[Federal Register Volume 59, Number 137 (Tuesday, July 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17426]
[[Page Unknown]]
[Federal Register: July 19, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34364; File No. SR-PSE-93-13]
Self-Regulatory Organizations; Order Approving and Notice of Filing
and Order Granting Accelerated Approval of Amendment Nos. 2 and 3
to a Proposed Rule Change by the Pacific Stock Exchange, Inc.,
Relating to Flexible Exchange Options (``FLEX Options'') on the
Wilshire Small Cap Index and the PSE Technology Index
July 13, 1994.
I. Introduction
On June 21, 1993, the Pacific Stock Exchange, Inc. (``PSE'' or
``Exchange'') submitted to the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b) of the Securities Exchange
Act of 1934 (``Act'')1 and Rule 19b-4 thereunder,2 a proposal
to list and trade large-size, customized index options, referred to as
Flexible Exchange Options (``FLEX Options'') based on the Wilshire
Small Cap Index (``Wilshire Index'') and the PSE Technology Index
(``Technology Index''). On October 1, 1993, the PSE filed Amendment No.
1 to the proposed rule change.3 Notice of the proposed rule change
and Amendment No. 1 were published for comment in the Federal Register
on November 1, 1993.4 On February 7, 1994, the PSE filed Amendment
No. 2 to the proposed rule change.5 On May 26, 1994, the PSE filed
Amendment No. 3 to the proposed rule change.6 This order approves
the proposal, as amended.
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\1\15 U.S.C. 78s(b)(1) (1982).
\2\17 CFR 240.19b-4 (1991).
\3\In Amendment No. 1, the PSE proposes: (1) to reduce the
proposed position limits for FLEX Options to 200,000 contracts on
the same side of the market; (2) that the proposal be approved as a
three-year pilot program; (3) to submit a monitoring report to the
Commission after the first year of trading FLEX Options on the
Exchange; (4) provide that the Exchange will use its best efforts to
assure that bids and offers will be in compliance with Section 11(a)
of the Act; (5) establish the trading hours for FLEX Options; (6)
specify the permissible averaging methods for calculating exercise
settlement values; and (7) establish the range for Request Response
Times between 10 and 30 minutes. See Letter from Michael Pierson,
Senior Attorney, PSE, to Jeffrey Burns, Attorney, Office of Market
Supervision (``OMS''), Division of Market Regulation (``Division''),
Commission, dated September 28, 1993 (``Amendment No. 1'').
\4\See Securities Exchange Act Release No. 33100 (October 25,
1993), 58 FR 56368 (November 1, 1993).
\5\Amendment No. 2 adds Rule 7.50(a)(1), which specifies the
indexes on which FLEX Options have been approved for trading by the
Exchange. See Letter from Michael Pierson, Senior Attorney, PSE, to
Sharon Lawson, Assistant Director, OMS, Division, Commission, dated
February 7, 1994.
\6\In Amendment No. 3, the PSE proposes to: (1) define the term
``Market Maker'' to include lead market makers; (2) provide that the
automatic executive system shall not be available for transactions
in FLEX Options; (3) provide that PSE Rules 6.76 (Priority on Split
Price Transactions) and 6.80 (Accommodation Transactions) shall not
apply to transactions in FLEX Options; (4) state in the language of
the rule that all transactions must be in compliance with Section
11(a) of the Act; (5) provide, in certain circumstances, for
aggregation of p.m.-settled FLEX Options with positions in quarterly
index expiration options on the same index; (6) clarify that the
position limits for FLEX Options are limited to 200,000 contracts on
the same side of the market; (7) provide minimum financial
requirements for floor brokers of at least $100,000 in net
liquidating equity in order to effect transactions in FLEX Options;
and (8) provide that floor brokers effecting transactions in FLEX
Options must be issued one or more Letters of Authorization by a
clearing member accepting responsibility for the clearance of FLEX
Options transactions of the floor broker. See Letter from Michael
Pierson, Senior Attorney, PSE, to Brad Ritter, Attorney, OMS,
Division, Commission, dated May 26, 1994 (``Amendment No. 3'').
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II. Background
The purpose of the PSE's FLEX Option proposal is to provide a
framework for the Exchange to list and trade index options that give
investors the ability, within specified limits, to designate certain of
the terms of the options. The PSE is currently proposing to trade FLEX
Options only on the Wilshire and Technology Indexes. In recent years,
an over-the-counter (``OTC'') market in customized index options has
developed which permits participants to designate the basic terms of
the options, including size, term to expiration, exercise style,
exercise price, and exercise settlement value, in order to meet their
individual investment needs. Participants in this OTC market are
typically institutional investors, who buy and sell options in large-
size transactions7 through a relatively small number of securities
dealers. The Exchange believes FLEX Options will help it compete with
this growing OTC market in customized index options. In particular, the
PSE's proposal will allow FLEX Option market participants to designate
the following FLEX Option contract terms: (1) exercise price; (2)
exercise style (i.e., American,8 European,9 or capped);\10\
(3) expiration date;11 (4) option type (i.e., put, call, or
spread); and (5) form of settlement (i.e., a.m.-settlement v. p.m.-
settlement).
