[Federal Register Volume 61, Number 56 (Thursday, March 21, 1996)]
[Notices]
[Pages 11668-11671]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-6764]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36976; File no. SR-Phlx-96-07]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., To Adopt a Market
Index Option Hedge
Exemption March 14, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on February 13, 1996, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the self-regulatory
organization.\3\ The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
\3\ On February 26, 1996, the Phlx filed an amendment to the
rule proposal. See letter from Gerald D. O'Connell, First Vice
President, Market Regulation and Trading Operations, Phlx, to
Michael Walinskas, Branch Chief, Office of Market Supervision,
Division of Market Regulation, Commission, dated February 26, 1996
(``Amendment No. 1''). Amendment No. 1 made several minor changes to
the rule proposal in order to make it correspond to the final draft
of the narrow-based (industry) index option hedge exemption that was
recently approved for the Phlx by the Commission. See Securities
Exchange Act Release No. 36858 (February 16,1 996), 61 FR 7295
(February 27, 1996) (File No. SR-Phlx-95-45).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Phlx, pursuant to Rule 19b-4 of the Act, proposes to amend
Commentary .01 to Phlx Rule 1001A to establish a hedge exemption from
broad-based (market) index option position limits.
Specifically, the Phlx proposes to exempt from position and
exercise limits \4\ any position in a market index option that is
hedged by share positions in at least 20 stocks, or securities
convertible into such stock, in four industry groups comprising the
index, of which no one component security accounts for more than 15% of
the value of the portfolio hedging the index option position. Under the
proposal, no position in a market index option may exceed two-times \5\
the broad-based index option position specified in Phlx Rule
1001A(a).\6\ In addition, the underlying value of the option position
may not exceed the value of the underlying portfolio employed as the
hedge. The proposed exemption would be available to public customers,
as well as to firm and proprietary traders.
\4\ 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). 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 of options within five
consecutive business days.
\5\ For instance, if the position limit for a market index
option is 25,000 contracts, an additional 50,000 contracts under
this proposal would be permitted, for a total of 75,000 contracts.
\6\ Under Phlx Rule 1001A(a), the Value Line Composite Index
(``VLE''), the U.S. Top 100 Index (``TPX''), and the National Over-
the-Counter Index (``XOC'') each have a position limit of 25,000
contracts, of which no more than 15,000 contracts can be in the
nearest expiration month. The Phlx notes that the Big Cap Index
(``MKT'') is no longer listed on the Exchange.
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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 Phlx 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
[[Page 11669]]
Phlx 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
The Phlx is proposing to adopt a broad-based index option hedge
exemption under which broad-based index option positions hedged in
accordance with the proposal would be entitled to exceed existing
position limits by up to two-times above the limit. The purpose of the
proposal is to establish a provision parallel to the hedge exemption
for equity options \7\ as well as the broad-based index option hedge
exemptions that are in place on other option exchanges.\8\
\7\ See Phlx Rule 1001, Commentary .07. See also Securities
Exchange Act Release No. 35738 (May 18, 1995), 60 FR 27573 (May 24,
1995) (order approving permanent hedge exemption pilot programs)
(File Nos. SR-Phlx-95-10, SR-Amex-95-13, SR-CBOE-95-13, SR-NYSE-95-
04, and SR-PSE-95-05).
\8\ See infra notes 12-14 and accompanying text.
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In order to qualify for the exemption, the market index option
position must be hedged by share positions in at least 20 stocks, or
securities convertible into such stock,\9\ in four industry groups
comprising the index, of which no one component security accounts for
more than 15% of the value of the portfolio hedging the index option
position. Under the proposal, no position in a market index option may
exceed two-times the broad-based index option position specified in
Phlx Rule 1001A(a). In addition, the underlying value of the option
position may not exceed the value of the underlying portfolio employed
as the hedge.\10\ In addition, 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 this proposal, during five
consecutive business days.\11\
\9\ The Exchange permits the use of convertible securities in
its equity option hedge exemption. See Securities Exchange Act
Release No. 32174 (April 20, 1993), 58 FR 25687 (April 27, 1993)
(order approving File No. SR-Phlx-92-22). Similarly, other options
exchanges permit the use of convertible securities with respect to
broad-based index option hedge exemptions.
