Self-Regulatory Organizations; Notice of Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Position and Exercise Limits for Equity Options Overlying Securities Not Subject to Standardized Options Trading

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35180; File No. SR-NASD-94-54]

Self-Regulatory Organizations; Notice of Proposed Rule Change by

the National Association of Securities Dealers, Inc. Relating to

Position and Exercise Limits for Equity Options Overlying Securities

Not Subject to Standardized Options Trading

December 30, 1994.

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

(``Act''),\1\ notice is hereby given that on October 12, 1994, the

National Association of Securities Dealers, Inc. (``NASD'' or

``Association'') filed with the Securities and Exchange Commission

(``Commission'' or ``SEC'') the proposed rule change as described in

Items I, II, and III below, which Items have been prepared by the NASD.

The Commission is publishing this notice to solicit comments on the

proposed rule change from interested persons.

\1\15 U.S.C. 78s(b)(1) (1988). [[Page 2414]]

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

Substance of the Propose Rule Change

The NASD proposes to amend Section 33 of the NASD's Rules of Fair

Practice, the NASD's position limit rule for standardized and

conventional options, to increase the position and exercise limits for

certain equity securities that are not subject to standardized options

trading.\2\ In particular, under the proposal, if a security qualifies

for a position limit of 7,500 contracts or 10,500 contracts,\3\ it will

be subject to that higher position limit, regardless of whether it has

standardized options traded on it or not.

\2\Position limits impose a ceiling on the number of option

contracts in each class on the same side of the market (i.e.,

aggregating long calls and short puts and long puts and short calls)

that can be held or written by an investor or group of investors

acting in concert. Exercise limits restrict the number of options

contracts which an investor or group of investors acting in concert

can exercise within five consecutive business days. Under NASD

Rules, exercise limits correspond to position limits, such that

investors in options classes on the same side of the market are

allowed to exercise, during any five consecutive business days, only

the number of options contracts set fourth as the applicable

position limit for those options classes. See Sections 33(b)(3) and

(4) of the NASD Rules of Fair Practice.

\3\See infra note 4 for a description of how the position limit

for a particular equity security is determined.

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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 NASD 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 NASD 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, under NASD rules, position and exercise limits for

exchange-listed options traded by access firms\4\ or their customers

are determined according to a ``three-tiered'' system, where, depending

upon the float and trading volume of the underlying security, the

position limit for options on that security is 4,500, 7,500, or 10,500

contracts.\5\ For conventional equity options trading by any NASD

member,\6\ if the underlying security is subject to standardized

options trading, the NASD's position limit for conventional options on

that security is the same position limit imposed by the options

exchange(s) trading the option. However, if the security underlying the

option is not subject to standardized options trading, the applicable

position limit for conventional options on the security is the lowest

tier, i.e., 4,500 contracts.

\4\``Access'' firms are NASD members which conduct a business in

exchange-listed options but which are not members of any of the

options exchanges upon which the options are listed and traded.

\5\In this connection, the NASD's rules do not specifically

govern how a specific equity option falls within one of the three

position limit tiers. Rather, the NASD's position limit rule

provides that the position limit established by an options

exchange(s) for a particular equity option is the applicable

position limit for purposes of the NASD's rule. Under the rules of

each of the options exchanges, if the security underlying a

standardized option has trading volume of 40,000,000 shares over the

most recent six-month period or trading volume of 30,000,000 shares

over the most recent six-month period and float of 120,000,000, it

is subject to a position limit of 10,500 contracts; if the security

underlying a standardized option has trading volume of 20,000,000

shares over the most recent six-month period or trading volume of

15,000,000 shares over the most recent six-month period and float

40,000,000, it is subject to a position limit of 7,500 contracts;

and, if the underlying security is ineligible for a 10,500 or 7,500

contract position limit, it is subject to a 4,500-contract position

limit. The rules of each options exchange are uniform in regard to

the above. See e.g., Commentary .07 to American Stock Exchange Rule

904 and Interpretation and Policy .02 to Chicago Board Options

Exchange Rule 4.11.

