[Federal Register Volume 62, Number 46 (Monday, March 10, 1997)]
[Notices]
[Pages 10888-10892]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-5746]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38353; File No. SR-CBOE-96-59]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment Nos. 1 and 2 to Proposed Rule Change by the Chicago Board
Options Exchange, Inc., Relating to the Listing and Trading of Options
on the Morgan Stanley Multinational Company Index
February 28, 1997.
I. Introduction
On October 1, 1996, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``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 list and trade cash-settled,
European-style stock index options on the Morgan Stanley Multinational
Company Index (``Index''),\3\ a broad-based, capitalization-weighted
index comprised of 50 large domestic companies, as more fully described
below.
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\1\ 15 U.S.C. Sec. 78s(b)(1)(1988).
\2\ 17 CFR 240.19b-4.
\3\ The CBOE has clarified that the name of the Index will be
the Morgan Stanley Multinational Company Index. See letter from
Scott Lyden, Research & Product Development, CBOE, to Stephen M.
Youhn, Division of Market Regulation (``Division''), Commission,
dated February 5, 1997 (``Amendment No. 2'').
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The proposed rule change appeared in the Federal Register on
October 15, 1996.\4\ No comments were received on the proposed rule
change. The Exchange subsequently filed Amendment Nos. 1 and 2 to the
proposed rule change on December 23, 1996 and on February 5, 1997,
respectively.\5\ This order approves the CBOE's proposal, as amended,
and solicits comments on Amendment Nos. 1 and 2.
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\4\ See Securities Exchange Act Release No. 37790 (October 4,
1996), 61 FR 53774 (October 15, 1996).
\5\ See letter from William M. Speth, Senior Research Analyst,
Product Development, Research Department, CBOE, to Stephen M. Youhn,
Division, Commission, dated December 23, 1996 (``Amendment No. 1'').
In Amendment No. 1, the CBOE emended its rule filing regarding,
among other things, its maintenance procedures. See infra notes 8
and 9, and accompanying text.
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II. Description
The Exchange is proposing to list and trade cash-settled, European-
style stock index options on the Morgan Stanley Multinational Company
Index, a broad-based, capitalization-weighted index composed of 50
high-capitalization
[[Page 10889]]
domestic stocks.\6\ According to the Exchange, the 50 companies that
comprise the Index are multinational in nature as they each derive a
substantial portion of their earnings from foreign income and have cash
flows denominated in multiple currencies. Each of the component
securities are traded on the American Stock Exchange, Inc. (``Amex''),
the New York Stock Exchange, Inc. (``NYSE''), or through the facilities
of the National Association of Securities Dealers (``NASD'') Automated
Quotation system (``Nasdaq'') and are reported national market system
securities (``Nasdaq/NMS'').
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\6\ A list of Index components is available at the Commission
and at the CBOE.
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A. Index Design
The Morgan Stanley Multinational Company Index has been designed to
measure the performance of certain high capitalization stocks. The
Morgan Stanley Multinational Company Index is a capitalization-weighted
index with each stock affecting the Index in proportion to its market
capitalization. Each stock in the Index is eligible for options
trading.
On July 17, 1996, the 50 stocks ranged in capitalization from
$138.2 billion (General Electric Co.) to $4.7 billion (Becton Dickinson
Inc.). The median capitalization of the firms in the Index was $29.33
billion, while the average capitalization of the Index components was
$37.1 billion. The largest stock accounted for 7.33% of the total
weighting of the Index, while the smallest accounted for 0.25%. The
five highest weighted stocks accounted for 28.8% The average daily
trading volume for Index components during the six-month period ending
July 16, 1996 was 1.93 million shares.
B. 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 stocks relative to a particular base period. The
Morgan Stanley Multinational Company Index base date is December 31,
1991, when the Index value was set to 200. The Index had a closing
value of 405.60 on January 6, 1997. The daily calculation of the Morgan
Stanley Multinational Company 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 the CBOE and disseminated at 15-second intervals during
regular CBOE trading hours to market information vendors via the
Options Price Reporting Authority (``OPRA'').
