[Federal Register Volume 59, Number 249 (Thursday, December 29, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31996]
[[Page Unknown]]
[Federal Register: December 29, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35134; File No. SR-NASD-94-60]
Self-Regulatory Organizations; Proposed Rule Change and Amendment
No. 1 to Proposed Rule Change; National Association of Securities
Dealers, Inc.
December 21, 1994.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on October
27, 1994, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') 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 NASD. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule
The NASD proposes to amend Section 33 of the NASD Rules of Fair
Practice, the NASD's position limit rule for standardized and
conventional options, to add a new subsection governing the application
of the NASD's aggregation rules for options positions to certain ``OTC
collar'' transactions involving conventional equity options (``OTC
Collar Aggregation Exemption'').
Section 33 of the NASD By-Laws
* * * * *
Section (b)(3) Position Limits
(a)(1)-(5) No change.
(a)(6) OTC Collar Aggregation Exemption.
(a) For purposes of this subsection, the term OTC collar shall mean
a conventional equity option position comprised of short (long) calls
and long (short) puts overlying the same security that hedge a
corresponding long (short) position in that security.
(b) Notwithstanding the aggregation provisions for short (long)
call positions and long (short) put positions contained in subsections
(A)(1)-(A)(3) above, the conventional options positions involved in a
particular OTC collar transaction need not be aggregated for position
limit purposes, provided the following conditions are satisfied:
1. the conventional options can only be exercised if they are in-
the-money;
2. neither conventional option can be sold, assigned, or
transferred by the holder without the prior written consent of the
writer;
3. the conventional options must be European-style (i.e., only
exercisable upon expiration) and expire on the same date;
4. the strike price of the short call can never be less than the
strike price of the long put; and
5. no more than one side of the transaction can be in-the-money
when the color is established.
6. the size of the conventional options in excess of the applicable
basic position limit for the options established pursuant to
subsections (A) (1)--(3) above must be hedged on a one-to-one basis
with the requisite long or short stock position for the duration of the
collar, although the same long or short stock position can be used to
hedge both legs of the collar. (c) For multiple OTC collars on the same
security meeting the conditions set forth in subsection (b) above, all
of the short (long) call options that are part of such collars must be
aggregated and all of the long (short) put options that are part of
such collars must be aggregated, but the short (long) calls need not be
aggregated with the long (short) puts.
(d) Except as provided above in subsections (b) and (c), in no
event may a member fail to aggregate any conventional or standardized
options contract of the put class and the call class overlying the same
equity security on the same side of the market with conventional option
positions established in connection with an OTC collar.
(e) Nothing in this subsection (6) changes the applicable position
limit for a particular equity security.
On December 14, 1994, the NASD amended the proposal (``Amendment
No. 1'') to require that neither side of a particular OTC collar be in-
the-money at the time the collar is established.\1\
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\1\Letter from Thomas R. Gira, Assistant General Counsel, NASD,
to Stephen M. Youhn, Derivative Products Regulation, SEC, dated Dec.
14, 1994.
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II. Self-Regulatory Organizations's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD 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 NASD 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
The NASD is proposing to amend its options position limit rule to
provide that positions in conventional put and call options
establishing OTC collars meeting certain qualifications need not be
aggregated for position limit purposes.\2\ An OTC collar transaction
involves the purchase (sale) of a long put and the sale (purchase) of a
short call on the same underlying security to hedge a long (short)
stock position. Market participants typically establish OTC collars to
hedge price exposure to long stock positions. Because of the NASD's
aggregation rules for options positions on the same side of the market,
however, members have represented that they have been constrained when
seeking to establish OTC collar positions for their customers. For
example, if a customer wanted to hedge 900,000 shares in XYZ with an
OTC collar (assuming XYZ is subject to a position limit of 4,500
contracts), and if the calls and puts associated with the collar must
be aggregated, the customer could only establish the collar for 450,000
shares (i.e., 4500 short calls and 4,500 long puts).\3\ As a result,
the remaining 450,000 shares of XYZ would remain unhedged.
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\2\Section 33(b)(3) of the NASD Rules of Fair Practice provides
that ``options contracts of the put and call class on the same side
of the market covering the same underlying security'' are aggregated
for position limit purposes. Accordingly, long calls and short puts
are aggregated and short calls and long puts are aggregated.
\3\In this instance, 4,500 of the 9,000 contracts are
permissible under the basic position limit contained in Section
33(b)(3) (A)(1) of the NASD Rules of Fair Practice and the remaining
4,500 contracts are permissible because they are hedged by the
900,000 shares of XYZ and, therefore, fall within the NASD's hedge
exemption contained in Section 33(b)(3) (A)(5).
