[Federal Register Volume 59, Number 197 (Thursday, October 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25277]
[[Page Unknown]]
[Federal Register: October 13, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34791; International Series Release No. 723; File No.
SR-Amex-94-18]
Order Approving Proposed Rule Change and Notice of Filing and
Order Granting Accelerated Approval of Amendment No. 3 to the Proposed
Rule Change by the American Stock Exchange, Inc., Relating to the
Listing and Trading of Options on the Israeli Index
October 5, 1994.
On May 31, 1994, the American Stock Exchange, Inc. (``Amex'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to list and trade options on the
Israeli Index (``Israeli Index'' or ``Index''). On August 2, 1994, the
Exchange filed Amendment No. 1 to the proposed rule change, the subject
matter of which supersedes the original proposal.\3\ On August 8, 1994,
the Exchange filed Amendment No. 2 (``Amendment No. 2'') to the
proposal to clarify how the index will be weighted when the composition
of the Index changes from its current number of eleven components.\4\
On September 28, 1994, the Exchange filed Amendment No. 3 (``Amendment
No. 3'') to the proposal to extend the trading hours of the Index
options by five minutes, to 4:15 p.m., and to reduce the index value in
half by doubling the size of the divisor.\5\
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\1\15 U.S.C. 78s(b)(1) (1982).
\2\17 CFR 240.19b-4 (1991).
\3\In the original proposal, the Amex originally sought approval
of a narrow-based, capitalization-weighted index comprised of ten
components.
\4\See Letter from Nathan Most, Senior Vice President, New
Products Development, Amex, to Michael Walinskas, Derivative
Products Regulation, SEC, dated August 5, 1994.
\5\See Letter from Nathan Most, Senior Vice President, Amex, to
Michael Walinskas, Derivative Products Regulation, SEC, dated
September 28, 1994.
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Notice of the proposed rule change was published for comment in
Securities Exchange Act Release No. 34554 (Aug. 19, 1994) and appeared
in the Federal Register, 59 FR 44198 (Aug. 26, 1994). No comments were
received on the proposal. This order approves the proposal, as amended.
I. Description of the Proposal
The Amex has developed a new index called The Amex/Oscar Gruss
Israel Index, based entirely on shares of widely held Israeli stocks
and American Depositary Receipts (``ADRs'') traded on the NYSE, Amex,
or that are National Market (``NM'') securities traded through the
National Association of Securities Dealers. Automated Quotation system
(``NASDAQ''). The Index contains securities of highly capitalized
companies with major business interests in Israel. These include
companies which are incorporated in Israel, whose offices are located
in Israel, or whose research and development activities are
concentrated in Israel.
Index Calculation and Maintenance
The Index is calculated using a ``modified'' equal dollar weighting
methodology. Five of the eleven component securities have been given a
higher weighting in the Index in order to more closely approximate the
weight the industry represented by that component has in the Israeli
stock market. For example, ECI Telecom Ltd. and Teva Pharmaceutical
Industries, which are the largest capitalized components in the Index,
will have a higher weight in the Index, but not as high as if the Index
were capitalization weighted. The Amex believes that this ``modified''
equal dollar weighting methodology allows the Index to be a more
accurate reflection of the Israeli market since it provides a higher
weighting for the larger capitalized components, yet does not permit
those stocks to dominate the Index.
The following is a description of how the ``modified'' equal dollar
weighting calculation method works. As of the market close on June 17,
1994, a $100,000 portfolio comprised of eleven Israeli component
securities was established representing a hypothetical ``investment''
(rounded to the nearest whole share) of $12,000 in the five largest
capitalized Index components and $6,667 in each of the six remaining
Index components. The value of the Index equals the current market
value (i.e., based on U.S. primary market prices) of the sum of the
assigned number of shares of each of the Index components divided by
the Index divisor. The Index divisor was initially determined to yield
the benchmark value of 213.00 at the close of trading on June 17, 1994,
however, the Amex has since doubled the Index divisor in order to
reduce the Index level.\6\ Each quarter thereafter, following the close
of trading on the third Friday of March, June, September and December,
the Index components will be ranked in descending market capitalization
order and the Index portfolio adjusted by changing the number of whole
shares of each component stock so that the five largest capitalized
stocks in the Index represent 60% of the Index value, and the remaining
40% of the Index value is evenly distributed over the remaining
securities. If the number of components in the Index changes from
eleven securities, the Amex will continue to weigh the five components
with the highest market capitalizations 12%. The remaining components
will then be weighted equally.\7\ For example, if two new components
are added to the Index, the five securities with the highest market
capitalizations will be assigned 12% weightings while the remaining
eight securities in the Index would be weighted 5%.
