[Federal Register Volume 59, Number 55 (Tuesday, March 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-6602]
[[Page Unknown]]
[Federal Register: March 22, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 33766; File No. SR-Amex-93-37]
Self-Regulatory Organizations; American Stock Exchange Inc.;
Order Approving and Filing and Order Granting Accelerated Approval to
Amendment Nos. 1, 2, and 3 to a Proposed Rule Change by the American
Stock Exchange, Inc. Relating to the Listing of Options on the Amex
Broker/Dealer Index
March 15, 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 Broker/Dealer Index (``Broker/
Dealer Index'' or ``Index''). Notice of the proposed rule change
appeared in the Federal Register on December 15, 1993.\3\ No comment
letters were received on the proposed rule change. The Exchange
subsequently submitted Amendment Nos. 1, 2, and 3 to the proposed rule
change.\4\ This order approves the Exchange's proposal, as amended.
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\1\U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\See Securities Exchange Act Release No. 33305 (December 9,
1993), 58 FR 65605 (December 15, 1993).
\4\In Amendment No. 1, the Exchange proposes to provide that:
(1) If the number of components in the Index increases or decreases
by more than 33\1/3\% from the current number of components (i.e.,
9) the Exchange will provide written notice to the Commission; (2)
in no event will there be less than 9 components in the Index; and
(3) the average monthly trading volume for up to two of the
component securities can be not less than 500,000 shares. 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 December 31, 1993 (``Amendment No. 1''). On
February 2, 1994, the Exchange filed Amendment No. 2 to provide
update component information, to add Alex Brown, Inc. as an Index
component, and to delete Primerica Corp. and Raymond James
Financial, Inc. as Index components. 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 1, 1994. Finally, on February 22, 1994, the Exchange
submitted Amendment No. 3. to provide that: (1) The position and
exercise limits for the Index options would be 7,500 contracts on
the same side of the market; and (2) contrary to Amendment No. 1, if
the Amex decides to increase or decrease the number of components in
the Index by more than 33\1/3\%, the Exchange would be required to
submit a rule filing pursuant to Section 19(b) of the Act. 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.
3'').
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II. Description of Proposal
A. General
The Amex proposes to trade options on the Broker/Dealer Index, a
new stock index developed by the Amex based on stocks of securities
broker/dealer organizations which are traded on the Amex, the New York
Stock Exchange, Inc. (``NYSE''), or are national market system stocks
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.\5\ 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 Broker/
Dealer Index (``Broker/Dealer LEAPS'' or ``Index LEAPS'').\6\ Broker/
Dealer LEAPS will trade independent of and in addition to regular
Broker/Dealer 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\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.
\6\LEAPS is an acronym for Long-Term Equity Anticipation
Securities.
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B. Composition of the Index
The Index is comprised of nine stocks of highly-capitalizing
companies in the broker/dealer industry. Included in this group are
companies in the U.S. which provides securities brokerage service,
market-making services, U.S. Treasury primary dealer functions, and
other functions dealing with U.S. and international securities of all
types.\7\ The Exchange will use an ``equal dollar-weighted'' method to
calculate the Index.\8\ The Index was initialized at a level of 300 at
the close of trading on October 15, 1993.
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\7\The current component securities of the Index are Alex Brown,
Inc.; A.G. Edwards Inc.; Bear Stearns Companies, Inc.; Dean Witter
Discover and Co.; Merrill Lynch and Co.; Morgan Stanley Group Inc.;
Paine Webber Group Inc.; Salomon Inc.; and Charles Schwab Corp.
