

[Federal Register: December 15, 2005 (Volume 70, Number 240)]
[Notices]               
[Page 74399-74409]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15de05-108]                         


[[Page 74399]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52923; File No. SR-PCX-2005-79]

 
Self-Regulatory Organizations; Pacific Exchange, Inc., Notice of 
Filing and Order Granting Accelerated Approval of Proposed Rule Change 
and Amendment Nos. 2 and 3 Relating to Generic Listing Standards for 
Options on Narrow-Based and Micro Narrow-Based Indexes

December 7, 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 June 27, 2005, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'' or 
``SEC'') the proposed rule change as described in Items I and II below, 
which Items have been substantially prepared by the Exchange. The PCX 
filed Amendment Nos. 1 \3\ and 2 \4\ on November 3, 2005. On December 
6, 2005, the PCX filed Amendment No. 3.\5\ The Commission is publishing 
this notice to solicit comments on the proposed rule change, as 
amended, from interested persons and is approving the proposed rule 
change, as amended, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Exchange withdrew Amendment No. 1 on November 3, 2005.
    \4\ Amendment No. 2 supplemented the PCX's original filing and 
made certain technical corrections to the purpose section and to the 
proposed rule text.
    \5\ Amendment No. 3 makes certain technical corrections to the 
proposed rule text and purpose section, but did not materially 
impact the filing.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend its index options rules in order to 
provide for the listing and trading of narrow-based index options 
pursuant to Rule 19b-4(e) under the Act.\6\ The Exchange is also 
proposing to amend the position and exercise limits with respect to 
narrow-based index options, as well as a number of conforming changes 
in order to bring the PCX narrow-based index option rules up to date 
with those of other Self-Regulatory Organizations (``SROs'').\7\ In 
addition, the Exchange proposes to adopt new generic listing standards 
for options on micro narrow-based indexes. The proposed rule changes 
are based on the rules of the International Securities Exchange, Inc. 
(``ISE'') \8\ and the Chicago Board Options Exchange, Incorporated 
(``CBOE''),\9\ which were approved by the Commission. The text of the 
proposed rule change appears below. Additions are italicized; deletions 
are [bracketed].
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    \6\ 17 CFR 240.19b-4(e).
    \7\ The Exchange states that, on October 28, 2003, it filed a 
proposed rule change to update its broad-based and narrow-based 
index options rules. The Exchange further states that due to the 
time-sensitive circumstances at that time, the Exchange amended its 
filing to address only the updates to the broad-based index options 
rules and deleted all references to modifications to the narrow-
based index options rules. At this time, the Exchange is proposing 
to update its narrow-based index options rules in order to bring its 
rules in line with other SROs. See Securities Exchange Act Release 
No. 49455 (March 22, 2004), 69 FR 16316 (March 29, 2004) (Order 
approving SR-PCX-2003-60). The Commission notes, however, that Rule 
19b-4(e), with which the Exchange now proposes to bring its listing 
standards into compliance, has been in effect since December 8, 
1998. See Securities Exchange Act Release No. 40761 (December 8, 
1998), 63 FR 70952 (December 22, 1998).
    \8\ See Securities Exchange Act Release No. 48405 (August 25, 
2003), 68 FR 52257 (September 2, 2003) (SR-ISE-2003-05) (Order 
approving the ISE's generic listing standards for options on narrow-
based indexes).
    \9\ See Securities Exchange Act Release No. 49932 (June 28, 
2004), 69 FR 40994 (July 7, 2004) (SR-CBOE-2002-24) (Order approving 
generic listing standards for options on micro narrow-based security 
indexes) and Securities Exchange Act Release No. 51346 (March 9, 
2005), 70 FR 12916 (March 16, 2005) (SR-CBOE-2005-08) (Order 
approving CBOE's proposed modified capitalization-weighted 
methodology as an acceptable generic listing standard for options on 
narrow-based index).
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Rule 5--Options Contracts Traded on the Exchange

* * * * *
Definitions
    Rule 5.10(b)(1)-(24)--No Change.
    (25) The term ``Micro Narrow-Based Index'' means an industry or 
narrow-based index that meets the specific criteria provided under Rule 
5.13(d).
* * * * *

Designation of the Index Narrow-Based Index Options

    Rule 5.13(a) The component securities of an index underlying an 
index option contract need not meet the requirements of Rule 5.3. 
Except as set forth in subsection (b) below, the listing of a class of 
index options on a narrow-based index requires the filing of a proposed 
rule change to be approved by the SEC under Section 19(b) of the 
Securities Exchange Act of 1934 (``1934 Act''). [The listing of a class 
of index options on a new narrow-based index will be treated by the 
Exchange as a proposed rule change subject to filing with and approval 
by the Securities and Exchange Commission (``Commission'') under 
Section 19(b) of the Act. A rule change proposing the listing of a 
class of index options on a new underlying index may be designated by 
the Exchange as constituting a stated policy, practice or 
interpretation with respect to the administration of this Rule 5.13(a) 
within the meaning of subparagraph (3)(A) of subsection 19(b) of the 
Act, thereby qualifying the rule change for effectiveness upon filing 
with the Commission if the Exchange prefiles with the Commission a 
draft copy of the rule change not less than one week before it is 
filed, and if the Exchange proposes to commence trading in the subject 
class of index options not earlier than 30 days after the date of 
filing, and if each of the following conditions is satisfied:]
    (b) Narrow-Based Index. The Exchange may trade options on a narrow-
based index pursuant to Rule 19b-4(e) of the 1934 Act, if each of the 
following conditions is satisfied:
    (1)--No Change.
    (2) The index is capitalization-weighted, price weighted, [or] or 
equal dollar-weighted, or modified capitalization-weighted, and 
consists of ten or more component securities;
    (3)-(4)--No Change.
    (5) In a capitalization-weighted index or a modified 
capitalization-weighted index, the lesser of the five highest weighted 
component securities in the index or the highest weighted component 
securities in the index that in the aggregate represent at least 30% of 
the total number of component securities in the index each have had an 
average monthly trading volume of at least 2,000,000 shares over the 
past six months;
    (6) No single component security represents more than [25] 30% of 
the weight of the index, and the five highest weighted component 
securities in the index do not in the aggregate account for more than 
50% ([60] 65% for an index consisting of fewer than 25 component 
securities) of the weight of the index.
    (7)--No Change.
    (8) [All Component securities are ``reported securities'' as 
defined in Rule 11Aa3-1 under the Exchange Act.] Each component 
security must be an ``NMS Stock'' as defined in Rule 600 of Regulation 
NMS of the Securities Exchange Act of 1934.
    (9)-(12)--No Change.

