[Federal Register Volume 60, Number 27 (Thursday, February 9, 1995)]
[Notices]
[Pages 7805-7808]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3280]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35327; File No. SR-AMEX-94-56]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendment No. 1 to Proposed Rule Change by the American
Stock Exchange, Inc., Relating to Buy-Write Options Unitary Derivatives
(``BOUNDs'')
February 3, 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 December
12, 1994, the American Stock Exchange, Inc. (``Amex'' 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 Amex, pursuant to Rule 19b-4 under the Act, proposes to amend
its rules to permit trading in Buy-Write Options Unitary Derivatives
(``BOUNDs''). As described in more detail below, BOUNDs are long term
options which the Amex believes have the same economic characteristics
as a covered call writing strategy. On December 23, 1994, the Exchange
submitted Amendment No. 1 (``Amendment No. 1'') to the filing to
provide that BOUNDs will be listed with a maximum expiration date
corresponding to the longest prescribed long term equity options
(``LEAPs'') then available for trading, which is currently 39
months.\1\
\1\Letter from William Floyd-Jones, Jr., Assistant General
Counsel, Amex, to Michael Walinskas, Derivative Products Regulation,
SEC, dated Dec. 23, 1994. The Amex originally proposed listing
BOUNDs with 60 month expirations and extending the maximum duration
of LEAPs from 39 months to 60 months.
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The text of the proposed rule change and Amendment No. 1 are
available at the Office of the Secretary, Amex and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of, and statutory basis for,
the proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in sections (A), (B), and (C) below,
of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
(1) Purpose
In 1986, the Exchange began listing 26 unit investment trusts, each
of which held shares of a single ``blue-chip'' equity security.
Investors were offered an opportunity to separate their ownership
interests in these trusts into two distinct trading components
representing different economic characteristics of the individual
stocks held in the trusts. These separate trading components were known
as PRIMEs and SCOREs. [[Page 7806]]
PRIMEs were the enhanced income/limited capital gain component. The
holder of a PRIME retained the dividends on the stock held by the trust
and participated in the underlying stock's appreciation up to a fixed
dollar amount. SCOREs were the capital appreciation component. The
holder of a SCORE had the right to all capital appreciation above a
fixed dollar amount, but did not receive the dividends on the
underlying stock.
PRIMEs and SCOREs were extremely popular with investors, but the
trusts from which they derived have now reached their five-year
termination dates. Certain Internal Revenue Service regulations,
moreover, effectively preclude the creation of new PRIMEs and SCOREs
through the original trust mechanism.
The Exchange, for some time, has sought a replacement for the
expired PRIMEs and SCOREs. During this process, the Exchange and other
options exchanges began to list and trade LEAPs. Like SCOREs, LEAPs
enable investors to receive the benefits of a stock's price
appreciation above a fixed dollar amount over a long period of time.
Currently, however, there is no generally available replacement for
PRIMEs.
The Exchange, accordingly, proposes to list BOUNDs as a replacement
for PRIMEs. The Options Clearing Corporation (``OCC'') will be the
issuer of all BOUNDs traded on the Exchange. As with all OCC issued
options, BOUNDs will be created when an opening buy and an opening sell
order are executed. The execution of such orders will increase the open
interest in BOUNDs. Except as described herein, BOUNDs will be subject
to the rules governing standardized options.
The Exchange anticipates listing BOUNDs with respect to those
underlying securities that have listed LEAPs. The criteria for stocks
underlying BOUNDs will be the same as the criteria for stocks
underlying LEAPs.
It is anticipated that the sum of the market prices of a LEAP and a
BOUND on the same underlying stock with the same expiration and
exercise price will closely approximate the market price for the
underlying stock. If the combined price of the LEAP and BOUND diverge
from that of the underlying common stock, there will be an arbitrage
opportunity which, when executed, should bring the price relationships
back into line.
BOUNDs will have the same strike prices and expiration dates as
their respective LEAPs except that the Exchange will list only a strike
price that is at or very close to the price of the underlying stock at
the time of listing, or that is below the price of the stock at that
time. For example, at the time of initial listing, the strike prices
for a BOUND with the underlying stock trading at $50 per share, would
be set at $40 and $50. The Exchange would not list a BOUND with a
strike price of $60 in this example.
