Self Regulatory Organizations; Order Approving Proposed Rule Change and Amendment Nos. 1, 2, 3, and 4, and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 5 to the Proposed Rule Change, by the Philadelphia Stock Exchange, Inc. Relating to the Listing and Trading of Options on the Phone Index.

SECUTITIES AND EXCHANGE COMMISSION

[Release No. 34-34345; File No. SR-Phlx-94-01]

Self Regulatory Organizations; Order Approving Proposed Rule

Change and Amendment Nos. 1, 2, 3, and 4, and Notice of Filing and

Order Granting Accelerated Approval of Amendment No. 5 to the Proposed

Rule Change, by the Philadelphia Stock Exchange, Inc. Relating to the

Listing and Trading of Options on the Phone Index.

July 11, 1994

Introduction

On January 3, 1994, the Philadelphia Stock Exchange, Inc. (``Phlx''

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 provide for the listing and trading of options

on the Phlx Phone Index (``Phone Index'' or ``Index''). On February 18,

1994, February 24, 1994, April 6, 1994, April 11, 1994, and July 5,

1994, the Exchange filed Amendment Nos. 1,\3\ 2,\4\ 3,\5\ 4,\6\ and

5,\7\ respectively, to this proposal.

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\1\15 U.S.C. Sec. 78s(b)(1) (1982).

\2\17 CFR 240.19b-4 (1993).

\3\In Amendment No. 1, the Phlx amended the proposal: (1) to

provide that the Index will be updated during the trading day at

least once every 15 seconds, rather than once every minute; (2) to

provide that the exercise prices will be set at five point Index

intervals rather than 2\1/2\ point Index intervals as stated in the

original filing; (3) to specify that the expiration cycle applicable

to options on the Index will be three expiration months from the

March, June, September, December cycle plus two additional near-term

months; (4) to clarify the Exchange's obligations with respect to

delisting and replacing components of the Index; (5) to clarify that

all of the proposed Index's component stocks are, and any future

replacement or added component securities will be, listed and traded

on either the New York Stock Exchange (``NYSE'') or the American

Stock Exchange (non-ECM) (``Amex''), or quoted on and traded through

the Nasdaq National Market (``Nasadaq/NM''); and (6) to clarify that

all of the current Index component stocks have overlying exchange-

traded options on them. See Letter from Michele R. Weisbaum,

Associate General Counsel, Phlx, to Sharon Lawson, Assistant

Director, Division of Market Regulation, Commission, dated February

16, 1994.

\4\In Amendment No. 2, the Phlx amended the proposal to change

the name of the Index from the Phlx Baby Bell Index to the Phlx

Phone Index. See Letter from Michele R. Weisbaum, Associate General

Counsel, Phlx, to Michael Walinskas, Staff Attorney, Division of

Market Regulation, Commission, dated February 24, 1994.

\5\In Amendment No. 3, the Phlx amended the proposal to

represent that the Phlx will submit a Rule 19b-4 filing to the

Commission prior to opening any new series of options on the Index

for trading if at any time less than 90 percent of the component

securities, by weight, are eligible for exchange options trading, or

if at any time the number of stocks in the Index increases to more

than ten or decreases to less than eight. See Letter from Michele R.

Weisbaum, Associate General Counsel, Phlx, to Sharon Lawson,

Assistant Director, Division of Market Regulation, Commission, dated

March 3, 1994.

\6\In Amendment No. 4, the Phlx amended the proposal: (1) to

change the manner in which the current Index value would be

calculated; (2) to represent that the surveillance procedures

currently used to monitor trading in each of the Exchange's other

index options, which include having complete access to trading

activity in the underlying securities comprising the Index (all of

which are traded on the NYSE), also will be used to monitor trading

in options on the Index; (3) to provide that the Intermarket

Surveillance Group Agreement dated July 14, 1983, as amended on

January 29, 1990, will be applicable to the trading of options on

the Index; and (4) to confirm that the trading hours for the Index

will be 9:30 a.m. to 4:10 p.m. (New York time). See Letter from

Michele R. Weisbaum, Associate General Counsel, Phlx, to Thomas

McManus, Division of Market Regulation, Commission, dated April 7,

1994.

\7\In Amendment No. 5, the Phlx amended its proposal to include

(1) the listing, pursuant to Phlx Rule 1101A(b)(iv), of quarterly

index options (``QIX options'') on the Phone Index; and (2) the

listing, pursuant to Phlx Rule 1101A(b)(iii), of series of long-term

options (``LEAPS'') on the Phone Index. See Letter from Michele R.