[Maintenance Requirements Narrow-Based Index Options]

    [5.13(b)](c) Maintenance Criteria. The following maintenance 
listing standards shall apply to each class of index options originally 
listed pursuant to subsection [paragraph] [(a)](b) above:

[[Page 74400]]

    (1) The requirements [conditions] stated in subsections 
[subparagraphs] [(a)](b)(1), (3), (6), (7), (8), (9), (10), (11) and 
(12) must continue to be satisfied, provided that the requirements 
[conditions] stated in subparagraph [(a)](b)(6) must be satisfied only 
as of the first day of January and July in each year;
    (2)-(3)--No change.
    (4) In a capitalization-weighted index or a modified 
capitalization-weighted index, the lesser of the five highest weighted 
component securities in the index or the highest weighted component 
securities in the index that in the aggregate represent at least 30% of 
the total number of stocks in the index each have had an average 
monthly trading volume of at least 1,000,000 shares over the past six 
months.
    In the event of a class of index options listed on the Exchange 
fails to satisfy the maintenance listing standards set forth herein, 
the Exchange shall not open for trading any additional series of 
options of that class unless such failure is determined by the Exchange 
not to be significant and the Commission concurs in that determination, 
or unless the continued listing of that class of index options has been 
approved by the Commission under Section 19(b)(2) of the Act.
    (d) Notwithstanding subsection (a) above, the Exchange may trade 
options on a Micro Narrow-Based security index pursuant to Rule 19b-
4(e) of the 1934 Act, if each of the following condition is satisfied:
    (1) The Index is a security index:
    (i) That has 9 or fewer component securities; or
    (ii) In which a component security comprises more than 30 percent 
of the index's weighting; or
    (iii) In which the 5 highest weighted component securities in the 
aggregate comprise more than 60 percent of the index's weighting; or
    (iv) In which the lowest weighted component securities comprising, 
in the aggregate, 25 percent of the index's weighting have an aggregate 
dollar value of average daily trading volume of less than $50,000,000 
(or in the case of an index with 15 or more component securities, 
$30,000,000) except that if there are two or more securities with equal 
weighting that could be included in the calculation of the lowest 
weighted component securities comprising, in the aggregate, 25 percent 
of the index's weighting, such securities shall be ranked from lowest 
to highest dollar value of average daily trading volume and shall be 
included in the calculation based on their ranking starting with the 
lowest ranked security;
    (2) The index is capitalization-weighted, modified capitalization-
weighted, price-weighted, share weighted, equal dollar-weighted, 
approximate equal-dollar weighted, or modified equal-dollar weighted;
    (i) For the purposes of this Rule 5.13(d), an approximate equal-
dollar weighted index is composed of one or more securities in which 
each component security will be weighted equally based on its market 
price on the index's selection date and the index must be reconstituted 
and rebalanced if the notional value of the largest component is at 
least twice the notional volume of the smallest component for fifty 
percent or more of the trading days in the three months prior to 
December 31 of each year. For purposes of this provision the ``notional 
value'' is the market price of the component times the number of shares 
of the underlying component in the index. Reconstitution and 
rebalancing are also mandatory if the number of components in the index 
is greater than five at the time of rebalancing. The Exchange reserves 
the right to rebalance quarterly at its discretion.
    (ii) For the purposes of this Rule 5.13(d), a modified equal-dollar 
weighted index is an index in which each underlying component 
represents a pre-determined weighting percentage of the entire index. 
Each component is assigned a weight that takes into account the 
relative market capitalization of the securities comprising the index. 
A modified equal-dollar weighted index will be balanced quarterly.
    (iii) For the purposes of this Rule 5.13(d), a share-weighted index 
is calculated by multiplying the price of the component security by an 
adjustment factor. Adjustment factors are chosen to reflect the 
investment objective deemed appropriate by the designer of the index 
and will be published by the Exchange as part of the contract 
specifications. The value of the index is calculated by adding the 
weight of each component security and dividing the total by an index 
divisor, calculated to yield a benchmark index level as of a particular 
date. A share-weighted index is not adjusted to reflect changes in the 
number of outstanding shares of its components. A share-weighted Micro 
Narrow-Based index will not be re-balanced. If a share-weighted Micro 
Narrow-Based Index fails to meet the maintenance listing standards 
under Rule 5.13(e), the Exchange will restrict trading in existing 
option series to closing transactions and will not issue additional 
series for that index.
    (iv) The Exchange may rebalance any Micro Narrow-Based index on an 
interim basis if warranted as a result of extraordinary changes in the 
relative values of the component securities. To the extent investors 
with open positions must rely upon the continuity of the options 
contract on the index, outstanding contracts are unaffected by 
rebalancings.
    (3) Each component security in the index has a minimum market 
capitalization of at least $75 million, except that each of the lowest 
weighted securities in the index that in the aggregate account for no 
more than 10% of the weight of the index may have a minimum market 
capitalization of only $50 million;
    (4) The average daily trading volume in each of the preceding six 
months for each component security in the index is at least 45,500 
shares, except that each of the lowest weighted component securities in 
the index that in the aggregate account for no more than 10% of the 
weight of the index may have an average daily trading volume of only 
22,750 shares for each of the last six months;
    (5) In a capitalization-weighted index, the lesser of: (1) The five 
highest weighted component securities in the index each have had an 
average daily trading volume of at least 90,000 shares over the past 
six months; or (2) the highest weighted component securities in the 
index that in the aggregate represent at least 30% of the total number 
of component securities in the index each have had an average daily 
trading volume of at least 90,000 shares over the past six months;
    (6) Subject to subparagraphs (4) and (5) above, the component 
securities that account for at least 90% of the total index weight and 
at least 80% of the total number of component securities in the index 
must meet the requirements of Rule 5.3 applicable to individual 
underlying securities;
    (7)(i) Each component security must be an ``NMS Stock'' as defined 
in Rule 600 of Regulation NMS of the Securities Exchange Act of 1934; 
and
    (ii) Foreign securities or ADRs that are not subject to 
comprehensive surveillance sharing agreements do not represent more 
than 20% of the weight of the index;
    (8) The current underlying index value will be reported at least 
once every fifteen seconds during the time the index options are traded 
on the Exchange;

[[Page 74401]]

