the underlying 
at expiration. This offers the investor the ability to make an exact 
risk/reward analysis of the investment if he is correct in his 
assumption on the underlying stock at expiration. In contrast, the 
traditional call buyer can make only estimates of risk/reward based on 
multiple assumptions.
    The Exchange believes that FROs would also provide investors with 
an efficient way to establish various strategies and enhance portfolio 
performance. For example, the Finish High FRO has characteristics 
similar to a bull call spread; however, in the case of the FRO, an 
investor could accomplish the strategy with reduced execution cost. We 
believe that such unique uses for FROs would provide investors with 
greater opportunities to effectively use options as part of an 
investment strategy. In sum, the Exchange believes that the simple 
structure of FROs will attract investors to the benefits of options 
trading.
Standardization
    The Exchange in proposing FROs is attempting to list a binary 
option in an exchange-traded environment.\11\ In this manner, the 
Exchange intends, to the extent possible, to have FROs recognized and 
treated like existing standardized options. Standardized systems for 
listing, trading, transmitting, clearing, and settling options, 
including systems used by OCC, would be employed in connection with 
FROs. As a result, FROs would have symbology based on the current 
system so that symbols are created that represent the underlying 
security, the fact that the option is a ``Finish High'' or ``Finish 
Low'' FRO as opposed to a traditional put or call, the expiration date, 
the strike price, and the exchange trading FROs.
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    \11\ The Exchange to its knowledge is the first national 
securities exchange to propose the listing and trading of a binary 
option in a standardized environment. The Exchange has pending a 
patent application for trading binary options in an exchange-traded 
environment.
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Options Contract Multiplier
    The standardized option contract traded by all U.S. options 
exchanges typically is quoted in amounts that are multiplied by ``100'' 
due to the fact that the option represents rights associated with 100 
shares of the underlying security upon exercise. The multiplier of 100 
has also been carried over to index options. The Exchange has proposed 
to continue this industry convention for FROs. For example, an option 
that currently is quoted at $0.50 actually costs the investor $50.00 
($0.50 x 100).
Minimum Price Variation
    Amex Rule 952 generally provides that the MPV for an option on a 
stock or ETF shall be: (i) For option issues quoted under $3 a 
contract, $0.05; (ii) for option issues quoted at $3 a contract or 
greater, $0.10. However, in connection with those options classes 
included within the Penny Quoting Pilot Program,\12\ the MPV is as 
follows: (iii) For option issues quoted under $3 a contract, $0.01; 
(iv) for option issues quoted at $3 a contract or greater, $0.05. In 
addition, options on the Power Shares QQQ Trust (formerly, the QQQQ) 
trade at an MPV of $0.01 for all options premiums.
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    \12\ See Securities Exchange Act Release No. 55162 (January 24, 
2007), 72 FR 5738 (February 1, 2007).
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    The MPV for FROs would be $0.05 (and $0.01 for those options 
classes in the Penny Quoting Pilot Program) because, by definition, an 
FRO would never be quoted over $1.00.
Maximum Bid/Ask Differentials
    To contribute to the maintenance of a fair and orderly market, 
specialists and registered options traders (``ROTs'') are typically 
expected to bid and offer so as to create differences of no more than: 
(i) $0.25 between the bid and offer for each option contract for which 
the prevailing

[[Page 31639]]

