[Federal Register Volume 60, Number 61 (Thursday, March 30, 1995)]
[Notices]
[Pages 16518-16521]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-7841]
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SECURITIES AND EXCHANGE COMMISSION
[Release No 34-35532; File No. SR-CBOE-94-43]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving a Proposed Rule Change and Notice of Filing and
Order Granting Accelerated Approval of Amendment No. 2 to a Proposed
Rule Change Relating to the Listing of Regular and Long-Term Index
Options on the S&P SmallCap 600 Index
March 24, 1995.
I. Introduction
On November 8, 1994, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commision (``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 proposal to list and trade on the Exchange cash-
settled, European-style index options on the Standard & Poor's SmallCap
600 Index (``S&P SmallCap 600'' or ``Index''), a broad-based
capitalization weighted index designed to measure the performance of
small capitalization stocks. The CBOE filed Amendment No. 1 to its
proposal on January 9, 1995, and Amendment No. 2 to its proposal on
March 14, 1995.\3\ The proposed rule change was published for comment
and appeared in the Federal Register on February 1, 1995.\4\ No
comments were received regarding the CBOE's proposal.
\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1994).
\3\Amendment No. 1 Provides the following information regarding
the Index: (1) Industry groups represented; (2) price and volume
information regarding the component stocks; and (3) component stock
seleciton criteria. See letter from Eileen Smith, Director, Product
Development, Research Department, CBOE, to Steve Youhn, Attorney,
Division of Market Regulation (``Division''), Commission, dated
January 5, 1995 (``Amendment No. 1'').
Amendment No. 2 provides that the CBOE will monitor the Index
semi-annually, and will notify staff of the Commission in the event
that certain index component capitalization and volume levels fall
below designated thresholds. See letter from Joseph Levin, Vice-
President, Research & Product Development, CBOE, to Michael
Walinskas, Branch Chief, Division, Commission, dated March 14, 1995
(``Amendment No. 2'').
\4\See Securities Exchange Act Release No. 35280 (January 25,
1995), 60 FR 6325.
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II. Description of the Proposal
A. General
The CBOE proposes to list and trade cash-settled, European-style
stock index options on the S&P SmallCap, a capitalization-weighted
index of 600 domestic stocks chosen for market size, liquidity, and
industry group representation.
B. Composition of the Index
The S&P SmallCap 600 Index has been designed to measure the
performance of small capitalization stocks. The Index is a
capailization-weighted index of U.S. stocks with each stock affecting
the Index in proportion to its market capitalization.
As of October 19, 1994, the 600 component stocks ranged in
capitalization from $933 million to $46 million, and the market
capitalization of the Index totalled $181 billion. The largest stock
accounted for 0.51% of the total weighting of the Index, while the
smallest accounted for 0.03%. The median capitalization of the
components in the Index was $267 million. A breakdown of the component
stocks by trading markets shows that Nasdaq is the primary market for
53% of the weight of the Index (318 issues), the New York Stock
Exchange (``NYSE'') represents 43% (257 issues), and the American Stock
Exchange (``Amex'') represents 4% (25 issues). The Nasdaq stocks in the
Index are authorized as Nasdaq National Market Securites, the top tier
of Nasdaq stocks.
A total of 98 industry groups are represented in the Index. The top
five groups and their weights are: (1) Computer Software and Services--
9.01%; (2) Insurance--5.13%; (3) Savings and Loans--4.88%; (4) Health
Care Services--4.31%; and (5) Banks--Regional--4.26%. During the period
April through September 1994, the average monthly trading volume for
the Index component stocks ranged from 93,000 to 25.3 million shares.
The average monthly volume was 1.9 million shares. The top 100 stocks
account for 33.42% of the Index, while the bottom 100 stocks account
for 5.69% of the Index. The prices for each of the components ranged
from $1.385 to $64.50. The average price was $19.37. The shares
outstanding for each of the Index component stocks ranged from 4.0
million to 189.0 million with an average of 17.8 million.\5\
\5\See Amendment No. 1, supra note 3.
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S&P relies on several criteria to select Index component stocks.
