[Federal Register: December 12, 2005 (Volume 70, Number 237)]
[Notices]
[Page 73497-73500]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12de05-100]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-52894; File No. SR-ISE-2005-45]
Self-Regulatory Organizations; International Securities Exchange,
Inc.; Notice of Filing and Order Granting Accelerated Approval to a
Proposed Rule Change and Amendment No. 1 Thereto Relating to the
Elimination of Position and Exercise Limits on NDX Options
December 5, 2005.
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 21, 2005, the International Securities Exchange, Inc.
(``ISE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I and II below, which Items have been prepared by the ISE. On
November 14, 2005, the ISE filed Amendment No. 1 to the proposed rule
change.\3\ The Commission is publishing this notice to solicit comments
on the proposed rule change, as amended, from interested persons. In
addition, the Commission is granting accelerated approval of the
proposed rule change, as amended.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Amendment No. 1, which replaced and superseded the original
filing in its entirety, added certain reporting requirements and
margin provisions and expanded on the purpose of the proposed rule
change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The ISE proposes to amend its rules to eliminate position and
exercise limits for options on the Nasdaq 100 Index (``NDX''). The text
of the proposed rule change, as amended, is below. Proposed new
language is in italics; proposed deletions are in [brackets].
* * * * *
Rule 2004. Position Limits for Broad-Based Index Options
(a) Rule 412 generally shall govern position limits for broad-based
index options, as modified by this Rule 2004. There may be no position
limit for certain Specified (as provided in Rule 2000) broad-based
index options contracts. All other broad-based index options contracts
shall be subject to a contract limitation fixed by the Exchange, which
shall not be larger than the limits provided in the chart below.
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Standard limit (on
Broad-based underlying index the same side of the Restrictions
market)
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S&P SmallCap 600 Index...... 100,000 contracts... No more than 60,000
near-term.
S&P MidCap 400 Index........ 45,000 contracts.... No more than 25,000
near-term.
Reduced Value S&P 1000 Index 50,000 contracts.... No more than 30,000
near-term.
Micro S&P 1000 Index........ 500,000 contracts... No more than 300,000
near-term.
Nasdaq 100 Index............ None [75,000 None.
contracts].
Mini Nasdaq 100 Index....... 750,000 contracts... None.
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Remainder of the Chart--No Change.
* * * * *
(b)-(d) No Change.
* * * * *
Rule 2006. Exemptions from Position Limits
(a) Broad-based Index Hedge Exemption. The broad-based index hedge
exemption is in addition to the other exemptions available under
Exchange Rules, interpretations and policies. The following procedures
and criteria must be satisfied to qualify for a broad-based index hedge
exemption:
(1)-(4) No Change.
(5) Positions in broad-based index options that are traded on the
Exchange are exempt from the standard limits to the extent specified
below.
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Broad-based index hedge
Broad-based index option type exemption (is in addition to
standard limit)
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Nasdaq 100 Stock Index (\1/10\th value) 1,500,000 contracts.
(MNX).
[Nasdaq 100 Stock Index (full value) [150,000 contracts].
(NDX)].
Other broad-based indexes.............. 75,000.
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(6)-(12) No Change.
(13) Each member (other than Exchange market-makers) that maintains
a broad-based index option[s] position on the same side of the market
in excess of 100,000 contracts in NDX [a Specified (as provided in Rule
2000) number of contracts] for its own account or for the account of a
customer, shall report information as to whether the positions are
hedged and provide documentation as to how such contracts
[[Page 73498]]
are hedged, in the manner and form required by the Exchange. The
Exchange may impose other reporting requirements as well as the limit
at which the reporting requirement may be triggered.
(14) Whenever the Exchange determines that additional margin is
warranted in light of the risks associated with an under-hedged NDX
options position[in Specified (as provided in Rule 2000) broad-based
indices], the Exchange may impose additional margin upon the account
maintaining such under-hedged position pursuant to its authority under
Rule 1204. The clearing firm carrying the account also will be subject
to capital charges under Rule 15c3-1 under the Exchange Act to the
extent of any margin deficiency resulting from the higher margin
requirements.
(b) No Change.