\8\ 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 266.51. The market capitalizations of the individual stocks
in the Index as of the close of trading on January 27, 1994 ranged from
a high of $8.89 billion (Merrill Lynch and Co.) to a low of $416.70
million (Alex Brown, Inc.), with the mean and median being $3.77
billion and $2.74 billion, respectively. The market capitalization of
all the stocks in the Index was $33.97 billion. The total number of
shares outstanding for the stocks in the Index ranged from a high of
209.73 million shares (Merrill Lynch and Co.) to a low of 15.95 million
shares (Alex Brown, Inc.). In addition, the average monthly trading
volume of the stocks in the Index, for the six-month period from July
27, 1993 through January 27, 1994, ranged from a high of 23.65 million
shares per month (Merrill Lynch and Co.) to a low of 1.37 million
shares per month (Alex Brown, Inc.), with the mean and median being
7.77 million and 5.04 million shares, respectively. Lastly, no one
stock comprised more than 11.60% of the Index's total value and the
percentage weighting of the five largest issues in the Index accounted
for 56.36% of the Index's value. The percentage weighting of the lowest
weighted stock was 10.76% of the Index and the percentage weighting of
the five smallest issues in the Index accounted for 54.69% 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,\9\ 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 9 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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\9\Notwithstanding Rule 901C, the Exchange must maintain the
Index with no less than nine stocks. See Amendment No. 1, supra note
4.
\10\Accordingly, the Broker/Dealer 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. 3, 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 broker/dealer 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 two
component stocks may have an average monthly trading volume of not less
than 500,000 shares.\12\
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\12\See Amendment No. 1, supra note 4.
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The Index currently has nine component stocks, all of which are
subject to 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 stocks 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 broker/dealer 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 broker/dealer industry, Merrill Lynch and Co. currently represents
over 26% of the aggregate market value of the Index. In addition, while
currently there is no extreme 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-weighting index.\13\
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\13\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 stock 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 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 stocks 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.\14\
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\14\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.\15\ 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 Broker/Dealer 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 Broker/Dealer LEAPS
until their time to expiration is less than twelve months.\16\
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\15\A European-style option can be exercised only during a
specified period before the option expires.
\16\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
Broker/Dealer 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
Broker/Dealer 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 Broker/Dealer 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 266.46 would be 26.65 for the Index LEAPS and 266.43 would
become 26.64. 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
Broker/Dealer 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,\17\
position and exercise limits,\18\ and trading halt procedures\19\ 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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\17\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.
\18\Pursuant to Amex rules 904C and 905C, respectively, the
position and exercise limits for the Index options will be 7,500
contracts, unless the Exchange determines, pursuant to rules 904C
and 905C, that a lower limit is warranted. See Amendment No. 3,
supra note 4.
\19\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 Index options and 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.\20\
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\20\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. Findings 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).\21\ Specifically, the
Commission finds that the trading of Broker/Dealer Index options,
including full-value and reduced-value Broker/Dealer 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 stocks in the broker/dealer
industry.\22\
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\21\15 U.S.C. 78f(b)(5) (1988).
\22\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 Broker/Dealer Index will provide investors
with a hedging vehicle that should reflect the overall movement of
the stocks comprising the broker/dealer 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 broker/dealer 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 Broker/
Dealer Index, will serve the needs of broker/dealer 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 Broker/Dealer 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. Broker Design and Structure
The Commission finds that the Broker/Dealer Index is a narrow-based
index. The Broker/Dealer Index is comprised of only nine stocks, all of
which are within on industry--the broker/dealer industry.\23\
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.\24\
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\23\The reduced-value Broker/Dealer Index, which is comprised of
the same component securities as the Broker/Dealer Index and
calculated by dividing the Broker/Dealer Index value by ten, is
identical to the Broker/Dealer Index.
\24\See supra Section II.G entitled ``Position and Exercise
Limits, Margin Requirements, and Trading Halts.''
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The Commission 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 7.77 million and 5.04
million shares, respectively.\25\ Second, the market capitalizations of
the stocks in the Index are very large, ranging from a high of $8.89
billion (Merrill Lynch and Co.) to a low of $416.70 million (Alex
Brown, Inc.) as of January 27, 1994, with the mean and median being
$3.77 billion and $2.74 billion, respectively. Third, although the
Index is only comprised of nine stocks, no one particular stock or
group of stocks dominates the Index. Specifically, no one stock
comprises more than 11.60% of the Index's total value and the
percentage weighting of the five largest issues in the Index accounts
for 56.36% of the Index's value.\26\ Fourth, all of the component
stocks in the Index currently have standardized options trading on
them.\27\ 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.\28\ 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 Broker/Dealer 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 Broker/Dealer 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 stocks, will help deter such illegal
activity.
