[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: 94-17524]
[[Page Unknown]]
[Federal Register: July 19, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34359; File No. SR-Amex-91-35]
Self-Regulatory Organizations; Order Approving and Notice of
Filing and Order Granting Accelerated Approval of Amendment No. 1 to a
Proposed Rule Change by the American Stock Exchange, Inc., Relating to
the Development of Stock Indexes for Index Option Trading.
July 12, 1994.
On December 26, 1991, the American Stock Exchange, Inc. (``Amex''
or ``Exchange'') filed with 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 proposed rule change to provide the Exchange with greater flexibility
in developing stock indexes for index option trading. Notice of the
proposal appeared in the Federal Register on February 14, 1992.3
No comment letters were received on the proposed rule change.4 The
Amex subsequently filed Amendment No. 1 to the proposed rule change on
May 20, 1994.5 This order approves the Exchange's proposal, as
amended.
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\1\15 U.S.C. Sec. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\See Securities Exchange Act Release No. 30356 (February 10,
1992), 57 FR 30356 (February 14, 1992).
\4\The Commission, however, did receive a letter from
Congressman Edward Markey requesting additional information
regarding the subject matter of the proposed rule change and seeking
assurances that the proposal would not result in any enhanced
opportunities for market manipulation or other improper trading
activities. See Letter from Rep. Edward Markey, Chairman, Committee
on Energy and Commerce, U.S. House of Representatives, to Richard
Breeden, Chairman, Commission, dated March 5, 1992. For the reasons
discussed below, the Commission believes that the proposal is
structured to minimize any potential for market manipulation and
other improper trading activity.
\5\In Amendment No. 1, the Amex represents that: (1) members
will be prohibited from using hand signals for purposes of
communicating between the Exchange's main equity trading floor
(``Equity Floor'') and the mezzanine trading level (``Mezzanine'')
when index options on indexes where Amex-listed stocks comprise more
than 10% of the index value, by weight, are being traded in the
Mezzanine; (2) members will be notified by the Exchange of the
prohibition on the use of hand signal communications; and (3) no
trading of index options on indexes containing Amex-listed stocks
will be allowed on the Mezzanine in areas visible from the Equity
Floor. See Letter from Claire McGrath, Managing Director and Special
Counsel, Derivative Securities, Amex, to Michael Walinskas, Branch
Chief, Office of Market Supervision, Division of Market Regulation,
Commission, dated May 20, 1994 (``Amendment No. 1'').
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When exchange-traded stock index options were developed, there was
a concern with allowing options to trade on indexes composed of a
relatively small number of stocks where a substantial portion of those
stocks were traded on the same exchange. As a result, the Exchange has
rules restricting the number of Amex-traded stocks that can be included
in a stock index upon which options are also traded on the Amex.
Specifically, no components of an index may be traded on the Amex if
the index is composed of less than 25 stocks; less than 10% of the
market value of the index may be accounted for by stocks traded on the
Amex if the index is composed of 25 or more stocks but less than 50
stocks; and 10% or more of the market value of the index may be
accounted for by stocks traded on the Amex if the index is composed of
50 or more components.6
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\6\See Amex Rule 901C(a).
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Further, the first indexes on which options were traded were valued
either on the price of the components of the index (price-weighted) or
on the market capitalizations of the components of the index
(capitalization-weighted). Accordingly, Exchange Rule 900C defines the
term ``stock index group'' as a group of stocks each of whose inclusion
and relative representation in the group is determined by the inclusion
and relative representation of their current market values or market
prices in a widely disseminated stock index.
As a result of significant changes in the options industry, the
Exchange believes that the restrictions on the inclusion of Amex-traded
stocks in indexes on which options are traded on the Exchange are no
longer appropriate. Similarly, the Exchange believes that the
definition of stock index group is now too restrictive because of the
creation of new and different methods of calculating and determining
the relative representation of the stocks underlying an index (e.g.
equal dollar-weighting).\7\ The Exchange is, therefore, proposing to
revise Exchange Rule 901C to provide for greater flexibility in the
design and development of new stock index option products which can be
listed and traded on the Exchange, and to revise Rule 900C to reflect
the changes in the methods of valuing indexes. With regard to Rule
900C, the Exchange proposes to eliminate references to market value and
market price as the methods of determining the relative representation
of a stock within an index. This will clarify that an index need not be
based on a strictly proportional representation of the prices or market
values of its component stocks. The Exchange believes this is necessary
because the Exchange either currently trades or has had approved for
trading, index options on several indexes which are neither
capitalization-weighted or price-weighted (e.g., the Morgan Stanley
Consumer and Cyclical Indexes, the Biotechnology Index, and the Natural
Gas Index).
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\7\An equal dollar-weighted index is based on the number of
shares of each component that could be purchased spending the same
dollar amount on each. The value of the index equals the sum of the
current market value of the assigned number of shares of each of the
stocks in the index portfolio divided by the current index divisor.
