[Federal Register Volume 59, Number 48 (Friday, March 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5675]
[[Page Unknown]]
[Federal Register: March 11, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33720; File No. SR-Amex-93-36]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Approving and Notice of Filing and Order Granting Accelerated
Approval to Amendment Nos. 1 and 2 to a Proposed Rule Change by the
American Stock Exchange, Inc. Relating to the Listing of Options on the
Amex Natural Gas Index
March 7, 1994.
I. Introduction
On November 12, 1993, the American Stock Exchange, Inc. (``Amex''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``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 Amex Natural Gas Index (``Natural Gas
Index'' or ``Index''). Notice of the proposed rule change appeared in
the Federal Register on December 16, 1993.\3\ This order approves the
Exchange's proposal. No comment letters were received on the proposed
rule change. The Exchange subsequently submitted Amendments Nos. 1 and
2 to the proposed rule change.\4\
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\See Securities Exchange Act Release No. 33312 (December 9,
1993), 58 FR 65740 (December 16, 1993).
\4\In Amendment No. 1, the Exchange proposes to provide that the
number of components in the Index will not increase or decrease by
more than 33\1/3\% from the current number of components (i.e., 15)
and in no event will there be less than 9 components in the Index.
See Letter from Claire McGrath, Managing Director and Special
Counsel, Derivative Securities, Amex, to Richard Zack, Branch Chief,
Office of Derivatives and Equity Regulation, Division of Market
Regulation, Commission, dated January 14, 1994 (``Amendment No.
1''). In order to increase or decrease the number of components in
the Index beyond this range, the Exchange would be required to
submit a rule filing to the Commission pursuant to section 19(b) of
the Act. On February 22, 1994, the Exchange filed Amendment No. 2 to
clarify that the position and exercise limits for the Index options
would be 10,500 contracts on the same side of the market. See Letter
from Claire McGrath, Managing Director and Special Counsel,
Derivative Securities, Amex, to Sharon Lawson, Assistant Director,
Office of Derivatives and Equity Regulation, Division of Market
Regulation, Commission, dated February 18, 1994 (``Amendment No.
2'').
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II. Description of Proposal
A. General
The Amex proposes to trade options on the Natural Gas Index, a new
stock index developed by the Amex based on natural gas industry stocks
or American Depositary Receipts (``ADRs'')\5\ thereon which are traded
on the Amex, the New York Stock Exchange, Inc. (``NYSE''), or are
national market system securities traded through the facilities of the
National Association of Securities Dealers Automated Quotation System
(``NASDAQ-NMS''). In addition, the Amex proposes to amend Rule 901C,
Commentary .01 to reflect that 90% of the Index's numerical index value
will be accounted for by stocks that meet the current criteria and
guidelines for securities underlying options set forth in Rule 915.\6\
The Amex also proposes to list either long-term options on the Index or
long-term options on a reduced-value Index that will be computed at
one-tenth of the value of the Natural Gas Index (``Natural Gas LEAPS''
or ``Index LEAPS'').\7\ Natural Gas LEAPS will trade independent of and
in addition to regular Natural Gas Index options traded on the
Exchange, however, as discussed below, position and exercise limits of
Index LEAPS and regular Index options will be aggregated.
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\5\An ADR is a negotiable receipt which is issued by a
depositary, generally a bank, representing shares of a foreign
issuer that have been deposited and are held, on behalf of holders
of the ADRs, at a custodian bank in the foreign issuer's home
country. See discussion of standards for ADR components, infra note
31.
\6\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.
\7\LEAPS is an acronym for Long-Term Equity Anticipation
Securities.
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B. Composition of the Index
The Index is comprised of fifteen securities of highly-capitalized
companies in the natural gas industry. Included in this group are
companies in the U.S. which are involved in natural gas exploration and
production, natural gas transmission, or natural gas distribution.\8\
The Exchange will use an ``equal dollar-weighted'' method to calculate
the Index.\9\ The Index was initialized at a level of 300 at the close
of trading on October 15, 1993.
