[Federal Register Volume 60, Number 177 (Wednesday, September 13, 1995)]
[Notices]
[Pages 47637-47639]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-22655]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36194; File No. SR-PHLX-95-16]
Self-Regulatory Organization; Order Approving Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to
Modifications of the Position and Exercise Limits for Narrow-Based
Index Options
September 6, 1995.
I. Introduction
On March 6, 1995, the Philadelphia Stock Exchange, Inc. (``PHLX''
or ``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``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 amend PHLX Rule 1001A,
``Position Limits,'' to increase the position and exercise limits \3\
for narrow-based (or industry) index options from the current levels of
5,500, 7,500, or 10,500 contracts to 6,000, 9,000, or 12,000 contracts.
\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
\3\ Position limits impose a ceiling on the number of option
contracts which an investor or group of investors acting in concert
may hold or write in each class of options on the same side of the
market (i.e., aggregating long calls and short puts or long puts and
short calls). Exercise limits prohibit an investor or group of
investors acting in concert from exercising more than a specified
number of puts or calls in a particular class within five
consecutive business days. PHLX Rule 1002A, ``Exercise Limits,''
states that for the purposes of determining compliance with PHLX
Rule 1002, ``Exercise Limits,'' exercise limits for index option
contracts shall be equivalent to the position limits described in
PHLX Rule 1001A.
---------------------------------------------------------------------------
Notice of the proposed rule change appeared in the Federal Register
on May 16, 1995.\4\ No comments were received on the proposal.
\4\ See Securities Exchange Act Release No. 35694 (May 9, 1995),
60 FR 26067.
---------------------------------------------------------------------------
II. Background and Description
Since the inception of standardized options trading, the options
exchanges have had rules imposing limits on the aggregate number of
option contracts that a member or customer can hold or exercise. These
rules are intended to prevent the establishment of large options
positions that can be used or might create incentives to manipulate or
disrupt the underlying market so as to benefit the options position. At
the same time, the Commission has recognized that option position and
exercise limits must not be established at levels that are so low as to
discourage participation in the options market by institutions and
other investors with substantial hedging needs or to prevent
specialists and market makers from adequately meeting their obligations
to maintain a fair and orderly market.\5\
\5\ See, e.g., Securities Exchange Act Release No. 33285
(December 3, 1993), 58 FR 65201 (December 13, 1993) (order approving
File No. SR-Amex-93-27) (increasing position and exercise limits for
equity options and narrow-based index options).
---------------------------------------------------------------------------
In 1983, the PHLX set position and exercise limits for narrow-based
index options at 4,000 contracts.\6\ In 1993, the Commission approved a
PHLX proposal to amend PHLX Rule 1001A to increase the position limits
for narrow-based index options to the current levels of 5,500, 7,500,
or 10,500 contracts.\7\ The PHLX proposes to amend Exchange Rule
1001A(b)(1) to increase the position and exercise limits for industry
index options from 5,500, 7,500, or 10,500 contracts to 6,000, 9,000 or
12,000 contracts.\8\
\6\ See Securities Exchange Act Release No. 20437 (December 2,
1983), 48 FR 55229 (December 9, 1983) (order approving File No. SR-
PHLX-83-17).
\7\ See Securities Exchange Act Release No. 33288 (December 3,
1993), 58 FR 65221 (December 13, 1993) (order approving File No. SR-
PHLX-93-07) (``1993 Approval Order''). Specifically, PHLX Rule
1001A(b)(1) currently provides the following position limits for
industry index options: (i) 5,500 contracts for an index where a
single component stock accounted, on average, for 30% or more of the
index value during the 30-day period immediately preceding the
Exchange's semi-annual review of industry index option position
limits; (ii) 7,500 contracts for an index where a single component
stock accounted, on average, for 20% or more of the index value or
any five component stocks together accounted, on average, for more
than 50% of the index value but no single component stock accounted,
on average, for 30% or more of the index value during the 30-day
period immediately preceding the Exchange's semi-annual review of
industry index option position limits; or (iii) 10,500 contracts
where the conditions requiring a limit of 5,500 contracts or 7,500
contracts have not occurred.