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\6\See Amendment No. 3.
\7\See Amendment No. 2.
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The Exchange has chosen to rebalance following the close of trading
on the quarterly expiration cycle because it allows an option contract
to be held for up to three months without a change in the Index
portfolio while at the same time, maintaining the ``modified'' equal
dollar weighting feature of the Index. If necessary, a divisor
adjustment is made at the rebalancing to ensure continuity of the
Index's value. The newly adjusted portfolio becomes the basis for the
Index's value on the first trading day following the quarterly
adjustment.
Adjustments to the Index are done on a regular basis and timely,
proper and adequate notice is given to investors. An information
circular is distributed to all Exchange members notifying them of the
quarterly changes. This circular is also sent by facsimile to the
Exchange's contacts at the major options firms, mailed to recipients of
the Exchange's options related information circulars, and made
available to subscribers of the Options News Network. In addition, the
Exchange will include in its promotional and marketing materials for
the Index a description of the ``modified'' equal dollar weighting
methodology.
As noted above, the number of shares of each component stock in the
Index portfolio remains fixed between quarterly reviews except in the
event of certain types of corporate actions such as the payment of a
dividend other than an ordinary cash dividend, a stock distribution,
stock splits, reverse stock splits, a rights offering distribution,
reorganization, recapitalization, or similar event with respect to the
component stocks. In a merger or consolidation of an issuer of a
component stock, if the stock remains in the Index, the number of
shares of that security in the portfolio may be adjusted, to the
nearest whole share, to maintain the components's relative weight in
the Index at the level immediately prior to the corporate action. In
the event of a stock replacement, the average dollar value of the
remaining portfolio components in the same weighting tier as the stock
being replaced will be calculated and that amount ``invested'' in the
stock of the new component, to the nearest whole share. In all cases,
the divisor will be adjusted, if necessary, to ensure Index continuity.
The Amex will calculate and maintain the Index, and pursuant to
Exchange Rule 901C(b) may at any time or from time to time substitute
stocks, or adjust the number of stocks included in the Index, based on
changing conditions in Israel. However, the Exchange will not decrease
the number of Index component stocks to less than nine or increase the
number of component stocks to greater than fourteen without prior
Commission approval.
The value of the Index will be calculated continuously and
disseminated every 15 seconds over the Consolidated Tape Association's
Network B.
Expiration and Settlement
The Exchange proposes to trade cash-settled, European-style Index
options (i.e., exercises are permitted to expiration only). The
Exchange also proposes that Israeli Index options will have trading
hours from 9:30 a.m. to 4:15 p.m. EST.\8\ As with other index options
traded on the Amex, the options on the Index will expire on the
Saturday following the third Friday of the expiration month
(``Expiration Friday''), The last trading day in an option series will
normally be the second to last business day preceding the Saturday
following the third Friday of the expiration month (normally a
Thursday). Trading in expiring options will cease at the close of
trading on the last trading day.
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\8\See Amendment No. 3.
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The Index value for purposes of settling a specific Israeli Index
option will be calculated based upon the primary exchange regular way
opening sale prices for the component securities.\9\ In the case of NM
securities, the first reported sale price will be used. As trading
begins in each of the Index's component securities, its opening sale
price is used in the calculation. Once all of the component stocks have
opened, the value of the Index is determined and that value is used as
the settlement value of the option. If any of the component stocks do
not open for trading on the last trading day before expiration, then
the prior day's last sale price is used in the calculation.
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\9\In the case of ADRs, the primary exchange refers tot he
primary exchange for the ADR and not the underlying security.
Telephone conversation between Claire McGrath, Special Counsel,
Derivative Securities, Amex, and Stephen Youhn, Derivative Products
Regulation, SEC, on Aug. 19, 1994.
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The Exchange plans to list options series with expirations in the
three near-term calendar months and in the two additional calendar
months in the March cycle. In addition, longer term option series
having up to thirty-six months to expiration may be traded. In lieu of
such long-term options on a full-value Index level, the Exchange may
instead list long-term, reduced-value put and call options based on
one-tenth (\1/10\th) the Index's full-value. In either event, the
interval between expiration months for either a full-value or reduced-
value long-term option will not be less than six months.
