[Federal Register Volume 60, Number 191 (Tuesday, October 3, 1995)]
[Notices]
[Pages 51825-51831]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24536]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36283; File No. SR-Amex-95-26]
Self-Regulatory Organizations; American Stock Exchange, Inc;
Order Approving and Notice of Filing and Order Granting Accelerated
Approval to Amendment Nos. 1, 3 and 4 to a Proposed Rule Change by the
American Stock Exchange, Inc. Relating to the Listing of Options on the
Morgan Stanley High Technology 35 Index
September 26, 1995.
I. Introduction
On June 29, 1995, the American Stock Exchange, Inc. (``Amex' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to provide for the listing and trading of index
options on the Morgan Stanley High Technology 35 Index (``Tech 35
Index'' or ``Index''). Notice of the proposed rule change appeared in
the Federal Register on July 13, 1995.\3\ No comment letters were
received on the proposed rule change. The Exchange subsequently
submitted Amendment No. 1 to the proposed rule change on August 10,
1995,\4\
[[Page 51826]]
Amendment No. 2 on August 15, 1995,\5\ Amendment No. 3 on September 6,
1995,\6\ and Amendment No. 4 on September 19, 1995.\7\ This order
approves the Exchange's proposal, as amended.
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1994).
\3\See Securities Exchange Act Release No. 35944 (July 7, 1995),
60 FR 37500.
\4\In Amendment No. 1, the Exchange proposed: (1) that if a
determination is made to increase the number of components in the
Index to more than 46 or decrease the number to less than 24, the
Exchange will obtain Commission approval pursuant to Section 19(b)
of the Act prior to making such a change; (2) that all securities
placed on a Replacement List (as defined herein) provided to the
Exchange must have a share price of at least $7.50 at the time the
list is provided to the Exchange and also at the time a replacement
security chosen from a Replacement List is announced as an addition
to the Index; (3) that the Exchange will be required, after each
quarterly review, to replace component securities that fail to meet
the maintenance criteria discussed herein; (4) that if a component
remains in the Index following a merger or consolidation, the number
of shares of that security in the Index will be adjusted, if
necessary, to the nearest whole share, to maintain the component's
relative weight in the Index; (5) the Exchange will review on a
quarterly basis, whether the component securities continue to meet
the required options eligibility standards discussed herein; and (6)
to maintain the Index so that if at any time between annual
rebalancings the top five component securities, by weight, account
for more than one-third of the weight of the Index, the Amex will
rebalance the Index after the close of trading on Expiration Friday
(as defined herein) in the next month in the March cycle. See Letter
from Claire McGrath, Managing Director and Special Counsel,
Derivative Securities, Amex, to Michael Walinskas, Branch Chief,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Division''), Commission, dated August 10, 1995
(``Amendment No. 1'').
\5\Amendment No. 2 was subsequently superseded by Amendment No.
3. See Amendment No. 3, infra note 6.
\6\In Amendment No. 3, the Amex provided that: (1) the Exchange
will replace component securities in the Index that, at the time of
any quarterly review, have failed to maintain a share price of $5.00
or greater for a majority of business days during the three months
prior to such quarterly review; and (2) the Exchange will publicly
disseminate each Replacement List as soon as practicable following
receipt from Morgan Stanley. In Amendment No. 3 the Exchange also
clarified that options on the Index will be listed on the March
cycle. See Letter from Claire McGrath, Managing Director and Special
Counsel, Derivative Securities, Amex, to Michael Walinskas, Branch
Chief, OMS, Division, Commission, dated September 6, 1995
(``Amendment No. 3'').
\7\In Amendment No. 4, the Amex provided that: (1) the Exchange
will in its initial Information Circular describing the trading of
options on the High Tech 35 Index advise its membership that a list
of securities from which the Exchange will choose replacements for
the Index will be publicly available each quarter for their review,
and that the Exchange will issue an Information Circular each
quarter setting forth the updated replacement list; and (2) each
security included on the replacement list will meet the initial
criteria for components in the Index and each security chosen from
that list as a replacement will continue to meet those criteria at
the time of its inclusion in the Index. See letter from Claire
McGrath, Managing Director and Special Counsel, Derivative
Securities, Amex, to Michael Walinskas, Branch Chief, OMS, Division,
Commission, dated September 19, 1995 (``Amendment No. 4'').
