[Federal Register Volume 59, Number 93 (Monday, May 16, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-11798]
[[Page Unknown]]
[Federal Register: May 16, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34025; File No. SR-CBOE-93-60]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Chicago Board Options Exchange, Inc., Relating to
Permanent Approval of the Pilot Program Involving Debit Put Spreads in
Broad-Based Indexes With European-Style Exercise
May 9, 1994.
On December 27, 1993, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``Commission'' or ``SEC''), pursuant to section 19(b)(10 of
the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ proposed rule change seeking permanent approval of
Exchange Rule 24.11A, ``Debit Put Spread Cash Account Transactions,''
which establishes a pilot program allowing approved public customers
with qualified portfolios (``spread exemption customers'') to effect
and maintain in cash accounts debit put spread transactions in broad-
based index options with European-style exercise.\3\
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\Initially, the Commission approved the pilot program on a
one-year basis through November 25, 1992. See Securities Exchange
Act Release No. 29992 (November 26, 1991), 56 FR 63526 (order
approving File Nos. SR-Amex-91-14 and SR-CBOE-91-17) (``Debit Put
Spread Approval Order''). Subsequently, both the CBOE and the
American Stock Exchange, Inc. (``Amex'') amended the definition of
``debit put spread'' to provide that the strike price of the long
leg of the spread must exceed, not equal, the strike price of the
short leg. See Securities Exchange Act Release Nos. 30267 (January
21, 1992), 57 FR 3234 (order approving File No. SR-CBOE-91-50) and
30419 (February 26, 1992), 57 FR 7825 (order approving File No. SR-
Amex-92-07). On June 30, 1993, the Commission approved an extension
of the pilot program through December 31, 1993. See Securities
Exchange Act Release No. 32556 (June 30, 1993), 58 FR 32556 (order
approving File No. SR-CBOE-93-13) (``Pilot Extension Order''). Most
recently, the Commission approved a proposal extending the pilot
program through December 31, 1994. See Securities Exchange Act
Release No. 33407 (December 30, 1993), 59 FR 1041 (notice of filing
and order granting partial accelerated approval of File No. SR-CBOE-
93-60) (``1994 Extension Order'').
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The proposed rule change was published in Securities Exchange Act
Release No. 33407 (December 30, 1993), 59 FR 1041. No comments were
received on the proposed rule change.
Currently, Sec. 220.8 of Regulation T under the Act precludes
customers from effecting spread transactions in cash accounts.
Specifically, Sec. 220.8(a)(3)(ii) of Regulation T includes in
permissible cash account transactions a creditor's issue, endorsement
or guarantee of a put option for a customer if the creditor obtains
cash in an amount equal to the exercise price of the option or holds in
the account any of the following instruments with a current market
value at least equal to the exercise price of the option and with one
year or less to maturity: U.S. government securities, negotiable bank
certificates of deposit, or bankers acceptance issued by a U.S. bank
and payable in the United States. Because offsetting option positions
fail to satisfy these criteria, spreads are not included in permissible
cash account transactions and therefore must be effected in margin
accounts.
On November 26, 1991, the Commission approved proposals submitted
by the CBOE and the Amex which established one year pilot programs
allowing approved public customers\4\ with qualified portfolios of
stock to effect and maintain in cash accounts debit put spread
transactions in broad-based index options with European-style
exercise.\5\ The Commission approved proposals extending the CBOE's
pilot program through December 31, 1993, and, most recently, through
December 31, 1994.\6\
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\4\For purposes of its pilot program, a public customer is a
customer whose orders are eligible to be placed on a CBOE limit
order book under Exchange Rule 7.4(a).
\5\See Debit Put Spread Approval Order, supra note 3.
\6\See Pilot Extension Order and 1994 Extension Order, supra
note 3.
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The pilot program defines a ``debit put spread'' as ``a long put
position coupled with a short put position overlying the same broad-
based index and having an equivalent underlying aggregate index value,
where the short put(s) expires with the long put(s), and the strike
price of the long put(s) exceeds the strike price of the short
put(s).'' Under the terms of the pilot, only public customers approved
by the CBOE are permitted to participate in the pilot program. To
obtain the CBOE's approval, customers are required, among other things,
to hold a qualified stock portfolio or its equivalent that is composed
of net long positions in common stocks in at least four industry groups
and that contains at least twenty stocks, none of which accounts for
more than fifteen percent of the value of the portfolio. A portfolio
must meet these standards at all times, regardless of trading activity
in the stocks. In addition, the debit put spread positions must be
carried in an account with an Exchange member organization and the
qualified portfolio must be maintained with either an Exchange member
organization, another broker-dealer, a bank, or a securities
depository.
In conjunction with the creation of the pilot program, the
Commission staff also issued no-action letters to the Amex and the CBOE
stating the staff would not recommend enforcement action against the
Amex and the CBOE due to the operation of the pilot program, namely the
maintenance of spread positions in a cash account.\7\ The staff of the
Board of Governors of the Federal Reserve System (``Board'') also
informed the Commission staff that Board staff would not object to the
Commission staff's issuance of these no-action positions in connection
with the pilot programs.\8\ Most recently, Board staff indicated that
it would not raise objections to permanent approval of the pilot
program.\9\
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\7\See Letter from Howard L. Kramer, Assistant Director,
Division, Commission, to Mary L. Bender, First Vice President,
Division of Regulatory Services, CBOE, dated November 25, 1991, and
Letter from Howard L. Kramer, Assistant Director, Division,
Commission, to James M. McNeil, Assistant Vice President, Chief
Examiner, Amex, dated November 25, 1991.
