[Federal Register Volume 63, Number 75 (Monday, April 20, 1998)]
[Notices]
[Pages 19549-19554]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10273]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39855; File No. SR-PCX-97-07]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1 Thereto, by the Pacific Exchange, Inc., 
Relating to Position and Exercise Limits

April 13, 1998.

I. Introduction

    On March 5, 1997, the Pacific Exchange, Inc. (``PCX'' 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 
proposed rule change to modify its rules on option position and 
exercise limits by (a) expanding the scope of the firm facilitation 
exemption, (b) increasing the position and exercise limits for narrow-
based index options, (c) expanding the broad-based index hedge 
exemption to include broker-dealers, and (d) clarifying the general 
rule on exercise limits. On March 27, 1997, the PCX submitted an 
amendment to the Commission regarding its proposal.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Michael D. Pierson; Senior Attorney, 
Regulatory Policy, PCX, to Matthew S. Morris, Office of Market 
Supervision, Division of Market Regulation, Commission, dated March 
26, 1997 (``Amendment No. 1'').
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    The proposed rule change appeared in the Federal Register on May 
20, 1997.\4\ No comments were received on the proposed rule change. 
This order approves the PCX's proposal, as amended.
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    \4\ See Securities Exchange Act Release No. 38612 (May 12, 1997) 
62 FR 27643 (May 20, 1997).
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II. Description

    The Exchange has proposed to modify several of its rules on 
position and exercise limits for equity and index options as follows:

A. Firm Facilitation Exemption

    The PCX's firm facilitation exemption currently applies only to a 
member firm that facilitates and executes an order for its own 
customer.\5\ The PCX proposes to amend the firm facilitation exemption 
in two ways. First, a member firm will qualify for the exemption if it 
facilitates its own customer whose account it carries, whether the firm 
executes the order itself or gives the order to an independent broker 
for execution. Second, the exemption will be expanded to include member 
firms who facilitate another member's customer order. Such a customer 
order must be for execution only against the member firm's proprietary 
account. Further, unlike a member firm that facilitates its own 
customer, the resulting position will not be carried by the 
facilitating member firm.\6\
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    \5\ The PCX defines a customer order as one that is entered, 
cleared, and in which the resulting position is carried with the 
firm.
    \6\ The Commission notes that any solicitation of a member by 
another member or customer to facilitate a customer order must 
comply with the relevant Exchange rules concerning solicited 
transactions.
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    Specifically, PCX Rule 6.8, Commentary .08 currently provides that 
for the purpose of facilitating (in accordance with the provisions of 
PCX Rule 6.47(b)) orders of its own customer (one that will enter, 
clear and have the resulting position carried with the firm) in non-
multiply-listed Exchange options, the proprietary account of a

[[Page 19550]]

member organization may receive and maintain an exemption 
(``facilitation exemption'') from the applicable standard position 
limit to the extent that certain procedures and criteria are satisfied. 
The Exchange proposes to replace this provision with another stating 
that to the extent that certain procedures and criteria are satisfied, 
a member organization may receive and maintain for its propriety 
account an exemption (``facilitation exemption'') from the applicable 
standard position limit in non-multiply-listed Exchange options for the 
purpose of facilitating, pursuant to the provisions of PCX Rule 
6.47(b), (a) orders for its own customer (one that will have the 
resulting position carried with the firm) or (b) orders received from 
or on behalf of a customer for execution only against the member firm's 
proprietary account.\7\
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    \7\ According to the PCX, the text of the proposed rule is 
substantially the same as the text of the first paragraph of 
Interpretation and Policy .06 to CBOE Rule 4.11 as well as the first 
paragraph of Commentary .10 to Amex Rule 904 and Commentary .02 to 
Amex Rule 904C. See Securities Exchange Act Release Nos. 37808 
(October 10, 1996) 61 FR 54691 (October 21, 1996) (File No. CBOE-96-
35), and 37945 (November 13, 1996) 61 FR 59122 (November 20, 1996) 
(File No. Amex-96-32).
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B. Narrow-Based Index Options

