[Federal Register Volume 59, Number 95 (Wednesday, May 18, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-12045]
[[Page Unknown]]
[Federal Register: May 18, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34052; File No. SR-CBOE-93-46]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by the Chicago Board Options Exchange, Inc. Relating to the
Listing and Trading of Flexible Exchange Options Based on the Nasdaq
100 Index
May 12, 1994.
I. Introduction
On October 20, 1993, 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 proposal to list and trade large-size, customized
index options, referred to as Flexible Exchange Options (``FLEX
Options''), based on the Nasdaq 100 Index (``Nasdaq 100'').\3\
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\The Nasdaq 100 is a capitalization-weighted index composed of
the stocks of 100 of the largest, non-financial U.S. issuers whose
securities are traded on the Nasdaq National Market. The Nasdaq 100
is maintained by the Nasdaq Stock Market, Inc., a subsidiary of the
National Association of Securities Dealers, Inc. (``NASD''). On
January 5, 1994, the Commission approved a proposed rule change by
the CBOE that provided for the listing and trading on the CBOE of
standardized options, including both full-value and reduced-value
long-term options series, based on the Nasdaq 100. See Securities
Exchange Act Release No. 33428 (January 5, 1994), 59 FR 1576
(January 11, 1994) (``Nasdaq 100 Approval Order''). In approving
Nasdaq 100 options, the Commission believed that the Index would
provide investors with an important trading and hedging mechanism
that accurately reflected the overall movement of 100 of the
largest, non-financial stocks listed on Nasdaq. In addition, the
Commission determined that the Nasdaq 100 was a broad-based index
not readily susceptible to manipulation. For information regarding
the makeup, weighting, and formula used to calculate the value of
the Nasdaq 100, see Nasdaq 100 Approval Order.
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Notice of the proposed rule change was published for comment and
appeared in the Federal Register on November 23, 1993.\4\ No comments
were received on the proposal. This order approves the proposal.
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\4\See Securities Exchange Act Release No. 33199 (November 15,
1993), 58 FR 61934 (November 23, 1993) (``Notice'').
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II. Description of the Proposal
In this proposal, the CBOE is seeking to expand its FLEX Options
program to include FLEX Options on the Nasdaq 100.\5\ The purpose of
the CBOE's FLEX Options program is to provide a framework for the
Exchange to list and trade index options that give investors the
ability, within specified limits, to designate certain of the terms of
the options. Consistent with the original FLEX Options Approval Order,
the present proposal to trade FLEX Options based on the Nasdaq 100
similarly will permit market participants to designate certain terms of
the options contract, such as the strike price, exercise type,
expiration date, and form of settlement.\6\ However, a market
participant's designation of the expiration date is not without
limitation. Specifically, in order to protect against possible market
disruptions that may otherwise result from the concurrent expiration of
listed options and FLEX Options, the expiration dates for FLEX Options
must be at least three business days away from the expiration dates for
existing listed options.\7\
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\5\The Commission approved the CBOE's Flex Options framework on
February 24, 1993, permitting the Exchange to list and trade FLEX
Options based on the Standard & Poor's Corporation (``S&P'') 100
(``OEX'') and 500 (``SPX'') Indexes. See Securities Exchange Act
Release No. 31920 (February 24, 1993), 58 FR 12280 (March 3, 1993)
(``FLEX Options Approval Order''). Subsequently, on July 29, 1993,
the Commission approved the listing and trading on the CBOE of FLEX
Options on the Russell 2000 Index (``Russell 2000''), consistent
with the FLEX Options Approval Order. See Securities Exchange Act
Release No. 32694 (July 29, 1993), 58 FR 41814 (August 5, 1993)
(``Russell 2000 Approval Order'').
\6\In the FLEX Options Approval Order, the Commission designated
FLEX Options as ``standardized options'' for purposes of the option
disclosure framework established under Rule 9b-1 under the Act. See
Securities Exchange Act Release No. 31919 (February 24, 1993), 58 FR
12286 (March 3, 1993) (``9b-1 Order''). As described in note 24
infra, and for the same reasons stated in the 9b-1 Order, Nasdaq 100
FLEX Options are deemed ``standardized options'' for purposes of the
Rule 9b-1 options disclosure framework.
\7\See FLEX Options Approval Order, supra note 5.
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Currently, the CBOE lists and trades FLEX Options based on the OEX
and SPX Indexes, which consist of 100 and 500 highly capitalized
stocks, respectively, and on the Russell 2000, which consists of the
bottom 2,000 of the 3,000 largest U.S. equity securities in terms of
domestic market capitalization. The components of the Nasdaq 100 are
the stocks of 100 of the largest, non-financial U.S. issuers quoted on
the Nasdaq National Market.
