[Federal Register Volume 62, Number 209 (Wednesday, October 29, 1997)]
[Notices]
[Pages 56221-56222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-28568]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34- 39265; File No. SR-PCX-97-22]


Self-Regulatory Organizations; Pacific Exchange, Inc.; Order 
Granting Approval to Proposed Rule Change Relating to the Trading of 
FLEX Index Options and LEAPS on the Dow Jones & Co. Taiwan Index

October 22, 1997

I. Introduction

    On June 9, 1997, the Pacific Exchange, Inc. (``PCX '' or 
``Exchange'') submitted to 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 its rules to allow the 
trading of Flexible Exchange Options (``FLEX Options'') and long-term 
index option series (``LEAPS'') on the Dow Jones & Co. Taiwan Index 
(``Taiwan Index'' or ``Index'').\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Commission previously approved the trading of 
standardized cash-settled, Europeanstyle stock index options on the 
Taiwan Index on December 23, 1996. See Securities Exchange Act 
Release No. 38081, 62 FR 138 (January 2, 1997) (order approving File 
No. SR-PSE-96-40). The Taiwan Index is a broad-based index, 
comprised of 113 representative stocks traded on the Taiwan Stock 
Exchange.
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    The proposed rule change was published for comment in the Federal 
Register on August 18, 1997.\4\ No comments were received on the 
proposal. This order approves the proposal.
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    \4\ See Securities Exchange Act Release No. 38920 (August 11, 
1997), 62 FR 44027.
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II. Description of the Proposal

    The Commission previously approved the Exchange's proposal to allow 
trading in FLEX Options on the Wilshire Small Cap and PSE Technology 
Indexes.\5\ FLEX Options give investors the ability, within specified 
limits, to designate certain of the terms of the options. In recent 
years, an over-the-counter (``OTC'') market in customized options has 
developed which permits participants to designate the basis 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 the OTC market are 
typically institutional investors, who buy and sell options in large-
size transactions through a relatively small number of securities 
dealers. To compete with this growing OTC market in customized options, 
the PCX permits FLEX index options trading with the Options Clearing 
Corporation (``OCC'') as issuer and guarantor.\6\
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    \5\ See Securities Act Release No. 34364 (July 13, 1994), 59 FR 
36813 (July 19, 1994) (order approving File No. SR-PSE-93-13) 
(``Wilshire/PSE Technology Order'').
    \6\ The Commission has previously designated FLEX Index Options 
as standardized options for the purposes of the options disclosure 
framework established under Rule 9b-1 of the Act. See Securities 
Exchange Act Release No. 31910 (February 23, 1993), 58 FR 12056 
(March 2, 1993). In addition, the Commission has approved the 
listing by the PCX of FLEX Index Options on the Wilshire Small Cap 
and PSE Technology Indexes. See Wilshire/PSE Technology Order, supra 
note 5.
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    The PCX now proposed to amend its Rules 8.100 and 8.102\7\ to 
permit the trading of FLEX Options based on the same Dow Jones & Co. 
Taiwan Index previously approved for standardized non-Flex options 
trading.\8\ The PCX's proposal will allow FLEX Option market 
participants to designate the following contract terms for FLEX Options 
on the Taiwan Index: (1) exercise price; (2) exercise style (i.e., 
American,\9\ European,\10\ or capped \11\);

[[Page 56222]]