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\8\The current component securities of the Index are Apache
Corp.; Anadarko Petroleum Corp.; Burlington Resources; Consolidated
Natural Gas; Cabot Oil and Gas Corporation (Class A); Enron Corp.;
Ensearch Corp.; Louisiana Land and Exploration; Mitchell Energy and
Development; Noble Affiliates, Inc.; Oryx Energy; Parker and Parsley
Petroleum; Pogo Producing Co.; Seagull Energy Corp.; and Sonat Inc.
\9\See infra Section II.D entitled ``Calculation of the Index''
for a description of this calculation method.
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As of the close of trading on February 8, 1994, the Index was
valued at 276.69. The market capitalizations of the individual stocks
in the Index on that date ranged from a high of $8.13 billion (Enron
Corp.) to a low of $470 million (Cabot Oil and Gas Corp. (Class A)),
with the man and median being $2.35 billion and $1.37 billion,
respectively. The market capitalization of all the stocks in the Index
was $35.32 billion. The total number of shares outstanding for the
stocks in the Index ranged from a high 238.97 million shares (Enron
Corp.) to a low of 20.56 million shares (Cabot Oil and Gas Corp. (Class
A)). In addition, the average daily trading volume of the stocks in the
Index, for the six-month period from August 8, 1993 through February 8,
1994, ranged from a high of 522,510 shares per day (Enron Corp.) to a
low of 36,520 shares per day (Cabot Oil and Gas Corp. (Class A)), with
the mean and median being 226,080 and 159,000 shares, respectively.
Lastly, no one stock comprised more than 7.31% of the Index's total
value and the percentage weighting of the five largest issues in the
Index accounted for 34.92% of the Index's value. The percentage
weighting of the lowest weighted stock was 6.08% of the Index and the
percentage weighting of the five smallest issues in the Index accounted
for 31.73% of the Index's value.
C. Eligibility and Maintenance Standards for the Inclusion of Component
Stocks in the Index
Exchange Rule 901C specifies criteria for the inclusion of stocks
in an index on which options will be traded on the Exchange.
Specifically, rule 901C states that an index must have a minimum of
five stocks, and any index with less than 25 component stocks may not
include stocks traded on the Amex.\10\ If, however, the Exchange
determines to increase or decrease the number of Index component stocks
by 33\1/3\% or more from its current level of 15 components, the Amex
will submit a rule filing with the Commission pursuant to section 19(b)
of the Act.\11\ The Exchange also notes that component stocks may be
replaced in the event of certain corporate events, such as takeovers or
mergers, that change the nature of the security. Furthermore, the Amex
will be required to ensure that each of the components of the Index is
subject to last sale reporting requirements in the U.S.
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\10\Accordingly, the Natural Gas Index as currently constituted
does not include Amex-traded stocks. The Amex, however, has
submitted a proposal, that, among other things, revises Amex Rule
901C to remove the limitation on the number of Amex stocks that can
be included in an index which underlies a stock index option traded
on the Exchange. Specifically, the proposal would allow, among other
things, Amex-listed stocks to be included in Amex-traded index
options that are comprised of less than 25 stocks. See Securities
Exchange Act Release No. 30356 (February 12, 1992), 57 FR 5497
(February 14, 1992).
\11\See Amendment No. 1, supra note 4.
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In addition, the Exchange will require, as reflected in amended
Commentary .01 to Exchange Rule 901C, that at least 90% of the Index's
numerical value, after each quarterly rebalancing of the Index, will be
accounted for by stocks that meet the Exchange's options listing
standards.
In choosing among natural gas industry stocks that meet the minimum
criteria set forth in Rule 901C, the Exchange will focus only on stocks
that are traded on either the NYSE, Amex (subject to the limitations of
Rule 901C) or traded through NASDAQ-NMS. In addition, the Exchange
intends to select stocks that (1) have a minimum market value (in U.S.
dollars) of at least $75 million, and (2) have an average monthly
trading volume in the U.S. markets over the previous six month period
of not less than one million shares except that component stocks
accounting for not more than 10% of the Index value at each quarterly
rebalancing may have an average monthly trading volume of not less than
500,000 shares.
