Self-Regulatory Organizations; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 2 to Proposed Rule Change, by the American Stock Exchange, Inc. Relating to the Listing and Trading of Options and Full- Value and Reduced-Value Long-Term Options on the Nikkei Stock Index 300

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34526; International Series Release No. 699; File No.

SR-Amex-94-19]

Self-Regulatory Organizations; Order Approving Proposed Rule

Change and Notice of Filing and Order Granting Accelerated Approval of

Amendment No. 2 to Proposed Rule Change, by the American Stock

Exchange, Inc. Relating to the Listing and Trading of Options and Full-

Value and Reduced-Value Long-Term Options on the Nikkei Stock Index 300

August 11, 1994.

I. Introduction

On May 31, 1994, the American Stock Exchange, Inc. (``Amex'' 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

and long-term options (``LEAPS'')\3\ based on the Nikkei Stock Index

300 (``Nikkei 300 Index'' or ``Index''), as well as LEAPS based on a

reduced-value Index. On June 10, 1994, the Exchange filed Amendment No.

1 to the proposed rule change.\4\ On July 14, 1994, the Exchange filed

Amendment No. 2 to the proposed rule change.\5\

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

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

\3\``LEAPS'' is an acronym for Long-Term Equity Anticipation

Securities. LEAPS are long-term index option series that expire from

12 to 36 months from their date of issuance. See Amex Rule 903C.

\4\In Amendment No. 1, the Amex amended its proposal to provide

that (1) the exercise settlement value for all of the Nikkei Stock

Index 300 expiring option contracts will be calculated by Nihon

Keizai Shimbun based upon the opening price of each of the component

securities in Japan on the last business day prior to expiration;

(2) the position and exercise limits for Nikkei Stock Index 300

option contracts in the series with the nearest expiration month

will be 30,000 contracts; (3) the trading unit for Nikkei Stock

Index 300 options is the Index value multiplied by $100; (4) for

valuation purposes, one Nikkei Stock Index 300 unit (1.0) is

assigned a fixed value of one U.S. dollar; and (5) the Tokyo Stock

Exchange has recently requested that a new comprehensive

surveillance sharing agreement be entered into for options on the

Nikkei Stock Index 300, which agreement will cover the sharing of

surveillance information regarding the index's component securities.

See Letter from Claire P. McGrath, Managing Director and Special

Counsel, Derivative Securities, Amex, to Michael Walinskas, Branch

Chief, Derivatives Regulation, Division of Market Regulation,

Commission, dated June 10, 1994.

\5\In Amendment No. 2, the Exchange lowered the proposed

position limits for Index options and Index LEAPS to 25,000

contracts on the same side of the market, provided that no more than

15,000 contracts are in series in the nearest expiration month. See

Letter from Claire P. McGrath, Managing Director and Special

Counsel, Derivative Securities, Amex, to Michael Walinskas, Branch

Chief, Derivatives Oversight, Division of Market Regulation,

Commission, dated July 14, 1994.

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The proposed rule change was published for comment in the Federal

Register on June 17, 1994.\6\ No comments were received on the proposed

rule change. This order approves the Exchange's proposal and Amendment

Nos. 1 and 2 thereto.

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\6\See Securities Exchange Act Release No. 34198 (June 10,

1994), 59 FR 31282 (June 17, 1994).

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II. Description of the Proposal

A. General

The Amex proposes to trade standardized index option contracts

based on the Nikkei 300 Index, an index comprised of 300 representative

stocks of the first section\7\ of the Tokyo Stock Exchange (``TSE'').

The Amex also proposes to list LEAPS on the full-value Index and LEAPS

on a reduced-value Index that will be computed at one-tenth of the

value of the Index. Nikkei 300 Index LEAPS will trade independently of

and in addition to regular Nikkei 300 Index options traded on the

Exchange; however, as discussed below, position and exercise limits of

Index LEAPS and regular Index options will be aggregated.\8\

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\7\First section stocks are distinguished from second section

stocks by more stringent listing standards.

\8\See infra Section II.G.

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B. Composition and Maintenance of the Index

The Nikkei 300 Index was designed by Nihon Keizai Shimbun, Inc.

