[Federal Register Volume 64, Number 26 (Tuesday, February 9, 1999)]
[Notices]
[Pages 6410-6413]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-3031]
[[Page 6410]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41009; File No. SR-CBOE-98-49]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Granting Approval to Proposed Rule Change and
Notice of Filing and Order Granting Accelerated Approval of Amendment
No. 1 to Proposed Rule Change Relating to Trading and Listing Options
on the Dow Jones Equity REIT Index
February 1, 1999.
I. Introduction
On November 5, 1998 the Chicago Board Options Exchange,
Incorporated (``CBOE'' or ``Exchange'') submitted to the Securities and
Exchange Commission (``Commission'' or ``SEC''), 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 options on the Dow Jones Equity Real Estate Investment
Trust Index (``Index'' or ``REITS Index''). The Commission published
the proposed rule change for comment in the Federal Register on
December 22, 1998.\3\ No comments were received.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 40794 (December 15,
1998), 63 FR 70816.
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On January 28, 1999, the CBOE submitted Amendment No. 1 to the
proposed rule change.\4\ This order approves the proposed rule change,
and also approves Amendment No. 1 on an accelerated basis.
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\4\ See letter, dated January 27, 1999, from Eileen Smith,
Director, Product Development, CBOE, to Marianne Duffy, Special
Counsel, Division of Market Regulation, Commission (``Amendment No.
1''). Among other things, Amendment No. 1 clarified that the Dow
Jones' internal surveillance procedures apply to the Index as well,
included the full list of the Index components, amended Rule
24.4.01(e) to include a hedge exemption of 625,000 contracts on the
Index and clarified that the maintenance standard of 80% is by
weight.
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II. Description of the Proposal
A. Index Design
The proposed rule change would permit the Exchange to list and
trade cash-settled, European-style,\5\ A.M.-settled stock index
options. The Index is a broad-based, capitalization-weighted index
currently composed of 116 equity real estate investment trusts
(``REITs'').\6\ The Index was designed by Dow Jones & Company. The
Index has been designed to measure the performance of REITs that
comprise 95% of the market capitalization of the domestic equity REIT
investable universe, which includes equity REITs that are listed on the
New York Stock Exchange (``NYSE''), the American Stock Exchange
(``Amex'') and the Nasdaq National Market (``NNM'').
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\5\ A European-style option is one that may be exercised only
during a limited period of time prior to expiration of the option.
\6\ REITs, created by the U.S. Congress to facilitate small
investor participation in real estate on a wholesale scale, pool
capital from multiple investors like mutual funds.
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The Index components are subject to a screening process that: (1)
eliminates REITs that have more than 10 no-trading days over the past
quarter; (2) eliminates REITs that comprise the bottom 1% of the
aggregate REIT market capitalization; and (3) eliminates REITs that
comprise the bottom 0.01% of the average dollar-trading volume. All of
the component REITs are ``reported securities,'' as that term is
defined in Rule 11Aa3-1 under the Act.\7\ All but one REIT in the Index
are eligible for options trading.
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\7\ See 17 CFR 240.11Aa3-1. A ``reported security'' is defined
as ``any security or class of securities for which transaction
reports are collected, processed and made available pursuant to an
effective transaction reporting plan.'' A ``transaction reporting
plan'' is in turn defined in paragraph (a)(2) of this rule as ``any
plan for collecting, processing, making available or disseminating
transaction reports with respect to transactions in reported
securities filed with the Commission pursuant to, and meeting the
requirements of this section.''
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On October 20, 1998, the 116 components ranged in capitalization
from $207 million to $6.13 billion. The largest component accounted for
5.08% of the total weighting of the Index, while the smallest accounted
for 0.17%. The total capitalization of the REITs in the Index was
$120.4 billion. The average capitalization was $1.04 billion, and the
median capitalization was $655 million. Also, as of October 20, 1998,
the Index components represented eleven distinct property
classifications: office property (21.01%), apartments (19.31%),
shopping centers (12.27%), hotels/restaurants (9.33%), regional malls
(9.17%), diversified (8.56%), warehouses/industrial (7.53%), healthcare
(5.35%), self-storage (4.99%), manufactured homes (1.65%) and outlet
centers (0.83%). In addition, the Index components are diversified by
geographic region, representing real estate investments throughout much
of the United States.
B. Index Value Calculation
The methodology used to calculate the value of the Index is similar
to the methodology used to calculate the value of other well-known
broad-based indices. The level of the Index reflects the total market
value of the component REITs relative to a particular base period. The
Index base date is January 2, 1990, when the Index value was set to
100. The Index had a closing value of 131.44 on October 19, 1998. The
daily calculation of the Index is computed by dividing the total market
value of the companies in the Index by the Index divisor. The divisor
keeps the Index comparable over time and is adjusted periodically to
maintain the Index. The values of the Index will be calculated by Dow
Jones & Company, Inc. or its designee and disseminated at 15-second
intervals during regular CBOE trading hours to market information
vendors via the Options Price Reporting Authority (``OPRA'').