* * * * *
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 had received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item III below. The Exchange 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 Exchange proposes to eliminate position and exercise limits for
options on the NDX, a broad-based securities index. Under ISE Rule
2004, the current position and exercise limit for options on the NDX is
75,000 contracts on the same side of the market. Given the
institutional demand for options on the NDX, the Exchange believes the
current position and exercise limit of 75,000 contracts to be too low
and a deterrent to the successful trading of the product. Additionally,
the ISE believes that these limits for options on the NDX no longer
serve their stated purpose. The Commission has previously stated that:
Since the inception of standardized options trading, the options
exchanges have had rules imposing limits on the aggregate number of
options contacts that a member or customer could hold or exercise.
These rules are intended to prevent the establishment of 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 and for corners or
squeezes of the underlying market. In addition such limits serve to
reduce the possibility for disruption of the options market itself,
especially in illiquid options classes.\4\
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\4\ See Securities Exchange Act Release No. 39489 (December 24,
1997), 63 FR 276 (January 5, 1998).
The Commission has previously granted relief from position and
exercise limits with respect to options on indexes that the ISE
believes are similar to the NDX without any adverse affects on the
market as a result.\5\ The Exchange believes that the circumstances and
considerations relied upon in approving the elimination of position and
exercise limits for options on the SPX, OEX, and DJX on the CBOE
equally apply to the Exchange's proposed rule change regarding position
and exercise limits for options on the NDX.
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\5\ See Securities Exchange Act Release No. 44994 (October 26,
2001), 66 FR 55722 (November 2, 2001) (order granting permanent
approval to a Chicago Board Options Exchange, Incorporated
(``CBOE'') pilot program to eliminate position and exercise limits
for options on the S&P 500 Index (``SPX''), the S&P 100 Index
(``OEX''), and the Dow Jones Industrial Average (``DJX'')) (``SPX/
OEX/DJX Permanent Approval Order''). See also Securities Exchange
Act Release No. 40969 (January 22, 1999), 64 FR 4911 (February 1,
1999) (order approving the CBOE's original pilot program) (``SPX/
OEX/DJX Pilot Approval Order''). Telephone conversation between
Samir M. Patel, Assistant General Counsel, ISE, and Ira L.
Brandriss, Special Counsel, Division of Market Regulation,
Commission, on November 23, 2005 (``Telephone Conversation with
ISE'').
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In approving the elimination of position and exercise limits for
options on the SPX, OEX, and DJX, the Commission noted their active
trading volume and the deep, liquid markets for the securities
underlying the indexes, as well as their market capitalization.\6\ The
Exchange notes that the average daily trading volume (``ADTV'') of the
underlying components of and options on the NDX as well as the market
capitalization of the index are comparable to the ADTV and market
capitalization figures for SPX, OEX, and DJX. As of October 18, 2005,
the approximate market capitalizations of SPX, OEX and DJX were $10.87
trillion, $5.95 trillion and $3.53 trillion, respectively. The ADTVs
for all underlying components of the indexes were 1,825 million, 800
million, and 370 million shares, respectively, and the ADTV for options
on the indexes were 288,644 contracts, 74,725 contracts, and 22,282
contracts, respectively.\7\ The market capitalization of the NDX was
$1.82 trillion, the ADTV for the underlying securities of the index was
716 million shares, and the options ADTV was 51,661 contracts.
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\6\ See SPX/OEX/DJX Pilot and Permanent Approval Orders.
Telephone Conversation with ISE.
\7\ ADTVs are calculated over the previous three months of
trading.
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Additionally, in approving the elimination of position and exercise
limits for options on the SPX, OEX, and DJX, the Commission also noted
the financial requirements imposed by both the CBOE and the Commission
in an effort to guard against a CBOE member or its customer(s) from
maintaining a large unhedged position in those securities. The Exchange
believes that the current financial requirements imposed by the ISE and
by the Commission adequately address concerns that a member or its
customer may try to maintain an inordinately large unhedged position in
NDX options. The Exchange notes that, under its rules, it has the
authority to impose additional margin upon accounts maintaining
underhedged positions,\8\ and is further able to monitor accounts to
determine when such action is warranted. As noted in the Exchange's
rules, the clearing firm carrying such an account would be subject to
capital charges under Rule 15c3-1 under the Act \9\ to the extent of
any resulting margin deficiency.\10\ It also should be noted that the
Exchange has the authority under ISE Rule 1204 to impose higher margin
requirements upon a member when the Exchange determines that higher
requirements are warranted. Additionally, ISE Rule 415, which requires
members to file reports with the Exchange for any customer who held
aggregate long or short positions of 200 or more option contracts of
any single class for the previous day, will remain unchanged and will
continue to serve as an important part of the Exchange's surveillance
efforts.