(``NKS''). The Amex represents that Index component stocks were

selected by NKS for their high market capitalizations, and their high

degree of liquidity, and are representative of the relative

distribution of industries within the broader Japanese equity market.

As of the date of this order, the Amex had not yet formally executed a

licensing agreement with NKS to list options on the Nikkei 300 Index.

As of July 8, 1994, the total capitalization of the Index was

approximately US$2.47 trillion.\9\ Market capitalizations of the

individual stocks in the Index ranged from a high of US$83.8 billion to

a low of US$1.03 billion, with a median of US$3.56 billion and a mean

of US$8.25 billion. In addition, the average daily trading volume of

the stocks in the Index, for the six-month period ending June 30, 1994,

ranged from a high of 4,740,000 shares to a low of 6,000 shares, with a

mean and median of approximately 676,000 and 417,000 shares,

respectively. The highest weighted component stock in the Index

accounts for 3.39 percent of the Index. The five largest Index

components account for approximately 14.9 percent of the Index's value.

The lowest weighted component stock comprises 0.042 percent of the

Index, and the five smallest Index components account for approximately

0.25 percent of the Index's value.

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\9\Based on the July 8, 1994 exchange rate of Y98.2 per US$1.00.

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The Index is maintained by NKS. To maintain the continuity of the

Index, NKS will adjust the Index divisor to reflect certain event

relating to the component stocks. These events include, but are not

limited to, changes in the number of shares outstanding, spin-offs,

certain rights issuances, and mergers and acquisitions. The Amex

represents that NKS reviews the composition of the Index periodically.

C. Contract Specifications

The proposed options on the Index will be cash-settled, European-

style options.\10\ Trading hours for the options will be from 9:30 a.m.

to 4:15 p.m. (New York time). The multiplier for the Index will be 100.

Strike prices on Index options and full-value Index LEAPS will be set

to bracket the Index level at $5.00 intervals. In addition, the

Exchange may list near-the-money (i.e., within ten points above or

below the current Index value) option series on the Index at 2\1/2\

point strike price intervals when the value of the Index is below 200

points. The Exchange intends to list options series with expirations in

the three near-term calendar months, plus up to three additional

calendar months in the March, June, September, December cycle. As

described in more detail below, the Exchange also intends to list Index

LEAPS, and LEAPS on a reduced-value Index, that will expire from 12 to

36 months from the date of their issuance.

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\10\A European-style option can be exercised only during a

specified period before the option expires.

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D. Calculation of the Index

The Nikkei 300 Index is capitalization-weighted and reflects

changes in the prices of the Index component securities relative to the

base date of the Index (October 1, 1982). The value of the Index is

calculated by multiplying the price of each component security by the

number of shares outstanding of each such security, adding the

products, and dividing by the current Index divisor. The Index divisor

is adjusted to reflect certain events relating to the component

stocks.\11\ The Index had a closing value of 299.47 on July 13, 1994.

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\11\See supra Section II.B. The Index divisor was set to give

the Index a value of 100 on its base date.

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Because trading does not occur on the TSE during the Amex's trading

hours, the daily dissemination of the Index value is calculated by the

Amex once each day based on the most recent official closing price of

each Index component security as reported by the TSE. This closing

value is disseminated throughout the trading day on the Amex.

E. Settlement of Index Options

Options on the index (including full-value and reduced-value Index

LEAPS) will expire on the Saturday following the third Friday of the

expiration month (``Expiration Friday''). The last trading day in an

option series normally will be the second to last business day

preceding the Saturday following the third Friday of the expiration

month (normally a Thursday). Trading in expiring options will cease at

the close of trading on the last trading day. The exercise settlement

value for all of the index's expiring options will be calculated by NKS

based upon the opening price of each of the component securities in

Japan on the last business day prior to expiration. If a stock fails to

open for trading, the last available price of the stock will be used to

calculate the Index's settlement value. When an option expiration is

moved in accordance with an Exchange holiday, the last trading day for

the expiring Index options will be Wednesday, and the exercise

settlement value of the Index options will be determined at the opening

of the regular Thursday trading session on the TSE, even if the TSE is

open on Friday. If the TSE is closed on the Friday before expiration

but the Amex is not closed, the last trading day for expiring Index

options will be on Wednesday and the exercise settlement value of

expiring Index options will be determined at the opening of the regular

Thursday trading session on the TSE.

