

[Federal Register: June 7, 2007 (Volume 72, Number 109)]
[Notices]
[Page 31636-31642]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07jn07-119]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55843; File No. SR-Amex-2004-27]


Self-Regulatory Organizations; American Stock Exchange LLC;
Notice of Filing of a Proposed Rule Change as Modified by Amendment
Nos. 2 and 3 Thereto Relating to the Listing and Trading of Fixed
Return Options

 June 1, 2007.
    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 April 29, 2004, the American Stock Exchange LLC (``Amex'' or
``Exchange'') filed with the Securities and Exchange Commission

[[Page 31637]]

(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been substantially prepared by Amex.
Amex filed Amendment No. 1 to the proposed rule change on September 26,
2006.\3\ Amex filed Amendment No. 2 to the proposed rule change on
April 19, 2007.\4\ Amex filed Amendment No. 3 to the proposed rule
change on May 23, 2007.\5\ The Commission is publishing this notice to
solicit comments on the proposed rule change, as amended, from
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaces the original filing in its
entirety.
    \4\ Amendment No. 2 replaces the original filing and Amendment
No. 1 in their entirety.
    \5\ Amendment No. 3 made changes to the proposed rule text
relating to minimum margin requirements.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The Exchange proposes to list and trade options having a fixed
return in cash based on a set strike price (``Fixed Return Options'' or
``FROs'').
    The text of the proposed rule change is available at Amex, from the
Commission's Public Reference Room, and on Amex's Web site at http://www.amex.com
.


