[Federal Register Volume 59, Number 72 (Thursday, April 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-7006]
[[Page Unknown]]
[Federal Register: April 14, 1994]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33874; File No. SR-PSE-93-22]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change by the Pacific
Stock Exchange, Inc., Relating to the Listing of Capped-Style Stock
Index Options
April 7, 1994.
I. Introduction
On August 20, 1993, the Pacific Stock Exchange, Inc. (``PSE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act''), 15 U.S.C. 78s(b)(1), and
Rule 19b-4 thereunder,\1\ a proposed rule change to allow the Exchange
to list capped-style stock index options (``capped options'').\2\
Initially, the Exchange proposes to list capped options on the Wilshire
Small Cap Index and the PSE Technology Index (together, the
``Indexes'').
---------------------------------------------------------------------------
\1\17 CFR 240.19b-4 (1992).
\2\On October 20, 1993, the PSE amended its proposal to replace
references to ``CAPS'' with references to ``capped-style'' options
and to state that the Exchange plans initially to adopt a cap
interval of 20 points. See Letter from Michael D. Pierson, Senior
Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff
Attorney, Options Branch, Division of Market Regulation
(``Division''), Commission, dated October 15, 1993 (``Amendment No.
1''). On November 3, 1993, the PSE amended its proposal to indicate
that the proposal will apply only to broad-based domestic index
options and to clarify that Bridge Data Company calculates the
opening and closing index values for the Wilshire Small Cap Index
and the PSE Technology Index. See Letter from Michael D. Pierson,
Senior Attorney, Market Regulation, PSE, to Yvonne Fraticelli, Staff
Attorney, Options Branch, Division, Commission, dated October 29,
1993 (``Amendment No. 2''). On February 7, 1994, the PSE amended its
proposal to include new Rule 7.8(c), which will (1) indicate those
indexes that have been approved by the PSE for capped option
trading; (2) provide, in rule form, that, unless modified by the
PSE, the cap interval will be $20.00; and (3) set forth the
standards for listing and adding series of capped options. See
letter from Michael D. Pierson, Senior Attorney, Market Regulation,
PSE, to Michael A. Walinskas, Staff Attorney, Options Branch,
Division of Market Regulation (``Division''), Commission, dated
February 7, 1994 (``Amendment No. 3''). On April 5, 1994, the PSE
amended the proposal to indicate that the PSE has developed
procedures to identify and correct any exercise settlement values
prior to clearance and settlement of such contracts at the Options
Clearing Corporation. See letter from Michael D. Pierson, Senior
Attorney, PSE, to Michael Walinskas, Branch Chief, Division of
Market Regulation, SEC, dated April 5, 1994 (``Amendment No. 4).
---------------------------------------------------------------------------
II. Description of the Proposal
Proposed PSE Rule 7.1(r) defines a ``capped-style index option'' as
an index option that is exercised automatically prior to expiration
when the cap price is less than or equal to the closing index value for
calls or when the cap price is greater than or equal to the closing
index value for puts. The cap price, which is assigned by the Exchange
when the capped option is listed, is the exercise price plus the cap
interval for a call or the exercise price minus the cap interval for a
put. Accordingly, the cap price is above the exercise price (i.e.,
strike price) for calls and below the exercise price (i.e., strike
price) for puts. The difference between the strike price and the cap
price is equal to the ``cap interval.'' Specifically, the PSE defines
the cap interval as a ``value specified by the Exchange which, when
added to the exercise price for the series (in the case of a series of
calls) or subtracted from the exercise price for such series (in the
case of a series of puts), results in the cap price for the series.''
The PSE has set as an initial standard, subject to Exchange
modification that the cap interval for capped options must be
$20.00.\3\
---------------------------------------------------------------------------
\3\See Amendment No. 3, supra note 1.
---------------------------------------------------------------------------
While capped options will be subject to automatic exercise due to
movements in the underlying index, they also will be European-style, so
that if the cap price is not reached prior to expiration the option can
be exercised by the holder only at expiration pursuant to the rules of
the Options Clearing Corporation (``OCC''). Thus, if the underlying
index fails to reach the cap price during the life of the capped
option, the option becomes European-style on the last business day
before expiration.
Upon automatic exercise of a capped option, the holder receives a
cash settlement amount equal to the cap interval times the multiplier
for the option. Under no circumstances, however, does the holder
receive a cash settlement amount greater than the cap interval times
the index multiplier. Therefore, the cap price establishes a maximum
pre-defined value for the capped options. For example, if the index
multiplier is 100, the index closes at 382 and the investor holds a
capped call option with a strike price of 360 and a cap interval of 20,
then the holder would receive a cash settlement amount equal to $2,000
(20 times $100).
