95-12690. Self-Regulatory Organizations; Order Approving Proposed Rule Changes by the American Stock Exchange, Inc., the Chicago Board Options Exchange, Inc., the New York Stock Exchange, Inc., the Pacific Stock Exchange, Inc., and the Philadelphia ...  

  • [Federal Register Volume 60, Number 100 (Wednesday, May 24, 1995)]
    [Notices]
    [Pages 27573-27575]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 95-12690]
    
    
    
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    SECURITIES AND EXCHANGE COMMISSION
    [Release No. 34-35738; File Nos. SR-Amex-95-13, SR-CBOE-95-13, SR-NYSE-
    95-04, SR-PSE-95-05, and SR-PHLX-95-10]
    
    
    Self-Regulatory Organizations; Order Approving Proposed Rule 
    Changes by the American Stock Exchange, Inc., the Chicago Board Options 
    Exchange, Inc., the New York Stock Exchange, Inc., the Pacific Stock 
    Exchange, Inc., and the Philadelphia Stock Exchange, Inc. Relating to 
    Permanent Approval of the Hedge Exemption Pilot Programs
    
    May 18, 1995.
        On February 1, 1995, the Chicago Board Options Exchange, Inc. 
    (``CBOE''); on February 3, 1995, the Philadelphia Stock Exchange, Inc. 
    (``PHLX''); on February 21, 1995, the Pacific Stock Exchange, Inc. 
    (``PSE''); on February 28, 1995, the New York Stock Exchange, Inc. 
    (``NYSE''); and on March 14, 1995, the American Stock Exchange, Inc. 
    (``Amex'') (each individually referred to as an ``Exchange'' and two or 
    more collectively referred to as ``Exchanges''), pursuant to Section 
    19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
    19b-4 thereunder,\2\ filed with the Securities and Exchange Commission 
    (``SEC'' or ``Commission'') proposed rule changes seeking permanent 
    approval of the Exchanges' hedge exemption pilot programs.
    
        \1\ 15 U.S.C. 78s(b)(1) (1988).
        \2\ 17 CFR 240.19b-4 (1994).
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        The proposed rule changes were published for comment in the Federal 
    Register on March 28, 1995.\3\ No comments were received regarding the 
    Exchanges' proposals.
    
        \3\ See Securities Exchange Act Release No. 35523 (March 22, 
    1995), 60 FR 15947.
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        The proposals filed by the Exchanges seek permanent approval of the 
    Exchanges' pilot programs for exemptions from equity position limits 
    for certain hedged positions.\4\ In addition, the proposals filed by 
    the CBOE, the NYSE, and the PSE also seek permanent approval of the 
    Exchanges' pilot programs for position limit exemptions for certain 
    hedged broad-based stock index option positions.\5\
    
        \4\ Position limits impose a ceiling on the aggregate number of 
    options contracts on the same side of the market that can be held or 
    written by an investor or group of investors acting in concert.
        \5\ Under the equity option hedge exemption pilots, the 
    applicable position and exercise limits can never exceed twice the 
    existing position limit. Under the CBOE's and the PSE's broad-based 
    index hedge exemption pilots, the exempted positions may not exceed 
    75,000 same-side of the market option contracts in a class of broad-
    based index options. Under the NYSE's broad-based index hedge 
    exemption pilot, the exempted positions may not exceed 125,000 same-
    side of the market contracts. Unlike the equity option hedge 
    exemption, each exemption to position limits under the broad-based 
    index option hedge exemption must be specifically approved by the 
    Exchange for each customer and each position. See CBOE Rule 24.4, 
    ``Position Limits for Broad-Based Index Options,'' Interpretation 
    and Policy .01; NYSE Rule 704, ``Position Limits,'' Supplementary 
    Material .70; and PSE Rule 7.8, ``Terms of Option Contracts,'' 
    Commentary .02. [[Page 27574]] 
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        In 1988, the Commission approved pilot programs by the Amex, and 
    the PHLX providing exemptions from position limits for certain fully 
    hedged equity option positions.\6\ In addition, the Commission approved 
    pilot programs proposed by the CBOE, the NYSE, and the PSE providing 
    exemptions from position limits for certain fully hedged equity option 
    positions and/or stock index option positions.\7\ Most recently, the 
    Exchanges' pilot programs were extended through May 17, 1995.\8\
    
