[Federal Register: December 30, 2002 (Volume 67, Number 250)]
[Notices]
[Page 79676-79680]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30de02-130]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47080; File No. SR-NASD-2002-134]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to Exemptions From Options Position and Exercise Limits
December 23, 2002.
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 October 1, 2002, the National Association of Securities Dealers,
Inc. (``NASD'') 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 NASD. 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. 78s(b)(1).
\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
NASD is proposing to amend Rule 2860(b)(3)(A) of the Conduct Rules
of NASD, relating to options position and exercise limits for positions
entered into under certain enumerated hedge strategies.
Below is the text of the proposed rule change. Proposed new
language is in italics; proposed deletions are in brackets.
* * * * *
2860. Options
(a) No Change
(b) Requirements
(1) and (2) (No Change)
(3) Position Limits \3\
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\3\ The Commission notes that it made typographical changes to
the rule text submitted in the proposed rule change. NASD has
committed to submitting an amendment reflecting those changes.
Telephone conversation between Gary Goldsholle, Office of General
Counsel, NASD and Tim Fox, Law Clerk, Division of Market Regulation
(``Division''), Commission on December 20, 2002.
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(A) Stock Options--Except in highly unusual circumstances, and with
the prior written approval of [the Association] NASD pursuant to the
Rule 9600 Series for good cause shown in each instance, no member shall
effect for any account in which such member has an interest, or for the
account of any partner, officer, director or employee thereof, or for
the account of any customer, non-member broker, or non-
[[Page 79677]]
member dealer, an opening transaction through Nasdaq, the over-the-
counter market or on any exchange in a stock option contract of any
class of stock options if the member has reason to believe that as a
result of such transaction the member or partner, officer, director or
employee thereof, or customer, non-member broker, or non-member dealer,
would, acting alone or in concert with others, directly or indirectly,
hold or control or be obligated in respect of an aggregate equity
options position in excess of:
(i) 13,500 option contracts of the put class and the call class on
the same side of the market covering the same underlying security,
combining for purposes of this position limit long positions in put
options with short positions in call options, and short positions in
put options with long positions in call options; or
(ii) 22,500 option[s] contracts of the put class and the call class
on the same side of the market covering the same underlying security,
providing that the 22,500 contract position limit shall only be
available for option contracts on securities [which] that underlie
Nasdaq or exchange-traded options qualifying under applicable rules for
a position limit of 22,500 option contracts; or
(iii) 31,500 option contracts of the put class and the call class
on the same side of the market covering the same underlying security
providing that the 31,500 contract position limit shall only be
available for option contracts on securities [which] that underlie
Nasdaq or exchange-traded options qualifying under applicable rules for
a position limit of 31,500 option contracts; or
(iv) 60,000 option[s] contracts of the put and the call class on
the same side of the market covering the same underlying security,
providing that the 60,000 contract position limit shall only be
available for option contracts on securities [which] that underlie
Nasdaq or exchange-traded options qualifying under applicable rules for
a position limit of 60,000 option contracts; or
(v) 75,000 option[s] contracts of the put and the call class on the
same side of the market covering the same underlying security,
providing that the 75,000 contract position limit shall only be
available for option contracts on securities [which] that underlie
Nasdaq or exchange-traded options qualifying under applicable rules for
a position limit of 75,000 option contracts; or
(vi) such other number of stock option[s] contracts as may be fixed
from time to time by [the Association] NASD as the position limit for
one or more classes or series of options provided that reasonable
notice shall be given of each new position limit fixed by [the
Association] NASD.
(vii) Equity Option Hedge Exemptions
a. The following qualified hedge strategies and positions described
in subparagraphs 1. through 5. below shall be exempt from the
established position limits under this rule for standardized options.
Hedge strategies and positions described in subparagraphs 6. and 7.
below in which one of the option components consists of a conventional
option, shall be subject to a position limit of five times the
established position limits contained in subparagraphs (i) through (vi)
above. Hedge strategies and positions in conventional options as
described in subparagraphs 1. through 5. below shall be subject to a
position limit of five times the established limits contained in
subparagraphs (i) through (vi) above. Options positions limits
established under this subparagraph shall be separate from limits
established in other provisions of this rule.
1. Where each option contract is ``hedged'' or ``covered'' by 100
shares of the underlying security or securities convertible into the
underlying security, or, in the case of an adjusted option, the same
number of shares represented by the adjusted contract: (a) Long call
and short stock; (b) short call and long stock; (c) long put and long
stock; or (d) short put and short stock.
2. Reverse Conversions--A long call position accompanied by a short
put position, where the long call expires with the short put, and the
strike price of the long call and short put is equal, and where each
long call and short put position is hedged with 100 shares (or other
adjusted number of shares) of the underlying security or securities
convertible into such underlying security.
