95-29685. Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Pacific Stock Exchange, Inc., Relating to Establishing a Hedge Exemption for Narrow-Based Index Options  

  • [Federal Register Volume 60, Number 234 (Wednesday, December 6, 1995)]
    [Notices]
    [Pages 62517-62519]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 95-29685]
    
    
    
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    SECURITIES AND EXCHANGE COMMISSION
    [Release No. 34-36526; File No. SR-PSE-95-28]
    
    
    Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
    Change by the Pacific Stock Exchange, Inc., Relating to Establishing a 
    Hedge Exemption for Narrow-Based Index Options
    
    November 29, 1995.
        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 November 
    1, 1995, the Pacific Stock Exchange, Inc., (``PSE'' or ``Exchange'') 
    filed with the Securities and Exchange Commission (``SEC'' or 
    ``Commission'') the proposed rule change as described in Items, I, II 
    and III below, which Items have been prepared by the self-regulatory 
    organization. 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 Change
    
        The PSE proposes to amend PSE Rule 7.6, ``Position Limits for Index 
    Options,'' to establish a hedge exemption from industry (narrow-based) 
    index option position limits which would allow PSE members and member 
    organizations, as well as public customers, to exceed the established 
    position limits for narrow-based index options by three times the 
    established position limit for such index options, provided that the 
    position is ``hedged'' with shares of at least 75% of the number of 
    stocks comprising the index.\1\
    
        \1\Position limits impose a ceiling on the number of option 
    contracts which an investor or group of investors acting in concert 
    may hold or write in each class of options on the same side of the 
    market (i.e., aggregating long calls and short puts or long puts and 
    short calls). The PSE's proposal is identical to a proposal 
    submitted by the Philadelphia Stock Exchange, Inc. (``PHLX''), See 
    Securities Exchange Act Release No. 36380 (October 17, 1995), 60 FR 
    54403 (October 23, 1995) (File No. SR-PHLX-95-45).
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        The text of the proposed rule change is available at the Office of 
    the Secretary, PSE 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 aspect of such statements.
    
    (A) Self-Regulatory Organization's Statement of the Purpose of, and 
    Statutory Basis for, the Proposed Rule Change
    
    Purpose
        The purpose of the proposed rule change is to establish a hedge 
    exemption from the industry index option position limits established in 
    PSE Rule 7.6(a).\2\ Specifically, the PSE proposes to add Commentary 
    .03 to PSE Rule 7.6, which will provide that industry index option 
    positions may be exempt from established position limits for each 
    contract ``hedged'' by an equivalent dollar amount of the underlying 
    component securities or securities convertible into such components, 
    provided that each option position to be exempted is hedged by a 
    position in at least 75% of the number of component securities 
    underlying the index, and that the underlying value of the option 
    position does not exceed the value of the underlying portfolio. The 
    value of the portfolio is: (a) the total market value of the net stock 
    position, 
    
    [[Page 62518]]
    less (b) the national value of (1) any offsetting calls and puts in the 
    respective index option; and (2) any offsetting positions in related 
    stock index futures.\3\ The values of any such index option position or 
    related futures position are determined by aggregating the national 
    value of each option contract comprising the position. Under the 
    proposed exemption, position limits for any hedged industry index 
    option may not exceed three times the limits established under PSE Rule 
    7.6(a).
    
        \2\PSE Rule 7.6(a) provides the following position limits for 
    industry index options: 5,500 contracts if, during the Exchange's 
    semi-annual review, the Exchange determines that any single stock in 
    the group accounted, on average, for 30% or more of the index value 
    during the 30-day period immediately preceding the review; 7,500 
    contracts if the Exchange determines that any single stock in the 
    group accounted, on average, for 20% or more of the index value for 
    that any five stocks in the group together accounted, on average, 
    for more than 50% of the index value, but that no single stock in 
    the group accounted, on average, for 30% or more of the index value, 
    during the 30-day period immediately preceding the review; or 10,500 
    contracts if the Exchange determines that the above conditions have 
    not occurred.
        \3\National values are determined by adding the number of 
    contracts and multiplying the total by the multiplier, expressing 
    that number in dollar terms.
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        Members, member organizations, and public customers seeking to use 
    the proposed exemption must obtain prior Exchange approval. In 
    addition, the exemption requires that both the option and stock 
    positions be initiated and liquidated in an orderly manner. 
    Specifically, a reduction of the option position must occur at or 
    before the corresponding reduction in the stock portfolio position.
        Under the proposal, exercise limits will continue to correspond to 
    position limits, so that investors may exercise the number of contracts 
    set forth as the position limit, as well as those contracts exempted by 
    the proposal, during five consecutive business days.\4\
    
        \4\Exercise limits prohibit an investor or group of investors 
    acting in concert from exercising more than a specified number of 
    puts or calls in a particular class within five consecutive business 
    days.
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        Currently, PSE Rule 7.6, Commentary .02, allows public customers to 
    apply for position limit exemptions in broad-based index options that 
    are hedged with exchange-approved qualified stock portfolios.\5\ Under 
    the broad-based index option hedge exemption, a qualified portfolio is 
    comprised of net long or short positions in common stocks or securities 
    readily convertible into common stock in at least four industry groups 
    and contains at least 20 stocks, none of which accounts for more than 
    15% of the value of the portfolio. To remain qualified, a portfolio 
    must meet the standards at all time, notwithstanding the trading 
    activity in the stocks or their equivalents.
    