II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, Amex included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The 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
Introduction
    The Exchange proposes to list and trade options, called Fixed
Return Options, having a fixed return in cash based on a set strike
price.\6\ The proposed Fixed Return Options would initially consist of
two types as follows: (1) ``Finish High''\SM\--Each contract returns
$100 if the underlying settlement value is above the strike price at
expiration and (2) ``Finish Low''\SM\--Each contract returns $100 if
the underlying settlement value is below the strike price at
expiration. The Finish High and Finish Low FROs are similar to existing
long calls and long puts traded on the Exchange.
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    \6\ Patent Pending. The contract specifications for a FRO are
set forth in Exhibit A to the proposal.
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    The structure of the FRO is commonly referred to as a ``binary''
option.\7\ Although FROs would be based on the same underlying
securities and in the same framework as existing standardized options
traded on Amex and the other options exchanges, the amount of the
payout or profit of an FRO is based on whether the option is in the
money, not by the degree it is in the money. As a result, the payout at
expiration is an ``all-or-nothing'' occurrence. As with a standard
European-style option, the payoff is based on the price of the
underlying asset at expiration. However, unlike standard options
currently traded on the Exchange, the payoff would be a fixed amount as
of the writing of the option contract. In addition, an FRO would be
automatically exercised at expiration if the price of the underlying
security settles above the pre-defined strike price, in the case of a
Finish High, or below the pre-defined strike price, in the case of a
Finish Low.\8\
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    \7\ A ``binary option'' is an option with a fixed, pre-
determined payoff if the underlying security or index is in the
money at expiration. The value of the payoff is not affected by the
magnitude of the differenfce between the underlying and the strike
price. A binary option is characterized by a discontinuous or non-
linear payoff (i.e., an ``all-or-nothing'' feature).
    \8\ Currently, the Exchange lists and trades Index Flex Options
that are automatically exercised pursuant to Rule 1804(c) of The
Options Clearing Corporation (``OCC''). Automatic exercise in this
context refers to the fact that all in the money options are
automatically exercised with the holder of such option having no
choice to not exercise. This differs significantly from the ``Ex-by-
Ex'' procedure (often inaccurately referred to as ``automatic
exercise'') employed by OCC in OCC Rule 805, which always allows an
OCC Clearing Member to effect a choice not to exercise an option
that is in the money by the exercise threshold amount or more, or to
exercise an option which has not reached the exercise threshold
amount. The exercise threshold amount set forth in OCC Rule 805 is
$0.25 per share in the money for customer accounts and $0.15 per
share in the money for firm and market maker accounts. The exercise
threshold amount employed in the ``Ex-by-Ex'' procedure triggers the
automatic exercise only in the absence of contrary instructions from
the Clearing Member. See also Amex Rule 980.
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    Binary options have been traded in the over-the-counter (``OTC'')
market for many years.\9\ However, OTC binary options have certain
disadvantages. OTC binary options are typically offered by an
institution on a non-fungible basis so the customer can purchase the
option from or close out the option with only the particular
institution that issued the option. As a result, OTC binary options
lack both a trading market (liquidity) as well as transparency. The
Exchange proposal to list and trade FROs is intended to provide the
market for binary options with a standardized, fungible product without
the credit risk of an individual issuer. By providing a listed or
standardized market for a class of binary options named FROs, the
Exchange seeks to attract investors who desire a binary option but at
the same time prefer the certainty and safeguards of a regulated and
standardized marketplace.
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    \9\ As reported by the Bank for International Settlements
(``BIS''), the worldwide OTC equity-linked derivatives market was
estimated on a notional amount basis to be $6.8 trillion as of June
2006. As of the same time period, OTC equity-based options were
estimated on a notional amount basis to amount to $5.3 trillion. See
BIS, OTC Derivatives Market Activity in the First Half of 2006
(November 2006).
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    The FROs that the Exchange proposes to list and trade would be
European-style \10\ with expirations based on existing option cycles.
Strike prices would be quoted based on existing intervals with minimum
price variations (``MPVs'') expected to be $0.05 (except for those
option classes that are part of the Penny Quoting Pilot Program, where
the MPV would be $0.01). Strike prices initially would be established
at approximate levels up to 20% above and below the price of the
underlying asset. The Exchange is proposing in this filing to allow
individual stocks and exchange-traded fund shares (``ETFs'') that meet
the listing criteria set forth below to underlie an FRO.
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    \10\ A ``European style'' option is an option where the holder
may exercise the contract only on the last business day prior to
expiration.
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Benefits and Uses
    FROs are designed to be a simplified version of traditional,
exchange-traded options. The inherent benefit of FROs is largely
associated with the certainty provided writers and purchasers, i.e., a
known maximum payout or liability at the time the contract is entered
into. For investors, Amex believes that three positive attributes
relating to FROs are apparent: (i) Simplicity; (ii) risk transparency;
and (iii) liquidity. First, an FRO is easier to understand and utilize
than a traditional equity option largely based on the certain payment
amount and cash settlement. Second, unlike traditional options where a
writer has unlimited risk, the maximum obligation in connection with an
FRO is known at $100. Third, as an exchange-traded option, the FRO
would have the advantage of liquidity provided by specialists and
market makers; therefore, spreads should be tighter than exists in the
OTC market. In addition,

[[Page 31638]]

