32878 Federal Register / Vol. 61, No. 123 / Tuesday, June 25, 1996 / Notices

9 15 U.S.C. § 78f(b)(5)(1988).

10 17 CFR 200.30–3(a)(12).

1 15 .S.C. § 78s(b)(1) (1988).

2 17 CFR 240.19b-4 (1994).

3Position limits impose a ceiling on the number

of option contracts which an investor or group of

investors acting in concert may hold or write in

each class of options on the same side of the market

(i.e., aggregating long calls and short puts or long

puts and short calls). Exercise limits prohibit an

investor or group of investors acting in concern

from exercising more than a specified number of

puts or calls in a particular class of options within

five consecutive business days.

4See Securities Exchange Act Release No. 36976

(March 14, 1996), 61 FR 11668 (March 21, 1996).

5The Exchange notes that is adopting the

language ‘‘two times above the limit’’ to signify ‘‘in

addition to’’ the current position limit. For instance,

if the position limit for a market index option is

25,000 contracts, an additional 50,000 contracts

under this proposal would be permitted, for a total

of 75,000 contracts. This language parallels a recent

change by another exchange. See Securities

Exchange Act Release No. 36609 (December 20,

1995), 60 FR 67002 (December 27, 1995) (notice of

File No. SR–CBOE–95–68).

6See Phlx Rule 1001, Commentary .07. See also

Securities Exchange Act Release No. 35738 (May

18, 1995), 60 FR 27573 (May 24, 1995) (order

approving permanent hedge exemption pilot

programs) (File Nos. SR–Phlx–95–10, SR–Amex–

95–13, SR–CBOE–95–13, SR–NYSE–95–04, and

SR–PSE–95–05).

7See, e.g., CBOE Rule 24.4 and the Interpretations

and Policies thereunder, and Commentary .01 to

Amex Rule 904C.

8The Exchange permits the use of convertible

securities in its equity option hedge exemption as

long as such securities are immediately or readily

convertible into the underlying stock. See Securities

Exchange Act Release No. 32174 (April 20, 1993),

58 FR 25687 (April 27, 1993) (order approving file

No. SR–Phlx-92–22). Similarly, other options

exchange permit the use of convertible securities

with respect to broad-based index option hedge

exemptions.

9Under Phlx Rule 1001A(a), the Value Line

Composite Index (‘‘VLE’’) the U.S. Top 100 Index

(‘‘TPX’’), and the National Over-the-Counter Index

(‘‘XOC’’) each have a position limit of 25,000

contracts, of which no more than 15,000 contracts

can be in the nearest expiration month. The Phlx

notes that the Big Cap Index (‘‘MKT’’) is no longer

listed on the Exchange.

Section 6(b)(5) in particular,9 in that it

is designed to prevent fraudulent and

manipulative acts and practices, to

foster cooperation and coordination

with persons engaged in regulating,

clearing, settling, processing

information with respect to, and

facilitating transactions in, securities as

well as to protect investors and the

public interest, by bolstering the

exercise advice requirement to include

all non-expiration exercises, not just

exercises of 25 or more contracts.

Specifically, the Phlx believes that

requiring exercise advices for all

American-style index options exercised

prior to expiration should enhance

surveillance efforts regarding

compliance with the exercise cut-off

time by providing a more complete

audit trail.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The self-regulatory organization 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

No written comments were solicited

or received with respect to the proposed

rule change.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the publication of

this notice in the Federal Register or

within such longer period (i) as the

Commission may designate up to 90

days of such date if it finds such longer

period to be appropriate and publishes

its reasons for so finding, or (ii) as to

which the self-regulatory organization

consents, the Commission will:

A. by order approve the proposed rule

change, or

B. institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. 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

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 at

the Commission’s Public Reference

Section, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of such

filing also will be available for

inspection and copying at the principal

office of the self-regulatory organization.

All submissions should refer to File No.

SR–Phlx–96–21 and should be

submitted by July 16, 1996.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.10

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96–16063 Filed 6–24–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37320; File No. SR–Phlx–

96–07]

Self-Regulatory Organizations; Order

Granting Approval to Proposed Rule

Change by the Philadelphia Stock

Exchange, Inc., to Adopt a Market

Index Option Hedge Exemption

June 18, 1996.

I. Introduction

On February 13, 1996, the

Philadelphia Stock Exchange, Inc.