See, e.g., Securities Exchange Act Release No. 33720 (March 7,
1994), 59 FR 11630 (March 11, 1994).
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The Exchange also proposes to revise Rule 901C to remove the
limitation on the number of Amex-listed stocks that can be included in
an index on which stock index options trade on the Exchange. The
proposed revision would allow indexes composed of less than 50
securities to have Amex-listed stocks account for more than 10% of the
index's value, by weight, and it would allow Amex-listed stocks to be
included in indexes that are composed of less than 25 stocks. The
Exchange believes that concerns that certain market participants would
have an informational advantage when trading an option on an index that
is composed of stocks that also trade on the same exchange have
lessened considerably since index options were first developed, due in
large part to the real-time electronic quotation and transaction
information dissemination systems that now link today's securities
markets. The Exchange also believes that there is less concern that an
index value can be influenced by any one stock, given the preference
for insuring that no one security represents a large portion of the
value of an index.
In order to further minimize these concerns, however, the Exchange
is proposing certain restrictions on the trading of such index options.
First, index option trading areas shall not be located on the
Exchange's Equity Floor.8 Secondly, for index options traded on
the Mezzanine where Amex-listed stocks comprise more than 10% of the
value of the index, by weight, (1) those options shall not be traded in
the portion of the Mezzanine that is visible from the Equity Floor, and
(2) members will be prohibited from using hand signals to communicate
between the Mezzanine and the Equity Floor.9
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\8\Currently, all index options traded on the Exchange are
physically traded on the Mezzanine, which abuts and overlooks the
Exchange's equity trading floor. See Amendment No. 1, supra note 5.
\9\Id.
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Finally, if greater than 10% of the value of a narrow-based index
is represented by Amex-traded stocks, the index options and each Amex-
listed component of the index must be treated as a ``paired
security.''10 Treating the stocks and the narrow-based index
options as paired securities invokes several additional safeguards
designed to prevent the misuse of market information and market
manipulation by Amex members. First, as discussed earlier, trading of
the index option and the underlying securities must take place in
physically separated trading rooms. Secondly, a registered options
trader (``ROT'') who is also a registered equity trader or a registered
equity market maker would be prohibited from executing a proprietary
transaction in the index option if, during the preceding 60 minutes, he
or she had been on the Equity Floor. Third, an Amex equity specialist
in any of the stocks contained in the narrow-based index would be
prohibited from acting as a specialist or ROT in the index options.
Finally, odd-lot dealers in the Amex-traded stocks would be prohibited
from being ROTs in the index option. These restrictions are an
extension of the restrictions currently in place regarding paired
securities of Amex-listed options on Amex-listed stocks.11
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\1\0Telephone conversation between Claire McGrath, Managing
Director and Special Counsel, Derivative Securities, Amex, and Brad
Ritter, Attorney, Office of Market Supervision, Division of Market
Regulation, Commission, on May 31, 1994. A paired security is
defined as a security which is the subject of securities trading on
the Amex as well as options trading. See Amex Rule 900(b) (38).
\1\1See Securities Exchange Act Release No. 26147 (October 3,
1988), 53 FR 39556 (October 7, 1988).
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The Commission believes that the Amex proposal is consistent with
the requirements of Section 6 of the Act, in general, and Section
6(b)(5)12 in particular, in that it should help to remove
impediments to and perfect the mechanism of a free and open market,
promote just and equitable principles of trade and protect investors
and the public interest. Specifically, the proposal will provide the
Exchange with greater flexibility to construct new indexes which may
offer additional means to investors of hedging exposure to market risk.
The Commission believes that the proposal will allow this flexibility
while at the same time minimizing the potential for abuse by ensuring
that Amex traders will not be able to obtain unfair informational
advantages as a result of increasing the representation of Amex-listed
stocks as components of indexes on which index options trade on the
Exchange. The Commission agrees with the Exchange that the real-time
electronic dissemination of quotation and transaction information
dissemination has improved in recent years in both stock and options
markets. The Commission, however, still believes that floor traders and
market makers, by virtue of their close proximity to the trading crowds
and access to market information, may have a time and place advantage
over other market participants.13 For the reasons stated below,
however, the Commission believes that the restrictions contained in the
Amex proposal adequately minimize any potential for misuse of
information or market manipulation.
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\1\215 U.S.C. Sec. 78f(b)(5) (1988).
\1\3Specifically, floor traders in the crowd may be able to gain
an insight into the future direction of a market on the basis of,
among other things, the other traders in the crowd and their
bidding/offering patterns. Likewise, market makers have an
informational advantage about order flow and quote changes.
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First, regardless of how an index is weighted or constructed, the
Exchange is still required to submit all index option proposals to the
Commission for approval.14 During this review process, the
Commission will examine, among other things, whether the proposal is
consistent with the protection of investors and the maintenance of fair
and orderly markets. In reviewing Amex narrow-based index option
proposals, the Commission will examine the number of Amex-listed stocks
comprising each particular index. The Commission will only approve
those indexes found not to be readily susceptible to manipulation.
