Self-Regulatory Organizations; Filing of Proposed Rule Change by the Pacific Stock Exchange, Inc. Relating to Listing and Trading Options on the Interactive Communications Sector Index

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33431; File No. SR-PSE-93-32]

Self-Regulatory Organizations; Filing of Proposed Rule Change by

the Pacific Stock Exchange, Inc. Relating to Listing and Trading

Options on the Interactive Communications Sector Index

January 5, 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 November

30, 1993, the Pacific Stock Exchange (``PSE'' 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 self-regulatory organization. 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 PSE proposes to list for trading options on the Interactive

Communications Sector Index. The text of the proposed rule change is

available at the Office of the Secretary, PSE, 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 Exchange 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 PSE 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

The Exchange proposes to trade options on the Interactive

Communications Sector Index (``Index''), a new stock index developed by

the Exchange based on various stocks in the interactive communications

industry that are traded on either the New York Stock Exchange, Inc.

(``NYSE''), the American Stock Exchange, Inc. (``Amex''), or are

national market system (``NMS'') securities traded through the

facilities of the National Association of Securities Dealers (``NASD'')

Automated Quotations System (``NASDAQ''). The Exchange also proposes to

list long-term options on the Index and on a reduced-value Index

(``Index LEAPS''), which will trade independent of and in addition to

regular Index options traded on the Exchange.

Composition of the Index

The Index contains securities of highly-capitalized companies in

the interactive communications industry. Currently, the Index is

comprised of 24 stocks from the following three categories: Content

providers (8 stocks);\1\ distribution networks (8 stocks);\2\ and

information processors (8 stocks).\3\ More specifically, the Index is

comprised of individual stocks from the following 15 industry

subgroups: Transaction services; filmed entertainment; programmers;

music, games & education; publishing; business information systems;

cable television operating companies; regional telephone companies;

long-distance telephone companies; wireless communications; computers;

consumer electronics; software; semiconductors; and communications

equipment.

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\1\These components of the Index are: Time Warner, Inc.; Walt

Disney Co.; turner Broadcasting System Inc. (Class B); QVC Network,

Inc.; Viacom, Inc. (Class B); Tribune Company; Electronic Arts,

Inc.; and Broderbund Software, Inc.

\2\These components of the Index are: Bell Atlantic Corp.;

BellSouth Corp.; U.S. West, Inc.; Motorola, Inc.; American Telephone

& Telegraph Co.; Comcast Corp.; Pacific Telesis Group; and Telephone

and Data Systems, Inc.

\3\These components of the Index are: DSC Communications Corp.;

Northern Telecom Limited; 3DO Co.; Apple Computer, Inc.; Silicon

Graphics, Inc.; General Instrument Corp.; Scientific-Atlanta, Inc.;

and Microsoft Corp.

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The 24 component stocks are listed for trading on the NYSE (13

stocks), the Amex (3 stocks),\4\ or are traded through NASDAQ (8

stocks).\5\ As of November 9, 1993, all of the component stocks in the

Index, with the exception of one component (comprising 4.2% of the

Index value) meet the Exchange's initial listing standards set forth in

PSE Rule 3.6.

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\4\All of the Amex components are listed pursuant to Amex's

Original Listing Requirements contained in Sections 101-145 of the

Amex Company Guide. Telephone conversation between Michael Pierson,

Senior Attorney, Market Regulations, PSE, and Brad Ritter, Attorney,

Office of Derivatives Regulation, Division of Market Regulation,

Commission, on January 5, 1994.

\5\Currently all of the NASDAQ issues included in the Index are

NMS securities.

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Index Calculation

The Index value is calculated using an ``equal-dollar weighting''

methodology designed to ensure that each of the component securities is

represented in approximately an ``equal'' dollar amount in the Index.

The Exchange believes that this method of calculation is important

since even among the largest companies in the interactive

communications industry there is a great disparity in market value. For

example, although the stocks included in the Index represent many of

the most highly capitalized companies in the interactive communications

industry, AT&T currently represents over 22% of the aggregate market

value of the Index. The Exchange believes that options on market-value

weighted indexes dominated by one component stock are less useful to

investors, since the index will tend to represent the one component and

not the target industry that the Index is designed to represent.