C. Maintenance
Index maintenance includes monitoring and completing the
adjustments for company additions and deletions, share changes, stock
splits, stock dividends (other than ordinary cash dividends), and stock
price adjustments due to company restructurings or spinoffs. Routine
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 and will be handled by CBOE. Non-routine
corporate actions, such as share issuances, change the market value of
the Index and require an Index divisor adjustment as well. The CBOE
will refer all such non-routine matters and other material changes to
the Index to Morgan Stanley.\7\ Over time the number of component
securities in the Index may change. In the event of a stock
replacement, the divisor will be adjusted to provide continuity in
values of the Index. In addition, whenever a component change is made
to the Index, every effort will be made to substitute a component that
maintains the character of the Index.\8\ Lastly, the CBOE will notify
the Commission if: (i) less than 75% of the weight of the Index is
comprised of stocks that are eligible for options trading; or (ii) the
number of securities in the Index is decreased to less than 35.\9\
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\7\ Since Morgan Stanley may be consulted regarding the
maintenance of the Index, a ``chinese wall'' has been erected around
the personnel at Morgan Stanley who have access to information
concerning changes and adjustments to the Index. Details of Morgan
Stanley's chinese wall procedures, which are closely modeled on
existing procedures for other Morgan Stanley indexes underlying
standardized options, have been submitted to the Commission under
separate cover.
\8\ See Amendment No. 1. The Commission expects CBOE to maintain
the character of the Index as represented in its proposal, i.e., as
an index comprised of very highly capitalized U.S. stocks that are
multinational in nature, as defined above. Failure to maintain the
Index in this manner would raise issues as to whether additional
approval pursuant to Section 19(b) of the Act would be necessary in
order for CBOE to continue trading the product. See also note 9,
infra.
\9\ Id. The Commission notes that its and the CBOE's regulatory
responses for failure to meet the above maintenance criteria could
include, but are not limited to, the removal of the securities from
the Index, prohibiting opening transactions, or discontinuing the
listing of new series of Index options. In addition, if the
composition of the Index's underlying securities was to
substantially change, the Commission's decision regarding the
appropriateness of the Index's current maintenance standards would
be reevaluated, and whether additional approval under Section 19(b)
is necessary to continue to trade the product. See also note 8,
supra.
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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 (all such LEAPS series are hereinafter
referred to as ``LEAPS''). 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 3:15 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 3:15 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 the Exchange based on the opening prices of the component securities
on the business day prior to expiration. If a stock fails to open for
trading, the last available price on the stock will be used in the
calculation of the Index, as is done for other currently listed
indexes.\10\ 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
[[Page 10890]]
value of Index options at expiration will be determined at the opening
of regular Thursday trading.
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\10\ The Commission notes that pursuant to Article XVII, Section
4 of the Options Clearing Corporation's (``OCC'') by-laws, the OCC
is empowered to fix an exercise settlement amount in the event it
determines a current index value is unreported or otherwise
unavailable. Further, the 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 the 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 (OCC-95-19).
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F. Surveillance
The Exchange will use the same surveillance procedures currently
utilized for each of the Exchange's other index options to monitor
trading in Index options and Index LEAPS on the Morgan Stanley
Multinational Company Index. For surveillance purposes, the Exchange
will have complete access to information regarding trading activity in
the underlying securities.
G. Position Limits
The Exchange proposes to establish position limits for options on
the Morgan Stanley Multinational Company Index at 50,000 contracts on
either side of the market, and no more than 30,000 of such contracts
may be in the series in the nearest expiration month. These limits are
roughly equivalent, in dollar terms, to the limits applicable to
options on other indices.
H. Other Exchange Rules and Matters
As modified herein, the Exchange Rules in Chapter XXIV will be
applicable to Morgan Stanley Multinational Company Index options. In
addition, broad-based margin rules will apply to the Index.
The CBOE is also proposing to amend Exchange Rule 24.14 in order to
include specific reference to Morgan Stanley as entitled to the benefit
of the disclaimer of liability in respect of the Index.