3. Conversions--A short call position accompanied by a long put
position where the short call expires with the long put, and the strike
price of the short call and long put is equal, and where each short
call and long put position is hedged with 100 shares (or other adjusted
number of shares) of the underlying security or securities convertible
into such underlying security.
4. Collars--A short call position accompanied by a long put
position, where the short call expires with the long put, and the
strike price of the short call equals or exceeds the strike price of
the long put position and where each short call and long put position
is hedged with 100 shares (or other adjusted number of shares) of the
underlying security or securities convertible into such underlying
security. Neither side of the short call/long put position can be in-
the-money at the time the position is established.
5. Box Spreads--A long call position accompanied by a short put
position with the same strike price and a short call position
accompanied by a long put position with a different strike price.
6. Back-to-Back Options--A listed option position hedged on a one-
for-one basis with an over-the-counter (OTC) option position on the
same underlying security. The strike price of the listed option
position and corresponding OTC option position must be within one
strike price interval of each other and no more than one expiration
month apart.
7. For reverse conversion, conversion and collar strategies set
forth above in subparagraphs 2., 3. and 4., one of the option
components can be an OTC option guaranteed or endorsed by the firm
maintaining the proprietary position or carrying the customer account.
[a. The following positions, where each option contract is
``hedged'' by 100 shares of stock or securities readily convertible
into or economically equivalent to such stock, or, in the case of an
adjusted option contract, the same number of shares represented by the
adjusted contract, shall be exempted from established limits contained
in paragraphs (i) through (vi) above:]
[1. long call and short stock;]
[2. short call and long stock;]
[3. long put and long stock;]
[4. short put and short stock.]
[b. Except as provided under OTC Collar Exemption contained in
subparagraph (b)(3)(A)(viii), in no event may the maximum allowable
position, inclusive of options contracts hedged pursuant to the equity
option position limit hedge exemption in subparagraph a. above, exceed
three times the applicable position limit established in subparagraph
(b)(3)(A)(i) through (v) with respect to standardized equity options,
or paragraph (b)(3)(A)(ix) with respect to conventional equity
options.]
[(viii) OTC Collar Aggregation Exemption]
[a. For purposes of this paragraph (b), the term OTC collar shall
mean a conventional equity option position comprised of short (long)
calls and long (short) puts overlying the same security that hedge a
corresponding long (short) position in that security.]
[b. Notwithstanding the aggregation provisions for short (long)
call positions and long (short) put positions contained in
subparagraphs (b)(3)(A)(i) through (v) above, the conventional options
positions involved in a particular OTC collar transaction need not be
[[Page 79678]]
aggregated for position limit purposes, provided the following
conditions are satisfied:]
[1. the conventional options can only be exercised if they are in-
the-money;]
[2. neither conventional option can be sold, assigned, or
transferred by the holder without the prior written consent of the
writer;]
[3. the conventional options must be European-style (i.e., only
exercisable upon expiration) and expire on the same date;]
[4. the strike price of the short call can never be less than the
strike price of the long put; and]
[5. neither side of any particular OTC collar transaction can be
in-the-money when that particular OTC collar is established.]
[6. the size of the conventional options in excess of the
applicable basic position limit for the options established pursuant to
subparagraph (b)(3)(A)(ix) must be hedged on a one-to-one basis with
the requisite long or short stock position for the duration of the
collar, although the same long or short stock position can be used to
hedge both legs of the collar.]
[c. For multiple OTC collars on the same security meeting the
conditions set forth in subparagraph b. above, all of the short (long)
call options that are part of such collars must be aggregated and all
of the long (short) put options that are part of such collars must be
aggregated, but the short (long) calls need not be aggregated with the
long (short) puts.]
[d. Except as provided above in subparagraphs b. and c., in no
event may a member fail to aggregate any conventional options contract
of the put class and the call class overlying the same equity security
on the same side of the market with conventional option positions
established in connection with an OTC collar.]
[e. Nothing in this subparagraph (b)(3)(A)(viii) changes the
applicable position limit for a particular equity security.]
[(ix)](viii) Conventional Equity Options
a. For purposes of [sub]paragraph (b), standardized equity
option[s] contracts of the put class and call class on the same side of
the market overlying the same security shall not be aggregated with
conventional equity option[s] contracts or FLEX Equity Option[s]
contracts overlying the same security on the same side of the market.
Conventional equity option[s] contracts of the put class and call class
on the same side of the market overlying the same security shall be
subject to a position limit equal to the greater of:
1. the basic limit of 13,500 contracts, or
2. any standardized equity options position limit as set forth in
[sub]paragraphs (b)(3)(A)(ii) through (v) for which the underlying
security qualifies or would be able to qualify.
a. In order for a security not subject to standardized equity
options trading to qualify for an options position limit of more than
13,500 contracts, a member must first demonstrate to NASD's [the
Association's] Market Regulation Department that the underlying
security meets the standards for such higher options position limit and
the initial listing standards for standardized options trading.