The following is a description of how the equal-dollar weighted

calculation method works. As of the market close on November 11, 1993,

a portfolio of interactive communications stocks was established

representing an investment of $41,667 in the stock (rounded to the

nearest whole share) of each of the companies in the Index. The value

of the Index equals the current market value of the sum of the assigned

number of shares of each of the stocks in the Index portfolio divided

by the Index divisor. Each quarter, following the close of trading on

the third Friday of January, April, July, and October, the Index

portfolio will be adjusted by changing the number of whole shares of

each component stock so that each company is again represented in

``equal'' dollar amounts. The Exchange has chosen to rebalance the

Index following the close of trading on the quarterly expiration cycle

because it allows an option contract to be held for up to three months

without a change in the Index portfolio while at the same time,

maintaining the equal-dollar weighting feature of the Index. If

necessary, a divisor adjustment is made when the rebalancing occurs to

ensure continuity of the Index's value. The newly adjusted portfolio

then becomes the basis for the Index's value on the first trading day

following the quarterly adjustment.

The Exchange does not believe that there will be investor confusion

regarding the adjustments since they will be done on a regular and

timely basis, with adequate notice given. Specifically, the Exchange

represents that an information circular will be distributed to all

Exchange members notifying them of the quarterly changes. This circular

will also be sent by facsimile to the Exchange's contacts at the major

options firms, mailed to recipients of the Exchange's options-related

information circulars, and made available to subscribers of the Options

News Network. In addition, the Exchange will include in its promotional

and marketing materials for the Index a description of the equal-dollar

weighting methodology.

As noted above, the number of shares of each component stock in the

Index portfolio remains fixed between quarterly reviews except in the

event of certain types of corporate actions such as the payment of a

dividend (other than an ordinary cash dividend), stock distribution,

stock split, reverse stock split, rights offering, distribution,

reorganization, recapitalization, or similar event with respect to the

component stocks. In a merger or consolidation of an issuer of a

component stock, if the stock remains in the Index, the number of

shares of that security in the portfolio may be adjusted, to the

nearest whole share, to maintain the component's relative weight in the

Index at the level immediately prior to the merger or consolidation. In

the event of a stock replacement, the average dollar value of the

remaining portfolio components will be calculated and that amount

invested in the stock of the new component, to the nearest whole share.

In all cases, the divisor will be adjusted, if necessary, to ensure

Index continuity.

The Exchange or its designee will calculate and maintain the Index,

and may at any time or from time to time substitute stocks, or adjust

the number of stocks included in the Index, based on changing

conditions in the interactive communications industry. However, in the

event the Exchange determines to increase the number of index component

stocks to greater than thirty-two or reduce the number of component

stocks to fewer than sixteen, the Exchange will give prior written

notice to the Commission.\6\ In selecting securities to be included in

the Index, the Exchange will be guided by a number of factors including

market value of outstanding shares and trading activity. The

eligibility standards for Index components are described below.

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\6\Such a change in the number of components in the Index may

warrant the submission of a rule filing pursuant to Section 19 of

the Act of Rule 19b-4 thereunder.

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The value of the Index will be calculated every fifteen seconds

throughout the trading day by Bridge Data Services and will be

disseminated by the Options Price Reporting Authority to wire services,

quote vendors and the financial media.

Expiration and Settlement

The proposed options on the Index will be European-style\7\ and

cash-settled. The Exchange's standard options trading hours, from 6:30

a.m. to 1:15 p.m. Eastern Standard Time, will apply. The options on the

Index will expire on the Saturday (``Expiration Saturday'') following

the third Friday of the expiration month. The last trading day in an

expiring series will normally be the second to the last business day

preceding Expiration Saturday (normally a Thursday), with trading to

cease at the close of business on such day.

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\7\European-style options can only be exercised during a

specified period before the options expire.

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The Exchange plans to list option series with expirations in the

three near-term calendar months and in the two additional calendar

months in the January cycle. In addition, the Exchange proposes to list

longer term option series having up to thirty-six months to expiration.

