[Federal Register Volume 63, Number 202 (Tuesday, October 20, 1998)]
[Notices]
[Pages 56052-56055]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-28002]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40537; File No. SR-Amex-98-12]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the American Stock Exchange, Inc. Relating to the Trading of
Differential Index Options
October 8, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on March 5, 1998, the American Stock Exchange,
Inc. (``Amex'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') the proposed rule change as
described in Items I, II and III below, which Items have been prepared
by the self-regulatory organization. The Exchange filed with the
Commission amendments to the proposed rule change on April 21, 1998,\3\
and September 3, 1998.\4\ The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter to Michael Walinskas, Division of Market
Regulation, Commission, from Claire P. McGrath, Amex, dated April
20, 1998 (``Amendment No. 1''). Amendment No. 1 amends the portion
of the proposal that refers to settlement values for Differential
Index Options where the designated or benchmark security is traded
through the Nasdaq system. Amendment No. 1 provides that the price
of a Nasdaq security used in determining the settlement value of a
Differential Index Option will be equal to the first reported
regular-way sale that occurs after the best bid and best offer for
that security are unlocked and uncrossed and is greater than or
equal to the best bid and less than or equal to the best offer at
the time of the reported sale. For designated and benchmark indices,
the settlement value of the Differential Index Option will continue
to be used on the settlement value for standardized options on the
index. Amendment No. 1 also indicates the Exchange's intent to trade
flexible exchange-traded options on Differential Index options.
\4\ See Letter to Richard Strasser, Division of Market
Regulation, Commission, from Claire P. McGrath, Amex, dated
September 2, 1998 (``Amendment No. 2''). Amendment No. 2 provides
information as to what the Exchange will do to make adjustments in
value for differential index options contracts when certain
corporate events take place in the case of Equity Differential and
Paired Stock Differential options, or when significant action has
been taken by the publisher of an index in the case of Index
Differential options. Amendment No. 2 also clarifies that
Differential Index options will open for trading at 10:00 a.m.
Furthermore, Amendment No. 2 states that transactions may be
effected until 4:15 p.m. for Index Differential options where both
the designated and benchmark indexes are broad stock index groups,
unless the Board of Governors has established different hours of
trading for certain Differential Index options. Amendment No. 2 also
provides that, in consultation with the Commission, the Exchange
will establish the appropriate option position limit for a
Differential Index option, where the Exchange chooses as either a
designated or benchmark index, a broad-based index that has been
approved by the Commission for index warrant trading only. The
position limit for a differential option using a narrow-based index
warrant will be established using Amex's narrow-based index option
rules. Amendment No. 2 also clarifies that the restrictions of Amex
Rule 909I(b) will apply to designated or benchmark stock in Equity
Differential or Paired Stock Differential options. Lastly, Amendment
No. 2 provides the proposed rule language allowing for flexible
exchange-traded options to be traded on Differential Index options.
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The Amex proposes to trade Differential Index Options, a new type
of standardized index option whose value at expiration is based on the
relative performance of either a designated index versus a benchmark
index, a designated stock versus a benchmark index or a designated
stock versus a benchmark stock.
The text of the proposed rule change is available at the Office of
the Secretary, Amex and at the Commission.
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 self-regulatory organization
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 self-regulatory organization
has prepared summaries, set forth in sections A, B and C below, of the
most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange is proposing to trade a new type of standardized index
option, the Differential Index Option, which will offer new investment
and hedging opportunities. Differential Index Options will have a value
at expiration based on an index, called the ``differential index,'' of
the relative performance of a designated index versus a benchmark index
over a specific time period (``Index Differential Option''); of a
designated stock versus a benchmark index over a specific time period
(``Equity Differential Option''); or of a designated stock versus a
benchmark stock (``Paired Stock Differential Option'') over a specific
time period. If the percent gain in the level of the designated index
or stock during the period is greater than the percent gain in the
underlying benchmark index or stock, then a Differential Put Option
originally struck at the money will have a positive value at expiration
and a Differential Put Option originally struck at the money will
expire worthless. If the percentage gain in the level of the designated
index or stock during the period is less than the percent gain in the
underlying benchmark, then a Differential Put Option originally struck
at the money will have a positive value at expiration and a
Differential Call Option originally struck at the money will expire
worthless. Thus, a Differential Index Option affords an investor the
opportunity, through a single investment, to participate in the
relative outperformance of a designated index or stock versus a
benchmark index or stock (a Differential Call Option) or the relative
underperformance of a designated index or stock versus a benchmark
index or stock (a Differential Put Option) over the life of the option,
regardless of the absolute performance of the designated index or
stock.
