
[Federal Register: March 21, 2008 (Volume 73, Number 56)]
[Notices]               
[Page 15236-15239]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21mr08-117]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57503; File No. SR-BSE-2008-10]

 
Self-Regulatory Organizations; Boston Stock Exchange, Inc.; 
Notice of Filing and Immediate Effectiveness of Proposed Rule Change To 
Create a Delta Hedging Exemption From Equity Options Position Limits

March 14, 2008.
    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 February 27, 2008, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been substantially prepared by BSE. The 
Exchange has filed the proposal as a ``non-controversial'' rule change 
pursuant to Section 19(b)(3)(A) of the Act \3\ and Rule 19b-4(f)(6) 
thereunder,\4\ which renders it effective upon filing with the 
Commission. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    BSE proposes to amend the rules of the Boston Options Exchange 
(``BOX''). The proposal would create a new exemption from equity 
options position and exercise limits for positions held by BOX 
Participants under the BOX Rules. The text of the proposed rule change 
is available at BSE, the Commission's Public Reference Room, and http:/
/www.bostonstock.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, BSE 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. BSE has prepared summaries, set forth in Sections A, B, 
and C below, of the most significant aspects of such statements.

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

1. Purpose
    The purpose of the proposed rule change is to permit expanded hedge 
positions pursuant to a carefully crafted delta hedge exemption from 
equity options position limits in Section 7 of Chapter III of the BOX 
Rules.
    All options traded on BOX are subject to position and exercise 
limits, as provided under Sections 7 and 9 of Chapter III of the BOX 
Rules. Position limits are imposed, generally, to maintain fair and 
orderly markets for options and other securities by limiting the amount 
of control one or more

[[Page 15237]]

