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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40757; File No. SR-Phlx-98-39]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

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

in Position and Exercise Limits for Narrow-Based Index Options

December 7, 1998.

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

(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice

is hereby given that on September 3, 1998, 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. Phlx filed an amendment to the

proposed rule change on September 28, 1998.\3\ The Commission is

publishing this notice to solicit

[[Page 69705]]

comments on the proposed rule change from interested persons.

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

\2\ 17 CFR 240.19b-4.

\3\ See Letter to Michael Walinskas, Deputy Associate Director,

Division of Market Regulation, Commission, from Nandita Yagnik,

Attorney, Phlx, dated September 25, 1998 (``Amendment No. 1'').

Amendment No. 1 clarified that the Exchange intended to propose a

tripling of the current position and exercise limits for narrow-

based index options, not a doubling of the limits as stated in the

original filing.

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

Substance of the Proposed Rule Change

Phlx proposed to amend Phlx Rule 1001A(b)(1) by increasing narrow-

based (industry) index option position limits,\4\ which are subject to

a three-tier position limit determination. Specifically, the current

levels of 9,000, 12,000 and 15,000 contracts are proposed to be

increased to 27,000, 36,000 and 45,000 contracts--a tripling of the

current limits.

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\4\ 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 or long puts and short calls)

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

acting in concert.

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Exchange exercise limits,\5\ which are contained in Phlx Rule

1002A, are established by reference to position limits, such that any

increase in position limits would also increase exercise limits.

Accordingly, the Phlx is proposing to increase its exercise limits to

correspond to the proposed increases in position limits.

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\5\ 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 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 self-regulatory organization

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

1. Purpose

The purpose of the proposed rule change is to increase industry

index option position and exercise limits in order to attract

additional trading interest and, thus, promote depth and liquidity in

Phlx index options. The Exchange believes that the current limits

constrain certain investors from trading index options. Pursuant to

Rule 1001A, the three-tiered levels of position and exercise limits are

currently 9,000, 12,000 or 15,000 contracts. These position limits,

which are standard among all of the options exchanges respecting

narrow-based index options, are based on the degree of concentration of

a component stock of the index.\6\ For the reasons given below, the

Exchange proposes to increase these limits to 27,000, 36,000 or 45,000

contracts.

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\6\ Specifically, Rule 1001A(b)(1) currently provides the

following position limits for industry index options: (i) 9,000

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 industry

index option position limits; (ii) 12,000 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 not

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 industry index option position

limits; or (iii) 15,000 contracts where the conditions requiring a

limit of 9,000 or 12,000 contracts have not occurred.

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The Exchange believes that the proposed increase is appropriate at

this time, in light of the Exchange's nearly 15 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.\7\ Since that time, the Exchange has

listed additional index options, many of which have been successful

products. Currently, the Phlx trades options on the following ten

narrow-based indexes, noting the current position limits:

\7\ Exchange Act Release No. 20437 (December 2, 1983)(SR-Phlx-

83-17).

(1) Gold/Silver Index (``XAU''): 9,000 contracts

(2) Utility Index (``UTY''): 15,000 contracts

(3) Phlx/KBW Bank Index (``BKX''): 15,000 contracts

(4) Phone Index (``PNX''): 12,000 contracts

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

(6) Airline Sector Index (``PLN''): 15,000 contracts

(7) Forest and Paper (``FPP''): 15,000 contracts

(8) Box Maker Index (``BMX''): 9,000 contracts

(9) OTC Prime Index (``OTC''): 12,000 contracts

(10) Oil Service Index (``OSX''): 12,000 contracts

The market for index options has also evolved, as more investors

are familiar with the product and its uses.

The Exchange recognizes that the purposes of these limits are to

prevent manipulation and protect against disruption of the markets for

both the option as well as the underlying security. The Exchange has

considered the effects of increased position limits on the marketplace,

and believes that manipulation and disruption concerns are addressed by

a tripled position limit and are offset by the market need for the

increased limits. Specifically, 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; the new

limits will not diminish the surveillance function in this regard.

The current levels has been in place since October 1996,\8\ such

that a review of the current position limits is appropriate. The

Exchange believes that the proposed increases are reasonable. In prior

releases approving increased position limits, the Commission

acknowledged that a gradual, evolutionary approach has been adopted by

the Commission and the various options exchanges in increasing position

and exercise limits. In light of the nearly 2 years since limits were

changed, the Exchange believes that these increases are reasonable.\9\

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\8\ See Exchange Act Release No. 37863 (October 24, 1996) (SR-

Phlx-96-33). Previously, position limits were increased in 1983,

1993 and 1995.

\9\ The most recent position limit change in 1996 represented a

50% percent increase in the lowest tier from 6,000 to 9,000

contracts; a 33% increase in the middle tier from 9,000 to 12,000

contracts and a 25% increase in the highest tier from 12,000 to

15,000 contracts. In 1995, the changes represented a 9% increase in

the lowest tier from 5,500 to 6,000 contracts; a 20% increase from

7,500 to 9,000 contracts; and a 15% increase in the highest tier

from 10,500 to 12,000 contracts. In 1993, the changes resulted in

increases in 38% from 4,000 to 5,500 contracts; 25% from 6,000 to

7,500 contracts; and 31% from 8,000 to 10,500 contracts.

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The Phlx also believes that higher position limits would further

accommodate the hedging needs of Exchange market makers and

specialists, who are also restricted by current levels. The Exchange

continues to believe that increases are needed for traders and

investors. The Exchange has been requested by its members and

customers, who have repeatedly expressed that these limits hamper the

ability to execute investment strategies, to again propose an increase

in position limits. Such requests emphasize that institutional hedging

needs and trading objectives may exceed current limits, in view of the

large portfolios common to institutional trading and that certain sized

transactions are required to execute complicated, cross-market

strategies. Floor members have expressed the resulting deleterious

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

such

[[Page 69706]]

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 also accommodate the liquidity and hedging needs of

large investors and the facilitators of those investors.

Concurrent with the proposed increase to position limits, the

Exchange is also proposing a corresponding increase to industry index

option exercise limits. The Exchange believes that this increase is

necessary and appropriate for the same reasons as the rationale cited

herein 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 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.\10\

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\10\ The following index options are European style: UTY, BKX,

PLN, FPP, BMX, OTC, OSX and SOX (SOX have both European and American

style options).

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2. Statutory Basis

The Exchange believes that the proposed rule change is consistent

with Section 6 of the Act \11\ in general, and in particular, with

Section 6(b)(5) in that it is designed to promote just and equitable

principles trade, prevent fraudulent and manipulative acts and

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

Exchange believes that the proposed rule change 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 level. The Phlx also 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. The Exchange believes

that the proposal represents a balance between creating a disincentive

to manipulate or disrupt the marketplace consistent with the purposes

of such limits, and setting such limit so low so as to discourage

market participation or liquidity providing activity.

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\11\ 15 U.S.C. 78f(b).

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

The Exchange does not believes 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.

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 findings 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 person are invited to submit written date, views and

arguments concerning the foregoing, including whether the proposed rule

change is consistent with the Act. 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 submissions, 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 of 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 at the

Commission's Public Reference Room. Copies of such filing will also be

available for inspection and copying at the principal office at the

Exchange. All submissions should refer to File No. SR-File-98-39 and

should be submitted by January 7, 1999.

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).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-33361 Filed 12-16-98; 8:45 am]

BILLING CODE 8010-01-M