Self-Regulatory Organizations; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Changes by the New York Stock Exchange, Inc., the Pacific Stock Exchange, Inc., the American Stock Exchange, Inc., and the Philadelphia Stock Exchange, Inc., To Add Two Positions and Exercise Limit Tiers for Qualifying Equity Option Classes and To Expand the Equity Option Hedge Exemption

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-36409; File Nos. SR-NYSE-95-31; SR-PSE-95-25; SR-Amex-

95-42; SR-Phlx-95-71]

Self-Regulatory Organizations; Notice of Filing and Order

Granting Accelerated Approval of Proposed Rule Changes by the New York

Stock Exchange, Inc., the Pacific Stock Exchange, Inc., the American

Stock Exchange, Inc., and the Philadelphia Stock Exchange, Inc., To Add

Two Positions and Exercise Limit Tiers for Qualifying Equity Option

Classes and To Expand the Equity Option Hedge Exemption

October 23, 1995.

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

(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that

on September 26, October 5, October 16, October 17, 1995, respectively,

the New York Stock Exchange, Inc. (``NYSE''), the Pacific Stock

Exchange, Inc. (``PSE''), the American Stock Exchange,

[[Page 55400]]

Inc. (``Amex``), and the Philadelphia Stock Exchange, Inc. (``Phlx'')

(collectively the ``Exchanges''), filed with the Securities and

Exchange Commission (``Commission'') the proposed rule changes as

described in Items I and II below, which Items have been prepared by

the self-regulatory organizations. The PSE subsequently filed Amendment

No. 1 to their proposed rule change on October 17, 1995.\3\ The

Exchanges have requested accelerated approval of the proposals. The

Commission is approving the proposals on an accelerated basis and

soliciting comments.

\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).

17 CFR 240.19b-4 (1994).

\3\ See letter from Michael D. Pierson, Senior Attorney, Market

Regulation, PSE, to Michael A. Walinskas, Branch Chief, Options

Regulation, Division of Market Regulation, Commission, dated October

13, 1995 (``Amendment No. 1''). In Amendment No. 1, the PSE

requested accelerated approval for their proposed rule change.

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I. Self-Regulatory Organizations' Statements of the Terms of Substance

of the Proposed Rule Changes

The Exchanges propose to add two upper position and exercise limit

\4\ tiers for those equity option classes that meet certain criteria

for high liquidity in the underlying stocks. In addition, the Exchanges

propose to expand the current equity option hedge exemption from twice

to three times the standard or base position limit.\5\

\4\ Positions limits impose a ceiling on the aggregate number of

option contracts on the same side of the market that an investor, or

group of investors acting in concert, may hold or write. Similarly,

exercise limits impose a ceiling on the aggregate long positions in

option contracts that an investor, or group of investors acting in

concert, can or will have exercised within five consecutive business

days.

\5\ The equity hedge exemption currently exempts certain

specified equity options positions from the stated (or base)

position limits where the option contracts are hedged by 100 shares

of stock or securities convertible into such stock (or hedged by the

same number of shares represented by an adjusted option contract),

up to a maximum allowable position of twice the standard or base

limit.

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The Exchanges request the Commission to find good cause, pursuant

to Section 19(b)(2) of the Act, for approving the proposed rule changes

prior to the thirtieth day after publication in the Federal Register.

II. Self-Regulatory Organizations' Statements of the Purpose of, and

Statutory Basis for, the Proposed Rule Changes

In its filings with the Commission, the self-regulatory

organizations included statements concerning the purpose of and basis

for the proposed rule changes and discussed any comments they received

on the proposed rule changes. The text of these statements may be

examined at the places specified in Item III below. The self-regulatory

organizations have prepared summaries, set forth in Sections A, B, and

C below, of the most significant aspects of such statements.