affiliated persons or entities may have over one particular options 
class or the security or securities that underlie that options class. 
BOX Rules also contain various hedge exemptions to allow certain hedged 
positions in excess of the applicable standard position limit.\5\
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    \5\ See Section 8 of Chapter III of the BOX Rules (Exemptions 
from Position Limits).
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    In recent years, options exchanges have increased the size of 
options position and exercise limits, as well as the size and scope of 
available hedge exemptions to the applicable position limits.\6\ These 
hedge exemptions generally require a one-to-one hedge, i.e., one stock 
option contract must be hedged by the number of shares underlying the 
options contract, typically 100 shares. In practice, however, many 
firms do not hedge their options positions in this manner. Instead, 
these firms engage in what is commonly known as ``delta hedging.'' 
Delta hedging varies the number of shares of the underlying security 
used to hedge an options position based upon the relative sensitivity 
of the value of the option contract to a change in the price of the 
underlying security.\7\
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    \6\ See, e.g., Securities Exchange Act Release Nos. 55176 
(January 25, 2007), 72 FR 4741 (February 1, 2007) (SR-CBOE-2007-08); 
51244 (February 23, 2005), 70 FR 10010 (March 1, 2005) (SR-CBOE-
2003-30); and 45603 (March 20, 2002), 67 FR 14751 (March 27, 2002) 
(SR-CBOE-00-12).
    \7\ For example, a stock option contract with a delta of .5 will 
move $0.50 for every $1.00 move in the underlying stock.
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    BOX proposes to adopt a new exemption from equity options position 
and exercise limits \8\ for positions held by BOX Participants and 
certain of their affiliates that are ``delta neutral'' \9\ under a 
``permitted pricing model'' (as defined below), subject to certain 
conditions (``Exemption''). The proposed Exemption would only apply to 
equity stock options and options on exchange-traded funds (``ETFs'').
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    \8\ The proposed rule change does not change the BOX Rules 
options exercise limits in Section 9 of Chapter III of the BOX Rules 
(Exercise Limits) because such exercise limits only apply to the 
extent that position limits under Section 7 of Chapter III of the 
BOX Rules are imposed. Thus, as delta neutral positions would be 
exempt from position limits under the proposed rule change, such 
positions also would be exempt from exercise limits. Similarly, for 
positions held that are not delta neutral, only the option contract 
equivalent of the net delta of such positions would be subject to 
exercise limits.
    \9\ The term ``delta neutral'' would be defined as an equity 
option position that is hedged, in accordance with a permitted 
pricing model, by a position in the underlying security or one or 
more instruments relating to the underlying security, for the 
purpose of offsetting the risk that the value of the option position 
will change in response to incremental changes in the price of the 
security underlying the option position. See proposed Section 
8(b)(i) of Chapter III of the BOX Rules.
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    Any equity position that is not delta neutral would be subject to 
position and exercise limits, subject to the availability of other 
exemptions. Only the ``option contract equivalent of the net delta'' of 
such position would be subject to the appropriate position limit.\10\
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    \10\ Under the proposed rule, ``option contract equivalent of 
the net delta'' would mean the net delta divided by the number of 
shares underlying the option contract. ``Net delta'' would mean, at 
any time, the number of shares (either long or short) required to 
offset the risk that the value of an equity option position will 
change with incremental changes in the price of the security 
underlying the option position, as determined in accordance with a 
permitted pricing model. See proposed Section 8(b)(ii) of Chapter 
III of the BOX Rules.
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    Only financial instruments relating to the security underlying an 
equity options position could be included in any determination of an 
equity options position's net delta, or in determining whether the 
options position is delta neutral. In addition, BOX Participants could 
not use the same equity or other financial instrument position in 
connection with more than one hedge exemption. Therefore, a stock 
position used as part of a delta hedging strategy could not also serve 
as the basis for any other equity hedge exemption.
    Permitted Pricing Model. Under the proposed rule, the calculation 
of the delta for any equity option position, and the determination of 
whether a particular equity option position is delta neutral, must be 
made using a permitted pricing model. A ``permitted pricing model'' is 
defined in proposed Section 8(b)(iii) of Chapter III, to mean the 
pricing model maintained and operated by the Options Clearing 
Corporation (``OCC'') and the pricing models used by: (i) A Participant 
or its affiliate subject to consolidated supervision by the Commission 
pursuant to Appendix E of Rule 15c3-1 under the Act; (ii) a financial 
holding company (``FHC'') or a company treated as an FHC under the Bank 
Holding Company Act of 1956, or its affiliate subject to consolidated 
holding company group supervision;\11\ (iii) a Commission-registered 
OTC derivatives dealer; \12\ and (iv) a national bank.\13\
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    \11\ The pricing model of an FHC or of an affiliate of an FHC 
would have to be consistent with: (i) The requirements of the Board 
of Governors of the Federal Reserve System (``FRB''), as amended 
from time to time, in connection with the calculation of risk-based 
adjustments to capital for market risk under capital requirements of 
the FRB, provided that the Participant or affiliate of a Participant 
relying on this exemption in connection with the use of such model 
is an entity that is part of such company's consolidated supervised 
holding company group; or (ii) the standards published by the Basel 
Committee on Banking Supervision, as amended from time to time and 
as implemented by such company's principal regulator, in connection 
with the calculation of risk-based deductions or adjustments to or 
allowances for the market risk capital requirements of such 
principal regulator applicable to such company--where ``principal 
regulator'' means a member of the Basel Committee on Banking 
Supervision that is the home country consolidated supervisor of such 
company--provided that the Participant or affiliate of a Participant 
relying on this exemption in connection with the use of such model 
is an entity that is part of such company's consolidated supervised 
holding company group. See proposed Section 8(b)(iii)(3) of Chapter 
III of the BOX Rules.
    \12\ The pricing model of a Commission-registered OTC 
derivatives dealer would have to be consistent with the requirements 
of Appendix F to Rules 15c3-1 and 15c3-4 under the Act, as amended 
from time to time, in connection with the calculation of risk-based 
deductions from capital for market risk thereunder. Only an OTC 
derivatives dealer and no other affiliated entity (including a 
Participant) would be able to rely on this part of the Exemption. 
See proposed Section 8(b)(iii)(4) of Chapter III of the BOX Rules.
    \13\ The pricing model of a national bank would have to be 
consistent with the requirements of the Office of the Comptroller of 
the Currency, as amended from time to time, in connection with the 
calculation of risk-based adjustments to capital for market risk 
under capital requirements of the Office of the Comptroller of the 
Currency. Only a national bank and no other affiliated entity 
(including a Participant) would be able to rely on this part of the 
Exemption. See proposed Section 8(b)(iii)(5) of Chapter III of the 
BOX Rules.
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    Aggregation of Accounts. Participants and non-Participant 
affiliates relying on the Exemption would be required to ensure that 
the permitted pricing model is applied to all positions in or relating 
to the security underlying the relevant options position that are owned 
or controlled by the Participant, or its affiliates.
    However, the net delta of an options position held by an entity 
entitled to rely on the Exemption, or by a separate and distinct 
trading unit of such entity, could be calculated without regard to 
positions in or relating to the security underlying the option position 
held by an affiliated entity or by another trading unit within the same 
entity, provided that: (i) the entity demonstrates to the satisfaction 
of Boston Options Exchange Regulation (``BOXR''), the regulatory 
subsidiary of BSE, that no control relationship, as defined in Section 
7(e) of Chapter III of the BOX Rules, exists between such affiliates or 
trading units, and (ii) the entity has provided BOXR written notice in 
advance that it intends to be considered separate and distinct from any 
affiliate, or, as applicable, which trading units within the entity are 
to be considered separate and distinct from each other for purposes of 
the Exemption.\14\
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    \14\ See proposed Section 8(b)(iv)(2) of Chapter III of the BOX 
Rules.
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    Any Participant or non-Participant affiliate relying on the 
Exemption would be required to designate, by prior written notice to 
BOXR, each trading unit or entity whose options positions