The CBOE believes that it has the necessary systems capacity to
support new series that would result from the introduction of Morgan
Stanley Multinational Company Index options. The CBOE has also been
informed that OPRA has the capacity to support the new series.
III. Findings and Conclusions
The Commission finds that the proposed rule chang 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).\11\ Specifically,
the Commission finds that the trading of options on the Morgan Stanley
Multinational Company Index, includes LEAPS, will serve to promote the
public interest as well as to help remove impediments to a free and
open securities market. Further, 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.
By broadening the hedging and investment opportunities of investors,
the Commission believes that the trading of Index options will serve to
protect investors, promote the public interest, and contribute to the
maintenance of a fair market.\12\
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\11\ 15 U.S.C. Sec. 78f(b) (1988).
\12\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new securities product upon a finding that
the introduciton of such product is in the public interest. Such
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.
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Nevertheless, the trading of options on the 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 rules.
A. Index Design and Structure
The Commission believes that it is appropriate for the Exchange to
designate the Morgan Stanley Multinational Company Index as a broad-
based index for purposes of index option trading. Specifically, the
Commission believes that the Index is broad-based because, among other
reasons, it contains 50 actively-traded stocks representing 27 industry
groups, and thus reflects a substantial segment of the U.S. equities
market. Accordingly, the Commission believes that it is appropriate for
the Exchange to apply its rules governing broad-based index options to
trading in the Index options.
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 as
well as provide a sufficient basis for the Index's maintenance
standards.\13\ First, the Index represents and consists of the common
stock values of 50 actively-traded domestic companies. Second, as of
July 17, 1996, no one stock comprised more than 7.33% of the Index's
value, and the five highest weighted stocks accounted for only 28.8% of
the Index's value. Third, the stocks that comprise the index are
actively-traded, with an average daily trading volume for Index
components during the six-month period ending July 16, 1996 of 1.93
million shares. Fourth, as of July 17, 1996, the market capitalizations
of the stocks in the Index were substantial, ranging from high of
$138.2 billion (General Electric Co.) to a low of $4.7 billion (Becton
Dickinson Inc.). The median capitalization of th efirms in the Index
was $29.33 billion, while the average capitalization of the Index
components was $37.1 billion. Fifth, the Index is comprised of stocks
representing a diverse group of 27 industries, including
pharmaceuticals (15.57%), crude/petroleum (9.26%), and beverages
(9.00%). Sixth, all of the component securities currently are eligible
for options trading and the maintenance standards require that at least
75% of the index components remains options eligible.\14\ Finally, the
Commissoin believes that, as discussed below, existing mechanisms to
monitor trading actvity in those securities will help to deter as well
as to detect illegal trading activity involving Index options.
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\13\ The Commission notes, however, that if the composition of
the Index's underlying securities was to substantially change, its
decision regarding the appropriateness of the Index's current
maintenance standards would be reevaluated.
\14\ The Exchange's options listing standards, which are uniform
among the options exchange, 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 Interpretation .01 to Exchange Rule 5.3. See
also note 8, supra.
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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 options on the Morgan
Stanley Multinational Company Index (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
others 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 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
[[Page 10891]]
options on the Morgan Stanley Multinational Company Index.
C. Surveillance
The Commission 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.\15\ In this regard, the markets
upon which all of the Index component stocks trade are members of the
Intermarket Surveillance Group (``ISG'').\16\ Similarly, the options on
the individual component securities trade on markets which are ISG
members. In addition, the Exchange will apply the same surveillance
procedures as those used for existing broad-based index option trading
on the CBOE.
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\15\ See, e.g., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (October 5, 1992) (CBOE-91-51)
(order approving the listing of options on the CBOE Biotech Index).