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\8\ See, e.g. Commentary .02 to ISE Rule 412.
\9\ See 17 CFR 240.15c3-1.
\10\ See also the proposed change to ISE Rule 2006(a)(14), to
include a specific reference to options on the NDX. Telephone
Conversation with ISE.
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Finally, in approving the elimination of position and exercise
limits for options on the SPX, OEX, and DJX, the Commission relied on
the CBOE's ability to provide surveillance and reporting safeguards to
detect and deter trading abuses that could arise from the elimination
of position and exercise limits in those securities. The Exchange
believes that the updated surveillance procedures and reporting
requirements
[[Page 73499]]
at the ISE,\11\ coupled with the surveillance procedures and reporting
requirements of the other options exchanges, are capable of properly
identifying unusual and/or illegal trading activity. These procedures
utilize daily monitoring of market movements via automated surveillance
techniques to identify unusual activity in both options and in
underlying stocks. Additionally, the Exchange intends to impose a
reporting requirement on ISE members (other than Exchange market-
makers) who trade NDX options.\12\ This reporting requirement would
require Exchange members who maintain in excess of 100,000 NDX
contracts on the same side of the market, for their own accounts or for
the account of customers, to report information as to whether the
positions are hedged and provide documentation as to how such contracts
are hedged, in a manner and form required by the Exchange.\13\ The
Exchange also would be permitted to specify other reporting
requirements, as well as the limit at which the reporting requirement
may be triggered.\14\
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\11\ The Exchange has separately submitted, on a confidential
basis, updated surveillance procedures regarding trading in NDX
options.
\12\ ISE does not currently trade options on any security for
which there are no position and exercise limits. As such, the
Exchange has never imposed this reporting requirement on its
members. The Exchange will issue a Regulatory Information Circular
to its members informing them of the elimination of position and
exercise limits for options on the NDX and the resulting reporting
requirement.
\13\ See proposed changes to ISE Rule 2006(a)(13).
\14\ Id.
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The Exchange believes that eliminating position and exercise limits
for NDX options will allow ISE members and their customers greater
hedging and investment opportunities.
2. Statutory Basis
The ISE believes the proposed rule change is consistent with
Section 6(b) of the Act,\15\ in general, and furthers the objectives of
Section 6(b)(5),\16\ in particular, in that it is designed to promote
just and equitable principles of trade, 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.
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\15\ U.S.C. 78f(b).
\16\ U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The ISE believes that the proposed rule change does not impose any
burden on competition that is not necessary or appropriate in the
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
The Exchange has not solicited, and does not intend to solicit,
comments on this proposed rule change. The Exchange has not received
any unsolicited written comments from members or other interested
parties.
III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as amended, is consistent with the Act. Comments may be
submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-ISE-2005-45 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549-9303.
All submissions should refer to File Number SR-ISE-2005-45. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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, 100 F Street,
NE., Washington, DC 20549. Copies of such filing also will be available
for inspection and copying at the principal office of the ISE. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make publicly available. All
submissions should refer to File Number SR-ISE-2005-45 and should be
submitted on or before January 3, 2006.
IV. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
After careful consideration, the Commission finds that the proposed
rule change is consistent with the requirements of the Act and the
rules and regulations thereunder applicable to a national securities
exchange.\17\ In particular, the Commission finds that the proposed
rule change is consistent with Section 6(b)(5) of the Act,\18\ which
requires, among other things, that the rules of the Exchange be
designed to promote just and equitable principles of trade, 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.
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\17\ In approving this proposal, the Commission has considered
its impact on efficiency, competition, and capital formation. 15
U.S.C. 78c(f).
\18\ 15 U.S.C. 78f(b)(5).
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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 options
positions that can be used or might create incentives to manipulate or
disrupt the underlying market so as to benefit the options position,
and to reduce the possibility for the disruption of the options market
itself.
The Commission notes that it continues to believe that the
fundamental purposes of position and exercise limits remain valid.