    Pursuant to PCX Rule 7.6, the position and exercise limits for 
narrow-based (industry) index options traded on the Exchange are 
currently set at 6,000, 9,000, and 12,000 contracts.\8\ Specifically, 
Exchange Rule 7.6(a) provides that position and exercise limits for 
narrow-based index options be set at one of three levels depending upon 
the weightings of the component securities in such narrow-based index. 
Currently, a narrow-based index option will have a 6,000 contract limit 
if a single component security accounts for more than 30% of the index 
value; a 9,000 contract limit if a single component security accounts 
for more than 20% (but less than 30%) of the index value or any five 
component securities together account for more than 50% of the index 
value; and a 12,000 contract limit for those narrow-based indexes that 
do not fall within any one of the other categories. The Exchange 
proposes to increase these position and exercise limits to 9,000, 
12,000, and 15,000 contracts. The Exchange notes that the Commission 
has approved such increases to the position and exercise limits of 
other options exchanges.\9\
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    \8\ See Securities Exchange Act Release No. 36537 (November 30, 
1995), 60 FR 62916 (December 7, 1995) (order approving increases to 
narrow-based index option position and exercise limits from 5,500, 
7,500, and 10,500 contracts to 6,000, 9,000, and 12,000 contracts) 
(File No. PSE-95-30).
    \9\ See, e.g., Securities Exchange Act Release Nos. 37863 
(October 24, 1996) 61 FR 56599 (November 1, 1996) (FIle No. SR-Phlx-
96-33), 38202 (January 23, 1997) 62 FR 4555 (January 30, 1997) (FIle 
No. SR-Amex-96-41), and 38613 (May 12, 1997) 62 FR 27638 (May 20, 
1997) (File No. SR-CBOE-97-09).
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C. Broad-Based Index Hedge Exemption

    PCX Rule 7.6, Commentary .02, currently provides that positions in 
broad-based index option issues traded on the Exchange, held in the 
aggregate by a customer (who is neither a member nor a broker-dealer) 
are exempt from this position limit rule to the extent that certain 
procedures and criteria are met to qualify for a hedge exemption. The 
Exchange proposes to modify this provision and the subject procedures 
in several respects.\10\
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    \10\ The Exchange notes that the Commission has approved similar 
changes to the rules of the CBOE. See Securities Exchange Act 
Release No. 37504 (July 31, 1996) 61 FR 40868 (August 6, 1996) (File 
No. CBOE-96-01).
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    First, the Exchange proposes to extend the broad-based index hedge 
exemption to broker-dealers. Accordingly, the Exchange is replacing 
various references to ``customer`' in the text of Commentary .02 with 
references to ``accounts,'' which refer to the accounts in which the 
exempt options positions are held (i.e., the ``hedge exemption 
account'').
    Second, the Exchange proposes that it be allowed to grant approval 
of a broad-based index hedge exemption on the basis of verbal 
representations, provided that the hedge exemption account furnishes to 
the Exchange, within two business days (or such other time period 
designated by the Exchange) appropriate documentation substantiating 
the basis for the exemption.
    Third, the Exchange proposes to add a provision (at new subsection 
(c)) stating that a hedge exemption account that is not carried by a 
PCX member organization must be carried by a member of a self-
regulatory organization participating in the Intermarket Surveillance 
Group (``ISG'').
    Fourth, the Exchange is eliminating current subsections (c) and (d) 
and replacing them with new subsection (d), which provides that the 
hedge exemption account must maintain a qualified portfolio, or will 
effect transactions necessary to obtain a qualified portfolio 
concurrent with or at or about the same time \11\ as the execution of 
the exempt option positions of: (1) a net long or short position in 
common stocks in at least four industry groups and contains at least 
twenty stocks, none of which account for more than fifteen percent of 
the value of the portfolio or in securities readily convertible, and 
additionally in the case of convertible bonds, economically 
convertible, into common stocks which would comprise a portfolio, and/
or (2) a net long or short position in index futures contracts or in 
options on index futures contracts, or long or short positions in index 
options or index warrants, for which the underlying index is included 
in the same margin or cross-margin product group cleared at the Options 
Clearing Corporation (``OCC'') as the index option class to which the 
hedge exemption applies. To remain qualified, a portfolio must at all 
times meet these standards notwithstanding trading activity.
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    \11\ The Exchange expects that the hedge will be established 
concurrently with or immediately following the execution of the 
option transaction absent good cause. In this regard, the Exchange 
notes that extreme market conditions, the implementation of circuit 
breakers, or the lack of liquidity may affect a market participant's 
ability to establish a hedge within the noted time-frame.
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    Fifth, the Exchange proposes to clarify the method of determining 
the unhedged value of a ``qualified portfolio.'' Accordingly, 
subsection (e) of Commentary .02 will provide that the unhedged value 
will be determined as follows: (1) the values of the net long or short 
positions of all qualifying products in the portfolio are totaled; (2) 
for positions in excess of the standard limit, the underlying market 
value (A) of any economically equivalent opposite side of the market 
calls and puts in broad-based index options, and (B) of any opposite 
side of the market positions in stock index futures, options on stock 
index futures, and any economically equivalent opposite side of the 
market positions, assuming no other hedges for these contracts exist, 
is subtracted from the qualified portfolio; and (3) the market value of 
the resulting unhedged portfolio is equated to the appropriate number 
of exempt contracts as follows: the unhedged portfolio is divided by 
the correspondent closing index value and the quotient is then divided 
by the index multiplier or 100.
    Sixth, the proposal specifies that only the following qualified 
hedging transactions and positions are eligible for purposes of hedging 
a qualified portfolio (i.e., stocks, futures, options, and warrants): 
(1) Long put(s) used to hedge the holding of a qualified portfolio; (2) 
Long call(s) used to hedge a short position in a qualified portfolio; 
(3) Short call(s) used to hedge the holding of a qualified portfolio; 
and (4) Short put(s) used to hedge a short position in a qualified 
portfolio. In addition, the proposal states that the following 
strategies may be effected only in conjunction with a qualified