(B) No Change
(4) through (24) 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, 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. 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
1. Purpose
The proposed rule change amends NASD's options position and
exercise limits. Earlier this year, the Commission approved changes to
the rules of the options exchanges that eliminated standardized equity
option \4\ position and exercise limits for certain qualified hedge
strategies and established position and exercise limits of five times
the standard limit for certain of those strategies when they include an
over-the-counter (OTC) option contract.\5\ NASD is proposing changes to
substantially conform its rules to those of the options exchanges.
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\4\ A standardized equity option contract is any equity options
contract issued, or subject to issuance by, the Options Clearing
Corporation that is not a FLEX Equity Option. NASD Rule
2860(b)(2)(vv).
\5\ See Securities Exchange Act Release No. 45603 (March 20,
2002), 67 FR 14751 (March 27, 2002) (CBOE-2000-12); Securities
Exchange Act Release No. 45650 (March 26, 2002), 67 FR 15638 (Apr.
2, 2002) (AMEX-2001-71); Securities Exchange Act Release No. 45737
(April 11, 2002), 67 FR 18975 (Apr. 17, 2002) (PCX-2000-45);
Securities Exchange Act Release No. 45899 (May 9, 2002), 67 FR 34980
(May 16, 2002) (PHLX-2002-33); and Securities Exchange Act Release
No. 46228 (July 18, 2002), 67 FR 48689 (July 25, 2002) (ISE-2002-
15).
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The proposed rule change establishes six qualified hedge
strategies:
1. Where each option contract is ``hedged'' or ``covered'' by 100
shares of the underlying \6\ security or securities convertible into
the underlying security, or, in the case of an adjusted option, the
same number of shares represented by the adjusted contract: (a) long
call and short stock; (b) short call and long stock; (c) long put and
long stock; or (d) short put and short stock.
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\6\ NASD represents that the phrase ``securities convertible
into the underlying security'' does not include single stock futures
products. Telephone Conversation between Gary Goldsholle, Office of
General Counsel, NASD and Tim Fox, Law Clerk, Division, Commission
on December 6, 2002.
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2. Reverse Conversions--A long call position accompanied by a short
put position, where the long call expires with the short put, and the
strike price of the long call and short put is equal, and where each
long call and short put position is hedged with 100 shares (or other
adjusted number of shares) of the underlying security or securities
convertible into such underlying security.
3. Conversions--A short call position accompanied by a long put
position where the short call expires with the long put, and the strike
price of the short call and long put is equal, and where each short
call and long put position is hedged with 100 shares (or other adjusted
number of shares) of the underlying security or securities convertible
into such underlying security.
4. Collars--A short call position accompanied by a long put
position, where the short call expires with the long put and the strike
price of the short call equals or exceeds the strike price of the long
put position and where each short call and long put position is hedged
with 100 shares (or other adjusted number of shares) of such the
underlying security or securities convertible into such underlying
security. Neither side of the short call/long put position can be in-
the-money at the time the position is established.
5. Box Spreads--A long call position accompanied by a short put
position with the same strike price and a short call position
accompanied by a long put position with a different strike price.
6. Back-to-Back Options--A listed option position hedged on a one-
for-one basis with an OTC option position on the same underlying
security. The strike price of the listed option position and
corresponding OTC option position must be within one strike price
interval
[[Page 79679]]
of each other and no more than one expiration month apart.
Under the proposed rule change, there would be no position and
exercise limits when such qualified hedge strategies are effected
solely with standardized equity options. In addition, the proposed rule
change establishes standardized equity option position and exercise
limits of five times the standard limit when one component of such
strategies is an OTC option contract.
Further, within the list of proposed hedge strategies, NASD
proposes that the option component of a reversal, a conversion or a
collar position can be treated as one contract rather than as two
contracts. NASD believes that all three strategies serve to hedge a
related stock portfolio. Because these strategies require the
contemporaneous purchase/sale of both a call and put component, against
the appropriate number of shares underlying the option (generally 100
shares), NASD believes, like the options exchanges, that the position
should be treated as one contract for hedging purposes.
NASD currently establishes position and exercise limits on
conventional \7\ equity options.\8\ The NASD's position limits for
conventional equity options are identical to those for standardized
options.\9\ Moreover, like position and exercise limits for
standardized equity options, NASD recognizes certain hedge strategies
under which persons can establish greater options positions. NASD
currently has an equity option hedge exemption \10\ and an OTC collar
aggregation exemption.\11\ Under the current equity option hedge
exemption, a person can establish a conventional equity options
position of three times the standard position limit. Under the OTC
collar aggregation exemption, a person can establish a conventional
equity options position of three times the standard position limit for
each side of the OTC collar.
