Self-Regulatory Organizations; Notice of Filing Proposed Rule Change and Amendment Nos. 1 and 2 by the Philadelphia Stock Exchange, Inc., Relating To Modifications of the Position and Exercise Limits for Foreign Currency Options

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34525; International Series Release No. 698; File No.

SR-PHLX-93-13]

Self-Regulatory Organizations; Notice of Filing Proposed Rule

Change and Amendment Nos. 1 and 2 by the Philadelphia Stock Exchange,

Inc., Relating To Modifications of the Position and Exercise Limits for

Foreign Currency Options

August 11, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on March

29, 1993, as amended on July 19, 1994, and on July 26, 1994,\1\ the

Philadelphia Stock Exchange, Inc. (``PHLX'' or ``Exchange'') filed with

the Securities and Exchange Commission (``SEC'' or ``Commission'') the

proposed rule change as described in Items I, II, and III below, which

Items have been prepared by the self-regulatory organization.\2\ The

Commission is publishing this notice to solicit comments on the

proposed rule change from interested persons.

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\1\On July 19, 1994, the PHLX amended its proposal to establish

a foreign currency option (``FCO'') position limit of 150,000

contracts for FCOs with annual trading volume of at least 4,000,000

contracts. See Letter from Gerald D. O'Connell, First Vice

President, Regulation and Trading Operations, PHLX, to Michael

Walinskas, Branch Chief, Options Regulation, Division of Market

Regulation (``Division''), Commission, dated July 19, 1994

(``Amendment No. 1''). On July 26, 1994, the PHLX amended the

proposal to provide that FCOs with annual trading volume of

3,500,000 contracts would be eligible for a position limit of

150,000 contracts and to indicate that the PHLX plans a one-time

immediate review to implement the higher position limit for FCOs

which meet the annual trading volume requirement. See Letter from

Gerald D. O'Connell, First Vice President, Regulation and Trading

Operations, PHLX, to Michael Walinskas, Branch Chief, Options

Regulation, Division, Commission, dated July 26, 1994 (``Amendment

No. 2'').

\2\The PHLX also submitted information concerning the

implementation and effective date of the proposal. See Letter from

Edith Hallahan, Attorney, Market Surveillance, PHLX, to Richard

Zack, Branch Chief, Options Branch, Division, Commission, dated July

27, 1993 (``July 27 Letter'').

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

Currently, PHLX Rule 1001, ``Position Limits,''\3\ establishes a

position limit of 100,000 contracts for FCOs traded on the PHLX.\4\ The

PHLX proposes to amend Exchange Rule 1001 and Exchange Rule 1002,

``Exercise Limits,''\5\ to increase the position and exercise limits

for FCOs. Specifically, under proposed Commentary .05(b) to PHLX Rule

1001, the PHLX proposes to review the previous year's volume

information for all FCOs, including cross-rate FCOs,\6\ at the

beginning of each calendar year and to establish a position limit of

150,000 contracts for FCOs with annual trading volume of at least

3,500,000 contracts, based upon the previous year's volume. At the

beginning of each calendar year, the PHLX will review FCO volume

information from the previous year to determine which limit will apply;

a higher limit will be effective on the date set by the Exchange, and a

lower limit will take effect after the last expiration then trading. In

addition, the PHLX's Market Surveillance Department plans to monitor

trading volume on a monthly basis, so that FCOs will be eligible

immediately for a higher position limit when annual trading volume, as

measured from the beginning of the calendar year, exceeds the levels

established in the proposal.

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\3\Position 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).

\4\See Securities Exchange Act Release No. 23710 (October 15,

1986), 51 FR 37691 (order approving File Nos. SR-PHLX-86-24 and SR-

CBOE-86-30).

\5\Exercise limits prohibit an investor or group of investors

acting in concert from exercising more than a specified number of

puts or calls in a particular class within five consecutive business

days.

\6\See July 27 Letter, supra note 1. Currently, the PHLX trades

two cross-rate FCOs, the British pound/Deutsche mark and the

Deutsche mark/Japanese yen.