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\7\Large size in this context is intended to mean options having
an underlying contract value equal to or greater than $1 million.
\8\An American-style index option is one that may be exercised
at any time on or before the expiration date.
\9\A European-style index option is one that may be exercised
only during a limited period of time prior to expiration of the
option.
\1\0A capped-style index option is one of 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.
\1\1The FLEX Options proposal, however, requires that the
expiration dates for FLEX Options be at least three business days
away from the expiration dates for existing listed options in order
to protect against possible market disruptions that may otherwise
result from the concurrent expiration of existing listed non-FLEX
index options and FLEX Options.
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The PSE believes that market participants will benefit from the
trading of FLEX Options in several ways, including, but not limited to:
(1) enhanced efficiency in initiating and closing out positions; (2)
increased market transparency; and (3) heightened contra-party
creditworthiness due to the role of the Options Clearing Corporation
(``OCC'') as issuer and guarantor of FLEX Options.12
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\1\2The Commission has designated FLEX Options as standardized
options for purposes of the options disclosure framework established
under Rule 9b-1 of the Act. See Securities Exchange Act Release No.
31919 (February 24, 1993), 58 FR 12286 (March 3, 1993) (``9b-1
Order''). As described in note 33 infra, and for the same reasons
stated in the 9b-1 Order, Wilshire and Technology Index FLEX Options
are deemed ``standardized options'' for purposes of the Rule 9b-1
options disclosure framework.
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III. Description of the Proposal
Transactions in FLEX Options traded on the PSE generally will be
subject to the same rules that presently apply to the trading of PSE
index options.\13\ In order, however, to provide investors with the
flexibility to designate certain of the terms of the options and to
accommodate other special features of FLEX Options and the way in which
they are traded, the PSE has proposed several new rules.
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\13\See PSE Rule 7.
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The princpal rules proposed by the PSE that are uniquely applicable
to the FLEX Option market include a rule containing new definitions
(Rule 7.50(b)), a rule regarding hours of trading FLEX Options (Rule
7.51(a)), a special rule regarding trading rotations (Rule 7.51(b)),
rules setting forth the special terms of FLEX Option contracts and
certain special pieces of information that must be included in FLEX
Option Requests for Quotes and Responsive Quotes (Rule 7.52), rules
prescribing the mechanics of initiating a FLEX Option Request for
Quotes and bidding and offering in response thereto, rules setting
forth the principles applicable to the formation of binding FLEX Option
contracts, rules defining the applicable priority principles (Rules
7.53(e)), special position limit and exercise limit rules (Rues 7.55
and 7.56), special FLEX Option market maker appointment rules (Rule
7.57), and special market maker and floor broker capital and letter of
guarantee rules (Rules 7.59(a), (b), and (c)). Discussion of each of
these rules follows.
Proposed Rule 7.50(b) adopts nomenclature uniquely tailored to fit
the special characteristics of FLEX Options and the FLEX Option market.
For example, the term ``Request Response Time'' refers to the time
interval, set by the submitting member in its Request for Quotes,
during which responsive bidding and offering is to take place.\14\
Similarly, the term ``FLEX Quote`` has both its usual connotation--
market maker bids and offers--and a new connotation--floor brokers'
orders to purchase and orders to sell--that is necessary in view of the
unique mechanics of the FLEX Option exchange auction.
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\14\The ``Request Response Time'' is intended by the Exchange to
initially be set at a minimum of 10 minutes and a maximum of 30
minutes. See Amendment No. 1, supra note 3.
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Proposed Rule 7.51(a) provides that FLEX Option trading will
commence at 7 a.m. Pacific Time, one-half hour later than the opening
time currently set for the trading of regular index options, and, will
conclude at 1:15 p.m. Pacific Time, the existing close of trading at
the Exchange for regular index options. The Exchange may, from time to
time, determine to amend the trading hours set for FLEX Options.\15\ As
a complementary rule uniquely applicable to FLEX Options, Proposed Rule
7.51(b) specifies that there will be no trading rotations in FLEX
Options, either at the opening or at the close of trading.
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\15\Specifically, the PSE proposes to implement the hours of
trading for FLEX Options as follows: (1) initial hours of FLEX
trading will be 7 a.m.--1:15 p.m. (Pacific Time); (2) FLEX trading
hours may be altered at the discretion of the Exchange by 15 minutes
or less so long as the change does not extend trading beyond the
normal PSE business hours of 6:30 a.m.--1:15 p.m. (Pacific Time);
(3) FLEX trading hours that are altered by more than 15 minutes but
remain within normal business hours must be submitted by the
Exchange to the Commission in a Section 19(b)(3)(A) filing; (4) FLEX
trading hours extended beyond the PSE's normal business hours must
be submitted to the Commission for approval pursuant to Section
19(b)(2); and (5) the Exchange will provide adequate advance
notification to its members and member organizations of such changes
in FLEX trading hours. id.
