[Federal Register Volume 64, Number 243 (Monday, December 20, 1999)]
[Notices]
[Pages 71158-71160]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-32821]
[[Page 71158]]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42223; File No. SR-Amex-99-40; SR-PCX-99-41; SR-CBOE-
99-59]
Self-Regulatory Organizations; American Stock Exchange LLC;
Pacific Exchange, Inc.; Chicago Board Options Exchange, Inc.; Order
Granting Accelerated Approval to Proposed Rule Change Relating to the
Permanent Approval of the Elimination of Position and Exercise Limits
for FLEX Equity Options
December 10, 1999.
I. Introduction
On October 5, 1999, October 13, 1999, and November 4, 1999, the
American Stock Exchange LLC (``Amex''), Pacific Exchange, Inc.
(``PCX''), and the Chicago Board Options Exchange, Inc. (``CBOE'')
(collectively, the ``Exchanges''), submitted to the Securities and
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\
and Rule 19b-4 thereunder, \2\ proposed rule changes to make permanent
their pilot programs to eliminate position and exercise limits for FLEX
Equity options.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
The proposed rule changes were published for comment in the Federal
Register on November 11, 1999. \3\ No comments were received on the
proposals. This order approves the proposals on an accelerated basis.
---------------------------------------------------------------------------
\3\ See Securities Exchange Act Release No. 42126 (November 10,
1999), 64 FR 63064 (November 18, 1999).
---------------------------------------------------------------------------
II. Background and Description
On February 14, 1996 and June 19, 1996, the Commission approved the
Exchanges' proposals to list and trade FLEX Equity options on specified
equity securities. \4\ According to the Exchanges, those proposals were
designed to provide investors with the ability, within specified
limits, to designate certain terms of the options. In support of their
proposals, the Exchanges stated that in recent years, an over-the-
counter (``OTC'') market in customized equity options had developed
which permitted participants to designate the basic terms of the
options including size, term to expiration, exercise style, exercise
price, and exercise settlement value. According to the Exchanges,
participants in this OTC market were typically institutional investors,
who bought and sold options in large-size transactions through a
relatively small number of securities dealers. To compete with this
growing OTC market in customized equity options, the Exchanges proposed
to expand their FLEX options rules \5\ to permit the introduction of
trading in FLEX options on specified equity securities that satisfied
the Exchanges' listing standards for equity options. \6\ The Exchanges'
proposals allowed FLEX Equity option market participation to designate
the following contract terms: (1) certain exercise prices; \7\ (2)
exercise style (i.e., American, European, or capped); \8\ expiration
date; \9\ and (4) option type (i.e., put call, or spread). In addition,
the Exchanges set position and exercise limits for FLEX Equity options
at three times the position limits for the corresponding Non-FLEX
Equity options on the same underlying security. \10\
---------------------------------------------------------------------------
\4\ See Securities Exchange Act Release Nos. 36841 (February 14,
1996), 61 FR 6666 (February 21, 1996) (File Nos. SR-CBOE-95-43 and
SR-PSE-95-24), and 37336 (June 19, 1996), 61 FR 33558 (June 27,
1996) (File No. SR-Amex-95-57).
\5\ See e.g., Amex Rules 900G through 909G. At the time of their
FLEX Equity option proposals, the Amex and the CBOE had already
secured Commission approval to list and trade FLEX options on
several broad-based market indexes composed of equity securities
(``FLEX Index options''). See, e.g., Securities Exchange Act Release
Nos. 32781 (August 20, 1993), 58 FR 45360 (August 27, 1993) (order
approving the trading of FLEX Index options on the Major Market,
Institutional, and S&P MidCap Indexes) (File No. SR-Amex-93-05), and
34052 (May 12, 1994), 59 FR 25972 (May 18, 1994) (order approving
the trading of FLEX Index options on the Nasdaq 100 Index) (File No.
SR-CBOE-93-46).