    (9) An equal dollar-weighted index will be rebalanced at least once 
every quarter;
    (10) If the underlying index is maintained by a broker-dealer, the 
index is calculated by a third party who is not a broker-dealer, and 
the broker-dealer has in place an information barrier around its 
personnel who have access to information concerning changes in and 
adjustments to the index;
    (11) Each component security in the index is registered pursuant to 
Section 12 of the Exchange Act; and
    (12) Cash settled index options are designated as A.M.-settled 
options.
    (e) The following maintenance listing standards shall apply to each 
class of index options originally listed pursuant to paragraph (d) 
above:
    (1) The index meets the criteria of paragraph (d)(1) of this Rule;
    (2) Subject to subparagraphs (9) and (10) below, the component 
securities that account for at least 90% of the total index weight and 
at least 80% of the total number of component securities in the index 
must meet the requirements of Rule 5.3;
    (3) Each component security in the index has a market 
capitalization of at least $75 million, except that each of the lowest 
weighted component securities that in the aggregate account for no more 
than 10% of the weight of the index may have a market capitalization of 
only $50 million;
    (4) Each component security must be an ``NMS stock'' as defined in 
Rule 600 of Regulation NMS of the Securities and Exchange Act of 1934; 
and
    (5) Foreign securities or ADRs thereon that are not subject to 
comprehensive surveillance sharing agreements do not represent more 
than 20% of the weight of the index;
    (6) The current underlying index value will be reported at least 
once every fifteen seconds during the time the index options are traded 
on the Exchange;
    (7) If the underlying index is maintained by a broker-dealer, the 
index is calculated by a third party who is not a broker-dealer, and 
the broker-dealer has in place an information barrier around its 
personnel who have access to information concerning changes in and 
adjustments to the index;
    (8) The total number of component securities in the index may not 
increase or decrease by more than 33\1/3\% from the number of component 
securities in the index at the time of its initial listing;
    (9) Trading volume of each component security in the index must be 
at least 500,000 shares for each of the last six months, except that 
for each of the lowest weighted component securities in the index that 
in the aggregate account for no more than 10% of the weight of the 
index, trading volume must be at least 400,000 shares for each of the 
last six months;
    (10) In a capitalization-weighted index and a modified 
capitalization-weighted index, the lesser of the five highest weighted 
component securities in the index or the highest weighted component 
securities in the index that in the aggregate represent at least 30% of 
the total number of stocks in the index each have had an average 
monthly trading volume of at least 1,000,000 shares over the past six 
months;
    (11) Each component security in the index is registered pursuant to 
Section 12 of the Exchange Act;
    (12) In an approximate equal-dollar weighted index, the index must 
be reconstituted and rebalanced if the notional value of the largest 
component is at least twice the notional volume of the smallest 
component for fifty percent or more of the trading days in the three 
months prior to December 31 of each year. For purposes of this 
provision the ``notional value'' is the market price of the component 
times the number of shares of the underlying component in the index. 
Reconstitution and rebalancing are also mandatory if the number of 
components in the index is greater than five at the time of 
rebalancing. The Exchange reserves the right to rebalance quarterly at 
its discretion;
    (13) In a modified equal-dollar weighted index the Exchange will 
re-balance the index quarterly;
    (14) In a share-weighted index, if a share-weighted Micro Narrow-
Based Index fails to meet the maintenance listing standards under Rule 
5.13(e), the Exchange will not re-balance the index, will restrict 
trading in existing option series to closing transactions, and will not 
issue additional series for that index; and
    (15) In the event a class of index options listed on the Exchange 
fails to satisfy the maintenance listing standards set forth herein, 
the Exchange shall not open for trading any additional series of 
options of that class unless such failure is determined by the Exchange 
not to be significant and the Commission concurs in that determination, 
or unless the continued listing of that class of index options has been 
approved by the Commission under Section 19(b)(2) of the 1934 Act.
* * * * *

Position Limits for Industry (Narrow-Based) Index Options

[Narrow-Based Index Options]

    Rule 5.16(a). Rule 6.8 generally shall govern position limits for 
industry index options, as modified by this Rule 5.16. Option contracts 
on an industry index shall, subject to the procedures specified in 
subsection (c) of this rule, be subject to the following position 
limits: [In determining compliance with Rule 6.8, narrow based 
(industry) index option contracts shall be subject to position limits 
determined as follows:]
    (1) 18,000 [--9,000] contracts if the Exchange determines, at the 
time of a review conducted pursuant to subsection [paragraph] (b) 
below, that any single underlying stock [in the group] accounted, on 
average, for 30% or more of the index value during the 30-day period 
immediately preceding the review; or
    (2) 24,000 [--12,000] contracts if the Exchange determines, at the 
time of a review conducted pursuant to subsection [paragraph] (b) 
below, that any single underlying stock [in the group] accounted, on 
average, for 20% or more of the index value or that any five underlying 
stocks [in the group] together accounted, on average, for more than 50% 
of the index value, but that no single stock in the group accounted, on 
average, for 30% or more of the index value, during the 30-day period 
immediately preceding the review; or
    (3) 31,500 [--15,000] contracts if the Exchange determines that the 
conditions specified above, which would require the establishment of a 
lower limit, have not occurred.
    (b) The Exchange shall make the determinations required by 
subsection (a) above with respect to options on each industry index at 
the commencement of trading of such options on the Exchange and 
thereafter review the determination semi-annually on January 1 and July 
1. [determine the appropriate position limit at the time options on an 
index are initially opened for trading and shall review its 
determination semi-annually, at the same time it reviews position and 
exercise limits for stock options, pursuant to Rule 6.8 and Rule 6.9. 
If the Exchange determines after conducting its review that a higher 
position limit is appropriate for an index the Exchange shall increase 
the limit as soon as practicable. If the Exchange determines that a 
lower limit is appropriate for an index, the lower limit shall take 
effect after the expiration of the farthest term series open for 
trading at the time of the Exchange's review.]

[[Page 74402]]

    (c) If the Exchange determines, at the time of a semi-annual 
review, that the position limit in effect with respect to options on a 
particular industry index is lower than the maximum position limit 
permitted by the criteria set forth in subsection (a), the Exchange may 
effect an appropriate position limit increase immediately. If the 
Exchange determines, at the time of a semi-annual review, that the 
position limit in effect with respect to options on a particular 
industry index exceeds the maximum position limit permitted by the 
criteria set forth in subsection (a), the Exchange shall reduce the 
position limit applicable to such options to a level consistent with 
such criteria; provided, however, that such a reduction shall not 
become effective until after the expiration date of the most distantly 
expiring options series relating to the industry index that is open for 
trading on the date of the review; and provided further that such a 
reduction shall not become effective if the Exchange determines, at the 
next semi-annual review, that the existing position limit applicable to 
such options is consistent with the criteria set forth in subsection 
(a).
    (d)--No Change.
    [(c)] (e) Index [O]option contracts [on an index] shall not be 
aggregated with option contracts on any stocks whose prices are the 
basis for the calculation of the index.
    (f) Positions in reduced-value index options shall be aggregated 
with positions in full-value index options. For such purposes, ten (10) 
reduced-reduced value options shall equal one (1) full-value contract.

Position Limits for Options on Cash Settled Micro Narrow-Based Indexes

    Rule 5.16(f) Methodology for Establishing Position Limits on Cash-
Settled Options on Micro Narrow-Based Indexes as defined under Rule 
5.10(b)(25). The position limit for a cash-settled option on a Micro 
Narrow-Based Index that meets the criteria under Rule 5.13(d) shall be 
calculated in accordance with the following methodology:
    (1) Determine the Market Capitalization of the S&P 500 Index.
    (2) Calculate the Notional Value of a position at the limit in the 
Chicago Mercantile Exchange's (``CME'') S&P 500 futures contract. The 
position limit for that contract is 20,000 (in all months combined) and 
the Index Multiplier is $250.
    Notional Value for the purposes of this rule = Index Level * Index 
Multiplier. Therefore, Notional Value of 20,000 S&P 500 futures 
contracts = 20,000 * S&P 500 Index Level * 250.
    (3) Calculate the Market Capitalization Ratio of the S&P 500 Index 
Market Capitalization to the Notional Value of a position limit at the 
limit.
    Market Capitalization Ratio = Market Capitalization of the S&P 500/
Notional Value of 20,000 S&P 500 futures contract positions.
    (4) Determine the Market Capitalization of the Micro Narrow-Based 
Index by adding together the market capitalization of each underlying 
security component.
    (5) Determine the Notional Value of the Micro Narrow-Based Index 
Option (Index Level * Contract Multiplier).
    (6) Calculate the Position Limit of the Micro Narrow-Based Index 
using the following formula:
    Contract Position Limit on the Micro Narrow-Based Index = Market 
Capitalization of Micro Narrow-Based Index/(Notional Value of Micro 
Narrow-Based Index Option * Market Capitalization Ratio).
    (7) Establishing the Position Limit. After the applicable position 
limit has been determined pursuant to Rule 5.16(f)(1)-(6), round the 
calculated position limit to the nearest 1,000 contracts using standard 
rounding procedures. For position limits that are 400 or greater, but 
less than 1000 contracts, round up to 1,000 contracts.
    Rule 5.13(d) shall not apply to any Micro Narrow-Based Index in 
which the applicable position limit, as calculated using Rule 
5.16(f)(1)-(6), for that Micro Narrow-Based Index is less than 400 
contracts.