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II. Description of Proposal
A. General
The Amex proposes to trade options on the Tech 35 Index, a new
stock index developed by Morgan Stanley & Co. Incorporated (``Morgan
Stanley'') based on technology stocks that are traded on the Amex, the
New York Stock Exchange, Inc. (``NYSE''), or are National Market
securities traded through Nasdaq. In addition, the Amex proposes to
amend Amex Rule 902C(d) to include the Tec 35 Index in the disclaimer
provisions of that rule.\8\ The Amex also proposes to list long-term
options on the Index having up to 36 months to expiration. In lieu of
such long-term options on the full value of the Index, the Amex may
instead list long-term options based on one-tenth of the value of the
Tech 35 Index. These long-term options on either the full or reduced
value of the Index are referred to as ``Tech 35 LEAPS'' or ``Index
LEAPS.'' Tech 35 LEAPS will trade independent of and in addition to
regular Index options traded on the Exchange. However, as discussed
below, position and exercise limits of Index LEAPS (both full and
reduced-value) and regular Index options will be aggregated.
\8\Amex Rule 902C(d) provides, among other things, that Morgan
Stanley does not guarantee the accuracy or completeness of the Tech
35 Index or any data included therein, nor does Morgan Stanley make
any warranty, either express or implied, as to the results to be
obtained by any person or entity from the use of the Tech 35 Index
or any data included therein.
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B. Composition of the Index
The Index is comprised of 35 large, actively traded, technology
stocks. Included in this group are companies in the following
industries: computer services, design software, server software, PC
software and new media, networking and telecommunications equipment,
server hardware, PC hardware and peripherals, specialized systems, and
semiconductors.\9\ The Exchange will use an ``equal dollar-weighted''
method to calculate the value of the Index.\10\ The Index was
initialized at a level of 200 as of the close of trading on December
16, 1994. As of the close of trading on September 5, 1995, the Index
was valued at 300.0. The market capitalizations of the individual
stocks in the Index as of the close of trading on June 15, 1995, ranged
from a high of $54.0 billion to a low of $1.1 billion, with the mean
and median being $11.0 billion and $5.2 billion, respectively. The
market capitalization of all the stocks in the Index on that date was
approximately $386.7 billion. The total number of shares outstanding
for the stocks in the Index ranged from a high of 588.6 million shares
to a low of 19.9 million shares. In addition, the average monthly
trading volume of the stocks in the Index, for the six-month period
from December 1, 1994 through May 31, 1995, ranged from a high of 63.3
million shares per month to a low of 4.5 million shares per month, with
the mean and median being 24.1 million and 14.4 million shares,
respectively. Lastly, as of the close on June 15, 1995, no one stock
accounted for more than 3.98% of the Index's total value and the
percentage weighting of the five largest issues in the Index accounted
for 18.25% of the Index's value.
\9\The current components of the Index are: Apple Computer,
Inc.; Autodesk, Inc.; Adobe Systems Incorporated; Applied Materials,
Inc.; America Online, Inc.; Automatic Data Processing, Inc.; Bay
Networks, Inc.; Broderbund Software, Inc.; Computer Associates
International Inc.; 3Com Corporation; Compaq Computer Corporation;
Cabletron Systems, Inc.; Computer Sciences Corporation; Cisco
Systems, Inc.; EMC Corporation; Electronic Arts Inc.; First Data
Corporation; General Motors (Class E); Hewlett-Packard Company; IBM;
Intel Corporation; Intuit Inc.; KLA Instruments Corporation; Linear
Technology Corporation; Motorola, Inc.; Microsoft Corporation;
Novell, Inc.; Oracle Systems Corporation; Parametric Technology
Corporation; Seagate Technology, Inc.; Silicon Graphics, Inc.;
Synopsys, Inc.; Tellabs Inc.; Texas Instruments, Incorporated; and
Xilinx, Inc.
\10\T3See infra Section II.D entitled ``Calculation of the
Index'' for a description of this calculation method.