the structure of an FRO eliminates the potential counterparty risk
inherent in OTC products.
    Amex believes that a significant benefit of an FRO is that the
purchaser and writer of the FRO know the expected return at the time of
purchase if the underlying security performs as expected. In contrast,
the ``traditional'' option does not typically have a known return at
the time of purchase, i.e., the return cannot be accurately determined
until the option is nearing expiration due to price movements. In
addition, because the return on the FRO is a fixed amount, a buyer of
the FRO would not need to determine the absolute magnitude of the
underlying security's price movement relative to the strike price, as
is the case with traditional options. Yet another benefit of the FRO is
the limited risk/return to the writer/purchaser because of the payout
being a known, fixed dollar amount. A systemic benefit provided by the
FRO versus its OTC counterpart is the ability of standardized clearing
and settlement systems to be programmed to recognize FROs based on
their unique underlying symbols and segregation for particular
treatment by systems used for calculating permissible margin as well as
final payout amounts due at settlement.
    Amex believes that investors will want to utilize FROs to earn
additional income on securities they own. An ``FRO Call Writing''
strategy describes a situation where an investor is long stock and
writes a Finish High FRO on that same security. In this instance, the
writer has earned premium while risking a fixed and known portion of
the upside should the stock close above the FRO strike price at
expiration. The amount at risk is the difference between $100 and the
premium received.
    In contrast, if a holder of a long stock position employs a ``Call
Writing'' strategy by writing a traditional call covered by the
corresponding long stock position, up to 100% of the potential upside
may be given up if the stock moves up beyond the option strike price. A
holder of stock, particularly stock that has depreciated, may lock in a
loss by selling traditional ``covered calls''--there is no potential
for upside, beyond the premium received, if the stock moves up and
closes above the strike at expiration.
    With the ``FRO Call Writing'' strategy, an investor believing his
long stock position would remain stagnant in the short term may further
choose to write more than one Finish High FRO, increasing the short-
term return potential by receiving more premium for the additional
calls sold. The investor by engaging in this FRO Call Writing strategy
would maintain certainty of stock ownership while knowing the total
capital or funds at risk if the stock exceeds the strike price of the
Finish Highs sold.
    On the buy side, Amex believes that the decision process is made
simpler for the investor with the advent of the FRO. To profit from
buying a traditional call, an investor must be correct in his
prediction that the underlying security will appreciate within a given
period of time. In addition, due to the linear payoff nature of the
traditional call, the investor must also be correct about the amount of
time erosion or ``decay'' of the position in the time he holds the
call. Thus, with a traditional long call purchase, if the investor is
correct in his prediction that the stock will appreciate within a set
period of time, there are still other factors, such as volatility and
time premium, that could affect potential returns.
    If the purchaser of a long FRO position is correct about the
prediction that the stock will appreciate and also correct about the
timeframe within which this appreciation will occur, he then has a
known risk/return profile, due to the non-linear relationship between
the Fixed Return Option payoff amount and the price of the underlying