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Accordingly in order to facilitate the needs of market participants
seeking to hedge their long stock positions with OTC collars, while not
compromising the market integrity and anti-manipulation concerns
underlying the NASD's options position limit rule, the NASD proposes to
waive the aggregation rules for certain OTC collar transactions meeting
specific criteria. Specifically, under the proposal, puts and calls on
the same side of the market would not have to be aggregated for
position limit purposes if they are part of an OTC collar transaction
meeting the following characteristics: (1) the options can only be
exercised if they are in-the-money; (2) neither option can be sold,
assigned, or transferred by the holder without the prior written
consent of the writer; (3) the options must be European-style (i.e.,
only exercisable upon expiration) and expire on the same date; (4) the
strike price of the short call can never be less than the strike price
of the long put; and (5) neither side of the transaction can be in-the-
money when the collar is established.\4\
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\4\See Amendment No. 1.
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In addition, consistent with the NASD'S position limit hedge
exemption rule, to the extent that the size of the conventional options
involved in an OTC collar exceed the size of the applicable basic
position limit for that option, the OTC Collar Aggregation Exemption
provides that such options positions must be hedged on a one-for-one
basis with the corresponding long/short stock position for the duration
of the collar. The NASD also notes that the OTC Collar Aggregation
Exemption will not affect the NASD's other aggregation rules for
options positions on the same side of the market. Thus, the NASD will
aggregate all standardized an conventional options positions with
options positions established pursuant to the OTC Collar Aggregation
Exemption, as well as options positions established in multiple OTC
collars on the same security. For example, if an investor establishes a
short position in 1,000 standardized call options on XYZ, a long
position in 1,000 standardized put options on XYZ, a short position in
1,000 conventional call options on XYZ (not established as part of an
OTC collar), a long position in 1,000 conventional put options on XYZ
(not established as part of an OTC collar), and an OTC collar meeting
the standards set forth above covering 500,000 shares of XYZ, the total
options position for position limit purposes would be 9,000
contracts.\5\ The proposal also contains provisions governing the
aggregation of conventional options positions establishing multiple OTC
collars. Specifically, for multiple OTC collars on the same security
meeting the conditions for the OTC Collar Aggregation Exemption, all of
the short (long) call options that are part of such collars must be
aggregated and all of the long (short) put options that are part of
such collars must be aggregated, but the short (long) calls need not be
aggregated with the long (short) puts.
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\5\See Amendment No. 1. This sentence was amended to correct a
typographical error.
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The NASD believes the conditions and limitations contained in the
OTC Collar Aggregation Exemption proposal strike a reasonable balance
between the need to facilitate legitimate hedging needs of market
participants and the need to have rules in place that do not compromise
the regulatory purposes served by equity option position limits. In
particular, because the conditions and limitations for the OTC Collar
Aggregation Exemption effectively provide that no more than one leg of
the OTC collar can ever be in-the-money at any time during the term of
the collar and no more than one leg of the collar can ever be exercised
throughout the term of the collar, the NASD believes that the potential
for market manipulation or disruption will not be increased by not
requiring the aggregation of the short (long) calls and long (short)
puts established pursuant to the OTC Collar Aggregation Exemption. In
addition, even though the legs of an OTC collar do not have to be
aggregated if the collar meets the standards for the aggregation
exemption, the NASD notes that these positions must be aggregated with
all other standardized and conventional options on the same side of the
market overlying the same security.\6\ Accordingly, the NASD believes
the proposal will not undermine the regulatory purposes served by
equity option position limits.
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\6\However, as noted above, if there are multiple OTC collars on
the same security meeting the conditions for the aggregation
exemption, then all of the short (long) call options that are part
of the collars must be aggregated and all of the long (short) put
options that are part of the collars must be aggregated, but the
short (long) calls need not be aggregated with the long (short)
puts.
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The NASD believes the proposed rule change is consistent with
Section 15A(b)(6) of the Act. Section 15A(b)(6) requires that the rules
of a national securities association be 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 regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system and, in general, to
protect investors and the public interest. Specifically, the NASD
believes that the OTC Collar Aggregation Exemption may increase the
depth and liquidity of the options markets by permitting investors to
hedge greater amounts of stock than would otherwise be the case without
the exemption. In addition, to the extent that investors have greater
assurance that they can hedge larger stock positions through the use of
OTC collars, the NASD believes liquidity in the underlying cash market
may be enhanced by the proposal. At the same time, the NASD believes
that the larger options positions available by virtue of the proposal
will not result in disruptions to the underlying stock market due to
the conditions and limitations that must be met to be eligible for the
aggregation exemption, and the NASD's surveillance program. In this
connection, the NASD will monitor the use of the OTC Collar Aggregation
Exemption to ensure that NASD members are complying with the
requirements of the exemption.
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD believes that the proposed rule change will not result in
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
Comments 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 NASD 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. 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. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to the file number in the caption
above and should be submitted by January 19, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\7\
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\7\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-31996 Filed 12-28-94; 8:45 am]
BILLING CODE 8010-01-M
