[Federal Register Volume 61, Number 97 (Friday, May 17, 1996)]
[Notices]
[Pages 24979-24982]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12382]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37196; File No. SR-CBOE-96-18]
Self-Regulatory Organizations; Notice of Filing and Order
Granting Accelerated Approval of Proposed Rule Change and Amendment No.
1 to the Proposed Rule Change by the Chicago Board Options Exchange,
Inc., Relating to a Hedge Exemption for Industry (Narrow-Based) Index
Options
May 10, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on March 18, 1996, the
Chicago Board Options Exchange, Inc. (``CBOE'' or ``Exchange'') filed
with the Securities and Exchange Commission (``SEC'' or ``Commission'')
the proposed rule change as described in Items I and II below, which
Items have been prepared by the self-regulatory organization.\2\ The
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Commission is approving this proposal on an accelerated basis.
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\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ On April 15, 1996, the Exchange amended its proposal to
indicate that, in connection with the narrow-based index hedge
exemption, the CBOE's Department of Market Regulation will monitor
daily to determine that each exempted option contract is hedged by
the equivalent dollar amount of component securities and for unusual
option and stock activity. In addition, the CBOE notes that the
hedge exemption account must promptly notify the Exchange of
material changes in the portfolio. See Letter from Margaret G.
Abrams, Senior Attorney, CBOE, to Yvonne Fraticelli, Attorney,
Commission, dated April 10, 1996 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The CBOE proposes to amend CBOE Rule 24.4A, ``Position Limits for
Industry Index Options,'' to establish a hedge exemption from industry
(narrow-based) index option position and exercise limits.\3\ The
Commission previously has approved similar proposals by the
Philadelphia Stock Exchange, Inc. (``PHLX'') and the Pacific Stock
Exchange, Inc. (``PSE'').\4\
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\3\ Position limits impose a ceiling on the number of option
contracts which an investor or group of investors acting in concert
may hold or write in each class of options on the same side of the
market (i.e., aggregating long calls and short puts or long puts and
short calls). Exercise limits prohibit an investor or group of
investors acting in concert from exercising more than a specified
number of puts or calls in a particular class within five
consecutive business days.
\4\ See Securities Exchange Act Release Nos. 36858 (February 16,
1996), 61 FR 7295 (February 27, 1996) (order approving File No. SR-
PHLX-95-45) (``PHLX Approval Order''); and 36981 (March 15, 1996),
61 FR 11929 (March 22, 1996) (order approving File No. SR-PSE-95-28)
(``PSE Approval Order'').
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The text of the proposed rule change is available at the office of
the Secretary, CBOE, and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in sections (A), (B), and (C) below,
of the most significant aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed rule Change
The CBOE proposes to adopt new Interpretation and Policies .01 and
.02 to CBOE Rule 24.4A to establish an industry hedge exemption based
on the industry index hedge exemptions filed by the PHLX and the PSE,
which were approved recently by the Commission.\5\ Interpretation and
Policy .02 establishes certain compliance requirements for industry
index hedge exemption accounts.
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\5\ See PHLX Approval Order and PSE Approval Order, supra note
4.
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Currently, the Exchange has an equity option hedge exemption and a
broad-based option index hedge exemption, but no hedge exemption for
positions in CBOE industry index options. The CBOE states that its
proposal will adopt the same formula used by the PHLX and the PSE for
their industry index hedge exemptions, with minor modifications. The
proposed narrow-based hedge exemption will be available to both broker-
dealers and customers.
In order to qualify for the proposed hedge exemption, a position
must be ``hedged'' by share positions in at least 75% of the number of
component stocks of the index, or securities convertible into such
stock. The proposed exemption is in addition to the standard limit and
other exemptions and may not exceed twice the standard limit
established under CBOE Rule 24.4A. The underlying value of the option
position may not exceed the value of the underlying portfolio. The
value of the underlying portfolio is determined as follows: (1) The
total market value of the net stock position; and (2) for positions in
excess of the standard limit, subtract the underlying market value \6\
of (a) any offsetting calls and puts in the respective index option
class; (b) any offsetting positions in stock index futures; and (c) any
economically equivalent position (assuming no other hedges for these
contracts exist).
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\6\ The CBOE uses the term ``underlying market value,'' instead
of the equivalent term ``notional value,'' which the PHLX uses in
its proposal, for consistency with a pending CBOE proposal to amend
the CBOE's broad-based index hedge exemption. See Securities
Exchange Act Release No. 36738 (January 19, 1996), 61 FR 2324
(January 25, 1996) (notice of filing of File No. SR-CBOE-96-01)
(``Broad-Based Index Option Proposal'').
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Further, the proposal requires that both the options and stock
positions be initiated and liquidated in an orderly manner.
Specifically, a reduction of the options position must occur at or
before the corresponding reduction in the stock portfolio position.