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C. Eligibility Standards for the Inclusion Component Stocks in the
Index
The Tech 35 Index conforms with Exchange Rule 901C, which specifies
criteria for the inclusion of stocks in an index on which standardized
options will be traded on the Exchange. In addition, Morgan Stanley has
included in the Index only those stocks that meet the following
standards: (1) a minimum market capitalization of $75 million; (2)
average monthly trading volume of at least one million shares during
the preceding six month period; (3) each component security must be
traded on the Amex or the NYSE, or must be a National Market security
traded through Nasdaq; and (4) upon annual rebalancing, at least 90% of
the Index's numerical value must satisfy the then current criteria for
standardized options trading set forth in Exchange Rule 915.\11\
\11\The Amex's options listing standards, which are uniform
among the options exchanges, provide that a security underlying an
option must, among other things, meet the following requirements:
(1) the public float must be at least 7,000,000 shares; (2) there
must be a minimum of 2,000 stockholders; (3) trading volume must
have been at least 2.4 million over the preceding twelve months; and
(4) the market price must have been at least $7.50 for a majority of
the business days during the preceding three calendar months. See
Amex Rule 915. As of June 15, 1995, all of the Index component
securities had standardized options trading on them.
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D. Calculation of the Index
The Index will be calculated using an ``equal dollar-weighting''
methodology designed to ensure that each of the component stocks are
represented in approximately ``equal'' dollar amounts in the Index. In
calculating the initial ``equal dollar-weighting'' of component stocks,
the Amex, using closing prices on December 16, 1994, calculated the
number of shares that would represent an investment of $300,000 in each
of the stocks contained in the Index (to the nearest whole share). The
value of the Index equals the current market value (i.e., based on U.S.
primary market prices) of the assigned number of shares of each of the
stocks in the Index divided by the current Index divisor. The Index
divisor was initially calculated to yield a benchmark value of 200.00
at the close of trading on December 16, 1994. Annually thereafter,
following the close of trading on the third Friday of December, the
Index portfolio will be adjusted by changing the number of shares of
each component stock so that each company is again represented in
``equal'' dollar
[[Page 51827]]
amounts.\12\ If necessary, a divisor adjustment is made 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
annual adjustment.
\12\In certain circumstances, the Index will be rebalanced prior
to the end of a calendar year. See infra Section II.E. (Maintenance
of the Index).
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Subject to the maintenance criteria discussed below, the number of
shares of each component stock in the Index will remain fixed between
annual reviews except in the event of certain types of corporate
actions, such as the payment of a dividend (other than an ordinary cash
dividend), stock distributions, stock splits, reverse stock splits,
rights offerings, distributions, reorganizations, recapitalizations, or
similar event with respect to an Index component stock. In a merger or
consolidation of an issuer of a component security, if the security
remains in the Index, the number of shares of that security will be
adjusted, if necessary, to the nearest whole share, to maintain the
component's relative weight in the Index at the level immediately prior
to the corporate action.\13\ In the event of a stock replacement, the
average dollar value of the remaining Index components will be
calculated and that amount invested in the replacement stock, rounded
to the nearest whole share. In all cases, the divisor will be adjusted,
if necessary, to ensure Index continuity.
\13\See Amendment No. 1, supra note 4.
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Similar to other stock index values published by the Exchange, the
value of the Index will be calculated continuously and disseminated
every 15 seconds over the Consolidated Tape Association's Network B and
to the Options Price Reporting Authority (``OPRA'').
E. Maintenance of the Index
The Tech 35 Index will be calculated and maintained by the Amex in
consultation with Morgan Stanley which may, from time to time, suggest
changes in the technology industry categories represented in the Index
or changes in the number of component stocks in an industry category to
reflect the changing conditions in the technology sector. In addition
to the annual rebalancings of the Index discussed above, the Amex will
maintain the Index so that if at any time between annual rebalancing
the top five component securities, by weight, account for more than
one-third of the weight of the Index, the Index will be rebalanced
after the close of trading on the third Friday (``Expiration Friday'')
in the next month in the March cycle.\14\
\14\See Amendment No. 1, supra note 4.
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The Amex will also review the Index securities on a quarterly basis
and will replace component securities that fail to meet the following
maintenance criteria:\15\ (1) a minimum market capitalization of $75
million; (2) average monthly trading volume in the component security
of at least 500,000 shares during the preceding six month period; (3) a
share price greater than $5.00 for a majority of the trading days
during the preceding three month period;\16\ and (4) at least 90% of
the Index components, by weight, must satisfy the Exchange's options
eligibility requirements in Rule 915. In addition, the Exchange expects
to maintain the Index with 35 components, however, in the event that
the Exchange determines to increase the number of components in the
Index to more than 46 or decrease the number of components to less than
24, the Exchange must obtain prior approval from the Commission
pursuant to Section 19(b) of the Act.\17\
\15\Id.
\16\See Amendment No. 3. supra note 6.