\8\ The PHLX currently trades options on the following narrow-
based indexes: (1) the Gold/Silver Index (``XAU'') 5,500 contracts;
(2) the Utility Index (``UTY'') (10,500 contracts); (3) the PHLX/KBW
Bank Index (``KBX'') (10,500 contracts); (4) the Phone Index
(``PNX'') (5,500 contracts); (5) the Semiconductor Index (``SOX'')
(7,500 contracts); and (6) the Airline Sector Index (``PLN'')
(10,500 contracts).
---------------------------------------------------------------------------
The Exchange believes that its proposal is consistent with the Act
for several reasons. First, the Exchange notes that the current
industry index option position limits have been in place since 1993 and
that there have been no further increases in position limits for
narrow-based index options since that time, despite substantial changes
in the marketplace. Most notable among these changes, according to the
PHLX, is an appreciable growth in index options trading. The PHLX
states that this marked increase in index options volume has
significantly increased liquidity in PHLX-traded index options.\9\
\9\ The PHLX states that index options volume increased 450%
(from 354,614 contracts to 1,957,171 contracts in 1994 as compared
to 1993.
---------------------------------------------------------------------------
Second, the Exchange believes that the proposed increases are
reasonable and consistent with the gradual, evolutionary approach
adopted previously by the Commission and the options exchanges when
increasing position and exercise limits.\10\ Accordingly, the PHLX
proposes a 9% increase in the lowest tier (from 5,000 to 6,000
contracts); a 20% increase for options currently at the 7,500 contract
limit (increased to 9,000 contracts); and a 15% increase in the highest
tier, currently at 10,500 contracts (increased to 12,000 contracts).
\10\ According to the PHLX, the most recent position limit
changes in 1993 represented changes of 38% (from 4,000 to 5,500
contracts); 25% (from 6,000 to 7,500 contracts); and 31% (from 8,000
to 10,500 contracts).
---------------------------------------------------------------------------
Third, the Exchange believes that the proposed increases are needed
by traders and investors. According to the PHLX, Exchange members and
customers have asked the Exchange to propose an increase in position
limits, primarily because interested trading
[[Page 47638]]
participants have not been able to meet their investment needs at
current position limit levels. Specifically, the PHLX notes that
certain institutional traders handling industry funds deal in
securities valued many times higher than the maximum permissible
position under PHLX rules. Based on such member and customer requests,
the Exchange believes that the current position limit levels discourage
market participation by large investors and the institutions that
compete to facilitate the trading interests of large investors.
Accordingly, the PHLX proposes to raise position and exercise limits
for narrow-based index options to accommodate the liquidity and hedging
needs of large investors and the facilitators of those investors.
Fourth, the Exchange believes that the proposal should increase the
depth and liquidity of the markets for index options. The PHLX also
believes that higher position limits would further accommodate the
hedging needs of Exchange market makers and specialists, who are also
restricted by current levels.
The PHLX notes that it continues to monitor the markets for
evidence of manipulation or disruption caused by investors with
positions at or near current position or exercise limits and that the
new limits will not diminish the surveillance function in this regard.
Additionally, the PHLX states that its surveillance procedures have
become increasingly sophisticated and automated.
For these reasons, the Exchange believes that the proposal to
increase narrow-based index option position limits 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 and to prevent fraudulent and manipulative acts and
practices, as well as to protect investors and the public interest. The
Exchange believes that the proposal should remove impediments to and
perfect the mechanism of a free and open market by providing market
opportunity to investors constricted by current position limit levels.
The PHLX also believes that by stimulating market participation and
thereby increasing option market depth and liquidity, the proposed rule
change should promote just and equitable principles of trade.
III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5).\11\ Specifically, the
Commission finds that the proposed position and exercise limits for
narrow-based index options should accommodate the needs of investors
and market participants and should increase the potential depth and
liquidity of the options market as well as the underlying cash market
without significantly increasing concerns regarding intermarket
manipulations or disruptions of the market for the options or the
underlying securities.
\11\ 15 U.S.C. 78f(b) (1988 & Supp. V 1993).