F. Listing of Long-Term Options on the Full-Value or Reduced-Value

Index

The Exchange may list series of LEAPS on the Nikkei 300 Index that

expire from 12 to 36 months from the date of their issuance on either

the full-value Index or a reduced-value Index computed at one-tenth of

the full-value Index, subject to existing Exchange requirements

applicable to full-value and reduced-value LEAPS.\12\ In either event,

the interval between expiration months for either a full-value or

reduced-value long-term option will not be less than six months. The

current and closing values for reduced-value Index LEAPS will be

computed by dividing the value of the full-value Index by ten and

rounding the resulting figure to the nearest one-hundredth. For

example, a Nikkei 300 Index value of 299.47 would be 29.95 for the

reduced-value Index LEAPS, and 299.44 would become 29.94. The reduced-

value Index LEAPS will have a European-style exercise and will be

subject to the same rules that govern trading of all of the Exchange's

index options, including sales practices rules, margin requirements,

and floor trading procedures. Strike price intervals for the reduced-

value Index LEAPS will be no less than $2.50, instead of $5.00.

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\12\See Amex Rule 903C.

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

Position limits for options (including Index LEAPS) on the Nikkei

300 Index will be set at no more than 25,000 contracts on the same side

of the market, provided that no more than 15,000 of such contracts are

in series in the nearest expiration month.\13\ Exercise limits will be

set at the same level as position limits.\14\ For purposes of

calculating applicable position and exercise limits, positions in

reduced-value options on the index will be aggregated with each other

and with positions in the full-value Index options. Ten reduced-value

contracts will equal one full-value contract for purposes of

aggregating these positions.\15\

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\13\See Amex Rule 904C.

\14\See Amex Rule 905C.

\15\See Amex Rule 904C.

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Exchange rules applicable to options on the Index will be identical

to the rules applicable to other broad-based index options for purposes

of trading rotations, halts, and suspensions,\16\ and margin

treatment.\17\

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\16\See Amex Rule 918C.

\17\See Amex Rule 462(d)(2)(D)(iii).

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Finally, the Exchange proposes to utilize its Auto-Ex system for

orders in Index options of up to 50 contracts.\18\

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\18\Auto-Ex is the Exchange's automated execution system which

provides for the automatic execution of market and marketable limit

orders at the best bid or offer at the time the order is entered.

The Exchange believes that the ability to use Auto-Ex for orders of

up to 50 contracts will provide customers with deep, liquid markets,

as well as expeditious executions.

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H. Surveillance

The Exchange will use the same surveillance procedures currently

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

trading in Index options and Index LEAPS. The Exchange represents that

the TSE has requested that a new comprehensive surveillance sharing be

executed with respect to options on the Index. The Exchange expects

this agreement to cover the sharing of surveillance information

regarding the Index's component securities.\19\

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\19\See Infra Section III.C.

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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) of the Act.\20\

Specifically, the Commission finds that the trading of options based on

the Nikkei 300 Index will serve to protect investors, promote the

public interest, and help to remove impediments to a free and open

securities market by providing investors with a means to hedge exposure

to market risk associated with the Japanese equity market and provide a

surrogate instrument for trading in the Japanese securities market.\21\

The trading of options based on the Nikkei 300 Index should provide

investors with a valuable hedging vehicle that should reflect

accurately the overall movement of the Japanese equity market.

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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 securities product upon a finding that

the introduction of such product is in the public interest. Such a

finding would be difficult with respect to an option 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.

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In addition, the Commission believes, for the reasons discussed

below, that the Amex has adequately addressed issues related to

customer protection, index design, surveillance, and market impact on

Nikkei 300 Index options.

A. Index Design and Structure

The Commission finds that it is appropriate and consistent with the

Act to classify the Index as a broad-based index. Specifically, the

Commission believes the Index is broad-based because it reflects a

substantial segment of the Japanese equity market, and, among other

things, contains a large number of stocks that trade in that market.