\17\See Amendment No. 1, supra note 4. The Commission notes that
in the event that the number of components in the Index is changed
to any number other than 35, the Amex must contact the Commission to
determine whether a rule filing pursuant to Section 19(b) of the Act
will be required to change the name of the Index.
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At the beginning of each calendar quarter, Morgan Stanley will
provide the Amex with a current list of 45 replacement stocks from
which to draw in the event that a component in the Index must be
replaced due to merger, takeover, failure to satisfy the above
maintenance criteria, or other similar event (each a ``Replacement
List''). The Amex will be required to hold each Replacement List for a
three month ``seasoning period'' before that Replacement List can be
used by the Amex for selecting replacement securities for the
Index.\18\ The Amex will publicly distribute the Replacement Lists as
soon as practicable following receipt from Morgan Stanley.\19\ In
addition to the requirements discussed above for initial inclusion in
the Index, a security must have a share price of at least $7.50 at the
time it is added to a Replacement List.\20\ Moreover, a security
selected from a Replacement List to be added to the Index must also
have a share price of at least $7.50, as well as meet the other
criteria for inclusion in the Index, at the time it is publicly
announced as a replacement.\21\
\18\See Letter from Robin Roger, Vice President and Counsel,
Morgan Stanley, to Michael Walinskas, Branch Chief, OMS, Division,
Commission, dated September 18, 1995 (``Morgan Stanley Letter'').
\19\See Amendment No. 3, supra note 6.
\20\See Amendment No. 1, supra note 4.
\21\Id. See Also Amendment No. 4, supra note 7.
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The stocks on each Replacement List will be selected and ranked by
Morgan Stanley based on a number of criteria, including conformity to
Exchange Rules 915 and 916, which set forth the criteria for the
initial and continued listing of standardized options on equity
securities, trading liquidity, market capitalization, ability to borrow
shares, and share price. The replacement stocks will be categorized by
Morgan Stanley by industry within the technology sector and ranked
within their category based on the aforementioned criteria. The
replacement stock for a security being removed from the Index will be
selected solely by the Amex from the most recent ``seasoned''
Replacement List based on industry category and liquidity.\22\
\22\The Amex will ensure that at the time of selection it will
only select securities that continue to meet the eligibility
requirements discussed above. See Amendment No. 4, supra note 7.
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In addition, Morgan Stanley will advise the Exchange regarding the
handling of unusual corporate actions which may arise from time to
time. Routine corporate actions (e.g., stock splits, routine spinoffs,
etc.) which require straightforward index divisor adjustments will be
handled by the Exchange's staff without consultation with Morgan
Stanley. All stock replacements and unusual divisor adjustments caused
by the occurrence of extraordinary events such as dissolution, merger,
bankruptcy, non-routine spin-offs, or extraordinary dividends will be
made by Exchange staff in consultation with Morgan Stanley, although
Amex ultimately will select the actual replacement stock from the
Replacement List without Morgan Stanley's assistance. All stock
replacements and the handling of non-routine corporate actions will be
announced at least ten business days in advance of such effective
change, whenever practicable. As with all options currently trading on
the Amex, the Exchange will make this information available to the
public through the dissemination of information circulars.
F. Expiration and Settlement
The Index value for purposes of settling outstanding Index options
and Index LEAPS contracts upon expiration will be calculated based upon
the regular way opening sale prices for each of the Index's component
stocks in their primary market on the last trading day prior to
expiration. In the case of National Market securities traded through
Nasdaq, the first reported sale
[[Page 51828]]
price will be used. Once all of the component stocks have opened for
trading, the value of the Index will be determined and that value will
be used as the final settlement value for expiring Index options
contracts. If any of the component stocks do not open for trading on
the last trading day before expiration, then the prior trading day's
(i.e., Thursday's) last sale price will be used in the Index
calculation. In this regard, before deciding to use Thursday's closing
value of a component stock for purposes of determining the settlement
value of the Index, the Amex will wait until the end of the trading day
on expiration Friday.\23\
\23\For purposes of the daily dissemination of the Index value,
if a stock included in the Index has not opened for trading, the
Amex will use the closing value of that stock in its primary market
on the prior trading day when calculating the value of the Index,
until the stock opens for trading.