Exemptions From Position Limits

    Rule 5.17(a). Broad-based Index Hedge Exemptions--No Change.
    (b) Industry (Narrow-Based) Index Hedge Exemptions. The industry 
(narrow-based) index hedge exemption is in addition to the other 
exemptions available under Exchange Rules, interpretations and 
policies, and may not exceed twice the standard limit established under 
Rule 5.16. Industry [Narrow-based (industry)] index option positions 
may be exempt from established position limits for each option contract 
``hedged'' by an equivalent dollar amount of the underlying component 
securities or securities convertible into such components; provided 
that, in applying such hedge, each option position to be exempted is 
hedged by a position in at least 75% of the number of component 
securities underlying the index. In addition, the underlying value of 
the option position may not exceed the value of the underlying 
portfolio. The value of the underlying portfolio is:
    (1)[(a)] the total market value of the net stock position; and [, 
less]
    (2)[(b)] for positions in excess of the standard limit, subtract 
the underlying market value of:
    (A)[(1)] any offsetting calls and puts in the respective index 
option; and
    (B)[(2)] any offsetting positions in related stock index futures or 
options; and
    (C)[(3)] any economically equivalent positions (assuming no other 
hedges for these contracts exist).
    The following procedures and criteria must be satisfied to qualify 
for an industry index hedge exemption:

[Prior Exchange approval on the appropriate form designated by the 
Exchange is required. This exemption requires that both the option and 
stock positions be initiated and liquidated in an orderly manner. 
Specifically, a reduction of the option position must occur at or 
before the corresponding reduction in the stock portfolio position. The 
position in a narrow-based index option may not exceed the total of: 
(a) the limit established under Rule 5.16, plus (b) two times that 
limit (for hedged positions). The Exchange may determine, in its 
discretion, to grant a hedge exemption for a number of contracts that 
is less than the maximum number permitted under this Commentary. The 
Exchange may also grant other position limit exemptions under Exchange 
rules, and such exemptions shall be applied in addition to any 
exemption provided under this Commentary.]
    (1) The hedge exemption account must have received prior Exchange 
approval for the hedge exemption specifying the maximum number of 
contracts that may be exempt under this Rule. The hedge exemption 
account must have provided all information required on Exchange-
approved forms and must have kept such information current. Exchange 
approval may be granted on the basis of verbal representations, in 
which event the hedge exemption account shall within two business days, 
or such other time period designated by the Exchange, furnish the 
Exchange with appropriate forms and documentation substantiating the 
basis for the exemption. The hedge exemption account may apply from 
time to time for an increase in the maximum number of contracts exempt 
from the position limits.
    (2) A hedge exemption account that is not carried by an OTP Holder 
or OTP Firm must be carried by a member of a

[[Page 74403]]

self-regulatory organization participating in the Intermarket 
Surveillance Group.
    (3) The hedge exemption account shall:
    (A) liquidate and establish options, stock positions, or 
economically equivalent positions in an orderly fashion; not initiate 
or liquidate positions in a manner calculated to cause unreasonable 
price fluctuations or unwarranted price changes; and not initiate or 
liquidate a stock position or its equivalent with an equivalent index 
option position with a view toward taking advantage of any differential 
in price between a group of securities and an overlying stock index 
option;
    (B) liquidate any options prior to or contemporaneously with a 
decrease in the hedged value of the portfolio which options would 
thereby be rendered excessive.
    (C) promptly notify the Exchange of any change in the portfolio 
that materially affects the unhedged value of the portfolio.
    (4) If an exemption is granted, it will be effective at the time 
the decision is communicated. Retroactive exemptions will not be 
granted.
    (5) The hedge exemption account shall promptly provide to the 
Exchange any information requested concerning the portfolio.
    (6) Positions included in a portfolio that serve to secure an index 
hedge exemption may not also be used to secure any other position limit 
exemption granted by the Exchange or any other self regulatory 
organization or futures contract market.
    (7) Any OTP Holder or OTP Firm that maintains an industry index 
option position in such OTP Holder or OTP Firm's own account or in a 
customer account, and has reason to believe that such position is in 
excess of the applicable limit, shall promptly take the action 
necessary to bring the position into compliance. Failure to abide by 
this provision shall be deemed to be a violation of Rule 6.8 and this 
Rule 5.16 by the OTP Holder or OTP Firm.
    (8) Violation of any of the provisions of this Rule, absent 
reasonable justification or excuse, shall result in withdrawal of the 
index hedge exemption and may form the basis for subsequent denial of 
an application for an index hedge exemption hereunder.
* * * * *

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 the 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 III below. The PCX 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

Purpose
    1. Designation of Narrow-Based Index Options. The Exchange is 
proposing to amend PCX's index option rules to provide for the listing 
and trading of narrow-based stock index options pursuant to Rule 19b-
4(e) under the Act.\10\ The purpose of the proposal is to allow the PCX 
to list and trade narrow-based index options immediately without filing 
a proposed rule change with the Commission under Section 19(b)(3)(A) of 
the Act prior to trading the product, as PCX Rule 5.13(a) currently 
requires.\11\ Current PCX Rule 5.13(a) states that the Exchange may 
list and trade options on a narrow-based index 30 days after the 
Exchange files a formal rule filing under Section 19(b)(3)(A) 
describing the index option, provided that the index meets the generic 
listing criteria set forth in PCX Rule 5.13(a)(1)-(12). However, the 
19b-4(e) Adopting Release no longer requires a Section 19(b)(3)(A) 
filing and subsequent waiting period so long as the exchange, relying 
on Rule 19b-4(e) under the Act, has generic listing criteria which have 
been approved by the Commission. The 19b-4(e) Adopting Release 
indicated that products meeting the listing criteria approved by the 
Commission qualified for filing under Rule 19b-4(e), so long as the 
exchange eliminated that requirement from its existing rules.\12\
---------------------------------------------------------------------------

    \10\ Rule 19b-4(e)(1) provides that ``the listing and trading of 
a new derivative securities product by a self-regulatory 
organization shall not be deemed a proposed rule change, pursuant to 
paragraph (c)(1) of [Rule 19b-4], if the Commission has approved, 
pursuant to Section 19(b) of the Exchange Act, the self-regulatory 
organization's trading rules, procedures and listing standards for 
the product class that would include the new derivative securities 
product and the self-regulatory organization has a surveillance 
program for the product class.'' 17 CFR 240.19b-4(e)(1). When 
relying on Rule 19b-4(e), the SRO must submit Form 19b-4(e) to the 
Commission within five business days after the exchange begins 
trading the new derivative securities products. See Securities 
Exchange Act Release No. 40761 (December 8, 1998), 63 FR 70952 
(December 22, 1998) (File S7-13-98) (``19b-4(e) Adopting Release'').
    \11\ The Commission notes that this procedure for listing and 
trading of narrow-based stock index options has been obsolete since 
the Commission approved the Rule 19b-4(e) Adopting Release in 1998.
    \12\ See id. at note 89.
---------------------------------------------------------------------------