[[Page 19551]]

stock portfolio: (5) For non-P.M. settled, European-style index options 
only--a short call position accompanied by long put(s), where the short 
call(s) expire with the long put(s), and the strike price of the short 
call(s) equals or exceeds the strike price of the long put(s) (a 
``collar'') (provided that neither side of the collar transaction can 
be in-the-money at the time the position is established);\12\ (6) For 
non-P.M. settled, European-style index options only--a long put 
position coupled with a short put position overlying the same broad-
based index and having an equivalent underlying aggregate index value, 
where the short put(s) expire with the long put(s), and the strike 
price of the long put(s) exceed the strike price of the short put(s) (a 
``debit put spread position''); and (7) For non-P.M. settled, European-
style index options only--a short call position accompanied by a debit 
put spread position, where the short call(s) expire with the puts and 
the strike price of the short call(s) equals or exceeds the strike 
price of the long put(s) (provided that neither side of the short call, 
long put transaction can be in-the-money at the time the position is 
established).\13\
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    \12\ For purposes of determining compliance with PCX Rules 6.8 
and 7.6, a collar position will be treated as one contract.
    \13\ For purposes of determining compliance with PCX Rules 6.8 
and 7.6, the short call and long put positions will be treated as 
one contract.
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    Finally, the Exchange proposes to add a new provision stating that 
positions included in a qualified portfolio that serve to secure an 
index hedge exemption may not also be used to secure any other position 
limit exemption granted by the Exchange or any other self-regulatory 
organization or futures contract market.

D. Exercise Limits

    PCX Rule 6.9 currently provides that Exchange member organizations 
are prohibited from exercising certain long positions in options dealt 
in on the Exchange as well as options dealt in on other options 
exchanges.\14\ The Exchange proposes to remove the phrase ``of a class 
of options dealt in on the Exchange'' in PCX Rule 6.9, Commentary .01, 
in order to make that Commentary consistent with current PCX Rule 
6.9(a).
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    \14\ See Securities Exchange Act Release No. 36350 (October 6, 
1995) 60 FR 53654 (October 16, 1995) (approval order relating to 
members' compliance with position and exercise limits for non-PCX 
listed options) (File No. PSE-95-17).
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III. Findings and Conclusions

    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).\15\ Specifically, 
the Commission finds that the proposal is designed to perfect the 
mechanisms of a free and open market and to protect investors and the 
public interest.
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    \15\ 15 U.S.C. 78f(b).
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A. Firm Facilitation Exemption