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G. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\24\ Standard options trading hours (9:30 a.m. to 4:10
p.m. New York time) will apply to the contracts. The options on the
Index will expire on the Saturday following the third Friday of the
expiration month. Under Amex Rule 903C, the Exchange intends to list up
to three near-term calendar months and two additional calendar months
in three month intervals in the March cycle.\25\ The Exchange also
intends to list Index LEAPS having up to thirty-six months to
expiration. Pursuant to the Amex's rules, strike price interval, bid/
ask differential and price continuity rules will not apply to the
trading of Index LEAPS until their time to expiration is less than
twelve months.
\24\A European-style option can be exercised only during a
specified period before the option expires.
\25\See Amendment No. 3, supra note 6. With respect to Amex Rule
903C(b), the Exchange proposes to list near-the-money option series
on the Index at 2\1/2\ point strike price intervals when the value
of the Index is below 200.
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The options on the Index will expire on the Saturday following
Expiration Friday. Because options on the Index will settle based upon
the opening prices of the component stocks on the last trading day
before expiration (normally a Friday), the last trading day for an
expiring Index option series will normally be the second to the last
business day before expiration (normally a Thursday).
H. Listing of Long-Term Options on the Full Value or Reduced Value
Broker/Dealer Index
The proposal provides that the Exchange may list long-term index
options that expire from 12 to 36 months from listing on the full-value
Tech 35 Index or a reduced-value Index that will be computed at one-
tenth the value of the full-value Index. The current and closing Index
value for reduced-value Tech 35 LEAPS will be computed by dividing the
value of the full-value Index by 10 and rounding the resulting figure
to the nearest one-hundredth. The reduced-value Index LEAPS will also
have a European-style exercise and will be subject to the same rules
that govern the trading of all the Exchange's index options, including
sales practice rules, margin requirements and floor trading procedures.
The strike price interval for the reduced-value Index LEAPS will be no
less than $2.50 instead of $5.00.
In addition, the Amex's rules provide that full-value or reduced-
value Index LEAPS will be issued at no less than six month intervals
and that new strike prices will either be near or bracketing the
current Index value.
I. Position and Exercise Limits, Margin Requirements, and Trading Halts
Because the Index is a Stock Index Option under Amex Rule 901C(a)
and a Stock Index Industry Group under Rule 900C(b)(1), the proposal
provides that Exchange rules that are applicable to the trading of
narrow-based index options will apply to the trading of options on the
Index. Specifically, Exchange rules governing margin requirements,\26\
position and exercise limits,\27\ and trading halt procedures\28\ that
are applicable to the trading of narrow-based index options will apply
to options traded on the Index. The proposal further provides that
positions in full and reduced-value Index LEAPS will be aggregated with
positions in regular Index options. For aggregation purposes, ten
reduced-value contracts will equal one full-value contract.
\26\Pursuant to Amex Rule 462(d)(2)(D)(iv), the margin
requirements for the Index options will be: (1) For each short
options positions, 100% of the current market value of the options
contract plus 20% of the underlying aggregate Index value, less any
out-of-the-money amount, with a minimum requirement of the options
premium plus 10% of the underlying Index value; and (2) for long
options positions, 100% of the options premium paid.
\27\Pursuant to Amex Rules 904C and 905C, respectively, the
position and exercise limits for the Index options will be 10,500
contracts, unless the Exchange determines, pursuant to Rules 904C
and 905C, that a lower limit is warranted.
\28\Pursuant to Amex Rule 918C, the trading of Index options
will be halted or suspended whenever trading in underlying
securities whose weighted value represents more than 20% of the
Index value are halted or suspended.
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J. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in Index options and full-value and reduced-value Index LEAPS.
These procedures include complete access to trading activity in the
underlying securities. Further, the Intermarket Surveillance Group
(``ISG'') Agreement, dated July 14, 1983, as amended on January 29,
1990, will be applicable to the trading of options on the Index.\29\
\29\ISG was formed on July 14, 1983 to, among other things,
coordinate more effectively surveillance and investigative
information sharing arrangements in the stock and options markets.
See Intermarket Surveillance Group Agreement, July 14, 1983. The
most recent amendment to the ISG Agreement, which incorporates the
original agreement and all amendments made thereafter, was signed by
ISG members on January 29, 1990. See Second Amendment to the
Intermarket Surveillance Group Agreement, January 29, 1990. The
members of the ISG are: the Amex; the Boston Stock Exchange, Inc.;
the Chicago Board Options Exchange, Inc.; the Chicago Stock
Exchange, Inc.; the National Association of Securities Dealers,
Inc.; the NYSE; the Pacific Stock Exchange, Inc.; and the
Philadelphia Stock Exchange, Inc. Because of potential opportunities
for trading abuses involving stock index futures, stock options, and
the underlying stock; and the need for greater sharing of
surveillance information for these potential intermarket trading
abuses, the major stock index futures exchanges (e.g., the Chicago
Mercantile Exchange and the Chicago Board of Trade) joined the ISG
as affiliate members in 1990.