at expiration. This offers the investor the ability to make an exact
risk/reward analysis of the investment if he is correct in his
assumption on the underlying stock at expiration. In contrast, the
traditional call buyer can make only estimates of risk/reward based on
multiple assumptions.
    The Exchange believes that FROs would also provide investors with
an efficient way to establish various strategies and enhance portfolio
performance. For example, the Finish High FRO has characteristics
similar to a bull call spread; however, in the case of the FRO, an
investor could accomplish the strategy with reduced execution cost. We
believe that such unique uses for FROs would provide investors with
greater opportunities to effectively use options as part of an
investment strategy. In sum, the Exchange believes that the simple
structure of FROs will attract investors to the benefits of options
trading.
Standardization
    The Exchange in proposing FROs is attempting to list a binary
option in an exchange-traded environment.\11\ In this manner, the
Exchange intends, to the extent possible, to have FROs recognized and
treated like existing standardized options. Standardized systems for
listing, trading, transmitting, clearing, and settling options,
including systems used by OCC, would be employed in connection with
FROs. As a result, FROs would have symbology based on the current
system so that symbols are created that represent the underlying
security, the fact that the option is a ``Finish High'' or ``Finish
Low'' FRO as opposed to a traditional put or call, the expiration date,
the strike price, and the exchange trading FROs.
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    \11\ The Exchange to its knowledge is the first national
securities exchange to propose the listing and trading of a binary
option in a standardized environment. The Exchange has pending a
patent application for trading binary options in an exchange-traded
environment.
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Options Contract Multiplier
    The standardized option contract traded by all U.S. options
exchanges typically is quoted in amounts that are multiplied by ``100''
due to the fact that the option represents rights associated with 100
shares of the underlying security upon exercise. The multiplier of 100
has also been carried over to index options. The Exchange has proposed
to continue this industry convention for FROs. For example, an option
that currently is quoted at $0.50 actually costs the investor $50.00
($0.50 x 100).
Minimum Price Variation
    Amex Rule 952 generally provides that the MPV for an option on a
stock or ETF shall be: (i) For option issues quoted under $3 a
contract, $0.05; (ii) for option issues quoted at $3 a contract or
greater, $0.10. However, in connection with those options classes
included within the Penny Quoting Pilot Program,\12\ the MPV is as
follows: (iii) For option issues quoted under $3 a contract, $0.01;
(iv) for option issues quoted at $3 a contract or greater, $0.05. In
addition, options on the Power Shares QQQ Trust (formerly, the QQQQ)
trade at an MPV of $0.01 for all options premiums.
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    \12\ See Securities Exchange Act Release No. 55162 (January 24,
2007), 72 FR 5738 (February 1, 2007).
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    The MPV for FROs would be $0.05 (and $0.01 for those options
classes in the Penny Quoting Pilot Program) because, by definition, an
FRO would never be quoted over $1.00.
Maximum Bid/Ask Differentials
    To contribute to the maintenance of a fair and orderly market,
specialists and registered options traders (``ROTs'') are typically
expected to bid and offer so as to create differences of no more than:
(i) $0.25 between the bid and offer for each option contract for which
the prevailing