Weisbaum, Associate General Counsel, Phlx, to Thomas McManus,

Division of Market Regulation, Commission, dated July 1, 1994.

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The proposed rule change and Amendment Nos. 1, 2, 3, and 4 thereto

were published for comment in the Federal Register on June 6, 1994.\8\

No comments were received on the proposed rule change, nor the

amendments. This order approves the proposal and its five amendments.

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\8\See Securities Exchange Act Release No. 34130 (May 27, 1994),

59 FR 29317 (June 6, 1994).

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II. Description of Proposal

A. Composition of the Index

The Phlx proposes to list for trading options on the Phone Index, a

stock index to be calculated and maintained by the Phlx. The Index will

be composed of the common stocks of the eight companies created as a

result of the divestiture of American Telephone & Telegraph Co.

(``AT&T'') in 1983, including the seven regional telephone companies

spun off from AT&T as well as AT&T itself.\9\ AT&T and the spun-off

regional telephone companies represent some of the largest and most

widely-held U.S. common stocks. All eight of the common stocks are

listed on the NYSE. The Phlx will use a capitalization-weighted

methodology to calculate the Index.\10\

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\9\The components of the Index are: AT&T; Ameritech Corp.; Bell

Atlantic Corp.; BellSouth Corp.; Nynex Corp.; Pacific Telesis Group;

Southwestern Bell Corp.; and US West Inc.

\10\See infra Section II.C., entitled `'Calculation of the

Index,'' for a description of this calculation method.

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As of March 11, 1994, the market capitalizations of the individual

stocks in the Index ranged from a high of $68.7 billion (AT&T) to a low

of $15 billion (Nynex), with the mean and median being $27.6 billion

and $22.8 billion, respectively. The market capitalization of all the

stocks in the Index was $220.6 billion. The total number of shares

outstanding for the stocks in the Index ranged from a high of 1.4

billion shares (AT&T) to a low of 412.7 million shares (Nynex). In

addition, the average daily trading volume of the stocks in the Index,

for the six months immediately preceding February 24, 1994, ranged from

a high of 1,646,200 shares per day (AT&T) to a low of 425,100 shares

per day (BellSouth Corp.), with a mean of approximately 773,638 shares.

For the same period, the average monthly trading volume of the stocks

in the Index ranged from a high of 40,916,000 shares per month (AT&T)

to a low of 8,928,000 shares per month (BellSouth Corp.), with a mean

of approximately 17.03 million shares. Finally, no one stock comprised

more than 31.14 percent of the Index's total value as of March 11, 1994

(AT&T), and the percentage weighing of the four largest issues in the

Index accounted for 64.77 percent of the Index's value. The percentage

weighting of the lowest weighted stock was 6.78 percent of the Index

(Nynex), and the percentage weighting of the five smallest issues in

the Index accounted for 35.23 percent of the Index's value.

B. Maintenance

The Index will be maintained by the Phlx. The Phlx will make

special adjustments to the securities comprising the Index to reflect

such events as stock splits or reverse splits, spinoffs, stock

dividends, reorganizations, recapitalizations, and similar events, upon

their occurrence. In accordance with Phlx Rule 1009A, if any change in

the nature of any stock in the Index that is caused by delisting,

merger, acquisition, or otherwise occurs which would change the overall

market character of the Index, the Exchange will take appropriate steps

to delete this Index component stock from the Index. Such Index

component stock would be replaced by another Index component stock

which the Exchange in its discretion believes would be compatible with

the intended market character of the Index.\11\

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\11\The Exchange represents that any future replacement or added

component securities will be listed and traded on either the NYSE or

Amex, or quoted on and traded through the Nasdaq/NM. See supra note

3.

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If at any time less than 90 percent of the component stocks in the

Index, by weight, are eligible for exchange options trading, or if the

number of stocks in the Index ever increases to more than ten or

decreases to less than eight, the Exchange would submit a filing to the

Commission pursuant to Rule 19b-4 under the Act prior to opening any

new series of options on the Index for trading.

C. Calculation of the Index

The Index will be calculated using a capitalization-weighting

methodology. The representation of each security in the Index will be

proportional to the security's last sale price multiplied by the total

number of shares outstanding, in relation to the total market value of

all of the securities in the Index. The value of the Index was set to

equal 200 on December 1, 1993. As of June 24, 1994, the Index value was

196.73. The formula for calculating the Index value is as follows:

TN15JY94.011

Where:

Total Capitalization = Sum of Market Values (price x shares

outstanding) for all component securities

Divisor = The number which, when divided from the total capitalization

when the Index was initially calculated (on December 1, 1993), yielded

an Index value of 200.