(‘‘Phlox’’ 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 amend Commentary .01 to

Phlx Rule 1001A to establish a hedge

exemption from broad-based (Market)

index option position and exercise

limits.3

The proposed rule change appeared in

the Federal Register on March 21,

1996.4 No comments were received on

the proposed rule change. This order

approves the Phlx’s proposal.

II. Background and Description

The Phlx proposes to adopt a market

index option hedge exemption under

which broad-based index option

positions hedged in accordance with the

proposal would be entitled to exceed

existing position and exercise limits by

up to two-times about the limit.5

According to the Phlx, the purpose of

the proposal is to establish a provision

parallel to the hedge exemption of

equity options 6 as well as the broadbased index option hedge exemptions

that are in place at other option

exchanges.7

In order to qualify for the exemption,

the market index option position must

be hedged by share positions in at lease

20 stocks, or securities immediately or

readily convertible into such stock,8 in

four industry groups comprising the

index, of which no one component

security accounts for more than 15% for

the value of the portfolio hedging the

index option position. Under the

proposal, no position in a market index

option may exceed two-times the broadbased index option position specified in

Phlx Rule 1001A(a).9 In addition, the

underlying value of the option position

may not exceed the value of the
Federal Register / Vol. 61, No. 123 / Tuesday, June 25, 1996 / Notices 32879

10The value of the underlying portfolio is

determined as follows: (1) the total market value of

the net stock position; less (2) the value of: (a) any

offsetting calls and puts in the respective index

option; (b) any offsetting positions in related stock

index futures or options; and (c) any economically

equivalent positions.

The values of offsetting positions are determined

by the multiplying the number of opposite-side-ofthe-market (offsetting) calls, puts, or futures

contracts by the index value and by the index

multiplier. Then, the value if subtracted from the

market value of the portfolio. This number must be

compared with the underlying value of the option

position, in excess of the standard or base position

limit being hedge/exempted, which is calculated by

multiplying the number of option contracts for

which the exemption is sought by the index value

and the multiplier; this value cannot exceed the

value of the underlying portfolio.

11See Phlx Rule 1002A.

12The Phlx notes that as the dollar value of the

hedging portfolio fluctuates, the number of exempt

contracts may need to be adjusted. 13 15 U.S.C. § 78f(b)(5) (1988).

underlying portfolio employed as the

hedge.10

In addition, under the proposal,

exercise limits will continue to

correspond to position limits, so that

investors may exercise the number of

contracts set forth as the position limit,

as well as those contracts exempted by

this proposal, during five consecutive

business days.11

The Phlx notes that broad-based index

option hedge exemptions are in place at

other options exchanges. Generally,

these index option hedge exemptions

allow public customers to apply for

position limit exemptions in broadbased index options that are hedged

with exchange-approved qualified stock

portfolios.

In light of the Exchange’s experience

with the equity option hedge

exemption, as well as its review of the

rules of the other options exchanges, the

Phlx believes that a similar hedge

exemption for its market index options

is appropriate. The Phlx also believes

that the proposed conditions for

granting such an exemption are

reasonable and in line with prior

Commission-approved provisions.

According to the Phlx, trading volume

for index options has markedly

increased. In 1994, volume increased

two-fold over 1993, from 1,119,147

contracts to 2,456,685. In 1995, volume

remained steady with over 2,783,043

contracts traded. The Phlx attributes the

recent growth in trading and open

interest to institutional trading, which,

according to the Phlx, is typically

hedged by baskets of the underlying

stocks.

The Phlx proposes to exempt

positions in broad-based index options

in a manner which balances the hedging

needs of index options traders with the

Exchange’s obligation to maintain a fair

and orderly market. The Phlx believes

that a hedge exemption up to two-times

above the limit for broad-based index

options would considerably enhance the

attractiveness of these products for

institutional traders, who would, in

turn, trade more of the product in a

hedged manner and thereby provide

stabilizing liquidity in both the index

options and the underlying securities.

The Phlx also believes that it is

appropriate and necessary to expand the

availability of the exemption beyond

public customers. The Phlx states that

significant increases in the depth and

liquidity of the market for these index

options could result from permitting

firm and proprietary traders to be

eligible for the exemption. According to

the Phlx, because customers rely, for the

most part, on a limited number of

proprietary traders to facilitate largesized orders, not including such traders

in the exemption effectively reduces the

benefit of the exemption to customers.