A. Self-Regulatory Organizations' Statements of the Purpose of, and

Statutory Basis for, the Proposed Rule Changes

1. Purpose

The Exchanges are proposing to add two new tiers to their current

three tier position and exercise limits.\6\ The requested tiers are

identical to the new tiers that the Commission recently approved for

the Chicago Board Options Exchange, Inc. (``CBOE'').\7\

\6\ See NYSE Rules 704 and 705; PSE Rules 6.8 and 6.9; Amex

Rules 904 and 905; and Phlx Rules 1001 and 1002.

\7\ See Securities Exchange Act Release No. 36371 (October 13,

1995) (File No. SR-CBOE-95-42) (``CBOE Approval Order'').

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The Exchanges propose to add two position and exercise limit tiers

at 25,000 and 20,000 contract levels. The criterion to qualify for the

proposed 25,000 contract limit will require that the underlying

security must have at least 300 million shares outstanding with 75

million shares traded in the past six months, or have 100 million

shares traded in the past six months. To qualify for the proposed

20,000 contract limit, the underlying security must have at least 240

million shares outstanding with 60 million shares traded in the past

six months, or have 80 million shares traded in the past six months.

According to the Exchanges, the number of equity option classes

currently listed that would qualify for either of these new higher

position and exercise limit tiers is small. The NYSE has 11 options

classes, the PSE has 30 options classes, the Amex has 62 options

classes, and the Phlx has 16 options classes that would qualify for the

25,000 contract tier. Similarly, the NYSE has five options classes, the

PSE has 13 options classes, the Amex has 28 options classes, and the

Phlx has 11 options classes that would satisfy the 20,000 contract tier

requirements.\8\

\8\ The number of options classes listed on the Exchanges that

would qualify for the two new position and exercise limit tiers

should be considered in conjunction with the fact that the NYSE

currently has 170 equity option classes listed, the PSE currently

has 354 equity option classes listed, the Amex currently has 539

equity option classes listed, and the Phlx currently has 350 equity

option classes listed.

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In addition to the proposed 25,000 and 20,000 contract tiers, the

Exchanges are also proposing to expand the equity option position limit

hedge exemption.\9\ This proposal is also identical to the CBOE's

recently approved rule amendment.\10\ The exemption provides that the

maximum allowable position where each option contract is hedged by 100

shares of stock or securities convertible into stock, will be three

times instead of twice the standard or base limit currently

provided.\11\

\9\ See NYSE Rule 704(b)(ii); PSE Rule 6.8, Commentary .07; Amex

Rule 904, Commentary .09; and Phlx Rule 1001, Commentary .07.

\10\ See CBOE Approval Order, supra note 7.

\11\ The Commission notes that the proposed increase in the

maximum hedge exemption will apply to all position limit tiers, not

just to the proposed 25,000 and 20,000 contract tiers.

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The Exchanges are requesting approval of the proposed 20,000 and

25,000 position and exercise limit tiers for qualifying equity option

classes and an expansion of the current equity option hedge exemption

to three times the base position limit because the Exchanges strongly

believe that the investing community will benefit from the rule

proposals. In particular, according to the Exchanges, investors with

sizable holdings, accounts, or assets who employ equity options to

hedge large holdings, and who have found the existing equity option

position limit tiers and hedge exemption to be too restrictive will be

greatly benefited through the rule proposals. The Exchanges do not

believe that the increased limits and expanded equity hedge exemption

proposed herein will increase the risk of, or exposure to, market

disruption resulting from the higher number of equity option contracts

permitted to be under common control.

2. Statutory Basis

The Exchanges believe that the proposed rule changes are consistent

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

Section 6(b)(5) of the Act in particular,\12\ in that the proposals are

designed to remove the impediments to and perfect the mechanisms of a

free and open market and a national market system by providing

investors with enhanced hedging capabilities.

\12\ 15 U.S.C. 78f(b)(5) (1988).

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B. Self-Regulatory Organizations' Statements on Burden on Competition

The Exchanges do not believe that the proposed rule changes will

impose any burden on competition.

C. Self-Regulatory Organizations' Statements on Comments on the

Proposed Rule Changes Received From Members, Participants, or Others

No written comments were either solicited or received.