Among other things, stocks must trade on the NYSE or Amex, or be Nasdaq
National Market securities; stocks must trade above $1.00 at the time
of selection; companies with 50% or more of their shares outstanding
held by another corporation are not included; companies with 60% or
more of their shares held by insiders are not included; stocks must
have at least a six month trading history; stocks that do not trade on
any three days during a 12-month period are not included; and share
turnover (annual trading volume as a percent of shares outstanding) has
to exceed 20% on an annualized basis. Index component stocks are then
chosen from the field of stocks that meets these criteria so that they
balance the economic sector weighings, described above.\6\
\6\Id. The CBOE has represented that should the character of the
Index change from the basic description contained herein, it shall
so notify the Commission staff, and such change could require a
filing pursuant to Section 19(b)(1) of the Exchange Act and Rule
19b-4 thereunder. Telephone conversation between Eileen Smith,
Director, Product Development, Research Department, CBOE, and
Francois Mazur, Attorney, Division, Commission, on March 1, 1995.
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C. Calculation of the Index
The methodology used to calculate the value of the Index is similar
to that used to calculate the value of the S&P 500 Index. The value of
the Index is determined by adding the price of each stock multiplied by
the number of shares outstanding. This sum is then divided by an index
divisor (``Index Divisor'') which gives the Index a value of 100 on its
base date of December 31, 1993. The Index Divisor is adjusted for
pertinent changes as described below in the section titled
``Maintenance.'' The Index had a closing value of 96.82 on September
30, 1994.
D. Maintenance
The S&P SmallCap 600 will be maintained by S&P, and the CBOE has
represented that it will not influence any S&P decisions concerning
maintenance of the Index.\7\ To maintain [[Page 16519]] continuity of
the Index, the Index Divisor will be adjust to reflect certain events
relating to the component stocks. These events include, but are not
limited to, adjustments for company additions and deletions, share
changes, stock splits, stock dividends, and stock price adjustments due
to company restructurings or spinoffs. 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, change the market
value of the Index and require an Index Divisor adjustment as well.
\7\See March 1, 1995 telephone conversation, supra note 6.
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Although the CBOE is not involved in the maintenance of the Index,
it has represented that it will monitor the Index on a semi-annual
basis and will notify staff of the Commission when: (1) 10% of the
capitalization of the Index comprises securities with a market
capitalization of less than $100 million; or (2) when 10% of the
capitalization of the Index is made up of components with an average
daily trading volume of less than 10,000 shares over the previous six
months.\8\
\8\See Amendment No. 2, supra note 3.
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E. Index Option Trading
In addition to regular Index options, the Exchange may provide for
the listing of long-term (up to three years expiration) index options
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.
The Exchange seeks to have the discretion to list series in 2\1/2\
point intervals when the Index level is below 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.
F. Settlement of Index Options
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 immediately preceding Thursday. The exercise settlement value of
the Index at option expiration will be calculations by S&P based on the
opening prices of the component securities on the business day prior to
expiration, which will normally be a Friday (``A.M. Settlement'').\9\
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
currently listed indexes.
\9\When the last trading day is moved because of Exchange
holidays (such as when 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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G. Surveillance
The Exchange will use the same surveillance procedures currently
used for each of the Exchange's other index options to monitor trading
in Index options and Index LEAPS on the S&P SmallCap 600. These
procedures include complete access to trading activity in the
underlying securities. In addition, the Intermarket Surveillance Group
Agreement (``ISG Agreement''), dated July 14, 1983, as amended January
29, 1990, will be applicable to the trading of options on the
Index.\10\
\10\The CBOE is a member of the 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 members of the ISG are: the Amex;
the Boston Stock Exchange, Inc.; the CBOE; the Chicago Stock
Exchange, Inc.; the National Association of Securities Dealers,
Inc.; the NYSE; the Pacific Stock Exchange, Inc.; and the
Philadelphia Stock Exchange, Inc. Because of the potential
opportunities for trading abuses involving stock index futures,
stock options, and the underlying stock, and the need for greater
sharing of surveillance information for these potential intermarket
trading abuses, the major stock index futures exchanges (e.g., the
Chicago Mercantile Exchange and the Chicago Board of Trade) joined
the ISG as affiliate members in 1990.
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H. Position Limits
The Exchange proposes to establish position limits for options on
the S&P SmallCap 600 at 100,000 contracts on either side of the market,
and no more than 60,000 of such contracts may be in the series in the
nearest expiration month. Exercise limits will be set at the same level
as position limits.\11\ The Exchange represents that these limits are
roughly equivalent, in dollar terms, to the limits applicable to
comparable small-capitalization indexes, including the Wilshire Small
Cap Index and the Russell 2000 Index.