[[Page 31639]]

bid is less than $2; (ii) $0.40 where the prevailing bid is $2 but does
not exceed $5; (iii) $0.50 where the prevailing bid is more than $5 but
does not exceed $10; (iv) $0.80 where the prevailing bid is more than
$10 but does not exceed $20; and (v) $1 where the last prevailing bid
is more than $20.\13\ With respect to FROs, the Exchange believes that
the maximum bid/ask differential should typically be $0.25. However,
due to the non-linear payoff nature of FROs, we believe that during the
last day of trading prior to expiration, the maximum bid/ask
differential should be $0.50.\14\
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    \13\ If the bid/ask spread in the underlying security is greater
than the bid/ask spread for the option, the permissible spread for
any in the money option series may be identical to the underlying
security market. We believe FROs should follow this existing
practice for traditional options. See Amex Rule 958--ANTE(c).
    \14\ Where warranted by market conditions, the Exchange is
proposing to be able to establish maximum bid/ask spreads other than
those noted above for one or more series or classes of FROs.
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    In terms of the maximum bid-ask differential, existing options with
a prevailing bid of $1 equate to the $100 value of an FRO and,
therefore, a maximum bid-ask differential of $0.25 or $25.00 ($0.25 x
100). Accordingly, Amex believes, consistent with existing rules, that
the maximum bid-ask differential for FROs should generally be $0.25.
Expiration Cycles and Strike Price Intervals
    Pursuant to Amex Rule 903, the Exchange generally opens up to four
expiration months for each options class upon the initial listing of
such class for trading. Upon expiration of the near-term month, the
Exchange will then list an additional expiration month. FROs would use
the same expiration cycle as currently is the case for traditional
options listed on the Exchange, consistent with Amex Rule 903.
    Strike price intervals in connection with FROs also would employ
the same procedure as exists for traditional options under Amex Rule
903 and related commentaries. Specifically, the interval between strike
prices of series of options on individual stocks may be (i) $2.50 or
greater where the strike price is $25 or less, provided that the
Exchange may not list $2.50 intervals below $20 (e.g., $12.50, $17.50)
for any class included within the $1 Strike Price Pilot Program, if the
addition of $2.50 intervals would cause the class to have strike price
intervals that are $0.50 apart; (ii) $5 or greater where the strike
price is greater than $25 but less than $200; or (iii) $10 or greater
where the strike price is greater than or equal to $200. For series of
options on ETFs that satisfy the criteria set forth in Commentary .06
to Amex Rule 915, the interval of strike prices would be $1 or greater
where the strike price is $200 or less or $5 or greater where the
strike price is over $200.\15\
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    \15\ Commentaries .05 and .06 to Amex Rule 903 provide limited
exceptions to the general strike price intervals in connection with
the $1 Strike Price Pilot Program and the 2\1/2\ Point Strike Price
Program.
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    The Exchange proposes that securities underlying options classes
that currently are part of the $1 Strike Price Pilot Program and the
2\1/2\ Point Strike Price Program also may underlie an FRO. Due to the
heightened listing standards proposed by the Exchange in proposed Amex
Rules 915FRO and 916FRO, the number of FROs available under these
existing programs would be limited.\16\ Accordingly, the Exchange
proposes that the strike price intervals for FROs would be established
under existing procedures as set forth in Amex Rule 903.
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    \16\ As of March 5, 2007, the number of underlying stocks
available under the $1 Strike Price Pilot Program for FROs would be
four, while the number of underlying stocks available under the 2\1/
2\ Point Strike Price Program would be 39.
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VWAP Settlement Pricing
    To protect against any potential price manipulation that could
occur at expiration due to the ``all-or-nothing'' nature of FROs, the
Exchange has proposed that the expiration or settlement price for an
underlying individual equity security be calculated as a ``volume
weighted average price'' or ``VWAP.'' As provided below, FROs would be
listed only on the most liquid and actively-traded equity securities.
VWAP is a simple algorithm that is defined as the number of shares
multiplied by the corresponding reported price of the security. The
total number of shares reported divides the sum of these transactions
during the time period used for the calculation. The VWAP calculation
would be based on composite prices reported during regular trading
hours for the underlying securities. In addition, the current value of
the VWAP calculation for each series of FROs would be published and
disseminated at least every 15 seconds throughout the trading day. The
Exchange believes that a settlement price based on an ``all-day'' VWAP
during the last trading day prior to expiration is appropriate for FROs
based on individual stocks and ETFs. We believe that the use of an
``all-day'' VWAP for determining the settlement price of an FRO is
sufficient to protect against concerns of manipulation, and that the
publication and dissemination of intraday updates of the current VWAP
calculation would add greater transparency.
    For purposes of the VWAP calculation, the Exchange believes that
composite prices should be used. Composite pricing is currently
employed by OCC in connection with the settlement of equity
options.\17\
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    \17\ See OCC Clearing Members Memorandum No. 18930 (May 29,
2003); and Securities Exchange Act Release No. 49045 (January 8,
2004), 69 FR 2377 (January 15, 2004).
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    The VWAP settlement price would be disseminated by the Exchange as
the official settlement price for FROs and would be made publicly
available through various market data vendors as well as on the Amex
Web site at http://www.amex.com.