\6\Conventional equity options are defined in Section

33(b)(2)(GG) of the NASD Rules of Fair Practice to mean ``any option

contract not issued, or subject to issuance, by The Options Clearing

Corporation.''

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In some instances, however, a security may qualify for an options

position limit of 7,500 or 10,500 contracts but it is subject to a

position and exercise limit of 4,500 contracts because it does not

underlie a standardized option. Given that these securities qualify for

higher position limits but are not eligible for them solely because

there is no standardized option traded on them in the U.S., the NASD

believes its option position limit rule may be unduly restrictive for

these securities and unnecessarily constrain members' legitimate

hedging activity. Accordingly, the NASD proposes to amend Section 33 to

provide that the position limit for options on a security shall be

determined by the position limit tier the security falls under,

regardless of whether the security is subject to standardized options

trading.\7\

\7\To ensure that the higher position limits for conventional

options overlying securities not subject to standardized options

trading are only available for securities qualifying for a position

limit of 7,500 or 10,500 contracts, a member must demonstrate to the

NASD's Market Surveillance Department that the security satisfies

the standards for such higher options position limit prior to

establishing an unhedged options position on that security in excess

of 4,500 contracts.

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The NASD believes its proposal is warranted for the following

reasons. First, if a security has sufficient trading volume and public

float to satisfy the standards for a position limit of 7,500 contracts

or 10,500 contracts, the NASD does not believe that raising the

position and exercise limits for conventional options on the security

will adversely affect the cash market for the security. In the NASD's

view, if the cash market for a security is large enough to qualify for

an options position limit of 7,500 contracts or 10,500 contracts, it is

irrelevant whether that security is only subject to conventional

options trading and not standardized options trading. The NASD believes

the primary consideration governing the appropriate position limit

level for options on a security should be the characteristics and size

of the underlying cash market for that security, not whether the

options overlying the security are standardized or conventional.

Second, the NASD does not believe its members' activities in the

conventional options market should be linked to or constrained by

decisions of the options exchanges concerning whether or not to trade

options on particular securities.

Moreover, the NASD believes that its proposal will not compromise

the stability of the securities markets underlying the conventional

options eligible for the higher position limits. In this regard, for

those securities that will be eligible for higher position limits under

the proposal, there will only be a slight increase in the percentage of

their capitalization that an investor or group of investors acting in

concert can control under the new position limits.

Therefore, the NASD believes the proposed rule change is consistent

with Section 15A(b)(6) of the Act. Section 15A(b)(6) requires that the

rules of a national securities association be designed to prevent

fraudulent and manipulative acts and practices, to promote just and

equitable principles of trade, to foster cooperation and coordination

with persons engaged in regulating, clearing, settling, processing

information with respect to, and facilitating transactions in

securities, to remove impediments to and perfect the mechanism of a

free and open market and a national market system and, in general, to

protect investors and the public interest. Specifically, the NASD

believes the proposal will promote the maintenance of fair and orderly

markets because it will serve to facilitate the use [[Page 2415]] of

conventional equity options by investors seeking to satisfy their

legitimate hedging needs, without compromising the integrity of the

underlying securities markets. In addition, to the extent that

investors have greater assurance that they can hedge larger stock

positions through the use of conventional options, liquidity in the

underlying cash market may be enhanced by the proposal.

B. Self-Regulatory Organization's Statement on Burden on Competition

The NASD believes that the proposed rule change will not result in

any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

Comments 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 NASD 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, N.W., Washington, D.C. 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 Room. Copies of such filing will also be

available for inspection and copying at the principal office of the

NASD. All submissions should refer to File Number SR-NASD-94-54 and

should be submitted by January 30, 1995.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\8\

\8\17 CFR 200.30-3(a)(12)(1993).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 95-430 Filed 1-6-95; 8:45 am]

BILLING CODE 8010-01-M