\11\See CBOE Rule 24.5.
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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, the requirements of Section 6(b)(5) of the Act.\12\ The
Commission finds that the trading of options on the Index will permit
investors to participate in the price movements of the 600 securities
on which the Index is based. 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 S&P SmallCap 600 options will provide investors with an
important trading and hedging mechanism that should reflect accurately
the overall movement of stocks in the small-capitalization range of
U.S. equity securities. By broadening the hedging and investment
opportunities of investors, the Commission believes that the trading of
S&P SmallCap 600 options will serve to protect investors, promote the
public interest, and contribute to the maintenance of fair and orderly
markets.\13\
\12\15 U.S.C. 78f(b)(5) (1988).
\13\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 or warrants on the S&P SmallCap 600 Index
will provide investors with a hedging vehicle that should reflect
the overall movement of the small-capitalization stock universe. The
Commission also believes that these options and warrants will
provide investors with a means by which to make investment decisions
in the small-capitalization equity market, allowing them to
establish positions or increase existing positions in small-
capitalized stocks in a cost effective manner.
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The trading of S&P SmallCap 600 options, however, raises several
issues, including issues related to index design, customer protection,
surveillance, and market impact. For the reasons discussed below, the
Commission believes that the CBOE has adequately addressed these
issues.
A. Index Design and Structure
The Commission finds that it is appropriate and consistent with the
Act to classify the Index as broad-based, and therefore to permit
Exchange rules applicable to the trading of broad-based index options
to apply to the Index options. Specifically, the Commission believes
the Index is broad-based [[Page 16520]] because it reflects a
substantial segment of the U.S. equities market, in general, and small-
capitalization securities in particular. First, the Index consists of
600 relatively actively traded,\14\ small-capitalization domestic
securities. Second, the total capitalization of the Index, as of
October 19, 1994, was $181 billion, with the market capitalizations of
the individual stocks in the Index ranging from a high of $933 million
to a low of $46 million, with a median value of $267 million. Third,
the Index includes stocks of companies from a broad range of
industries, and no industry segment comprises more than 9.01% of the
Index's total value.\15\ Fourth, as of October 19, 1994, no single
stock comprises more than 0.51% of the Index's total value, and the
percentage weighting of the 100 largest issues in the Index accounted
for only 33.42% of the Index. Fifth, the Index selection and
maintenance criteria will serve to ensure that the Index maintains its
broad representative sample of stocks in the small-capitalization range
of U.S. equity securities. Accordingly, the Commission believes it is
appropriate to classify the Index as broad-based.
\14\A significant majority of the stocks are relatively actively
traded, as indicated by an Index component median average daily
trading volume of 53,179 shares. Telephone conversation between
Eileen Smith, Director, Product Development, Research Department,
CBOE, and Francois Mazur, Attorney, Division, Commission, on
February 23, 1995.
The Commission notes that an index purportedly representing high
capitalization stocks might not be deemed to have actively traded
stocks if the components stocks' median average daily volume was
only 53,179 shares. With regard to a small capitalization index,
where almost by their nature the most active stocks will likely not
be included, a median average daily trading volume less than that
for existing broad based indexes could be acceptable, depending upon
the index's other features. For the S&P SmallCap 600, the median
average daily trading volume is acceptable given the large number of
component stocks and the inclusion of criteria designed to exclude
inactively traded stocks from being selected.
\15\See Section II.B, supra.
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The Commission believes that the general broad diversification,
capitalizations, and relatively liquid markets of the Index's component
stocks significantly minimize the potential for manipulation of the
Index. First, as discussed above, the Index represents a broad cross-
section of domestic small capitalization stocks, with no single
industry group or stock dominating the Index. Second, the majority of
the stocks that comprise the Index are relatively actively traded.\16\
Third, the Commission believes that the Index selection and maintenance
criteria will serve to ensure that the Index will not be dominated by
low-priced stocks with small capitalizations, floats, and trading
volumes.\17\ Fourth, the CBOE has represented that it will monitor the
Index semi-annually and will notify the staff of the Commission when:
(1) ten percent of the capitalization of the Index is comprised of
securities with a market capitalization of less than $100 million; or
(2) ten percent of the capitalization of the Index is made up of
components with an average daily trading volume of less than 10,000
shares over the previous six months.\18\ Fifth, 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. Although a position and exercise limit of 100,000
contracts is high by traditional standards, in dollar value it
represents $968,200,000 (based on the September 30, 1994 Index closing
value of 96.82), an amount equivalent to that allowed for other small-
capitalization index options currently trading.\19\ Accordingly, the
Commission believes it is unlikely that attempted manipulations of the
prices of the Index components would affect significantly the Index's
value.