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Proposed Rule 7.52 specifies the term elements and other
informational ingredients that must be included in Requests for Quotes,
FLEX Quotes submitted in response to such requests, and, ultimately,
FLEX Option contracts that are the product of FLEX Option trading. As
paragraph (b) of this proposed rule indicates, the content of certain
terms of each FLEX Option contract is to be determined by the parties
of the contract. Other terms, such as the level of the index multiplier
and the nature of the rights and obligations of FLEX Option purchasers
and sellers, are the same for FLEX Options as for regular index
options.
More specifically, Paragraph (b) of Proposed Rule 7.52 specifies
the term elements that a submitting member must include in its Request
for Quotes and indicates the alternatives available for each term.
Under this paragraph, a submitting member must designate, among other
terms, the day, month, and year of the FLEX Option's expiration,
subject to certain limitations designed to avoid the overlap of FLEX
Option expirations with expirations of regular index options.\16\ To
further ensure against any adverse market impact, expirations for FLEX
Options may not fall within 3 business days (before or after) of
conventional options expirations (generally, the third Friday of the
month). Similarly, a submitting member must identify the exercise
price\17\ and the exercise settlement value\18\ of the FLEX Option, and
those variable FLEX Option terms must fit within stated parameters.
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\16\See Securities Exchange Act Release No. 33700 (March 2,
1994), 59 FR 11342 (March 10, 1994) (order approving quarterly index
expiration options on Wilshire Index).
\17\Specifically, exercise prices can be determined in reference
to (a) a specific index value number, (b) a method for fixing such a
number at the time a FLEX Quote is accepted, (c) a percentage of
index value calculated as of the open or close of trading on the
Exchange on the trade date, or (d) the cap interval in the case of
capped-style options.
\18\The Exchange proposes that the averaging parameters will be
limited to three alternatives: the average of the opening and
closing index values; the average of the intra-day high and low
index values; values; and the average of the opening, closing, and
intra-day high and low index values. See Amendment No. 1, supra note
3.
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Paragraph (c) of this proposed rule lists certain additional
categories of information that must be addressed by the submitting
member in its Request for Quotes. In particular, under this paragraph a
submitting member must indicate the type and form of quote sought, the
length of the Request Response Time (i.e., the time interval during
which FLEX Option-participating members may enter quotes responsive to
the request), and the submitting member's intention, if any, to cross a
customer order or act as principal with respect to any part of the FLEX
Option trade.
Finally, paragraph (d) of this proposed rule specifies the maximum
term and the minimum value size of any FLEX Option contract and
provides that the term and size may be set, within the stated limits,
at the discretion of the submitting member or the quoting party, as
applicable. Under this paragraph, the maximum FLEX Option term is five
years; the minimum value size (i.e., the aggregate underlying dollar
value that is the subject of the option) for a FLEX Request for Quotes
is $10 million in an opening transaction in a new FLEX Option series
and $1 million in an opening or closing transaction in any currently-
opened FLEX Option series (or less in a closing transaction where the
remaining underlying value is less than $1 million); and the minimum
value size for quotes of market makers in response to a Request for
Quotes is $1 million or any lesser amount reflected in a Request for
Quotes (except that market makers appointed to FLEX Options on the
underlying index that is the subject of the Request for Quotes must be
prepared to respond to a Request for Quotes in a size of at least $10
million underlying value or the dollar amount indicated in the Request
for Quote, whichever is less).
These provisions, collectively, provide investors and FLEX Option-
participating members with significant latitude in structuring the
terms of FLEX Options contracts. The Exchange believes that such
latitude is both important and necessary to the Exchange's effort to
create a product and a market that provides members and investors
interested in FLEX Options with an improved but comparable alternative
to the OTC options market. To enable the efficient, centralized
clearance and active secondary trading of opened FLEX Options, however,
the extent of variability in structuring FLEX Options is necessarily
limited. Only certain terms are subject to flexible structuring by the
parties to FLEX Option transactions, and most of such terms have a
specified number of alternative configurations. In addition to the
specified term alternatives indicated above, FLEX Options will be
limited to transactions on the Wilshire and Technology Indexes (Rule
750(a)(1)) and shall be denominated for settlement in cash in U.S.
dollars only (Rule 7.52(e)).
Proposed Rule 7.53 prescribes in some detail the mechanics of
submitting Requests for Quotes and entering responsive bids and offers.
These mechanics, described below, are designed to create a modified
auction that takes into account the relatively small number of
transactions that are lively to occur in this institutional, large-size
market, while at the same time providing the FLEX Option market with
the price improvement and transparency benefits of competitive Exchange
floor bidding and offering, as compared with the OTC market.\19\
Proposed Rule 7.53 establishes time and price priority principles and
contains special rules respecting the bidding and offering process and
the method of allocating trades in instances in which the submitting
member expresses an intention to cross or act as principal on a Request
for Quotes. These proposed rules are designed to promote active bidding
and offering that will generate the best price available, while also
providing incentives to market makers appointed to FLEX Options, floor
brokers, other floor participants, and upstairs firms alike to
participate in the FLEX Option market.
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\19\All FLEX Option transactions must be in compliance with
Section 11(a) of the At and the rules thereunder. See Amendment No.
