[Federal Register Volume 59, Number 14 (Friday, January 21, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-1429]
[[Page Unknown]]
[Federal Register: January 21, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33473; File No. SR-CBOE-93-50]
Self-Regulatory Organizations; Order Granting Accelerated
Approval of and Notice of Filing and an Order Granting Accelerated
Approval to Amendment No. 1 to a Proposed Rule Change by the Chicago
Board Options Exchange, Inc. Relating to the Listing of Options and
Long-Term Options on the CBOE Telecommunications Index and Long-Term
Options on a Reduced-Value Telecommunications Index
January 13, 1994.
I. Introduction
On October 27, 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 CBOE Telecommunications Index
(``Telecommunications Index'' or ``Index'').\3\ Notice of the proposal
appeared in the Federal Register on December 16, 1993.\4\ 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 (1992).
\3\On January 6, 1994, the CBOE amended the proposal in order to
request accelerated approval of the proposal pursuant to section
19(b)(2) of the Act, asserting that the proposal does not raise
regulatory concerns that have not been previously been addressed by
the Commission in its consideration and approval of the trading of
options on a telecommunications index on the American Stock
Exchange, Inc. (``Amex'') (``Amendment No. 1). See note 29, infra.
\4\See Securities Exchange Act Release No. 33313 (December 9,
1993), 58 FR 65744.
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II. Description of Proposal
A. General
The CBOE proposes to list and trade options on the CBOE
Telecommunications Index, an index developed by the CBOE. The CBOE also
proposes to list either long-term options on the full-value Index or
long-term options on a reduced-value Index that will be computed at
one-tenth of the value of the Telecommunications Index
(``Telecommunications LEAPS'' or ``Index LEAPS'').\5\
Telecommunications LEAPS will trade independent of and in addition to
regular Telecommunications Index options traded on the Exchange.\6\
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\5\LEAPS is an acronym for Long-Term Equity Anticipation
Securities. LEAPS are long term index option series that expire from
twelve to thirty-six months from their date of issuance. See CBOE
rule 24.9(b)(1).
\6\According to the CBOE, the S&P Telecommunications Index
represents a segment of the U.S. equity market that is not currently
represented in the derivative markets and, as such, the CBOE
concludes, should offer investors a low-cost means to achieve
diversification of their portfolios toward or away from the
telecommunications industry. The CBOE believes the Index will
provide retail and institutional investors with a means to benefit
from their forecasts of that industry's market performance. Options
on the Index also can be utilized by portfolio managers and
investors to provide a performance measure and evaluation guide for
passively or actively managed telecommunications industry funds, as
well as a means of hedging the risks of investing in the
telecommunications industry.
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B. Composition of the Index
The Index is based on twenty-five telecommunications industry
stocks. Eleven of those stocks currently trade on the New York Stock
Exchange, Inc. (``NYSE''), two trade on the American Stock Exchange,
Inc. (``Amex''), and twelve trade through the facilities of the
National Association of Securities Dealers Automated Quotation System
(``NASDAQ'').\7\ The Index is price-weighted and will be calculated on
a real-time basis using last sale prices.
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\7\All twelve NASDAQ component stocks are currently qualified
for and traded on the NASDAQ National Market.
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As of December 31, 1993, the Index was at 153.59. As of October 20,
1993, the market capitalizations of the individual stocks in the Index
ranged from a high of $81.192 billion to a low of $808.32 million, with
the mean and median being $15.027 billion and $11.4 billion,
respectively. The market capitalization of all the stocks in the Index
was $375.68 billion. The total number of shares outstanding for the
stocks in the Index ranged from a high of 1.348 billion shares to a low
of 17.12 million shares. The average price per share of the stocks in
the Index, for a six-month period between April 1 and September 30,
1993, ranged from a high of $80.52 to a low of $23.15. In addition, the
average daily trading volume of the stocks in the Index, for the same
six-month period, ranged from a high of 1.847 million shares per day to
a low of 70,730 shares per day, with the mean and median being 604,462
and 457,294 shares, respectively. Lastly, no one stock comprised more
than 6.91% of the Index's total value and the percentage weighting of
the five largest issues in the Index accounted for 27.77% of the
Index's value. The percentage weighting of the lowest weighted stock
was 2.27% of the Index and the percentage weighting of the five
smallest issues in the Index accounted for 12.27% of the Index's value.