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Morgan Stanley has also adopted special procedures to prevent the
potential misuse of material, non-public information by the research,
sales and trading divisions of the firm in connection with the
maintenance of the Index.\30\ As discussed above, the stocks on each
Replacement List are not eligible to be added to the Index by the Amex
for a period of three months after receipt of the Replacement List by
the Exchange. Moreover, the Amex has agreed to publicly disseminate
each Replacement List by issuing information circulars so that
investors will know in advance which securities will be considered as
replacements for the Index.\31\
\30\See Morgan Stanley Letter, supra note 18.
\31\See Amendment No. 3, supra, note 6.
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In addition, Morgan Stanley will have a limited role in the stock
replacement selection and substitution process. First, when a stock in
the Index no longer meets the published criteria as determined
following a quarterly review of the components by the Exchange, the
Amex will determine, without consultation with Morgan Stanley, which
security from the applicable Replacement List will be selected for
addition to the Index. Second, the Amex will also make adjustments as a
result of stock splits, spin-offs, and otherwise, without consultation
with Morgan Stanley. Finally, even in those situations where the Amex
consults
[[Page 51829]]
with Morgan Stanley, upon the occurrence of certain events, the actual
replacement stock will be selected solely by Amex from the 45 stocks on
the replacement list.
III. Findings and Conclusions
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)\32\ Specifically, the
Commission finds that the trading of Tech 35 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 an additional means to
hedge exposure to market risk associated with stocks in the various
high technology industries.\33\
\32\15 U.S.C. 78f(b)(5) (1988).
\33\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 instruments 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 the potential for manipulation,
diminished public confidence in the integrity of the markets, and
other valid regulatory concerns. In this regard, the trading of
listed options on the Index will provide investors with a hedging
vehicle that should reflect the overall movement of the stocks
representing companies in the high technology sector in the U.S.
stock markets.
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The trading of options on the Tech 35 Index and on a reduced-value
Index, however, raises several issues relating to index design,
customer protection, surveillance, and market impact. The Commission
believes, for the reasons discussed below, that the Amex adequately has
addressed these issues.
A. Index Design and Structure
The Commission believes it is appropriate for the Exchange to
designate the Index as a narrow-based index for purposes of index
options trading. The Index is comprised of a limited number (35) of
stocks intended to track a limited range of the technology sector of
the stock market. Accordingly, the Commission believes it is
appropriate for the Amex to apply its rules governing narrow-based
index options to trading in the Index options.\34\
\34\See supra Section II.I (Position and Exercise Limits, Margin
Requirements, and Trading Halts).
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The Commission also believes that the large capitalizations, liquid
markets, and relative weightings of the Index's component stocks
significantly minimize the potential for manipulation of the Index.
First, the stocks that comprise the Index are actively traded, with a
mean and median average monthly trading volume for the period between
December 1, 1994, and May 31, 1995, of 24.1 million and 14.4 million
shares, respectively. Second, the market capitalizations of the stocks
in the Index are very large, ranging from a high of $54.0 billion to a
low of $1.1 billion as of June 15, 1995, with the mean and median being
$11.0 billion and $5.2 billion, respectively. Third, because the index
is equal dollar-weighted, no one particular stock or group of stocks
dominates the Index. Specifically, as of July 15, 1995, no one stock
accounted for more than 3.98% of the Index's total value and the
percentage weighting of the five highest weighted stocks in the Index
accounted for 18.25% of the Index's value. Fourth, the Index will be
maintained so that in addition to the other maintenance criteria
discussed above, at each quarterly review and rebalancing (annual or
otherwise), at least 90% of the weight of the Index will be composed of
securities eligible for standardized options trading.\35\ Currently,
all of the component stocks in the Index have standardized options
trading on them. Fifth, Morgan Stanley and the Amex will be required to
ensure that each component of the Index is subject to last sale
reporting requirements in the U.S. 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 the existing
mechanisms to monitor trading activity in the component stocks of the
Index, or options on those stocks, will help deter as well as detect
any illegal activity.
