[Federal Register Volume 60, Number 81 (Thursday, April 27, 1995)]
[Unknown Section]
[Pages 20782-20785]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10295]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35634; File No. SR-NASD-94-54]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval and Notice of Filing and Order 
Granting Accelerated Approval of Amendments No. 1 and 2 of Proposed 
Rule Change Relating to Position and Exercise Limits for Equity Options 
Overlying Equity Securities Not Subject to Standardized Options Trading

April 20, 1995.

I. Introduction

    On October 12, 1994, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``SEC'' or `` Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'')\1\ and Rule 19b-4 thereunder.\2\ On March 3 and 22, 
1995, and NASD submitted amendments to the proposal.\3\ The NASD 
proposes to amend its Rules of Fair Practice to allow, under certain 
circumstances, members to increase the applicable position and exercise 
limits\4\ for conventional options\5\ overlying those equity securities 
that are not subject to standardized options trading.\6\

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1994).
    \3\Letters from Joan Conley, Corporate Secretary, NASD, to Mark 
Barracca, Branch Chief, SEC (Mar. 3, 1995) and Thomas R. Gira, 
Assistant General Counsel, Nasdaq, to Mark Barracca, Branch Chief, 
SEC (Mar. 22, 1995). The NASD amended its filing to provide, most 
significantly that: (1) To be eligible to qualify for a higher 
position limit, the underlying security must satisfy the initial 
listing standards for standardized options trading; (2) to continue 
to be eligible to qualify for a higher position limit, the 
underlying security must satisfy the maintenance criteria for 
standardized options trading; and (3) if the position limit is 
lowered, members will not be required to liquidate their position 
but will be prohibited from increasing it if it is above the new 
limit.
    \4\Under NASD rules, exercise limits placed on options trading 
equal the limits imposed for options positions. NASD Manual, Rules 
of Fair Practice, Art. III, Sec. 33(b)(3)(A), (CCH) 2183.
    \5\A conventional option is any option contract not issued, or 
subject to issuance, by The Options Clearing Corporation. NASD 
Manual, Rules of Fair Practice, Art. III, Sec. 33(b)(1)(GG), (CCH) 
2183.
    \6\Position limits impose a ceiling on the number of option 
contracts in each class on the same side of the market (i.e., 
aggregating long calls and short puts and long puts and short calls) 
that can be held or written by an investor or group of investors 
acting in concert. Exercise limits restrict the number of options 
contracts which an investor or group of investors acting in concert 
can exercise within five consecutive business days. Under NASD 
Rules, exercise limits correspond to position limits, such that 
investors in options classes on the same side of the market are 
allowed to exercise, during any five consecutive business days, only 
the number of options contracts set forth as the applicable position 
limit for those options classes. See NASD Manual, Rules of Fair 
Practice, Art. III, Sec. 33(b) (3) & (4), (CCH) 
2183. [[Page 20783]] 
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    Notice of the proposed rule change appeared in the Federal Register 
on January 9, 1995.\7\ The Commission did not receive any comments on 
the proposal. For the reasons discussed below, this order approves the 
proposed change, as amended.

    \7\Securities Exchange Act Release No. 35180 (Dec. 30, 1994), 60 
FR 2413 (Jan. 9, 1995).
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II. Description of the Proposed Rule

A. Background and Purpose

    As indicated above, the NASD proposes to allow members to increase 
the applicable position and exercise limits for conventional options 
overlying those equity securities that are not subject to standardized 
options trading if certain conditions are satisfied. For conventional 
equity options traded by any NASD member, if the underlying security is 
subject to standardized options trading, the NASD's position limit for 
conventional options on that security is the same position limit 
imposed by the options exchange(s) trading the option. Specifically 
under NASD rules, position and exercise limits for exchange-listed 
options traded by access firms\8\ or their customers are determined 
according to a ``three-tiered'' system, where, depending upon the float 
and trading volume of the underlying security, the position limit for 
options on that security is 4,500, 7,500, or 10,500 contracts.\9\ 
However, if the security underlying the option is not subject to 
standardized options trading, the applicable position limit for 
conventional options on the security is the lowest tier, i.e., 4,500 
contracts.