[[Page 55401]]

III. Solicitation of Comments

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

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule changes that are filed

with the Commission, and all written communications relating to the

proposed rule changes 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 at the Commission's Public Reference Section, 450 Fifth Street,

N.W., Washington, D.C. 20549. Copies of such filings also will be

available for inspection and copying at the principal offices of the

Exchanges. All submissions should refer to File Nos. SR-NYSE-95-31, SR-

PSE-95-25, SR-Amex-95-42, and SR-Phlx-95-71, and should be submitted by

November 21, 1995.

IV. Commission's Findings and Order Granting Accelerated Approval of

Proposed Rule Changes

A. Description and Background

Since the inception of standardized options trading, the options

exchanges have had rules imposing limits on the aggregate number of

options contracts that a member or customer could hold or exercise.

These rules are intended to prevent the establishment of large options

positions that can be used or might create incentives to manipulate or

disrupt the underlying market so as to benefit the options position. In

particular, position and exercise limits are designed to minimize the

potential for mini-manipulations \13\ and for corners or squeezes of

the underlying market. In addition, they serve to reduce the

possibility for disruption of the options market itself, especially in

illiquid options classes.

\13\ Mini-manipulation is an attempt to influence, over a

relatively small range, the price movement in a stock to benefit a

previously established derivatives position.

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In establishing position and exercise limits, the Commission has

been careful to balance two competing concerns. First, the Commission

has recognized that the limits must be sufficient to prevent investors

from disrupting the market for the underlying security by acquiring and

exercising a number of options contracts disproportionate to the

deliverable supply and average trading volume of the underlying

security. At the same time, the Commission has realized that limits

must not be established at levels that are 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\

\14\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. at 189-91

(Comm. Print 1978) (``Options Study'').

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In October 1980, the Commission approved proposed rule changes by

several options exchanges to increase position and exercise limits from

1,000 to 2,000 contracts for all individual equity options classes.\15\

In conjunction with the approval, the Commission received commitments

from the options exchanges to study the effects of the increased

limits. The Commission indicated that the experience gained under the

increased limits, if coupled with adequate monitoring and surveillance

procedures, could serve as a basis for considering further position and

exercise limit modifications.

\15\ See Securities Exchange Act Release No. 17237 (October 22,

1980), 45 FR 71454 (October 28, 1980) (order approving File Nos. SR-

PSE-80-15, SR-Amex-80-23, and SR-Phlx-80-21) (``1980 Release'').

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In July 1983, the Commission approved a further increase in

position and exercise limits for individual stock options based on a

tiering approach.\16\ Limits for options on stocks with the greatest

trading volume and public float were increased to 4,000 contracts and

limits on all other options classes were increased to 2,500

contracts.\17\ In approving the increased limits under a two-tiered

framework, the Commission noted that tiering was consistent with the

gradual, evolutionary approach that the Commission and the exchanges

have adopted in increasing position and exercise limits.

\16\ See Securities Exchange Act Release No. 19975 (July 15,

1983), 48 FR 33389 (July 21, 1983) (order approving File Nos. SR-

PSE-83-09, SR-Amex-83-05, and SR-Phlx-83-04) (``1983 Release'').

\17\ To be eligible for the 4,000 contract limit an underlying

security was required to have had either (i) trading volume of at

least 20 million shares during the most recent six month trading

period; or (ii) trading volume of at least 15 million shares during

the most recent six month trading period and at least 60 million

shares currently outstanding. All other options not meeting these

requirements were subject to the 2,500 contract limits.

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In 1985, the Commission approved a further increase in position and

exercise limits for individual equity options. This approval extended

the tiering approach commenced by the options exchanges in 1983.\18\

The Commission noted in the 1985 Release that liberalizing position and

exercise limits would further increase the potential depth and

liquidity of the individual stock options markets without significantly

increasing concerns regarding intermarket manipulations or disruptions

of the market for the options or underlying securities.

