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NASD Notice to Members 98-49

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NASD Notice to Members 98-49 Executive Summary Background And Discussion NASD On June 12, 1998, the Securities and NASD Rule 2860 governs members’ Exchange Commission (SEC) activities in standardized, convention- approved amendments to National al, and FLEX equity options. Stan- Notice to Association of Securities Dealers, dardized options are exchange-traded Inc. (NASD®) Rule 2860 and Inter- options issued by the Options Clear- pretive Material 2860-1 (IM-2860-1). ing Corporation (OCC) that have Members The amendments to Rule 2860 make standardized terms for strike prices, three basic changes. First, the expiration dates, and the amount of 98-49 amendments increase the position the underlying security. Convention- limits on conventional equity options al options are any other options con- to the greater of three times the basic tracts not issued, or subject to limit of 4,500 contracts, or three issuance, by the OCC. Conventional times any standardized equity options are also frequently referred to SEC Approves options position limit for which the as over-the-counter (OTC) options. Amendments To Rule underlying security qualifies or would FLEX equity options are exchange- Regarding Options be able to qualify. Second, the traded options issued by the OCC Position Limits; Effective amendments disaggregate conven- that give investors the ability, within tional equity options from standard- specified limits, to designate certain June 12, 1998 ized equity options and FLEX equity terms of the option (i.e., the exercise options for position limit purposes, price, exercise style, expiration date, i.e., standardized and FLEX equity or option type). option positions do not count towards Suggested Routing the position limits for conventional NASD Rule 2860(b)(3) imposes a Senior Management equity options on the same underly- ceiling or position limit on the number ing security. Third, the amendments of conventional and standardized Advertising provide that the OTC Collar Aggrega- equity options contracts in each class Continuing Education tion Exemption shall be available on the same side of the market (i.e., with respect to an entire conventional aggregating long calls and short puts Corporate Finance equity options position, not just that or long puts and short calls) that can Executive Representatives portion of the position that is estab- be held or written by a member, a Government Securities lished pursuant to the NASD’s Equity person associated with a member, a Option Hedge Exemption (Hedge customer, or a group of customers Institutional Exemption). In addition, the amend- acting in concert. The position limits Insurance ments to IM-2860-1 clarify and for equity options are established Internal Audit update the illustrative examples to be according to a five-tiered system consistent with the new amendments whereby more actively traded securi- Legal & Compliance and prior increases in the Hedge ties with larger public floats are sub- Municipal Exemption. The amendments ject to higher position limits and less became effective on June 12, 1998. actively traded stocks are subject to Mutual Fund The text of the amended rules and lower limits. The current tiers for Operations the Federal Register version of the standardized equity options are Options SEC Release are attached. See 63 4,500, 7,500, 10,500, 20,000, and FR 33746 (June 19, 1998). 25,000 options contracts.1 The Registered Representatives NASD rules do not specifically gov- Registration Questions concerning this Notice ern whether a particular equity option Research should be directed to Gary L. Gold- falls within one of the position-limit sholle, Assistant General Counsel, tiers. Rather, the NASD position limit Syndicate Office of General Counsel, NASD rule generally provides that the posi- Systems Regulation, Inc., at (202) 728-8104. tion limit established by an options exchange(s) for a particular equity Trading option is the applicable position limit Training for purposes of the NASD rule. Variable Contracts NASD Notice to Members 98-49 July 1998 377 On September 9, 1997, the Commis- To illustrate how these new limits OTC Collar Aggregation Exemption, sion approved a two-year pilot pro- work, consider the following example i.e., that if the terms of the exemption gram to eliminate position and of stock ABCD, which is subject to a are met, the segments of an OTC exercise limits for FLEX equity position limit of 25,000 standardized collar will never both be in-the- options, which are traded on the vari- equity option contracts. In this exam- money at the same time or exer- ous options exchanges.2 In light of ple, a market participant could estab- cised. the pilot program, NASD RegulationSM lish a position of 25,000 standardized amended its rules governing position option contracts on ABCD and an To illustrate how these new provi- and exercise limits for conventional additional 75,000 conventional option sions work, consider the following