Long capped call options closely resemble vertical bull spreads
traded as a single security (i.e., the combination of one long and one
short call position with the same expiration but where the strike price
of the short call is higher than the strike price of the long call).
Conversely, long capped put options closely resemble vertical bear
spreads traded as a single security (i.e., the combination of one long
put and one short put position with the same expiration, but where the
strike price of the short put is lower than the strike price of the
long put).
The PSE has proposed the following rule changes to accommodate the
trading of capped index options. First, the PSE plans to amend Exchange
Rule 7.1, ``Definitions,'' to define ``capped-style option,'' ``capped-
style index option.'' ``cap interval,'' and ``cap price.''
Second, the Exchange proposes to amend Exchange Rule 7.6,
``Position Limits,'' to provide that capped options will be aggregated
with standard index option contracts on the same stock index for
position limit purposes. However, the Exchange proposes to amend
Exchange Rule 7.7, ``Exercise Limits,'' to provide that capped options
will not be aggregated with standard option contracts on the same stock
index when calculating exercise limits. This amendment is designed to
avoid instances where an investor would violate exercise limits by
virtue of the automatic exercise of the capped options, an event over
which the investor has no control.
Third, the Exchange proposes to amend Rule 7.8, ``Terms of Options
Contracts,'' to: (1) Indicate those indexes upon which capped options
can be traded; (2) reflect that the cap interval for capped options,
unless modified by the Exchange, shall be $20.00; (3) provide that
initially, one at-the-money capped option call and put will be listed
with an expiration of up to one year in the future and additional at-
the-money capped option series may be listed every two months with
expirations up to one year in the future; and (4) capped option series
may be added to expiration months with three or more months remaining
to their expiration, if there has been a move of ten or more points in
the index value.
Fourth, the Exchange proposes to amend Exchange Rule 7.16,
``Margin,'' to provide the following margin treatment for short
positions in capped options. For cash accounts, the customer must
deposit an amount equal to the cap interval times the index multiplier
in cash or cash equivalents as defined in Section 220.8(a)(3) of
Regulation T under the Act. For margin accounts, the margin requirement
is 100% of the current market value of the contract plus 15% of the
current index value times the index multiplier. In each case, the
amount shall be decreased by any excess of the aggregate exercise price
of the option over the current index value as multiplied by the index
multiplier in the case of a call, or any excess of the current index
value as multiplied by the index multiplier over the aggregate exercise
price of the option in the case of a put; provided, however, that the
minimum margin required on each contract shall not be less than (a) the
option market value plus 10% of the current index value multiplied by
the index multiplier or (b) the cap interval multiplied by the index
multiplier, whichever is less. The maximum margin required on each
contract shall not exceed the cap interval multiplied by the index
multiplier.
III. Commission Findings
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),\4\ and, therefore,
approves the Exchange's proposal.\5\ Specifically, the Commission
believes that the capped options are an innovative financial product
that will provide investors with additional choice and flexibility in
their use of derivatives. In addition, capped options offer both
holders and writers of options a means to participate in the options
markets at a predetermined maximum gain or loss. Under the terms of the
capped options, the option writer's (holder's) maximum loss (gain) is
established at the time of the investment by the option's cap interval.
Once the option's cap price (the strike price plus the cap interval for
a call or the strike price minus the cap interval for a put) has been
reached, the option is exercised automatically. The option writer's
maximum potential liability is the amount of the cap interval, and,
conversely, the option holder's maximum gain is the amount of the cap
interval. Thus, capped options permit investors to participate in the
options market at a known and limited cost. By limiting some of the
risks associated with spread positions in American-style and European-
style options, capped options likely will make the options markets more
attractive to a broad range of investors. In addition, the Commission
notes that capped options, which are the equivalent of vertical bull
and bear spreads traded as a single security, likely will benefit
investors by providing them with a more efficient and cost-effective
method of executing spread transactions.
---------------------------------------------------------------------------
\4\15 U.S.C. 78f(b)(5) (1984).
\5\The PSE proposal is nearly identical to separate proposals to
list and trade capped-style index options submitted by the CBOE and
Amex and subsequently approved by the Commission. See Securities
Exchange Act Release Nos. 29865, 56 FR 56255 (November 1, 1991)
(order approving File No. SR-CBOE-91-24) and 29934, 56 FR 58593
(November 20, 1991) (order approving File No. SR-Amex-91-24).