\18\ See Securities Exchange Act Release No. 21907 (March 29,

1985), 50 FR 13440 (April 4, 1985) (order approving File Nos. SR-

PSE-85-01, SR-Amex-84-30, and SR-Phlx-84-25) (``1985 Release''). The

1985 Release created a three-tiered system of position and exercise

limits of 8,000, 5,500, and 3,000 contracts. To be eligible for the

8,000 contract limit an underlying security was required to have had

either (i) trading volume of at least 40 million shares during the

most recent six month trading period; or (ii) trading volume of at

least 30 million shares during the most recent six month trading

period and at least 120 million shares currently outstanding. To be

eligible for the 5,500 contract limit an underlying security was

required to have had either (i) trading volume of at least 20

million shares during the most recent six month trading period; or

(ii) trading volume of at least 15 million shares during the most

recent six month trading period and at least 40 million shares

currently outstanding. All other options not meeting these

requirements were subject to the 3,000 contract limits.

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Lastly, in December 1993, the Commission approved the Exchanges'

existing position and exercise limit framework for individual equity

options.\19\ Depending on certain criteria related to the trading

volume of the underlying stock or a combination of both the trading

volume and the number of shares outstanding of the underlying stock,

the Exchanges' current position and exercise limits were established at

levels of 10,500 contracts, 7,500 contracts, and 4,500 contracts.\20\

\19\ See Securities Exchange Act Release Nos. 33284 (December 3,

1993), 58 FR 65215 (December 13, 1993) (order approving File No. SR-

NYSE-93-41); 33282 (December 3, 1993), 58 FR 65218 (December 13,

1993) (order approving File No. SR-PSE-92-38); 33285 (December 3,

1993), 58 FR 65201 (December 13, 1993) (order approving File No. SR-

Amex-93-27); and 33288 (December 3, 1993), 58 FR 65221 (December 13,

1993) (order approving File No. SR-Phlx-93-07) (collectively ``1993

Release'').

\20\ To be eligible for the 10,500 contract limit an underlying

security must have either (i) trading volume of at least 40 million

shares during the most recent six month trading period; or (ii)

trading volume of at least 30 million shares during the most recent

six month trading period and at least 120 million shares currently

outstanding. To be eligible for the 7,500 contract limit an

underlying security must have either (i) trading volume of at least

20 million shares during the most recent six month trading period;

or (ii) trading volume of at least 15 million shares during the most

recent six month trading period and at least 40 million shares

currently outstanding. All other options not meeting these

requirements are subject to the 4,500 contract limits.

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The Exchanges proposed to add two position and exercise limit tiers

at 25,000 and 20,000 contract levels. As stated above, the criterion to

qualify for

[[Page 55402]]

the proposed 25,000 contract limit will require that the underlying

security must have at least 300 million shares outstanding with 75

million shares traded in the past six months, or have 100 million

shares traded in the past six months. To qualify for the proposed

20,000 contract limit, the underlying security must have at least 240

million shares outstanding with 60 million shares traded in the past

six months, or have 80 million shares traded in the past six months.

In addition to the proposed 25,000 and 20,000 contract tiers, the

Exchanges are also proposing to expand the equity hedge exemption.

Under this proposal, the maximum allowable position, after exempting

from the base limit specified positions where the option contract is

hedged by 100 shares of stock or securities convertible into stock,

will be three times instead of twice the standard or base limit

currently provided.

B. Discussion

The Commission finds that the proposed rule changes are consistent

with the requirements of the Act and the rules and regulations

thereunder applicable to the national securities exchanges, and, in

particular, with the requirements of Section 6(b)(5).\21\ Specifically,

the Commission believes that the proposed addition of position and

exercise limit tiers of 25,000 contracts and 20,000 contracts for

qualifying equity options, and the proposed expansion of the equity

hedge exemption to three times the standard or base limit will

accommodate the needs of investors and market participants. The

Commission also believes that the proposed rule changes will increase

the potential depth and liquidity of the equity options market as well

as the underlying cash market without significantly increasing concerns

regarding intermarket manipulations or disruptions of the market for

the options or underlying securities. Accordingly, as discussed below,

the rule proposal is consistent with the requirements of Section

6(b)(5) that exchange rules facilitate transactions in securities while

continuing to further investor protection and the public interest.