The CBOE notes that its proposal makes minor modifications to the
PHLX's narrow-based index hedge exemption requirements to conform the
CBOE's language to a pending CBOE proposal to amend broad-based index
options position limits and exemptions.\7\ According to the CBOE, the
Exchange's modifications do not affect the hedge exemption definition
or the calculation of the value of the portfolio, but will impose
uniform CBOE Department of market Regulation monitoring requirements
for both the proposed narrow-based and broad-based index hedge
exemptions.
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\7\ See Broad-Based Index Option Proposal, supra note 6.
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Under the proposal, exercise limits will continue to correstpond to
position limits, so that investors may exercise the number of contracts
set forth as the position limit, as well as those contracts exempted by
this proposal, during five consecutive business days.
As of March 1, 1996, the CBOE trades the following industry index
options, with limits as shown:
(1) S&P Banking Index--12,000 contracts;
(2) S&P Chemical Index--9,000 contracts;
(3) S&P Health Care Index--9,000 contracts;
(4) S&P Insurance Index--9,000 contracts;
(5) S&P Retail Index--9,000 contracts;
(6) S&P Transportation Index--9,000 contracts;
(7) CBOE Software Index--9,000 contracts;
(8) CBOE Environmental Index--9,000 contracts;
(9) CBOE Gaming Index--9,000 contracts;
(10) CBOE Global Telecommunications Index--12,000 contracts;
(11) CBOE Israel Index--9,000 contracts;
(12) CBOE Mexico Index--12,000 contracts;
(13) CBOE REIT Index--12,000 contracts;
(14) CBOE Telecommunications Index--12,000 contracts;
(15) CBOE Biotech Index--9,000 contracts;
(16) CBOE Latin 15 Index--12,000 contracts; and
(17) CBOE High Technology Index--12,000 contracts.
The CBOE will require that documentation regarding the qualified
stock portfolio be filed with the CBOE's Department of Market
Regulation on behalf of a hedge exemption account seeking an exemption.
Proposed Interpretation and Policy .02 contains compliance requirements
for industry hedge exemption accounts which are identical to the
compliance requirements proposed in a pending CBOE proposal for broad-
based index hedge exemption accounts.\8\ The Exchange states that its
Department of Market Regulation will continue to monitor trading
activity in industry index options to detect potential abuses, and
review to ensure that closing positions subject to an exemption is
[[Page 24981]]
conducted in a fair and orderly manner. In addition, the CBOE's
Department of Market Regulation will monitor daily to determine that
each exempted option contract is hedged by the equivalent dollar amount
of component securities and for unusual option and stock activity.\9\
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\1\ See Broad-Based Index Option Proposal, supra note 6.
\2\ See Amendment No. 1, supra note 2.
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The CBOE notes that the proposed industry index hedge exemption
contains build-in safeguards. Specifically, the ``basket'' of stocks
constituting the hedge must be comprised of at least 75% of the stocks
underlying the index. The hedge exemption account must promptly notify
the Exchange of any material changes in the value of the portfolio.\10\
Further, both the options and stock positions must be initiated and
liquidated in an orderly manner, so that a reduction of the options
position must occur at or before the corresponding reduction in the
stock portfolio position. Finally, the aggregate underlying value of
the industry index option position cannot exceed the market value of
the underlying hedging portfolio, to ensure that stock transactions are
not used to manipulate the market in a manner benefiting the option
position.
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\10\ Id.
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The Exchange believes that the proposal is consistent with Section
6 of this Act, in general, and, in particular, with Section 6(b)(5), in
the narrow-based hedge exemption should increase the depth and
liquidity of narrow-based index options markets and allow more
effective hedging by investors without increasing the potential for
market disruption, thereby removing impediments to and perfecting the
mechanism of a free and open market and a national market system in a
manner consistent with the protection of investors and the public
interest.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The CBOE does not believe that the proposed rule change will impose
any burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Commission's Findings and Order Granting Accelerated Approval of
Proposed Rule Change
The CBOE has requested that the proposed rule change be given
accelerated effectiveness pursuant to Section 19(b)(2) of the Act. The
CBOE believes that approval on an accelerated basis would promote fair
competition among exchanges and eliminate the risk, in a multiple-
exchange trading environment, of investor confusion respecting hedge
exemptions for industry index options. As noted above, the Commission
has previously approved similar proposals submitted by the PHLX and the
PSE.\11\ The CBOE believes that the proposal presents no significant
new issues.
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\11\ See PHLX Approval Order and PSE Approval Order, supra note
4.
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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).\12\ The Commission
concludes, as it has found previously,\13\ that providing for increased
position and exercise limits for narrow-based index options in
circumstances where those excess positions are fully hedged with
offsetting stock positions will provide greater depth and liquidity to
the market and will allow investors to hedge their stock portfolios
more effectively, without significantly increasing concerns regarding
inter-market manipulations or disruptions of either the options market
or the underlying stock market.
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\12\ 15 U.S.C. 78f(b) (1988 & Supp. V 1993).