bid is less than $2; (ii) $0.40 where the prevailing bid is $2 but does 
not exceed $5; (iii) $0.50 where the prevailing bid is more than $5 but 
does not exceed $10; (iv) $0.80 where the prevailing bid is more than 
$10 but does not exceed $20; and (v) $1 where the last prevailing bid 
is more than $20.\13\ With respect to FROs, the Exchange believes that 
the maximum bid/ask differential should typically be $0.25. However, 
due to the non-linear payoff nature of FROs, we believe that during the 
last day of trading prior to expiration, the maximum bid/ask 
differential should be $0.50.\14\
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    \13\ If the bid/ask spread in the underlying security is greater 
than the bid/ask spread for the option, the permissible spread for 
any in the money option series may be identical to the underlying 
security market. We believe FROs should follow this existing 
practice for traditional options. See Amex Rule 958--ANTE(c).
    \14\ Where warranted by market conditions, the Exchange is 
proposing to be able to establish maximum bid/ask spreads other than 
those noted above for one or more series or classes of FROs.
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    In terms of the maximum bid-ask differential, existing options with 
a prevailing bid of $1 equate to the $100 value of an FRO and, 
therefore, a maximum bid-ask differential of $0.25 or $25.00 ($0.25 x 
100). Accordingly, Amex believes, consistent with existing rules, that 
the maximum bid-ask differential for FROs should generally be $0.25.
Expiration Cycles and Strike Price Intervals
    Pursuant to Amex Rule 903, the Exchange generally opens up to four 
expiration months for each options class upon the initial listing of 
such class for trading. Upon expiration of the near-term month, the 
Exchange will then list an additional expiration month. FROs would use 
the same expiration cycle as currently is the case for traditional 
options listed on the Exchange, consistent with Amex Rule 903.
    Strike price intervals in connection with FROs also would employ 
the same procedure as exists for traditional options under Amex Rule 
903 and related commentaries. Specifically, the interval between strike 
prices of series of options on individual stocks may be (i) $2.50 or 
greater where the strike price is $25 or less, provided that the 
Exchange may not list $2.50 intervals below $20 (e.g., $12.50, $17.50) 
for any class included within the $1 Strike Price Pilot Program, if the 
addition of $2.50 intervals would cause the class to have strike price 
intervals that are $0.50 apart; (ii) $5 or greater where the strike 
price is greater than $25 but less than $200; or (iii) $10 or greater 
where the strike price is greater than or equal to $200. For series of 
options on ETFs that satisfy the criteria set forth in Commentary .06 
to Amex Rule 915, the interval of strike prices would be $1 or greater 
where the strike price is $200 or less or $5 or greater where the 
strike price is over $200.\15\
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    \15\ Commentaries .05 and .06 to Amex Rule 903 provide limited 
exceptions to the general strike price intervals in connection with 
the $1 Strike Price Pilot Program and the 2\1/2\ Point Strike Price 
Program.
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    The Exchange proposes that securities underlying options classes 
that currently are part of the $1 Strike Price Pilot Program and the 
2\1/2\ Point Strike Price Program also may underlie an FRO. Due to the 
heightened listing standards proposed by the Exchange in proposed Amex 
Rules 915FRO and 916FRO, the number of FROs available under these 
existing programs would be limited.\16\ Accordingly, the Exchange 
proposes that the strike price intervals for FROs would be established 
under existing procedures as set forth in Amex Rule 903.
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    \16\ As of March 5, 2007, the number of underlying stocks 
available under the $1 Strike Price Pilot Program for FROs would be 
four, while the number of underlying stocks available under the 2\1/
2\ Point Strike Price Program would be 39.
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VWAP Settlement Pricing
    To protect against any potential price manipulation that could 
occur at expiration due to the ``all-or-nothing'' nature of FROs, the 
Exchange has proposed that the expiration or settlement price for an 
underlying individual equity security be calculated as a ``volume 
weighted average price'' or ``VWAP.'' As provided below, FROs would be 
listed only on the most liquid and actively-traded equity securities. 
VWAP is a simple algorithm that is defined as the number of shares 
multiplied by the corresponding reported price of the security. The 
total number of shares reported divides the sum of these transactions 
during the time period used for the calculation. The VWAP calculation 
would be based on composite prices reported during regular trading 
hours for the underlying securities. In addition, the current value of 
the VWAP calculation for each series of FROs would be published and 
disseminated at least every 15 seconds throughout the trading day. The 
Exchange believes that a settlement price based on an ``all-day'' VWAP 
during the last trading day prior to expiration is appropriate for FROs 
based on individual stocks and ETFs. We believe that the use of an 
``all-day'' VWAP for determining the settlement price of an FRO is 
sufficient to protect against concerns of manipulation, and that the 
publication and dissemination of intraday updates of the current VWAP 
calculation would add greater transparency.
    For purposes of the VWAP calculation, the Exchange believes that 
composite prices should be used. Composite pricing is currently 
employed by OCC in connection with the settlement of equity 
options.\17\
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    \17\ See OCC Clearing Members Memorandum No. 18930 (May 29, 
2003); and Securities Exchange Act Release No. 49045 (January 8, 
2004), 69 FR 2377 (January 15, 2004).
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    The VWAP settlement price would be disseminated by the Exchange as 
the official settlement price for FROs and would be made publicly 
available through various market data vendors as well as on the Amex 
Web site at http://www.amex.com.
Underlying Closing Price Methodology
    In the money amounts for any option, including FROs, are a function 
of the underlying security price. For traditional equity and ETF 
options, OCC as the issuer of the options uses the ``composite closing 
price'' (i.e., the last reported sale price during regular trading 
hours) for the underlying security on the trading day immediately 
preceding the expiration date as reported by industry price 
vendors.\18\ As noted above, the Exchange similarly believes, that for 
purposes of calculating the VWAP settlement price for FROs based on 
individual stocks and ETFs, ``composite prices'' should be used. As a 
result, the Exchange would use composite prices of the underlying 
securities to calculate the VWAP settlement price for FROs. In contrast 
to traditional options, the Exchange, not OCC, would determine the 
underlying security prices and calculate the VWAP settlement price.
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    \18\ Id.
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    In a case where the underlying security does not trade during 
regular trading hours on the last trading day prior to expiration or a 
last sale price is not obtainable either due to a trading halt or 
unreliable pricing, OCC has the discretionary authority to set a 
closing price on such basis as it believes appropriate under the 
circumstances.\19\