3, supra note 6.
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In particular, paragraphs (a) and (b) of proposed Rule 7.53
indicate that the FLEX Option bidding and offering process is initiated
once a submitting member has supplied a Request for Quotes in proper
form and the terms and specifications of the Request for Quotes are
disseminated at the post and over FLEX Option communications
facilities. Thereafter, FLEX Quotes in proper form may be entered,
modified, or withdrawn (subject to special limitations imposed on
appointed market makers) by public outcry at any time during the
Request Response Time. The length of the Request Response Time, which
must fall within time parameters to be set by the Exchange, is to be
specified in the Request for Quotes. At the expiration of the Request
Response Time, the FLEX Post Official will determine the best bid and/
or offer (``BBO'').
Proposed paragraph (c) of Rule 7.53 provides that the BBO will be
displayed at the post and over communication facilities and, at that
point, or after further bidding and offering that occurs in certain
specified circumstances the submitting member will have the opportunity
to accept or reject the BBO. The submitting member, however, has no
obligation to accept the BBO. Thus, whenever the BBO is rejected the
Request for Quotes expires, although FLEX Option-participating members
other than the submitting member may accept the unfilled balance of the
BBO. Similarly, whenever the BBO is accepted, the transaction (or
transactions) will be executed in accordance with the crossing
principles and priority principles set forth in paragraph (e) of
proposed Rule 7.53, although, again, FLEX Option-participating members
may accept any unfilled balance of the BBO.
Proposed Rule 7.55 states position limits that will be unique to
FLEX Options.\20\ Specifically, the PSE is proposing that FLEX Options
will be subject to a maximum limit of 200,000 contracts on the same
side of the market on a given underlying index, without aggregation for
other contracts on the same index with one exception. Under the
proposal members must, at the close of business two days prior to the
last day of trading of the calendar quarter, aggregate positions in
p.m.-settled FLEX Options on the Wilshire Index with quarterly
expiration index options (``QIXs'') with the same expiration date and
those positions may not exceed the QIX limits specified in Rule
7.6(d)(2) (i.e., 37,500 contracts on the same side of the market in the
case of QIX options on the Wilshire Index).\21\ In this case, the
applicable hedge exemptions under Rule 7.6 may be applied to the
aggregate positions.\22\
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\20\Proposed Rule 7.56 establishes exercise limit provisions
that correspond to the position limits prescribed in proposed Rule
7.55.
\21\QIX options have not been approved for trading on the
Technology Index.
\22\Under the proposal, FLEX Options would be listed for trading
by the Exchange on a three-year pilot, during or following which
adjustments may be required. In addition, among other things,the PSE
has stated that it will monitor the effect of the position limits at
the end of the first year of trading and provide the Commission with
a report concerning the adequacy of the limits and its effects on
the underlying cash market. See, Amendment No. 1, supra note 3.
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Proposed Rule 7.57 provides for separate appointments of market
makers to FLEX Options, although the appointment process will be
essentially the same as appointments to other options. This rule
further provides that appointed market makers will have an affirmative
obligation to quote in a size of at least $10 million in response to
every Request for Quotes on a FLEX Option on an index to which the
market maker is appointed. Such quotes must be firm, unless modified or
withdrawn prior to the end of the Request Response Time, for the
duration of the Request Response Time and, if applicable, the BBO
Improvement Interval. As noted earlier, market makers have no
obligation to maintain continuous quotes or to quote a minimum spread,
and quotes expire at the end of each FLEX Option bidding and offering
period.
Proposed Rules 7.59(a)-(c) set minimum financial requirements for
market makers trading or appointed to FLEX Options. The financial
minimums stated in proposed Rules 7.59(a) and (b) are unique to FLEX
Options.
Specifically, proposed Rule 7.59(a) requires every market maker
approved to effect transactions in FLEX Options to maintain at least
$100,000 in net liquidating equity in any FLEX Option trading account
with each given clearing member. Similarly, proposed Rule 7.59(b)(2)
requires every floor broker eligible to effect FLEX Option transactions
to maintain at least $100,000 in net liquidating equity in any FLEX
Option trading account with each given clearing member. The Exchange
believes that these stated minimums provide an adequate and suitable
financial floor for FLEX Options trading activity without unduly
restricting access to these markets.
Proposed Rule 7.59(b) requires FLEX Option-appointed market makers
to maintain at least $1 million in net liquidating equity or net
capital, as applicable. Again, although this minimum requirement is
unique to FLEX Options, the Exchange believes that it represents a
suitable and adequate financial floor for FLEX Option-appointed market
makers undertaking the substantial FLEX Quote responsibility.