The Index divisor will be adjusted for changes in the

capitalization of any of the component securities resulting from

mergers, acquisitions, delistings, substitutions, and other like

corporate events. The formula for adjusting the divisor is as follows:

TN15JY94.012

Adjustments in the value of the Index which are necessitated by the

addition and/or deletion of an issue from the Index are made by adding

and/or subtracting the market value (price x shares outstanding) of

the relevant issues.

The Index value will be updated dynamically and disseminated at

least once every fifteen seconds during the trading day.\12\ The Phlx

has retained Bridge Data, Inc. to compute and do all necessary

maintenance of the Index. Pursuant to Phlx Rule 1100A, updated Index

values will be disseminated and displayed by means of primary market

prints reported by the Consolidated Tape Association and over the

facilities of the Options Price Reporting Authority (``OPRA''). The

Index value also will be available on broker/dealer interrogation

devices to subscribers of the option information.

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\12\To the extent that a component stock does not open for

trading on a particular trading day, or trading in that component

stock is halted during the course of a particular trading day, the

last reported sale price of such security will be used for purposes

of calculating the current Index value.

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The Index value, for purposes of settling outstanding Index options

contracts upon expiration, will be calculated based upon the regular

way opening sale prices for each of the Index's component stocks on the

last trading day prior to expiration. Once all of the component stocks

have opened, the value of the Index will be determined and that value

will be sued as the final settlement value for expiring Index option

contracts. If any of the component stocks do not open for trading on

the last trading day before expiration, then the last reported sale

price of such security will be used in any case where that security

does not trade on that day.

D. Contract Specifications

The proposed options on the Index will be cash-settled. American-

style options.\13\ Standard options trading hours (9:30 a.m. to 4:10

p.m. New York time) will apply to the contracts. The Index multiplier

will be 100. Strike prices will be set at five point intervals in terms

of the current value of the index.\14\

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\13\An American-style option can be exercised at any time prior

to its expiration.

\14\Additional exercise prices will be added in accordance with

Phlx Rule 1101A(a).

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The Exchange will trade consecutive and cycle month series pursuant

to Phlx Rule 1101A. Specifically, there will be three expiration months

from the March, June, September, December cycle, plus two additional

near-term months so that the three nearest-term months always will be

available. In addition, pursuant to and in accordance with Phlx Rule

1101A(b)(iii), the Exchange will list and trade series of LEAPS on the

Index.

Index options will expire on the Saturday following the third

Friday of the expiration month. Since options on the Index will settle

based upon the opening prices of the component stocks on the last

trading day before expiration (normally a Friday), the last trading day

for an expiring Index option series will be the second to last business

day before expiration (normally a Thursday). Alternatively, pursuant to

Phlx Rule 1101A(b)(iv), the Exchange may provide for the listing of up

to eight near-term quarterly expirations for the Index. These QIX

options would expire on the first business day following the end of

each calendar quarter, and all such QIX options would be P.M.-

settled.\15\

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\15\See Securities Exchange Act Release No. 34234 (June 17,

1994), 59 FR 32729 (June 24, 1994), which approved the Exchange's

proposal to amend Phlx Rule 1101A to permit the Exchange to list QIX

options on all existing and future Exchange indexes (with each

listing of QIX options on future indexes subject to Commission

approval).

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E. Position and Exercise Limits, Margin Requirements, and Trading Halts

Position limits and exercise limits for the Index options will be

set at no more than 5,500 contracts.\16\ Index options will be traded

pursuant to the current Phlx rules governing the trading of index

options, particularly Phlx Rules 1000A through 1103A, and generally,

Phlx Rules 1000 through 1070. For example, Exchange rules applicable to

options on the Phone Index will be identical to the rules applicable to

other narrow-based index options for purposes of trading rotations,

halts, and suspensions,\17\ and margin treatment.\18\

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\16\See Phlx Rules 1001A(b)(i) and 1002A, respectively.

\17\See Phlx Rule 1047A.

\18\See Phlx Rules 722 and 1000A.

