[Federal Register Volume 61, Number 62 (Friday, March 29, 1996)]
[Notices]
[Pages 14168-14172]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7704]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37017; File No. SR-Amex-96-03]
Self-Regulatory Organizations; American Stock Exchange, Inc.;
Order Approving Proposed Rule Change by the American Stock Exchange,
Inc. Relating to the Listing and Trading of Options and Long-Term
Options on the Networking Index and Long-Term Options on a Reduced-
Value Networking Index
March 22, 1996.
I. Introduction
On January 23, 1996, the American Stock Exchange, Inc. (``Amex'' or
``Exchange'') submitted to the Securities
[[Page 14169]]
and Exchange Commission (``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 Networking Index (``Index''). Notice of
the proposed rule change appeared in the Federal Register on February
13, 1996.\3\ No comment letters were received on the proposed rule
change. This order approves the Exchange's proposal.
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
\3\ See Securities Exchange Act Release No. 36812 (February 6,
1996), 61 FR 5590.
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II. Description of Proposal
A. General
The Amex proposes to trade options on The Networking Index, a
modified equal-dollar weighted index developed by the Amex comprised of
15 computer and telecommunication networking stocks which are traded on
the Amex, the New York Stock Exchange, Inc. (``NYSE''), or through the
facilities of the National Association of Securities Dealers Automated
Quotation system and are reported national market system securities
(``NASDAQ/NMS''). In addition, the Amex proposes to amend rule 901C,
Commentary .01, to reflect that 90% of the Index's numerical value will
be accounted for by stocks that meet the current criteria and
guidelines set forth in Rule 915.
B. Eligibility Standards for Index Components
The Networking Index currently conforms with Exchange Rule 901C,
which specifies criteria for inclusion of stocks in an index on which
standardized options will be traded. In addition, the Index also
currently conforms to all the criteria set forth in Rule 901C,
Commentary .02, which provides for the commencement of trading of
options on an index thirty days after the date of filing, with the
exception that the Index is calculated using a modified version of the
equal-dollar weighting method. Therefore, the component securities all
meet the following eligibility standards: (1) They are traded on the
Amex or NYSE, or are NASDAQ/NMS securities; (2) component stocks
comprising the top 90% of the Index by weight have a minimum market
capitalization of $75 million, and those component stocks constituting
the botton 10% of the Index by weight have a market capitalization of
at least $50 million; and (3) stocks constituting the top 90% of the
Index by weight have minimum monthly volume of 1,000,000 shares over
the six months preceding this filing, and stocks constituting the
bottom 10% of the Index by weight have a minimum monthly volume of at
least 500,000 shares over the six months preceding this filing.
C. Index Calculation
The Index is calculated using a ``modified equal-dollar weighting''
methodology. Four of the fifteen component securities are given higher
weightings to reflect their higher market capitalizations relative to
the rest of the group, while not allowing their weightings to dominate
the Index to the extent they would in a straight market capitalization
weighted Index. According to the Amex, this method of cacluation is
important given the great disparity in market value of a few of the
Index's components. It has been the Exchange's experience that options
on market value weighted indexes dominated by relatively few component
stocks are less useful to investors, since the index will tend to
represent these few components and not the industry as a whole. At the
same time, the increase in Index weight for the smaller, less liquid
stocks is lower than if the index had been straight equal-dollar
weighted; and the decrease in Index weight of the larger, more liquid
stocks also is less dramatic than using straight equal-dollar
weighting.
The following is a description of how the modified equal-dollar
weighting calculation method works. As of the market close on October
20, 1995, a portfolio of networking stocks was established representing
an investment of $12,000 in each of the four most highly capitalized
securities in the Index and $4,727.27 in each of the 11 remaining
stocks (rounded 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 sum of the assigned number of shares of each of the
stocks in the Index portfolio divided by the Index divisor. The Index
divisor was initially determined to yield the benchmark value of 200.00
at the close of trading on October 20, 1995. Each quarter thereafter,
following the close of trading on the third Friday of January, April,
July and October, the Index portfolio will be ranked in descending
market capitalization order and the Index portfolio adjusted by
changing the number of whole shares of each component stock so that the
four largest capitalized stocks in the Index each represents 12% of the
Index value for a total of 48%, and the remaining 52% of the Index
value is evenly distributed over the remaining securities. At the
inception of the Index, each of the remaining 11 components had a
weight of approximately 4.73%. The Exchange has chosen to rebalance
following the close of trading on the quarterly expiration cycle
because it allows an option contract to be held for up to three months
without a change in the Index portfolio being effected, while at the
same time maintaining the equal-dollar weighting feature of the Index.
If necessary, a divisor adjustment is made at the rebalancing 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.
As noted above, the number of shares of each component stock in the
Index portfolio 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 distribution,
stock split, reverse stock split, rights offering, distribution,
reorganization, recapitalization, or similar event with respect to the
component stocks.\4\ In a merger or consolidation of an issuer of a
component stock, if the stock remains in the Index, the number of
shares of that security in the portfolio may 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 in the same weighting tier of the stock being
replaced (i.e., either the top four stocks by market capitalization as
of the last rebalance, or the remaining stocks) will be calculated and
that amount invested in the stock of the new component, to the nearest
whole share. In all cases, the divisor will be adjusted, if necessary,
to ensure Index continuity.