    The Commission believes that by allowing member firms an exemption 
from position limits to facilitate large customer orders, whether they 
are firms who accept customer orders for execution only against the 
member firm's proprietary account, or they are firms who carry their 
own customers' accounts and positions, the depth and liquidity of the 
market will be enhanced in a manner consistent with the protection of 
investors and the public interest. Further, permitting a member firm 
who facilitates its own customer order to qualify for the exemption 
whether it executes the order itself or gives it to an independent 
broker for execution should provide firms with flexibility in handling 
such orders while still requiring compliance with the rule's 
requirements.
    Specifically, the Commission believes that the PCX's proposal to 
amend its firm facilitation exemption will accommodate the needs of 
investors as well as market participants without substantially 
increasing concerns regarding the potential for manipulation and other 
trading abuses. The Commission also believes that the proposed rule 
change will further enhance the potential depth and liquidity of the 
options market as well as the underlying markets by providing Exchange 
members greater flexibility in executing large customer orders. 
Moreover, the Commission is relying on the absence of discernible 
manipulation problems under the PCX's current firm facilitation 
exemption as an indicator that the proposal is appropriate. In 
addition, the PCX's existing safeguards that apply to the current 
facilitation exemption will continue to serve to minimize any potential 
disruption or manipulation concerns.
    In summary, the Commission continues to believe that the safeguards 
built into the facilitation exemptive process will serve to minimize 
the potential for disruption and manipulation concerns, while at the 
same time benefiting market participants by allowing member firms 
greater flexibility to facilitate large customer orders. The Commission 
also notes that the facilitation exemption will be monitored in the 
same manner, whether the facilitation is done by the member firm for 
its own customer and executed by the firm itself or given to an 
independent broker for execution, or whether the facilitation is done 
by another member firm willing to facilitate the order of another 
member firm's customer. Further, as noted above, any firm solicitation 
to facilitate a customer order must comply with the PCX's solicitation 
rules as well as with the PCX's facilitation and crossing rules. 
Lastly, the Commission believes that the PCX has adequate surveillance 
procedures to surveil for compliance with the rule's requirements. 
Based on these reasons, the Commission believes that it is appropriate 
for the PCX to amend its firm facilitation exemption.

B. Narrow-Based Index Options

    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.
    In this regard, the PCX 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 
PCX notes that index option trading volume has increased significantly 
since 1995, 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 PCX's proposal is a reasonable effort to 
accommodate the needs of market participatants.
    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, 9,000 contracts,

[[Page 19552]]

will apply to narrow-based index options in which a single underlying 
stock 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 positions limits. A position limit of 
12,000 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 15,000 contract limit will apply only if the Exchange determines 
that the conditions requiring either the 9,000 contract limit or the 
12,000 contract limit have not occurred.
    The Commission believes that the proposed increases for the three 
tiers of 25%, 33%, and 50%, for highest to lowest, respectively, appear 
to be appropriate and consistent with the Commission's evolutionary 
approach to position and exercise limits. As noted above, the 
Commission also has approved previously these increased position and 
exercise limits for several other exchanges.\16\ To date, there have 
been no discernible manipulation problems that have arisen at the 
higher three-tier position and exercise limits for narrow-based index 
options on these exchanges. The Commission notes that the Exchange has 
had considerable experience monitoring the current three-tiered 
framework in narrow-based 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 options will not 
cause significant problems.
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    \16\ See supra note 9.
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    Finally, 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. Accordingly, the Commission concludes 
that the increase in the position and exercise limits for narrow-based 
index options proposed by the Exchange are warranted and should be 
approved.\17\
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    \17\ 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.
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C. Broad-Based Index Hedge Exemption

