[Federal Register Volume 60, Number 204 (Monday, October 23, 1995)]
[Notices]
[Pages 54403-54406]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26186]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36380; File No. SR-PHLX-95-45]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to Industry
Index Option Hedge Exemption
October 17, 1995.
Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on
September 18, 1995, the Philadelphia Stock Exchange, Inc. (``PHLX'' or
``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II, and III below, which Items have been prepared by the self-
regulatory organization. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The PHLX proposes to amend PHLX Rule 1001A, ``Position Limits,'' to
establish a hedge exemption from industry (narrow-based) index option
position limits.\1\ Specifically, the PHLX proposes to exempt from
position limits any position in an industry index option that is hedged
by share positions in at least 75% of the number of component stocks of
that index or securities convertible into such stock. Under the
proposal, no position in an industry index option may exceed three
times the narrow-based index option position specified in PHLX Rule
1001A(b)(i) \2\ and the value of the index option position may not
exceed the value of the underlying hedging portfolio. Exercise limits
\3\ will continue to correspond to position limits, so that investors
may exercise the number of contracts set forth as the position limit,
as well as those contracts exempted by the proposal, during five
consecutive business days. The proposed exemption will be available to
firm and proprietary traders, as well as public customers.
\1\ 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).
\2\ PHLX Rule 1001A(b)(i) provides the following position limits
for industry index options: 6,000 contracts if any single stock
accounted, on average, for 30% or more of the index value during the
30-day period preceding the review; 9,000 contracts if any single
stock accounted, on average, for 20% or more of the index value or
any five stocks together accounted, on average, for more than 50% of
the index value, but no single stock in the group accounted on
average, for 30% or more of the index value during the 30-day period
preceding the review; or 12,000 contracts if none of the above
conditions apply. See Securities Exchange Act Release No. 36194
(September 6, 1995), 60 FR 47637 (order approving File No. SR-PHLX-
95-16) (increasing position limits for industry index options to
6,000, 9,000, or 12,000 contracts).
\3\ 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.
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The text of the proposed rule change is available at the Office of
the Secretary, PHLX, and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in sections (A), (B), and (C) below,
of the most significant aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The purpose of the proposed industry index option hedge exemption
is to establish a provision parallel to the hedge exemptions for equity
options and certain broad-based index options to permit certain hedged
positions to exceed established position limit levels.\4\ In 1989, the
Commission approved a hedge exemption for Utility Index options
(``UTY'') on a pilot basis.\5\ At this time, the PHLX proposes to adopt
an industry index hedge exemption applicable to all of the Exchange's
industry index options.
\4\ See PHLX Rule 1001, Commentary .07. See Securities Exchange
Act Release No. 35738 (May 18, 1995), 60 FR 27573 (May 24, 1995)
(File Nos. SR-AMEX-95-13, SR-CBOE-95-13, SR-NYSE-95-04, SR-PSE-95-
05, and SR-PHLX-95-10) (permanently approving hedge exemption pilot
programs).
\5\ See Securities Exchange Act Release No. 27486 (November 30,
1989), 54 FR 50675 (December 8, 1989) (order approving File No. SR-
PHLX-89-27). The UTY hedge exemption was approved for a one-year
pilot period, which ended on November 30, 1990.
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Specifically, the PHLX proposes to adopt Commentary .02 to PHLX
Rule 1001A to establish a narrow-based index option hedge exemption
under which industry index option positions hedged in accordance with
the proposal would be entitled to exceed existing narrow-based index
option position limits by up to three times the limit.
In order to qualify for the exemption, the industry index option
position must be ``hedged'' by share positions in at least 75% of the
number of component stocks of the index, or securities convertible into
such stock.\6\ Under the proposed exemption, position limits for any
hedged industry index option may not exceed three times the limits
established under PHLX Rule 1001A(b)(i). In addition, the value of the
index option position may not exceed the value of the underlying
portfolio employed as the hedge. The value of the underlying portfolio
is determined as follows: (1) The total market value of the net stock
position, less (2) the value of: (a) the notional value \7\ of any
offsetting
[[Page 54404]]
calls and puts in the respective index option class; and (b) the
notional value of any offsetting positions in stock index futures.