For example, an investor may feel that pharmaceutical companies
will outperform the broader market over the next several months, but is
unsure whether the overall market will move higher or lower. If the
investor were to buy an at-the-money standardized Pharmaceutical Index
(``DRG'') call option and the Index declined, the option would expire
worthless even if the Index declined by a much smaller percentage than
the overall market. On the other hand, if the investor were to purchase
an at-the-money Index Differential Call Option on the relative perforce
of the Pharmaceutical Index versus the Standard & Poor's 500 Stock
Index (``S&P 500''), a benchmark measure of large capitalization stock
broad market performance, and DRG declined by a smaller percentage than
the S&P 500, the Index Differential Call Option would have a positive
value at expiration. Conversely, an investor who believes that DRG will
underperform the S&P 500 may purchase at-the-money Index Differential
Put Options, perhaps to hedge a portfolio of pharmaceutical stocks
against such market underperformance. If DRG
[[Page 56053]]
underperforms the S&P 500, the Index Differential Put Options will have
a positive value at expiration, regardless of whether the DRG index
level itself has increased or decreased on an absolute basis.
a. Differential Calculation. The underlying security for a
Differential Index Option is an index (called the ``differential
index'') of the performance of the designated stock or index relative
to the benchmark stock or index. The differential index is calculated
as follows: on December 31 of each year, prior to the listing of a
Differential Index Option series, base reference prices are established
for the designated index or stock and the benchmark index or stock
(typically, the closing levels on a designated business day).
Thereafter, percent changes from the base values of both the designated
index or stock and the benchmark index or stock are continuously
calculated and the percent change in the benchmark is subtracted from
the percent change in the designated index or stock, providing a
positive number if the designated index or stock has either out-gained
or suffered a lesser percentage decline than the benchmark, and a
negative number if the benchmark has out-gained the designated index or
stock or suffered a lesser percent loss.
The percentage differential in the relative gain or loss is then
multiplied by 100 and added to a fixed base index value (typically 100)
to yield the differential index which will underlie the Differential
Index Options:
Dt=((It/I0)-(Bt/
B0)) x 100+F
Where:
D=differential index
I=designated index or security;
B=benchmark index or security;
t=current or settlement value of index or security;
0=base reference value of index or security;
F=a fixed base index value, typically 100.
Thus, if the designated index or security has outperformed the
benchmark by 7%, and the fixed value, F, is set at 100, the
differential index value will be 107; if it has underperformed by 7%,
the differential index value would be 93. The base reference values
will remain in effect for a predetermined, fixed period (expected to be
between six months and two years). Similar to other index values
published by the Exchange, the value of each differential index will be
calculated continuously and disseminated under separate symbol every 15
seconds over the Consolidated Tape Association's Network B.
b. Designated Indexes, Designated Stocks, Benchmark Indexes and
Benchmark Stocks. Only stocks which meet the current Exchange Rules for
listing standardized equity options will be eligible designated stocks
in Equity Differential Options. Only stocks which meet the current
Exchange Rules for listing standardized equity options will be eligible
designated stocks or benchmark stocks in Paired Stock Differential
Options. In this way, only the most liquid, actively traded stocks will
be considered.
Similarly, only indexes which meet the current Exchange Rules for
listing standardized index options and have been approved for options
or warrant trading by the Commission will be eligible for designation
either as designated indexes or benchmark indexes in Equity and Index
Differential Options. In this way, only those indexes already deemed by
the Commission to be suitable for options trading will be considered.
c. Expiration and Settlement. The proposed Differential Index
Options will be European style (i.e., exercises permitted at expiration
only), and cash settled. Index Differential Options in which both the
designated or benchmark indexes are broad-based will trade between the
hours of 10:00 a.m. and 4:15 p.m., New York time.\5\ All other
Differential Index Options will trade between 10:00 a.m. and 4:02 p.m.,
New York time. Differential Index Options will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). The last trading day in an expiring 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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\5\ See also Amendment No. 2, supra, note 4.
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While the Exchange seeks approval to list series of Differential
Index Options as set forth in Rule 9031(a)(i), (ii) and (iii), it is
anticipated that the Exchange will initially list only five series with
expirations corresponding to the four calendar months in the March
cycle in the current calendar year, and a fifth series expiring in
March of the following calendar year.