---------------------------------------------------------------------------
As noted above, the Commission believes that although the position
and exercise limits for options must be sufficient to protect the
options and related markets from disruptions by manipulation, the
limits must not be established at levels that are so low as to
discourage participation in the options market by institutions and
other investors with substantial hedging needs or to prevent market
makers from adequately meeting their obligations to maintain a fair and
orderly market. In this regard, the PHLX has stated that the current
position limits discourage market participation by certain large
investors and the institutions that compete to facilitate their
trading. In addition, the PHLX notes that index option trading volume
has increased significantly since 1993, when the current industry index
option position limits were established. In light of the increased
volume of narrow-based index option trading and the needs of investors
and market makers, the Commission believes that the PHLX's proposal is
a reasonable effort to accommodate the needs of market participants.
In addition, the Commission notes that the proposal, while
increasing the positions limits for narrow-based index options,
continues to reflect the unique characteristics of each index option
and to maintain the structure of the current three-tiered system.
Specifically, the lowest proposed limit, 6,000 contracts, will apply to
narrow-based index options in which a single underlying stock accounts
for 30% or more of the index value during the 30-day period immediately
preceding the Exchange's semi-annual review of industry index option
positions limits. A position limit of 9,000 contracts will apply if any
single underlying stock accounts, on average, for 20% or more of the
index value or any five underlying stocks account, on average for more
than 50% of the index value, but no single stock in the group accounts,
on average, for 30% or more of the index value during the 30-day period
immediately preceding the Exchange's semi-annual review of industry
index option position limits. The 12,000-contract limit will apply only
if the Exchange determines that the conditions requiring either the
6,000-contract limit or the 9,000-contract limit have not occurred.
Accordingly, the proposal allows the Exchange to avoid placing
unnecessary restraints on those narrow-based index options where the
manipulative potential is the least and the need for increased
positions, both by traders and institutional investors, may be the
greatest.
The Commission believes that the proposed increases for the three
tiers of 9%, 20%, and 15%, for lowest to highest, respectively, appear
to be appropriate and consistent with the Commission's evolutionary
approach to position and exercise limits. In this regard, the absence
of discernible manipulative problems under the current three-tiered
position and exercise limit system for narrow-based index options leads
the Commission to conclude that the modest increases proposed by the
Exchange are warranted. The Commission recognizes that there are no
ideal limits in the sense that options positions of any given size can
be stated conclusively to be free of any manipulative concerns.
However, based upon the absence of discernible manipulation or
disruption problems under current limits, the Commission believes that
the proposed limits can be safely considered. Accordingly, the
Commission believes that the liberalization of existing position and
exercise limits for narrow-based index options is now appropriate.\12\
\12\ The Commission continues to believe that proposals to
increase position limits and exercise limits must be justified and
evaluated separately. After reviewing the proposed exercise limits,
along with the eligibility criteria for each tier, the Commission
has concluded that the proposed exercise limit increases for the
three-tiered framework do not raise manipulation problems or
increase concerns over market disruption in the underlying
securities.
The Commission notes that the Exchange has had considerable
experience monitoring the current three-tiered framework in narrow-
based stock index options. The Commission has not found that differing
position and exercise limit requirements based on the particular
options product to have created programming or monitoring problems for
securities firms, or to have led to significant customer confusion.
Based on the current experience in handling position and exercise
limits, the Commission believes that the proposed increase in position
and exercise limits for narrow-based index
[[Page 47639]]
options will not cause significant problems.
Finally, the PHLX has indicated that its surveillance procedures
have become increasingly sophisticated and automated. The Commission
believes that the Exchange's surveillance programs are adequate to
detect and deter violations of position and exercise limits as well as
to detect and deter attempted manipulative activity and other trading
abuses through the use of such illegal positions by market
participants.\13\
\13\ The Commission emphasizes that the PHLX must closely
monitor compliance with position and exercise limits and to impose
appropriate sanctions for failures to comply with the Exchange's
position and exercise limit rules.
---------------------------------------------------------------------------
IV. Conclusion
For the foregoing reasons, the Commission finds that the proposal
to increase the position and exercise limits for narrow-based index
options to 6,000, 9,000, or 12,000 contracts, depending on the
percentage stock concentrations within the index, is consistent with
the requirements of the Act and the rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-PHLX-95-16) is approved.
\14\ 15 U.S.C. Sec. 78f(b)(2) (1988).
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
\15\ 17 CFR 200.30-3(a)(12) (1994).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-22655 Filed 9-12-95; 8:45 am]
BILLING CODE 8010-01-M