First, the Index consists of 300 actively-traded stocks traded on the

first section of the TSE, representing 36 different industry groups in

Japan. Second, the market capitalizations of the stocks comprising the

Index are very large. Specifically, the total capitalization of the

Index, as of July 8, 1994, was US$2.47 trillion, with the market

capitalizations of the individual stocks in the Index ranging from a

high of US$83.8 billion to a low of US$1.03 billion, with a median

value of US$3.56 billion and a mean of US$8.25 billion. Third, no one

particular stock or group of stocks dominates the Index. Specifically,

no single stock comprises more than 3.39 percent of the Index's total

value, and the percentage weighting of the five largest issues in the

Index accounts for 14.9 percent of the Index's value. Accordingly, the

Commission believes it is appropriate to classify the Index as broad-

based.

B. Customer Protection

The Commission believes that a regulatory system designed to

protect public customers must be in place before the trading of

sophisticated financial instruments, such as Nikkei 300 Index options

(including full-value and reduced-value Index LEAPS), can commence on a

national securities exchange. The Commission notes that the trading of

standardized, exchange-traded options occurs in an environment that is

designed to ensure, among other things, that (1) the special risks of

options are disclosed to public customers; (2) only investors capable

of evaluating and bearing the risks of options trading are engaged in

such trading; and (3) special compliance procedures are applicable to

options accounts. Accordingly, because the Index options and Index

LEAPS will be subject to the same regulatory regime as the other

standardized options currently traded on the Amex, the Commission

believes that adequate safeguards are in place to ensure the protection

of investors in Nikkei 300 Index options and full-value and reduced-

value Nikkei 300 Index LEAPS.

C. Surveillance

As a general matter, the Commission believes that comprehensive

surveillance sharing agreements between the relevant foreign and

domestic exchanges are important where an index product comprised of

foreign securities is to be traded in the United States. In most cases,

in the absence of such a comprehensive surveillance sharing agreement,

the Commission believes that it would not be possible to conclude that

a derivative product, such as a Nikkei 300 Index option, was not

readily susceptible to manipulation.

Although the Amex and the TSE do not yet have a written

comprehensive surveillance sharing agreement that covers the trading of

Nikkei 300 Index options,\22\ a number of factors support approval of

the proposal at this time. First, while the size of an underlying

market is not determinative of whether a particular derivative product

based on that market is readily susceptible to manipulation, the size

of the market for the securities underlying the Nikkei 300 Index makes

it less likely that the proposed Index options are readily susceptible

to manipulation.\23\ In addition, the Commission notes that the TSE is

under the regulatory oversight of the Japanese Ministry of Finance

(``MOF''). The MOF has responsibility for both the Japanese securities

and derivatives markets. Accordingly, the Commission believes that the

ongoing oversight of the trading activity on the TSE by the MOF will

help to ensure that the trading of Nikkei 300 Index options will be

carefully monitored with a view toward preventing unnecessary market

disruptions.

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\22\The Amex and the TSE, however, currently have a surveillance

sharing agreement in place that covers other derivative products

traded on the Amex. That agreement has been previously amended by

the Amex and the TSE to include new products such as the trading of

Japan Index options. The Exchange represents that it currently is

pursuing a comprehensive surveillance sharing agreement with the TSE

with respect to Nikkei 300 Index options, which the Exchange expects

will cover the sharing of surveillance information regarding the

Index's component securities.

\23\In evaluating the manipulative potential of a proposed index

derivative product, as it relates to the securities that comprise

the index and the index product itself, the Commission has

considered several factors, including (1) the number of securities

comprising the index or group; (2) the capitalizations of those

securities; (3) the depth and liquidity of the group or index; (4)

the diversification of the group or index; (5) the manner in which

the index or group is weighted; and (6) the ability to conduct

surveillance on the product. See Securities Exchange Act Release No.

31016 (August 11, 1992), 57 FR 37012 (August 17, 1992).