The exercise settlement value for Differential Index Options will
be calculated based on the respective exercise settlement values for
standardized options on each of the designated and benchmark indexes
expiring on the same day. The exercise settlement value for Equity
Differential Options will be calculated based on the primary exchange
regular-way opening sale price of the designated stock, or, if the
stock is traded through the Nasdaq system, the first reported regular-
way sale that occurs after the best bid and best offer for that
security are unlocked and uncrossed and is greater than or equal to the
best bid and less than or equal to the best offer at the time of the
reported sale,\6\ and the exercise settlement value for standardized
options on the benchmark index expiring on the same day. The exercise
settlement value for Paired Stock Differential Options will be
calculated based on the primary exchange regular-way opening sale
prices of the designated and benchmark stocks, or, if the stock is
traded through the Nasdaq system, the first reported regular-way sale
that occurs after the best bid and best offer for that security are
unlocked and uncrossed and is greater than or equal to the best bid and
less than or equal to the best offer at the time of the reported
sale.\7\
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\6\ See Amendment No. 1, supra, note 3.
\7\ See Amendment No. 1, supra, note 3.
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d. Applicable Exchange Rules. AMEX Rules 900I through 9800I will
apply to the trading of Differential Index Option contracts. 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 options will also be used to monitor trading in
Differential Index Options. In addition, Differential Index Options
will be subject to the Exchange's sales practice and suitability rules
applicable to standardized options.
The Exchange currently intends to create Differential Index Options
using, among others, indexes it has licensed from the Standard & Poor's
Corporation. Thus, Rule 902I includes in paragraph (c) a limitation of
liability for the Standard & Poor's Corporation. If the Exchange enters
into license arrangements with other organizations it may amend Rule
902I to include a similar limitation of liability for other
organizations.
Differential Index Options are ``securities'' under Section
3(a)(10) of the Exchange Act, and therefore are exempt pursuant to
Section 28(a) of the Exchange Act from any state law that prohibits or
regulates the making or promoting of wagering or gaming contracts, or
the operation of ``bucket shops'' or other similar or related
activities. Differential Index Options will be traded pursuant to the
Exchange's rules and rule amendments
[[Page 56054]]
discussed herein, which are subject to prior approval by the
Commission.
e. Position Limits. The Exchange proposes that the position limits
for Index Differential Options be set at the lower of the separate
positions limits for standardized index options trading on the
designated index and the benchmark index. In the event that one or both
of the indexes is not currently the subject of standardized index
options trading, but rather has been approved for index warrant trading
only, then the Exchange will establish position limits as the lesser of
those that would be in effect for standardized options on the indexes
if such options were trading.\8\ For Equity Differential Options, the
Exchange proposes that the position limits be set at the position limit
of standardized equity options trading on the designated stock. In the
event that standardized options currently do not trade on the
designated stock, then the Exchange will establish a position limit at
the level that would be in effect if standardized options did trade on
such stock. For Paired Stock Differential Options, the Exchange
proposes that the position limits be set at the lower of the separate
position limits of standardized equity options trading on the
designated and benchmark stocks. In the event that one or both of the
stocks is not currently the subject of standardized options trading,
then the Exchange will establish positions limits as the lesser of
those that would be in effect for standardized options on the stocks if
such options were trading.
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\8\ In the event that one or both of the indexes is the subject
of index warrant trading only, the position limit for a differential
option using a narrow-based index warrant will be established using
Amex's narrow-based index option rules. See Amex Rule 904C(c). The
Exchange will consult with the Commission to establish a position
limit for a differential option using a broad-based index warrant.
Telephone call between Claire P. McGrath, Vice President and Special
Counsel, Amex, and Christine Richardson, Attorney, Commission,
September 29, 1998. See also Amendment No. 2, supra, note 4.
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The Exchange also proposes, for position and exercise limit
purposes, to require that positions in Differentials with the same
designated or benchmark stock or narrowbased index be aggregated. For
example, if a Paired Stock Differential option has been created using
Intel Corporation stock as the benchmark and Motorola, Inc. as the
designated stock, positions in that differential option will be
aggregated for position and exercise limit compliance purposes with
positions in other Paired Stock Differentials that use one of these two
stocks. Furthermore, Equity Differential options using narrow-based
indexes versus either Intel or Motorola as the benchmark or designated
stocks also will be aggregated for position and exercise limit
compliance purposes with positions in Paired Stock Differential options
using one of those two stocks. However, with respect to the use of
board-based indexes as either the benchmark or designated index in an
Equity or Index Differential, no aggregation of positions will be
required. For example, if Equity Differentials are created using the
S&P 500 Index as the benchmark index and Apple Computer, Inc., Philip
Morris Companies, Inc. and Telecommunications, Inc. as designated
stocks, members will not be required to aggregate positions in those
differentials to determine whether an account is in compliance with
position and exercise limit rules.