\4\ Telephone conversation between Claire McGrath, Managing
Director and Special Counsel, Amex, and Francois Mazur, Attorney,
Office of Market Supervision, Division of Market Regulation,
Commission, on February 2, 1996.
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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.
D. Maintenance of the Index
The Exchange will review the Index quarterly,\5\ and maintain it so
that: (1) The total number of component securities will not increase or
decrease by more than 33\1/3\% from the number
[[Page 14170]]
of components in the Index at the time of its initial listing, and in
no event will the Index have fewer than nine components; (2) component
stocks constituting the top 90% of the Index by weight will have a
minimum market capitalization of $75 million and the component stocks
constituting the bottom 10% of the Index by weight will have a minimum
market capitalization of $50 million; (3) the monthly trading volume
for each of the past six months \6\ for each component security shall
be at least 500,000 shares, or, for each of the lowest weighted
components in the Index that in the aggregate account for no more than
10% of the weight of the Index, the monthly trading volume shall be at
least 400,000 shares; (4) no single component will represent more than
25% of the weight of the Index and the five highest weighted components
will represent no more than 60% of the Index at each quarterly
rebalancing; and (5) at least 90% of the index's numerical index value
and at least 80% of the total number of component securities
individually will meet the then current criteria for standardized
option trading set forth in Exchange rule 915;\7\
\5\ Id.
\6\ Id.
\7\ Currently, all Index component securities are the subject of
standardized options trading.
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The Exchange will notify promptly Commission staff at any time it
determines that the Index fails to satisfy any of the foregoing
maintenance critera. Moreover, in such an event, the Exchange shall not
open for trading any additional option series, unless such failure is
determined by the Exchange not to be significant and Commission staff
concurs in that determination.
E. Expiration and Settlement
The proposed options on the Index will be European style (i.e.,
exercises permitted at expiration only), and cash settled. Standard
option trading hours (9:30 a.m. to 4:10 p.m. New York time) will apply.
Networking Index options will expire on the Saturday following the
third Friday of the expiration month (``Expiration Friday''). The last
trading day in an expiring option series normally will be the second to
last business day preceding the Saturday following the third Friday of
the expiration month (normally a Thursday). Trading in expiring options
will cease at the close of trading on the last trading day.
The Exchange plans to list options series with expirations in the
three near-term calendar months and in the two additional calendar
months in the January cycle. In addition, longer term option series
having up to thirty-six months to expiration may be traded. In lieu of
such long-term options on a full-value Index level, the Exchange may
instead list long-term, reduced-value put and call options based on
one-tenth (\1/10\th) the Index's full value. In either event, the
interval between expiration months for either a full-value or reduced-
value long-term option will be not less than six months. The trading of
any long-term options would be subject to the same rules which goven
the trading of all the Exchange's index options, including sales
practice rules, margin requirements and floor trading procedures, and
all options will have European style exercise. Position limits on
reduced-value long-term Networking Index options will be equivalent to
the position limits for regular (full-value) Index options and would be
aggregated with such options (for example, if the position limit for
the full-value options is 9,000 contracts on the same side of the
market, then the position limit for the reduced-value options will be
90,000 contracts on the same side of the market).
The exercise settlement value for all of the Index's expiring
options will be calculated based upon the primary exchange regular way
opening sale prices for the component stocks. In the case of securities
traded through the NASDAQ/NMS, the first reported regular way sale
price will be used. If any component stock does not open for trading on
its primary market on the last trading day before expiration, then the
prior day's last sale price will be used in the calculation.
F. Exchange Rules Applicable to Stock Index Options
The Index is deemed to be a Stock Index Option under Rule 901C(a)
and a Stock Index Industry Group under Rule 900C(b)(1). Exchange rules
governing margin requirements, position and exercise limits, and
trading halt procedures applicable to the trading of narrow-based index
options will apply to options traded on the Index. For example, the
Exchange expects that the review required by Rule 904C(c) will result
in a position limit of 9,000 contracts with respect to options on the
Index. Surveillance procedures currently used to monitor trading in
each of the Exchange's other index options also will be used to monitor
trading in options on The Networking Index. With respect to Rule
903C(b), the Exchange proposes to list near-the-money option series on
the Index at 2\1/2\ point strike (exercise) price intervals when the
value of the Index is below 200 points.
G. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options also will be used to monitor
trading in Index options and full-value and reduced-value Index long-
term options. 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.\8\
\8\ 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.
(``NASD''); 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).\9\ Specifically, the
Commission finds that the trading of Networking Index options,
including full-value and reduced-value long-term Index options, will
serve to promote the public interest and help to remove impediments to
a free and open securities market by providing investors with an
additional means to hedge exposure to market risk associated with
stocks in the networking industry.\10\
\9\ 15 U.S.C. Sec. 78f(b)(5) (1988).