Underlying Closing Price Methodology
    In the money amounts for any option, including FROs, are a function
of the underlying security price. For traditional equity and ETF
options, OCC as the issuer of the options uses the ``composite closing
price'' (i.e., the last reported sale price during regular trading
hours) for the underlying security on the trading day immediately
preceding the expiration date as reported by industry price
vendors.\18\ As noted above, the Exchange similarly believes, that for
purposes of calculating the VWAP settlement price for FROs based on
individual stocks and ETFs, ``composite prices'' should be used. As a
result, the Exchange would use composite prices of the underlying
securities to calculate the VWAP settlement price for FROs. In contrast
to traditional options, the Exchange, not OCC, would determine the
underlying security prices and calculate the VWAP settlement price.
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    \18\ Id.
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    In a case where the underlying security does not trade during
regular trading hours on the last trading day prior to expiration or a
last sale price is not obtainable either due to a trading halt or
unreliable pricing, OCC has the discretionary authority to set a
closing price on such basis as it believes appropriate under the
circumstances.\19\

[[Page 31640]]

OCC currently performs this function for standardized options traded by
all options exchanges. The Exchange believes that in most cases OCC
will use the last sale price reported during regular trading hours on
the most recent trading day for which a last sale price is available.
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    \19\ OCC Rule 805(j) defines the term ``closing price'' to mean
the last reported sale price for the underlying security on the
trading day immediately preceding the expiration date on such
national securities exchange or other domestic securities market as
the Corporation shall determine. Notwithstanding the foregoing, if
an underlying security was not traded on such market on the trading
day immediately preceding the expiration date or if the underlying
security was traded on such trading day but the Corporation is
unable to obtain a last sale price, the Corporation may, in its
discretion: (i) Fix a closing price on such basis as it deems
appropriate in the circumstances (including, without limitation,
using the last sale price during regular trading hours on the most
recent trading day for which a last sale price is available); or
(ii) suspend the application of the ex-by-ex procedure to option
contracts for which that security is an underlying security.
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Listing Requirements
    The Exchange proposes that, in addition to meeting the criteria set
forth in Amex Rule 915 (Initial Listing), an FRO may be initially
listed only on an individual stock issued by a company that has: (i) A
market capitalization of at least $40 billion; (ii) minimum trading
volume over the last 12 months of at least one billion shares; (iii)
minimum average daily trading volume of at least four million shares;
(iv) minimum average daily value traded of at least $200 million during
the prior six months; and (v) the market price per share of the
underlying security has been at least $10 during the five consecutive
business days preceding listing. The underlying security price per
share is measured by the closing price reported in the primary listed
market in which the underlying security is traded.\20\
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    \20\ See Commentary .01 to Amex Rule 915 for the current options
listing criteria.
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    With respect to ETFs, the Exchange proposes that, in addition to
meeting the criteria set forth in Amex Rule 915 (Initial Listing), an
FRO may be listed only on an ETF that has: (i) A minimum trading volume
over the last 12 months of at least one billion shares; (ii) a minimum
average daily trading volume of at least four million shares; (iii) a
minimum average daily value traded of at least $200 million during the
prior six months; and (iv) the market price per share of the underlying
security has been at least $10 during the five consecutive business
days preceding listing.
    To be eligible for additional FRO series, the Exchange proposes
that, in addition to meeting the criteria set forth in Amex Rule 916
(Continued Listing),\21\ an underlying stock have: (i) A market
capitalization of at least $30 billion; (ii) a minimum trading volume
over the last 12 months of at least one billion shares; (iii) a minimum
average daily trading volume of four million shares; (iv) a minimum
average daily value traded of $125 million during the prior six months;
and (v) a market price per share of at least $5. For intra-day series
additions, the market price of an underlying security is measured by
the last reported trade in the primary listed market in which the
underlying security trades at the time the Exchange determines to add
these additional series. In the case of next-day or expiration series