Eligibility Standards for Index Components
The Index's component securities all have major business interests
in Israel, and have been selected on the basis of their market
capitalization, trading liquidity, and representation of Israeli
business industries. The Amex believes the components represent the
largest and most liquid of all Israeli securities trading in the U.S.,
and that the Index tracks closely the performance of larger broad
market Israeli indexes, such as the Oscar Gruss Israel Index, which
contains all of the more than 50 Israeli securities currently traded in
the U.S. this index is carried in the Israeli press as well as by
Bloomberg L.P., a major U.S. data vendor.
In choosing among Israeli stocks that meet the minimum criteria set
forth in Exchange Rule 901C, the Exchange will select stocks that: (1)
Have a minimum market value in U.S. dollars of at least $75 million,
except that for each of the lowest weighted component securities in the
Index that in the aggregate account for no more than 10% of the weight
of the Index, the market value may be at least $50 million; (2) have an
average monthly trading volume in the U.S. markets over the previous
six month period of not less than 500,000 shares (or ADRs); (3) have at
least 85% of the numerical Index value and at least 80% of the total
number of component securities meeting the current criteria for
standardized option trading set forth in Exchange Rule 915; and (4) are
reported securities that trade on either the NYSE, Amex (subject to the
limitations of Rule 901C), or are NM securities.
The Amex will ensure that not more than 20% of the weight of the
Index is represented by ADRs overlying foreign securities that are not
subject to comprehensive surveillance sharing agreements.\10\ Currently
no Index components have the majority of their trading volume occurring
on an exchange with which the Amex does not currently have in place an
effective surveillance sharing agreement.
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\10\See Amendment No. 2.
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Exchange Rules Applicable to Stock Index Options
Amex Rules 900C through 980C will apply to the trading of regular
and long-term contracts based on the Index. These Rules cover issues
such as surveillance, exercise prices, and position limits.
Surveillance procedures currently used to monitor trading in each of
the Exchange's other index options will also be used to monitor trading
in options on the Index. The Index is deemed to be a Stock Index option
under Rule 901C(a) and a Stock Index Industry Group under Rule
900C(b)(1). With respect to Rule 903C(b), the Exchange proposes to list
near-the-money (i.e., within ten points above or below the current
index value) options series on the Index at 2\1/2\ point strike
(exercise) price intervals when the value of the Index is below 200
points. In addition, the Exchange proposes to establish, pursuant to
Rule 904C(c), a position limit of 7,500 contracts on the same side of
the market.
The Exchange seeks to have the ability to utilize its Auto-Ex
system for orders in Index options of up to 50 contracts. Auto-Ex is
the Exchange's automated execution system which provides for the
automatic execution of market and marketable limit orders at the best
bid or offer at the time the order is entered. The Amex represents that
it has the necessary systems capacity to support new series that would
result from the introduction of Israeli Index Options.\11\
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\11\See Letter from Warren I. Kaiser, Senior vice President,
Information Technology, Amex, to Michael Walinskas, Derivative
Products Regulation, SEC, dated August 8, 1994. Additionally, the
Options Price reporting Authority (``OPRA'') has stated that it has
the necessary systems capacity to support those new series of index
options that would result from the introduction of Index options an
Index LEAPS. See Memorandum from Joe Corrigan, Executive Director,
OPRA, to Charles Faurot, Managing Director, Market Data Services,
Amex, dated August 8, 1994.
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II. Discussion
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, and, in
particular, the requirements of Section 6(b)(5).\12\ Specifically, the
Commission finds that the trading of Israeli Index options, including
full-value and reduced-value Index LEAPS, will serve to promote the
public interest and help to remove impediments to a free and open
securities market by providing investors with a means of hedging
exposure to market risk associated with Israeli securities.\13\
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\12\15 U.S.C. 78f(b)(5) (1988).