        \6\ See Securities Exchange Act Release No. 25738 (May 24, 
    1988), 53 FR 20201 (June 2, 1988) (order approving File Nos. SR-
    Amex-87-13, SR-CBOE-87-27, and SR-PHLX-87-37).
        \7\ See Securities Exchange Act Release Nos. 25738 (May 24, 
    1988), 53 FR 20204 (June 2, 1988) (order approving File No. SR-CBOE-
    87-25) (establishing CBOE's stock index option hedge exemption pilot 
    program); 27786 (March 8, 1990), 55 FR 9523 (March 14, 1990) (order 
    approving File No. SR-NYSE-89-09) (establishing NYSE's equity option 
    and stock index option hedge exemption pilot programs); 25811 (June 
    20, 1988), 53 FR 23821 (June 24, 1988) (order approving File No. SR-
    PSE-88-09) (establishing PSE's equity option hedge exemption pilot 
    program); 32900 (September 14, 1993), 58 FR 49077 (September 21, 
    1993) (order approving File No. SR-PSE-92-38) (extending PSE's stock 
    index option hedge exemption pilot program); and 32903 (September 
    14, 1993), 58 FR 49068 (September 21, 1993) (order approving File 
    No. SR-CBOE-91-44) (extending the CBOE's index option hedge 
    exemption program).
        \8\ See Securities Exchange Act Release Nos. 34986 (November 18, 
    1994) 59 FR 60856 (November 28, 1994) (order approving File Nos. SR-
    Amex-94-49, SR-CBOE-94-41, SR-PSE-94-33, and PHLX-94-53); and 85194 
    (January 5, 1995), 60 FR 2800 (January 11, 1995) (order approving 
    File No. SR-NYSE-94-47).
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        The pilot programs for equity option positions allow an exemption 
    from equity option position and exercise limits for accounts that have 
    established one of the four most commonly used hedged positions on a 
    limited one-for-one basis (i.e., 100 shares of stock for one option 
    contract). The four hedged positions are: (1) Long stock and short 
    call; (2) long stock and long put; (3) short stock and long call; and 
    (4) short stock and short put. Under the equity option programs, the 
    maximum position limit (including the allowed exemptions) may not 
    exceed twice the established option position limit.
        The index hedge exemption programs allow public customers to apply 
    for position limit exemptions for positions in broad-based index 
    options that are hedged with Exchange-approved qualified portfolios of 
    stock.\9\ Under the broad-based index option hedge exemption program a 
    public customer must receive specific Exchange approval to exceed the 
    position limits by a specified amount before establishing a position in 
    reliance upon the hedge exemption requirements. Under these 
    requirements, a qualified portfolio is comprised of net long or short 
    positions in common stocks or securities readily convertible into 
    common stocks in at least four industry groups and contains at least 
    twenty stocks, none of which accounts for more than 15% of the value of 
    the portfolio. To remain qualified, a portfolio must meet these 
    standards at all times, regardless of trading activity in the stocks.
    
        \9\ The CBOE's broad-based index hedge exemption program does 
    not apply to A.M.-settled, European-style Standard & Poor's 
    (``S&P'') 500 Index options and Quarterly Index Expiration options 
    on the S&P 500.
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        Subject to the maximum number of exempt option contracts allowed 
    under the Exchanges' broad-based index option hedge exemption 
    programs,\10\ the broad-based index option hedge exemption applies to 
    positions in broad-based index options to the extent that the 
    underlying value of the option positions does not exceed the unhedged 
    value of the qualified portfolio. The unhedged value is determined as 
    follows: (1) The value of the net long or short positions for each of 
    the stocks or their equivalents are totaled; and (2) the value of (a) 
    any opposite side of the market calls and puts in broad-based index 
    options, (b) any opposite side of the market positions in stock index 
    futures, and (c) any economically equivalent opposite side of the 
    market positions in other stock index options and in options on stock 
    index futures, is subtracted from the total.
    