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The text of the proposed rule change is available at the Office of

the Secretary, PHLX, and at the Commission.

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

Currently, PHLX Rule 1001 establishes a position limit of 100,000

contracts for FCOs traded on the PHLX. The PHLX proposes to amend

Exchange Rules 1001 and 1002 to increase the position and exercise

limits for FCOs, including cross-rate FCOs. Specifically, under

proposed Commentary .05(b) to PHLX Rule 1001, the PHLX proposes to

establish a position limit of 150,000 contracts for FCOs with annual

trading volume of at least 3,500,000 contracts, based upon the previous

year's volume. At the beginning of each calendar year, the PHLX will

review FCO volume information from the previous year to determine which

limit will apply; a higher limit will be effective on the date set by

the Exchange, and a lower limit will take effect after the last

expiration then trading. In addition, the PHLX's Market Surveillance

Department plans to monitor trading volume on a monthly basis, so that

FCOs will be eligible immediately for a higher position limit when

annual trading volume, as measured from the beginning of the calendar

year, exceeds the levels established in the proposal.

The PHLX notes that the Exchange's exercise limits are established

by reference to position limits, so that any increase in position

limits will also increase exercise limits. Accordingly, the PHLX

proposes to amend Exchange Rule 1002 to reflect the proposed amendment

to Exchange Rule 1001.

The Exchange views the current FCO position and exercise limits as

too low in light of increased levels of trading activity in the

underlying currency markets and the resultant growth in liquidity of

PHLX FCOs in recent years. In addition, the PHLX notes the number of

products (e.g., long-term, month-end, American- and European-style

options) that are currently aggregated to determine position limits as

well as the likelihood that additional products will be aggregated in

the future.

Accordingly, the PHLX's proposal is designed to identify and

accommodate those active currencies where heavier trading and open

interest warrant higher limits. Under this proposal, the PHLX does not

anticipate that all of the limits will be increased, as only one

currency currently qualifies for higher limits under the proposed

standards.\7\

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\7\During 1993, only Deutsche mark options had trading volume

which would qualify for the 150,000 contract limit.

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When FCOs began trading on the PHLX in 1982, FCO position limits

were set at 10,000 contracts.\8\ Since that time the position limits

have been changed three times, including an increase to the current

level of 100,000 contracts in 1986.\9\ Since 1986, the PHLX has added

several new products for which position limits are aggregated with

other trading in the same underlying foreign currency.\10\ As a result,

many traders have recently begun to regularly accumulate positions near

existing limits, especially in certain more active currencies. However,

in other currencies lacking the same volume or trading interest, the

current level of 100,000 contracts has proved adequate and reasonable.

In those active currencies, the PHLX believes that trading interest

could migrate to the over-the-counter market, hampering PHLX liquidity

if large traders continue to be restricted by the current position

limits.

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\8\See Securities Exchange Act Release No. 19313 (December 8,

1982) 47 FR 56591 (order approving File No. SR-PHLX-81-4).

\9\See Securities Exchange Act Release No. 27310, supra note 2.

See also Securities Exchange Act Release Nos. 21676 (January 18,

1985) 50 FR 3859 (order approving File No. SR-PHLX-84-18)

(increasing position limits from 10,000 to 25,000 contracts); and

22479 (September 27, 1985), 50 FR 41276 (order approving File No.

SR-PHLX-85-22) (increasing position limits to 50,000 contracts).

\10\See e.g., Securities Exchange Act Release Nos. 24859 (August

27, 1987) 52 FR 33493 (order approving File No. SR-PHLX-87-24)

(aggregating European-style contracts); 29804 (October 10, 1991) 57

FR 20546 (order approving File No. SR-PHLX-91-30) (aggregating long-

term options); and 30945 (July 21, 1992) 57 FR 33381 (order

approving File No. SR-PHLX-92-13) (aggregating month-end options).