\10\ The value of the underlying portfolio is determined as
follows: (1) the total market value of the net stock position; less
(2) the value of: (a) any offsetting calls and puts in the
respective index option; (b) any offsetting positions in related
stock index futures or options; and (c) any economically equivalent
positions.
The values of offsetting positions are determined by multiplying
the number of opposite-side-of-the-market (offsetting) calls, puts,
or futures contracts by the index value and by the index multiplier.
Then, the value is subtracted from the market value of the
portfolio. This number must be compared with the underlying value of
the option position in excess of the position limit being hedged/
exempted, which is calculated by multiplying the number of option
contracts for which the exemption is sought by the index value and
the multiplier; this value cannot exceed the value of the underlying
portfolio.
\11\ See Phlx Rule 1002A.
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The Phlx notes that broad-based index option hedge exemptions are
in place on other options exchanges. Generally, these index option
hedge exemptions allow public customers to apply for position limit
exemptions in broad-based index options that are hedged with exchange-
approved qualified stock portfolios. A qualified portfolio is
comparison of net long or short positions in at least 20 common stocks
or securities readily convertible into such common stock, none of which
accounts for more than 15% of the value of the portfolio.
The Phlx notes that the Chicago Board Options Exchange, Inc.
(``CBOE''), in CBOE Rule 24.4, provides a broad-based index option
hedge exemption for public customers holding positions in broad-based
index options other than a.m.-settled, European-style Standard and
Poor's (``S&P'') 500 Index options, and Quarterly Index Expirations
(``QIXs'') and Capped-Style QIXs (``Q-CAPS'') on the S&P 500 Index.
Under Interpretation and Policy .01 to CBOE Rule 24.4, exempted
positions may not exceed 75,000 contracts (two-times above the regular
position limit),\12\ except as otherwise provided in CBOE Rule 24.4,
Interpretation and Policies .02 and .03, and except that exempted
combined positions in options based on the S&P/Barra Value Index and
the S&P/Barra Growth Index may not exceed 65,000 same-side of the
market options contracts.\13\
\12\ Under CBOE Rule 24.4(a), the position limit for broad-based
index options, other than Russell 2000 Index options and S&P/Barra
Growth Index and S&P/Barra Value Index options, is 25,000 contracts
on the same-side of the market. CBOE Rule 24.4(b), (c), and (d)
contain separate position limit provisions for a.m.-settled,
European-style option contracts on the S&P 500 Index, and QIXs and
Q-CAPS on the S&P 500 Index, QIXs and Q-CAPS on the S&P 100 Index,
and QIXs on the Russell 2000 index.
\13\ CBOE Rule 24.4, Interpretation and Policy .02 provides a
hedge exemptionf or certain positions in a.m-settled, European-style
S&P 500 Index options, and QIXs and Q-CAPS on the S&P 500 Index.
Specifically, Interpretation and Policy .02(d) provides that a
customer's exempted position may not exceed 150,000 same-side of the
market contracts in am.m.-settled S&P 500 Index options, and QIXs
and Q-CAPS on the S&P 500 Index. Interpretation and Policy .02(b)
states that a money manager may not hold in its aggregated accounts
more than 250,000 exempted same-side of the market option contracts
or, in a single account, more than 135,000 exempted same-side of the
market option contracts.
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Similarly, Commentary .01 to the American Stock Exchange, Inc.'s
(``Amex'') Rule 904C provides a broad-based index option position limit
exemption for public customers who satisfy the criteria established by
AMEX.\14\
\14\ In addition, Amex Rule 904C, Commentary .02 provides a
facilitation exemption for Institutional Index and MidCap Index
options up to 100,000 and 75,000 contracts, respective.
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In light of the Exchange's exerience with the equity option hedge
exemption, as well as its review of the rules of the other options
exchanges, the Phlx believes that a similar hedge exemption for its
market index options is appropriate. The Phlx also believes that the
proposed conditions for granting such an exemption are reasonable and
in line with prior Commission-approved provisions.