C. Maintenance
The Index will be maintained by the CBOE. The CBOE may change the
composition of the Index at any time to reflect the conditions in the
telecommunications industry. If it becomes necessary to replace a stock
in the Index, the Exchange represents that it will make every effort to
add new stocks that are representative of the telecommunications
industry and will take into account a stock's capitalization,
liquidity, volatility, and name recognition. Further, stocks may be
replaced in the event of certain corporate events, such as takeovers or
mergers, that change the nature of the security. If, however, the
Exchange determines to increase the number of Index component stocks to
greater than thirty-three or reduce the number of Index component
stocks to fewer than seventeen, the proposal provides that the CBOE
will submit a rule filing with the Commission pursuant to section 19(b)
of the Act. In addition, in choosing replacement stocks for the Index,
the CBOE will be required to ensure that at least 90% of the weight of
the Index continues to be made up of stocks that are eligible for
standardized options trading.\8\
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\8\See note 23, infra.
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D. Applicability of CBOE Rules Regarding Index Options
Except as modified by this order, the rules in Chapter XXIV of the
CBOE Rules will be applicable to Telecommunications Index options.
Those rules address, among other things, the applicable position and
exercise limits, policies regarding trading halts and suspensions, and
margin treatment for both broad and narrow based index options.
E. Calculation of the Index
The CBOE Telecommunications Index is a price-weighted index and
reflects changes in the prices of the Index component stocks relative
to the Index's base date. Specifically, the Index value is calculated
by adding the prices of the component stocks and then dividing this
summation by a divisor that is equal to the number of stocks in the
Index to get the average price. To maintain the continuity of the
Index, the divisor will be adjusted to reflect non-market changes in
the prices of the component securities as well as changes in the
composition of the Index. Changes which may result in divisor
adjustments include, but are not limited to, stock splits and
dividends, spin-offs, certain rights issuances, and mergers and
acquisitions.
The Index will be calculated continuously and will be disseminated
to the Options Price Reporting Authority (``OPRA'') every fifteen
seconds by the CBOE, based on the last-sale prices of the component
stocks.\9\OPRA, in turn, will disseminate the Index value to other
financial vendors such as Reuters, Telerate, and Quotron.
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\9\For purposes of the daily dissemination of the Index value,
if a stock included in the Index has not opened for trading, the
CBOE will use the closing value of that stock on the prior trading
day when calculating the value of the Index, until the stock opens
for trading.
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The Index value for purposes of settling 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 in their
primary market on the last trading day prior to expiration. In the case
of securities traded on and through the NASDAQ National Market, the
first reported sale price will be used. 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 prior
trading day's (i.e., Thursday's) last sale price will be used in the
Index calculation. In this regard, before deciding to use Thursday's
closing value of a component stock for purposes of determining the
settlement value of the Index, the CBOE will wait until the end of the
trading day on expiration Friday.\10\
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\10\Id.
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F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\11\ Standard options trading hours (8:30 a.m. to 3:10
p.m. Central Standard time) will apply to the contracts. The Index
multiplier will be 100. The strike price interval will be $5 for full-
value Index options with a duration of one year or less to
expiration.\12\ In addition, pursuant to CBOE rule 24.9, there will be
six expiration months outstanding at any given time. Specifically,
there will be three expiration months from the March, June, September,
and December cycle plus three additional near-term months so that the
two nearest term months will always be available. As described in more
detail below, the Exchange also intends to list several Index LEAP
series that expire from twelve to thirty-six months from the date of
issuance.
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\11\A European-style option can be exercised only during a
specified period before the option expires.
\12\For a description of the strike price intervals for reduced-
value Index options and long-term Index options, see section G,
infra.
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Lastly, the options on the Index will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). Accordingly, since options on the Index will settle based
upon 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).
G. Listing of Long-Term Options on the Full-Value or Reduced-Value
Telecommunications Index
The proposal provides that the Exchange may list long-term Index
options that expire from 12 to 36 months from listing on the full-value
Telecommunications Index or a reduced-value Telecommunications Index
that will be computed at one-tenth the value of the full-value Index.
Existing Exchange requirements applicable to full-value and reduced-
value LEAPS will apply to full-value and reduced-value Index LEAPS.\13\
The current and closing Index value for reduced-value
Telecommunications 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 Index
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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\13\See CBOE Rule 24.9(b).
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H. Position and Exercise Limits, Margin Requirements, and Trading Halts
Because the Index is classified as an Industry Index under CBOE
rules, Exchange rules that are applicable to the trading of options on
narrow-based indexes will apply to the trading of Telecommunications
Index options and Telecommunications Index LEAPS. Specifically,
Exchange rules governing margin requirements,\14\ position and exercise
limits,\15\ and trading halt procedures\16\ that are applicable to the
trading of narrow-based index options will apply to options traded on
the Index. The proposal further provides that, 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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\14\Pursuant to CBOE rule 24.11, the margin requirements for the
Index options will be: (1) For short options positions, 100% of the
current market value of the options contract plus 20% of the
underlying aggregate Index value, less any out-of-the-money amount,
with a minimum requirement of the options premium plus 10% of the
underlying Index value; and (2) for long term options positions,
100% of the options premium paid.