\6\ The PHLX permits the use of convertible securities in its
equity option hedge exemption. See Securities Exchange Act Release
No. 32174 (April 20, 1993), 58 FR 25687 (April 27, 1993) (order
approving File No. SR-PHLX-92-22). Similarly, other options exchange
permit the use of convertible securities in broad-based index hedge
exemptions. See Securities Exchange Act Release No. 35738, supra
note 4.
\7\ Notional values are determined by adding the number of
contracts and multiplying the total by the multiplier, expressing
that number in dollar terms.
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The proposed exemption requires that both the options and stock
positions be initiated and liquidated in an orderly manner.
Specifically, a reduction of the options position must occur at or
before the corresponding reduction in the stock portfolio position.
Under the proposal, exercise limits will continue to correspond to
position limits; accordingly, investors may exercise during five
consecutive business days the number of contracts set forth in the
position limit as well as those contracts exempted by the proposal.
The PHLX notes that a broad-based (market) index option hedge
exemption is in place on other options exchanges. The Commission
recently granted permanent approval to several broad-based index option
hedge exemptions.\8\ Generally, the broad-based index option hedge
exemptions allow public customers to apply for position limit
exemptions in broad-based index options that are hedged with exchange-
approved qualified stock portfolios. 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 20 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.
\8\ See Securities Exchange Act Release No. 35738, supra note 4.
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The PHLX notes that the Chicago Board Options Exchange's (``CBOE'')
broad-based index option hedge exemption, contained in Interpretation
and Policy .01 to CBOE Rule 24.4, ``Position Limits for Broad-Based
Index Options.'' applies to public customers holding positions in
broad-based index options other than a.m.-settled, European-style
Standard & Poor's (``S&P'') 500 Index options and Quarterly Index
Expirations (``QIXs'') and Capped-Style QIXs (``Q-CAPS'') on the S&P
500 Index. Under Interpretation and Policy .01, exempted positions may
not exceed 75,000 same-side of the market options,\9\ except as
otherwise provided in CBOE Rule 24.4, Interpretation and Policies .02
and .03, and except that exempted combined positions in options on the
S&P/Barra Value Index and S&P/Barra Growth Index may not exceed 225,000
same-side of the market option contracts.\10\
\9\ Under CBOE Rule 24.4(a), the position limit for broad-based
index options, other than Russell 2000 Index options and S&P/Barra
Growth Index and S&P/Barra Value Index options, is 25,000 contracts.
CBOE Rules 24.4 (b), (c), and (d) contain separate position limit
provisions for a.m.-settled, European-style options on the S&P 500
Index (``SPX'') and QIXs and Q-CAPS on the SPX, QIXs and Q-CAPS on
the S&P 100 Index (``OEX''), and QIXs on the Russell 2000 Index.
\10\ CBOE Rule 24.4, Interpretation and Policy .02 provides a
hedge exemption for certain positions in a.m.-settled, European-
style S&P 500 Index options and QIXs and Q-CAPS on the S&P 500
Index. Specifically, Interpretation and Policy .02(d) provides that
a customer's exempted position may not exceed 150,000 same-side of
the market contracts in a.m.-settled S&P 500 index options and QIXs
and Q-CAPS on the S&P 500 Index. Interpretation and Policy .02(b)
states that a money manger shall not hold in its aggregated accounts
more than 250,000 exempted same-side of the market options or, for
any single account, more than 135,000 exempted same-side of the
market option contracts.
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In addition, the PHLX notes that Commentary .01 to American Stock
Exchange, Inc. (``Amex'') Rule 904C, ``Position Limits,'' provides a
broad-based index option position limit exemption for public customers
who satisfy the criteria established by the Amex.\11\
\11\ In addition, Amex Rule 904C, Commentary .02 provides a
facilitation exemption for Institutional Index and MidCap Index
options up to 100,000 and 75,000 contracts, respectively.
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In light of the PHLX's experience with the equity option hedge
exemption, as well as a review of the rules of the other options
exchanges, the PHLX believes that the proposed hedge exemption for
industry index options is appropriate. The PHLX also believes that the
proposed conditions for granting such an exemption are reasonable and
in line with prior Commission-approved provisions. With respect to
choosing a minimum number of stocks from the index to qualify the
portfolio for the hedge, the PHLX believes that a percentage, as
opposed to a fixed number, is necessary in view of the varying numbers
of stocks in PHLX-traded industry indexes.\12\ Currently, the PHLX
trades the following six industry index options: \13\
\12\ In the case of UTY options, the PHLX notes that the
proposed 75% figure amounts to 15 stocks, rather than the 10 stocks
required under the UTY hedge exemption pilot program. See Securities
Exchange Act Release No. 27486, supra note.