[[Page 15238]]

are required by BOX Rules to be aggregated with the options positions 
of such Participant or non-Participant affiliate relying on the 
Exemption for purposes of compliance with BOX position or exercise 
limits.\15\
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    \15\ See proposed Section 8(b)(iv)(3) of Chapter III of the BOX 
Rules.
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    Obligations of Participants and Affiliates. Any Participant relying 
on the Exemption would be required to provide a written certification 
to BOXR that it is using a permitted pricing model as defined in BOX 
Rules for purposes of the Exemption. In addition, by such reliance, 
such Participant would authorize any other person carrying for such 
Participant an account including, or with whom such Participant has 
entered into, a position in or relating to a security underlying the 
relevant option position to provide to BOXR or OCC such information 
regarding such account or position as BOXR or OCC may request as part 
of BOXR's confirmation or verification of the accuracy of any net delta 
calculation under this Exemption.\16\
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    \16\ See proposed Section 8(b)(v)(1) of Chapter III of the BOX 
Rules.
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    The options positions of a non-Participant affiliate relying on the 
Exemption would have to be carried by a Participant with which it is 
affiliated.\17\ A Participant carrying an account that includes an 
equity option position for a non-Participant affiliate that intends to 
rely on the Exemption would be required to obtain from such non-
Participant affiliate a written certification that it is using a 
permitted pricing model as defined in the BOX Rules for purposes of the 
Exemption.\18\
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    \17\ See proposed Section 8(b)(v)(2) of Chapter III of the BOX 
Rules.
    \18\ In addition, the Participant would be required to obtain 
from such non-Participant affiliate a written statement confirming 
that such non-Participant affiliate: (a) Is relying on the 
Exemption; (b) will use only a permitted pricing model for purposes 
of calculating the net delta of its option positions for purposes of 
the Exemption; (c) will promptly notify the Participant if it ceases 
to rely on the Exemption; (d) authorizes the Participant to provide 
to BOXR or the OCC such information regarding positions of the non-
Participant affiliate as BOXR or OCC may request as part of BOXR's 
confirmation or verification of the accuracy of any net delta 
calculation under the Exemption; and (e) if the non-Participant 
affiliate is using the OCC model, has duly executed and delivered to 
BOXR such documents as Participant may require as a condition to 
reliance on the Exemption. See proposed Section 8(b)(v)(3) of 
Chapter III of the BOX Rules.
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    Reporting. Under proposed Section 8(b)(vi) of Chapter III of the 
BOX Rules, each Participant relying on the Exemption would be required 
to report, in accordance with Section 10 of Chapter III of the BOX 
Rules, (i) all equity option positions (including those that are delta 
neutral) that are reportable thereunder, and (ii) on its own behalf or 
on behalf of a designated aggregation unit pursuant to Section 8(c)(iv) 
of Chapter III, for each such account that holds an equity option 
position subject to the Exemption in excess of the levels specified in 
Section 7, the net delta and the options contract equivalent of the net 
delta of such position. The Exchange and other self-regulatory 
organizations are working on modifying the Large Options Position 
Report system and/or OCC reports to allow a Participant to indicate 
that an equity options position is delta neutral.
    Records. Under proposed Section 8(b)(vii) of Chapter III of the BOX 
Rules, each Participant relying on the Exemption would be required to 
(i) retain, and would be required to undertake reasonable efforts to 
ensure that any non-Participant affiliate of the Participant relying on 
the exemption retains, a list of the options, securities and other 
instruments underlying each options position net delta calculation 
reported to the BOXR hereunder, and (ii) produce such information to 
BOXR upon request.
    Reliance on Federal Oversight. As provided under proposed Section 
8(b)(iii) of Chapter III of the BOX Rules, a permitted pricing model 
includes proprietary pricing models used by Participants and affiliates 
that have been approved by the Commission, the FRB or another federal 
financial regulator. In adopting the proposed Exemption, the Exchange 
would be relying upon the rigorous approval processes and ongoing 
oversight of a federal financial regulator. The Exchange notes that it 
would not be under any obligation to verify whether a Participant's or 
its affiliate's use of a proprietary pricing model is appropriate or 
yielding accurate results.
    The Exchange will announce the operative date of the proposed rule 
change in a regulatory circular to be published no later than 30 days 
after the Commission issues a release regarding the proposal herein, or 
such later date as may be necessary to ensure completion of the 
required technology changes by the OCC and the Securities Industry 
Automation Corporation.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\19\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\20\ in particular, in that it is designed 
to promote just and equitable principles of trade, to prevent 
fraudulent and manipulative acts and practices, 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. The Exchange believes that the proposed delta neutral-based 
hedge exemption from equity options position and exercise limits is 
appropriate in that it is based on a widely accepted risk management 
method used in options trading. Also, the Commission has previously 
stated its support for recognizing options positions hedged on a delta 
neutral basis as properly exempted from position limits.\21\
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    \19\ 15 U.S.C. 78f(b).
    \20\ 15 U.S.C. 78f(b)(5).
    \21\ See Securities Exchange Act Release No. 40594 (October 23, 
1998), 63 FR 59362, 59380 (November 3, 1998) (S7-30-97) (adopting 
rules relating to OTC Derivatives Dealers).
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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