        \5\See Securities Exchange Act Release Nos. 32900 (September 14, 
    1993), 58 FR 181 (September 21, 1993) (order approving hedge 
    exemption for broad-based index options on a pilot basis); 35738 
    (May 18, 1995), 60 FR 27573 (May 24, 1995) (order approving broad-
    based index option hedge exemption on a permanent basis).
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        Although the broad-based index option hedge exemption applies only 
    to public customers, the Exchange believes it is appropriate to expand 
    the availability of the proposed narrow-based index option position 
    limit exemption beyond public customers.\6\ The PSE believes that 
    significant increases in the depth and liquidity of these index options 
    could result from permitting firm and proprietary traders to be 
    eligible for the exemption. According to the PSE, because customers 
    rely, for the most part, on a limited number of proprietary traders to 
    facilitate large-sized orders, not including such traders in the 
    exemption effectively reduces the benefit of the exemption to 
    customers. While large-sized positions in industry index options are 
    most commonly initiated by institutional traders hedging stock 
    portfolios on behalf of public customers, the PSE believes that 
    proprietary traders should be afforded the same exemption so that they 
    may fulfill their role as facilitators.
    
        \6\The Exchange proposes to apply only the proposed narrow-based 
    industry index option hedge exemption, and not the existing broad-
    based index option hedge exemption, to firms and proprietary traders 
    as well as public customers. Telephone conversation between Michael 
    Pierson, Senior Attorney, Market Regulation, PSE, and Yvonne 
    Fraticelli, Attorney, Office of Market Supervision, Commission, on 
    November 14, 1995.
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        The Exchange believes that its proposed narrow-based index option 
    hedge exemption should not increase the potential for disruption or 
    manipulation in the markets for the stocks underlying each index. The 
    PSE notes that the position limits for narrow-based index options, even 
    tripled, are far less than the position limits for most broad-based 
    index options. In addition, the proposal incorporates several 
    surveillance safeguards, which the Exchange will employ to monitor the 
    use of this exemption. Specifically, the Exchange will require that 
    member firms and their customers who seek exemptions file a form with 
    the PSE, in lieu of granting an automatic exemption similar to that for 
    equity options. The PSE's Options Surveillance Department will monitor 
    trading activity in PSE-traded index options and the stocks underlying 
    those indexes to detect potential frontrunning and manipulation abuses, 
    as well as review to ensure that the closing of positions subject to an 
    exemption is conducted in a fair and orderly manner.
        And lastly, the PSE notes that the provision itself contains 
    several built-in safeguards. First, the hedge must consist of a 
    position in at least 75% of the stocks underlying the index, so that 
    the ``basket'' of stocks constituting the hedge will resemble the 
    underlying index.\7\ Secondly, position limits may not exceed three 
    times the limit established under PSE Rule 7.6(a). This places a 
    ceiling on the maximum size of the option position. Third, both the 
    options and stock positions must be initiated and liquidated in an 
    orderly manner, such that a reduction of the options position must 
    occur at or before the corresponding reduction in the stock portfolio 
    position. Lastly, the value of the industry index option position may 
    not exceed the dollar value of the underlying portfolio. The purpose of 
    this requirement is to ensure that stock transactions are not used to 
    manipulate the market in a manner benefitting the option position. In 
    addition, these safeguards prevent the increased positions from being 
    used in a leveraged manner.
    
        \7\To determine the share amount of each component required to 
    hedge an index option position: index value  x  index multiplier  x  
    component's weighing = dollar amount of component. That amount 
    divided by price = number of shares of component. Conversely, to 
    determine how many options can be purchased based on a certain 
    portfolio, divide the dollar amount of the basket by the index value 
     x  the index multiplier.
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        For the above reasons, the Exchange believes that the proposed 
    narrow-based index option hedge exemption should increase the depth and 
    liquidity of narrow-based index option markets and allow more effective 
    hedging with underlying stock portfolios, without increasing the 
    potential for market manipulation or disruption, consistent with the 
    purposes of position limits. For the same reasons, the Exchange 
    believes that exercise limits should correspond to the position limit 
    exempted granted by this proposal.
    Statutory Basis
        The PSE believes that the proposal is consistent with Section 6(b) 
    of the Act, in general, and with Section 6(b)(5), in particular, in 
    that it is designed to remove impediments to and perfect the mechanism 
    of a free and open market in a manner consistent with the protection of 
    investors and the public interest.
    
    (B) Self-Regulatory Organization's Statement on Burden on Competition
    
        The PSE 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.
    
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    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 reason 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. Persons making written submissions 
    should file six copies thereof with the Secretary, Securities and 
    Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
    Copies of the submission, all subsequent amendments, all written 
    statements with respect to the proposed rule change that are filed with 
    the Commission, and all written communications relating to the proposed 
    rule change between the Commission and any person, other than those 
    that may be withheld from the public in accordance with the provisions 
    of 5 U.S.C. 552, will be available for inspection and copying at the 
    Commission's Public Reference Section, 450 Fifth Street, NW., 
    Washington, DC. Copies of such filing will also be available for 
    inspection any copying at the principal office of the above-mentioned 
    self-regulatory organization. All submissions should refer to the file 
    number in the caption above and should be submitted by December 27, 
    1995.
    
        For the Commission, by the Division of Market Regulation, 
    pursuant to delegated authority.\8\
    
        \8\17 CFR 200.30-3(a)(12) (1994).
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    Margaret H. McFarland,
    Deputy Secretary.
    [FR Doc. 95-29685 Filed 12-5-95; 8:45 am]
    BILLING CODE 8010-01-M
    
    

Document Information

Published:
12/06/1995
Department:
Securities and Exchange Commission
Entry Type:
Notice
Document Number:
95-29685
Pages:
62517-62519 (3 pages)
Docket Numbers:
Release No. 34-36526, File No. SR-PSE-95-28
PDF File:
95-29685.pdf