    \8\``Access'' firms are NASD members which conduct a business in 
exchange-listed options but which are not members of any of the 
options exchanges upon which the options are listed and traded.
    \9\In this connection, the NASD's rules do not specifically 
govern how a specific equity option falls within one of the three 
position limit tiers. Rather, the NASD's position limit rule 
provides that the position limit established by an options 
exchange(s) for a particular equity option is the applicable 
position limit for purposes of the NASD's rule. Under the rules of 
each of the options exchanges, if the security underlying a 
standardized option has trading volume of 40,000,000 shares over the 
most recent six-month period or trading volume of 30,000,000 shares 
over the most recent six-month period and float of 120,000,000, it 
is subject to a position limit of 10,500 contracts; if the security 
underlying a standardized option has trading volume of 20,000,000 
shares over the most recent six-month period or trading volume of 
15,000,000 shares over the most recent six-month period and float of 
40,000,000, it is subject to a position limit of 7,500 contracts; 
and, if the underlying security is ineligible for a 10,500 or 7,500 
contract position limit, it is subject to a 4,500-contract position 
limit. The rules of each options exchange are uniform in regard to 
the above. See, e.g., Commentary .07 to American Stock Exchange Rule 
904 and Interpretation and Policy .02 to Chicago Board Options 
Exchange Rule 4.11.
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    In some instances, however, a security could be eligible for 
standardized options trading and qualify for an options exchange 
position limit of 7,500 or 10,500 contracts but, for purposes of NASD 
position limits, it is subject to a position and exercise limit of 
4,500 contracts because it does not underlie an exchange-listed 
standardized option. Given that these securities could qualify for 
higher position limits but are not eligible for them solely because 
there is no standardized option traded on them in the U.S., the NASD 
believes its option position limit rule may be unduly restrictive for 
these securities and unnecessarily constrain members' legitimate 
hedging activity. Accordingly, the NASD proposes to amend Section 33 to 
provide that the position limit for options on a security shall be 
determined by the position limit tier the security falls under, 
regardless of whether the security is subject to standardized options 
trading, as long as the security meets the initial and maintenance 
standards for standardized options trading.
    The NASD believes its proposal is warranted for the following 
reasons. First, if a security has sufficient trading volume and public 
float to satisfy the standards for a position limit of 7,500 contracts 
or 10,500 contracts, the NASD does not believe that raising the 
position and exercise limits for conventional options on the security 
will adversely affect the cash market for that security. In the NASD's 
view, if the cash market for a security is large enough to qualify for 
an options position limit of 7,500 contracts or 10,500 contracts, it is 
irrelevant whether that security is only subject to conventional 
options trading and not standardized options trading. The NASD believes 
the primary consideration governing the appropriate position limit 
level for options on a security should be the characteristics and size 
of the underlying cash market for that security, not whether the 
options overlying the security are standardized or conventional. 
Second, the NASD does not believe its members' activities in the 
conventional options market should be linked to or constrained by 
decisions of the options exchanges concerning whether or not to trade 
options on particular securities.
    Moreover, the NASD believes that its proposal will not compromise 
the stability of the securities markets underlying the conventional 
options eligible for the higher position limits. In this regard, for 
those securities that will be eligible for higher position limits under 
the proposal, there will only be a slight increase in the percentage of 
their capitalization that an investor or group of investors acting in 
concert can control under the new position limits.

B. New Proposal

    The NASD proposes to permit position and exercise limits of up to 
either 7,500 or 10,500 contracts, whichever is applicable, for 
conventional options, if the equity security satisfies the initial 
criteria and other listing standards for standardized options trading 
and otherwise qualifies for a higher position and exercise limits of 
7,500 or 10,500 contracts.\10\ Prior to establishing such a higher 
position, the member first must demonstrate to the NASD's Market 
Surveillance Department that the underlying equity security satisfies 
the initial listing criteria for standardized options trading and 
qualifies for a higher position and exercise limit of 7,500 or 10,500 
contracts. The initial listing criteria for standardized options 
trading are uniform among the five U.S. options exchanges (collectively 
referred to as the ``options exchanges''). \11\ Likewise, the criteria 
for qualifying for a higher position and exercise limit of 7,500 or 
10,500 contracts is uniform among the options exchanges.\12\