\21\ 15 U.S.C. 78f(b)(5) (1988).

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In approving the increased limits, the Commission recognizes that

securities with active and deep trading markets, as well as with broad

public ownership, are more difficult to manipulate or disrupt than

securities having less active and deep markets and having smaller

public floats.\22\ The proposed additional position and exercise limit

tiers recognize this by seeking to minimize the restraints on those

options classes that can accommodate larger limits without

significantly increasing manipulation concerns.\23\ In particular, the

proposed limit of 25,000 contracts and 20,000 contracts for options on

the most actively traded, widely held securities, permits the

Commission to avoid placing unnecessary restraints on those options

where the manipulative potential is the least and the need for

increased positions likely is the greatest. Accordingly, the Commission

believes that the additional position and exercise limit tiers and the

expanded equity hedge exemption is warranted.

\22\ The Commission notes that the quantitative options listing

and maintenance standards require: (1) A minimum of 7 and 6.3

million shares outstanding, respectively, which are owned by persons

other than ``insiders,'' as defined in Section 16 of the Act; (2) a

minimum of 2,000 and 1,600 shareholders, respectively; (3) trading

volume of at least 2.4 and 1.8 million shares, respectively, during

the past twelve months; (4) for an original listing, the market

price per share of the underlying security must have closed at or

above $7.50 during the majority of business days over the preceding

three months; and (5) to maintain its listing, the market price per

share of the underlying security must have closed at or above $5

during the majority of business days over the preceding six months.

\23\ The Commission continues to believe that proposals to

increase position and exercise limits must be justified and

evaluated separately. After reviewing the proposed exercise limits,

along with the eligibility criteria for the two new tiers, the

Commission has concluded that the proposed exercise limit additions

do not raise manipulation problems or increase concerns over market

disruption in the underlying securities.

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The Commission believes that the proposed additions to the

Exchanges' position and exercise limit tiers and increased hedge

exemption appear to be both appropriate and consistent with the

Commission's gradual, evolutionary approach. There are no ideal limits

in the sense that options positions of any given size can be stated

conclusively to be free of any manipulative concerns. The Commission,

however, is relying on the absence of discernible manipulation problems

under the current framework as an indicator that the proposed

additional limit tiers and the expanded hedge exemption is justified.

The Commission does not believe that the addition of the two new

higher limit tiers and the expanded hedge exemption will have any

adverse effects on the options markets. In approving the two-tiered

system in 1983, the Commission stated that it did not believe that

requiring traders to keep track of two limits rather than one was

burdensome or confusing or would lead to accidental violations.\24\ The

Commission does not believe that a change from the current three tiers

to five tiers should change this conclusion. Similarly, as the

Commission views the expansion of the equity hedge exemption as

consistent with its steady progression in this area, the enactment of

this portion of the proposed rule changes should not prove difficult to

implement or cumbersome to monitor.

\24\ In this regard, the Commission notes that the Exchanges

routinely, and on a continuous basis, review the trading

characteristics of the underlying stocks to determine the

appropriate position and exercise limit tiers for the option

classes.

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The Commission believes that although position and exercise limits

for options must be sufficient to protect the options and related

markets from disruptions by manipulations, the limits must not be

established at levels that are so low as to discourage participation in

the options market by institutions and other investors with substantial

hedging needs or to prevent market makers from adequately meeting their

obligations to maintain a fair and orderly market. In this regard, the

Exchanges have noted that customers and member firms view the current

position and exercise limits for certain options classes as too low.

The Commission believes that the Exchanges' proposals are a reasonable

and appropriately tailored effort to accommodate the identified needs

of options market participants. In this regard it is important to note

that the proposals only add higher position and exercise limit tiers

for classes of options overlying the most liquid stocks. As a result,

the proposals affect only a small number of equity option classes that

are traded on the Exchanges.