The Exchange anticipates that it will list new complementary LEAPs
and BOUNDs on the same underlying securities annually, or at more
frequent intervals, depending on market demand. The Exchange has the
current authority to list LEAPs with up to 39 months until expiration
and, therefore, seeks to introduce BOUNDs with up to the same 39 month
duration.\2\
\2\See Amendment No. 1.
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Like PRIMEs, BOUNDs will offer essentially the same economic
characteristics as covered calls with the added benefits that BOUNDs
can be traded in a single transaction and are not subject to early
exercise. BOUND holders will profit from appreciation in the underlying
stock's price up to the strike price and will receive payments
equivalent to any cash dividends declared on the underlying stock. On
the ex-dividend date for the underlying stock, OCC will debit all
accounts with short positions in BOUNDs and credit all accounts with
long positions in BOUNDs with an amount equal to the cash dividend on
the underlying stock.
Like regular options, BOUNDs will trade in standardized contract
units of 100 shares of underlying stock per BOUND so that at
expiration, BOUND holders will receive 100 shares of the underlying
stock for each BOUND contract held if, on the last day of trading, the
underlying stock closes at or below the strike price. However, if at
expiration the underlying stock closes above the strike price, the
BOUND contract holder will receive a payment equal to 100 times the
BOUND's strike price for each BOUND contract held. BOUND writers will
be required to deliver either 100 shares of the underlying stock for
each BOUND contract or the strike price multiplied by 100 at
expiration, depending on the price of the underlying stock at that
time. This settlement design is similar to the economic result that
accrues to an investor who has purchased a covered call (i.e., long
stock, short call) and held that position to the expiration of the call
option.
For example, if the XYZ BOUND has a strike price of $50 and XYZ
stock closes at $50 or less at expiration, the holder of the XYZ BOUND
contract will receive 100 shares of XYZ stock. This is the same result
as if the call option in a buy--write position had expired out of the
money; i.e., the option would expire worthless and the writer would
retain the underlying stock. If XYZ closes above $50 per share, then
the holder of an XYZ BOUND will receive $5,000 in cash (100 times the
$50 strike price). This mimics the economic result to the covered call
writer when the call expires in the money, i.e., the writer would
receive an amount equal to 100 shares times the strike price and would
forfeit any appreciation above that price (because the stock would be
delivered to satisfy the settlement obligations created upon the
exercise of the call option).
The settlement mechanism for the BOUNDs will operate in conjunction
with that of LEAP calls. For example, if at expiration the underlying
stock closes at or below the strike price, the LEAP call will expire
worthless, and the holder of a BOUND contract will receive 100 shares
of stock from the short BOUND. If on the other hand, the LEAP call is
in the money at expiration, the holder of the LEAP call is entitled to
100 shares of stock from a short LEAP upon payment of the strike price,
and the holder of a BOUND contract is entitled to the cash equivalent
of the strike price times 100 from the short BOUND. An investor long
both a LEAP and a BOUND, where XYZ closes above the $50 strike price at
expiration, would be entitled to receive $5,000 in cash from the short
BOUND and, upon exercise of the LEAP, would be obligated to pay $5,000
to receive 100 shares of XYZ stock.
An investor long the underlying stock, and who writes both a LEAP
and a BOUND, will be obligated to deliver the stock to the long LEAP
call if the underlying stock closes above the strike price, and will
receive in return payment of the strike price times 100, which amount
will then be delivered to the long BOUND. Accordingly, the Exchange
believes a covered writer's position is effectively closed upon the
delivery of the underlying stock. If a writer of both instruments has
deposited cash or securities other than the underlying stock as margin
for a short LEAP call and BOUND, then the writer delivers 100 shares of
stock (purchased on the open market) to the long LEAP call upon payment
of the strike price times 100. The writer of the BOUND then delivers
the cash value of 100 times the strike price to the holder of the long
BOUND.
It should be noted that LEAPs are American-style options whereas
[[Page 7807]] BOUNDs are European-style.\3\ The Exchange believes that
it would be inappropriate for the BOUND holder to have an American-
style exercise right since the BOUND will tend to trade at a discount
to the stock and strike price.
\3\A European-style option may only be exercised during a
limited period of time before the option expires. An American-style
option may be exercised at any time prior to its expiration.