C. Index Maintenance
Dow Jones or its designee is responsible for the maintenance of the
Index. Index maintenance includes monitoring and completing the
adjustments for company additions and deletions, share changes, stock
splits, stock dividends (other than an ordinary cash dividend), and
stock price adjustments due to company restructuring or spin-offs. Some
corporate actions, such as stock splits and stock dividends, require
simple changes in the common shares outstanding and the stock prices of
the companies in the Index. Other corporate actions, such as share
issuances or component changes, may change the market value of the
Index and require an index divisor adjustment as well.
The Index is reviewed on a quarterly basis by adding or deleting
REITs using end-of-quarter market capitalization values. If any
component REIT fails to meet the targeted threshold or the investable
universe cutoff rules, it will be deleted from the Index. Non-component
REITs that become eligible for inclusion are added, largest to
smallest, until the 95% threshold is attained. In order to preserve the
continuity of the Index, the actual threshold may be slightly higher or
lower than the targeted 95%. An annual review is performed to update
any changes in an issue's investment structure and/or property type. As
a result of these periodic reviews, over time the number of component
REITs in the Index may change.
The Exchange will notify the Commission if the number of securities
in the Index drops by 40 or more. In addition, the Exchange will notify
the Commission if any of the following occurs: 10% or more of the
weight of the
[[Page 6411]]
Index is represented by component REITs having a market value less than
$75 million; less than 80% of the weight of the Index is represented by
component REITs that are eligible for options trading; 10% or more of
the weight of the Index is represented by component REITs trading less
than 20,000 shares per day; the largest component REIT accounts for
more than 15% of the weight of the Index or the largest five components
in the aggregate account for more than 50% of the weight of the Index.
D. Index Option Trading
In addition to regular Index options, the Exchange may provide for
the listing of long-term index option series (``LEAPs'') and reduced-
value LEAPS on the Index. For reduced-value LEAPs, the underlying value
would be computed at one-tenth of the Index level. The current and
closing index value of any such reduced-value LEAP will, after such
initial computation, be rounded to the nearest one-hundredth.
Strike prices will be set to bracket the Index in 2\1/2\ point
increments for strikes below 200 and 5 point increments above 200. The
minimum tick size for series trading below $3 will be \1/16\th and for
series trading above $3 the minimum tick will be \1/8\th. The trading
hours for options on the Index will be from 8:30 a.m. to 3:02 p.m.
(Chicago time).
E. Exercise and Settlement
The proposed options on the Index will expire on the Saturday
following the third Friday of the expiration month. Trading in the
expiring contract month will normally cease at 3:02 p.m. (Chicago time)
on the business day preceding the last day of trading in the component
securities of the Index (ordinarily the Thursday before expiration
Saturday, unless there is an intervening holiday). The exercise
settlement value of the Index at option expiration will be calculated
by Dow Jones or its' designee based on the opening prices of the
component securities on the business day prior to expiration. If a REIT
fails to open for trading, the last available price will be used in the
calculation of the Index, as is done for currently listed indices.\8\
When the last trading day is moved because of Exchange holidays (such
as when the CBOE is closed on the Friday before expiration), the last
trading day for expiring options will be Wednesday and the exercise
settlement value of Index options at expiration will be determined at
the opening of regular Thursday trading.
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\8\ The Commission notes that pursuant to Article XVII, Section
4 of the by-laws of the Options Clearing Corporation (``OCC''), OCC
is empowered to fix an exercise settlement amount in the event it
determines a current index value is unreported or otherwise
unavailable. Further, OCC has the authority to fix an exercise
settlement amount whenever the primary market for the securities
representing a substantial part of the value of an underlying index
is not open for trading at the time when the current index value
(i.e., the value used for exercise settlement purposes) ordinarily
would be determined. See Securities Exchange Act Release No. 37315
(June 17, 1996), 61 FR 42671 (Commission order approving SR-OCC-95-
19).
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F. Surveillance and Position Limits
The Exchange will use the same surveillance procedures currently
utilized for each of the Exchanges' other index options to monitor
trading on options and LEAPs on the Index. For surveillance purposes,
the Exchange will have complete access to information regarding trading
activity in the underlying securities.
The Exchange proposes to establish position limits for options on
the Index at 250,000 contracts on either side of the market. These
limits are roughly equivalent, in dollar terms, to the limits
applicable to options on other indices.