\6\ See e.g., Amex Rule 915, containing initial listing
standards for a security to be eligible for options trading. In
addition, the Exchanges may trade FLEX options on any options-
eligible security regardless of whether standardized Non-FLEX
options overlie that security and regardless of whether such Non-
FLEX options trade on the Exchanges.
\7\ See Securities Exchange Act Release No. 37726 (September 25,
1996), 61 FR 51474 (October 2, 1996), regarding restrictions on the
available exercise prices for FLEX Equity call options.
\8\ An American-style option is one that may be exercised at any
time on or before the expiration date. A European-style option is
one that may be exercised only during a limited period of time prior
to expiration of the option. A capped-style option is one that is
exercised automatically prior to expiration when the cap price is
less than or equal to the closing price of the underlying security
for calls, or when the cap price is greater than or equal to the
closing price of the underlying security for puts.
\9\ The expiration date of a FLEX Equity option cannot, however,
fall on a day that is on, or within two business days of, the
expiration date of a Non-FLEX Equity option.
\10\ At that time, position and exercise limits for FLEX Equity
options were set as follows as compared to then-existing limits for
Non-FLEX Equity options on the same underlying security.
Non-FLEX Equity position limit
4,500 contracts
7,500 contracts
10,500 contracts
20,000 contracts
25,000 contracts
FLEX Equity position limit
13,500 contracts
22,500 contracts
31,500 contracts
60,000 contracts
75,000 contracts
Aggregation of positions or exercises in FLEX Equity options
with positions or exercises in Non-FLEX Equity options was not
required for purposes of the limits.
---------------------------------------------------------------------------
Thereafter, on September 9, 1997, the Commission approved proposed
rule change from the Exchanges eliminating position and exercise limits
for FLEX Equity options on a two-year pilot basis. \11\ In addition to
eliminating position and exercise limits, the pilot program required
that a member or member organization (other than a Specialist or
Registered Options Trader) report to the Exchange information for each
account that maintains a position on the same side of the market in
excess of three times the position limit level established pursuant to
the applicable exchange rule for Non-Flex Equity options of the same
class. The report included information regarding the FLEX Equity option
position, positions in any related instrument, the purpose or strategy
for the position, and the collateral used by the account. \12\
---------------------------------------------------------------------------
\11\ See Securities Exchange Act Release No. 39032 (September 9,
1997), 62 FR 48683 (September 16, 1997) (approving File Nos. SR-
Amex-96-19; SR-CBOE-96-79; SR-PCX-97-09).
\12\ The Exchanges also required that an updated report be filed
when a change in the options position occurred or when a significant
change in the hedge of that position occurred. See Securities
Exchange Act Release No. 39032 (September 9, 1997), 62 FR 48683
(September 16, 1997).
---------------------------------------------------------------------------
Furthermore, the Commission, in its order approving the pilot
program, required each of the Exchanges to submit a report containing a
description of: (i) the types of strategies used by FLEX Equity options
market participants and whether FLEX Equity options are being used in
lieu of existing standardized equity options; (ii) the type of market
participants using FLEX Equity option both before and during the pilot
program, including how the utilization of FLEX Equity options has
changed; (iii) the average size of FLEX Equity option contracts both
before and during the pilot program, the size of the largest FLEX
Equity option contract on any given day both before and during the
pilot program, and the size of the largest FLEX Equity option held by
any single customer/member both before and during the pilot program;
and (iv) any impact on the prices of underlying stocks during the
establishment or unwinding of FLEX positions that are greater than
three times the standard
[[Page 71159]]
position limit. Each of the Exchanges has filed their reports, which
will be discussed below.
On September 9, 1999, the Commission approved an extension of the
pilot programs for another three months.\13\ The current pilot programs
expired on December 9, 1999. Accordingly, the Exchanges request
approval of their programs on a permanent basis. All of the terms and
conditions applicable under the current pilots, including the reporting
requirements, will remain in effect after the proposals are approved
permanently.\14\
---------------------------------------------------------------------------
\13\ See Securities Exchange Act Release No. 41848 (September 9,
1999), 64 FR 50846 (September 20, 1999).
