[Federal Register Volume 61, Number 19 (Monday, January 29, 1996)]
[Notices]
[Pages 2853-2856]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-1475]



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[[Page 2854]]


SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36757; File No. SR-NASD-95-55]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the National 
Association of Securities Dealers, Inc., To Add Two Position and 
Exercise Limit Tiers for Qualifying Equity Option Classes

January 22, 1996.
    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 November 20, 1995, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by the self-regulatory 
organization. The NASD has requested accelerated approval for the 
proposal. This order approves the NASD's proposal on an accelerated 
basis and solicits comments from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to amend Article III, Section 33(b)(3)(A) of 
the NASD Rules of Fair Practice to add two new position limit tiers for 
option classes overlying equity securities that meet certain criteria 
for high liquidity. Specifically, the NASD proposes to add a 20,000-
contract position limit tier and a 25,000-contract position limit tier.
    The NASD requests that the Commission find good cause, pursuant to 
Section 19(b)(2) of the Act, to approve the proposed rule change prior 
to the thirtieth day after publication in the Federal Register.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD 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 III below. The NASD 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
    The NASD proposes to amend its rules governing position and 
exercise limits for equity options \3\ to conform to similar proposals 
by the options exchanges which were recently approved by the 
Commission.\4\ NASD rules currently provide that position and exercise 
limits are determined according to a ``three-tiered'' system. 
Specifically, depending upon the trading volume and public float of the 
underlying security, the position limit for an equity option is either 
4,500, 7,500, or 10,500 contracts.\5\

    \3\ 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 of group of investors 
acting in concern. Exercised 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 Sections 33(b) (3) and (4) of 
Article III of the NASD Rules of Fair Practice.
    \4\ See Securities Exchange Act Release Nos. 36371 (October 13, 
1995), 60 FR 54269 (October 20, 1995) (order approving File No. SR-
CBOE-95-42); and 36409 (October 23, 1995), 60 FR 55399 (October 31, 
1995) (Order approving File Nos. SR-NYSE-95-31, SR-PSE-95-25, SR-
Amex-95-42, and SR-Phlx-95-71).
    \5\ In this connection, NASD 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.
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    In particular, the 10,500-contract position limit applies to: (1) 
Exchange-listed options traded by ``access'' \6\ firms with a 
corresponding 10,500-contract position limit imposed by the options 
exchange(s) on which the option is traded; \7\ (2) all conventional 
options overlying equity securities which underlie exchange-traded 
options that have a 10,500-contract position limit; \8\ and (3) all 
conventional options overlying equity securities that qualify for, but 
do not underlie, an exchange-traded option with a position limit of 
10,500-contracts.

    \6\ ``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.
    \7\ To be eligible for the 10,500-contract position limit under 
the options exchanges' rules, an underlying security must have 
either (i) trading volume of at least 40 million shares during the 
most recent six month trading period; or (ii) trading volume of at 
least 30 million shares during the most recent six month trading 
period and at least 120 million shares currently outstanding.
    \8\ Conventional equity options are defined in Article III, 
Section 33(b)(2)(GG) of the NASD Rules of Fair Practice to mean 
``any option contract not issued, or subject to issuance, by The 
Options Clearing Corporation.''
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    Similarly, the 7,500-contract position limit applies to: (1) 
Exchange-listed options traded by ``access'' firms with a corresponding 
7,500-contract position limit imposed by the options exchange(s) on 
which the option is traded; \9\ (2) all conventional options overlying 
equity securities which underlie exchange-traded options that have a 
7,500-contract position limit; and (3) all conventional options 
overlying equity securities that qualify for, but do not underlie, an 
exchange-traded option with a position limit of 7,500-contracts.

    \9\ To be eligible for the 7,500-contract position limit under 
the options exchanges' rules, an underlying security must have 
either (i) trading volume of at least 20 million shares during the 
most recent six month trading period; or (ii) trading volume of at 
least 15 million shares during the most recent six month trading 
period and at least 40 million shares currently outstanding.
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    Lastly, the 4,500-contract position limit applies to: (1) Exchange-
listed options traded by ``access'' firms with a corresponding 4,500-
contract position limit imposed by the options exchange(s) on which the 
option is traded; \10\ and (2) all conventional options overlying 
equity securities which either underlie exchange-traded options that 
have a 4,500-contract position limit or do not underlie an exchange-
traded option.