\13\ In addition, a proposal to list options on the Forest and
Paper Products Index was effective upon filing. See Securities
Exchange Act Release No. 36193 (September 6, 1995), 60 FR 47635
(September 13, 1995) (File No. SR-PHLX-95-56).
\14\ The Commission recently approved a proposal 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. See
Securities Exchange Act Release No. 36194, supra note 2.
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Index Symbol Number Position limit \14\
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KBW/Bank Index...................... BKX 20 stocks............. 12,000 contracts.
Gold/Silver Index................... XAU 9 stocks.............. 6,000 contracts.
Utility Index....................... UTY 20 stocks............. 12,000 contracts.
PNX Index........................... PNX 8 stocks.............. 6,000 contracts.
Semiconductor....................... SOX 16 stocks............. 9,000 contracts.
Airplan Index....................... PLN 12 stocks............. 12,000 contracts.
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The PHLX realizes that some of the narrow-based index options trade
more actively than others and the corresponding need for a position
limit exemption is thus more extensive in the more actively traded
index options. Nevertheless, in lieu of adopting separate exemption
provisions for each index option, the PHLX believes that a uniform
provision is less confusing to investors, more easily administered, and
more fair to an investing community whose interest in any given index
is apt to change from time to time.
According to the PHLX, recent total trading volume for both narrow-
and broad-based indexes traded on the PHLX has increased markedly. The
PHLX states that in 1994, trading volume increased five-fold over 1993,
from 354,614 contracts to 1,957,171 contracts. In 1995, trading volume
has remained steady with over 1,000,000 contracts traded from January
through May. The PHLX attributes the recent growth in trading and open
interest in these products to institutional trading, which, according
to the PHLX, is typically hedged by baskets of the underlying stocks.
The PHLX proposes to exempt positions in narrow-based index options
up to three times the established position in a manner which balances
the hedging needs of index option traders with the Exchange's
obligation to
[[Page 54405]]
maintain a fair and orderly market. The PHLX believes that a hedge
exemption up to 31,500 contracts for UTY options would considerably
enhance the attractiveness of the product for institutional traders,
who would, in turn, trade more of the product in a hedged manner and
thereby provide stabilizing liquidity in both the index option and the
underlying securities. According to the PHLX, the hedge exemption for
OEX options, which permits public customers to hold positions in up to
75,000 contracts (three times the regular position limit),\15\ serves
as a significant liquidity provider in that product.
\15\ See CBOE Rule 24.4(a) and Interpretation and Policy .01.
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Although the UTY hedge exemption pilot program applied only to
customers, the PHLX believes that it is appropriate and necessary to
expand the availability of the proposed exemption beyond public
customers.\16\ The PHLX believes that significant increases in the
depth and liquidity of the market for these index options could result
from permitting firm and proprietary traders to be eligible for the
exemption. According to the PHLX, because customers rely, for the most
part, on a limited number of proprietary traders to facilitate large-
sized orders, not including such traders in the exemption effectively
reduces the benefit of the exemption to customers. While large-sized
positions in industry index options are most commonly initiated by
institutional traders hedging stock portfolios on behalf of public
customers, the PHLX believes that proprietary traders should be
afforded the same exemptions so that they may fulfill their role as
facilitators.
\16\ The Commission notes that the current hedge exemptions for
broad-based index options apply solely to public customers.
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The PHLX believes that the hedge exemption provision is necessary
to better meet the needs of investors who would use PHLX industry index
options for investment and hedging purposes. For example, with the
current position limit at 6,000 contracts and the Gold/Silver Index at
120, this position would have an index value of $72,000,000. However,
the PHLX states that many institutional traders and portfolio managers
deal in dollar amounts much greater than permissible under current
position limit levels and have expressed that Exchange position limits
hamper their ability to fully utilize Exchange index options. As a
result, the PHLX believes that many index options are ineffective for
such traders, who often turn to futures instruments where ample relief
is readily available.\17\ Thus, the PHLX believes that the proposed
hedge exemption should alleviate the situation where investors with
substantial hedging needs are discouraged currently from participation
in the options markets by existing position limits.