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Finally, the Commission and the MOF have concluded a Memorandum of

Understanding (``MOU'') that provides a framework for mutual assistance

in investigatory and regulatory matters.\24\ Moreover, the Commission

also has a longstanding working relationship with the MOF on these

matters. Based on the longstanding relationship between the Commission

and the MOF and the existence of the MOU, the Commission is confident

that it and the MOF could acquire information from one another similar

to that which would be available in the event that a comprehensive

surveillance sharing agreement were executed between the Amex and the

TSE with respect to transactions in TSE-traded stocks related to Nikkei

300 Index option transactions on the Amex.\25\

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\24\See Memorandum of United States Securities and Exchange

Commission and the Securities Bureau of the Japanese Ministry of

Finance on the Sharing of Information, dated May 23, 1986.

\25\It is the Commission's expectation that this information

would include transaction, clearing, and customer information

necessary to conduct an investigation.

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Nevertheless, the Commission continues to believe strongly that a

comprehensive surveillance sharing agreement between the TSE and the

Amex covering Nikkei 300 Index options would be an important measure to

deter and detect potential manipulations or other improper or illegal

trading involving Nikkei 300 Index options. Accordingly, the Commission

believes it is critical that the TSE and the Amex continue to work

together to consummate a formal comprehensive surveillance sharing

agreement to cover Nikkei 300 Index options and the component

securities as soon as practicable.\26\

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\26\See supra note 22.

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D. Market Impact

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

Nikkei 300 Index options, including full-value and reduced-value Index

LEAPS, will not adversely impact the securities markets in the United

States or Japan.\27\ First, as described above, the Index is broad-

based and presently is comprised of 300 stocks with no one stock

dominating the Index. Second, as noted above, the stocks contained in

the Index. Second, as noted above, the stocks contained in the Index

have large capitalizations and are actively-traded. Third, the proposed

position and exercise limits of 25,000 contracts on the same side of

the market, provided that no more than 15,000 of such contracts are in

series in the nearest expiration month, will serve to minimize

potential manipulation and market impact concerns. Fourth, existing

Amex stock index options rules and surveillance procedures will apply

to options on the Index. Finally, the Commission finds that the ability

to use Auto-Ex for orders of up to 50 contracts will provide customers

with liquid markets and efficient executions.

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\27\In addition, the Amex and the Options Price Reporting

Authority (``OPRA'') have both represented that they have the

necessary systems capacity to support those new series of options

that would result from the introduction of Index options (including

full-value and reduced-value Index LEAPS). See Letter from Edward

Cook, Jr., Managing Director, Information Technology, Amex, to

Michael Walinskas, Branch Chief, Options Regulation, Division of

Market Regulation, Commission, dated July 12, 1994; Letter from

Joseph P. Corrigan, Executive Director, OPRA, to Charles Faurot,

Managing Director, Market Data Services, Amex, dated July 18, 1994.

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E. Accelerated Approval of Amendment No. 2

The Commission finds good cause for approving Amendment No. 2 to

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

publication on notice of filing thereof in the Federal Register.

Amendment No. 2 reduces the proposed position limits with respect to

Nikkei 300 Index options from 50,000 contracts on the same side of the

market to 25,000 contracts (provided that no more than 15,000

contracts, as opposed to 30,000 contracts as originally proposed, are

in series in the nearest expiration month). By reducing the position

limits, this amendment will serve to protect investors and the public

interest, and further minimize the potential for manipulation. Further,

the proposal containing the higher position limits was published for

the full 21-day comment period, and no comments were received.

Therefore, the Commission finds that no new regulatory issues are

raised by Amendment No. 2. Accordingly, the Commission believes it is

consistent with Sections 19(b)(2) and 6(b)(5) of the Act to approve

Amendment No. 2 on an accelerated basis.

IV. Solicitation of Comments

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

arguments concerning Amendment No. 2 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. 552, will be available for inspection and

copying in the Commission's Public Reference Section, 450 Fifth Street,

NW., Washington, DC. Copies of such filings 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-Amex-94-19, and should be submitted by September 8, 1994.

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\28\ that the proposed rule change (SR-Amex-94-19), as amended, is

approved.

\28\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.\29\

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\29\17 CFR 200.30-3(a)(12) (1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-20235 Filed 8-17-94; 8:45 am]

BILLING CODE 8010-01-M