Proposed Rule 7.59(c) extends the general letter of guarantee
requirement under existing Exchange Rule 6.36(a) to FLEX Option market
makers and FLEX Options floor brokers, thereby subjecting them to a
focused credit worthiness review by their clearing members. The review
and issuance requirement imposed under proposed Rule 7.59(c)
substantially supplements the independent financial requirements of
proposed Rules 7.59(a) and (b).\23\
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\23\The proposed rule changes include the following changes as
well as the changes discussed in the text. Proposed Rule 7.54
enables a Floor Broker to exercise discretion with respect to the
number of FLEX Option contracts to be purchased or sold
(notwithstanding contrary limitations in Rule 6.48) in view of the
special features that will be associated with FLEX Option bidding
and offering. Finally, proposed Rule 7.58 establishes a new class of
Exchange employee (a FLEX Post Official) and sets forth the FLEX
Post Official's special duties.
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IV. Discussion
The Commission believes 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 Sections 6(b)(5)\24\ and 11A.\25\ In
particular, the Commission believes that the proposed rule change is
designed to provide investors with a tailored or customized product for
broad-based indexes currently traded on the Exchange that may be more
suitable to their investment needs than other outstanding FLEX
Options.\26\ Moreover, consistent with Section 11A, the proposal should
encourage fair competition among brokers and dealers and exchange
markets, by allowing the PSE to compete with the growing OTC market in
customized index options.
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\24\15 U.S.C. 78f(b)(5) (1982).
\25\15 U.S.C. 78k-1 (1982).
\26\The Chicago Board Options Exchange, Inc. (``CBOE'') trades
FLEX Options based on the S&P 100, S&P 500, and Russell 2000 stock
indexes. See Securities Exchange Act Release Nos. 31920 (February
24, 1993), 58 FR 12280 (March 3, 1993); and 32694 (July 29, 1993),
58 FR 41814 (August 5, 1993). The American Stock Exchange, Inc.
(``AMEX'') trades FLEX Options based on the Major Market,
Institutional, and S&P MidCap 400 indexes. See Securities Exchange
Act Release No. 32781 (August 20, 1993), 58 FR 45360 (August 27,
1993).
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For instance, as noted by the PSE, the OTC market in customized
index options has developed, in part, to meet the needs of
institutional investors who require increased flexibility for the
purpose of satisfying particular investment objectives that could not
be met by existing standardized exchange markets in options.
Accordingly, the Commission believes the PSE proposal is a reasonable
response by the Exchange to meet the demands of sophisticated portfolio
managers and other institutional investors who are increasingly using
the OTC market in order to satisfy their hedging needs, and will
thereby promote competition among these markets.
In addition, the Commission believes that the PSE proposal will
help to promote the maintenance of a fair a orderly market, consistent
with Sections 6(b)(5) and 11A of the Act, because the purpose of the
proposal is to extend the benefits of a listed, exchange market in
Wilshire Index and Technology Index options that have certain terms
varied by the particular investor. The attributes of the Exchange's
options market versus an OTC market include, but are not limited to, a
centralized market center, an auction market with posted transparent
market quotations and transaction reporting, standardized contract
specifications, parameters and procedures for clearance and settlement,
and the guarantee of OCC for all contracts traded on the Exchange.
In general, transactions in FLEX Options will be subject to many of
the same rules that apply to index options traded on the PSE. In order
to provide investors with the flexibility to designate terms of the
options and accommodate the special trading of FLEX Options, however,
several new rules will apply solely to FLEX Options.
Due to the customized nature of these options, FLEX Options will
not have trading rotations at either the opening or closing of trading.
In addition, the auction process outlined above in proposed Rule 7.53
sets forth a procedure of customized negotiation for those investors
seeking particular flexibility in setting certain options terms.\27\
Accordingly, the PSE proposed rules specific to FLEX Options vary from
the traditional procedure for trading regular index options.
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\27\A submitting member (the Exchange member that initiates the
FLEX Option auction process by submitting a request for quotes) is
under no obligation to accept any FLEX Option bid or offer, even if
it is the BBO. See, Proposed PSE Rule 7.53.
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The Commission believes that the FLEX Option auction process, as
outlined in PSE's proposal, appears reasonably designed to provide the
benefits of an Exchange auction environment for Wilshire and Technology
Index options with features of a negotiated transaction between
investors. The Commission recognizes that PSE's proposal marks, in many
respects, an experiment in trading option contracts of substantial
value, for which continuous quotation may be difficult to sustain.
Accordingly, PSE has established procedures for quotes upon request,
which must then be firm for a designated period and which will be
disseminated through the Options Price Reporting Authority (``OPRA'').
The Commission notes that FLEX Options based on the Wilshire and
Technology Indexes can be constructed with expiration exercise
settlement based on the closing values of the component securities,
which could potentially result in adverse effects for the markets in
these securities.\28\ Although the Commission continues to believe that
basing the settlement of index products on opening as opposed to
closing prices on Expiration Friday helps alleviate stock market
volatility,\29\ these concerns are reduced in the case of FLEX Options
because expiration of these stock index options will not correspond to
the normal expiration of stock index options, stock index futures, and
options on stock index futures. In particular, FLEX Options will never
expire on an ``Expiration Friday'' or any other ``Expiration Fridays''
in March, June, September and December, thereby diminishing the impact
that FLEX Options could have on the market.
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\28\See, e.g., Securities Exchange Act Release No. 30944 (July
21, 1992), 57 FR 33376 (July 28, 1992).