\13\Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument is in the public
interest. Such a finding would be difficult for a derivative
instrument that served no hedging or other economic function,
because any benefits that might be derived by market participants
likely would be outweighed by potential for manipulation, diminished
public confidence in the integrity of the markets, and other valid
regulatory concerns. In this regard, the trading of listed Index
options and full-value Index LEAPS will provide investors with a
hedging vehicle that should reflect the overall movement of Israeli
stocks and ADRs in the U.S. securities markets. The Commission also
believes that these Index options will provide investors with a
means by which to make investment decisions regarding Israeli
securities traded in the U.S. securities markets, allowing them to
establish positions or increase existing positions in such markets
in a cost effective manner. Moreover, the Commission believes that
the reduced-value Index LEAPS, which will be traded on an index
computed at one-tenth the value of the Israeli Index, will serve the
needs of retail investors by providing them with the opportunity to
use a long-term option to hedge their portfolios from long-term
markets moves at a reduced cost.
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The trading of options on the Israeli Index, including full-value
and reduced-value Index LEAPS, however, raises several concerns, namely
issues related to index design, customer protection, surveillance, and
market impact. The Commission believes, for the reasons discussed
below, that the Amex adequately has addressed these concerns.
A. Index Design and Structure
The Commission finds that the Israeli Index is a narrow-based
index. The Israeli Index is composed of only eleven securities, all of
which represent Israeli companies.\14\ Accordingly, in light of the
limited number of components in the Index, the Commission believes it
is proper to classify the Israeli Index as narrow-based and apply
Amex's rules governing narrow-based index options to trading in the
Index options.
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\14\The reduced-value Israeli Index, which is composed of the
same component securities as the Index and calculated by dividing
the Index value by ten, is identical to the Israeli Index.
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The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the Index's component securities
significantly minimize the potential for manipulation of the Index.
First, the overwhelming majority of the components that comprise the
Index are actively traded, with an average daily trading volume for the
period from January, 1994 through June, 1994, ranging from a high of
453,000 shares per day to a low of 32,000 shares per day. Second, the
market capitalizations of the securities in the Index are very large,
ranging, during the same period, from a high of $1.46 billion to a low
of $80 million, with the mean and median being $487.7 million and
$252.95 million, respectively. Third, although the Index is only
comprised of eleven component securities, no one particular security or
group of securities dominates the Index. Specifically, no one stock or
ADR comprises more than 12% of the Index's total value and the
percentage weighting of the five largest issues in the Index account
for 60% of the Index's value. Fourth, at least 85% of the securities in
the Index, by weight, and at least 80% of the number of components of
the Index, must be eligible for standardized options trading. This
proposed maintenance requirement will ensure that the Index is
substantially comprised of options-eligible securities.\15\ Fifth, if
the Amex increases the number of component securities to more than
fourteen or decreases that number to less than nine, the Amex will be
required to seek Commission approval pursuant to Section 19(b)(2) of
the Act before listing new strike price or expiration month series of
Israeli Index options and Index LEAPS. This will help protect against
material changes in the composition and design of the Index that might
adversely affect the Amex's obligations to protect investors and to
maintain fair and orderly markets in Israeli Index options and Index
LEAPS. Sixth, the Amex will be required to ensure that each component
of the Index is subject to last sale reporting pursuant to Rule 11Aa3-1
of the Act. This will further reduce the potential for manipulation of
the value of the Index. Finally, the Commission believes that, as
discussed below, the existing mechanisms to monitor trading activity in
the underlying Index components (or options on those securities), will
help deter such illegal activity.
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\15\Currently, nine of the eleven Index components are options-
eligible securities while 89% of the Index, by weight, is comprised
of options-eligible securities.
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The Commission finds that the Exchange's requirements covering
minimum capitalization, monthly trading volume, and relative weightings
of component stocks are designed to ensure that the trading markets for
component stocks are adequately capitalized and sufficiently liquid,
and that no one stock or stock group dominates an index. Thus, the
Commission believes these standards are reasonably designed to ensure
the protection of investors and the public interest and that the
satisfaction of these requirements significantly minimizes the
potential for manipulation of the Index.