\14\ Telephone call between Tim Thompson, CBOE, and Christine
Richardson, on December 10, 1999; telephone call between Robert
Pacileo, PCX, and Christine Richardson, on December 10, 1999. The
Amex proposal explicitly states that the same terms and conditions
applicable during the pilot will remain in effect after the proposal
is permanently approved.
---------------------------------------------------------------------------
III. 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, with the requirements of Sections 6 and 11A of the Act.\15\
Specifically, the Commission believes that the rule proposals are
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and are not designed to
permit unfair discrimination between customers, issuers, brokers, or
dealers.
---------------------------------------------------------------------------
\15\ See 15 U.S.C. 78f(b) and 78k-1. In approving this rule
change, the Commission notes that it has considered the proposal's
impact on efficiency, competition, and capital formation, consistent
with Section 3 of the Act. Id. at 78c(f).
---------------------------------------------------------------------------
The Commission also believes that the proposed rule changes are
consistent with Section 11A of the Act in that the permanent
elimination of position and exercise limits for FLEX Equity options
allows the Exchanges to better compete with the growing OTC market in
customized equity options, thereby encouraging fair competition among
brokers and dealers and exchange markets. The attributes of the
Exchanges' options markets versus an OTC market include, but are not
limited to, a centralized market center, an auction market with posted
transparent market quotations and transaction reporting, parameters and
procedures for clearance and settlement, and the guarantee of the OCC
for all contracts traded on the Exchanges.
The Commission has generally taken a gradual, evolutionary approach
toward expansion of position and exercise limits. Given that the
current pilot programs have run for the past two years without
incident, the Commission believes that it is appropriate to approve the
pilots on a permanent basis. First, the FLEX Equity options market is
characterized by large, sophisticated institutional investors (or
extremely high net worth individuals), who have both the experience and
ability to engage in negotiated, customized transactions. For example,
with a required minimum size of 250 contracts to open a transaction in
a new series, FLEX Equity options are designed to appeal to
institutional investors, and it is unlikely that many retail investors
would be able to engage in options transactions at that size. Second,
all of the Exchanges' other current rules and provisions governing FLEX
Equity options remain applicable.\16\ Third, the OCC will serve as the
counter-party guarantor in every exchange-traded transaction. Fourth,
the proposed elimination of position and exercise limits for FLEX
options could potentially expand the depth and liquidity of the FLEX
equity market without significantly increasing concerns regarding
intermarket manipulations or disruptions of the options or the
underlying securities. Fifth, the enhanced reporting requirements
should help the Exchanges to monitor accounts under risk and to take
any appropriate action. Finally, the Exchanges' surveillance programs
will be applicable to the trading of FLEX Equity options and should
detect and deter trading abuses arising from the elimination of
position and exercise limits.
---------------------------------------------------------------------------
\16\ See, e.g., Amex Rules 900G through 909G.
---------------------------------------------------------------------------
As described above, the Exchanges have adopted important safeguards
that will allow them to monitor large positions in order to identify
instances of potential risk and to assess additional margin and/or
capital charges, if necessary. The Exchange require each member or
member organization (other than a Specialist, a Registered Options
Trader, a Market Maker, or a Designated Primary Market Maker) that
maintains a position on the same-side of the market in excess of three
times the position limit level established pursuant to the applicable
exchange rule for Non-FLEX Equity options of the same class to report
information to the exchange regarding the FLEX Equity option position,
positions in any related instrument, the purpose or strategy for the
position, and the collateral used by the account. By monitoring
accounts in excess of three times the Non-FLEX Equity option position
limit in this manner, the Exchanges should be provided with the
information necessary to determine whether to impose additional margin
and/or whether to assess capital charges upon a member organization
carrying the account. In addition, this information should allow the
Exchanges to determine whether a large position could have an undue
effect on the underlying market and to take the appropriate action.