    Therefore, the PCX is proposing to eliminate the Section 
19(b)(3)(A) rule filing requirement from PCX Rule 5.13(a) and, instead, 
incorporate the provisions of Rule 19b-4(e) into the new proposed PCX 
Rule 5.13(b). The Exchange believes that this proposal will allow the 
PCX to list and trade narrow-based index options that comply with the 
PCX Rule 5.13(b) criteria, immediately, thereby providing a more 
expeditious method of offering these products in the marketplace. The 
Exchange represents that PCX's surveillance procedures are adequate to 
monitor the trading in options on narrow-based indexes as defined under 
Rule 5.13(b).
    In addition, the Exchange proposes to amend its Rules to include 
the modified capitalization-weighted methodology as an acceptable 
generic listing criteria for options on a narrow-based index.\13\ 
Current PCX Rule 5.13(a)(2) requires that the subject index be 
capitalization-weighted, price-weighted, or equal-dollar weighted and 
consist of ten or more component securities. The Exchange proposes to 
include the modified capitalization-weighted methodology as an 
acceptable generic listing criteria. The Exchange believes that such 
methodology is a widely established method of weighting securities 
indexes and is already in place at other SROs.\14\ The Exchange 
represents that PCX's surveillance procedures are adequate to monitor 
the trading in options on narrow-based index options that meet the 
specified criteria in PCX Rule 5.13(b).
---------------------------------------------------------------------------

    \13\ A modified capitalization weighted index is similar to a 
capitalization weighted index, where the components are weighted 
according to the total market value compared to the market value of 
the outstanding shares, except that an adjustment to the weighting 
of one or more of the components occurs. The general purposes for 
using this methodology are to: (1) retain the economic attributes of 
capitalization weighting; (2) promote portfolio weight 
diversification; (3) reduce index performance distortion by 
preserving the capitalization ranking of companies; and (4) reduce 
market impact on the smallest underlying components from necessary 
weight rebalancings. For example, indexes such as the Nasdaq-100 
Index, KBW Bank Index, KBW Capital Markets Index, and the Goldman 
Sachs Technology Indexes are calculated using the Modified 
Capitalization-Weighted Methodology.
    \14\ See supra note 9.
---------------------------------------------------------------------------

    2. Position and Exercise Limits. The Exchange is proposing to amend 
PCX Rule 5.16 in order to increase the position and exercise limits for 
narrow-based index options to the levels

[[Page 74404]]

currently in place at the ISE,\15\ the CBOE,\16\ the Philadelphia Stock 
Exchange, Inc. (``Phlx''),\17\ and the American Stock Exchange LLC 
(``Amex'').\18\ The three-tier position and exercise limit 
determination will remain unchanged. Specifically, the PCX proposes to 
increase the position and exercise limits for narrow-based index 
options from 9,000, 12,000 and 15,000 contracts to 18,000, 24,000 and 
31,500 contracts, respectively.
---------------------------------------------------------------------------

    \15\ See ISE Rules 2004 and 2005.
    \16\ See CBOE Rules 24.4, 24.4A, and 24.5.
    \17\ See Phlx Rule 1001A and 1002A.
    \18\ See Amex Rules 904C and 905C.
---------------------------------------------------------------------------

    In addition to providing regulatory equality, the PCX believes that 
an increase in the position and exercise limits for narrow-based index 
options is appropriate for a number of reasons. First, the Exchange 
believes that increased position and exercise limits for narrow-based 
index options may bring additional depth and liquidity, in terms of 
both volume and open interest, to these index options classes without 
significantly increasing concerns regarding inter-market manipulations 
or disruptions of the index options or the underlying component 
securities.
    Second, the Exchange notes that the proposal, while increasing the 
position limits for narrow-based index options, continues to reflect 
the unique characteristics of each index option and to maintain the 
structure of the current three-tiered system. Specifically, under the 
proposal, the lowest proposed limit, 18,000 contracts, will apply to 
narrow-based index options in which a single underlying 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. A position limit of 24,000 contracts will 
apply if: (1) any single underlying stock accounted, on average, for 
20% or more of the index value, or (2) any five underlying stocks 
together accounted, on average, for more than 50% of the index value, 
but no single stock in the group accounted, on average, for more than 
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. The 31,500 contract limit will apply only if the 
Exchange determines that the above-specified conditions requiring 
either the 18,000 contract limit or the 24,000 contract limit have not 
occurred.
    3. Narrow-Based Index Hedge Exemptions. The Exchange proposes to 
amend PCX Rule 5.17(b) in order to update the Exchange's exemptions 
from position limits for narrow-based index options and the procedures 
for requesting such exemptions. The Exchange represents that the 
proposed exemptions are substantially identical to those of other SROs.
    4. Micro Narrow-Based Index Options. The Exchange proposes to adopt 
new PCX Rules 5.13(d) and 5.16(f) in order to adopt the criteria for a 
new classification of narrow-based indexes, classified as ``micro 
narrow-based'' indexes and adopt initial listing standards, maintenance 
standards, and position and exercise limits for options on micro 
narrow-based security indexes.\19\
---------------------------------------------------------------------------

    \19\ See supra note 9.
---------------------------------------------------------------------------

    a. Listing and Maintenance Standards. The Exchange proposes to use 
the term ``micro narrow-based'' to distinguish this classification of 
narrow-based indexes from the existing ``narrow-based'' security 
indexes. Specifically, the Exchange proposes to list and trade options 
on a micro narrow-based security index, pursuant to Rule 19b-4(e) under 
the Act, if the index is a micro narrow-based security index: (1) That 
has 9 or fewer component securities; or (2) in which a component 
security comprises more than 30% of the index's weighting; or (3) in 
which the 5 highest weighted component securities in the aggregate 
comprise more than 60% of the index's weightings; or (4) in which the 
lowest weighted component securities comprising, in the aggregate, 25% 
of the index's weighting, have an aggregate dollar value of average 
daily trading volume of less than $50 million (or in the case of an 
index with 15 or more component securities, $30 million), except that 
if there are 2 or more securities with equal weighting that could be 
included in the calculation of the lowest weighted securities 
comprising, in the aggregate, 25% of the index's weighting, such 
securities shall be ranked from lowest to highest dollar value of 
average daily trading volume and shall be included in the calculation 
based on their ranking starting with the lowest ranked security. The 
proposed rule change also makes other modifications that are consistent 
with the standards for futures on narrow-based indices, including a 
requirement that all component securities of a narrow-based security 
index be registered pursuant to Section 12 of the Act.
    The Exchange proposes to permit a micro narrow-based index to be a 
modified capitalization-weighted index \20\ and proposes three 
additional index weighting methodologies for micro narrow-based 
indexes--modified equal-dollar weighted, approximate equal-dollar 
weighted, and share weighted. A modified equal-dollar weighted 
methodology is designed to be a fair measurement of the particular 
industry or sector represented by the index, but without assigning an 
excessive weight to one or more index components that have a larger 
market capitalization relative to other index components. Under this 
methodology, each component is assigned a weight that takes into 
account the relative market capitalization of the securities comprising 
the index. The index is subsequently rebalanced to maintain these pre-
established weighting levels. In the case of an index with 9 components 
or less, the weight assigned to the largest component will not exceed 
50% of the entire index weight. Like equal-dollar weighted indexes, the 
value of a modified equal-dollar weighted index will equal the current 
combined market value (based on U.S. primary market prices) of the 
assigned number of shares of each of the underlying components divided 
by the appropriate index divisor. A modified equal-dollar weighted will 
be balanced quarterly.
---------------------------------------------------------------------------