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\7\ A ``conventional option'' is any option contract not issued,
or subject to issuance, by the Options Clearing Corporation. NASD
Rule 2860(b)(2)(N).
\8\ NASD notes that the terms ``conventional'' and ``OTC''
options have identical meanings for the purposes of this proposed
rule change. Telephone conference among Gary Goldsholle, Office of
General Counsel, NASD, Susie Cho, Special Counsel, Division,
Commission, and Tim Fox, Law Clerk, Division, Commission on November
14, 2002.
\9\ NASD Rule 2860(b)(3)(A)(ix).
\10\ NASD Rule 2860(b)(3)(A)(vii).
\11\ NASD Rule 2860(b)(3)(A)(viii).
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The proposed rule change modifies the conventional equity options
position and exercise limits in several respects. First, the proposed
rule change expands the hedge exemption for conventional options to
include all of the qualified hedge strategies. NASD believes that
covered stock positions, conversions, reverse conversions, collars,\12\
and box spreads may all be effected with conventional options.
Moreover, NASD believes that having one set of hedge strategies
applicable to standardized and conventional options will simplify
members' compliance burdens.
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\12\ NASD Rule 2860(b)(3)(viii) currently provides for a collar
exemption. For purposes of clarity and consistency, NASD proposes
adopting the collar exemption developed by the Options Exchanges in
place of its existing collar exemption.
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Second, the proposed rule change increases the conventional equity
options position and exercise limits for such qualified hedge
strategies to five times the standard limits. NASD believes that this
change makes NASD's conventional equity options position limits
consistent with the limits for OTC options under the options exchange's
hedge exemptions. NASD's increased conventional options position limits
also will apply when not part of a standardized option hedge. According
to NASD, this change avoids having different conventional equity
options position and exercise limits apply depending on whether a
position is hedged by a standardized or conventional option.
Third, the proposed rule change provides that conventional equity
options positions under the hedge strategies not be aggregated with
other options positions similar to the way that positions under the
current equity option hedge exemption and OTC collar aggregation
exemption are not aggregated with other options positions.
NASD believes that rationales articulated by the Commission in its
prior approval of similar rule changes by the options exchanges apply
equally to the proposed rule change.\13\ It is NASD's view that
position and exercise limits serve as a regulatory tool designed to
address potential manipulative schemes and adverse market impact
surrounding the use of options. According to NASD, the Commission has
taken a gradual, evolutionary approach toward expansion of position and
exercise limits. NASD believes that the Commission has been careful to
balance two competing concerns when considering the appropriate level
at which to set position and exercise limits. According to NASD, the
Commission has recognized that the limits must be sufficient to prevent
investors from disrupting the market in the underlying securities. At
the same time, it is NASD's view that the Commission has determined
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. NASD believes that the
proposed rule change is consistent with these Commission policies.
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\13\ See supra note 4.
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Under the proposed rule change, the standard position and exercise
limits will remain in place for unhedged equity options positions. Once
an account reaches the standard limit, positions identified as a
qualified hedge strategy would be subject to the increased position
limits, or exempted from position limit calculations, as appropriate.
The exemption would be automatic (i.e., it will not require pre-
approval from NASD) to the extent that a member identifies that a pre-
existing qualified strategy is in place or is employed from the point
that an account's position reaches the standard limit and provides the
required supporting documentation to NASD.\14\ The exemption would
remain in effect to the extent that the exempted position remains
intact and NASD is provided with any required supporting documentation.
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\14\ Under the proposed rule change, the existing reporting
procedures that serve to identify and document hedged positions
above a certain threshold continue to apply. Paragraph (b)(5) of
NASD Rule 2860 requires reporting to NASD of aggregate positions of
200 more contracts of the put class and the call class on the same
side of the market covering the same underlying security.
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2. Statutory Basis
NASD believes that the proposed rule change is consistent with the
provisions of Section 15A of the Act,\15\ in general and with Section
15A(b)(6) of the Act,\16\ in particular, in that it is designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest. NASD also believes that the proposed
rule change is necessary to keep NASD's rules consistent with similar
rules of Options Exchanges approved by the Commission.
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\15\ 15 U.S.C. 78o-3.
\16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
NASD does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
[[Page 79680]]
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were 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 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, 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, NW., Washington, DC 20549-0609.
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 filings will also be
available for inspection and copying at the principal office of the
NASD.
All submissions should refer to File No. SR-NASD-2002-134 and
should be submitted by January 21, 2003.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\17\
\17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32921 Filed 12-27-02; 8:45 am]
BILLING CODE 8010-01-P