CBOE Rule 24A.7 provides that FLEX Options are subject to maximum
position and exercise limits of 200,000 contracts on the same side of
the market on a given index, without aggregation for other contracts on
the same index, with one exception.\8\ This exception requires that at
the close of business two days prior to the last day of trading of the
Calendar quarter, members must aggregate positions in P.M.-Settled\9\
FLEX Options and comparable quarterly expiration index options
(``QIXs''), with such positions not exceeding the QIX limits specified
in CBOE Rule 24.4. However, the applicable hedge exemptions under Rule
24.4 may be applied to aggregate positions.
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\8\The applicable position limits with respect to the CBOE's
FLEX Options program were established as a three year pilot,
commencing as of February 24, 1993, during or following which
adjustments may be required. See FLEX Options Approval Order, supra
note 5.
\9\The settlement value of a P.M.-settled stock index options
contract is based on the closing prices of the component securities.
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The CBOE proposes that FLEX Options on the Nasdaq 100 be subject to
position limits of 200,000 contracts on the same side of the market
(which is identical to the existing limits for OEX, SPX, and Russell
2000 FLEX Options), without aggregation for other contracts on the same
index.\10\ Because the CBOE does not anticipate listing and trading
QIXs on the Nasdaq 100, the CBOE's proposal to add the Nasdaq 100 to
the CBOE FLEX Options program does not provide for the exception to the
prohibition against aggregation. The CBOE represents that it would
amend Rule 24A.7, pursuant to a filing with the Commission made in
accordance with Section 19(b) of the Act, in the event that it decided
to list such QIXs in the future.\11\
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\10\The position limits pilot for Nasdaq 100 FLEX Options will
expire on February 24, 1996, unless specifically extended by the
Commission. See supra note 8.
\11\See Notice, supra note 4.
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III. Discussion
The Commission believes 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 Sections 6(b)(5) and 11A.\12\ In
particular, the Commission believes that the proposed rule change is
designed to provide investors with a tailored or customized product for
a broad-based index consisting of Nasdaq National Market-listed, high-
capitalization stocks that may be more suitable to their investment
needs than the other outstanding FLEX index options. Moreover,
consistent with Section 11A, the proposal should encourage fair
competition among brokers and dealers and exchange markets by allowing
the CBOE to compete in the growing over-the-counter (``OTC'') market
for customized index options.
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\12\15 U.S.C. 78f(b)(5) and 78k-1 (1982). See FLEX Options
Approval Order and Russell 2000 Approval Order, supra note 5, for
the Commission's findings and discussions relating to the FLEX
Options program. These findings are incorporated by reference
herein.
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In addition, the Commission believes that the CBOE proposal will
help to promote the maintenance of a fair and orderly market,
consistent with Sections 6(b)(5) and 11A, because the purpose of the
proposal is to extend the benefits of a listed exchange market in
Nasdaq 100 options that have certain terms varied by the particular
investor. The attributes of the Exchange's options market versus an OTC
market include, but are not limited to, a centralized market center, an
auction market with posted transparent market quotations and
transaction reporting, standardized contract specifications, parameters
and procedures for clearance and settlement, and the guarantee of The
Options Clearing Corporation for all contracts traded on the Exchange.
In general, transactions in FLEX Options based on the Nasdaq 100
will be subject to many of the same rules that apply to index options
traded on the CBOE. However, in order to provide investors with the
flexibility to designate certain terms of the options and accommodate
the special trading of FLEX Options, several rules of the CBOE apply
solely to FLEX Options.\13\
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\13\See FLEX Options Approval Order, supra note 5.
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The Commission believes that the FLEX auction process appears
reasonably designed to provide the benefits of a competitive Exchange
auction environment for Nasdaq 100 options while allowing market
participants the flexibility to negotiate certain terms. For example,
because certain terms of these options can be negotiated between the
parties to the transaction, Nasdaq 100 FLEX Options, unlike regular
Nasdaq 100 options, will not have trading rotations at either the
opening or closing of trading. In addition, the individually-tailored
auction process outlined in the FLEX Options Approval Order sets forth
in detail the procedure of negotiation for those investors seeking
particular flexibility in options terms.\14\ Accordingly, the CBOE's
FLEX Options framework for trading stock index options, such as Nasdaq
100 FLEX Options, differs from the traditional exchange procedure for
trading non-FLEX stock index options, due to the special FLEX
procedures allowing for limited individual negotiation of certain of
the terms of the contract between the parties.