\29\Id.
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Also, as noted above, the proposal would limit the effect on
securities markets by addressing the relationship between FLEX Options
and QIXs. As proposed, PSE Rule 7.55(c) requires P.M.-settled FLEX
Options to be aggregated with QIXs that are based on the same index and
have the same expiration date. In such a case, the FLEX Options would
be aggregated two days prior to expiration subject to the lower
position limits of 37,500 contracts for QIX options on the Wilshire
Index. The Commission believes that these rules should help prevent an
investor for using FLEX Options for the purpose of avoiding the
position limits applicable to QIXs.
Nevertheless, because the position limits for FLEX Options are much
higher than those currently existing for outstanding exchange-traded
index options and open interest in one or more FLEX Option series could
grow to significant exposure levels, the Commission cannot rule out the
potential for adverse effects on the securities markets for the
component securities underlying FLEX Option stock indices. The PSE has
taken several steps to address this concern, including establishing the
proposed FLEX Options as a three-year pilot and undertaking to monitor
open interest, position limit compliance and potential adverse market
effects carefully and to report to the Commission after one year's
experience trading FLEX Options.\30\ That report will include, among
other things:
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\30\See Amendment No. 1, supra note 3.
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The type of strategies used by FLEX Options market
participants and whether FLEX Options are being used, in lieu of
existing standardized stock index options.
The type of market participants using FLEX Options.
The terms which are predominantly being ``flexed'' by
market participants, i.e., strike prices, settlement value (A.M. v.
P.M.), term of duration, European v. American style.
The size of the FLEX Option position on average, the size
of the largest FLEX Option positions on any given day and size of the
largest FLEX Option position held by any single customer/member.
The relationship between strike prices and current index
value.
Whether there is significant interest in long-term
expirations greater than nine months.
Any effect FLEX Option positions have had on the
underlying cash market, including an analysis of FLEX Option positions
and their market impact on days Rule 80A of the New York Stock Exchange
is invoked.
In addition, the Commission expects the PSE to monitor the actual
effect of FLEX Options once trading commences and take prompt action
(including timely communication with marketplace self-regulatory
organizations responsible for oversight of trading in component stocks)
should any anticipated adverse market effects develop.
Lastly, based on representations from the PSE, the Commission
believes that the PSE and OPRA will have adequate systems processing
capacity to accommodate the additional options listed in connection
with FLEX Options. Specifically, the Exchange represents that PSE and
OPRA have the necessary systems capacity to support the new series
which could result from introduction of FLEX Options.\31\
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\31\See Letter from Michael Pierson, Senior Attorney, Market
Regulation, PSE, to Brad Ritter, Attorney, OMS, Division,
Commission, dated May 27, 1994; and Letter from Joe Corrigan,
Executive Director, OPRA, to Kim Koppien, PSE, dated May 26, 1994.
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The Commission finds good cause for approving Amendment Nos. 2 and
3 prior to the thirtieth day after the date of publication of notice
thereof in the Federal Register. Amendment No. 2 merely proposes to
include in the PSE's rules applicable to FLEX Options those particular
broad-based indexes on which FLEX Options have been approved for
trading. The Commission believes this will serve to minimize investor
confusion. Amendment No. 3 to the proposed rule change makes several
clarifying amendments and other changes designed to conform the PSE's
rules regarding FLEX Options to those rules approved for the listing
and trading of FLEX Options by the CBOE and the Amex,\32\ which to the
Commission's knowledge, have not resulted in any problems. Accordingly,
for the reasons discussed herein, the Commission believes that the
changes contained in Amendment No. 3 strengthen the PSE's proposal and
thus will help to promote the maintenance of a fair and orderly market.
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\32\See supra note 26.
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V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 2 and 3. 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 changes 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 20549. Copies of such filing will also be available
for inspection and copying at the principal office of the PSE. All
submissions should refer to File No. SR-PSE-93-13 and should be
submitted by August 9, 1994.
VI. Conclusion
For the reasons discussed above, the Commission finds that the
proposal is consistent with the Act and sections 6 and 11A of the Act
in particular. In addition, the Commission finds pursuant to Rule 9b-1
under the Act, that FLEX Options based on the Wilshire and Technology
Indexes are standardized options for purposes of the options disclosure
framework established under Rule 9b-1 of the Act.\33\
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\33\As part of the original approval process of the FLEX Options
framework, the Commission delegated to the Director of the Division
of Market Regulation the authority to authorize the issuance of
orders designating securities as standardized options pursuant to
Rule 9b-1(a)(4) under the Act. See Securities Exchange Act Release
No. 31911 (February 23, 1993), 58 FR 11792 (March 1, 1993). On May
4, 1993, Chairman Breeden, pursuant to Public Law 87-592, 76 Stat.