[[Page 31640]]

OCC currently performs this function for standardized options traded by 
all options exchanges. The Exchange believes that in most cases OCC 
will use the last sale price reported during regular trading hours on 
the most recent trading day for which a last sale price is available.
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    \19\ OCC Rule 805(j) defines the term ``closing price'' to mean 
the last reported sale price for the underlying security on the 
trading day immediately preceding the expiration date on such 
national securities exchange or other domestic securities market as 
the Corporation shall determine. Notwithstanding the foregoing, if 
an underlying security was not traded on such market on the trading 
day immediately preceding the expiration date or if the underlying 
security was traded on such trading day but the Corporation is 
unable to obtain a last sale price, the Corporation may, in its 
discretion: (i) Fix a closing price on such basis as it deems 
appropriate in the circumstances (including, without limitation, 
using the last sale price during regular trading hours on the most 
recent trading day for which a last sale price is available); or 
(ii) suspend the application of the ex-by-ex procedure to option 
contracts for which that security is an underlying security.
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Listing Requirements
    The Exchange proposes that, in addition to meeting the criteria set 
forth in Amex Rule 915 (Initial Listing), an FRO may be initially 
listed only on an individual stock issued by a company that has: (i) A 
market capitalization of at least $40 billion; (ii) minimum trading 
volume over the last 12 months of at least one billion shares; (iii) 
minimum average daily trading volume of at least four million shares; 
(iv) minimum average daily value traded of at least $200 million during 
the prior six months; and (v) the market price per share of the 
underlying security has been at least $10 during the five consecutive 
business days preceding listing. The underlying security price per 
share is measured by the closing price reported in the primary listed 
market in which the underlying security is traded.\20\
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    \20\ See Commentary .01 to Amex Rule 915 for the current options 
listing criteria.
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    With respect to ETFs, the Exchange proposes that, in addition to 
meeting the criteria set forth in Amex Rule 915 (Initial Listing), an 
FRO may be listed only on an ETF that has: (i) A minimum trading volume 
over the last 12 months of at least one billion shares; (ii) a minimum 
average daily trading volume of at least four million shares; (iii) a 
minimum average daily value traded of at least $200 million during the 
prior six months; and (iv) the market price per share of the underlying 
security has been at least $10 during the five consecutive business 
days preceding listing.
    To be eligible for additional FRO series, the Exchange proposes 
that, in addition to meeting the criteria set forth in Amex Rule 916 
(Continued Listing),\21\ an underlying stock have: (i) A market 
capitalization of at least $30 billion; (ii) a minimum trading volume 
over the last 12 months of at least one billion shares; (iii) a minimum 
average daily trading volume of four million shares; (iv) a minimum 
average daily value traded of $125 million during the prior six months; 
and (v) a market price per share of at least $5. For intra-day series 
additions, the market price of an underlying security is measured by 
the last reported trade in the primary listed market in which the 
underlying security trades at the time the Exchange determines to add 
these additional series. In the case of next-day or expiration series 
additions, the market price of an underlying security is measured by 
the closing price reported in the primary listed market on the last 
trading day before the series are added.
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    \21\ See Commentaries .01 and .02 to Amex Rule 916 for the 
current options continuing listing criteria.
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    For additional FRO series based on ETFs, the Exchange proposes 
that, in addition to meeting the criteria set forth in Amex Rule 916 
(Continued Listing), an underlying ETF have: (i) A minimum trading 
volume over the last 12 months of at least one billion shares; (ii) a 