Nevertheless, the Commission believes that experience with the trading
of index options as well as enhanced reporting requirements and
exchange surveillance capabilities make it possible to approve the
elimination of position and exercise limits on certain broad-based
index options. Thus, in 2001, the Commission approved a CBOE proposal
to eliminate permanently position and exercise limits for options on
the SPX, OEX, and DJX,\19\ and in 2002 approved a proposal by the
American Stock Exchange LLC (``Amex'') to eliminate permanently
position and exercise limits for options on the Major Market Index
(``XMI'') and the Institutional Index (``XII''). Recently the
Commission also approved proposals by the CBOE and the Amex to
eliminate position and exercise limits for options on the NDX trading
on those
[[Page 73500]]
exchanges.\20\ The Commission believes that the considerations upon
which it relied in approving those proposals equally apply with respect
to the instant proposed rule change by the ISE.
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\19\ See SPX/OEX/DJX Permanent Approval Order, supra note 5.
\20\ See Securities Exchange Act Release Nos. 52650 (October 21,
2005), 70 FR 62147 (October 28, 2005) (order approving File No. SR-
CBOE-2005-41); and 52649 (October 21, 2005), 70 FR 62146 (October
28, 2005) (order approving File No. SR-Amex-2005-063) (``CBOE and
Amex NDX Approval Orders'').
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As noted by the Exchange, the market capitalization of the NDX as
of October 18, 2005 was $1.82 trillion. The ADTV for a period of three
months prior to that date for all underlying components of the index
was 716 million shares. As it stated in the CBOE and Amex NDX Approval
Orders, the Commission believes that the enormous market capitalization
of the NDX and the deep, liquid markets for the underlying component
securities significantly reduce concerns regarding market manipulation
or disruption in the underlying market. Removing position and exercise
limits for NDX options may also bring additional depth and liquidity,
in terms of both volume and open interest, to NDX options without
significantly increasing concerns regarding intermarket manipulation or
disruption of the options or the underlying securities.
In addition, the Commission believes that financial requirements
imposed by both the Exchange and the Commission adequately address
concerns that a ISE member or its customer may try to maintain an
inordinately large unhedged position in NDX options. Current risk-based
haircut and margin methodologies serve to limit the size of positions
maintained by any one account by increasing the margin and/or capital
that a member must maintain for a large position held by itself or by
its customer.\21\ As specified in the proposal, the ISE also would have
the authority under its rules to impose a higher margin requirement
upon an account maintaining an under-hedged position in NDX options
when it determines a higher requirement is warranted. As also noted in
the applicable ISE rules, the clearing firm carrying the account would
be subject to capital charges under Rule 15c3-1 under the Act to the
extent of any margin deficiency resulting from the higher margin
requirement.
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\21\ See SPX/OEX/DJX Pilot Approval Order, supra note 5.
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Finally, in approving the elimination of position and exercise
limits for options on the indexes noted above, the Commission took note
of the enhanced surveillance and reporting safeguards that the relevant
exchange had adopted to allow it to detect and deter trading abuses
that might arise as a result.\22\ The ISE's updated safeguards,
including the 100,000-contract reporting requirement described above,
would allow the ISE to monitor large positions in order to identify
instances of potential risk and to assess and respond to any market
concerns at an early stage. In this regard, the Commission expects the
ISE to take prompt action, including timely communication with the
Commission and other marketplace self-regulatory organizations
responsible for oversight of trading in component stocks, should any
unanticipated adverse market effects develop. Moreover, as previously
noted, the Exchange has the flexibility to specify other reporting
requirements, as well as to vary the limit at which the reporting
requirements may be triggered.
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\22\ See, in particular, SPX/OEX/DJX Pilot Approval Order, supra
note 5.
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The ISE has requested that the Commission find good cause for
approving the proposed rule change prior to the thirtieth day after
publication of notice thereof in the Federal Register. As already
noted, the Commission recently approved similar proposals eliminating
position and exercise limits for NDX options on the CBOE and the Amex.
The Commission believes that granting accelerated approval of the
proposal will allow the ISE to conform its rules to those of other
exchanges trading NDX options without delay. Accordingly, the
Commission finds good cause, pursuant to Section 19(b)(2) of the
Act,\23\ for approving the proposed rule change, as amended, prior to
the thirtieth day after the date of publication of notice thereof in
the Federal Register.
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\23\ 15 U.S.C. 78s(b)(2).
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\24\ that the proposed rule change (SR-ISE-2005-45), as amended,
be, and hereby is, approved on an accelerated basis.
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\24\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-7187 Filed 12-9-05; 8:45 am]
BILLING CODE 8010-01-P