    \10\For foreign securities, before an option is eligible for 
standardized options trading, market surveillance sharing 
arrangements must be satisfied. For the NASD to satisfy these 
requirements under its proposal, prior to allowing higher (7,500 or 
10,500) position and exercise limits for options overlying a foreign 
security, the NASD will need to ensure that: (1) It has in place a 
comprehensive surveillance sharing agreement with the primary 
exchange in the home country where the foreign security is primarily 
traded; or (2) the combined trading volume of the foreign security 
(and other related securities) occurring in the U.S. markets 
represents at least 50% of the combined worldwide trading volume in 
the underlying security (including other related securities). See 
Securities Exchange Act Release No. 35554 (Jan. 31, 1994), 59 FR 
5622 (Feb. 7, 1994).
    \11\The five options exchanges are: Chicago Board Options 
Exchange (``CBOE''); American Stock Exchange (``Amex''); New York 
Stock Exchange (``NYSE''); Philadelphia Stock Exchange (``Phlx''); 
and Pacific Stock Exchange (``PSE''). See CBOE Rules, Rule 5.3, 
(CCH) 2113; Amex Rules, Rule 915, (CCH) 9715; NYSE Rules, Rule 
715, (CCH) 2715; Phlx Rules, Rule 1009, (CCH) 3009; PSE Rules, 
Rule 3.6, (CCH) 3591.
    \12\See CBOE Rules, Rules 4.11 & 4.12, (CCH) 2091 & 2092; Amex 
Rules, Rules 904 & 905, (CCH) 9704 & 9705; NYSE Rules, Rules 704 & 
705, (CCH) 2704 & 2705; Phlx Rules, Rules 1001 & 1002, (CCH) 3001 
& 3002; PSE Rules, Rules 6.8 & 6.9, (CCH) 4769 & 4775.
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    After a member has demonstrated that an equity security meets the 
criteria for increased position and exercise limits, the increased 
limit will remain in effect for all other conventional options 
positions established by the same or other NASD members on that equity 
[[Page 20784]] security, subject to a review to be conducted by the 
NASD on the Monday following the third Friday of the next January or 
July, whichever occurs first, and each successive January and July. The 
NASD's periodic reviews will be conducted to determine whether: (a) The 
underlying equity security continues to satisfy the options exchanges' 
maintenance criteria for listing standardized options upon such 
security;\13\ and (b) the equity security continues to satisfy the 
criteria for higher position and exercise limits. If either test is not 
satisfied, the position and exercise limit will be lowered to the 
applicable level,\14\ effective on the Monday following the third 
Friday of January or July.\15\ If position and exercise limits are 
lowered, a member will not be required to reduce its position to meet 
the new position limit level; however, a member will not be permitted 
to increase its existing position if such position is greater than the 
new limit.\16\

    \13\See CBOE Rules, Rule 5.4, (CCH) 2114; Amex Rules, Rule 916, 
(CCH) 9716; NYSE Rules, Rule 716, (CCH) 2716; Phlx Rules, Rule 
1010, (CCH) 3010; PSE Rules, Rule 3.7, (CCH) 3597.
    \14\If the maintenance criteria is not satisfied, the security 
would not be eligible for standardized option listing and, 
therefore, the position and exercise limits would return to 4,500 
contracts, regardless of whether the volume and float data of the 
security continue to meet the criteria for a higher position and 
exercise limit.
    \15\If, however, subsequent to the six-month review, the 
security becomes eligible for a higher limit prior to the next 
review, the NASD may increase immediately the position and exercise 
limit to the applicable level.
    \16\Letters from Joan Conley, Corporate Secretary, NASD, to Mark 
Barracca, Branch Chief, SEC (Mar. 3, 1995) and Thomas R. Gira, 
Assistant General Counsel, Nasdaq, to Mark Barracca, Branch Chief, 
SEC (Mar. 22, 1995).
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    Finally, the NASD recognizes that its proposal allows for the 
possibility that a NASD member complying with the new position limit 
standards might nonetheless be deemed in violation of options exchange 
position limit standards. Specifically, if an NASD member is also a 
member of one or more of the options exchanges, the member could be in 
violation of the respective option exchange's position and exercise 
limits if standardized options trading commences covering an underlying 
equity security for which the NASD previously granted a higher (7,500 
or 10,500 contracts) limit. The potential risk arises if the options 
exchange position and exercise limits are lower than the NASD's limits 
and the member exceeds the exchange's limit.\17\ While the member would 
not violate the NASD's rule,\18\ the NASD cannot exempt its members 
from the options exchanges' rules. To address this potential issue, the 
NASD has committed to notifying its members\19\ that they could be in 
violation of the options exchanges' rules if the options exchanges do 
not grant an exemption under the above described circumstances.\20\