\35\See Amendment No. 1, supra note 4.
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In addition, even though the Index is only scheduled to be
rebalanced annually, the Commission believes that the Amex and Morgan
Stanley have developed several composition and maintenance criteria for
the Index that will minimize the possibility that the Index could be
manipulated through trading in less actively traded securities or
securities with smaller prices or floats. First, if at any time during
the year the top five components in the Index, by weight, account for
more than one-third of the weight of the Index, the Exchange will
rebalance the Index following the close of trading on Expiration Friday
in the next month in the March cycle. These rebalancing requirements
will serve to ensure that any ``overweight'' stock\36\ will be brought
back into line with the other stocks, thus ensuring that less
capitalized stocks do not become excessively weighted in the Index.
\36\A stock would be ``overweight'' if its weight in the Index
were greater than the average weight of all of the stocks in the
Index. This would occur, for example, if the price of a component
stock significantly increased relative to the other stocks in the
Index during a particular quarter and prior to the rebalancing.
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Second, after each quarterly review and each rebalancing (annual or
otherwise), at least 90% of the weight of the Index will be comprised
of stocks that are eligible for standardized options trading. The
Commission believes that this requirement will ensure that the Index
will be almost entirely made up of stocks with large public floats that
are actively traded, thus reducing the likelihood that the Index could
be easily manipulated by abusive trading in the smaller stocks
contained in the Index.
Third, at each quarterly review of the Index, a component may only
remain in the Index if it satisfies the maintenance requirements
discussed above.\37\ These requirements are similar to the continued
listing requirements for options on individual equity securities.\38\
\37\See supra Section II.E (Maintenance of the Index).
\38\See Amex Rule 916.
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Fourth, because the Index is narrow-based, the applicable position
and exercise limits (currently 10,500) and margin requirements will
further reduce the susceptibility of the Index to manipulation. Lastly,
Morgan Stanley will only add stocks to a Replacement List that are
representative of the high technology sector and, as discussed
above,\39\ satisfy the inclusion criteria.
\39\See supra Section II.C (Eligibility Standards for the
Inclusion of Component Stocks in the Index).
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The Commission notes that certain concerns are raised when a
broker-dealer, such as Morgan Stanley, is involved in the development
and maintenance of a stock index that underlies an exchange-traded
derivative product. For several reasons, however, the Commission
believes that the Amex has adequately addressed this concern with
respect to options on the Index.
First, the value of the Index is to be calculated and disseminated
by the Amex so that unless a party independently calculates the Index
value, neither Morgan Stanley nor any other party will be in receipt of
the values prior to the public dissemination of the Index value.
Second, routine corporate actions (e.g., stock splits, routine
spinoffs, etc.) will be handled by the Amex without consultation with
Morgan Stanley. Third, although stock
[[Page 51830]]
replacements and unusual divisor adjustments caused by the occurrence
of extraordinary events, such as dissolution, merger, bankruptcy, non-
routine spinoffs, or extraordinary dividends, will be made by Exchange
staff in consultation with Morgan Stanley, Amex alone ultimately will
select the actual replacement stock from the Replacement List without
Morgan Stanley's assistance. Such replacements will be announced
publicly at least 10 business days in advance of the effective change
by the Amex through the dissemination of an information circular,
whenever practicable. Fourth, each Replacement List submitted to the
Amex by Morgan Stanley will be published by the Amex and securities
cannot be selected from a Replacement List for three months after
receipt by the Amex. Fifth, the Commission believes that the procedures
Morgan Stanley has established to detect and prevent material non-
public information concerning the Index from being improperly used by
the person or persons responsible for compiling the Replacement Lists,
as well as other persons within Morgan Stanley, as discussed above,\40\
adequately serve to minimize the susceptibility to manipulation of the
Index, the securities in the Index, and securities added to and deleted
from any Replacement List. Finally the Exchange's existing surveillance
procedures for stock index options will apply to the options on the
Index and should provide the Amex with adequate information to detect
and deter trading abuses that may occur. In summary, the Commission
believes that the procedures outlined above help to ensure that Morgan
Stanley will not have any informational advantages concerning
modifications to the composition of the Index due to its limited role
in consulting with Amex on the maintenance of the Index under certain
circumstances.
\40\See Morgan Stanley Letter, supra note 18.