\16\ The 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, dated July 14, 1983,
amended January 29, 1990. The members of the ISG are the following:
the American Stock Exchange, Inc,; the Boston Stock Exchange, Inc.;
the CBOE; the Chicago Stock Exchange, Inc.; the National Association
of Securities Dealers, Inc.; the New York Stock Exchange, Inc.; the
Securities Stock Exchange Inc.; and the Philadelphia Stock Exchange,
Inc. The major stock index futures exchanges (including the Chicago
Mercantile Exchange and the Chicago Board of Trade) joined the ISG
as affiliate members in 1990.
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The Commission notes that certain concerns are raised when a
broker-dealer, such as Morgan Stanley, is involved in the development
and maintenance of a stock index that underlies an exchange-traded
derivative product. For several reasons, however, the Commission
believes that the CBOE has adequately addressed this concern with
respect to options on the Morgan Stanley Multinational Company Index.
First, the value of the Index, including the final settlement
values, are to be calculated and disseminated independent of Morgan
Stanley by the CBOE. Accordingly, neither Morgan Stanley nor any of its
affiliates or other persons (except CBOE) will be in receipt of the
values prior to their public dissemination. Second, the Commission
believes that the procedures Morgan Stanley has established to detect
and to prevent material non-public information concerning the Index
from being improperly used by members of Morgan Stanley's Equity
Research Department, as well as other persons within Morgan Stanley,
adequately serve to minimize the susceptibility to manipulation of the
index as well as the securities underlying the Index. Finally, the
Exchange's existing surveillance produceures for stock index options
will apply to the options on the Index and should provide the CBOE with
adequate information to detect and to deter trading abuses that may
occur. In summary, the Commission believes that the procedures outlined
above will ensure that Morgan Stanley will not be able to take
advantage of any informational advantages concerning modifications to
the composition of the Index due to its role in the maintenance of the
Index.
D. Market Impact
The Commission believes that the listing and trading of options on
the Morgan Stanley Multinational Company Index, including LEAPS, will
not adversely impact the underlying securities, markets.\17\ First, as
descried above, the Index is broad-based and comprised of 50 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 50,000 contract position and
exercise limits, with no more than 30,000 contracts in the nearest
expiration month, 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 LEAPS
will be issued and guaranteed by the Options Clearing Corporation
(``OCC''), similar to all other standardized option traded in the
United States. Fifth, existing CBOE stock index options rules and
surveillance procedures will apply to options on the Morgan Stanley
Multinational Company Index.
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\17\ 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 and
LEAPS.
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Lastly, the Commission believes that settling expiring Morgan
Stanley Multinational Company Index options, including LEAPS, 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 stocks underlying
options on the Index.\18\
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\18\ See, e.g., Securities Exchange Act Release No. 30944 (July
21, 1992), 57 FR 33376 (July 28, 1992) (CBOE-92-09) (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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The Commission finds good cause to approve Amendment Nos. 1 and 2
to the proposed rule filing prior to the thirtieth day after the date
of publication of notice of filing thereof in the Federal Register.
Amendment No. 1 to the CBOE's proposal describes details of certain
Index maintenance procedures. In this regard, the Commission believes
that the Exchange's review of the Index's component securities will
help to ensure that the Index maintains its intended market character
as well as remains an appropriate trading vehicle for public customers.
In addition, Amendment No. 2, which changes the name of the Index to
the Morgan Stanley Multinational Company Index, raises no substantive
issues and will help to avoid investor confusion regarding the
components of the Index. The Commission also notes that no comments
were recevied 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 Section 6(b)(5) of the Act to
approve Amendment Nos. 1 and 2 to the proposed rule change on an
accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1 and 2 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 Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing also will be available for inspection and copying
at the principal office of the CBOE. All submissions should refer to
File No. SR-CBOE-96-59 and should be submitted by March 31, 1997.
[[Page 10892]]
IV. Conclusion
For the foregoing reasons, the Commission finds that the CBOE's
proposal to list and trade options on the Morgan Stanley Multinational
Company Index is consistent with the requirements of the Act and the
rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-CBOE-96-59), as amended, is
approved.
\19\ 15 U.S.C. Sec. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-5746 Filed 3-7-97; 8:45 am]
BILLING CODE 8010-01-M