\15\Pursuant to CBOE rules 24.4A and 24.5, respectively, the
position and exercise limits for the Index options will be 8,000
contracts, unless the Exchange determines, pursuant to Rules 24.4A
and 24.5 that a lower limit is warranted.
\16\Pursuant to CBOE rule 24.7, the trading on the CBOE of Index
options may be halted or suspended whenever trading in underlying
securities whose weighted value represents more than 20% of the
Index value are halted or suspended.
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I. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in full-value and reduced-value Index options. These procedures
include complete access to trading activity in the underlying
securities. Further, the Intermarket Surveillance Group Agreement,
dated July 14, 1983, as amended on January 29, 1990, will be applicable
to the trading of options on the Index.\17\
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\17\ISG 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.
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III. Findings and Conclusions
The Commission finds 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, and, in
particular, the requirements of section 6(b)(5).\18\ Specifically, the
Commission finds that the trading of Telecommunications Index options,
including full-value and reduced-value Index LEAPS, will serve to
promote the public interest and help to remove impediments to a free
and open securities market by providing investors with a means to hedge
exposure to market risk associated with securities in the
telecommunications industry.\19\ The trading of options on the
Telecommunications Index, including full-value and reduced-value LEAPS
on the Index, 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
adequately has addressed these concerns.
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\18\15 U.S.C. 78f(b)(5) (1988).
\19\Pursuant to section 6(b)(5) of the Act, the Commission must
predicate approval of any new option 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 Telecommunications Index will provide
investors with a hedging vehicle that should reflect the overall
movement of the stocks comprising the telecommunications industry in
the U.S. stock markets. The Commission also believes that these
Index options will provide investors with a means by which to make
investment decisions in the telecommunications industry sector of
the U.S. stock markets, allowing them to establish positions or
increase existing positions in such markets in a cost effective
manner. Moreover, the Commission believes that the reduced-value
Index LEAPS, that will be traded on an index computed at one-tenth
the value of the Telecommunications Index, will serve the needs of
retail investors by providing them with the opportunity to use a
long-term option to hedge their portfolios from long-term market
moves at a reduced cost.
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A. Index Design and Structure
The Commission finds that the Telecommunications Index and reduced-
value Telecommunications Index are narrow-based indices. The
Telecommunications Index is comprised of only twenty-five stocks, all
of which are within one industry--the telecommunications industry. In
addition, the basic character of the reduced-value Telecommunications
Index, which is comprised of the same component securities as the
Telecommunications Index and calculated by dividing the
Telecommunications Index value by ten, is essentially identical to the
Telecommunications Index.\20\ Accordingly, the Commission believes it
is appropriate for the CBOE to apply its rules governing narrow-based
index options to trading in the Index options.\21\
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\20\See generally Securities Exchange Act Release No. 29994
(November 26, 1991), 56 FR 63536 (December 4, 1991) (order
designating the PSE Technology Index as a broad-based index rather
than a narrow-based index).
\21\See supra notes 14 through 16, and accompanying text.
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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 overwhelming majority of the stocks that comprise the Index
are actively traded, with a mean and median average daily trading
volume of 604,462 and 457,294 shares, respectively.\22\ Second, the
market capitalizations of the stocks in the Index are very large,
ranging from a high of $18.192 billion to a low of $808.32 million as
of October 20, 1993, with the mean and median being $15.027 billion and
$11.4 billion, respectively. Third, although the Index is only
comprised of twenty-five component stocks, no one particular stock or
group of stocks dominates the Index. Specifically, no one stock
comprises more than 6.91% of the Index total value and the percentage
weighting of the three largest issues in the Index accounting for
17.77% of the Index's value. Fourth, all twenty-five stocks in the
Index currently are eligible for options trading.\23\ The proposed CBOE
maintenance requirement that 90% of the weighting of the Index be
comprised of stocks that are eligible for options trading will ensure
that the Index is almost completely comprised of options eligible
stocks. Fifth, if the CBOE increases the number of component stocks to
more than thirty-three or decreases that number to less than seventeen,
the CBOE will be required to seek Commission approval pursuant to
section 19(b)(2) of the Act before listing new strike price or
expiration month series of Telecommunications Index options. This will
help protect against material changes in the composition and design of
the Index that might adversely affect the CBOE's obligations to protect
investors and to maintain fair and orderly markets in
Telecommunications Index options. Finally, the Commission believes that
the expense of attempting to manipulate the value of the
Telecommunications Index in any significant way through trading in
component stocks (or options on those stocks) coupled with, as
discussed below, existing mechanisms to monitor trading activity in
those securities, will help deter such illegal activity.