The Index currently has fifteen component stocks, all of which are
eligible for standardized options trading and thirteen of the fifteen
are currently the subject of standardized options trading. However, to
address concerns about the possibility of manipulation of an index
containing a large percentage of stocks that do not meet the
eligibility standards applicable to stocks eligible for standardized
options trading, at each quarterly rebalancing, stocks that meet the
then current criteria for standardized options trading set forth in
Exchange Rule 915 will be required to account for at least 90% of the
Index's numerical value, and this requirement will be reflected in
commentary to Exchange Rule 901C.
D. Calculation of the Index
The Index will be calculated using an ``equal dollar-weighting''
methodology designed to ensure that each of the component securities
are represented in approximately ``equal'' dollar amounts in the Index.
The Exchange believes that this method of calculation is important
since even among the largest companies in the natural gas industry
there is a great disparity in size. For example, although the stocks
included in the Index represent many of the most highly capitalized
companies in the natural gas industry, Enron Corp. currently represents
over 23% of the aggregate market value of the Index. In addition, while
currently there is not much disparity in the prices of the stocks
included in the Index, using a price-weighted method to calculate the
Index's value is not the Exchange's preferred method since the prices
of such stocks can fluctuate significantly as a result of a corporate
action (e.g., a stock split or distribution), rather than as a result
of stock performance, causing the relative weightings of the stocks
within the Index to fluctuate significantly.
In calculating the initial ``equal dollar-weighting'' of component
stocks, the Amex, using closing prices on October 15, 1993, calculated
the number of shares that would represent an investment of $10,000 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 portfolio divided by the current Index divisor.
The Index divisor was initially calculated to yield a benchmark value
of 300.00 at the close of trading on October 15, 1993. Each quarter
thereafter, following the close of trading on the third Friday of
January, April, July and October, the Index portfolio is adjusted by
changing the number of shares of each component stock so that each
company is again represented in $10,000 ``equal'' dollar amounts. 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 quarterly
adjustment.
The Exchange represents that it has had experience making regular
quarterly adjustments to certain of its indexes (e.g., the Amex
Institutional Index) and has not encountered investor confusion
regarding the adjustments because they are done on a regular basis and
timely, proper, and adequate notice is given in the form of an
information circular distributed to all Exchange members notifying them
of the quarterly changes. This circular is also sent to the Exchange's
contacts at the major options firms, mailed to recipients of the
Exchange's options related information circulars, and made available to
subscribers of the Options News Network. In addition, the Exchange will
include in its promotional and marketing materials for the Index, a
description of the equal dollar-weighting methodology. The Exchange
states that this procedure has been used for the Exchange's
Biotechnology Index, another equal dollar-weighted index.\12\
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\12\See Securities Exchange Act Release No. 31245 (September 28,
1992), 57 FR 45844 (October 5, 1992).
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The number of shares of each component stock in the Index portfolio
will remain fixed between quarterly 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, or a distribution,
reorganization, recapitalization, or some such similar event with
respect to an Index component stock. The number of shares will also be
adjusted in the event of a merger, consolidation, dissolution or
liquidation of an issuer of a component stock. When the Index is
adjusted between quarterly reviews, the number of shares of the
relevant security in the portfolio will be adjusted, to the nearest
whole share, to maintain the component's relative weight in the Index
at the level immediately prior to the corporate action. In the event of
a stock replacement, the average dollar value of the remaining
portfolio components will be calculated and that amount invested in the
new component stock to the nearest whole share. In both cases, the
divisor will be adjusted, if necessary, to ensure Index continuity.
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'').
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 securities traded through the NASDAQ-NMS
system, the first reported sale price will be used. Once all of the
component stocks have opened, 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.\13\
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\13\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 on the prior trading
day when calculating the value of the Index, until the stock opens
for trading.
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E. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\14\ 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 January cycle. The Exchange also
intends to list Natural Gas LEAPS, having up to thirty-six months to
expiration. Strike price interval, bid/ask differential and price
continuity rules will not apply to the trading of Natural Gas LEAPS
until their time to expiration is less than twelve months.\15\
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\14\A European-style option can be exercised only during a
specified period before the option expires.