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\25\In addition, for the six-month period between July 27, 1993
and January 27, 1994, all of the companies within the Index had an
average daily trading volume greater than 370,000 shares.
\26\For an index with a significantly greater number of stocks
than nine issues, the Commission might come to a different
conclusion if only a few stocks accounts for this level of the
index's weighting. Further, if an index contained fewer than nine
stocks, the Commission would question whether it can be traded as an
index product. In this regard, the Amex must maintain the Index at
nine or more components. See Amendment No. 1, supra note 4. If the
Amex needs to replace a stock at a time when there are only nine
components in the Index but cannot find one meeting the inclusion
criteria, the Exchange shall immediately contact the Commission at
which time a decision will be made as to whether the Exchange will
be required to delist its Index options and Index LEAPS.
\27\See supra note 5.
\28\See Amendment No. 2, 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 floats that are actively traded,
thus reducing the likelihood that the Index could be easily 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 two component stocks 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\29\ 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
broker/dealer sector and, as discussed above,\30\ meet the inclusion
criteria.
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\29\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.
\30\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 Broker/Dealer Index
options (including full-value and reduced-value Broker/Dealer 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 Broker/Dealer 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 stocks. 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 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.\31\ 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.\32\
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\31\See Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\32\See supra note 20. The Commission notes that the Index
currently does not contain American Depositary Receipts (``ADRs''),
nor does the proposal provide that the Index could contain ADRs
representing broker/dealer industry stocks.
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D. Market Impact
The Commission believes that the listing and trading of Broker/
Dealer Index options, including full-value and reduced-value Index
LEAPS on the Amex will not adversely impact the underlying securities
markets.\33\ 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 stocks generally will be actively traded, highly capitalized
stocks. Third, the 7,500 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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\33\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 Broker/
Dealer 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 stocks underlying options on the Index.\34\
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\34\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, 2,
and 3 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, as subsequently amended by Amendment No. 3,
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.\35\ Amendment No. 1
also provides that the average monthly trading volume for up to two of
the component securities can be not less than 500,000 shares. While in
other proposals recently approved by the Commission, components
representing no more than 10% of the Index value by weight were
eligible for this reduced trading volume requirement, the proposed
requirement is still significantly higher than the trading volume
requirement for listing options on individual equity options and should
ensure that Index components have deep and liquid markets. Amendment
No. 2 adds Alex Brown, Inc. and deletes Primerica, Corp. and Raymond
James Financial, Inc. as components of the Index. Because Alex Brown,
Inc. and the remaining components originally proposed satisfy the
Exchange's listing and maintenance requirements discussed above,\36\
and the Commission has determined that nine components is adequate for
the Index to trade as an index product pursuant to Amex's rules, the
Commission believes this change is appropriate. Amendment No. 3, in
addition to amending Amendment No. 1 as discussed above, merely states
that the position and exercise limits for the proposed Index options
will be set at 7,500 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.\37\ Therefore, the
Commission believes it is consistent with section 6(b)(5) of the Act to
approve Amendment Nos. 1, 2, and 3 to the Amex's proposal on an
accelerated basis.
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\35\See 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). The Commission
notes that the Amex's proposal requires the Index to have a minimum
of nine stocks. See Amendment No. 1, supra note 4.
\36\See supra Section II.C entitled ``Eligibility and
Maintenance Standards for the Inclusion of Component Stocks in the
Index.''
\37\See 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, 2, and 3 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 12, 1994.
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\38\ that the proposed rule change (SR-Amex-93-37), as amended, is
approved contingent upon the Exchange's submission to the Commission of
adequate systems capacity representations.\39\
\38\15 U.S.C. 78s(b)(2) (1988).
\39\See supra note 33.
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\40\
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\40\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-6602 Filed 3-21-94; 8:45 am]
BILLING CODE 8010-01-M