\17\ The Commission has noted that under the rules promulgated
by the Commodity Futures Trading Commission, futures positions that
are deemed to be bona fide hedging transactions (as defined) are
exempted from position limit rules. See Securities Exchange Act
Release No. 25739 (May 24, 1988), 53 FR 20204 (June 2, 1988) (order
approving File No. SR-CBOE-87-25).
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The PHLX believes that the proposed narrow-based index option hedge
exemption should not increase the potential for disruption or
manipulation in the markets for the stocks underlying each index. The
PHLX notes that the position limits for industry index options, even
tripled, are far less than the position limits for most broad-based
index options.\18\ In this regard, the proposal incorporates several
surveillance safeguards, which the PHLX will employ to monitor the use
of this exemption. Specifically, the Exchange will require that a form
be filed by member firms and their customers who seek hedge exemptions,
in lieu of granting an automatic exemption. The Exchange's Market
Surveillance Department will monitor trading activity in PHLX-traded
index options and the stocks underlying those indexes to detect
potential front running and manipulation abuses, as well as review to
ensure that closing positions subject to an exemption is conducted in a
fair and orderly manner.
\18\ The position limit for the PHLX-traded Value Line Composite
Index options is 25,000 contracts. See PHLX Rule 1001A(a). The
position limit for Major Market Index options is 34,000 contracts.
See Amex Rule 904C(b). The position limit for OEX options is 25,000
contracts, and the position limit for SPX options is 45,000
contracts. See CBOE Rule 24.4 (a) and (b).
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And lastly, the PHLX notes that the provision itself contains
several built-in safeguards. First, the hedge must consist of a
position in at least 75% of the stocks underlying the index. Thus, the
``basket'' of stocks constituting the hedge resembles the underlying
index.\19\ Secondly, position limits under the proposal may not exceed
three times the limits established under PHLX Rule 1001A(b)(i). This
places a ceiling on the maximum size of the option position. The PHLX
notes that an exemption of up to three times the limit is similar to
that of the CBOE for OEX options.\20\ Third, both the options and stock
positions must be initiated and liquidated in an orderly manner,
meaning that a reduction of the options position must occur at or
before the corresponding reduction in the stock portfolio position.
Lastly, the value of the industry index option position cannot exceed
the dollar value of the underlying portfolio. The purpose of this
requirement is to further ensure that stock transactions are not used
to manipulate the market in a manner benefiting the option position. In
addition, these safeguards prevent the increased positions from being
used in a leveraged manner.
\19\ To determine the share amount of each component required to
hedge an index option position: index value x index multiplier x
component's weighing = dollar amount of component. That amount
divided by price = number of shares of component. Conversely, to
determine how many options can be purchased based on a certain
portfolio, divide the dollar amount of the basket by the index value
x index multiplier.
\20\ See CBOE Rule 24.4(a).
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For the above reasons, the PHLX believes that the proposed industry
index hedge exemption should increase the depth and liquidity of the
markets for narrow-based index options and allow more effective hedging
with underlying stock portfolios without increasing the potential for
market manipulation or disruption, consistent with the purposes of
position limits. For the same reasons, the Exchange believes that
exercise limits should correspond to the position limit exemption
granted by this proposal. The Exchange notes that the rules of other
options exchanges provide a hedge exemption from exercise limits as
well.\21\
\21\ See Securities Exchange Act Release No. 35738, supra note
4.
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Accordingly, the Exchange believes that the proposal 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 protect investors and the public interest.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The PHLX does not believe that the proposed rule change will impose
any inappropriate burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
No written comments were either received or requested.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register, or within such longer period (i) as the Commission
may designate up to 90 days of such date if it finds such
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longer period to be appropriate and publishes its reason for so finding
or (ii) as to which the self-regulatory organization consents, the
Commission will:
(a) By order approve such proposed rule change, or
(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. 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 at 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 the file
number in the caption above and should be submitted by November 13,
1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
\22\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret M. McFarland,
Deputy Secretary.
[FR Doc. 95-26186 Filed 10-20-95; 8:45 am]
BILLING CODE 8010-01-M