Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices 19549

17Similarly, NASD Rule 6440(i)(1), as amended,

will state that a member may, but is not obligated

to, accept a stop order in an eligible security.

18 15 U.S.C. 78s(b)(2).

19 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See 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’’).

4See Securities Exchange Act Release No. 38612

(May 12, 1997) 62 FR 27643 (May 20, 1997).

5The PCX defines a customer order as one that

is entered, cleared, and in which the resulting

position is carried with the firm.

6The 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.

guarantee that an order receives an

execution at no worse than the limit

price. However, if the market drops

below the limit price of a sell stop order

before the order can be executed, it is

possible that the order will be executed.

For example, if an investor enters a sell

stop limit order where the stop price

and the limit price are 34, then the

investor’s order may be executed only at

34 or better and may not be executed at

all if the market moves below 34 before

the order can be executed. However, if

the investor is able to enter a sell order

with a stop price of 34 and a limit price

of 32, then the investor’s order may be

executed at 32 or better. Accordingly, by

permitting investors to place orders

where the limit price differs from the

stop price, the NASD’s proposal will

increase the opportunities for execution

of investors’ orders and will allow

investors to tailor their orders to reflect

their objectives and strategies.

The Commission also believes that it

is reasonable for the NASD to amend

NASD Rule 6440(i) to clarify that

members are not obligated to accept

stop orders or stop limit orders.

Currently, NASD Rule 6440(i)(2) states

that members may accept stop limit

orders in eligible securities. The NASD

proposes to add language to NASD Rule

6440(i)(2) indicating that members are

not obligated to accept stop limit

orders.17 Because this is a clarification

of the NASD’s existing policy, it does

not raise new regulatory issues.

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 thereof in the

Federal Register. Amendment No. 1

corrects a typographical error in NASD

Rule 6440(I)(2). Specifically, NASD Rule

6440(i)(2) stated that when a transaction

occurs at the stop price, a stop limit

order to buy or sell becomes a limit

order at the stop price. Amendment No.

1 revises NASD Rule 6440(i)(2) to state

that when a transaction occurs at the

stop price, a stop limit order to buy or

sell becomes a limit order at the limit

price. Because Amendment No. 1

corrects the text of the NASD’s rule, the

Commission finds that it is consistent

with Sections 6(b) and 19(b)(2) of the

Act to approve Amendment No. 1 on an

accelerated basis.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning Amendment No.

1, including whether Amendment No. 1

is consistent with the Act. Persons

making written submissions should file

six copies thereof with the Secretary,

Securities and Exchange Commission,

450 Fifth Street, N.W., Washington, D.C.

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

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File No.

SR–NASD–97–20 and should be

submitted by May 11, 1998.

V. Conclusion

It Is Therefore Ordered, pursuant to

Section 19(b)(2) of the Act,18 that the

proposed rule change (SR–NASD–97–

20) is approved, and that Amendment

No. 1 is approved on an accelerated

basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.19

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–10339 Filed 4–17–98; 8:45 am]

BILLING CODE 8010–01–M

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 narrowbased 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

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.

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

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
19550 Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices

7According 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).

8See 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).

9See, 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).

10The 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).

11The 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.

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

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 narrowbased 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

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

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 broadbased 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.

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
Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices 19551

12For purposes of determining compliance with

PCX Rules 6.8 and 7.6, a collar position will be

treated as one contract.

13For 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.

14See 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). 15 15 U.S.C. 78f(b).

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-themoney 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 broadbased 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

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).

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.

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,
19552 Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices

16See supra note 9.

17The 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.

18See 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.

19See Interpretation .01(a) to CBOE’s Rule 24.4.

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 threetiered 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.

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

C. Broad-Based Index Hedge Exemption

1. Expansion of Definition of Qualified

Portfolio and Extension of Broad-Based

Index Hedge Exemption to BrokerDealers

Currently, the PCX’s broad-based

index hedge exemption may be granted

for positions in broad-based index

options that are hedged with Exchangeapproved 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 broadbased indexes, including index futures,

options on index futures, index options,

and index warrants, where the indexes

are represented in margin or crossmargin 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 broadbased 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 brokerdealers.

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

In addition, the Commission believes

that it is reasonable for the PCX to allow
Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices 19553

20See also 11, supra, on when the hedge is

expected to be established.

21The 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).

22The Commission notes that it has previously

approved identical changes to the rules of CBOE.

See supra note 10.

23 15 U.S.C. 78f(b)(5).

24See 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).

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

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.

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

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.

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

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

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.
19554 Federal Register / Vol. 63, No. 75 / Monday, April 20, 1998 / Notices

27 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See Letter from Michele R. Weisbaum, Vice

President and Associate General Counsel, Phlx, to

Sharon Lawson, Senior Special Counsel, Division of

Market Regulation (‘‘Division’’), Commission, dated

February 19, 1998 (‘‘Letter Amendment’’). In the

Letter Amendment, the Phlx proposes to amend its

proposed rule change to: (1) conduct margin

reviews quarterly rather than semi-annually; (2)

monitor currencies monthly when the confidence

level falls to between 97% and 97.5% until the

confidence level exceeds 97.5% for two consecutive

months, rather than just one month; and (3) revise

Rule 722 to exclude the actual margin level for each

currency and to note that instead, the Phlx will

distribute membership circulars announcing the

margin levels that are derived pursuant to

Commentary .16 of Rule 722.