\8\See Letter from Laura Homer, Securities Credit Officer,
Board, to Howard L. Kramer, Assistant Director, Division,
Commission, dated July 12, 1991.
\9\See Letter from Scott Holz, Senior Attorney, Board, to Sharon
M. Lawson, Assistant Director, Division, Commission, dated January
28, 1994 (``Board Letter'').
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As required by the Debit Put Spread Approval Order, the CBOE
submitted a report assessing the effectiveness of the pilot
program.\10\ In addition, as required under the Pilot Extension Order,
the CBOE has submitted a report dated as of November 10, 1993,
assessing the effectiveness of the pilot program from January 1993
through September 1993.\11\ In its 1993 Pilot Report, the CBOE states
that no participant has operated in violation of the pilot since its
inception. As it concluded in its initial Pilot Report, the CBOE states
that the pilot program has provided an efficient means for investors
who are limited to cash account transactions to effectively hedge their
portfolios against market declines. The CBOE states that it has neither
experienced or detected any problems related to the pilot program and,
in addition, that no activity of any participant appeared to violate
the requirements of the pilot program or other Exchange Rules. The
Exchange has found no evidence of market manipulation or other negative
impact on market operations arising from the pilot program.
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\10\See Letter from Mary L. Bender, First Vice President,
Division of Regulatory Services, CBOE, to Sharon Lawson, Assistant
Director, Division, Commission, dated October 1, 1992 (``Pilot
Report''). In the Pilot Report, the CBOE stated that the pilot
program has been an efficient means for investors that are limited
to cash account transactions to effectively hedge their portfolios
against declines in the market. The CBOE represented that it had
neither experienced nor detected any problems related to the pilot.
Moreover, the Exchange stated that no activity of any pilot
participant appeared violative of the program's requirements or
other Exchange rules, nor did Exchange studies find evidence of
market manipulation or other negative impact on market operations.
\11\See Letter from Mary L. Bender, CBOE, to Sharon Lawson,
Assistant Director, Division, Commission, dated November 10, 1993
(``1993 Pilot Report'').
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The Commission finds that the proposal to grant permanent approval
to the debit pub spread pilot program 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.\12\ Specifically, the Commission believes,
as it has concluded previously,\13\ that the pilot program is designed
to benefit qualified public customers who are prohibited or restricted
in their use of margin accounts by facilitating their purchase of index
option debit put spreads. Because the purchaser of a debit put spread
uses the call premium to reduce the cost of purchasing the put, index
option pub spreads provide investors with an affordable means to hedge
their portfolios against adverse market moves. In addition, to the
extent that the pilot program has increased index options transactions,
the program has benefitted all options investors by contributing to the
depth and liquidity of the CBOE's options markets.
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\12\15 U.S.C. 78f(b)(5) (1988).
\13\See Debit Pub Spread Approval Order, supra note 3.
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The Commission continues to believe that the economic
characteristics of index option debit put spreads permit an exception
to the application of Regulation T. In a debit put spread, the long put
entitles the spread exemption customer to receive payment when the
index reaches the pub option's strike price; because the strike price
of the long put must exceed the strike price of the short put, the
spread exemption customer's right to receive payment under the long put
will offset any obligations he incurs from the sale of the short put.
Because the short position must expire with the long position, the
offset provided by the long put will last for the duration of the
spread exemption customer's obligation as a short put writer. In
addition, there is no risk that the short put will be exercised prior
to the long put because the exemption applies solely to European-style
options, which may be exercised only during a specified period prior to
expiration.
In its 1993 Pilot Report, the CBOE states that no participant has
operated in violation of the pilot since its inception, nor have the
CBOE's surveillance procedures revealed evidence of manipulation or
abuse of knowledge of impending expiration-related program trades for
each expiration Friday during the review period. The 1993 Pilot Report
indicates that the pilot program's 39 participants included
corporations, pension/retirement plans, non-profit organizations,
mutual funds, and individual or family trusts, the majority of which
were prohibited by contractual agreements from using margin accounts.
The debit put spreads of all of the participants were comprised of
Standard & Poor's (``S&P'') 500 Index (``SPX'') options with one to
four months remaining until expiration. During the review period the
total number of spreads effected on a monthly basis under the pilot
program each month ranged from 3,696 to 12,544.
On the basis of the 1993 Pilot Report, the Commission believes that
the debit put spread pilot program has facilitated that needs of
qualified public customers who are limited to cash account transactions
by providing them with an effective means to hedge their portfolios
against adverse market moves. At the same time, the 1993 Pilot Report
indicates that no pilot participant has violated the pilot's
parameters, nor has the Exchange discovered any market manipulation or
abuse in connection with the pilot program.\14\ In addition, the
Commission has received no comments regarding the operation of the
pilot program, and Board staff has raised no objection to permanent
approval of the pilot program.\15\ For these reasons, the Commission
believes that the debit put spread pilot program has provided qualified
public customers with additional means to implement their hedging
strategies and, by facilitating index options transactions, has
benefitted all options investors by contributing to the depth and
liquidity of the CBOE's options markets.
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\14\The Commission expects the CBOE to notify the Commission
promptly of any problems arising in connection with the program.
\15\See Board Letter, supra note 9.
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It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\16\ that the proposed rule change (SR-CBOE-93-60) granting
permanent approval to the CBOE's debit put spread program is approved.
\16\15 U.S.C. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\17\
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\17\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-11798 Filed 5-13-94; 8:45 am]
BILLING CODE 8010-01-M