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The PHLX notes that since the time of the most recent increase in

position limits, it is estimated that the size of the underlying

currency market has grown exponentially.\11\ For example, it is

estimated that 250,000 PHLX Deutsche mark contracts would represent

less than 1% of the daily international currency transaction volume in

the Deutsche mark. Since 1986, average daily trading volume in PHLX

FCOs has grown from 30,880 to 48,246 contracts in 1992.\12\ As of

February 1993, average daily volume was 61,062 contracts. Monthly

volume and open interest have also increased dramatically since 1986,

especially in certain FCOs. Further, the highest monthly open interest

in FCOs reached 995,941 in 1986; 1,188,570 contracts in 1987; and

1,190,389 contracts in 1992. Total volume has increased from 7,905,239

contracts in 1986 to 12,158,069 contracts in 1992.

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\11\In 1989, total gross global foreign exchange turnover was

estimated to be $932 billion per day and net global turnover was

estimated to be $640 billion per day. See Bank for International

Settlements (``BIS'') Survey of Foreign Exchange Market Activity,

April 1989. In 1992, total gross global foreign exchange turnover

was estimated to be $1,354 billion per day, a 35% increase since

April 1989. After allowing for the elimination of local and cross-

border double-counting and estimated gaps in reporting (e.g.,

exchange-traded options and futures and countries not providing

counterparty information for over-the-counter transactions), global

``net-net'' exchange market turnover in spot, forward and derivative

contracts may be estimated at $880 billion per day during April

1992. See BIS Central Bank Survey of Foreign Exchange Market

Activity in April 1992, March 1993.

\12\Average daily volume in foreign currency options was 14,829

contracts in 1985 and 30,880 contracts in 1986.

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In light of these market changes, the PHLX believes that increased

position and exercise limits are necessary to add depth and liquidity

to the market. Because of the large size of the underlying market in

foreign currencies, the PHLX does not believe that manipulative

concerns would be enhanced if limits were increased. Moreover, the

Exchange believes that these increases are particularly appropriate

because the FCO market attracts a large number of institutional and

corporate investors who have substantial hedging needs and do block\13\

size transactions in FCOs.

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\13\For the purposes of this proposal, the PHLX defines ``block-

sized orders'' as orders of 100 contracts or more. See July 27

Letter, supra note 1.

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In prior releases approving increases in FCO position limits, the

PHLX notes that the Commission has stated that although position and

exercise limits must be sufficient to protect the options and related

markets from disruptions caused by manipulation, at the same time, the

limits must not be so low as to discourage participation in the options

market by institutions and other investors with substantial hedging

needs or to prevent specialists and market makers from adequately

meeting their obligations to maintain a fair and orderly market.\14\

Although the Exchange may grant position limit exemptions in the

interest of fair and orderly markets, the Exchange believes that it is

more direct and logical to establish more appropriate position limits

for all investors.

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\14\See Securities Exchange Act Release No. 22479, supra, note

9.

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The PHLX believes that the proposed rule change is consistent with

Section 6 of the Act, in general, and, in particular, with Section

6(b)(5), in that it is designed to promote just and equitable

principles of trade as well as to protect investors and the public

interest. The PHLX believes that the increased depth and liquidity of

the FCO market should promote just and equitable principles of trade.

In addition, the PHLX believes that the proposed approach to FCO

position limits should ensure that the applicable limit is reasonably

related to trading volume. The PHLX believes that this, in turn, should

result in position limit levels that serve the purposes of protecting

investors and the public interest as well as preventing unfair acts and

practices, such as manipulation.

(B) Self-Regulatory Organization's Statement on Burden on Competition

The PHLX 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 either received or requested.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of 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 reason for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

(a) By order approve such 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, NW., Washington, DC 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, NW.,

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

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

self-regulatory organization. All submissions should refer to the file

number in the caption above and should be submitted by September 8,

1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\15\

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\15\17 CFR 200.30-3(a)(12) (1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-20232 Filed 8-17-94; 8:45 am]

BILLING CODE 8010-01-M