---------------------------------------------------------------------------
The Commission also finds that the specific rules proposed by the
PSE to accommodate capped options are consistent with the Act.\6\
Specifically, the Commission believes it is reasonable for the Exchange
to set a cap interval of $20.00 in that the cap price is placed
sufficiently far from the exercise price so that the capped options
will not be exercised automatically on a frequent basis.\7\
---------------------------------------------------------------------------
\6\The Commission notes that PSE Rule 7.1(q) defines capped-
style options and PSE 7.1(r) defines capped-style index options.
Because the current Exchange proposal, as the Commission's approval
order herein, is limited to capped options on the Wilshire Small Cap
Index and the PSE Technology Index, should the PSE decide to list
capped-style options on other indexes, including a foreign broad-
based stock index, a narrow-based stock index, or an individual
security, then the Commission believes an Exchange rule filing made
pursuant to Section 19(b) of the Act would be necessary.
\7\The Commission notes that a rule filing pursuant to Section
19(b) of the Act would be necessary if the PSE decided to change the
present cap interval.
---------------------------------------------------------------------------
In addition, the Commission believes that the Exchange's proposal
to bring up new at-the-money series of capped options every other month
and after significant market moves is consistent with the Act because
it will not result in a proliferation of options series. The Commission
also finds that it is consistent with the Act to exclude capped options
from exercise limit calculations because holders of capped options have
no control over when their positions will be exercised, except on the
last business day before expiration of the options. Moreover, the
Commission notes that capped options are not excluded from position
limit calculations, in that capped options are aggregated with non-
capped-style index options for position limit purposes.
Finally, the Commission believes that the proposed margin treatment
for capped options in cash and margin accounts is consistent with the
Act. Specifically, the Commission believes that it is consistent with
the Act to permit short capped options positions in a cash account so
long as the maximum exposure (the difference between the exercise price
and the cap price times the index multiplier) is deposited. This
position is the equivalent of a completely covered position, because
the maximum risk of loss is already on deposit. In addition, the
Commission believes the proposed margin requirements for capped options
positions maintained in margin accounts are consistent with the Act
because they are virtually identical to the margin requirements for
short stock index options positions in non-capped style stock index
options held in margin accounts, except for the fact that a limit equal
to the maximum exposure to the option writer is placed on the margin
requirement. It is reasonable to limit the margin in this fashion
because, if the limit is invoked, the margin covers 100% of the
exposure to the writer and no additional margin calls need be made.
Lastly, the Commission believes that the automatic exercise feature
of capped options necessitates that, when the PSR lists capped options
on a specific index, the PSE ensures that the exercise settlement value
for the index is accurate at all times. An erroneous exercise
settlement value could conceivably result in the unwarranted automatic
exercise of capped options and the irreversible elimination of an
options position. Accordingly, in this regard, the Commission notes
that the PSE has developed procedures to identify and correct any
exercise settlement values prior to settlement of such contracts at
OCC.\8\
---------------------------------------------------------------------------
\8\See Amendment No. 4, supra note 1.
---------------------------------------------------------------------------
The Commission finds good cause for approving the PSE's proposal to
list capped options prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register because
the Exchange's proposal is substantially the same as the formerly
submitted and approved CBOE and Amex proposals to list and trade capped
options.\9\ The Commission received no adverse comments on the CBOE or
Amex proposals during the 21-day comment period. The Commission also
does not find any different regulatory issues arising from the PSE's
proposal. Thus, the Commission believes it is appropriate to approve
the proposed rule change on an accelerated basis in order to facilitate
competition between the exchanges for product services, which, in turn,
should benefit public investors. The Commission believes, therefore,
that good cause exists for approving the proposed rule change on an
accelerated basis.
---------------------------------------------------------------------------
\9\See note 5, supra.
---------------------------------------------------------------------------
IV. Solicitation of Comments
With respect to the PSE proposal, including all amendments,
interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying at the
Commission's Public Reference Section, 450 Fifth Street, NW.,
Washington, DC. Copies of such filing will also be available for
inspection 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 May 5, 1994.
It it therefore ordered, Pursuant to section 19(b)(2) of the
Act,\10\ that the proposed rule change (SR-PSE-93-22) is approved.
\10\15 U.S.C. 78s(b)(2) (1988).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
---------------------------------------------------------------------------
\11\17 CFR 200.30-3(a)(12) (1993).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-7006 Filed 4-13-94; 8:45 am]
BILLING CODE 8010-01-M
