[Federal Register Volume 59, Number 7 (Tuesday, January 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 93-622]
[[Page Unknown]]
[Federal Register: January 11, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33428; File No. SR-CBOE-93-42]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving a Proposed Rule Change by the Chicago Board
Options Exchange, Inc. Relating to the Listing of Regular and Long-Term
Options on the Nasdaq 100 Index
January 5, 1994.
I. Introduction
On September 22, 1993, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'') or ``Commission''), pursuant to section 19(b)(1)
of the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for the listing and
trading of index options on the Nasdaq 100 Index (``Nasdaq Index'' or
``Index'').\3\ The proposed rule change was published for comment in
Securities Exchange Act Release No. 33166 (November 8, 1993), 58 FR
60710 (November 17, 1993). No comment letters were received on the
proposed rule change. This order approves the Exchange's proposal.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\The CBOE amended the rule change proposal on October 27, 1993
to include an updated list of the securities comprising the Nasdaq
100 Index. This list of securities became the basis of calculations
of the value of the Nasdaq 100 Index as of October 26, 1993. See
letter from Robert B. Wilcox, Jr., Schiff Hardin & Waite to Michael
A. Walinskas, Staff Attorney, Division of Market Regulation, SEC,
dated October 27, 1993 (``Amendment No. 1'').
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II. Description of Proposal
A. General
The CBOE proposes to trade options on the Nasdaq Index, a stock
index calculated and maintained by the Nasdaq Stock Market, Inc.
(``Nasdaq''), a subsidiary of the National Association of Securities
Dealers, Inc. (``NASD''). The CBOE also proposes to list long-term
options (``LEAPS'') on the Index. Index LEAPS will trade independent of
and in addition to regular Index options traded on the Exchange.
B. Composition of the Index
The Index contains one hundred of the largest non-financial
securities issued by U.S. issuers and traded on the Nasdaq National
Market. Nasdaq will use a capitalization-weighted method to calculate
the Index.\4\ As of January 3, 1994 the Index was at 398.28.
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\4\See infra Section D entitled ``Calculation of the Index'' for
a description of this calculation method.
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As of October 25, 1993, the market capitalizations of the
individual stocks in the Index ranged from a high of $26.8 billion to a
low of $437 million, with the mean and median being $2.54 billion and
$1.3 billion, respectively. The market capitalization of all the stocks
in the Index was $253.8 billion. The total number of shares outstanding
for the stocks in the Index ranged from a high of 536 million shares to
a low of 15.1 million shares. The average price per share of the stocks
in the Index, for a six-month period between April 1, 1993 and
September 1, 1993, ranged from a high of $103.29 to a low of $6.15. In
addition, the average daily trading volume of the stocks in the Index,
for the same six-month period, ranged from a high of 2.853 million
shares per day to a low of 10,579 shares per day, with the mean and
median being 631,631 and 407,639 shares, respectively. Lastly, no one
stock comprised more than 10.54% of the Index's total value and the
percentage weighting of the five largest issues in the Index accounted
for 33.27% of the Index's value. The percentage weighting of the lowest
weighted stock was 0.17% of the Index and the percentage weighting of
the five smallest issues in the Index accounted for 1.12% of the
Index's value.
C. Maintenance
The Index will be maintained by Nasdaq. Nasdaq has notified the
CBOE that it recently updated the list of securities comprising the
Index and will continue to make revisions to the Index on an annual
basis. Nasdaq also, in its discretion, will make special adjustments to
the securities comprising the Index to reflect such events as stock
splits or reverse splits, spinoffs, stock dividends, reorganizations,
recapitalizations, and similar events, upon their occurrence.
D. Calculation of the Index
The Index will be calculated using a capitalization-weighting
methodology. The representation of each security in the Index will be
proportional to the security's last sale price times the total number
of shares outstanding, in relation to the total market value of all of
the securities in the Index. The level of the Index is calculated as
follows:
TN11JA94.005
The numerical value of the Index was established at 250 prior to
the opening of the market on February 1, 1985. At the close of the
market on December 31, 1993, the Index was at 796.56. Then, effective
January 3, 1994, the Index value was halved, creating an Index level of
398.28 at the market opening on January 3, 1994. The Index is
calculated and disseminated every fifteen seconds to market information
vendors. Nasdaq will also calculate the exercise settlement value for
each expiring series of Nasdaq Index options and make this value
available to the CBOE for use by the Options Clearing Corporation in
effecting settlement of exercises and assignments of the options.