In lieu of such long-term options on a full-value Index level, the

Exchange also proposes to have the option of listing long-term,

reduced-value put and call options based on one-tenth (\1/10\th) the

Index's full value. In either event, the interval between expiration

months for either a full-value or reduced-value long-term option would

not be less than six months. The trading of any long-term options would

be subject to the same rules which govern the trading of all the

Exchange's index options, including sales practice rules, margin

requirements and floor trading procedures and all options will have

European-style exercise. Position limits on reduced-value long-term

Index options would be ten times the position limits for regular (full

value) Index options and would be aggregated on a one for one basis

with such options (for example, if the position limit for full value

options is 10,500 contracts on the same side of the market, then the

position limit for the reduced-value options will be 105,000 contracts

on the same side of the market).

The Index value for purposes of settling the Index options will be

calculated based upon the opening prices of the component securities

pursuant to the normal opening procedures of the primary exchange where

the securities are traded on the Friday before Expiration Saturday. In

the case of securities traded through the NASDAQ system, the first

reported sale price on the Friday before Expiration Saturday will be

used. As trading begins in each of the Index's component securities,

its opening sale price is captured for use in the calculation. Once all

of the component stocks have opened, the Index settlement value is then

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

the last trading day before Expiration Saturday, then the prior day's

last sale price is used in the calculation.

Eligibility Standards for Index Components

In choosing among interactive communications industry stocks for

inclusion in the Index, the Exchange will focus only on stocks that are

traded on the NYSE, the Amex,\8\ or are NMS securities traded through

the NASDAQ. In addition, the Exchange intends to select stocks that:

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\8\Securities listed on the Amex will only be considered for

inclusion in the Index if those securities satisfy the Original

Listing Requirements set forth in Sections 101-145 of the Amex

Company Guide. Telephone conversation between Michael Pierson,

Senior Attorney, Market Regulation, PSE, and Brad Ritter, Attorney,

Office of Derivatives Regulation, Division of Market Regulation,

Commission, on January 5, 1994.

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(1) Have a minimum market value (in U.S. dollars of at least $75

million;\9\ and

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\9\In the case of ADRs, this represents market value as measured

by total world-wide shares outstanding.

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(2) Have an average monthly trading volume in U.S. markets over the

previous six month period of not less than one million shares (or

American Depository Receipts (``ADRs''\10\)).

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\10\An ADR is a negotiable receipt which is issued by a

depository, generally a bank, representing shares of a foreign

issuer that have been deposited and are held, on behalf of holders

of the ADRs, at a custodian bank in the foreign issuer's home

country.

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The Index is currently comprised of 24 component securities. Of the

components, 23 are eligible for, and are the subject of, standardized

options trading.\11\ However, to address concerns about the possibility

of manipulation of an index containing a large percentage of stocks

that do not meet the eligibility standards applicable to stocks

eligible for standardized options trading, at each quarterly

rebalancing, stocks that meet the then current criteria for

standardized options trading set forth in Exchange Rule 3.6 will be

required to account for at least 90% of the Index's numerical index

value.

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\11\3DO Co. is the only component of the Index not currently

eligible for standardized options trading.

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Exchange Rules Applicable to Stock Index Options

PSE Rule 7 will apply to the trading of options contracts based on

the Index. Surveillance procedures currently used to monitor trading in

the Exchange's other index options will also be used to monitor trading

in options on the Index. The Exchange proposes to 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 (exercise) price intervals

when the value of the Index is below 200 points.

Basis

The Exchange believes that the proposed rule change is consistent

with section 6 of the Act, in general, and furthers the objectives of

section 6(b)(5) of the Act, in particular, in that it is designed to

prevent fraudulent and manipulative acts and practices and to promote

just and equitable principles of trade.

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

The Exchange 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

Written comments on the proposed rule change were neither solicited

nor received.

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 reasons 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 in 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 PSE. All

submissions should refer to File No. SR-PSE-93-32 and should be

submitted by February 3, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\12\

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

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-822 Filed 1-12-94; 8:45 am]

BILLING CODE 8010-01-M