

[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    \3\ Amendment No. 1, which replaced and superseded the original 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.

------------------------------------------------------------------------
                               Standard limit  (on
Broad-based underlying index  the same side of the      Restrictions
                                     market)
------------------------------------------------------------------------
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.
------------------------------------------------------------------------

    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.

------------------------------------------------------------------------
                                             Broad-based index hedge
     Broad-based index option type        exemption  (is in addition to
                                                 standard limit)
------------------------------------------------------------------------
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.
------------------------------------------------------------------------

    (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