394 [15 U.S.C. 78d-1, 78d-2], and Article 30-3 of the Commission's
Statement of Organization; Conduct and Ethics; and Information and
Requests [17 CFR 200.30-3], designated that persons serving in the
position of Deputy Director, Associate Director, and Assistant
Director, in the Division of Market Regulation, be authorized to
issue orders designating securities as ``standardized options''
pursuant to Rule 9b-1(A)(4). Accordingly, this subdelegation
provides the necessary authority for Wilshire and Technology FLEX
Options to be designated as ``standardized options'' by the Division
of Market Regulation. See Designation of Personnel to Perform
Delegated Functions in the Division of Market Regulation, dated May
4, 1993.
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\34\ that the proposed rule change (SR-PSE-93-13) is approved, as
amended, on a pilot basis until July 13, 1997.
\34\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.\35\
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\35\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17522 Filed 7-18-94; 8:45 am]
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ILLING CODE 80-01-M
[Release No. 34-34357; International Series Release No. 682; File No.
SR-PHLX-94-05]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to Quote
Spread Parameters for Long-Term Foreign Currency Options
July 12, 1994.
On February 7, 1994, the Philadelphia Stock Exchange, Inc.
(``PHLX'' or ``Exchange'') submitted to the Securities 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 proposal to amend Exchange Rule 1014, ``Obligations
and Restrictions Applicable to Specialists and Registered Options
Traders,'' and Floor Procedure Advice (``Advice'') F-6, ``Option Quote
Spread Parameters'' to: (1) establish quote spread parameters for long-
term foreign currency options (``FCOs''); (2) revise the quote spread
parameters for options on the French franc; and (3) revise the quote
spread parameters for cross-rate FCOs.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
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The proposal was published for comment in Securities Exchange Act
Release No. 33693 (February 28, 1994), 59 FR 10659 (March 7, 1994). No
comments were received on the proposal.\3\
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\3\On June 27, 1994, the PHLX submitted a letter explaining the
rationale for the proposed quote spread parameters for long-term
FCOs. The PHLX notes that foreign currency swaps and forward
contracts are used frequently to hedge long-term FCOs and that
foreign currency swaps are the basis for pricing long-term FCOs
because the swap market takes into account the interest rate
differential among the relevant countries, which becomes less
certain over time. In light of the hedging process for long-term
FCOs, and based on its experience in trading long-term FCOs, the
PHLX believes that the foreign currency swap market provides a
reasonable basis for measuring quote spread parameters for long-term
FCOs. See Letter from Edith Hallahan, Special Counsel, PHLX, to
Michael Walinskas, Branch Chief, Options Regulation, Division of
Market Regulation, Commission, dated June 23, 1994 (``June 23
Letter'').
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The PHLX has traded long-term FCOs since 1992, when PHLX Rule 1012
was amended to permit the listing of options with an expiration of up
to 36 months in the future.\4\ The Long-Term FCO Approval Order stated
specifically that long-term FCOs would not be subject to existing quote
spread parameters because, at that time, there was no basis for
establishing reasonable prices for long-term FCOs due to the lack of
historical pricing. Under the Long-Term FCO Approval Order, long-term
FCOs are subject to Advice F-6 once there is less than twelve months
remaining until expiration.
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\4\See Securities Exchange Act Release No. 30672 (May 6, 1992),
57 FR 20546 (order approving File No. SR-PHLX-91-30) (``Long-Term
FCO Approval Order'').
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Currently, the PHLX trades four long-term FCOs: British pound,
German mark, French franc, and Japanese yen.\5\ The PHLX proposes to
codify specific parameters for long-term FCOs in order to demonstrate
consistency in quote width to FCO customers and to prevent overly wide
quotes.
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\5\Although the PHLX has not yet listed a long-term option on
the Swiss franc, the PHLX may do so in the future. Its proposed
Swiss franc spread parameter would be identical to the proposed
quote spread parameter applicable to the long-term German mark
option.
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Specifically, the PHLX proposes to establish the following quote
spread parameters for long-term FCOs: for options on the British pound,
a maximum quote spread of $.0100 where the bid is $.1500 or less and
$.0150 where the bid is more than $.1500; for options on the French
franc, a maximum quote spread of $.00100 where the bid is $.01500 or
less and $.00150 where the bid is more than $.1500; for options on the
German mark and Swiss franc, a maximum quote spread of $.0030 where the
bid is $.0500 or less and $.0050 where the bid is more than $.0500; and
for options on the Japanese yen, a maximum quote spread of $.000040
where the bid is $.000500 or less and $.000070 where the bid is over
$.000500.
In addition, the PHLX proposes to correct the parameters for cross-
rate FCOs, which appear in the incorrect base currency, and for French
franc options, which cannot be quoted in odd numbers due to system
limitations. Specifically, for options on the French Franc, the PHLX
proposes to establish a maximum quote spread of $.00014 where the bid
is $.00250 or less; $.00024 where the bid is between $.00252 and
.00750; and $.00034 where the bid is over $.00750.
