[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