According to the Phlx, trading volume for index options has
markedly increased. In 1994, volume increased-two-fold over 1993, from
1,119,147 contracts to 2,456,685. In 1995, volume remained steady with
over 2,783,043 contracts traded. The Phlx attributes the recent growth
in trading and open interest to institutional trading, which, according
to the Phlx, is typically hedged by baskets of the underlying stocks.
The Phlx proposes to exempt positions in broad-based options in a
manner which balances the hedging needs of index options traders with
the Exchange's obligation to maintain a fair and orderly market. The
Phlx believes that a hedge exemption up to 75,000 contracts for broad-
based index options would considerably enhance the attractiveness of
these products for institutional traders, who would, in turn, trade
more of the product in a hedged manner and thereby provide stabilizing
liquidity in both the index options and the underlying securities.\15\
\15\ In support of this contention, the Phlx believes that the
hedge exemption for S&P 100 Index (``OEX'') options, which permits
positions up to 75,000 contracts (two times above the regular
position limit), serves as a significant liquidity provider for that
product.
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In 1989, the Commission approved a Phlx proposed hedge exemption
for Utility Index options (``UTY''), on a pilot basis.\16\ Although the
UTY hedge
[[Page 11670]]
exemption pilot program applied only to customers, the Phlx believes
that it is appropriate and necessary to expand the availability of the
exemption beyond public customers. The Phlx believes that significant
increases in the depth and liquidity of the market for these index
options could result from permitting firm and proprietary traders to be
eligible for the exemption. According to the Phlx, 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 market index options are most
commonly initiated by institutional trades hedging stock portfolios on
behalf of public customers, the Phlx believes that proprietary traders
should be afforded the same exemption so that they may fulfill their
role as facilitators.
\16\ Specifically, the UTY hedge exemption provision exempted
any position taken by a public customer in UTY options that was
hedged by at least 10 UTY component stocks, of which no one
component stock could account for more than 15% of the stock
portfolio hedging the UTY position. See Securities Exchange Act
Release No. 27486 (November 30, 1989), 54 FR 50675 (December 8,
1989) (order approving File No. SR-Phlx-89-27). This provision was
approved for a one-year pilot program, which expired on November 30,
1990.
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The Phlx also believes that the hedge exemption is necessary to
better meet the needs of investors who use Phlx market index options
for investment and hedging purposes. According to the Phlx, many
institutional traders and portfolio managers deal in dollar amounts
much greater than that permissible under current position limit levels
and have expressed that Exchange position limits hamper their ability
to fully utilize such index options. As a result, the Phlx believes
that many index options are ineffective for such traders, who often
turn to futures instruments where ample relief is already
available.\17\ Thus, the Phlx believes that the proposed hedge
exemption should alleviate the situation where investors with
substantial hedging needs are discouraged from participating in the
options market due to existing position limits.
\17\ The Commission has recognized that under the rules
promulgated by the Commodity Futures Trading Commission (``CFTC''),
futures positions that are deemed to be bona fide hedging
transactions are exempt from position limit rules. See Securities
Exchange Act Release No. 25739 (May 24, 1988), 53 FR 20204 (June 2,
1988) (order approving File No. SR-CBOE-87-25).
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The Phlx believes that the proposed broad-based index option hedge
exemption should not increase the potential for disruption or
manipulation in the markets for the stocks underlying each index. The
Phlx notes that this is because the proposal incorporates several
surveillance safeguards, which the Phlx will employ to monitor the use
of this exemption. Specifically, the Exchange will require that a form
be filed by member firms and their customers who seek exemptions, in
lieu of granting an automatic exemption. Moreover, the hedge exemption
form must be kept current, with information updated as warranted. Any
information concerning the dollar value and composition of the stock
portfolio,\18\ or its equivalent, the current hedged and aggregate
options positions, and any stock index futures positions must be
promptly provided to the Exchange. In addition, the Exchange's Market
Surveillance Department will monitor trading activity in Phlx traded
index options and the stocks underlying those indexes to detect
potential frontrunning and manipulation abuses, as well as review such
trading to ensure that the closing of positions subject to the
exemption are conducted in a fair and orderly manner. On a daily basis,
the Exchange's Market Surveillance Department will also monitor each
option contract to ensure that it is hedged by the equivalent dollar
amount of component securities.