From 1988 through 1990, the Commission approved pilot programs

proposed by the Exchanges which provided exemptions from position

limits for certain fully hedged equity option positions.\25\ The pilot

programs created an exemption from equity option position and exercise

limits for accounts that had established one of the four most commonly

used hedged positions.\26\ Under this exemption, the maximum position

limit (including the allowable exemptions) could not exceed twice the

established option position limit.\27\

\25\ See Securities Exchange Act Release Nos. 25811 (June 20,

1988), 53 FR 23821 (June 24, 1988) (order approving File No. SR-PSE-

88-09); 25738 (May 24, 1988), 53 FR 20201 (June 2, 1988) (order

approving File Nos. SR-Amex-87-13 and SR-Phlx-87-37); and 27786

(March 8, 1990), 55 FR 9523 (March 14, 1990) (order approving File

No. SR-NYSE-89-09) (``Pilot Approval Orders.'').

\26\ The four hedged positions are: (1) long stock and short

call; (2) long stock and long put; (3) short stock and long call;

and (4) short stock and short put.

\27\ In May 1995, after several extensions, the Commission

granted permanent approval to the Exchanges' hedge exemption pilot

programs. See Securities Exchange Act Release No. 35738 (May 18,

1995), 60 FR 27573 (May 24, 1995) (order approving File Nos. SR-

NYSE-95-04, SR-PSE-95-05, SR Amex-95-13, and SR-Phlx-95-10).

[[Page 55403]]

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The Exchanges currently propose to increase the hedge exemption to

three times the applicable position limits. According to the Exchanges,

as institutional accounts are unable to fully hedge their stock

holdings due to the restrictive limits, investors are unnecessarily

forced to keep a portion of their portfolio at risk. The Commission

believes that the Exchanges' proposal to expand the hedge exemption is

an appropriate method to accommodate the identified needs of options

market participants. By increasing the hedge exemption, the Commission

believes, large hedge funds and institutional accounts will be provided

with the means necessary to adequately hedge their stock holdings

without adding risk to the options market.

Lastly, the Commission notes that despite an appreciable growth in

equity options trading and the sophisticated and automated surveillance

procedures employed by the Exchanges, the last change in position

limits occurred in 1993. Based on the Exchanges' experience, the

Commission believes that the proposed increased hedge exemption and

additional limit tiers should result in little or no additional risk to

the marketplace.\28\

\28\ The Commission notes that to the extent the potential for

manipulation increases because of the additional tiers and expanded

hedge exemption, the Commission believes the Exchanges' surveillance

programs will be adequate to detect as well as to deter attempted

manipulative activity. The Commission will, of course, continue to

monitor the Exchanges' surveillance programs to ensure that problems

do not arise.

The Commission finds good cause to approve the proposed rule

changes prior to the thirtieth day after the date of publication of

notice of filing thereof in the Federal Register. Specifically, by

accelerating the approval of the Exchanges' rule proposals, the

Commission is conforming the Exchanges' position and exercise limits

with those levels recently approved for the CBOE.\29\ Accelerated

approval of the proposed rule changes will thereby provide for the

desired uniformity of the exchanges' position and exercise limits as

well as hedge exemption rules. Any other course of action could lead to

unnecessary investor confusion. In addition, the CBOE's proposal was

noticed for the entire twenty-one day comment period and generated no

negative responses.\30\ Accordingly, the Commission believes that it is

consistent with Section 6(b)(5) of the Act to approve the proposed rule

changes on an accelerated basis.

\29\ See CBOE Approval Order, supra note 7.

\30\ In response to the CBOE's proposal, the Commission received

two comment letters. Both comment letters were generally supportive

of the CBOE's proposed rule change, and are described more fully in

the CBOE Approval Order, supra note 7.

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V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) \31\ of the

Act that the proposed rule changes (File Nos. SR-NYSE-95-31, SR-PSE-95-

25, SR-Amex-95-42, and SR-Phlx-95-71) are hereby approved on an

accelerated basis.

\31\ 15 U.S.C. Sec. 78s(b)(2) (1988).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\32\

\32\ 17 CFR 200.30-3(a)(12) (1994).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 95-26899 Filed 10-30-95; 8:45 am]

BILLING CODE 8010-01-M