minimum average daily trading volume of four million shares; (iii) a 
minimum average daily value traded of $125 million during the prior six 
months; and (iv) a market price per share of at least $5.
    Proposed Amex Rules 915FRO and 916FRO detail these requirements. 
The Exchange believes that this proposal for listing FROs on individual 
stocks and ETFs is consistent with current requirements for traditional 
options. In connection with individual stocks, Amex believes that a 
higher standard is appropriate for such listings. By providing 
heightened listing standards for underlying securities that may be the 
basis for FROs--consisting of market capitalization, 12-month trading 
volume, average daily trading volume, average daily trading value, and 
a minimum market price per share--the Exchange believes that the 
potential and/or susceptibility of manipulation is greatly reduced. In 
the case of ETFs, Ames has proposed that only actively traded and well 
capitalized ETFs may underlie an FRO. Amex believes that, based on the 
proposed initial and continued listing standards, the susceptibility to 
manipulation is severely dampened.
Position and Exercise Limits
    Amex proposes that an FRO based on an individual stock or ETF have 
a position limit of 25,000 contracts. Existing hedge exemptions found 
in Amex Rules 904 and 904C would not apply to FROs; however, the 
facilitation exemption to position limits currently available to 
members would apply in the case of FROs in connection with facilitating 
customer FRO orders. FROs would not be subject to exercise limits due 
to the fact that FROs are European-style options \22\ and are 
automatically exercised only if the settlement price is in the money.
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    \22\ See supra note 10.
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    The Exchange believes that position limits for FROs should not be 
aggregated with the position limits of existing standardized options on 
the same underlying security. Amex believes that the non-linear (i.e., 
``all-or-nothing'') nature of FROs as well as the risk/return profile 
for FROs provides significant differences to existing standardized 
options that render aggregation of position limits inconsistent. In 
addition, the automatic exercise feature of an FRO also supports Amex's 
belief that an exercise limit should not be imposed because FROs by 
definition cannot be exercised over a five-day period.\23\
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    \23\ Unlike with traditional equity options, exercise 
instructions are not entered for FROs because the contract is 
automatically exercised pursuant to the contract if the settlement 
price exceeds the strike price.
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    Position limits restrict the number of options contracts that an 
investor, or a group of investors acting in concert, may own or 
control. Similarly, exercise limits prohibit the exercise of more than 
a specified number of contracts on a particular instrument within five 
business days. Position limits on exchange-traded options are designed 
to: (i) Minimize the potential for mini-manipulations \24\ as well as 
other forms of market manipulation; (ii) impose a ceiling on the 
position that an investor with inside corporate or market information 
can establish; and (iii) reduce the possibility of disruption in the 
options and underlying cash markets.
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    \24\ Mini-manipulation is an attempt to influence, over a 
relatively small range, the price movement in a stock to benefit a 
previously established options position.
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    Amex believes that the structure of FROs--especially the ``all-
day'' VWAP settlement pricing, heightened listing requirements for 
individual stocks and ETFs underlying FROs, and lower position limits--
should allay regulatory concerns of potential manipulation. In 
particular, Amex notes that, for individual stocks underlying an FRO, 
in addition to the existing listing requirements, the Exchange has 
proposed heightened continuing or maintenance listing standards of: (i) 
At least $30 billion in market capitalization; (ii) a minimum trading 
volume of at least one billion shares over the last 12 months; (iii) a 
minimum average daily trading volume of at least four million shares; 
(iv) a minimum average daily trading value of $125 million; and (v) a 
minimum market price per share of the underlying