\18\ The Phlx notes that as the dollar value of the hedging
portfolio fluctuates, the number of exempt contracts may need to be
adjusted.
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The Phlx also notes that the proposal contains several specific
safeguards. First, the hedge must consist of a previously established
position in at least 20 of the stocks underlying the index, none of
which may constitute more than 15% of the hedge portfolio, and must
include stocks from at least four separate industry groups.\19\ Thus,
not only does the basket of stocks comprising the hedge resemble the
underlying index, but it also ensures that unwinding such positions
will be spread out among a wide and disparate group of stocks.
\19\ To determine the share amount of each component required to
hedge an exempt option position: index value x index multiplier
x component's weighting = 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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Second, the proposal provides a ceiling on the maximum size of the
options position by providing the positions established under the
proposal may not exceed two-times the limits set forth in Exchange Rule
1001A(a).\20\ In addition, the Exchange may determine to grant a
position limit exemption for less than the maximum of two-times above
the limit.
\20\ The Exchange notes that it is adopting the language ``two
times above the limit'' to signify ``in addition to'' the current
position limit. For instance, where the position limit is 25,000
contracts, an additional 50,000 hedged contracts would be
permissible. This language parallels a recent change by another
exchange. See Securities Exchange Act Release No. 36609 (December
20, 1995), 60 FR 67002 (December 27, 1995) (notice of File No. SR-
CBOE-95-68). This exemption, however, may be used in addition to any
other position limit exemption that is available under the
Exchange's rules.
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Third, both the options and stock positions must be initiated and
liquidated in an orderly manner. This means that a reduction of the
options position must occur at or before the corresponding reduction in
the stock portfolio position. Moreover, initiating or liquidating
positions should not be conducted in a manner calculated to cause
unreasonable price fluctuations or unwarranted price changes or with a
view toward taking advantage of any differential in price between a
group of securities and an overlying stock position. The Exchange's
Market Surveillance Department must be notified in writing for approval
in advance of initiating or liquidating any such position as well as of
any material change in the portfolio or futures positions which
materially affects the unhedged value of the qualified portfolio.
Fourth, any securities that are used as a hedge pursuant to the
rule may not also be used to hedge other option positions.
Fifth, the portfolio must be previously established and the options
must be carried in an account with an Exchange member.
Sixth, if any member or member organization carrying an account
which has received an exemption pursuant to this rule has reason to
believe that as a result of an opening transaction, the position
telescoping provisions of the rule, or the execution of a clearing
member trade assignment agreement transaction (``CMTA''),\21\ that its
customer, acting alone or in concert with others, directly or
indirectly, violates this position limit exemption, then the member or
member organization has violated this rule. Violation of any of these
provisions, absent reasonable justification or excuse, will result in
withdrawal of the hedge exemption and subsequent denial of an
application for a hedge exemption.
\21\ A CMTA agreement is an agreement between a Phlx Options
Clearing Corporation (``OCC'') member and a non-Phlx OCC member
which enables the non-Phlx OCC member to have trades executed on its
behalf on the Exchange by the Phlx member.
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Lastly, the value of the market index option position cannot exceed
the dollar value of the underlying portfolio. The purpose of this
requirement is to further ensures that sock transactions are not used
to manipulate the market in a manner benefitting the option position.
[[Page 11671]]
2. Statutory Basis
The Phlx believes that the proposed market index hedge exemption
should increase the depth and liquidity of the broad-based index
options market 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 exemption granted by the proposal.
Accordingly, the Phlx believes that the proposed rule change is
consistent with Section 6(b) of the Act in general, and with Section
6(b)(5) in particular,\22\ in that it is designed to promote just and
equitable principles of trade, and, by promoting liquidity in the index
options marketplace, will serve to protect investors and the public
interest.
\22\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Phlx does not believe that the proposed rule change will impose
any inappropriate 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 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 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 Phlx consents, the Commission will:
A. by order approve the 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. Sec. 552, will be available for inspection and copying at
the Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing also will be available
for inspection and copying at the principal office of the Phlx. All
submissions should refer to File No. SR-Phlx-96-07 and should be
submitted by April 11, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\23\
\23\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-6764 Filed 3-20-96; 8:45 am]
BILLING CODE 8010-01-M