additions, the market price of an underlying security is measured by
the closing price reported in the primary listed market on the last
trading day before the series are added.
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    \21\ See Commentaries .01 and .02 to Amex Rule 916 for the
current options continuing listing criteria.
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    For additional FRO series based on ETFs, the Exchange proposes
that, in addition to meeting the criteria set forth in Amex Rule 916
(Continued Listing), an underlying ETF have: (i) A minimum trading
volume over the last 12 months of at least one billion shares; (ii) a
minimum average daily trading volume of four million shares; (iii) a
minimum average daily value traded of $125 million during the prior six
months; and (iv) a market price per share of at least $5.
    Proposed Amex Rules 915FRO and 916FRO detail these requirements.
The Exchange believes that this proposal for listing FROs on individual
stocks and ETFs is consistent with current requirements for traditional
options. In connection with individual stocks, Amex believes that a
higher standard is appropriate for such listings. By providing
heightened listing standards for underlying securities that may be the
basis for FROs--consisting of market capitalization, 12-month trading
volume, average daily trading volume, average daily trading value, and
a minimum market price per share--the Exchange believes that the
potential and/or susceptibility of manipulation is greatly reduced. In
the case of ETFs, Ames has proposed that only actively traded and well
capitalized ETFs may underlie an FRO. Amex believes that, based on the
proposed initial and continued listing standards, the susceptibility to
manipulation is severely dampened.
Position and Exercise Limits
    Amex proposes that an FRO based on an individual stock or ETF have
a position limit of 25,000 contracts. Existing hedge exemptions found
in Amex Rules 904 and 904C would not apply to FROs; however, the
facilitation exemption to position limits currently available to
members would apply in the case of FROs in connection with facilitating
customer FRO orders. FROs would not be subject to exercise limits due
to the fact that FROs are European-style options \22\ and are
automatically exercised only if the settlement price is in the money.
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    \22\ See supra note 10.
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    The Exchange believes that position limits for FROs should not be
aggregated with the position limits of existing standardized options on
the same underlying security. Amex believes that the non-linear (i.e.,
``all-or-nothing'') nature of FROs as well as the risk/return profile
for FROs provides significant differences to existing standardized
options that render aggregation of position limits inconsistent. In
addition, the automatic exercise feature of an FRO also supports Amex's
belief that an exercise limit should not be imposed because FROs by
definition cannot be exercised over a five-day period.\23\
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    \23\ Unlike with traditional equity options, exercise
instructions are not entered for FROs because the contract is
automatically exercised pursuant to the contract if the settlement
price exceeds the strike price.
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    Position limits restrict the number of options contracts that an
investor, or a group of investors acting in concert, may own or
control. Similarly, exercise limits prohibit the exercise of more than
a specified number of contracts on a particular instrument within five
business days. Position limits on exchange-traded options are designed
to: (i) Minimize the potential for mini-manipulations \24\ as well as
other forms of market manipulation; (ii) impose a ceiling on the
position that an investor with inside corporate or market information
can establish; and (iii) reduce the possibility of disruption in the
options and underlying cash markets.
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    \24\ Mini-manipulation is an attempt to influence, over a
relatively small range, the price movement in a stock to benefit a
previously established options position.
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    Amex believes that the structure of FROs--especially the ``all-
day'' VWAP settlement pricing, heightened listing requirements for
individual stocks and ETFs underlying FROs, and lower position limits--
should allay regulatory concerns of potential manipulation. In
particular, Amex notes that, for individual stocks underlying an FRO,
in addition to the existing listing requirements, the Exchange has
proposed heightened continuing or maintenance listing standards of: (i)
At least $30 billion in market capitalization; (ii) a minimum trading
volume of at least one billion shares over the last 12 months; (iii) a
minimum average daily trading volume of at least four million shares;
(iv) a minimum average daily trading value of $125 million; and (v) a
minimum market price per share of the underlying