    \10\ Under the rules of the options exchanges, all securities 
that do not qualify for a position limit of 10,500-contracts or 
7,500-contracts are subject to the 4,500-contract tier.
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    Through this rule filing, the NASD proposes to add two new higher 
position limit tiers that correspond to the two new ``upper'' position 
limit tiers recently approved by the Commission for exchange-traded 
options.\11\ Specifically, the NASD proposes to add a 20,000-contract 
position limit tier and a 25,000-contract position limit tier. To 
qualify for the 20,000-contract position limit tier, the underlying 
security must have at least 240 million shares outstanding with 60 
million shares traded in the past six months, or have 80 million shares 
traded in the past six months. To qualify for the 25,000-contract 
position limit tier, the underlying security must have at least 300 
million shares outstanding with 75 million shares traded in the past 
six months, or have 100 million shares traded in the past six months. 
Thus, for NASD members that are ``access'' firms 

[[Page 2855]]
or that are involved in conventional equity option transactions, the 
proposal will conform the NASD's position and exercise limit rules to 
the position limit tiers recently approved by the Commission for the 
options exchanges.

    \11\ See supra note 4.
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    The NASD believes that the proposed ``upper'' position limits are 
warranted for the following reasons. First, the higher position and 
exercise limits will afford market participants, particularly investors 
with sizable holdings, accounts, or assets, greater flexibility to 
employ larger options positions when effecting their hedging and 
investment strategies. Second, the higher position limit tiers likely 
will facilitate greater activity in exchange-listed options and 
conventional equity options, thereby enhancing liquidity in the markets 
for exchange-traded options, conventional equity options, and the 
securities underlying those options. Third, by conforming the NASD's 
position and exercise limits to the limits imposed by the options 
exchanges, there will be no confusion by market participants concerning 
applicable position and exercise limits. Fourth, with respect to equity 
securities underlying exchange-traded options, market participants will 
be able to establish conventional options positions on these securities 
equivalent in size of standardized options positions on these 
securities.
    Moreover, the NASD believes that the proposed larger position limit 
tiers will not compromise the integrity of the options markets or 
jeopardize the stability of the securities markets underlying exchange-
traded equity options or conventional equity options. Specifically, 
because the eligibility standards for the higher position limit tiers 
will ensure that only those securities with a sufficiently large 
capitalization and public float will be eligible for the higher limits, 
the NASD does not believe that the higher position limit tiers will 
have an adverse market impact. In addition, as noted in the Chicago 
Board Options Exchange, Inc.'s (``CBOE'') rule filing concerning the 
higher position limit tiers, the largest dollar value that could be 
controlled in any equity options class by any one investor or group of 
investors acting in concert under the proposal would not exceed .7 
percent of the market capitalization of any security eligible for one 
of the higher position limit tiers.\12\ Accordingly, the NASD believes 
that the proposed position limit tiers would involve a very modest 
increase in position limits. Furthermore, the NASD notes that it will 
continue to apply its options surveillance procedures and that it and 
the options exchanges will continue to be members of the Intermarket 
Surveillance Group (``ISG'').

    \12\ See supra note 4.
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2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act.\13\ Section 15A(b)(6) requires that the 
rules of a national securities association 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 a national market system and, in general, to 
protect investors and the public interest. Specifically, the NASD 
believes that the proposal will promote the maintenance of fair and 
orderly markets because it will, among other things, serve to avoid 
investor confusion concerning applicable equity option position and 
exercise limits as well as to facilitate the use of equity options by 
investors, without compromising the integrity of the equity options 
markets or the markets for the securities underlying equity options.

    \13\ 15 U.S.C. Sec. 78f(b)(5) (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Comments were neither solicited nor received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule changes that are filed 
with the Commission, and all written communications relating to the 
proposed rule changes between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying at the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. 20549. Copies of such filings also will be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-95-55 and should 
be submitted by February 20, 1996.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    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 association, and, in 
particular, with the requirements of Section 15A(b)(6). Specifically, 
the Commission believes that the proposed addition of position and 
exercise limit tiers of 25,000-contracts and 20,000-contracts for 
qualifying equity options will accommodate the needs of investors and 
market participants. The Commission also believes that the proposed 
rule change will increase the potential depth and liquidity of the 
equity options market as well as the underlying cash market without 
significantly increasing concerns regarding intermarket manipulations 
or disruptions of the market for the options or the underlying 
securities. Accordingly, as discussed below, the Commission believes 
that the rule proposal is consistent with the requirements of Section 
15A(b)(6), that association rules facilitate transactions in securities 
while continuing to further investor protection and the public 
interest.
    In approving the increased limits, the Commission recognizes that 
securities with active and deep trading markets, as well as with broad 
public ownership, are more difficult to manipulate or disrupt than 
securities having less active and deep markets and having smaller 
public floats. The proposed additional position and exercise limit 
tiers recognize this by seeking to minimize the restraints on those 
options classes that can accommodate larger limits without 
significantly increasing manipulation concerns.\14\ In particular, 