The Commission believes that it is reasonable to treat FLEX Equity
options differently than regular standardized options. FLEX options
compete directly with the OTC options. The Commission believes that it
would be beneficial to attract OTC activity back to a more transparent
market with a clearinghouse guarantee. Hence, a liberalization of
position limits for FLEX Equity options is a measured deregulatory
means to enable the Exchanges to compete with the OTC market while
preserving important oversight safeguards.
As noted above, each of the Exchanges was required to submit a
report assessing the effects of the pilot programs. This information
was required to allow the Commission to evaluate the consequences of
the programs and to determine whether permanent approval was
appropriate. The Commission has reviewed these reports. Although the
Commission cannot entirely rule out the potential for future adverse
effects on the securities markets for the FLEX Equity options or
component securities underlying FLEX Equity options, the reports
support permanent approval of the pilots because such effects and
abuses have not occurred over the two year pilot period.
In reports, the Exchanges indicate that their experiences with the
pilot programs have been positive. Generally, none of the Exchanges
note a change in the types of strategies used by FLEX Equity options
market participants, nor do they believe that market participants are
using FLEX Equity options in lieu of existing standardized equity
options. Although the PCX experienced new activity by market makers,
the Exchanges generally indicate that the types of market participants
using FLEX Equity options during the pilots remained consistent to
those using the product before the elimination of position and exercise
limits. The average size of the FLEX Equity option contract increased
to varying degrees on all of the Exchanges. The size of the largest
FLEX Equity option contract also increased to varying degrees on each
of the Exchanges during the pilots. Despite
[[Page 71160]]
this increase, FLEX Equity options represented a very small percentage
of options transactions when compared to the standardized equity
market. Further, although each of the Exchanges generally experienced
an increase in trading activity and size of contracts during the pilot
period, a very insignificant number of positions actually exceeded
three times the standardized options position limit. Based on the
above, the Exchanges concluded that the elimination of position and
exercise limits for FLEX Equity options did not have any impact on the
prices of the underlying stocks during the establishment or unwinding
of FLEX Equity positions greater than three times the standard position
limit.
Finally, given the size and sophisticated nature of the FLEX Equity
options market, the reporting and margin requirements, and the fact
that the pilot programs have run the past two years without incident,
the Commission believes that eliminating position and exercise limits
for FLEX Equity options on a permanent basis does not substantially
increase manipulative concerns. The Commission continues to believe
that the enhanced market surveillance of large positions should help
the Exchanges to take the appropriate action in order to avoid any
manipulation or market risk concerns. The Commission expects the
Exchanges to take prompt action, including timely communication with
the Commission and other marketplace self-regulatory organizations
responsible for oversight of trading in FLEX options and the underlying
stocks, should any unanticipated adverse market effects develop. In
summary, because of the special nature of the FLEX Equity markets, the
Commission believes that the Exchanges' proposals should be approved on
a permanent basis. In permanently approving the proposals, the
Commission believes that the distinctions between the FLEX Equity
options market and the standardized equity options market, as described
above, warrant the different regulatory applications of position and
exercise limits under the Act.
The Commission finds good cause for approving the proposed rule
changes prior to the thirtieth day after the date of publication of
notice thereof in the Federal Register. Specifically, the Commission
believes that because approval of the permanent approval of the
proposals will allow the pilot programs to continue uninterrupted based
on the same terms and conditions of original pilot, it is consistent
with the protection of investors and the public interest to approve the
proposed rule changes on an accelerated basis. Further, a full 21-day
comment period was provided and no comments were received. Accordingly,
the Commission believes it is consistent with Section 6(b)(5) and
Section 19(b)(2) of the Act to grant accelerated approval to the
proposed rule changes.\17\
---------------------------------------------------------------------------
\17\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
---------------------------------------------------------------------------
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rule changes (SR-Amex-99-40; SR-PCX-99-41;
SR-CBOE-99-59) be approved.
---------------------------------------------------------------------------
\18\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
---------------------------------------------------------------------------
\19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-32821 Filed 12-17-99; 8:45 am]
BILLING CODE 8010-01-M