\13\ See PHLX Approval Order and PSE Approval Order, supra note
4.
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Specifically, the CBOE proposal contains safeguards that should
make it difficult to use the exempted positions to disrupt or
manipulate the market. First, requests for the exemption must be
approved by the CBOE, which should ensure that the hedges are
appropriate for the position being taken and are in compliance with
CBOE rules. Second, the stock portfolio must consist of at least 75% of
the number of component securities underlying the index, and must
correspond in value to the value of the options position hedged, so
that the increased positions are less likely to be used in a leveraged
manner in any manipulative scheme. As noted above, the value of the
hedging portfolio is equal to (1) the total market value of the net
stock position; less (2) the value of (a) any offsetting calls and puts
in the respective index option class; (b) any offsetting positions in
stock index futures; and (c) any economically equivalent positions
(assuming no other hedges for these contracts exist).\14\ Third, both
the options and the stock positions must be initiated and liquidated in
an orderly manner. Moreover, a reduction of the options position must
occur at or before the corresponding reduction in the stock portfolio
position, thereby helping to ensure that the stock transactions are not
used to impact the market so as to benefit the options positions.
Fourth, the CBOE must be notified of any material change in the
portfolio.\15\ Fifth, the maximum hedge exemption position is two times
the existing limit. The ``two times the limit'' is not automatic and
the CBOE has the authority to approve a hedge limit for less than that
amount.
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\14\ If a hedge position ceases to exist, this would be viewed
as a material change which must be reported promptly to the CBOE. In
such a case, the value of the stock portfolio would be reduced
accordingly and therefore the hedged options position must also be
reduced. As noted above, a reduction of the options position must
occur at or before the corresponding reduction in the stock
portfolio position.
\15\ See Amendment No. 1, supra note 2.
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The Commission notes that the CBOE's survelliance procedures are
designed to detect as well as deter manipulation and market
disruptions. In particular, the CBOE's Department of Market Regulation
will monitor the options position of a person utilizing the hedge
exemption on a daily basis to determine that each option contract is
hedged by the equivalent dollar amount of component securities.\16\ In
addition, the CBOE's Department of Market Regulation will continue to
monitor trading activity in industry index options to detect potential
abuses, and will review such activity and ensure that closing positions
subject to an exemption is conducted in a fair and orderly manner.
Violation of any of the provisions of CBOE Rule 24.4A and the
interpretations and policies thereunder, absent reasonable
justification or excuse, will result in the withdrawal of the hedge
exemption and subsequent denial of an application for a hedge exemption
thereunder.
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\16\ See Amendment No. 1, supra note 2. Market participants
granted a hedge exemption must promptly notify the Exchange of
material changes in the portfolio.
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The Commission believes that it is reasonable for the CBOE to allow
broker-dealers, as well as public customers, to utilize the proposed
hedge exemption.\17\ The Commission believes that extending the narrow-
based index option hedge exemption to broker-
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dealers may help to increase the depth and liquidity of the market for
industry index options and may help to ensure that public customers
receive the full benefit of the exemption. Moreover, the CBOE's
monitoring procedures, as described above, should be able to detect any
abuses and ensure that the options position, whether broker-dealer or
customer, is properly hedged.
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\17\ The Commission notes that broker-dealers and public
customers may utilize the CBOE's equity hedge exemption. See CBOE
Rule 4.11, Interpretation and Policy .04, and Securities Exchange
Act Release No. 35738 (May 18, 1995), 60 FR 27573 (May 24, 1995)
(order approving File Nos. SR-Amex-95-13, SR-CBOE-95-13, SR-NYSE-95-
04, SR-PSE-95-05, and SR-PHLX-95-10) (permanently approving hedge
exemption pilot programs).
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The Commission finds good cause for approving the proposed rule
change and 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. As noted above, the Commission previously has
approved similar proposals submitted by the PHLX and the PSE.\18\ The
PHLX's and PSE's proposals were published for the full notice and
comment period and the Commission received no comments on their
proposals. The CBOE's proposal raises no new regulatory issues.
Amendment No. 1 strengthens the CBOE's proposal by indicating that the
CBOE's Department of Market Regulation will monitor hedge exemption
accounts daily to determine that each exempted option contract is
hedged by the equivalent dollar amount of component securities.
Accordingly, the Commission believes it is consistent with Sections
6(b)(5) and 19(b)(2) of the Act to approve the proposed rule change and
Amendment No. 1 to the proposed rule change on an accelerated basis.
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\18\ See PHLX Approval Order and PSE Approval Order, supra note
4.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., 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, NW.,
Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the above-mentioned
self-regulatory organization. All submissions should refer to the file
number in the caption above and should be submitted by [insert date 21
days after the date of this publication].
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\19\ that the proposed rule change (SR-CBOE-96-18), as amended, is
approved.
\19\ 15 U.S.C. 78f(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) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12382 Filed 5-16-96; 8:45 am]
BILLING CODE 8010-01-M