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\22\In addition, for the six-month period between April 1 and
September 30, 1993, all of the companies comprising the Index had an
average daily trading volume greater than 70,730 shares per day.
\23\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.
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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 Telecommunications Index
options (including full-value and reduced-value Telecommunications
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 Telecommunications Index options and
Telecommunications Index LEAPS.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a stock index derivate product
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.\24\ In this regard, the CBPE,
NYSE, Amex, and NASD are all members of the Intermarket Surveillance
Group (``ISG''), which provides for the exchange of all necessary
surveillance information.\25\
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\24\Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\25\See note 17, supra. Although the Index currently does not
contain ADRs, the proposal provides that the Index could contain
ADRs representing telecommunications industry stocks. If the
composition of the Index would change so that greater than 20% of
the Index was represented by ADRs whose underlying securities were
not subject to a comprehensive surveillance sharing arrangement,
then it would be difficult for the Commission to reach the
conclusions reached in this order and the Commission would have to
determine whether it would be suitable to continue to trade options
on the Index. The CBOE should, accordingly, notify the Commission
immediately if more than twenty percent of the numerical value of
the Index is represented by ADRs whose underlying securities are not
subject to a comprehensive surveillance sharing agreement. Such a
change in the composition of the Index may warrant the submission of
a rule filing pursuant to Section 19 of the Act.
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D. Market Impact
The commission believes that the listing and trading of
Telecommunications Index options, including full-value and reduced-
value index LEAPS on the CBOE will not adversely impact the underlying
securities markets.\26\ First, as described above, for the most part,
no one stock or group of stocks dominates the Index must be accounted
for by stocks that meet the options listing standards, the component
securities generally will be actively-traded, highly-capitalized
stocks.\27\ Third, the contract position and exercise limits applicable
to Index options and Index LEAPS 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 and Index LEAPS will be issued and guaranteed by the Options
Clearing Corporation just like any other standardized option traded in
the United States.
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\26\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 Nancy L. Nielsen, Assistant Corporate Secretary,
CBOE, to Sharon Lawson, Assistant Director, Division of Market
Regulation, SEC, dated October 26, 1993 and memorandum from Joe
Corrigan Executive Director, OPRA, to Eileen Smith, CBOE, dated
October 22, 1993.
\27\See note 23, supra.
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Lastly, the Commission believes that settling expiring
Telecommunications Index options (including full-value and reduced-
value Index LEAPS) based on the opening prices of component securities
is consistent with the Act. As noted in other contexts, valuing options
for exercise settlement on expiration based on opening prices rather
than closing prices may help reduce adverse effects on markets for
securities underlying options on the Index.\28\
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\28\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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The Commission finds good cause for approving the proposed rule
change, including Amendment No. 1, prior to the thirtieth day after the
date of publication of notice of filing thereof in the Federal Register
in order to allow the Exchange to list Telecommunications Index options
without delay. The Commission notes that the proposal is very similar
to other narrow-based index option proposals that have been recently
approved by the Commission.\29\ In addition, the Commission notes the
proposal (excluding Amendment No. 1) was published for the full 21-day
comment period and no comments opposing the proposal were received by
the Commission. With regard to Amendment No. 1, the Commission finds
good cause for approving this amendment on an accelerated basis because
the amendment does not affect the substance of the proposed rule
change. It merely requests accelerated approval of the entire proposal
pursuant to section 19(b)(2) of the Act.
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\29\See Securities Exchange Act Release No. 33442 (January 6,
1994), 59 FR 1973 (January 13, 1994) (CBOE Gaming Index); and
Securities Exchange Act Release No. 33191 (November 12, 1993), 58 FR
61719 (November 22, 1993) (Amex Telecommunications Index).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549. 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 at the Commission's Public Reference Section, 450 Fifth Street,
NW., Washington, DC. Copies of such filing will also be available for
inspection and copying at the principal office of the above-mentioned
self-regulatory organization. All submissions should refer to the file
number in the caption above and should be submitted by February 11,
1994.
It is therefore ordered, Pursuant to section 19(b)(2) of the
Act,\30\ that the proposed rule change (SR-CBOE-93-50), as amended, is
approved.
\30\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\31\
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\31\17 CFR 200.30-3(a)(12) (1993).
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[FR Doc. 94-1429 Filed 1-19-94; 4:15 pm]
BILLING CODE 8010-01-M