equity options to foster competition contracts on ABCD on the same side example of stock ABCD that is sub- between the OTC market and the of the market, since conventional ject to a standardized equity option options exchanges. and standardized option positions position limit of 25,000 contracts and would be disaggregated. In addition, a conventional equity option position NASD Regulation believes that the market participant also may have limit of 75,000 contracts. If the mar- FLEX equity options closely resem- a position of any size in FLEX Equity ket participant had increased the size ble and are economically equivalent Options overlying ABCD, since such of its conventional equity options to conventional equity options. FLEX equity options would not be position to 225,000 pursuant to the Accordingly, the amendments to aggregated with either the conven- Hedge Exemption (based upon a Rule 2860(b)(3) seek to more closely tional equity options or standardized limit of three times the 75,000 con- align the NASD’s position limit rules equity options overlying ABCD. ventional equity options position for conventional equity options with limit), the market participant could those for FLEX equity options. In The NASD’s Hedge Exemption3 pro- then establish an OTC collar on fact, the new limits on conventional vides for an automatic exemption ABCD involving 225,000 long (short) equity options correspond to the from equity option position limits for calls and 225,000 short (long) puts, position limits that were in effect for accounts that have established for a total of 450,000 contracts. FLEX equity options prior to the elim- hedged positions on a limited one- ination of such limits in the pilot pro- for-one basis (i.e., 100 shares of Finally, members are reminded that gram. Under the new amendments, stock for one option contract). Under Rule 2860(b)(5) imposes reporting the position limits for conventional the Hedge Exemption, the largest obligations on “each account in equity options have increased to the options position that may be estab- which the member has an interest . greater of three times the basic limit lished (combining hedged and and each customer account, which of 4,500 contracts, or three times any unhedged positions) may not exceed has established an aggregate posi- higher standardized equity options three times the basic position limits tion of 200 or more option contracts position limit for which the underlying for either standardized or conven- (whether long or short) of the put security qualifies or would be able to tional equity options. The OTC Col- class and the call class on the same qualify. lar Aggregation Exemption4 provides side of the market covering the same that positions in conventional put and underlying security.” Information The new amendments also provide call options establishing OTC collars reported to the NASD is used by that conventional equity options posi- need not be aggregated for position NASD Regulation Market Regulation tions shall not be aggregated with limit purposes. An OTC collar trans- staff as part of their ongoing market standardized and FLEX equity action involves the purchase (sale) of surveillance operations. Additional options positions overlying the same a put and the sale (purchase) of a information concerning members’ security for position limit purposes. call on the same underlying security options reporting obligations may be Disaggregation of conventional and to hedge a long (short) stock posi- found in Notice to Members 94-46. other options is necessary to give full tion. effect to the increase in position lim- its for conventional equity options. The new amendments modify the Without disaggregation, positions in terms of the OTC Collar Aggregation FLEX equity options or standardized Exemption to apply to an entire con- equity options would reduce or ventional equity option position, not potentially even eliminate (in the just the portion that is established case of FLEX equity options) the pursuant to the Hedge Exemption. available position limits for conven- This amendment is consistent with tional equity options. the economic logic underlying the NASD Notice to Members 98-49 July 1998 378 Text Of Rule Amendments class and the call class on the same applicable rules for a position limit of (Note: New text is underlined; deletions are side of the market covering the same 25,000 option contracts; or bracketed.) underlying security, combining for purposes of this position limit long (vi) such other number of stock Rule 2860. Options positions in put options with short options contracts as may be fixed positions in call options, and short from time to time by the Association (a) No Change positions in put options with long as the position limit for one or more positions in call options; or classes or series of options provided (b) Requirements that reasonable notice shall be given (ii) 7,500 options contracts of the put of each new position limit fixed by (2) Definitions class and the call class on the same the Association.
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