With respect to cross-rate options, the PHLX states that the
original quote spread parameters were incorrect because the bids, which
determine the quote spread, should be based on bids relating to the
first currency. Under the current rule, for British pound/German mark
cross-rate options, if the bid is .0100 German marks or less, the
maximum quote spread is .0015 German marks. The PHLX states that this
has proved incompatible with the parameters commonly employed by
traders to quote the British pound/German mark cross-rate option for
two reasons: (1) the range of bids did not correspond to the ranges
previously used for British pound quotes;\6\ and (2) the actual
parameters (.0015, .0025 and .0035 German marks) proved to be too
narrow in view of the unique pricing and settlement of cross-rate
options. Thus, for British pound/German mark cross-rate options, the
PHLX proposes the following parameters: a maximum quote spread of .0030
German marks where the bid is .0250 German marks or less; .0050 German
marks where the bid is more than .0250 but does not exceed .0750 German
marks; and .0070 German marks where the bid is more than .0750 German
marks.
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\6\The range of bids that determine the quote spread parameters
applicable to British pound options is: $.0250 or less, $.0251 to
$.0750, and over $.0750.
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For German mark/Japanese yen cross-rate options, the PHLX proposes
the following parameters: a maximum quote spread of .12 Japanese yen
where the bid is .40 Japanese yen or less; .16 Japanese yen where the
bid is more than .40 but does not exceed 1.60 Japanese yen; and .20
Japanese yen where the bid is more than 1.60 Japanese yen.
For British pound/Japanese yen options, the PHLX proposes to
establish the following parameters:\7\ a maximum quote spread of .0030
Japanese yen where the bid is .0250 Japanese yen or less; .0050
Japanese yen where the bid is more than .0250 but does not exceed .0750
Japanese yen; and .0070 Japanese yen where the bid is more than .0750
Japanese yen. The exchange proposes to correct the cross-rate
parameters both in the text of exchange Rule 1014 as well as in Advice
F-6 in order to facilitate the efficient trading and quoting of the
relevant cross-rate options, as well as to inform members and customers
of the maximum quote spread parameters.
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\7\Although the PHLX has not yet listed the British pound/
Japanese yen option, the same inconsistency with British pound bid
ranges requires correction and the quote spread parameters were also
proposed too narrowly.
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The PHLX believes that the proposed rule change is consistent with
Section 6 of the Act, in general, and, in particular, with Section
6(b)(5), in that it is designed to promote just and equitable
principles of trade, prevent fraudulent and manipulative acts and
practices, and to protect investors and the public interest.
Specifically, the PHLX believes that established quote spread
parameters for long-term FCOs should prevent overly wide quotes and
foster uniformity in quote width, consistent with Section 6(b)(5). In
addition, the PHLX believes that the correction to cross-trade quote
spread parameters should promote just and equitable principles of trade
by providing a more feasible bid/ask differential, which, in turn,
should facilitate trading in those options.
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, with the requirements of Section 6(b)(5) in that proposal
is designed to promote just and equitable principles of trade and to
protect investors and the public interest.\8\ Specially, the Commission
believes that the PHLX's proposal to establish quote spread parameters
for long-term FCO's should result in improved price continuity and
tighter, more liquid markets. In light of the hedging process for long-
term FCOs and the PHLX's experience in trading long-term FCOS, the
Commission believes that it is reasonable for the Exchange to base the
quote spread parameters for long-term FCOs on the foreign currency swap
and forward markets.\9\ The Commission believes that the quote spread
parameters for long-term FCOs should prevent overly wide quotes and are
designed to be consistent with the obligations of PHLX specialists and
Registered Options Treaders (``ROTs'') under the Act to provide fair
and orderly markets.
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\8\15 U.S.C. 78f(b)(5) (1982).
\9\The PHLX states that swaps and forward contracts are often
used to hedge FCOs and that swaps provide the basis for pricing
long-term FCOs because the swap market takes into account the
interest rate differential among the relevant countries. Because of
the interest rate differential and the corresponding less-liquid
nature of the market for long-term FCO forward contracts, the
forward markets for long-term FCOs are wider than the FCO spot
market, which provides the basis for pricing shorter-term FCOs.
Accordingly, the quote spread parameters for long-term FCOs are
wider than the quote spread parameters for shorter-term FCOs. See
June 23 Letter, supra note 3.
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In addition, the Commission believes that it is reasonable for the
PHLX to establish new even-numbered quote spread parameters for options
on the French franc, which cannot be quoted in odd numbers, and to
establish new quote spread parameters for cross-rate FCOs, which the
PHLX believes should be based on bids relating to the first currency.
The Commission believes that these amendments should benefit investors
by helping the PHLX to maintain a fair and orderly market for FCOs.
In additional, the Commission believes that the proposed quote
spread parameters for cross-fire FCOs are based on the PHLX's
experience in trading cross-rate FCOs and more accurately reflect the
market for those options. The Commission believes that the proposed
parameters for cross-rate FCOs are intended to facilities tightly
quoted markets without impairing specialist's and ROT's ability to
provide market depth and liquidity. Accordingly, the Commission
believes that the cross-rate FCO parameters are consistent with the
obligations of PHLX specialists and ROTs to provide fair and orderly
markets.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\10\ that the proposed rule change (SR-PHLX-94-05) is approved.
\10\15 U.S.C. Sec. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
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\11\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17426 Filed 7-18-94; 8:45 am]
BILLING CODE 8010-01-M
