Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating to an Increase in Narrow-Based Index Option Position and Exercise Limits

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37629; File No. SR-Phlx-96-33]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the Philadelphia Stock Exchange, Inc., Relating to an

Increase in Narrow-Based Index Option Position and Exercise Limits

September 3, 1996.

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 August 2, 1996, the Philadelphia Stock Exchange, Inc. (``Phlx'' 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.

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

\2\ 17 CFR 240.19b-4.

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

Substance of the Proposed Rule Change

The Phlx, pursuant to Rule 19b-4 of the Act, proposes to amend Phlx

Rules 1001A(b)(1) and 1002A to increase the position and exercise

limits for narrow-based index options from 6,000, 9,000, or 12,000

contracts to 9,000, 12,000, or 15,000 contracts.\3\

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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). 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.

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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 self-regulatory organization

included statements concerning the prupose 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 Section 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

1. Purpose

According to the Phlx, the purpose of the proposed rule change is

to increase narrow-based index option position and exercise limits in

order to attract additional trading interest and, thus, promote depth

and liquidity and Phlx index options. The Exchange believes that the

current limits constrain certain investors from trading index options.

Currently, Phlx Rules 1001A(b)(1) and 1002A establish the following

position and exercise limits for narrow-based (industry) index options:

(i) 6,000 contracts for an index where a single component stock

accounted, on average, for 30% or more of the index value during the

30-day period immediately preceding the Exchange's semi-annual review

of narrow-based index option position limits; (ii) 9,000 contracts for

an index where a single component stock accounted, on average, for 20%

or more of the index value or any five component stocks together

accounted, on average, for more than 50% of the index value, but no

single component stock in the group accounted, on average, for 30% or

more of the index value during the 30-day period immediately preceding

the Exchange's semi-annual review of narrow-based index option position

limits; and (iii) 12,000 contracts where the conditions required a

limit of 6,000 contracts or 9,000 contracts have not occurred. For the

reasons presented herein, the Phlx proposes to amend Phlx Rules

1001A(b)(1) and 1002A to increase the position and exercise limits for

narrow-based index options from 6,000, 9,000, or 12,000 contracts to

9,000, 12,000, or 15,000 contracts.

[[Page 47776]]

The Exchange believes that the proposed increase is appropriate in

light of the Exchange's more than ten years experience trading index

options. In 1983, the Gold/Silver Index (``XAU'') was the first narrow-

based index option to be traded on the Phlx, listed with a position

limit of 4,000 contracts.\4\ Since that time, the Exchange has honed

its experience in monitoring and surveilling index options trading by

developing and implementing an increasingly sophisticated regulatory

program. This program has benefited from technological advances and has

matured alongside index options trading. Moreover, the market for index

options has also evolved, as more investors are familiar with the

product and its uses. This is reflected in the appreciable growth in

index options volume not only since 1983 but in most recent years as

well.\5\

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\4\ See Securities Exchange Act Release No. 20437 (December 2,

1983), 48 FR 55229 (December 9, 1993) (File No. SR-Phlx-83-17).

\5\ According to the Phlx, index options volume increased 48%

(from 998,780 contracts to 1,483,585 contracts) from the period

January-June 1995 to January-June 1996.

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The Exchange recognizes that the purposes of these limits are to

prevent manipulation and to protect against disruption of the markets

for both options as well as the underlying securities. The Exchange has

considered the effects of increased position limits on the marketplace

and believes that concerns regarding manipulation and disruption are

adequately addressed by the Phlx's regulatory program. The Phlx

continues to monitor the markets for evidence of manipulation or

disruption caused by investors with positions at or near current

position or exercise limits and the new limits will not diminish the

surveillance function in this regard.

Since 1983 and the advent of the XAU, the Exchange has listed

several index options. Currently, the Phlx trades options on the

following seven narrow-based indexes, with their current position

limits noted:

1. Gold/Silver Index (``XAU'') 6,000 contracts.

2. Utility Index (``UTY'') 12,000 contracts.

3. Phlx/KBW Bank Index (``BKX'') 12,000 contracts.

4. Phone Index (``PNX'') 6,000 contracts.

5. Semiconductor Index (``SOX'') 12,000 contracts.

6. Airline Sector Index (``PLN'') 12,000 contracts.

7. Forest/Paper Products (``FPP'') 12,000 contracts.

The current levels for narrow-based index options have been in

place since September 1995.\6\ Since that time, however, index options

have continued to experience heavy and steady volume, with a

concomitant increase in open interest. In this light, the Exchange

believes that the proposed limits of 9,000, 12,000, or 15,000 contracts

should further increase the depth and liquidity of the markets for

index options by attracting additional investor interest. The Phlx also

believes that higher position limits would further accommodate the

hedging needs of Exchange market makers and specialists, who are

restricted by current levels.