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\1\4Pursuant to the recently-approved generic standards for
options on narrow-based indexes, the Exchange may submit proposals
to list and trade options on indexes, which become effective upon
filing. The Exchange, however, cannot begin trading options on the
index until 30 days after the filing date. During this time period,
the Commission will be able to review the index and consider any
comments received on the proposal. If the Commission determines that
an Amex proposal submitted pursuant to the generic standards is
susceptible to manipulation because, for example, of the number of
Amex-listed components in the Index, the Commission will have 60
days from the filing date in which to abrogate the rule change. See
Securities Exchange Act Release No. 34157 (June 3, 1994), 59 FR
30062 (June 10, 1994).
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Secondly, where Amex-listed stocks comprise more than 10% of the
value of a particular index,15 (1) options on that index must be
traded in a room physically separated from the Equity Floor, (2) if
index options are traded on the Mezzanine, the trading area must be
located so as to avoid direct sight lines with the Equity Floor, and
(3) communication by means of hand signals between the mezzanine and
the Equity Floor will be prohibited.16 The Commission believes
that each of these restrictions will further serve to minimize the
informational advantages that can be gained by Amex equity and options
floor traders as a result of permitting the Amex to trade index options
with Amex-listed stock components.
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\1\5For indexes where Amex-listed stocks comprise less than 10%
of the value of the index, changes in the prices of the Amex-listed
stocks should not have a significant impact on the value of the
index. As a result, the Commission believes that any informational
advantage that might exist in these circumstances as a result of an
Amex member being present on the Exchange floor will be deminimis.
Nevertheless, the Amex will apply its existing surveillance
procedures to all index options, which should deter as well as
detect any potential manipulation.
\1\6The Amex shall deliver written notice to its membership
informing them of the prohibition against the use of hand signal
communications.
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Finally, the Commission believes that treating a narrow-based index
and each Amex-listed component in the index as paired securities in
those cases where the Amex-listed components comprise more than 10% of
the index value, further minimizes any potential for manipulation. This
requirement would establish the same restrictions that are currently in
place regarding the trading of equity options on Amex-listed
securities, to narrow-based index options with Amex-listed components
representing over 10% of the value of the index. For example, a ROT who
is also a registered equity trader would be prohibited from executing a
proprietary trade in such an index option for 60 minutes after he or
she had been on the Equity Floor.17 The Commission believes that
these restrictions severely restrict the potential for the abuse of
informational advantages by Amex traders thereby ensuring that any
narrow-based index option constructed pursuant to the proposed rule
change will, as with narrow-based index options currently traded on the
Exchange, not be readily susceptible to manipulation. Accordingly, the
Commission believes it is appropriate to extend these restrictions to
Amex-listed stocks and options on narrow-based indexes containing those
stocks in cases where the Amex-listed stocks account for more than 10%
of the index.
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\1\7See supra notes 10 and 11, and accompanying text.
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The Commission also believes that the proposed change to the
definition of ``stock index group'' is appropriate in light of changes
in the securities market since that definition was adopted.
Specifically, the Amex currently is trading, or has had approved for
trading, options on equal dollar-weighted indexes, which do not fit
within the current definition. The Commission believes the proposed
change more accurately reflects the current index option products
approved for trading and is sufficiently broad enough to allow further
innovations in the methods for calculating and determining index
values.\18\ Accordingly, the Commission believes the proposed rule
change to Rule 900C is consistent with the Act.
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\18\The Commission, however, will continue to examine any new
weighting methods when reviewing new index option proposals pursuant
to Section 19(b) of the Act.
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Based on the foregoing, the Commission believes that the proposal
will provide the Exchange with flexibility to construct new hedging
vehicles for use by investors while sufficiently protecting investors
by minimizing the susceptibility of these securities to manipulation.
Accordingly, the Commission believes the proposed rule change, as
amended, is consistent with the Act.
The Commission finds good cause for approving Amendment No. 1 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Specifically, Amendment No. 1 proposes certain restrictions on the
trading of index options on narrow-based indexes comprised of Amex-
listed stocks accounting for more than 10% of the value of the index,
by weight. For the reasons discussed above, the Commission believes
these restrictions adequately minimize any potential for misuse of
information or market manipulation. Accordingly, the Commission
believes it is consistent with Section 6(b)(5) of the Act to approve
Amendment No. 1 to the Amex's proposal on an accelerated basis.
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying in the Commission's Public
Reference Section, 450 Fifth Street, NW., Washington, DC. Copies of
such filing will also be available for inspection and copying at the
principal office of the above-mentioned self-regulatory organization.
All submissions should refer to File No. SR-Amex-91-35 and should be
submitted by August 9, 1994.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-Amex-91-35), as amended, is
approved.
\19\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.\20\
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\20\17 CFR 200.30-3(a)(12) (1993).
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[FR Doc. 94-17524 Filed 7-18-94; 8:45 am]
BILLING CODE 8010-01-M