1. Expansion of Definition of Qualified Portfolio and Extension of 
Broad-Based Index Hedge Exemption to Broker-Dealers
    Currently, the PCX's broad-based index hedge exemption may be 
granted for positions in broad-based index options that are hedged with 
Exchange-approved qualified portfolios. The PCX proposes to expand the 
current definition of a qualified portfolio to take into account the 
broader range of hedging strategies currently used by market 
participants. Specifically, the PCX has proposed to include within the 
definition of a qualified portfolio products that overlay various 
broad-based indexes, including index futures, options on index futures, 
index options, and index warrants, where the indexes are represented in 
margin or cross-margin product groups at the OCC. Under the new index 
hedge exemption's requirements, a qualified portfolio may consist of: 
(i) net long or short positions in common stocks, or securities readily 
convertible into common stocks, in at least four industry groups, where 
the portfolio contains at least twenty stocks, none of which accounts 
for more than fifteen percent of the value of the portfolio; and/or 
(ii) net long or short positions in index futures contracts or in 
options on index futures contracts, or long or short positions in index 
options or index warrants, for which the underlying index is included 
in the same margin or cross-margin product group cleared at the OCC as 
the index option class to which the hedge exemption applies. To remain 
qualified, a portfolio must at all times meet these standards, 
notwithstanding trading activity. In addition, the index hedge 
exemption applies to positions in broad-based index options and is 
applicable to the unhedged value of the qualified portfolio.\18\ The 
Exchange also proposes to grant approval of a broad-based index hedge 
exemption on the basis of verbal representations, provided that the 
hedge exemption account furnishes to the Exchange, within two business 
days, or such other time period designated by the Exchange, appropriate 
documentation substantiating the basis for the exemption. The Exchange 
further proposes to extend the broad-based index hedge exemption to 
broker-dealers.
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    \18\ See new Commentary .02(c) to Rule 7.6. Under this 
provision, the unhedged value is determined as follows: (1) the 
values of the net long or short positions of all qualifying products 
in the portfolio are totaled; (2) for positions in excess of the 
standard limit, the underlying market value (A) of any economically 
equivalent opposite side of the market calls and puts in broad-based 
index options, and (B) of any opposite side of the market positions 
in stock index futures, options on stock index futures, and any 
economically equivalent opposite side of the market positions, 
assuming no other hedges for these contracts exist, is subtracted 
from the qualified portfolio; and (3) the market value of the 
resulting unhedged portfolio is equated to the appropriate number of 
exempt contracts as follows: the unhedged qualified portfolio is 
divided by the correspondent closing index value and the quotient is 
then divided by the index multiplier or 100.
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    The Commission believes, as it did when originally approving the 
PCX's index hedge exemption, that providing for increased position and 
exercise limits for broad-based index options in circumstances where 
those excess positions are effectively hedged with offsetting positions 
will provide greater depth and liquidity to the market and will allow 
investors to hedge their portfolios more effectively, without 
significantly increasing concerns regarding intermarket manipulations 
or disruptions of either the options market or the underlying stock 
market. The Commission believes that through the expanded definition of 
a qualified portfolio, an increased number of public customers with 
long or short portfolios will be able to utilize the broad-based index 
hedge exemption, thereby making an alternative hedging technique more 
available.
    Although the Exchange may, under the terms of the proposal, grant 
approval on the basis of verbal representations, the Commission 
believes that trading abuses are unlikely because the hedge exemption 
account is required to furnish to the Exchange, within two business 
days or such other time period designated by the Exchange, appropriate 
documentation substantiating the basis for the exemption. The Exchange 
recently adopted surveillance procedures appropriate to the new broad-
based index hedge exemption authority. The Commission also notes that 
the authority to grant approval for index hedge exemptions on the basis 
of verbal representations has been previously approved by the 
Commission for another exchange.\19\
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    \19\ See Interpretation .01(a) to CBOE's Rule 24.4.
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    In addition, the Commission believes that it is reasonable for the 
PCX to allow

[[Page 19553]]