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F. Surveillance

The Exchange will use the same surveillance procedures currently

utilized for each of the Exchange's other index options to monitor

trading in Phone Index options. These procedures include complete

access to trading activity in the underlying securities. Further, the

Intermarket Surveillance Group (``ISG'') Agreement, dated July 14,

1983, as amended on January 29, 1990, will be applicable to the trading

of options on the index.\19\

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\19\The Exchange is a member of the ISG, which was formed on

July 14, 1983, among other things, to coordinate more effectively

surveillance and investigative information sharing arrangements in

the stock and options markets. See Intermarket Surveillance Group

Agreement, July 14, 1983. The most recent amendment to the ISG

Agreement, which incorporates the original agreement and all

amendments made thereafter, was signed by ISG members on January 29,

1990. See Second Amendment to the Intermarket Surveillance Group

Agreement, January 29, 1990.

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III. Commission 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, the requirements of Section 6(b)(5).\20\ Specifically, the

Commission finds that the trading of Phone Index options will serve to

promote the public interest and help to remove impediments to a free

and open securities market by providing investors with a means of

hedging exposure to market risk associated with U.S. telephone industry

stocks.\21\

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\20\15 U.S.C. 78f(b)(5) (1988).

\21\Pursuant to Section 6(b)(5) of the Act, the Commission must

predicate approval of any new option proposal upon a finding that

the introduction of such new derivative instrument is in the public

interest. Such a finding would be difficult for a derivative

instrument that served no hedging or other economic function,

because any benefits that might be derived by market participants

likely would be outweighed by the potential for manipulation,

diminished public confidence in the integrity of the markets, and

other valid regulatory concerns. In this regard, the trading of

listed index options on the Phone Index will provide investors with

a hedging vehicle that should reflect the overall movement of

telephone industry stocks in the U.S. securities markets. The

Commission also believes that these Index options will provide

investors with a means by which to make investment decisions in this

sector of the U.S. securities markets, allowing them to establish

positions or increase existing positions in such markets in a cost-

effective manner.

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A. Index Design and Structure

The Commission finds that the Phone Index is a narrow-based index.

The Phone Index is composed of only eight securities, all of which are

U.S. telephone industry stocks. Accordingly, the Commission believes

that it is appropriate for the Phlx to apply its rules governing

narrow-based index options to trading in the Index options.\22\

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\22\See supra notes 13 through 15, and accompanying text.

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The Commission also finds that the large capitalizations, liquid

markets, and relative weightings of the index's component securities

significantly minimize the potential for manipulation of the Index.

First, the majority of the components that comprise the Index are

actively-traded, with a mean and median average daily trading volume of

773,800 and 637,700 shares, respectively, over the six months

immediately preceding February 24, 1994.\23\ Second, the market

capitalizations of the securities in the Index are very large, ranging

from a high of $68.7 billion to a low of $15 billion, as of March 11,

1994, with the mean and median being $27.6 billion and $22.8 billion,

respectively. Third, although the Index is only comprised of eight

component securities, no one particular security or group of securities

dominates the Index. Specifically, no individual stock comprises more

than 31.15 percent of the Index's total value, and the percentage

weighting of the four largest issues in the Index accounts for 64.77

percent of the Index's value.\24\ Fourth, all of the securities in the

Index are eligible for standardized options trading, and the proposed

Phlx maintenance requirement requires that at least 90 percent of the

weighting of the Index be comprised of securities that are eligible for

exchange options trading. Fifth, if the Phlx increases the number of

component securities to more than ten or decreases that number to less

than eight, the Phlx will be required to seek Commission approval

pursuant to Section 19(b)(2) of the Act before listing new strike price

of expiration month series of Phone Index options. This will help

protect against material changes in the composition and design of the

Index that might adversely affect the Phlx's obligations to protect

investors and to maintain fair and orderly markets in Index options.

Finally, the Index is comprised, and in the future may only be

comprised, of stocks listed and traded on the NYSE or Amex, or quoted

on and traded through the Nasdaq/NM. Accordingly, the Phlx will be

required to ensure that each component of the Index is subject to last

sale reporting requirements in the United States. This will further

reduce the potential for manipulation of the value of the Index.

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\23\In addition, over this same period, no component of the

Index had an average daily trading volume of less than 425,100

shares per day.

\24\The Commission's analysis is based on the eight securities

in the Index. For an index with several more underlying securities,

the Commission might come to a different conclusion if only a few

securities accounted for a substantial portion of the index's

weighting. In addition, although the Index is comprised of only

eight stocks, the Commission is satisfied that, based on the large

capitalizations, liquidity, and relative weightings of the component

securities, the Index can be traded as an index product.