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\6\ See Securities Exchange Act Release No. 36194 (September 6,

1995), 60 FR 47637 (September 13, 1995) (F8le No. SR-Phlx-95-16)

(increasing position and exercise limits for narrow-based index

options to 6,000, 9,000, or 12,000 contracts) (``Securities Exchange

Act Release No. 36194'').

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Further, the Exchange believes that the proposed increases are

reasonable. The Phlx states that in prior releases approving increased

position limits, the Commission has acknowledged that a gradual,

evolutionary approach has been adopted in increasing position and

exercise limits. Accordingly, the Phlx proposes a 25% increase in the

highest tier (from 12,000 to 15,000 contracts); a 33% increase in the

middle tier (from 9,000 to 12,000 contracts); and a 50% increase in the

lowest tier (from 6,000 to 9,000 contracts). The Exchange believes that

these proposed increases are consistent with the gradual evolution

cited by the Commission, as the proposed levels represent reasonable

increases which are in line with prior changes.\7\

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\7\ See, e.g., Securities Exchange Act Release No. 36194, supra

note 6, where the Phlx's narrow-based position limit changes

represented a 9% increase in the lowest tier (from 5,500 to 6,000

contracts); a 20% increase in the middle tier (from 7,500 to 9,000

contracts); and a 14% increase in the highest tier (from 10,500 to

12,000 contracts).

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The Exchange believes that the 1995 changes were so modest (20% or

less) that position limit increases are once again needed. Since the

1995 changes were implemented, the Exchange has been requested by its

members and customers to again propose an increase in position limits,

arguing that these limits hamper their ability to execute investment

strategies. In light of the large portfolios common to institutional

trading and the large-sized transactions that are required to execute

complicated, cross-market strategies, such requests emphasize that

institutional hedging needs and trading objectives may exceed current

limits. Floor members have also expressed the resulting deleterious

effect on index options trading in an exchange environment. Based on

such member and customer requests, the Exchange has also realized that

the current position limit levels continue to discourage market

participation by large investors and the institutions that compete to

facilitate the trading interests of large investors. Accordingly, this

proposal aims to accommodate the liquidity and hedging needs of large

investors as well as the facilitators of hose investors.

In proposing these position and exercise limit increases, the

Exchange considered whether alternatives were available to accommodate

both members and investors. For instance, an index option hedge

exemption was recently implemented by the Exchange. However, the

specific requirements of this exemption, including the definition of a

hedge, may not be useful for all investors. In addition, the Exchange

considered whether flexible index options (``FLEX options''), which are

subject to separate, higher position limits, address the needs

expressed to the Phlx. In this regard, the Exchange realized that

because of certain attributes of FLEX options, such as lack of

continuous quoting, this product's utility may be limited to a discrete

group of investors. Likewise, the Exchange does not believe that FLEX

options trading should foreclose the Exchange's responsibility to

embellish upon its listed index options program by revisiting and

addressing regulatory restrictions such as position limits.

Concurrent with the proposed increase in position limits, the

Exchange is also proposing a corresponding increase to narrow-based

index option exercise limits. The Exchange believes that this increase

is necessary and appropriate for the same reasons as the rationale

cited above for the proposed position limit increases. Furthermore,

exercise limits constrict trading strategies by preventing investors

from exercising positions larger than the limit within five consecutive

business days. The Exchange also notes that most of its index options

currently are or will become European-style, exercisable only during a

specified period at expiration, such that the manipulation and market

disruption concerns associated with large exercises will be limited.\8\

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\8\ See, e.g., Securities Exchange Act Release No. 37575 (August

15, 1996), 61 FR 43289 (August 21, 1996), (File No. SR-Phlx-96-18)

(order approving change in exercise style of Phlx's National Over-

the-Counter Index from American-style to European-style).

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2. Statutory Basis

The Exchange believes that its proposal to increase narrow-based

index option position and exercise limits is

[[Page 47777]]

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

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

equitable principles of trade, prevent fraudulent and manipulative acts

and practices, as well as to protect investors and the public interest.

The Exchange also believes that the proposal should remove impediments

to and perfect the mechanism of a free and open market by providing

market opportunity to investors constricted by current position limit

levels. The Phlx believes that by stimulating market participation, and

thereby increasing option market depth and liquidity, the proposed rule

change should promote just and equitable principles of trade. At the

same time, the Phlx believes that the proposed position limits should

continue to prevent fraudulent and manipulative acts and practices as

well as protect investors and the public interest by limiting the

ability to disrupt and manipulate the markets for options as well as

the underlying securities.

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

The self-regulatory organization 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 solicited or received with respect

to the proposed rule change.

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

for Commission Action

Within 35 days of the 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 the 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. 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 filing also will be available

for inspection and copying at the principal office of the Phlx. All

submissions should refer to File No. SR-Phlx-96-33 and should be

submitted by October 1, 1996.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\9\

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\9\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96-23038 Filed 9-9-96; 8:45 am]

BILLING CODE 8010-01-M