    \20\ See Securities Exchange Act Release No. 49932 (June 28, 
2004), 69 FR 40994 (July 7, 2004) (SR-CBOE-2002-24). The Exchange 
states that these listing and maintenance standards are consistent 
with the Commission's Staff Legal Bulletin No. 15: Listing Standards 
for Trading Security Futures Products (September 5, 2001).
---------------------------------------------------------------------------

    An approximate equal-dollar weighted index is composed of one or 
more securities in which each component security will be weighted 
equally based on its market price on the index's selection date. The 
index must be reconstituted and rebalanced if the notional value of the 
largest component is at least twice the notional volume of the smallest 
component for fifty percent or more of the trading days in the three 
months prior to December 31 of each year. For purposes of this 
provision, the Exchange defines ``notional value'' as the market price 
of the component times the number of shares of the underlying component 
in the index. The Exchange also states that the reconstitution and 
rebalancing are also mandatory if the number of components in the index 
changes. The Exchange also states that it will reserve the right to 
rebalance quarterly at its discretion.
    A share-weighted index is designed to mimic the value of a 
portfolio consisting of two or more securities. The weight of each 
component security is calculated by multiplying the price of the 
component security by an adjustment

[[Page 74405]]

factor. Adjustment factors are chosen to reflect the investment 
objective deemed appropriate by the designer of the index and will be 
published by the Exchange as part of the contract specifications.\21\ 
The value of the index is calculated by adding the weight of each 
component security and dividing the total by an index divisor.\22\ If a 
share-weighted micro narrow-based index fails to meet the maintenance 
listing standards under PCX Rule 5.13(e), the index would not be 
rebalanced by the Exchange. Instead, the Exchange would restrict 
options transactions to ``closing-only'' transactions and would not 
issue any additional series for that index.\23\ Upon the expiration of 
the last series on that index, the Exchange will no longer calculate 
that index and no additional series would be listed.
---------------------------------------------------------------------------

    \21\ For example, an index designer might want to apply an 
adjustment factor in order to prevent one or a few components from 
dominating the weight of the index. This is similar to an adjustment 
factor in other types of weighting methods, such as modified 
capitalization weighted indexes.
    \22\ The index ``divisor'' is calculated to yield a benchmark 
index level (50, 100, 200, etc.) as of a particular date.
    \23\ When option series are restricted to ``closing-only'' 
status, the only opening transactions allowed in such a series are 
(i) opening transactions by market-makers executed to accommodate 
closing transactions of other market participants and (ii) opening 
transactions by an OTP Holder to facilitate the closing transactions 
of public customers executed as crosses pursuant to and in 
accordance with PCX Rule 6.47. PCX will issue a bulletin to notify 
OTP Holders and OTP Firms of such a situation.
---------------------------------------------------------------------------

    Regardless of the weighting methodology, the Exchange represents 
that it will also reserve the right to rebalance any micro narrow-based 
index on an interim basis if warranted as a result of extraordinary 
changes in the relative values of the component securities. Proposed 
PCX Rule 5.13(d)(2)(iv) shall provide that, to the extent investors 
with open positions must rely upon the continuity of the options 
contracts on the index, outstanding contracts are unaffected by 
rebalancings. The Exchange believes that these provisions are 
consistent with previous rule changes approved by the Commission.\24\
---------------------------------------------------------------------------

    \24\ See Securities Exchange Act Release No. 42787 (May 24, 
2000), 65 FR 33598 (May 24, 2000) (Commentary .03 to Amex Rule 1000 
and Commentary .02 to Amex Rule 1000A).
---------------------------------------------------------------------------

    Proposed PCX Rule 5.13(e) contains the maintenance standards that 
will apply to micro narrow-based security indexes.\25\ The Exchange 
believes that the maintenance standards generally adhere to the 
Commission's Division of Market Regulation's Bulletin \26\ and those 
standards applicable to futures in a narrow-based security index. The 
Exchange represents that PCX's surveillance procedures are adequate to 
monitor the trading in options on micro narrow-based indexes as defined 
under PCX Rule 5.10(b)(25).
---------------------------------------------------------------------------

    \25\ Exhibit A summarizes how the Exchange generally expects to 
handle certain corporate actions upon listing Micro Narrow-Based 
Index Options based on approximate equal-dollar weighted or share-
weighted indexes.
    \26\ Commission Staff Legal Bulletin No. 15: Listing Standards 
for Trading Security Futures Products (September 5, 2001).
---------------------------------------------------------------------------

    b. Position and Exercise Limits. The Exchange also proposes to 
establish a new method for determining the applicable position limits 
for options on any micro narrow-based index that meets the generic 
listing standards under proposed PCX Rule 5.13(d). The Exchange 
represents that it will utilize a formulaic approach as provided in 
proposed PCX Rule 5.16(f), ``Position Limits for Options on Cash 
Settled Micro Narrow-Based Indexes'' as defined under PCX Rule 
5.10(b)(25).
    This new methodology is a departure from the manner in which 
position limits are assigned for index options under existing PCX 
rules. The current position limits for narrow-based index options are 
assigned from pre-determined tiers based on an analysis of the 
respective index's underlying components. Under the proposed 
methodology, position limits would be determined in accordance with a 
formula that considers a cash settled micro narrow-based index's market 
capitalization and contract size in relation to the market 
capitalization of the S&P 500 index and the contract size and position 
limit of a futures contract on the S&P 500 index.
    In determining compliance with PCX Rule 5.18 (Exercise Limits), the 
applicable exercise limit for option contracts on any micro narrow-
based index, as defined under proposed PCX Rule 5.10(b)(25), shall be a 
limit equivalent to the applicable position limits for options on that 
micro narrow-based index, as calculated under proposed PCX Rule 
5.16(f)(1)-(7).
    c. Margin and Strikes Prices. PCX Rule 4.16 governs the 
determination of the applicable margin treatment for options traded on 
the Exchange, including options that overlie narrow-based indexes. The 
existing applicable margin for options on narrow-based indexes, as 
provided under PCX Rule 4.16, also shall apply to micro narrow-based 
indexes. The interval between strike prices for options on indexes that 
meet the criteria under PCX Rule 5.13(d) will be no less than $2.50.
    5. System Capacity. Finally, the Exchange reasonably believes it 
has adequate system capacity to support the trading of options on 
narrow-based and micro narrow-based indexes, based on a calculation of 
the Exchange's current ISCA allocation and the number of new messages 
per second expected to be generated by options on such index.
Statutory Basis
    The Exchange believes that the proposal is consistent with Section 
6(b) of the Act,\27\ in general, and furthers the objectives of Section 
6(b)(5) \28\ of the Act, in particular, in that it is designed to 
facilitate transactions in securities, to promote just and equitable 
principles of trade, to enhance competition, and to protect investors 
and the public interest.\29\
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78f(b).
    \28\ 15 U.S.C. 78f(b)(5).
    \29\ PCX clarified that it believes the proposal is consistent 
with Section 6(b)(5) of the Act as opposed to Section 6(b)(4) as 
stated in Exhibit 1 to the original proposed rule change and 
requested that the statutory language relating to Section 6(b)(5) of 
the Act provided on page 13 of the original rule filing be inserted 
in place of the language cited from Section 6(b)(4) in Exhibit 1. 
Telephone conversation between David Strandberg, Director, Issuer 
Services PCX and Johnna B. Dumler, Attorney, Division of Market 
Regulation, Commission, December 6, 2005.
---------------------------------------------------------------------------

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

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in 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

    Written comments on the proposed rule change were neither solicited 
nor received.