G. Exchange Rules Applicable
As modified by this proposal, the Rules in Chapter XXIV will be
applicable to the Index options. Broad-based margin rules will apply to
the Index. In addition, the Index will have a broad-based index hedge
exemption of 625,000 contracts. CBOE is proposing to amend Rule 24.14
in order to include specific reference to Dow Jones & Company, Inc. as
being entitled to the benefit of the disclaimer of liability in respect
of the Index.
H. Systems Capacity
CBOE believes it has the necessary systems capacity to support new
series that would result from the introduction of the Index options.
CBOE also has been assured that the OPRA has the capacity to support
the new series.
III. Discussion
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, with the requirements of Section 6(b)(5).\9\ Specifically,
the Commission finds that the trading of options on the REIT Index,
including LEAPs and reduced-value LEAPs, will serve to promote the
public interest as well as to help remove impediments to a free and
open securities market. The Commission also believes that the 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
that the Index options will provide investors with an important trading
and hedging mechanism.\10\ By broadening the hedging and investment
opportunities of investors, the Commission believes that the trading of
options on the REIT Index will serve to protect investors, promote the
public interest, and contribute to the maintenance of fair and orderly
markets.\11\
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\9\ 15 U.S.C. 78f(b)(5).
\10\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new securities product upon a finding that
the introduction of such product is in the public interest. Such a
finding would be difficult with respect to a product 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 Index options will provide
investors with a hedging vehicle that should reflect the overall
market of stocks representing a substantial segment of the U.S.
securities market.
\11\ In approving this proposed rule change, the Commission
notes that is has considered the proposed rule's impact on
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
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Nevertheless, the trading of options on the REIT Index raises
several issues related to the design and structure of the Index,
customer protection, surveillance, and market impact. The Commission
believes, however, for the reasons discussed below, that the CBOE has
adequately addressed these issues.\12\
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\12\ The Commission notes that it did not object to the
designation of the Chicago Mercantile Exchange as a contract market
to trade futures and futures options on the Standard and Poor's REIT
Composite Index. See letter, dated November 23, 1998, from Richard
R. Lindsey, Director, Division of Market Regulation, Commission, to
Steven Manaster, Director, Division of Economic Analysis, Commodity
Futures Trading Commission. This index consisted of 105 REIT stocks,
most of which also are the components of the Index, and had a
similar market capitalization.
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A. Index Design and Structure
The Commission believes that it is appropriate for the Exchange to
designate the Index as a broad-based index for purposes of index option
trading because the REIT segment of the U.S. equities market
constitutes a substantial segment of the overall public U.S. equities
market and the Index reflects the REIT market.\13\ First, the
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Index consists of 116 component REITs, and incorporates approximately
95% of the REIT industry measured by capitalization. These 116
securities are diverse, representing a broad cross-section of the REIT
segment of the U.S. market. Second, all of the component REITs are
reported securities, and all but one REIT in the Index are eligible for
options trading.\14\ Third, no stock or group of stocks dominates the
Index. Specifically, no single REIT accounted for more than 5.08% of
the total weighting of the Index, and the five highest weighted
securities accounted for 19.02%. Accordingly, the Commission believes
that it is appropriate for the Exchange to classify the Index as broad-
based and apply its rules governing broad-based index options.
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\13\ The REIT segment is recognized as a discernible, unique
segment of the overall market that operates, in part, as a vehicle
for equity market participants to hold indirect interests in real
estate. During this decade, the REIT segment of the U.S. equities
market has grown to 210 REITs with a market capitalization of
approximately $140 billion as of October 30, 1998. See National
Association of Real Estate Investment Trusts (http://
www.nareit.com). The REIT segment has also evolved into a diverse
segment, with numerous REITs holding a variety of investments
including healthcare, office, residential, retail, self-storage,
hotel/restaurants, shopping centers and diversified use properties.
\14\ The Exchange's option 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 million shares; (2) there
must be a minimum of 2,000 stockholders; (3) trading volume must
have been at least 2.4 million shares over the preceding twelve
months; and (4) the market price per share must have been at least
$7.50 for a majority of business days during the preceding three
calendar months. See Interpretations and Policies .01 to Exchange
Rule 5.3.
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B. Potential for Manipulation
The Commission also believes that the large number of components,
the capitalization and weighting methodology of the Index, and the
depth and liquidity of the securities comprising the Index
significantly minimize the potential for manipulation of the Index.