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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 Index options (including
full-value and reduced-value 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 Tech 35 Index options and full-value or reduced value
Index LEAPS. Finally, the Amex has stated that it will distribute
information circulars to members following rebalancings and prior to
component changes to notify members of changes in the composition of
the Index. Additionally, the Amex will publicly disseminate each
Replacement List by means of information circulars. The Commission
believes this should help to protect investors and avoid investor
confusion.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a stock index derivative product
and the exchange(s) trading the stocks 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 stock index product less
readily susceptible to manipulation.\41\ In this regard, the Amex,
NYSE, and National Association of Securities Dealers, Inc. are all
members of the ISG, which provides for the exchange of all necessary
surveillance information.\42\
\41\See Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45829 (October 5, 1992).
\42\See supra note 29.
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D. Market Impact
The Commission believes that the listing and trading of Index
options, including full-value and reduced-value Index LEAPS on the Amex
will not adversely impact the underlying securities markets.\43\ First,
as described above, due to the ``equal dollar-weighting'' method, no
one stock or group of stocks dominates the Index. Second, because at
each quarterly review and each rebalancing of the Index, at least 90%
of the weight of the Index must be accounted for by stocks that meet
the Amex's options listing standards, the component stocks generally
will be actively-traded, highly-capitalized stocks. Third, the
currently applicable 10,500 contract position and exercise limits will
serve to minimize potential manipulation and market impact concerns.
Fourth, the risk to investors of contra-party non-performance will be
minimized because the Index options and Index LEAPS will be issued and
guaranteed by the Options Clearing Corporation just like any other
standardized option traded in the United States.
\43\In addition, the Amex has represented that the Amex and the
OPRA have the necessary systems capacity to support those new series
of index options that would result from the introduction of Index
options and Index LEAPS. See Letter from Charles Faurot, Managing
Director, Market Data Services, Amex, to Michael Walinskas, Branch
Chief, OMS, Division, Commission, dated August 10, 1995; Letter from
Edward Cook, Jr., Managing Director, Information Technology, Amex,
to Michael Walinskas, Branch Chief, OMS, Division, Commission, dated
August 15, 1995; and Letter from Joe Corrigan, Executive Director,
OPRA, to Michael Walinskas, Branch Chief, OMS, DIvision, Comission,
dated August 14, 1995.
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Lastly, the Commission believes that settling expiring Tech 35
Index options (including full-value and reduced-value Index LEAPS)
based on the opening prices of component securities is reasonable and
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
stocks underlying options on he Index.\44\
\44\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 Nos. 1,
3,\45\ and 4 to the proposed rule change prior to the thirtieth day
after the date of publication of notice of filing thereof in the
Federal Register. Specifically, as discussed above, the Commission
believes that Amendment Nos. 1, 3, and 4 serve to minimize the
susceptibility of the Index to manipulation by, among other things,
requiring more restrictive maintenance standards than those originally
proposed by the Exchange, and, in certain circumstances, requiring
rebalancing of the Index more frequently than on an annual basis.
Additionally, the Amex's original proposal was published in the Federal
Register for the full 21-day comment period without any comments being
received by the Commission. Finally, the Commission notes that except
for the proposed rebalancing requirements, the proposal, as amended,
satisfies the Exchange's generic narrow-based index option listing
standards contained in Amex Rule 901C, Commentary .02. As
[[Page 51831]]
discussed above, the Commission believes that the Exchange's proposed
rebalancing requirements are adequate to ensure that any overweight
components are brought back into line with the other components in the
Index. As a result, the Commission believes that accelerating approval
of Amendment Nos. 1, 3, and 4 will allow the Exchange to begin listing
options on the Index (including Index LEAPS) without further delay in
order to provide an additional exchange-traded hedging vehicle for
investors with risk exposure to securities in the various technology
industries.
\45\As noted above, Amendment No. 2 has been superseded by
Amendment No. 3. See supra note 5.
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Based on the above, the Commission believes that the proposal is
consistent with Section 6(b)(5) of the Act and that good cause exists
to approve Amendment Nos. 1, 3, and 4 to the Amex's proposal on an
accelerated basis.
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1, 3, and 4 to the proposed rule
change. 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 Section, 450 Fifth Street, N.W., Washington, D.C. 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-95-26 and should be submitted by October 24, 1995.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\46\ that the proposed rule change (SR-Amex-95-26), as amended, is
approved.
\46\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\47\
\47\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-24536 Filed 10-2-95; 8:45 am]
BILLING CODE 8010-01-M