        \10\ See note 5, supra.
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        Under the broad-based index option hedge exemption programs, hedge 
    exemption customers agree to, among other things, establish and 
    liquidate options and stock positions or their equivalents in an 
    orderly fashion; not establish or liquidate positions in a manner 
    calculated to cause unreasonable price fluctuations or unwarranted 
    price changes; not establish or liquidate a stock position or its 
    equivalent contemporaneously with the establishment or liquidation of 
    an equivalent broad index stock group option position with a view 
    toward taking advantage of any differential between the prices of the 
    stocks or their equivalents and the options; and liquidate an 
    offsetting portion of the options position prior to or 
    contemporaneously with any decrease in the available hedge value of the 
    qualified portfolio.
        Each of the pilot programs allow the underlying hedged positions to 
    include securities that are readily convertible into common stock.\11\ 
    Under all of the pilot programs, exercise limits continue to correspond 
    to position limits, so that investors are allowed to exercise, during 
    five consecutive business days, the number of option contracts set 
    forth as the position limit, as well as those contracts purchased 
    pursuant to the pilot program.\12\
    
        \11\ The Commission expects the Exchanges to determine on a 
    case-by-case basis whether an instrument that is being used as the 
    basis for an underlying hedged position is readily and immediately 
    convertible into the security underlying the corresponding option 
    position. In this regard, the Commission finds that an instrument 
    which will become convertible into a security at a future date, but 
    which is not presently convertible, is not a ``convertible'' 
    security for purposes of the equity option position limit hedge 
    exemption until the date it becomes convertible. In addition, if the 
    convertible security used to hedge an options position is called for 
    redemption by the issuer, the security would have to be converted 
    into the underlying security immediately or the corresponding 
    options position reduced accordingly. See, e.g., Securities Exchange 
    Act Release No. 32903, supra note 7.
        \12\ Exercise limits prohibit the exercise by an investor or 
    group of investors acting in concert of more than the number of 
    options contracts specified in the position limit rule within five 
    consecutive business days.
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        The Exchanges believe that the proposed rule changes are consistent 
    with Section 6(b) of the Act, in general, and further the objectives of 
    Section 6(b)(5), in particular, in that they are designed to protect 
    investors and the public interest and to remove impediments to and 
    perfect the mechanism of a free and open market.
        The Commission finds that the proposed rule changes seeking 
    permanent approval of the Exchanges' hedge exemption pilot programs are 
    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) thereunder.\13\ 
    The Commission concludes, as it did when originally approving each of 
    the pilot programs, that providing for increased position and exercise 
    limits for equity options and broad-based stock index options in 
    circumstances where those excess positions are fully hedged with 
    offsetting stock positions will provide greater depth and liquidity to 
    the market and will allow investors to hedge their stock portfolios 
    more effectively, [[Page 27575]] without significantly increasing 
    concerns regarding intermarket manipulations or disruptions of either 
    the options market or the underlying stock market.
    