\16\See supra note 14.
\17\Currently, 65% of the Index is accounted for by stocks
meetings the CBOE's options listing standards. Telephone
conversation between Eileen Smith, Director, Product Development,
Research Department, CBOE, and Francois Mazur, Attorney, Division,
Commission, on February 28, 1995. These 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.
As a general matter, for broad-based index options, the
Commission prefers that at least 50% of an index's components
continue to be options-eligible. Given the broad diversity of the
SmallCap 600 Index and the selection and maintenance criteria,
together with the fact that 65% of the Index's components are
options eligible, the Commission believes that the Index will not be
readily susceptible to manipulation. See supra Section II.B.
\18\See Amendment No. 2, Supra note 3.
\19\The Commission would not be inclined to approve such a high
position limit if the position limit dollar equivalent amount were
substantially higher than as currently proposed.
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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 Index options, 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 risk 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 traded on the CBOE, the Commission believes
that adequate safeguards are in place to ensure the protection of
investors in Index options.
C. Surveillance
The Commission generally believes that a surveillance sharing
agreement between an exchange proposing to list a stock index
derivative 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.\20\ In this regard,
the NYSE, Amex, and the NASD are all members of ISG.\21\ In addition,
the CBOE will apply the same surveillance procedures as those used for
existing broad based index options trading on the CBOE.
\20\See Securities Exchange Act Release No. 31243 (October 5,
1992), 57 FR 45849.
\21\See supra note 10.
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D. Market Impact
The Commission believes that the listing and trading of S&P
SmallCap 600 Index Options on the CBOE will not adversely affect the
underlying securities markets.\22\ First, as described above, the Index
is broad-based and comprised of 600 stocks with no one stock or
industry group dominating the Index. Second, as noted above, the stocks
contained in the Index have relatively large capitalizations and are
relatively actively traded. Third, existing CBOE stock index options
rules and surveillance procedures will apply to S&P SmallCap 600
options. Fourth, [[Page 16521]] the position limits of 100,000
contracts on either side of the market, with no more than 60,000 of
such contracts in a series in the nearest month expiration month, will
serve to minimize potential manipulation and market impact concerns.
Fifth, 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 Corportation just like any other standardized
option traded in the United States.
\22\The CBOE has stated that it has the necessary systems
capacity to support new series that would result from the
introduction of the S&P SmallCap 600 options. In addition, the
Options Price Reporting Authority (``OPRA'') has represented that
additional traffic generated by options and LEAPs on the S&P
SmallCap 600 Index is within OPRA's capacity. See letter from Joseph
P. Corrigan, Executive Director, OPRA, to Eileen Smith, Director,
Product Development, Research Department, CBOE, dated October 26,
1994.
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Lastly, the Commission believes that settling expiring S&P SmallCap
600 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.\23\
\23\Securities Exchange Act Release No. 30944 (July 28, 1992),
57 FR 33376.
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The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice of filing
thereof in the Federal Register. Specifically, Amendment No. 2 provides
that the CBOE will monitor, semi-annually, the Index and will notify
staff of the Commission in the event that certain index component
capitalization and volume levels fall below designated thresholds. The
Commission believes that this monitoring provision is not a material
change that raises regulatory concerns not already addressed by the
proposal. Accordingly, the Commission believes it is consistent with
Sections 6(b)(5) and 19(b)(2) of the Act to approve Amendment No. 2 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. 2. 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 the
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. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of such filing will also be
available for inspection and copying at the principal office of the
CBOE. All submissions should refer to File No. SR-CBOE-94-43 and should
be submitted by April 20, 1995.
V. Conclusion
For the reasons discussed above, the Commission finds that the
proposal is consistent with the Act, and, in particular, Section 6 of
the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\24\ that the proposed rule change (File No SR-CBOE-94-43), as
amended, is approved.
\24\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.\25\
\25\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-7841 Filed 3-29-95; 8:45 am]
BILLING CODE 8010-01-M