The Index value, for purposes of setting outstanding Index options
contracts upon expiration, will be calculated based upon the regular
way opening sale prices for each of the Index's component stocks on the
last trading day prior to expiration.\5\ Once all of the component
stocks have opened, the value of the Index will be determined and that
value will be used as the final settlement value for expiring Index
options contracts. If any of the component stocks do not open for
trading on the last trading day before expiration, then the last
reported sale price of such security will be used in any case where
that security does not trade on that day.\6\
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\5\See CBEO Rule 24.9(a)(4).
\6\Id.
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E. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\7\ Standard options trading hours (9:30 a.m. to 4:15
p.m. New York time) will apply to the contracts. The Index multiplier
will be 100. The strike price interval will be $5.00 for full-value
Index options with a duration of one year or less to expiration.\8\ The
Exchange intends to list up to three near-term calendar months and
three additional calendar months at three month intervals.\9\ As
described in more detail below, the Exchange also intends to list Index
LEAPS that will expire twelve to thirty-six months from the date of
their issuance.
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\7\A European-style option can be exercised only during a
specified period before the option expires.
\8\For a description of the strike price intervals for full-
value and reduced-value Index LEAPS, See, Section F, infra.
\9\See CBOE Rule 24.9(a)(2).
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Index options (including full-value and reduced-value Index LEAPS)
will expire on the Saturday following the third Friday of the
expiration month (``Expiration Friday''). Since options on the Index
will settle based upon the opening prices of the component stocks on
the last trading day before expiration (normally a Friday), the last
trading day for an expiring Index option series will normally be the
second to the last business day before expiration (normally a
Thursday).\10\
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\10\See notes 5 and 6, supra.
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F. Listing of Long-Term Options on the Full-Value or Reduced-Value
Nasdaq Index
The Exchange may list LEAPS that expire 12 to 36 months from date
of issuance on the full-value Nasdaq Index or a reduced-value Nasdaq
Index that will be computed on one-tenth the value of the full-value
Index.\11\ The current and closing Index value for reduced-value Nasdaq
LEAPS will be computed by dividing the value of the full-value Index by
10 and rounding the resulting figure to the nearest one-hundredth. For
example, a Index value of 185.46 would be 18.55 for the Index LEAPS and
185.43 would become 18.54. The reduced-value LEAPS will have a
European-style exercise and will be subject to the same rules that
govern the trading of all the Exchange's index options, including sales
practice rules, margin requirements and floor trading procedures. The
strike price interval for the reduced-value Index LEAPS will be no less
than $2.50 instead of $5.00.
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\11\See CBOE Rule 24.9(b).
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The same Exchange rules which are applicable to the trading of
full-value LEAPS will be applicable to the trading of reduced-value
Index LEAPS. For example, both full-value and reduced-value Index LEAPS
may expire from 12 to 36 months from the date of issuance, and there
may be up to six expiration months beyond one year to expiration.
Moreover, either full-value or reduced-value Index LEAPS may be issued
at six month intervals and new strike prices will either be near or
bracketing the current Index value. Strike price interval, bid/ask
differential, and continuity rules will not apply to the trading of the
full-value or reduced-value Index LEAPS until their time to expiration
is less than 12 months. The strike price interval for reduced-value
Index LEAPS will be no less than $2.50, instead of $5.00 for full-value
Index LEAPS. Lastly, additional LEAPS series may be added when the
value of the underlying Index increases or decreases by ten to fifteen
percent.
G. Position and Exercise Limits, Margin Requirements, and Trading Halts
Position limits for the Index options Index LEAPS will be set at no
more than 25,000 contracts on the same side of the market, provided
that no more than 15,000 of such contracts are in series in the nearest
expiration month.\12\ Exercise limits will be set at the same level as
position limits.\13\ CBOE hedge exemption provisions will apply to
Index options and Index LEAPS.\14\ Also, for purposes of determining
whether a given position in reduced-value Index options complies with
applicable position and exercise limits, positions in reduced-value
Index options will be aggregated with positions in the full-value Index
options. For these purposes, ten reduced-value contracts will equal one
full-value contract for purposes of aggregating these positions.
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\12\See CBOE 24.4.
\13\See CBOE Rule 24.5.
\14\See CBOE Rule 24.4(a) and Interpretation .01 to Rule 24.4.
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Exchange rules applicable to the Nasdaq Index options will be
identical to the rules applicable to other broad-based index options
for purposes of trading rotations, halts, and suspensions,\15\ and
margin treatment.\16\
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\15\See CBOE Rule 24.7.
\16\See CBOE Rule 24.11.