        \13\ 15 U.S.C. Sec. 78f(b)(5) (1988 & Supp. V 1993).
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        In this regard, the Commission notes that the Exchanges' hedge 
    exemption programs have operated on a pilot basis since 1988 and that 
    the Exchanges have not experienced any significant difficulties with 
    the pilots since their inception or observed any market disruptions 
    resulting from the increased positions. In addition, the Exchanges have 
    submitted reports to the Commission describing, among other things, the 
    frequency with which the exemptions have been utilized, the types of 
    investors using the exemptions, the size of the positions assumed 
    pursuant to the programs, and the market impact of the programs. The 
    reports indicate that the Exchanges have not observed any negative 
    impact on their markets as a result of the hedge exemption programs. 
    Finally, the Exchanges have established surveillance procedures 
    designed to monitor compliance with the position limit hedge exemption 
    programs. The Commission expects the Exchanges to continue to monitor 
    utilization of the hedge exemptions to ensure compliance with the 
    programs' requirements.
        With regard to the equity option hedge exemption, the Commission 
    believes, as it has concluded in the past,\14\ that the exemption will 
    not disrupt the options or equity markets or substantially increase the 
    possibility of manipulation in the underlying stocks or options. In 
    this regard, the Commission notes that the position and exercise limit 
    exemption is limited to accounts that have established one of four 
    hedged positions. Moreover, market disruption concerns are lessened 
    because any option positions in excess of current position limits must 
    be hedged fully with an offsetting stock position on a one-for-one 
    basis; thus, the holder of the options position would not be required 
    to enter the market to buy or sell the stock if the options were 
    exercised or assigned. The Commission also believes that a maximum 
    position of double the existing position and exercise limits will help 
    to ensure that any potential market disruptions are minimal.
    
        \14\ See Securities Exchange Act Release No. 25738, supra note 
    6.
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        With regard to the broad-based index option hedge exemption 
    programs, the Commission believes, as it has concluded previously,\15\ 
    that the programs will allow more effective hedging of stock portfolios 
    and may increase the depth and liquidity of the stock index options 
    market. In this regard, public customers with long or short stock 
    portfolios (or instruments convertible into such securities) will be 
    able to utilize the broad-based index hedge exemption, thereby making 
    an alternative hedging technique more available to such customers and 
    facilitating their use of index options to hedge their portfolios, 
    rather than financially equivalent index futures products.
    
        \15\ See Securities Exchange Act Release Nos. 32903 and 32900, 
    supra note 7.
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        As noted above, the broad-based index option hedge exemption 
    applies only to public customers and each request for the exemption 
    must be specifically approved by the appropriate Exchange. This should 
    ensure that the hedges are appropriate for the position being taken and 
    in compliance with Exchange rules.
        In addition, the Commission notes that the broad-based index option 
    hedge exemptions have additional safeguards that will make it difficult 
    to use the exempted positions to disrupt or manipulate the market. In 
    this regard, the qualified stock portfolio must be broad-based, and 
    correspond in value to the value of the options hedge so that the 
    increased positions could not be used in a leveraged manner. Both the 
    options and stock positions must be initiated and liquidated in an 
    orderly manner. The requirement that a reduction in the options 
    position must occur at or before the corresponding reduction in the 
    stock portfolio position should ensure that the stock transactions are 
    not used to impact the market so as to benefit the options position. 
    Moreover, because the exemption may not be used for arbitrage in stock 
    baskets and overlying stock index options, the broad-based index option 
    hedge exemption should not exacerbate stock market volatility. Finally, 
    the Commission notes that the index option hedge exemption applies only 
    to options on broad-based indexes, where the potential for manipulation 
    is minimal and thus regulatory concerns are decreased.
        It is therefore ordered, pursuant to Section 19(b)(2) of the 
    Act,\16\ that the proposed rule changes (SR-Amex-95-13, SR-CBOE-95-13, 
    SR-NYSE-95-04, SR-PSE-95-09, and SR-PHLX-95-10) are approved.
    
        \16\ 15 U.S.C. 78s(b)(2)(1982).
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        For the Commission, by the Division of Market Regulation, 
    pursuant to delegated authority.\17\
    
        \17\ 17 CFR 200.30-3(a)(12) (1994).
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    Margaret H. McFarland,
    Deputy Secretary.
    [FR Doc. 95-12690 Filed 5-23-95; 8:45 am]
    BILLING CODE 8010-01-M
    
    

Document Information

Published:
05/24/1995
Department:
Securities and Exchange Commission
Entry Type:
Notice
Document Number:
95-12690
Pages:
27573-27575 (3 pages)
Docket Numbers:
Release No. 34-35738, File Nos. SR-Amex-95-13, SR-CBOE-95-13, SR-NYSE- 95-04, SR-PSE-95-05, and SR-PHLX-95-10
PDF File:
95-12690.pdf