First, the Commission notes that the REIT Index is composed of 116
securities which represent a broad cross-section of the REIT segment of
the U.S. market. Second, the Commission notes that the Index is a
capitalization-weighted index whose value is more difficult to affect
than that of a price-weighted index. Third, CBOE has represented that
it will notify the Commission when: (1) the number of securities in the
Index drops by 40 or more; (2) 10% or more of the weight of the Index
is represented by component REITs having a market value less than $75
million; (3) less than 80% of the weight of the Index is represented by
component REITs that are eligible for options trading; (4) 10% or more
of the weight of the Index is represented by component REITs trading
less than 20,000 shares per day; or (5) the largest component REIT
accounts for more than 15% of the weight of the Index or the largest
five components in the aggregate account for more than 50% of the
weight of the Index.\15\ Fourth, the Exchange has proposed reasonable
position and exercise limits for the Index options that will serve to
minimize potential manipulation and other market impact concerns.
Accordingly, the Commission believes that these factors minimize the
potential for manipulation because it is unlikely that attempted
manipulations of the prices of the Index components would affect
significantly the Index's value. Moreover, the surveillance procedures
discussed below should detect as well as deter potential manipulation
and other trading abuses.
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\15\ If the composition of the Index was to substantially
change, the Commission may reevaluate its decision regarding the
appropriateness of the Index's current maintenance standards and may
consider whether additional approval under Section 19(b) of the Act
is necessary to continue to trade the Index options.
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C. 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 options on the Index
including LEAPS 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, including
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 options on the Index.
D. 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 the surveillance of the
derivatives and underlying securities markets. Such agreements ensure
the availability of information necessary to detect and to deter
potential manipulations and other trading abuses, thereby making the
stock index product less readily susceptible to manipulation.\16\ In
this regard, the markets upon which all of the Index component stocks
trade, the NYSE, Amex and NNM, are members of the ISG. In addition, the
Exchange will apply the same surveillance procedures as those used for
existing broad-based index option trading on the CBOE. Furthermore, Dow
Jones & Company also has a policy in place to prevent the potential
misuse of material, non-public information by members of the Wall
Street Journal managerial and editorial staff in connection with the
maintenance of the Index.\17\
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\16\ See e.g., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (October 5, 1992) (order approving
the listing of options on the CBOE Biotech Index).
\17\ See Amendment No. 1, supra note 4.
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E. Market Impact
The commission believes that the listing and trading of options,
including LEAPS and reduced-value LEAPs, on the Index will not
adversely affect the underlying securities markets.\18\ First, as
described above, the Index is broad-based and constituted of 116 REIT
stocks, with no one stock dominating the Index. Second, the position
limit of 250,000 contracts on either side of the market and exercise
limit of 250,000 contracts based on the value of the Index will serve
to minimize potential manipulation and market impact concerns. Third,
currently all components except one REIT comprising the Index are
options eligible and CBOE will notify the Commission if less than 80%
of the Index continues to be eligible for options trading. Fourth, the
risk to investors of contra-party one-performance will be minimized
because the Index options and LEAPS will be issued and guaranteed by
the OCC, similar to all other standardized options traded in the United
States. Lastly, the Commission believes that settling expiring Index
options based on the opening prices of component securities is
reasonable and consistent with the Act. As noted in other contexts,
valuing options for exercise settlement on expiration based on opening
prices rather than on closing prices may help reduce adverse effects on
markets for
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stocks underlying options on the Index.\19\
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\18\ In addition, the CBOE has represented that it and OPRA have
the necessary systems capacity to support those new series of index
options that would result from the introduction of Index options.
\19\ See e.g., Securities Exchange Act Release No. 30944 (July
21, 1992), 57 FR 33376 (July 28, 1992) (order approving position
limits for European-style Standard & Poor's 500 Stock Index options
settled based on the opening prices of component securities).
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F. Accelerated Approval of Amendment No. 1
The Commission finds good cause to approve Amendment No. 1 to the
proposed rule change prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register. The
Commission notes that Amendment No. 1 does not change, but rather
clarifies, the proposed rule change, and thus does not raise any new
regulatory issues. Specifically, among other things, Amendment No. 1
clarified that the Dow Jones' internal surveillance procedures apply to
the Index as well, included the full list of the Index components,
amended Rule 24.4.01(e) to include a hedge exemption of 625,000
contracts on the Index, and clarified that the maintenance standard of
80% is by weight. In addition, the Commission notes that no comments
were received on the original CBOE proposal, which was subject to the
full 21-day notice and comment period. Accordingly, the Commission
believes that it is consistent with Sections 6(b)(5) and 19(b)(2) of
the Act to approve Amendment No. 1 to the proposal on an accelerated
basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1 to the rule proposal. Persons
making written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 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 Room. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
submissions should refer to File No. SR-CBOE-98-49 and should be
submitted by March 2, 1999.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule change (SR-CBOE-98-49), including
Amendment No. 1, is approved.
\20\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
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\21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-3031 Filed 2-8-99; 8:45 am]
BILLING CODE 8010-01-M