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Sales Practices. BOUNDs will be subject to the Exchange's sales
practice and suitability rules applicable to standardized options.
Adjustments. BOUNDs will be subject to adjustments for corporate
and other actions in accordance with the rules of OCC.
Position Limits. BOUNDs will be subject to the position limits for
equity options set forth in Exchange Rule 904. In addition, BOUNDs will
be aggregated with other equity options on the same underlying stock
for purposes of calculating position limits. According to the Exchange,
since a BOUND to the holder is a bullish position (i.e., the equivalent
of a short put position where the strike price has been prepaid), the
Exchange proposes that long BOUNDs be aggregated with long call and
short put positions in the related equity options. Similarly, since the
Exchange believes the BOUND, from the perspective of the seller, is a
``bearish'' position (i.e., it is the equivalent of a long put position
where the strike price has been prepaid), it proposes to aggregate
short BOUNDs with short call and long put positions in the related
equity options.
Customer Margin. The Exchange proposes to apply options margin
treatment to BOUNDs as follows:
1. Long BOUND Positions: full payment required at the time of
purchase. As described more fully below, however, there will be a
credit for long BOUNDs in BOUND spread positions.
2. Short BOUND Positions: the BOUND seller receives full value of
the BOUND at the time of the initial sale and receives no further
payment when the contract is settled either by payment of the strike
price or delivery of the underlying stock. Short BOUND positions,
therefore, will be margined in an amount equal to the current market
price of the BOUND plus an amount equal to an ``add-on'' used to margin
short call options times the market value of the BOUND. Since the
maximum obligation of the seller of a BOUND cannot exceed the strike
price, however, the amount of margin will never exceed the strike
value. For example:
A. Assume a stock rice of $50, an exercise price of $50, a margin
add-on percent of 20% and the BOUND trading at $40. In this case, the
short seller would have to pay $48 to margin the position, i.e., $40
BOUND price plus 20% of $40.
B. Assume a stock price of $40, an exercise price of $50, a margin
add-on percent of 20% and the BOUND trading at $35. In this case, the
margin would be $42, i.e., $35 BOUND price plus 20% of $35.
3. Covered Positions: Short BOUND positions offset by the
equivalent number of shares of the underlying stock will not require
any additional margin since the seller's obligation to the buyer will,
in all cases, be covered by the position in the underlying stock.
Further, since the sum of the prices of a LEAP and a BOUND will be
approximately equal to the price of the underlying stock, a long stock
position is cover for both a short BOUND and a short LEAP position.
4. Spread Positions. (i) Same Expiration--Different Strike Prices:
There will be no margin requirement for BOUND positions which are long
the higher strike price and short the lower strike price since the long
BOUND more than covers the obligation of the short side of the
position. For positions short the higher strike price and long the
lower strike, a customer will be required to post the difference
between the strike prices.
(ii) Different Expiration--Same Strike Price: No margin will be
required for positions long the nearest expiration and short the longer
expiration since the value of the long BOUND will cover the obligation
on the short leg of the position. Positions that are short the near
expiration and long the distant expiration will require full margin on
the short position less 80% of the market value of the long position.
(iii) Different Expiration--Different Strike Prices: There will be
no margin required for positions that are long the near expiration and
short the distant expiration when the strike price on the near
expiration is higher than the strike on the distant expiration. For
positions which are long the near expiration and short the distant
expiration where the strike price on the near expiration is lower than
the strike on the distant contract, the margin will be the difference
in the strike between the near term and distant strikes. For positions
which are short the near expiration and long the distant expiration,
full margin will be required on the short position less 80% of the
market value of the long position.
(2) Basis
The Exchange believes that the proposed rule change is consistent
with section 6(b) of the Act, in general, and furthers the objectives
of section 6(b)(5), in particular, in that it is designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in facilitating transactions in securities, and to
remove impediments to and perfect the mechanism of a free and open
market and the national market system.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Amex believes that the proposed rule change will impose no
burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received with respect
to the proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(a) By order approve such proposed rule change, or
(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. 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 [[Page 7808]] available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street
NW., Washington, D.C. Copies of such filing will also be available for
inspection and 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 March 2, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\4\
\4\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-3280 Filed 2-8-95; 8:45 am]
BILLING CODE 8010-01-M