The Exchange further proposes that Differential Index Options not
be aggregated with other standardized options on the underlying
designated stock or index nor on the underlying benchmark stock or
index for purposes of determining whether an account is in compliance
with position and exercise limit rules. The Exchange believes this
policy is appropriate for the following reasons. First and foremost,
the value Differential Index Options will be calculated in a different
manner from the value of other currently trading standardized equity
and index options. In fact, because of the subtraction of the benchmark
from the designated stock or index, the value of a Differential Index
Options may appreciate (depreciate) even as the value of the
corresponding standardized option on the designated stock or index
decreases (increases). Further, the value of a Differential Index
Option is in part a function of the correlation between the designated
stock or index and the benchmark (i.e., the tendency of the designated
stock or index and the benchmark to move currently). This correlation
component of the Different Index Option price is not considered in
determing the value of other standardized options on either the
designated or benchmark stock or index. As a result, the Differential
Index Options is likely to be more or less sensitive to movements in
the designated stock or index than the other standardized options on
that stock or index, and changes in the Differential Index Option may
be in the opposite direction from changes in other standardized options
prices. Therefore, any attempt to aggregate Differential Index Options
with other standardized options for determination of position limits
would be combining contracts which, by nature, can change in value
quite differently.
Differential Index Options also have certain terms not found in
many other standard equity and index options. Differential Index
Options are cash settled, based on opening prices of the designated
stock or index and the benchmark and feature European exercise. Each
Differential Index Option contract changes in value as a function of
the differential performance of a $10,000 long position in the
designated stock or index and a $10,000 short position in the
benchmark. Many standardized equity options are settled by physical
delivery of 100 shares of the underiving stock, worth $5,000 per
contract for a $50 stock, and feature American exercise. Standardized
index options typically feature European exercise, cash settlement and
represent approximately $25,000 worth of a basket of stocks (with the
index at the 250 level). Any meaningful aggregation of positions in
contracts with different terms would be difficult to established as a
simple rule, and would require a case-by-case analysis of the terms for
each Differential Index Option contract compared to other standardized
contracts on the designated and/or benchmark stock or index.
The Exchange also believes that the aggregation of position limits
hinders the probability of success of any new product. The aggregation
of positions in Differential Options with positions in standardized
options will result in the new product competing with the establishing
product for a limited amount of potential volume. Thus, in the
Exchange's view, with aggregated position limits, new products cannot
``grow the pie'' and increase overall liquidity in all the products;
they start at a disadvantage which may be impossible to overcome.
f. Customer Margin. Since Differential Index Options are similar to
other index options, the Exchange proposed to apply standard index
options margin treatment to Differential Index Options. Index
Differential Options on the relative performance of one broad-based
index versus another will be margined as broad-based index options and
short positions therein will require margin equal to the current market
value of the Differential Index Options plus an amount equal to 15% of
the market value of the Differential Index reduced by any out of the
money amount to a minimum of the current market value of the option
plus 10% of the Index. All other Index Differential Options, Equity
Differential Options and Paired Stock Differential Options will be
margined as narrow-based index options and short
[[Page 56055]]
positions therein will require an amount equal to the current market
value of the Differential Index Option plus an amount equal to 20% of
the market value of the Differential Index reduced by any out of the
money amount to a minimum of the current market price of the options
plus 10% of the Index.
The Exchange believes that this method of determining customer
margin is appropriate since the range of volatilities expected for
Differential Indexes should not be significantly different than the
expected range for other indexes and equities. The volatility of a
Differential Index is based upon the volatilities of the designated and
benchmark indexes or stock and the correlation of these components. The
Exchange has constructed two-year Differential Index series for 44 of
its most actively traded equity option stocks versus the S&P 500 and
for two different index pairs. These combinations cover the range for
negatively correlated pairs through uncorrelated pairs to highly
correlated pairs. The table included in the Exchange's proposal
demonstrates that the volatilities of the Differential Indexes are not
significantly different than the underlying indexes and equities, and
thus should be margined similarly.
2. Basis
The Exchange believes that the proposal is consistent with Section
6(b) \9\ of the Act, in general, and Section 6(b)(5) \10\ of the Act,
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, and to
remove impediments to and perfect the mechanism of a free and open
market and a national market system.
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\9\ 15 U.S.C. 78f(b).
\10\ 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 burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments on the proposed rule change were neither solicited
nor received.
III. 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 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. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 in the
Commission's Public Reference Room, located at the above address.
Copies of such filing will also be available for inspection and copying
at the principal office of the self-regulatory organization. All
submissions should refer to File No. SR-Amex-98-12 and should be
submitted by November 10, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
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\11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-28002 Filed 10-19-98; 8:45 am]
BILLING CODE 8010-01-M