(3) Expiration date;\12\ (4) option type (put, call, or spread); and 
(5) form of settlement (A.M., P.M. or average). These terms are 
identical to the terms that can be designated for the previously 
approved PCX FLEX Index Options.\13\
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    \7\ These rules currently allow the Exchange to trade FLEX Index 
Options on the Wilshire Small Cap Index and the PSE Technology 
Index. The PCX has proposed to set position and exercise limits for 
FLEX options on the Index at 200,000 contracts, as set forth in PCX 
Rule 8.107. This is the same FLEX position and exercise limits 
established for the Wilshire Small Cap and PSE Technology Indexes.
    \8\ See supra note 3.
    \9\ An American-style option is one that may be exercised at any 
time on or before the expiration date.
    \10\ A European-style option is one that may be exercised only 
during a limited period of time prior to expiration of the option.
    \11\ A capped-style index option is one that is automatically 
exercised prior to expiration when the cap index value is less than 
or equal to the index value for calls or when the cap index value is 
greater than or equal to the index value for puts.
    \12\ The expiration date of a FLEX Option may not fall on a day 
that is on, or within two business days, of the expiration date of a 
non-FLEX option.
    \13\ See supra note 5.
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    The Exchange also proposes to list and trade full-value LEAPS, 
pursuant to PCX Rule 6.4(d), on the Index.\14\ LEAPS on the Index will 
allow the PCX to list options series with expirations of up to three 
years from the date of issuance. For LEAPS, the underlying value would 
be computed by using the same levels as proposed for the Index 
options.\15\
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    \14\ The Exchange is not proposing to trade reduced-value LEAPS 
on the Dow Taiwan Index.
    \15\ Telephone conversation on October 8, 1997 between Michael 
Pierson, Senior Attorney, PCX, and Deborah Flynn, Attorney, Division 
of Market Regulation, Commission.
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III. Discussion

    After careful review, 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.\16\ Specifically, the Commission believes the proposal is 
consistent with the requirements of Section 6(b)(5) of the Act \17\ 
because trading of FLEX Options and LEAPS on the Taiwan Index will 
serve to protect investors, promote the public interest, and help to 
remove impediments to a free and open securities market. The Commission 
also believes that the trading of FLEX Options and LEAPS on the Index 
will provide investors with more flexibility in hedging the risks 
associated with holding some or all of the securities underlying the 
Index.\18\ By broadening the hedging and investment opportunities of 
investors, the Commission believes that the trading of FLEX Options and 
LEAPS on the Index will serve to protect investors, promote the public 
interest, and contribute to the maintenance of fair and orderly 
markets.
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    \16\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
    \18\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new securities product upon a finding that 
the introduction of such product is in the public interest. Such a 
finding would be difficult with respect to a product that served no 
hedging or other economic function, because any benefits that might 
be derived by market participants likely would be outweighed by the 
potential for manipulation, diminished public confidence in the 
integrity of the markets, and other valid regulatory concerns.
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    In particular, as noted above, FLEX Options on the Index will allow 
investors to customize certain terms, including size, term to 
expiration, exercise style, exercise price, and exercise settlement 
value.\19\ LEAPS should also benefit investors by allowing them to 
hedge positions on the Index on a longer term basis through investment 
in one options series, rather than having to roll shorter term 
expirations into new series to remain hedged on a longer basis.
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    \19\ The Commission believes that the proposal to trade FLEX 
Options on the Taiwan Index should also encourage fair competition 
by allowing the Exchange to compete with the growing OTC market in 
customized index options to address the demands of sophisticated 
portfolio managers and other institutional investors who are 
increasingly relying on the OTC market to satisfy their hedging 
needs.
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    The Commission notes that the Taiwan Index was thoroughly reviewed 
recently in connection with the Exchange's proposal to list and trade 
standardized, non-FLEX options based on the Index.\20\ At that time, 
the Commission found that the Exchange had adequately addressed the 
Commission's concerns arising from issues relating to the design and 
structure of the Index, customer protection and surveillance. The 
Commission's findings relied on several factors, including the large 
capitalizations, substantial trading volume, wide diversity of the 
component stocks in the Taiwan Index and the size of the market 
underlying the Index.\21\
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    \20\ See supra note 11.
    \21\ Id.
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    The Commission believes that it is reasonable for the Exchange to 
allow trading in FLEX Options and LEAPS based on this Index given that, 
to the Commission's knowledge, there have been no significant, adverse 
changes to the Index to date that would change the Commission's initial 
findings approving the trading of options on the Index. For the 
foregoing reasons, the Commission finds that the PCX's proposal to 
trade FLEX Options and LEAPS based on the Taiwan index is consistent 
with the requirements of the Act and the rules and regulations 
thereunder.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change (SR-PCX-97-22) is approved.

    \22\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-28568 Filed 10-28-97; 8:45 am]
BILLING CODE 8010-01-M