broker-dealers as well as public customers to utilize the broad-based 
index hedge exemption. The Commission believes that extending the 
exemption to broker-dealers may help to increase the depth and 
liquidity of the market for broad-based index options and may help to 
ensure that public customers receive the full benefit of the exemption. 
Moreover, the Commission is relying on the absence of discernible 
manipulation problems under the corresponding equity hedge exemption, 
which is available to both public customers and broker-dealers, as an 
indicator that the proposed extension of the broad-based index hedge 
exemption is appropriate. The Commission notes that the broad-based 
index hedge exemption will continue to include safeguards designed to 
lessen the possibility that the exempted positions could be used to 
disrupt or manipulate the market.
2. Prospective Broad-Based Index Hedge Exemption for Broker-Dealers
    The PCX proposes to amend the broad-based index hedge exemption so 
that the Exchange may grant prospective broad-based index hedge 
exemptions to broker-dealers who may not yet have established qualified 
portfolios under Commentary .02(d) to Exchange Rule 7.6.
    The Commission does not believe that trading abuses are likely to 
result from the prospective hedge exemption for the following reasons. 
First, the exemption is limited to registered broker-dealers, and 
second these broker-dealers must effect the transaction(s) necessary to 
obtain a qualified portfolio ``concurrent with or at or about the same 
time as the execution of the exempt options positions.'' \20\ The 
Commission expects that the hedge will be established immediately 
following the execution of the options transaction. Moreover, broker-
dealers must provide to the Exchange appropriate documentation related 
to the portfolio within two business days. The Commission believes that 
the PCX's surveillance procedures are sufficient to detect and deter 
trading abuses arising from the prospective hedge exemption and, in the 
event a broker-dealer is found to have violated the exemption, the PCX 
is authorized to take all necessary and appropriate disciplinary 
actions. Accordingly, the Commission believes that it is appropriate 
for the Exchange to adopt a limited prospective broad-based index hedge 
exemption for broker-dealers.
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    \20\ See also 11, supra, on when the hedge is expected to be 
established.
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3. Treatment of Collar and Debit Put Spread Transaction as One Contract 
for Hedging and Position Limit Purposes and Neither Side of Collar 
Transaction Can Be In-the-Money When Established for Broad-Based Index 
Hedge Exemption Purposes
    The PCX proposes to treat a collar position as one contract rather 
than as two contracts in Commentary .02(g)(5) to Exchange Rule 7.6. 
Under the PCX's rules, a collar is defined as a short call position 
accompanied by long put(s), where the short call(s) expires with the 
long put(s), and the strike price of the short call(s) equals or 
exceeds the strike price of the long put(s). Within a limited range, 
the collar has less opportunity to benefit from upward and downward 
price changes than either of the collar's components. If the market 
climbs, the collar is equivalent to a covered write position. If the 
market declines, the collar is equivalent to a long put position. 
Because the strategy requires both the purchase of puts and the sale of 
calls, the PCX believes that the position is more appropriately treated 
as one contract for hedging purposes rather than two separate put and 
call components. In adopting this interpretation of a collar, the PCX 
is also proposing that new language in Commentary .02(g)(5) and 
.02(g)(7) to Exchange Rule 7.6 will be added to require that neither 
side of the collar transaction (or the short call, long put 
transaction) can be in-the-money at the time the position is 
established. Similarly, because a strategy involving a covered write 
accompanied by a debit put spread requires a collar component, the PCX 
also believes that the short call and long put should be treated as one 
contract in Commentary .02(g)(7) to Exchange Rule 7.6.\21\
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    \21\ The PCX defines a debit put spread position as a long put 
position coupled with a short put position overlying the same broad-
based index and having an equivalent underlying aggregate index 
value, where the short put(s) expires with the long put(s), and the 
strike price of the long put(s) exceeds the strike price of the 
short put(s).
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    The Commission believes that the increased number of options 
positions available by virtue of the Exchange's proposal will not 
result in disruptions to either the options or underlying stock market 
due to the conditions and limitations that must be met to be eligible 
for the exemption.\22\ For example, the broad-based index hedge 
exemption collar strategy can only be effected in conjunction with a 
qualified stock portfolio; the exemption is available only for non-p.m. 
settled, European-style index options; the short call(s) must expire 
with the long put(s); the strike price of the short call(s) must equal 
or exceed the strike price of the long put(s); and neither side of the 
collar transaction can be in-the-money at the time the position is 
established.
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    \22\ The Commission notes that it has previously approved 
identical changes to the rules of CBOE. See supra note 10.
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4. Miscellaneous Changes
    The PCX is also proposing several other changes to its rules, 
including a requirement in Commentary .02(c) to Exchange Rule 7.6 that 
a hedge exemption account can be carried by a member of a SRO 
participating in the ISG. The Commission believes that through the 
Exchange's ISG information sharing arrangements, the hedge exemption 
account will continue to be adequately monitored. Other changes to the 
Exchange's rules include: (1) clarifying language to reflect the change 
in the Exchange corporate name; (2) removing superfluous language from 
Commentary .02 to Rule 7.6; (3) changing a cross-reference from ``Rule 
6.74(b)'' to ``Rule 6.47(b)'' in Commentary .08 to Rule 6.8; and (4) 
changing the first character of the words ``member,'' ``firm,'' and 
``organization'' to upper case. Because these changes are non-
substantive or technical in nature or raise no additional regulatory 
issues, the Commission believes that they are consistent with Section 
6(b)(5) of the Act.\23\
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    \23\ 15 U.S.C. 78f(b)(5).
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D. Exercise Limits

    The Exchange proposes to remove the phrase ``of a class of options 
dealt in on the Exchange'' in PCX Rule 6.9, Commentary .01, in order to 
make that Commentary consistent with current PCX Rule 6.9(a). The 
Commission believes that the Exchange's rule change clarifies and 
strengthens the PCX's proposal, as originally intended, and raises no 
new regulatory issues.\24\
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    \24\ See discussion in order approving changes to PCX Rule 6.8 
and 6.9 in Securities Exchange Act Release No. 36350 (October 6, 
1995) 60 FR 53654 (October 16, 1995).
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the PCX's 
proposal relating to position and exercise limits 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,\26\ that the proposed rule change (SR-PCX-97-07), as amended, is 
approved.

    \26\ 15 U.S.C. 78s(b)(2).

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[[Page 19554]]

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10273 Filed 4-17-98; 8:45 am]
BILLING CODE 8010-01-M