[[Page 2856]]
the proposed limit of 25,000-contracts and 20,000-contracts for options 
on the most actively traded, widely held securities, permits the 
Commission to avoid placing unnecessary restraints on those options 
where the manipulative potential is the least and the need for 
increased positions likely is the greatest. Accordingly, the Commission 
believes that the additional position and exercise limit tiers is 
warranted.

    \14\ The Commission continues to believe that proposals to 
increase position and exercise limits must be justified and 
evaluated separately. After reviewing the proposed exercise limits, 
along with the eligibility criteria for the two new tiers, the 
Commission has concluded that the proposed exercise limit additions 
do not raise manipulation problems or increase concerns over market 
disruption in the underlying securities.
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    The Commission believes that the proposed additions to the NASD's 
position and exercise limit tiers appears to be both appropriate and 
consistent with the Commission's gradual, evolutionary approach. There 
are no ideal position limits in the sense that options positions of any 
given size can be stated conclusively to be free of any manipulative 
concerns. The Commission, however, is relying on the absence of 
discernible manipulation problems under the current framework as an 
indicator that the proposed additional limit tiers are justified.
    The Commission does not believe that the addition of the two new 
higher limit tiers will have any adverse effects on the options 
markets. In approving the initial two-tiered position limit system, the 
Commission stated that it did not believe that requiring traders to 
keep track of two limits rather than one was burdensome or confusing or 
would lead to accidental violations.\15\ The Commission does not 
believe that a change from the current three tiers to five tiers should 
change this conclusion.

    \15\ In this regard, the Commission notes that the options 
exchanges and the NASD routinely review the trading characteristics 
of the underlying stocks to determine the appropriate position and 
exercise limit tiers for the option classes.
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    The Commission believes that although position and exercise limits 
for options must be sufficient to protect the options and related 
markets from disruptions by manipulations, the 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 market makers from adequately meeting their 
obligations to maintain a fair and orderly market. The Commission 
believes that the NASD's proposal is a reasonable and appropriately 
tailored effort to accommodate the identified needs of options market 
participants. In this regard it is important to note that the proposals 
only add higher position and exercise limit tiers for classes of 
options involving the most liquid stocks. As a result, the proposal 
affects only a small number of equity option classes that are traded. 
In addition, based on the NASD's experience, the Commission believes 
that the proposed additional limit tiers should result in little or no 
additional risk to the marketplace.\16\

    \16\ The Commission notes that to the extent the potential for 
manipulation increases because of the additional tiers, the 
Commission believes the NASD's surveillance programs will be 
adequate to detect as well as to deter attempted manipulative 
activity. The Commission will, of course, continue to monitor the 
NASD's surveillance programs to ensure that problems do not arise.
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    The Commission finds good cause to approve the proposed rule 
changes prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. Specifically, by 
accelerating the approval of the NASD's rule proposal, the Commission 
is conforming the NASD's position and exercise limits with those levels 
recently approved for the options exchanges.\17\ Accelerated approval 
of the proposed rule change will thereby provide for the desired 
uniformity for position and exercise limits within the exchange traded 
options market. Any other course of action could lead to unnecessary 
investor confusion. In addition, the CBOE's proposal was noticed for 
the entire twenty-one day comment period and generated no negative 
responses.\18\ Accordingly, the Commission believes that it is 
consistent with Section 15A(b)(6) of the Act to approve the proposed 
rule change on an accelerated basis.

    \17\ See supra note 4.
    \18\ Id.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) \19\ of the 
Act that the proposed rule change (File No. SR-NASD-95-55) is hereby 
approved on an accelerated basis.

    \19\ 15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\

    \20\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-1475 Filed 1-26-96; 8:45 am]
BILLING CODE 8010-01-M