    \17\This could occur if from the time the NASD granted a higher 
position and exercise limit and the time the standardized option was 
introduced the trading characteristics of the security changed so 
that the standardized option was introduced at a lower position 
limit.
    \18\If a position limit is lowered, the NASD will not require 
liquidation to the new limit, but will prohibit increasing further 
the position. Letter from Joan Conley, Corporate Secretary, NASD, to 
Mark Barracca, Branch Chief, SEC (Mar. 22, 1995).
    \19\The NASD will provide this notification in its Notice to 
Members announcing the Commission's approval of this proposal. 
Letter from Thomas R. Gira, Assistant General Counsel, Nasdaq, to 
Mark Barracca, Branch Chief, SEC (Mar. 22, 1995).
    \20\NASD rules provide that, for purposes of assessing whether a 
member is complying with limits on options positions, standardized 
and conventional options positions must be aggregated. NASD manual, 
Rules of Fair Practice, Rule 33(b)(3)(A), (CCH)  2183.
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III. Discussion

    The Commission believes that the rule change is consistent with the 
requirements of Section 15A of the Act of the rules and regulations 
thereunder applicable to the NASD, and therefore, has determined to 
approve the proposal. Section 15A requires that the rules of the NASD, 
among other things, be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, to remove impediments to 
and perfect the mechanism of a free and open market, and, in general, 
to protect investors and the public interest.\21\

    \21\15 U.S.C. 78o-3(b)(6).
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    Currently, NASD members trading conventional equity options for 
which there is no standardized options trading covering the underlying 
equity security are limited to a position of 4,500 contracts. 
Nonetheless, some of the equity securities underlying these 
conventional options meet the standards for standardized options 
trading but, for business or other reasons, none of the options 
exchanges have decided to list standardized options upon them. 
Moreover, some of these equity securities satisfy the criteria to 
qualify for options position and exercise limits of 7,500 or 10,500 
contracts. However, because there are no standardized options traded 
upon them, the position and exercise limits remain at 4,500 contracts.
    The Commission believes it is appropriate for the NASD to increase, 
as proposed, its applicable equity option position and exercise limits 
to allow its members that establish positions in conventional options 
the benefit of those higher limits where the underlying security fully 
qualifies\22\ to be eligible for standardized options trading and the 
trading volume and/or shares outstanding for the underlying equity 
security warrant such increase. Moreover, the NASD has essentially 
agreed to review and apply the equity option maintenance standards used 
by the options exchanges, as well as the position and exercise limit 
standards, using procedures that basically mirror those that have been 
instituted by the options exchanges. The monitoring standards outlined 
above will provide that position and exercise limits are maintained at 
appropriate levels. Accordingly, this substitute review will allow the 
NASD to address those instances where the options exchange could list 
and trade equity options, subject to the 7,500 or 10,500 position and 
exercise limit tier but, for business or other non-regulatory reasons, 
have decided not to list such options.

    \22\The Commission notes that, with regard to options overlying 
foreign securities, the surveillance related requirements that apply 
to standardized options trading on foreign securities must also be 
met by the NASD before it allows increased conventional option 
position and exercise limits. See supra note 10.
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    Moreover, the Commission believes that the NASD proposal should not 
adversely affect the cash market for the underlying security. The 
options overlying these securities will continue to have position 
limits determined based on established standards.\23\ In addition, NASD 
members will be required to aggregate with other conventional options 
as well as standardized options if they are subsequently listed. 
Accordingly, the Commission believes that this rule change will not 
undermine the objective of preventing the establishment of large option 
positions that can be used to manipulate or disrupt the underlying 
market to the benefit of the option position.

    \23\See NASD Notice to Members 94-64, NASD Reminds Members of 
Their Obligations When Trading Options (June 1994).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendments No. 1 and 2. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549. [[Page 20785]] 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. Sec. 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 the file number SR-NASD-94-54 and should be 
submitted by May 18, 1995.

V. Conclusion

    For the reasons stated above, the Commission finds that the rule 
change is consistent with the Act and the rules and regulations 
thereunder applicable to the NASD, in particular, Section 15A(b)(6). In 
addition, pursuant to Section 19(b)(2) of the Act,\24\ the Commission 
finds good cause for approving the proposed rule change, as amended, 
prior to the 30th day after publication of Amendments No. 1 and 2 in 
the Federal Register. These amendments provide that the NASD will apply 
initial listing and maintenance criteria consistent with the 
application of these criteria by the options exchanges for determining 
whether a security qualifies for standardized options trading. The 
Commission finds that no new regulatory issues are raised by these 
amendments and notes that prior to them, the proposed rule change was 
published in the Federal Register for the full statutory period and no 
comments were received.

    \24\15 U.S.C. 78s(b)(2).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change SR-NASD-94-54 be, and hereby is, 
approved, as amended.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\

    \25\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-10295 Filed 4-26-95; 8:45 am]
BILLING CODE 8010-01-M