4See Letter from Nandita Yagnik, Counsel, Phlx,

to Sharon Lawson, Senior Special Counsel,

Division, Commission, dated April 3, 1998

(‘‘Amendment No. 1’’). Amendment No. 1

incorporates the original proposed rule change and

Letter Amendment into a Rule 19b–4 notice.

5This 4% ‘‘add-on’’ percentage is applicable to

the following foreign currencies: Australian dollar,

British pound, Canadian dollar, German mark,

European Currency Unit, French franc, Japanese

yen and Swiss franc. The Spanish peseta and the

Italian lira currently have a 7% add-on percentage

and the Mexican peso has an add-on percentage of

17%.

6See Securities Exchange Act Release No. 22469

(September 26, 1985) 50 FR 40663 (October 4, 1985)

(order approving File Nos. SR–Amex–84–29, SR–

CBOE–84–27, SR–NASD–85–15, SR–PSE–84–20,

SR–Phlx–84–32 and SR–Phlx–85–18 and

establishing a uniform margin system for options

products).

7See Securities Exchange Act Release No. 36255

(September 20, 1995) 60 FR 50229 (September 28,

1995) (order approving File Nos. SR–Phlx–95–20

and SR–Phlx–95–21).

8See Securities Exchange Act Release No. 39460

(December 17, 1997) 62 FR 67425 (December 24,

1997) (order approving File No. SR–Phlx–97–22).

9Although the Phlx initially proposed semiannual margin reviews, in Amendment No. 1, the

Phlx proposes to amend Commentary .16(b) of Rule

722 to require margin reviews to be conducted

quarterly, on the 15th of January, April, July and

October of each year. See Amendment No. 1, supra

note 4.

10As initially proposed, it was unclear whether

monthly margin reviews would be required once

the confidence level equaled 97.5%. Amendment

No. 1 makes clear that the confidence level must

exceed 97.5% for two consecutive months before

the currency will no longer be reviewed monthly.

See Amendment No. 1, supra note 4.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.27

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–10273 Filed 4–17–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39856; File No. SR–Phlx–

97–63]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change and

Amendment No. 1 Thereto by the

Philadelphia Stock Exchange, Inc. to

Amend its Method of Calculating Initial

and Maintenance Margin Requirements

for Foreign Currency Options

April 13, 1998.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 and Rule 19b–4 thereunder,2

notice is hereby given that on December

22, 1997, 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 Phlx. On

February 20, 1998, the Phlx filed a

Letter Amendment to the proposed rule

change.3 The Phlx filed Amendment No.

1 to the proposed rule change on April

6, 1998.4 The Commission is publishing

this notice to solicit comments on the

proposed rule change, as amended, 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 722 to codify its method of

calculating initial and maintenance

customer margin requirements for

foreign currency options. Under

proposed new Commentary .16 to Rule

722, the Exchange would calculate the

margin requirements for each foreign

currency separately, rather than

determining one margin level for all

foreign currencies based upon the

historical pricing information for all

foreign currencies together.

The complete text of the proposed

rule change is available at the Office of

the Secretary, Phlx and at the

Commission.

II. Self-Regulatory Organization’s

Statements Regarding the Purpose of,

and Statutory Basis for, the Proposed

Rule Change

In its filing with the Commission, the

Phlx 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 Phlx 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

1. Purpose

Currently, the Exchange calculates the

margin requirement for customers that

assume short foreign currency option

positions by adding 4% of the current

market value of the underlying foreign

currency contract to the option

premium price less an adjustment for

the out-of-the-money amount of the

option contract.5 The 4% add-on

percentage was adopted in 1986 and

provided for initial margin which would

cover the aggregate underlying foreign

currencies’ historical volatility over a

seven day period with a 95%

confidence level over the latest nine

month period.6 This add-on percentage

is now reviewed by the Exchange every

quarter to assure that it provides for a

97.5% confidence level over a five day

period. Recently, the Exchange has

listed new foreign currency options

such as the Spanish peseta and the

Italian lira 7 and has received approval

to trade options on the Mexican peso.8

In determining the appropriate margin

levels for these new currencies, the

Commission has indicated that it

believes that the Exchange should set

margin levels for each foreign currency

option independently and that it should

state its specific procedure for setting

these levels in its rules. The purpose of

this proposal is to address this issue by

adopting new foreign currency options

margin procedures as proposed in

Commentary .16 to Rule 722.

The Exchange is proposing to

determine the applicable add-on

percentage by reviewing, on a quarterly

calendar basis,9 five-day price changes

over the preceding three-year period for

each underlying currency and set the

add-on percentage at a level which

would have covered those price changes

at least 97.5% of the time (‘‘confidence

level’’). If the results of subsequent

reviews show that the current margin

level provides a confidence level below

97%, the Exchange will increase the

margin requirement for that individual

currency up to a 98% confidence level.

If the confidence level is between 97%

and 97.5%, the margin level will remain

the same but will be subject to monthly

follow-up reviews until the confidence

level exceeds 97.5% for two consecutive

months.10 If during the course of the

monthly follow-up reviews, the

confidence level drops below 97%, the

margin level will be increased to a 98%

level and if it exceeds 97.5% for two

consecutive months, the currency will

be taken off monthly reviews and will