\15\See Securities Exchange Act Release No. 25041 (October 16,
1987), 52 FR 40008 (October 26, 1987) (order approving SR-Amex-87-
22).
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The options on the Index will expire on the Saturday following the
third Friday of the expiration month (``Expiration Friday''). Since
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).
F. Listing of Long-Term Options on the Full Value or Reduced Value
Natural Gas 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
Natural Gas 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 Natural Gas 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. For example, an Index
value of 276.46 would be 27.65 for the Index LEAPS and 276.43 would
become 27.64. The reduced-value Index LEAPS will 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 proposal provides that full-value or reduced-value
Natural Gas 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.
G. 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,\16\
position and exercise limits,\17\ and trading halt procedures\18\ that
are applicable to the trading of narrow-based index options will apply
to options traded on the Index. The proposal further provides that, for
purposes of determining whether a given position in reduced-value Index
LEAPS complies with applicable position and exercise limits, positions
in reduced-value Index LEAPS will be aggregated with positions in the
full-value Index options. For aggregation purposes, ten reduced-value
contracts will equal one full-value contract.
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\16\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.
\17\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. See Amendment No. 2,
supra note 4.
\18\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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H. 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 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.\19\
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\19\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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III. Finding 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).\20\ Specifically, the
Commission finds that the trading of Natural Gas Index options,
including full-value and reduced-value Natural Gas LEAPS, will serve to
promote the public interest and help to remove impediments to a free
and open securities market by providing investors with a means to hedge
exposure to market risk associated with securities in the natural gas
industry.\21\
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\20\15 U.S.C. 78f(b)(5) (1988).
\21\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 instrument 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 Natural Gas Index will provide investors with
a hedging vehicle that should reflect the overall movement of the
stocks comprising the natural gas industry in the U.S. stock
markets. The Commission also believes that these Index options will
provide investors with a means by which to make investment decisions
in the natural gas industry sector of the U.S. stock markets,
allowing them to establish positions or increase existing positions
in such markets in a cost effective manner. The Commission also
believes that the trading of the Index options and Index LEAPS will
allow investors holding positions in some or all of the underlying
securities in the Index to hedge the risks associated with their
portfolios more efficiently and effectively. Moreover, the
Commission believes that the reduced-value Index LEAPS, that will be
traded on an index computed at one-tenth the value of the Natural
Gas Index, will serve the needs of natural gas industry investors by
providing them with the opportunity to use a long-term option to
hedge their portfolios from long-term market moves at a reduced
cost.
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The trading of options on the Natural Gas Index and on a reduced-
value Index, however, raises several concerns, namely issues related to
index design, customer protection, surveillance, and market impact. The
Commission believes, for the reasons discussed below, that the Amex
adequately has addressed these concerns.
A. Index Design and Structure
The Commission finds that the Natural Gas Index is a narrow-based
index. The Natural Gas Index is comprised of only fifteen stocks, all
of which are within one industry--the natural gas industry.\22\
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.\23\
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\22\The reduced-value Natural Gas Index, which is comprised of
the same component securities as the Natural Gas Index and
calculated by dividing the Natural Gas Index value by ten, is
identical to the Natural Gas Index.
\23\See supra Section II.G entitled ``Position and Exercise
Limits, Margin Requirements, and Trading Halts.''
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The Commission also finds 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 of 4.75 million and 3.34
shares, respectively.\24\ Second, the market capitalizations of the
stocks in the Index are very large, ranging from a high of $8.13
billion (Enron Corp.) to a low of $470 million (Cabot Oil and Gas
Corporation (Class A)) as of February 8, 1994, with the mean and median
being $2.35 billion and $1.37 billion, respectively. Third, although
the Index is only comprised of fifteen stocks, no one particular stock
or group of stocks dominates the Index. Specifically, no one stock
comprises more than 7.31% of the Index's total value and the percentage
weighting of the five largest issues in the Index accounts for 34.92%
of the Index's value.\25\ Fourth, all of the component stocks in the
Index currently are eligible for options trading,\26\ and all but two
components have standardized options trading on them. Fifth, the Amex,
prior to increasing or decreasing the number of component stocks by
more than 33\1/3\%, will be required to seek Commission approval
pursuant to section 19(b)(2) of the Act before effecting such
change.\27\ This will help protect against material changes in the
composition and design of the Index that might adversely affect the
Amex's obligations to protect investors and to maintain fair and
orderly markets in Natural Gas Index options. Sixth, the Amex will be
required to ensure that each component of the Index is subject to last
sale reporting requirements in the U.S. This will further reduce the
potential for manipulation of the value of the Index. Finally, the
Commission believes that the expense of attempting to manipulate the
value of the Natural Gas Index in any significant way through trading
in component stocks (or options on those stocks) coupled with, as
discussed below, existing mechanisms to monitor trading activity in
those securities, will help deter such illegal activity.