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as Israeli Index options
(including full-value and reduced-value Israeli LEAPS), can commence on
a national securities exchange. The Commission notes that the trading
of standardized exchange-traded options occurs in an environment that
is designed to ensure, among other things, that: (1) The special risks
of options are disclosed to public customers; (2) only investors
capable of evaluating and bearing the risks of options trading are
engaged in such trading; and (3) special compliance procedures are
applicable to options accounts. Accordingly, because the Index options
and Index LEAPS will be subject to the same regulatory regime as the
other standardized options currently traded on the Amex, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in Israeli Index options and full-value and reduced-value
Israeli Index LEAPS.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing the list a security index derivative
product and the exchange(s) trading the securities underlying the
derivative product is an important measure for surveillance of the
derivative and underlying securities markets. Such agreements ensure
the availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the security
index product less readily susceptible to manipulation.\16\ In this
regard, the Amex, NYSE, and NASD are all members of the ISG, which
provides for the exchange of all necessary surveillance
information.\17\ Further, as to present and future ADR components of
the Index, either the Exchange must have comprehensive surveillance
sharing agreements with the primary foreign markets for the securities
underlying the ADRs or the U.S. must be the relevant market for
surveillance purposes.\18\
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\16\Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\17\If the prices of the ADR components, or the composition of
the Index, should change so that greater than 20% of the weight of
the Index would be represented by ADRs whose underlying securities
were not the subject of a comprehensive surveillance sharing
agreement with the Amex, then it would be difficult for the
Commission to reach the conclusions reached in this order and the
Commission would have to determine whether it would be suitable for
the Exchange to continue to trade options on this Index. The Amex
should, accordingly, notify the Commission immediately if more than
20% of the numerical value of the Index is represented by ADRs whose
underlying securities are not subject to a comprehensive
surveillance sharing agreement. Such a change in the current
relative weights of the Index or in the composition of the Index
will warrant the submission of a rule filing pursuant to Section 19
of the Act. In determining whether a particular ADR is subject to a
comprehensive surveillance sharing agreement, see, e.g., Securities
Exchange Act Release Nos. 31531 (November 27, 1992), 57 FR 57250
(December 3, 1992); and 33554 (January 31, 1994), 59 FR 5622
(February 7, 1994).
\18\See Securities Exchange Act Release Nos. 31531 (November 27,
1992), 57 FR 57250 (December 3, 1992); and 33554 (January 31, 1994),
59 FR 5622 (February 7, 1994).
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D. Market Impact
The Commission believes that the listing and trading of Israeli
Index options, including full-value and reduced-value Index LEAPS, on
the Amex will not adversely impact the underlying securities markets.
First, as described above, for the most part, no one security or group
of securities dominates the Index. Second, because at least 85% of the
numerical value of the Index and at least 80% of the components of the
Index must be accounted for by securities that meet the Exchange's
options listing standards, and because each of the component securities
must be subject to last sale reporting pursuant to Rule 11Aa3-1 of the
Act, the component securities generally will be actively-traded,
highly-capitalized securities. Third, the 7,500 contract position and
exercise limits applicable to Index options and Index LEAPS will serve
to minimize potential manipulation and market impact concerns.
The Commission believes that settling expiring Israeli Index
options (including full-value and reduced-value Index LEAPS) based on
the opening prices of component securities is consistent with the Act.
As noted in other contexts, valuing options for exercise settlement on
expiration based on opening prices rather than closing prices may help
reduce adverse effects on markets for securities underlying options on
the Index.\19\ Lastly, the Commission believes the ability to use Auto-
Ex for orders of up to 50 contracts will provide customers with liquid
markets and efficient executions.
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\19\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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The Commission finds good cause for approving Amendment No. 3 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice there in the Federal Register. The Commission
believes that the Amex's doubling of the size of the Index divisor in
order to reduce the value of the Index in half is consistent with the
purposes of the Act. A lower Index should make the Index options more
affordable and available to individual investors, thereby resulting in
improved efficiency or liquidity in the execution of these Index
options. Furthermore, the Commission believes the Amex's extension of
its trading hours in the Index options by five minutes is non-
substantive and does not raise any new or unique regulatory issues.
Both the Chicago Board Options Exchange, Inc. and Pacific Stock
Exchange, Inc. currently trade a form of Index options on an Israeli
Index and their trading hours extend until 4:15 p.m. The Amex's change
simply brings the three Exchange's into conformity. Accordingly, the
Commission believes it is consistent with Sections 6(b)(5) and 19(b) of
the Act to approve Amendment No. 3 to the proposed rule change on an
accelerated basis.
III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 3. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549. 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 at the Commission's Public Reference Section, 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 Amex. All
submissions should refer to File No. SR-Amex-94-18 and should be
submitted by November 3, 1994.
It therefore is ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule change (SR-Amex-94-18) is approved, as
amended.
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\20\15 U.S.C. 78s(b)(2) (1988).
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) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-25277 Filed 10-12-94; 8:45 am]
BILLING CODE 8010-01-M