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 rules-comments@sec.gov. Please include 

Filed No. SR-PCX-2005-79 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission,

[[Page 74406]]

100 F Street, NE., Washington, DC 20549-9303.

All submissions should refer to File No. SR-PCX-2005-79. 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 Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the PCX. 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 available publicly. All submissions should refer to 
File No. SR-PCX-2005-79 and should be submitted on or before January 5, 
2006.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange. In particular, the Commission finds that the PCX's 
proposal is consistent with Section 6(b)(5) of the Act,\30\ which 
requires that the rules of an exchange be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism for a free and open market and a national market system, and, 
in general, to protect investors and the public interest.\31\ 
Specifically, the Commission notes that the proposed rule change would 
permit the Exchange to list and trade, pursuant to Rule 19b-4(e) under 
the Act,\32\ options on narrow-based and micro narrow-based security 
indexes that meet the listing criteria set forth in PCX Rule 5.13. The 
Commission finds that the proposal strikes a reasonable balance between 
the Commission's mandates under Section 6(b)(5) \33\ of the Act to 
remove impediments to, and perfect the mechanism of a free and open 
market and a national market system, while protecting investors and the 
public interest.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78f(b)(5).
    \31\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \32\ 17 CFR 240.19b-4(e).
    \33\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission believes that the proposed initial listing and 
maintenance standards for options on narrow-based and micro narrow-
based security indexes are consistent with the standards previously 
established by other SROs.\34\
---------------------------------------------------------------------------

    \34\ See CBOE Rule 24.2. See e.g. Securities Exchange Act 
Release No. 51346 (March 9, 2005), 70 FR 12916 (March 16, 2005) (SR-
CBOE-2005-08) (Order approving CBOE's proposed modified 
capitalization-weighted methodology as an acceptable generic listing 
standard for options on narrow-based index); see also Securities 
Exchange Act Release No. 34157 (June 3, 1994), 59 FR 30062 (June 10, 
1994) (SR-Amex-92-35) (SR-CBOE-93-59) (SR-NYSE-94-17) (SR-PSE-94-07) 
(SR-Phlx-94-10). The Commission findings in this approval order are 
prospective from the date of this order.
---------------------------------------------------------------------------

    The Commission also believes that the proposed generic listing 
standards for micro narrow-based index options covering, among other 
things, minimum capitalization, monthly trading volume, and relative 
weightings of component stocks are reasonably designed to ensure that 
the trading market for component stocks are adequately capitalized and 
sufficiently liquid. In addition, the Commission notes that position 
limits for options on any micro narrow-based index that meets the 
generic listing standards of proposed PCX Rule 5.13(d) would be 
determined in accordance with a proposed new formula that considers the 
index's market capitalization and contract size in relation to the 
market capitalization of the S&P 500 index and the contract size and 
position limit of a futures contract on the S&P 500 index. The 
Commission believes that the proposed formula for determining position 
limits for micro narrow-based index options is appropriate to deter 
manipulation of the index. In addition, the Commission finds that the 
weighting methodologies employed by the PCX, including the modified 
equal-dollar weighted, approximate equal-dollar weighted and share-
weighted methodologies, are appropriate index construction standards. 
The Commission notes that the Exchange represents that it reasonably 
believes it has sufficient operational system capacity to accommodate 
the PCX's listing and trading of narrow-based and micro narrow-based 
security indexes.
    The Exchange is also charged with surveillance for the product 
classes, including options on narrow-based and micro narrow-based 
security indexes. The Exchange represents that it has developed and 
submitted surveillance procedures that it will use to monitor the 
general trading and settlement activity in narrow-based and micro 
narrow-based indexes to ensure full compliance with Exchange Rules and 
federal securities laws. The Exchange indicates that it will have 
complete access to information regarding trading activity in the 
underlying securities. The Exchange has developed new surveillance 
procedures specific to these products that the Commission finds 
adequate to monitor for manipulation in the narrow-based and micro 
narrow-based indexes.
    The Commission's approval of the proposed generic listing standards 
for options on narrow-based and micro narrow-based security indexes 
will allow those options that satisfy these standards to start trading 
under Rule 19b-4(e), without constituting a proposed rule change within 
the meaning of Section 19(b) of the Act \35\ and Rule 19b-4,\36\ for 
which notice and comment and Commission approval is necessary. Rule 
19b-4(e) \37\ states that the listing and trading of a new derivative 
securities product by an SRO shall not be deemed a proposed rule 
change, pursuant to paragraph (c)(1) of Rule19b-4, if the Commission 
has approved, pursuant to Section 19(b) of the Act, such SRO's trading 
rules, procedures and listing standards for the product class that 
would include the new derivative securities product, and the SRO has a 
surveillance program for the product class.
---------------------------------------------------------------------------

    \35\ 15 U.S.C. 78s(b).
    \36\ 17 CFR 240.19b-4.
    \37\ 17 CFR 240.19b-4(e).
---------------------------------------------------------------------------

    The Exchange's ability to rely on Rule 19b-4(e) for these products 
potentially reduces the time frame for brining these securities to the 
market, promoting competition and providing investors with derivative 
securities products to meet their needs more quickly. As stated above, 
the Commission believes that the Exchange has adequate trading rules, 
procedures, listing standards, and a surveillance program for the 
narrow-based and micro narrow-based indexes, and thus, the Commission 
is approving the generic listing standards pursuant to 19b-4(e) for 
these product classes.

[[Page 74407]]

    The PCX has requested that the Commission find good cause for 
approving the proposed rule change, as amended, prior to the thirtieth 
day after the proposal is published for comment in the Federal 
Register. The Commission believes that the adoption of the proposal 
will enable the PCX to act expeditiously in listing options on narrow-
based and micro narrow-based securities indexes in the same manner 
currently afforded to other options exchanges, such as the CBOE.\38\ In 
addition, the Commission believes that the proposed rule change would 
remove impediments to a free and open market place by providing 
competition among exchanges for new products. Accordingly, the 
Commission finds good cause, pursuant to Section 19(b)(2) of the 
Act,\39\ for approving the proposed rule change, as amended, prior to 
the thirtieth day after publication thereof in the Federal Register.
---------------------------------------------------------------------------

    \38\ See supra note 9.
    \39\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, Section 6(b)(5) of the Act.\40\
---------------------------------------------------------------------------

    \40\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\41\ that the proposed rule change (SR-PCX-2005-79), as amended by 
Amendment Nos. 2 and 3, is approved on an accelerated basis.
---------------------------------------------------------------------------

    \41\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\42\
---------------------------------------------------------------------------

    \42\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jonathan G. Katz,
Secretary.