While large-sized positions in market

index options are most commonly

initiated by institutional trades hedging

stock portfolios on behalf of public

customers, the Phlx believes that

proprietary traders should be afforded

the same exemption so that they may

fulfill their role as facilitators.

The Phlx also believes that the hedge

exemption is necessary to better meet

the needs of investors who use Phlx

market index options for investment

and hedging purposes. According to the

Phlx, many institutional traders and

portfolio managers deal in dollar

amounts much greater than that

permissible under current position limit

levels and have expressed that Exchange

position limits hamper their ability to

fully utilize such index options.

The Phlx believes that the proposed

broad-based index option hedge

exemption should not increase the

potential for disruption or manipulation

in the markets for the stocks underlying

each index. The Phlx notes that this is

because the proposal incorporates

several surveillance safeguards, which

the Phlx will employ to monitor the use

of this exemption. Specifically, the

Exchange will require that a form be

filed by members firms and their

customers who seek exemptions, in lieu

of granting an automatic exemption. The

Exchange will review the request and

approve only those applications that

satisfy the hedge exemption

requirements. Moreover, the hedge

exemption form must be kept current,

with information updated as warranted.

Any information concerning the dollar

value and composition of the stock

portfolio,12 or its equivalent, the current

hedged and aggregate options positions,

and any stock index futures positions

must be promptly provided to the

Exchange. In addition, the Exchange’s

Market Surveillance Department will

monitor trading activity in Phlx traded

index options and the stocks underlying

those indexes to detect potential

frontrunning and manipulation, as well

as review such trading to ensure that the

closing of positions subject to the

exemption are conducted in a fair and

orderly manner. On a daily basis, the

Exchange’s Market Surveillance

Department will also monitor each

option contract to ensure that it is

hedged by the equivalent dollar amount

of component securities.

III. Discussion

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, the

requirements of Section 6(b)(5)

thereunder,13 The Commission believes

that providing for increased position

and exercise limits for broad-based

index options in circumstances where

those excess positions are fully hedged

with offsetting positions will provide

greater depth and liquidity to the market

and will allow investors to hedge their

stock portfolios more effectively,

without significantly increasing

concerns regarding intermarket

manipulations or disruptions of either

the options market or the underlying

stock market.

Specifically, the Phlx proposal

contains safeguard that should make it

difficult to use the exempted positions

to disrupt or manipulate the market.

First, request for the exemption must be

approved by the Phlx, which should

ensure that the hedges are appropriate

for the position being taken and are in

compliance with Phlx rules. Second, the

stock portfolio must consist of at least

20 stocks, or securities convertible into

such stock, in four industry groups

comprising the index, of which no one

component security accounts for more

than 15% of the value of the portfolio

hedging the index option position, so

that the increased positions are less

likely to be used in a leveraged manner

in any manipulative scheme. As noted

above, the value of the underlying

hedging portfolio is equal to (1) the total

market value of the net stock position;

less (2) the value of: (a) Any offsetting

calls and puts in the respective index

options; (b) any offsetting positions in

related stock index futures or options;

and (c) any economically equivalent
32880 Federal Register / Vol. 61, No. 123 / Tuesday, June 25, 1996 / Notices

14Market participants granted a hedge exemption

are also required to keep their application forms for

the hedge exemption current and promptly provide

the Phlx with any information concerning the dollar

value and composition of the stock portfolio, the

current hedged and aggregate options positions, and

any stock index futures positions, or economically

equivalent positions.

15 15 U.S.C. § 78s(b)(2) (1988).

16 17 CFR 200.30–3(a)(12) (1994).

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

2See letter from Murrary L. Ross, Vice President

and Secretary, Phlx, to Anthony P. Pecora,

Attorney, SEC, dated May 17, 1996. In this letter,

the Phlx represented that the limitation of liability

clause may not be relied upon to limit the

Exchange’s liability to nonmembers for any

intentional or negligent violations of the federal

securities laws. In addition, the Exchange made

some minor clarifying edits.