\10\ 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 Index will provide investors with a hedging
vehicle that should reflect the overall movement of the stocks
representing companies in the networking sector in the U.S. stock
markets.
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The trading of options on The Networking Index and on a reduced-
value Index, however, raises several issues relating to index design,
customer protection, surveillance, and market impact. The Commission
believes, for the reasons discussed below, that the Amex has addressed
these issues adequately.
A. Index Design and Structure
The Commission believes it is appropriate for the Exchange to
designate the Index as a narrow-based index for purposes of index
options trading. The Index is comprised of 15 stocks intended to track
the networking sector of the stock market. The Commission also finds
that the reduced-value Index is a narrow-based index because it is
composed of the same component securities as the Index, and merely
dividing the Index value by ten will not alter its basic character.
Accordingly, the Commission believes that it is appropriate for the
Amex to apply its rules governing narrow-based index options to trading
in the Index options and long-term full-value and reduced-value Index
options.\11\
\11\ See supra Section II.F.
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The Commission also believes 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 for the period between
July 1995 and December 1995 of 22.9 million and 10.0 million shares,
respectively. Second, the market capitalizations of the stocks in the
Index are very large, ranging from a high of $20.9 billion to a low of
$1.3 billion as of January 2, 1996, with the mean and median being $5.5
billion and $3.6 billion, respectively. Third, because the index is
modified equal dollar-weighted, as described above, no one particular
stock or group of stocks dominates the Index. Specifically, as of
January 2, 1996, no one stock accounted for more than 13.94% of the
Index's total value and the percentage weighting of the five highest
weighted stocks in the Index accounted for 50.63% of the Index's value.
Fourth, the proposed maintenance criteria will serve to ensure
that: (1) The Index remains composed substantially of liquid highly
capitalized securities; and (2) the Index is not dominated by one or
several securities that do not satisfy the Exchange's options listing
criteria. Specifically, in considering changes to the composition of
the Index, 90% of the weight of the Index and 80% of the number of
components in the Index must at all times comply with the listing
criteria for standardized options trading set forth in Amex Rule 915.
The Amex will notify Commission staff promptly at any time the Amex
determines that the Index fails to satisfy any of the foregoing
maintenance criteria.\12\ Further, in such an event, the Exchange will
not open for trading any additional series of Index options or Index
long-term options unless the Exchange determines that such failure is
not significant, and Commission staff concurs in the determination.
\12\ Telephone Conversation between Howard A. Baker, Senior Vice
President, Derivative Securities, Administration & Research, Amex,
and Francois Mazur, Attorney, Office of Market Supervision, Division
of Market Regulation, on March 20, 1996.
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Finally, the Commission believes that the existing mechanisms to
monitor trading activity in the component stocks of the Index, or
options on those stocks, will help deter as well as detect any illegal
activity.
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 Index options (including
full-value and reduced-value long-term Index options), 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 long-term full-value and reduced-value options will be
subject to the same regulatory regime as the other standardized index
options currently traded on the Amex, the Commission believes that
adequate safeguards are in place to ensure the protection of investors
in Index options and full-value or reduced-value Index long-term
options.
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.\13\ In this regard, the Commission
notes that the Amex, NYSE, and NASD are all members of the ISG.\14\ The
Commission believes that this arrangement ensures the availability of
information necessary to detect and deter potential manipulations and
other trading abuses, thereby making the Index options and full-value
and reduced-value long-term Index options less readily susceptible to
manipulation.\15\
\13\ See Securities Exchange Act Release No. 31243 (September
28, 1992), 57 FR 45849.
\14\ See supra note 8.
\15\ See, e.g., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (order approving the listing of
index options and index LEAPS on the Chicago Board Options Exchange
Biotech Index).
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D. Market Impact
The Commission believes that the listing and trading of Index
options, including full-value and reduced-value Index LEAPS on the
Amex, will not adversely affect the underlying securities markets.
First, because of the ``modified equal dollar-weighting'' method that
will be used, as described above, no one security or group of
securities represented in the Index will dominate the weight of the
Index immediately following a quarterly rebalancing. Second, the Index
maintenance criteria ensure that the Index will be substantially
comprised of securities that satisfy the Exchange's listing standards
for standardized options trading, and that one or a few stocks do not
dominate the Index. Third, the currently applicable 9,000 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 long-term options will be issued and guaranteed by
the Options Clearing Corporation just like any other standardized
option traded in the United States.
Lastly, the Commission believes that settling expiring Networking
Index options (including full-value and reduced-value long-term Index
options) based on the opening prices of component securities is
reasonable and consistent with the Act. As has been noted previously,
valuing index options for exercise settlement on expiration based on
opening rather than closing
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prices of index component securities may help to reduce adverse effects
on markets for such securities.\16\
\16\ See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change (SR-Amex-96-03), as amended, is
approved.
\17\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
\18\ 17 CFR 200.30-3(a)(12) (1994).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-7704 Filed 3-28-96; 8:45 am]
BILLING CODE 8010-01-M