    No written comments were either solicited or received.

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

    Because the foregoing rule change does not: (1) Significantly 
affect the protection of investors or the public interest; (2) impose 
any significant burden on competition; and (3) become operative for 30 
days after the date of this filing, or such shorter time as the 
Commission may designate, it has become effective pursuant to Section 
19(b)(3)(A) of the Act \22\ and Rule 19b-4(f)(6) thereunder.\23\
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    \22\ 15 U.S.C. 78s(b)(3)(A).
    \23\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under 19b-4(f)(6) normally may not 
become operative prior to 30 days after the date of filing.\24\ 
However, Rule 19b-4(f)(6)(iii) \25\ permits the Commission to designate 
a shorter time if such action

[[Page 15239]]

is consistent with the protection of investors and the public interest. 
The Exchange has requested that the Commission waive the 30-day 
operative delay. The Commission believes that waiving the 30-day 
operative delay is consistent with the protection of investors and the 
public interest because such waiver would allow the Exchange to 
implement the delta hedging exemption from equity options position 
limits without needless delay. The Commission notes that it recently 
approved a substantially similar proposal filed by the Chicago Board 
Options Exchange, Incorporated.\26\ The Commission believes that BSE's 
proposal to create a delta hedging exemption from equity options 
position limits raises no new issues. For these reasons, the Commission 
designates the proposed rule change to be operative upon filing with 
the Commission.\27\
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    \24\ 17 CFR 240.19b-4(f)(6)(iii). In addition, Rule 19b-
4(f)(6)(iii) requires that a self-regulatory organization submit to 
the Commission written notice of its intent to file the proposed 
rule change, along with a brief description and text of the proposed 
rule change, at least five business days prior to the date of filing 
of the proposed rule change, or such shorter time as designated by 
the Commission. The Exchange has satisfied the five-day pre-filing 
notice requirement.
    \25\ Id.
    \26\ See Securities Exchange Act Release No. 56970 (December 14, 
2007), 72 FR 72428 (December 20, 2007) (SR-CBOE-2007-99).
    \27\ For the purposes only of waiving the 30-day operative 
delay, the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of such proposed rule 
change the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is necessary or appropriate 
in the public interest, for the protection of investors or otherwise in 
furtherance of the purposes of the Act.

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-BSE-2008-10 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-BSE-2008-10. 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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of BSE. 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-BSE-2008-10 and should be 
submitted on or before April 11, 2008.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-5705 Filed 3-20-08; 8:45 am]

BILLING CODE 8011-01-P