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H. Surveillance
The Exchange will use the same surveillance procedures currently
utilized for each of the Exchange's other index options to monitor
trading in Nasdaq Index options and Index LEAPS. These procedures
include complete access to trading activity in the underlying
securities.
I. Disclaimer
The CBOE has proposed placing in its Rules a disclaimer of
liability made by Nasdaq and its affiliates that Nasdaq and such
affiliates do not make any warranties as to the results obtained from
the Nasdaq index, any opening, intra-day or closing value therefore,
any related data, or any errors or delays in calculating or
disseminating the Index, in connection with the trading of option
contracts based on the Index. The disclaimer is similar to other
disclaimers made on behalf of Standard & Poor's Frank Russell Company,
and LIFFE Administration & Management, that are currently in the CBOE's
Rules.\17\
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\17\See CBOE Rule 24.14.
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III. Commission Findings and Conclusions
The Commission has reviewed the proposal to list and trade Nasdaq
Index options and Index LEAPS. As discussed below, the Commission
believes that the proposed rule change is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange. In particular, the Index
is broad-based, the proposed options are designed to reduce the
potential for manipulation, and the proposal to list and trade Nasdaq
Index options and Index LEAPS is consistent with the CBOE's obligation
to promote investor protection.\18\ The Commission finds that the
trading of options on the Index, including full-value and reduced-value
Index LEAPS, will permit investors to participate in the price
movements of the 100 securities on which the Index is based. Further,
trading of options on the Index will allow investors holding positions
in some or all of the securities underlying the Index to hedge the
risks associated with their portfolios. Accordingly, the Commission,
believes the Nasdaq Index options will provide investors with an
important trading and hedging mechanism that should reflect accurately
the overall movement of 100 of the largest non-financial stocks listed
on the Nasdaq National Market. By broadening the hedging and investment
opportunities of investors, the Commission believes that the trading of
Nasdaq Index options will serve to protect investors, promote the
public interest, and contribute to the maintenance of fair and orderly
markets.\19\
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\18\The CBOE is a member of the Intermarket Surveillance Group
(``ISG''), which was formed on July 14, 1983 to, among other things,
coordinate more effectively surveillance and investigative
information sharing arrangements in the stock and options markets.
See Intermarket Surveillance Group Agreement, July 14, 1983. The
most recent amendment to the ISG Agreement, which incorporates the
original agreement and all amendments made thereafter, was signed by
ISG members on January 29, 1990. See Second Amendment to the
Intermarket Surveillance Group Agreement, January 29, 1990. The
Commission understands that the ISG Agreement, as amended, covers
investigations and inquiries regarding trading activity in Nasdaq
Index options and component securities.
\19\Pursuant to section 6(b)(5) of the Act, the Commission must
predicate approval of any new option or warrant proposal upon a
finding that the introduction of such new derivative instrument is
in the public interest. Such a finding would be difficult for a
derivative instrument that served no hedging or other economic
function, because any benefits that might be derived by market
participants likely would be outweighed by the potential for
manipulation, diminished public confidence in the integrity of the
markets, and other valid regulatory concerns. In this regard, the
trading of listed options on the Nasdaq Index will provide investors
with a hedging vehicle that should reflect the overall movement of
100 of the largest non-financial stocks listed on the Nasdaq
National Market. The Commission also believes that these options
will provide investors with a means by which to make investment
decisions in the utilities equity market, allowing them to establish
positions or increase existing positions in utilities stocks in a
cost effective manner.
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The trading of options on the Nasdaq Index, including the trading
of full-value and reduced-value Index LEAPS, however, raises several
concerns, namely issues related to index design, customer protection,
surveillance, and market impact. The Commission believes, for the
reasons discussed below, that the CBOE has addressed these concerns
adequately.
A. Index Design and Structure
The Commission finds that the Nasdaq Index and reduced-value Nasdaq
Index are broad-based indices, and thus it is appropriate to permit
Exchange rules applicable to the trading of broad-based index options
to apply to the Index options, including Index LEAPS. Specifically, the
Commission believes the Index is broad-based because it reflects a
substantial segment of the U.S. equities market. In addition, the basic
character of the reduced-value Nasdaq Index, which is comprised of the
same component securities as the Nasdaq Index and calculated by
dividing the Nasdaq Index by ten, is essentially identical to the
Nasdaq Index.
The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the Index's component stocks
significantly minimize the potential for manipulation of the Index.