Exhibit A

                                       Corporate Action Summary A for Approximately Equal Dollar-Weighted Indexes
--------------------------------------------------------------------------------------------------------------------------------------------------------
                           Type                                                   Adjustments
-------------------------------------------------------------------------------------------------------------------                 Notes
               Action                       Company             Close price/Action             Share lot (1)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Special Cash Dividend..............  Component of Index...  Adj. Close = Prev. Close--  Adj. Share lot = Prev.      Companies contribution to index not
                                                             Dividend.                   Share lot + (Prev. Share    affected by Special dividend.
                                                                                         lot * Div.)/Adj. Close.
Stock Split or Dividend............  Component of Index...  Adj. Close = Prev. Close/   Adj. Round Lot = Prev.      Adjustment Factor =  of New
                                                             Adjustment Factor.          Share Lot* Adjustment       Shares for 1 Old Share.
                                                                                         Factor.
Spin Off...........................  Component of Index     Adj. Close = Close--(Ratio                              Ratio =  of shares of spun
                                      (A).                   * Spun off Company's                                    off company received for every
                                                             Price).                                                 share of parent company owned. Spun
                                                                                                                     off company will be added at a
                                                                                                                     weight such that the index
                                                                                                                     contribution of the two companies
                                                                                                                     after the event is equal to the
                                                                                                                     index contribution of the parent
                                                                                                                     prior to the event.
                                     Spun Off Company (B).  ADDED.....................  Share lot = ((Share lot A*  ....................................
                                                                                         Prev. Close A)-(Share lot
                                                                                         A * Adj. Close A))/Close
                                                                                         B.
Two Components Merge in an All       Remaining Companies                                Adj. Share Lot = Share Lot  All remaining companies will be
 Stock, Cash or Combination Deal.     (A).                                               + ((B's Close * B's Share   adjusted using the formula to the
                                                                                         Lot))/ of          left. Their shares will increase
                                                                                         remaining components)/A's   based on their price so as to
                                                                                         Close.                      distribute the weight of the
                                                                                                                     acquired company evenly.
                                     Acquired Company (B).  DELETED...................  ..........................  ....................................
A Non-Component Takes Over a         Acquirer (A).........  ADDED.....................  Share Lot = (B's Round Lot  The acquiring company will replace
 Component.                                                                              * B's Close) / A's Close.   the acquired company. Its share lot
                                                                                                                     will be set to contribute the same
                                                                                                                     amount to the index as the acquired
                                                                                                                     company contributed prior to the
                                                                                                                     acquisition.
                                     Acquired Component of  DELETED...................  ..........................  ....................................
                                      Index (B).
Rights Issue.......................  Component of Index...  Adj. Close = (Close +       Adj. Share Lot = (Close *   Ratio =  of rights received
                                                             (Ratio * Subscription       Share Lot)/Adj. Close.      for 1 share of A.
                                                             Price))/(1 + Ratio).

[[Page 74408]]


Extraordinary Removal..............  (1) Remaining          ADDED if (2)..............  If (1):...................  Company B may be removed for any of
                                      Securities (A) or                                 Adj. Share Lot (A) = Prev.   the following reasons: Bankruptcy
                                      (2) Replacement                                    Share lot (A) + (B's        proceedings, Financial distress,
                                      Company (A).                                       share lot * B's Close)/     Delisting from a primary exchange
                                                                                         ( of Remaining     (NYSE, Nasdaq, Amex), or
                                                                                         Components * A's Close).    Illiquidity (10 consecutive no
                                                                                        If (2): Share lot A = (B's   trade days).
                                                                                         Share lot * B's Close)/    The Exchange would either:
                                                                                         A's Close.                 (1) Divide B's index contribution
                                                                                                                     evenly between remaining components
                                                                                                                     or
                                                                                                                    (2) If Replacement Company A is
                                                                                                                     added, Replacement Company A would
                                                                                                                     be the highest ranked (as of the
                                                                                                                     most recent selection date) of the
                                                                                                                     remaining securities in the
                                                                                                                     industry group which qualify for
                                                                                                                     inclusion.
                                                                                                                    The method to be utilized will be
                                                                                                                     described in the index's contract
                                                                                                                     specification.
                                     Component of Index     DELETED...................  ..........................  ....................................
                                      (B).
--------------------------------------------------------------------------------------------------------------------------------------------------------
(1) Share lots will be rounded to the nearest hundred at rebalance. Odd lots may exist between rebalances.


                                                  Corporate Action Summary B for Share-Weighted Indexes
--------------------------------------------------------------------------------------------------------------------------------------------------------
                           Type                                                   Adjustments
-------------------------------------------------------------------------------------------------------------------                 Notes
               Action                       Company           Component price change     Adjustment factor change
--------------------------------------------------------------------------------------------------------------------------------------------------------
Special Cash Dividend..............  Component of Index...  New Close = Prev. Close--   New Adj. Factor = (Prev.    ....................................
                                                             Dividend.                   Adj. Factor * Prev.
                                                                                         Close)/New Close.
Stock Split or Dividend............  Component of Index...  New Close = Prev. Close/    New Adj. Factor = Prev.     For example, in the case of a 2-for-
                                                             Split Ratio.                Adj. Factor * Split Ratio.  1 split, the Split Ratio would be
                                                                                                                     2. In the case of a 5% stock
                                                                                                                     dividend, the split ratio would be
                                                                                                                     1.05.
Spin Off...........................  Component of Index     New Close = Prev. Close--   New Adj. Factor = (Prev.    Price Adjustment due to value of
                                      (A).                   (Price Adjstment due to     Adj. Factor * Prev.         spun-off company = (Market
                                                             value of spun-off           Close)/New Close.           capitalization of parent company--
                                                             company).                                               market capitalization of spun-off
                                                                                                                     company)/number of outstanding
                                                                                                                     shares of the parent company. Spun-
                                                                                                                     off Company is not added.
Two Components Merge in an All       Acquiring Company....  ..........................  New Adj. Factor = Prev.     The weight of the Acquired Company
 Stock, Cash or Combination Deal.                                                        Adj. Factor + ((Acquired    is added to the weight of the
                                                                                         Company's Close *           Acquiring Company.
                                                                                         Acquired Company's Adj.
                                                                                         Factor)/Acquiring
                                                                                         Company's Close).
                                     Acquired Company.....  DELETED...................  ..........................  ....................................
A Non-Component Takes Over a         Non-Component          ADDED.....................  New Adj. Factor =           Non-Component Acquiring Company
 Component.                           Acquiring Company.                                 ((Acquired Company's        added to index at Acquired
                                                                                         Close * Acquired            Company's weight.
                                                                                         Company's Adj. Factor)/
                                                                                         Acquiring Company's
                                                                                         Close).
                                     Acquired Component of  DELETED...................  ..........................  ....................................
                                      Index.
Rights Offering....................  Component of Index...  New Close = Prev. Close--   New Adj. Factor = (Prev.    Price Adjustment due to value of
                                                             Price Adjustment due to     Adj. Factor * Prev.         rights offering = (market
                                                             value of offering.          Close)/New Close.           capitalization of parent company--
                                                                                                                     market capitalization of rights)/
                                                                                                                     number of outstanding shares of the
                                                                                                                     parent company.
Extraordinary Removal..............  Index Component......  DELETED...................  The Adjustment Factors for  An Index Component will be removed
                                                                                         each remaining component    for bankruptcy proceedings,
                                                                                         will be increased to        financial distress, or delisting
                                                                                         reflect an equal            from a national market (NYSE,
                                                                                         distribution of the         Nasdaq, Amex).
                                                                                         weight of a deleted
                                                                                         component.
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 74409]]

 [FR Doc. E5-7372 Filed 12-14-05; 8:45 am]

BILLING CODE 8010-01-P