[[Page 31641]]

security of $5.\25\ ETFs underlying an FRO would be subject to the same
continued listing standards except for the minimum market
capitalization requirement. These heightened listing requirements would
provide that only the most highly liquid securities may underlie an
FRO. In addition, Amex believes that the proposed FRO settlement
pricing based on an ``all-day'' VWAP would greatly reduce the ability
to use FROs for manipulative purposes.
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    \25\ As of March 5, 2007, 60 stocks and 11 ETFs would qualify
for FROs.
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    FROs would not be subject to any ``qualified hedge exemptions''
from the standard position and exercise limits that currently exist for
traditional options.
    Consistent with non-FRO or traditional options, positions in FROs
would have to be reported to the Exchange when an account establishes
an aggregate same-side-of-the-market position of 200 or more FROs. The
Exchange also would require that each member or member organization
(other than an Exchange specialist or registered trader) that maintains
a position on the same side of the market in excess of 25,000 FROs, for
its own account or for the account of a customer, report certain
information. This data would include, but would not be limited to, the
FRO position, whether such position is hedged and, if so, a description
of the hedge and, if applicable, the collateral used to carry the
position. The Exchange believes that the reporting requirements under
Amex Rule 906 and the surveillance procedures for hedged positions
would enable the Exchange to closely monitor sizable FRO positions and
corresponding hedges.\26\
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    \26\ Hedge information for member firm and customeraccounts
having 200 or more contracts are electronically reported via the
Large Options Positions Report. Specialist and registered options
trader account information is also reported to Amex by such member's
clearing firm. In addition, a member firm is required to report
hedge information for any proprietary or customer account that
maintains an options position in excess of 10,000 contracts. These
procedures would apply to FROs.
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    The Exchange further believes that financial requirements imposed
by the Exchange and by the Commission adequately address concerns that
a member or its customer may try to maintain an inordinately large
unhedged position in FROs. Current margin and risk-based haircut
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. The
Exchange has the authority under paragraph (d)(2)(k) of Amex Rule 462
to impose a higher margin requirement upon the member or member
organization when the Exchange determines a higher requirement is
warranted.
Contract Adjustments
    FROs will be subject to adjustments for corporate and other actions
in accordance with the rules of OCC. The general rule for adjustments
in connection with FROs is that, regardless of the corporate action,
the settlement value (paid in cash) of the FRO would always be
$100.\27\
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    \27\ Article VI, Section 11(c) of OCC's By-Lawsprovide the
general rule that there will be no adjustments to reflect ordinary
cash dividends or distributions or ordinary stock dividends or
distributions.
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    In the case of even splits \28\ and uneven splits,\29\ OCC and the
Exchange believe that FROs should be adjusted by changing the strike
price of the contract.
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    \28\ An ``even split'' is a case where the stock distribution or
stock split results in one or more whole numbers of shares of the
underlying security issued with respect to each outstanding share.
    \29\ An ``uneven split'' is a case where the stock distribution
or stock split results in other than whole numbers of shares of the
underlying security issued with respect to each outstanding share.
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    OCC submitted a proposed rule change with the Commission on
November 18, 2004 (OCC File No. SR-OCC-2004-21) to enable it to issue,
clear, and settle FROs. The OCC proposal would allow it to process FRO
transactions in accordance with procedures that are substantially
similar to its existing well established systems and procedures for the
clearance and settlement of traditional exchange-traded options.
Margin
    Consistent with Amex Rule 462(c)(11) and proposed new paragraph
(d)(10) of Amex Rule 462, the initial and maintenance margin for long
positions in FROs would have to equal at least 100% of the purchase
price of the option (i.e., the premium).\30\ In connection with short
positions in FROs, the customer margin required is the difference
between $100 and the proceeds received from the sale of the FRO. Amex
believes that this proposed margin treatment is adequate and should not
be otherwise based on the behavior of the underlying security, given
the fact that the greatest amount at risk for an option writer of an
FRO is the payout amount of $100. As with existing equity options,
short FRO positions could be carried in a cash account (not subject to
margin) and deemed ``covered,'' provided that proposed new paragraph
(d)(10)(F) of Amex Rule 462 were applicable. ``Covered'' for purposes
of an FRO is deemed to exist where the writer's obligation is secured
by a specific deposit or escrow deposit meeting the entire obligation
of $100 on the FRO. This standard is similar to the available ``cover''
for existing exchange-traded options under Amex Rules 462(d)(2)(I) and
900(b)(23).
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    \30\ New York Stock Exchange Regulation (``NYSER'') confirmed to
Amex that the proposed margin requirements are appropriate. NYSER
represented that prior to the launch of FROs, a regulatory circular
to members would be issued detailing the margin requirements in
connection with FROs.
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Options Disclosure Document
    As noted above, the OCC submitted a proposed rule change with the
Commission to accommodate the listing and trading of FROs.\31\ In
addition, the OCC will also seek a revision to the Options Disclosure
Document (``ODD'') to incorporate FROs.
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    \31\ See File No. SR-OCC-2004-21.
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent
with Section 6 of the Act,\32\ in general, and furthers the objectives
of Section 6(b)(5),\33\ in particular, in that it is designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to foster cooperation and
coordination with persons engaged in facilitating transactions in
securities, 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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    \32\ 15 U.S.C. 78f(b).
    \33\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement of Burden on Competition

    The Exchange does not believe that the proposed rule change would
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

    The Exchange has not received any written comments on the proposed
rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 35 days of the date of publication of this notice in the
Federal

[[Page 31642]]

Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change; or
    B. Institute proceedings to determine whether the proposed rule
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. 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-Amex-2004-27 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, Station Place, 100 F
Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-Amex-2004-27. 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 also will be available for inspection and copying at the
principal office of the Exchange. 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 Number SR-Amex-2004-27 and should be submitted on or before June
28, 2007.

    For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-10970 Filed 6-6-07; 8:45 am]

BILLING CODE 8010-01-P