First, the Index represents and consists of the common stock values of
100 actively traded U.S. companies. Second, no one particular stock or
group of stocks dominates the Index. Specifically, no one stock
comprises more than 10.54% of the Index's total value and the
percentage weighting of the five largest issues in the Index accounts
for 33.27% of the Index's value. Third, the overwhelming majority of
the stocks that comprise the Index are actively traded, with a mean and
median average daily trading volume of 631,631 and 407,639 shares,
respectively. Fourth, the market capitalizations of the stocks in the
Index are very large, ranging from a high of $26.8 billion to a low of
$437 million as of October 25, 1993, with the mean and median being
$2.54 billion and $1.3 billion, respectively. Fifth, the Index is
comprised of stocks representing a diverse group of industries, the
most heavily represented by Index weight including computer software
products and service, semiconductors, telephone equipment and service,
broadcasting, and retail. Sixth, 97 out of the 100 component stocks in
the Index, comprising 98.82% of the weighting of the Index, currently
are eligible for options trading.\20\ Finally, the Commission believes
that, as discussed below, existing mechanisms to monitor trading
activity in those securities will help deter as well as detect illegal
trading activity involving the index option.
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\20\The CBOE's options listing standards, which are uniform
among the options exchanges, provide that a security underlying an
option must, among other things, meet the following requirements:
(1) The public float must be at least 7,000,000; (2) there must be a
minimum of 2,000 stockholders; (3) trading volume must have been at
least 2.4 million over the preceding twelve months; and (4) the
market price must have been at least $7.50 for a majority of the
business days during the preceding three calendar months. See CBOE
Rule 5.3, Interpretation .01.
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B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as Nasdaq Index options
(including full-value and reduced-value LEAPS), can commence on a
national securities exchange. The Commission notes that the trading of
standardized exchange-traded options occurs in an environment that is
designed to ensure, among other things, that: (1) The special risks of
options are disclosed to public customers; (2) only investors capable
of evaluating and bearing the risks of options trading are engaged in
such trading; and (3) special compliance procedures are applicable to
options accounts. Accordingly, because the Index options and Index
LEAPS will be subject to the same regulatory regime as the other
standardized options currently traded on the CBOE, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in Nasdaq Index options and Nasdaq Index LEAPS.
C. Surveillance
The Commission generally believes that a surveillance sharing
agreement between an exchange proposing to list a stock index
derivative and the exchange(s) trading the stocks underlying the
derivative product is an important measure for surveillance of the
derivative and underlying securities markets. Such agreements ensure
the availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the stock index
product less readily susceptible to manipulation.\21\ In this regard,
the NASD, which currently is the primary market for all of the Index's
component securities, is a member of the Intermarket Surveillance Group
(``ISG''), which provides for the exchange of all necessary
surveillance information.\22\
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\21\See Securities Exchange Act Release No. 31243, 57 FR 45849
(October 5, 1992).
\22\See note 18, supra.
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D. Market Impact
The Commission believes that the listing and trading on the CBOE of
Nasdaq Index options, including full-value and reduced-value Index
LEAPS, will not adversely impact the underlying securities markets.\23\
First, as described above, the Index is broad-based and comprised of
100 stocks with no one stock dominating the Index. Second, as noted
above, the stocks contained in the Index have relatively large
capitalizations and are relatively actively traded. Third, the 25,000
contract position and exercise limits will serve to minimize potential
manipulation and market impact concerns. Fourth, the risk to investors
of contra-party non-performance will be minimized because the Index
options will be issued and guaranteed by the Options Clearing
Corporation just like any other standardized option traded in the
United States. Fifth, existing CBOE stock index options rules and
surveillance procedures will apply to Nasdaq Index options.
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\23\In addition, the CBOE has represented that the CBOE and the
Options Price Reporting Authority (``OPRA'') have the necessary
systems capacity to support those new series of index options that
would result from the introduction of Index options and Index LEAPS.
See letter from Charles J. Henry, President and Chief Operating
Officer, CBOE, to Sharon Lawson, Assistant Director, Division of
Market Regulation, SEC, dated January 4, 1993 and memorandum from
Joe Corrigan, Executive Director, OPRA, to Eileen Smith, CBOE, dated
January 4, 1993.
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Lastly, the Commission believes that settling expiring Nasdaq Index
options (including full-value and reduced-value Index LEAPS) based on
the opening prices of component securities is reasonable and consistent
with the Act. As noted in other contexts, valuing expiring index
options for exercise settlement purposes based on opening prices rather
than closing prices may help reduce adverse effects on the securities
underlying options on the Index.\24\
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\24\Securities Exchange Act Release No. 30944, 57 FR 33376 (July
28, 1992).
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It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-CBOE-93-42) is approved.
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\25\15 U.S.C. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 93-622 Filed 1-10-93; 8:45 am]
BILLING CODE 8010-01-M