[[Page 31641]]

security of $5.\25\ ETFs underlying an FRO would be subject to the same 
continued listing standards except for the minimum market 
capitalization requirement. These heightened listing requirements would 
provide that only the most highly liquid securities may underlie an 
FRO. In addition, Amex believes that the proposed FRO settlement 
pricing based on an ``all-day'' VWAP would greatly reduce the ability 
to use FROs for manipulative purposes.
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    \25\ As of March 5, 2007, 60 stocks and 11 ETFs would qualify 
for FROs.
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    FROs would not be subject to any ``qualified hedge exemptions'' 
from the standard position and exercise limits that currently exist for 
traditional options.
    Consistent with non-FRO or traditional options, positions in FROs 
would have to be reported to the Exchange when an account establishes 
an aggregate same-side-of-the-market position of 200 or more FROs. The 
Exchange also would require that each member or member organization 
(other than an Exchange specialist or registered trader) that maintains 
a position on the same side of the market in excess of 25,000 FROs, for 
its own account or for the account of a customer, report certain 
information. This data would include, but would not be limited to, the 
FRO position, whether such position is hedged and, if so, a description 
of the hedge and, if applicable, the collateral used to carry the 
position. The Exchange believes that the reporting requirements under 
Amex Rule 906 and the surveillance procedures for hedged positions 
would enable the Exchange to closely monitor sizable FRO positions and 
corresponding hedges.\26\
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    \26\ Hedge information for member firm and customeraccounts 
having 200 or more contracts are electronically reported via the 
Large Options Positions Report. Specialist and registered options 
trader account information is also reported to Amex by such member's 
clearing firm. In addition, a member firm is required to report 
hedge information for any proprietary or customer account that 
maintains an options position in excess of 10,000 contracts. These 
procedures would apply to FROs.
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    The Exchange further believes that 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 FROs. 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. The 
Exchange has the authority under paragraph (d)(2)(k) of Amex Rule 462 
to impose a higher margin requirement upon the member or member 
organization when the Exchange determines a higher requirement is 
warranted.
Contract Adjustments
    FROs will be subject to adjustments for corporate and other actions 
in accordance with the rules of OCC. The general rule for adjustments 
in connection with FROs is that, regardless of the corporate action, 
the settlement value (paid in cash) of the FRO would always be 
$100.\27\
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    \27\ Article VI, Section 11(c) of OCC's By-Lawsprovide the 
general rule that there will be no adjustments to reflect ordinary 
cash dividends or distributions or ordinary stock dividends or 
distributions.
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    In the case of even splits \28\ and uneven splits,\29\ OCC and the 
Exchange believe that FROs should be adjusted by changing the strike 
price of the contract.
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    \28\ An ``even split'' is a case where the stock distribution or 
stock split results in one or more whole numbers of shares of the 
underlying security issued with respect to each outstanding share.
    \29\ An ``uneven split'' is a case where the stock distribution 
or stock split results in other than whole numbers of shares of the 
underlying security issued with respect to each outstanding share.
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    OCC submitted a proposed rule change with the Commission on 
November 18, 2004 (OCC File No. SR-OCC-2004-21) to enable it to issue, 
clear, and settle FROs. The OCC proposal would allow it to process FRO 
transactions in accordance with procedures that are substantially 
similar to its existing well established systems and procedures for the 
clearance and settlement of traditional exchange-traded options.
Margin
    Consistent with Amex Rule 462(c)(11) and proposed new paragraph 
(d)(10) of Amex Rule 462, the initial and maintenance margin for long 
positions in FROs would have to equal at least 100% of the purchase 
price of the option (i.e., the premium).\30\ In connection with short 
positions in FROs, the customer margin required is the difference 
between $100 and the proceeds received from the sale of the FRO. Amex 
believes that this proposed margin treatment is adequate and should not 
be otherwise based on the behavior of the underlying security, given 
the fact that the greatest amount at risk for an option writer of an 
FRO is the payout amount of $100. As with existing equity options, 
short FRO positions could be carried in a cash account (not subject to 
margin) and deemed ``covered,'' provided that proposed new paragraph 
(d)(10)(F) of Amex Rule 462 were applicable. ``Covered'' for purposes 
of an FRO is deemed to exist where the writer's obligation is secured 
by a specific deposit or escrow deposit meeting the entire obligation 
of $100 on the FRO. This standard is similar to the available ``cover'' 
for existing exchange-traded options under Amex Rules 462(d)(2)(I) and 
900(b)(23).
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    \30\ New York Stock Exchange Regulation (``NYSER'') confirmed to 
Amex that the proposed margin requirements are appropriate. NYSER 
represented that prior to the launch of FROs, a regulatory circular 
to members would be issued detailing the margin requirements in 
connection with FROs.
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Options Disclosure Document
    As noted above, the OCC submitted a proposed rule change with the 
Commission to accommodate the listing and trading of FROs.\31\ In 
addition, the OCC will also seek a revision to the Options Disclosure 
Document (``ODD'') to incorporate FROs.
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    \31\ See File No. SR-OCC-2004-21.
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6 of the Act,\32\ in general, and furthers the objectives 
of Section 6(b)(5),\33\ in particular, in that it is designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and in general to 
protect investors and the public interest.
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    \32\ 15 U.S.C. 78f(b).
    \33\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement of Burden on Competition

    The Exchange does not believe that the proposed rule change would 
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

    The Exchange has not received any written comments on 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

[[Page 31642]]

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 self-regulatory organization 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. 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 Number SR-Amex-2004-27 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, Station Place, 100 F 
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-Amex-2004-27. 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. Copies of such 
filing also will be available for inspection and copying at the 
principal office of the Exchange. 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 Number SR-Amex-2004-27 and should be submitted on or before June 
28, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-10970 Filed 6-6-07; 8:45 am]
BILLING CODE 8010-01-P