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B. Surveillance

The Commission believes that a surveillance sharing agreement

between an exchange proposing to list a security index derivative

product and the exchange(s) trading the securities underlying the

derivative product is an important measure for surveillance of the

derivative and underlying securities markets. Such agreements ensure

the availability of information necessary to detect and deter potential

manipulations and other trading abuses, thereby making the security

index product less readily susceptible to manipulation.\25\ In this

regard, the NYSE, which currently is the primary market for all of the

stocks comprising the Index, is a member of the ISG, which provides for

the exchange of all necessary surveillance information.\26\

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\25\See Securities Exchange Act Release No. 31243 (September 28,

1992), 57 FR 45849 (October 5, 1992).

\26\See supra note 16. In addition, the Amex and the National

Association of Securities Dealers, Inc. are members of the ISG.

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C. Market Impact

The Commission believes that the listing and trading on the Phlx of

options on the Phone Index will not adversely impact the underlying

securities markets.\27\ First, as described above, for the most part no

one security or group of securities dominates the Index. Second,

because at least 90 percent of the numerical value of the Index must be

accounted for by securities that meet the Exchange's options listing

standards, the component securities generally will be actively-traded,

highly-capitalized securities. Third, the 5,500 contract position and

exercise limits applicable to Index options will serve to minimize

potential manipulation and market impact concerns.

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\27\In addition, the Phlx has represented that the Phlx and OPRA

have the necessary systems capacity to support those new series of

index options that would result from the introduction of options on

the Phone Index. See Letter from Michele R. Weisbaum, Associate

General Counsel, Phlx, to Thomas McManus, Division of Market

Regulation, Commission, dated June 24, 1994; and Letter from Joseph

P. Corrigan, Executive Director, OPRA, to Richard Cangelosi,

Assistant Vice President, New Product Development, Phlx, dated April

18, 1994.

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Lastly, the Commission believes that settling expiring Phone Index

options based on the opening prices of component securities is

consistent with the Act. As noted in other contexts, valuing options

for exercise settlement on expiration based on opening prices rather

than closing prices may help reduce the ``Expiration Friday'' effects

on markets for securities underlying options on the Index.\28\

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\28\See Securities Exchange Act Release No. 30944 (July 21,

1992), 57 FR 33376 (July 28, 1992).

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D. Accelerated Approval of Amendment No. 5

The Commission finds good cause for approving Amendment No. 5 to

the proposed rule change prior to the thirtieth day after the date of

publication on notice of filing thereof in the Federal Register. The

portion of Amendment No. 5 providing for the listing of QIX options on

the Index is consistent with the Exchange proposal approved by the

Commission on June 17, 1994 relating to the listing of QIX options on

all stock indexes for which index options are listed for trading by the

Exchange.\29\ That proposal was published for the full 21-day comment

period, and no comments were received. In addition, because Phlx Rule

1101A(b)(iii) generally permits the Exchange to list series of LEAPS on

stock indexes, the Commission finds that the portion of Amendment No. 5

relating to the listing of series of LEAPS on the Index presents no new

regulatory issues. Accordingly, the Commission believes it is

consistent with Section 6(b)(5) of the Act to approve Amendment No. 5

on an accelerated basis.

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\29\See supra note 15.

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IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning Amendment No. 5 to the proposed rule change.

Persons making written submissions should file six copies thereof with

the Secretary, Securities and Exchange Commission, 450 Fifth Street

NW., Washington, DC 20549. Copies of the submission, all subsequent

amendments, all written statements with respect to the foregoing that

are filed with the Commission, and all written communications relating

to the foregoing 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 Section, 450 Fifth Street

NW., Washington, DC. Copies of such filing also will be available for

inspection and copying at the principal office of the above-mentioned

self-regulatory organization. All submissions should refer to File No.

SR-Phlx-94-01 and should be submitted by August 5, 1994.

It is Therefore Ordered, pursuant to Section 19(b)(2) of the

Act,\30\ that the proposed rule change (File No. SR-Phlx-94-01), as

amended, is approved.

\30\15 U.S.C. Sec. 78s(b)(2) (1988).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\31\

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\31\17 CFR 200.30-3(a)(12) (1993).

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Jonathan G. Katz,

Secretary.

[FR Doc. 94-17255 Filed 7-14-94; 8:45 am]

BILLING CODE 8010-01-M