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\24\In addition, for the six-month period between August 8, 1993
and February 8, 1994, all of companies within the Index had an
average daily trading volume greater than 226,000 shares.
\25\For an index with a significantly greater number of stocks
than fifteen issues, the Commission might come to a different
conclusion if only a few stocks accounted for a significant portion
of the index's weighting. Further, if an index contained only a few
stocks, the Commission might question whether it can be traded as an
index product.
\26\See supra note 6.
\27\See Amendment No. 1, supra note 4.
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In addition, the Commission does not believe that the fact that the
Index is equal dollar-weighted instead of market-weighted or price-
weighted results in the Index being readily susceptible to
manipulation. Because the use of an equal dollar-weighting method could
give securities with relatively small floats or prices a greater weight
in the Index than if the Index were capitalization weighted or price
weighted, the Commission is concerned that this calculation method
could make the Index more readily susceptible to manipulation. The
Amex, however, has developed several composition and maintenance
criteria for the Index that the Commission believes 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, after each quarterly rebalancing, the Amex proposal requires
that 90% of the weighting of the Index be accounted for by 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
manipulated by abusive trading in the smaller stocks contained in the
Index. Second, the proposal provides that to be eligible for inclusion
in the Index, component stocks must have an average monthly trading
volume over the previous six-month period of not less than one million
shares, except that component stocks accounting for not more than 10%
of the value of the Index at rebalancing, may have an average monthly
trading volume of less than one million shares but not less than
500,000 shares. This trading volume requirement is considerably higher
than the requirement contained in the options listing standards for
individual equity options. Third, the Commission believes that the
quarterly rebalancing of the Index will further serve to reduce the
susceptibility of the Index to manipulation. Through the quarterly
rebalancing, any ``overweight'' stock\28\ will be brought back into
line with the other stocks, thus ensuring that less capitalized stocks
do not become excessively weighted. Fourth, because the Index is
narrow-based, the applicable position and exercise limits and margin
requirements will further reduce the susceptibility of the Index to
manipulation. Lastly, the Amex represents that it will make every
effort to add new stocks to the Index that are representative of the
natural gas sector and, as discussed above,\29\ will take into account
a stock's capitalization, liquidity, and volatility.
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\28\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.
\29\See supra Section II.C entitled ``Eligibility and
Maintenance Standards for the Inclusion of Component Stocks in the
Index.''
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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 Natural Gas Index options
(including full-value and reduced-value Natural Gas 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 Natural Gas Index options and full-value
or reduced value Index LEAPS.
The Commission also has some concern that the quarterly rebalancing
of the Index could result in investor confusion because the number of
stocks of each component issuer in the Index could fluctuate each
quarter. Such fluctuation, among other things, could make it difficult
for investors to maintain any corresponding cash positions in the
stocks underlying the Index. The Commission, however, does not believe
that the quarterly rebalancing will result in dramatic changes in the
weightings of the component securities. Moreover, the Commission
believes the benefits to be derived from using a quarterly rebalancing
will more than offset the potential confusion for investors.
Specifically, the Commission believes the quarterly rebalancing will
ensure that no stock or group of stocks will have a disproportionate
impact on the Index.