3See Securities Exchange Act Release No. 33732

(Mar. 8, 1994), 59 FR 12023 (approving File No. SR–

Phlx–93–10).

positions. Third, both the options and

stock positions must be initiated and

liquidated in an orderly manner. This

means that a reduction of the options

position must occur at or before the

corresponding reduction in the stock

portfolio position, thereby helping to

ensure that the stock transactions are

not used to impact the market so as to

benefit the options positions. Fourth,

the Phlx’s Market Surveillance

Department must be notified in writing

for approval prior to liquidating or

initiating any such position as well as

of any change in the portfolio or futures

positions which materially affects the

value of the qualified portfolio. Fifth,

the proposal provides a ceiling on the

maximum size of the options position

by providing that positions established

under the proposal may not exceed twotimes the limits set forth in Exchange

Rule 1001A(a). In addition, the

Exchange may determine to grant a

position limit exemption for less than

the maximum of two-times above the

limit.

The Commission notes that the Phlx’s

surveillance procedures are designed to

detect as well as deter manipulation and

market disruptions. In particular, the

Phlx will monitor the options position

of persons utilizing the hedge

exemption on a daily basis to ensure

that each option contract is hedged by

the equivalent dollar amount of

component securities.14 In addition, the

Phlx’s Market Surveillance Department

will monitor trading activity in Phlx

traded index options and the stocks

underlying those indexes to detect

potential frontrunning and

manipulation, as well as to review such

trading to ensure that the closing of

positions subject to the exemption are

conducted in a fair and orderly manner.

Violation of any of the provisions of the

market index hedge exemption, absent

reasonable justification or excuse, will

result in the withdrawal of the hedge

exemption and subsequent denial of an

application for hedge exemption

thereunder.

Finally, the Commission believes that

it is reasonable for the Phlx to allow

firm and proprietary traders as well as

public customers to utilize the proposed

hedge exemption. The Commission

believes that extending the broad-based

index option hedge exemption to firm

and proprietary traders may help to

increase the depth and liquidity of the

market for market index options and

may help to ensure that public

customers receive the full benefit of the

exemption. Moreover, the Phlx’s

monitoring procedures, as described

above, should be able to detect abuses

and ensure that the options position,

whether firm, proprietary trader, or

customer, are properly hedged.

IV. Conclusion

For the foregoing reasons, the

Commission finds that the Phlx’s

proposal to establish a hedge exemption

from broad-based index option 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,15 that the

proposed rule change (SR–Phlx–96–07)

is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.16

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96–16064 Filed 6–24–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37323; File No. SR–Phlx–

96–11]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

the Philadelphia Stock Exchange, Inc.

Relating to Exchange’s Calculation of

Settlement Values for Cash/Spot

Foreign Currency Option Contracts

(‘‘3–D Options’’)

June 18, 1996.

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

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

April 30, 1996, the Philadelphia Stock

Exchange, Inc. (‘‘Phlx’’ or ‘‘Exchange’’)

filed with the Securities and Exchange

Commission (‘‘Commission’’) the

proposed rule change as described in

Items I, II, and III below, which Items

have been prepared by the selfregulatory organization. On May 20,

1996, the Exchange submitted to the

Commission Amendment No. 1 to the

proposed rule change.2 The Commission

is publishing this notice to solicit

comments on the proposed rule change

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 1057 in order to provide the

Exchange with the election to calculate

settlement values for the cash/spot

Dollar Denominated Delivery foreign

currency option contracts (‘‘3–D

options’’). In addition, the Exchange

proposes to amend Phlx Rule 1057 by

including a ‘‘limitation of liability’’

clause for the settlement of 3–D options

similar to Phlx Rule 1102A, which

limits the Exchange’s liability in the

calculation and dissemination of

settlement values.

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

self-regulatory organization 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 self-regulatory organization 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

On March 8, 1994, the Commission

approved 3–D options for listing on the

Phlx.3 Currently, the closing settlement

value for 3–D options is calculated by a

market information vendor acting as the

Exchange’s designated agent. The

market information vendor will collect

the bid and offer quotations for the

current foreign exchange spot price from

quotations submitted by at least fifteen

interbank foreign exchange market

participants, which the designated agent

will select randomly from a list of

twenty-five active interbank foreign

exchange market participants. After

discarding the five highest and the five

lowest bids and offers, the market

information vendor averages the

remaining ten bids and offers to arrive

at a closing settlement price.

The Phlx proposes to amend Phlx

Rule 1057 to provide the Exchange with