Finally, the Amex has developed procedures to ensure that investors
are adequately notified of any changes due to the quarterly rebalancing
of the Index. In particular, the Amex represents that it will send
informational circulars to its members notifying them of any changes to
the Index as a result of the quarterly rebalancing prior to the
implementation of those changes. In addition, the Amex has stated that
it will include a description of the equal dollar-weighting methodology
in all its promotional and marketing materials for the Index. The
Commission believes these procedures should help to avoid any investor
confusion, while providing important information about the special
characteristics of the Index.
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.\30\ In this regard, the NYSE,
which currently is the primary market for all of the Index's component
stocks, is a member of the Intermarket Surveillance Group (``ISG''),
which provides for the exchange of all necessary surveillance
information.\31\
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\30\See Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\31\See supra note 19. Although the Index currently does not
contain ADRs, the proposal provides that the Index could contain
ADRs representing natural gas industry stocks. If the Amex were to
change the composition of the Index so that greater than 20% of the
Index by weight was represented by ADRs whose underlying securities
were not subject to a comprehensive surveillance sharing arrangement
with the Amex, then it would be difficult for the Commission to
reach the conclusions reached in this order and the Commission would
have to determine whether it would be suitable to continue to trade
options on the Index. The Amex should, accordingly, notify the
Commission immediately if more than 20% of the numerical value of
the Index is represented by ADRs whose underlying securities are not
subject to a comprehensive surveillance sharing agreement. Such a
change in the composition of the Index may warrant the submission of
a rule filing pursuant to Section 19 of the Act. In determining
whether a particular ADR is subject to a comprehensive surveillance
sharing agreement see, e.g., Securities Exchange Act Release Nos.
31529 (November 27, 1992), 57 FR 57248 (December 3, 1992); and 33555
(January 31, 1994), 59 FR 5619 (February 7, 1994).
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D. Market Impact
The Commission believes that the listing and trading of Natural Gas
Index options, including full-value and reduced-value Index LEAPS on
the Amex will not adversely impact the underlying securities
markets.\32\ First, as described above, due to the ``equal dollar-
weighting'' method, no one stock or group of stocks dominates the
Index. Second, because 90% of the numerical value of the Index must be
accounted for by stocks that meet the options listing standards, the
component securities generally will be actively-traded, highly-
capitalized stocks. Third, the 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.
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\32\The Commission notes that prior to listing Index options or
full-value or reduced-value Index LEAPS, the Exchange will be
required to provide written representations that both the Exchange
and OPRA have the necessary systems capacity to support those new
series of Index options.
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Lastly, the Commission believes that settling expiring Natural Gas
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
securities underlying options on the Index.\33\
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\33\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 and
2 to the proposed rule change prior to the thirtieth day after the date
of publication of notice of filing thereof in the Federal Register.
Amendment No. 1 provides that the Amex must submit a rule filing
pursuant to section 19(b) of the Act if the number of components in the
Index increases or decreases by more than 33\1/3\%. This amendment
conforms the proposal to other proposals recently approved by the
Commission for the listing and trading of options on narrow-based
indexes.\34\ Amendment No. 2 merely states that the position and
exercise limits for the proposed Index options will be set at 10,500
contracts pursuant to Amex Rule 904C consistent with the Commission's
recent approval order increasing the position and exercise limits for
narrow-based index options.35 Therefore, the Commission believes
it is consistent with section 6(b)(5) of the Act to approve Amendment
Nos. 1 and 2 to the Amex's proposal on an accelerated basis.
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\3\4See, e.g., Securities Exchange Act Release No. 33442
(January 6, 1994), 59 FR 1973 (January 13, 1994) order approving the
listing and trading of options on the CBOE Gaming Index).
\3\5See, e.g., Securities Exchange Act Release No. 33285
(December 3, 1993), 58 FR 65201 (December 13, 1993).
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Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1 and 2 to the proposed rule
change. 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 in the Commission's Public
Reference Section, 450 Fifth Street, NW., Washington, DC. 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 April 1, 1994.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,36 that the proposed rule change (SR-Amex-93-36), as amended,
is approved contingent upon the Exchange's submission to the Commission
of adequate systems capacity representations.37
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\36\15 U.S.C. 78s(b)(2) (1988).
\37\See supra note 32.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.38
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\38\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5675 Filed 3-10-94; 8:45 am]
BILLING CODE 8010-01-M