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\14\Among other things, there are specific procedures governing
the entering of quotes for FLEX Options, including that such quotes
must be firm for a designated period and be disseminated through the
Options Price Reporting Authority (``OPRA''). Id.
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The Commission further notes that FLEX Options based on the Nasdaq
100 can be constructed with expiration exercise settlement based on the
closing values of the component securities, which potentially could
result in adverse effects on the markets for those securities.\15\
Although the Commission continues to believe that basing the settlement
of index products on opening as opposed to closing prices on expiration
Fridays helps alleviate stock market volatility,\16\ these concerns
will be allayed in the case of FLEX Options based on the Nasdaq 100,
since expiration of these stock index options will not correspond to
the normal expiration of stock index options, stock index futures, and
options on stock index futures. In particular, Nasdaq 100 FLEX Options
will never expire on an expiration Friday or any other expiration
Fridays in March, June, September, and December, thereby diminishing
the impact that these FLEX Options could have on the underlying cash
market.\17\
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\15\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992) (order approving A.M. settlement
of options on the SPX).
\16\Id.
\17\See supra note 7 and accompanying text.
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Pursuant to the existing FLEX Options position limits framework,
the CBOE has proposed to establish position limits of 200,000 contacts
on the same side of the market for the Nasdaq 100 FLEX Options. The
Commission finds that these proposed position limits are consistent
with the FLEX Options position limit framework as set forth in the FLEX
Options Approval Order.\18\
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\18\See FLEX Options Approval Order, supra note 5.
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Nevertheless, because the position limits for Nasdaq 100 FLEX
Options are much higher than those currently existing for outstanding
exchange-traded Nasdaq 100 options, and open interest in one or more
FLEX series could grow to significant exposure levels, the Commission
cannot rule out the potential for adverse effects on the securities
markets for the component securities underlying the Nasdaq 100 FLEX
Options. The CBOE has taken several steps to address this concern,
including establishing the FLEX Options position limits framework as a
three year pilot program\19\ and undertaking to monitor carefully open
interest, position limit compliance, and potential adverse market
effects, and to report to the Commission after one year's experience
trading Nasdaq 100 FLEX Options.\20\ The reporting of the CBOE's
experience in connection with the trading of Nasdaq 100 FLEX Options
will be consistent with the original FLEX Options Approval Order and
the Russell 2000 Approval Order, and will include, among other things:
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\19\See supra note 8.
\20\See Letter from Michael L. Meyer, Schiff Hardin & Waite, to
Thomas N. McManus, Options Branch, Division of Market Regulation
(``Division''), SEC, dated April 22, 1994.
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The type of strategies used by Nasdaq 100 FLEX Options
market participants, and whether Nasdaq 100 FLEX Options are being used
in lieu of existing standardized stock index options on the Nasdaq 100.
The type of market participants using Nasdaq 100 FLEX
Options.
The terms which are predominantly being ``flexed'' by
market participants, i.e., strike prices, form of settlement (A.M.-
versus F.M.-settlement), expiration date, exercise type (European
versus American style).
The size of the Nasdaq 100 FLEX position on average, the
size of the largest Nasdaq 100 FLEX positions on any given day, and the
size of the largest Nasdaq 100 FLEX position held by any single
customer/member.
The relationship between strike prices and current index
value.
Whether there is significant interest in long-term
expirations greater than nine months.
Any effect that Nasdaq 100 FLEX positions have had on the
underlying cash market, including an analysis of Nasdaq 100 FLEX
positions and their market impact on days when the NYSE's Rule 80A\21\
is triggered.
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\21\NYSE Rule 80A is designed to ensure that index arbitrage
will be exercised only in a market-stabilizing manner during
volatile market conditions. Thus, Rule 80A places conditions on
index arbitrage orders to buy or sell NYSE component stocks of the
SPX when the Dow Jones Industrial Average advances or declines by 50
points or more from its previous day's closing value. See Securities
Exchange Act Release No. 29854 (October 24, 1991), 56 FR 55963
(October 30, 1991).
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In addition, the Commission expects, and the CBOE has agreed, to
monitor the actual effect of Nasdaq 100 FLEX Options once trading
commences and take prompt action (including timely communication with
marketplace self-regulatory organizations responsible for oversight of
trading in component stocks) should any unanticipated adverse market
effects develop.
Finally, based on representations from the CBOE, the Commission
believes that the CBOE and OPRA will have adequate systems processing
capacity to accommodate the additional options listed in accordance
with Nasdaq 100 FLEX Options. Specifically, the Exchange represents
that it ``has the necessary systems capacity to support the new series
that could result from introduction of Nasdaq 100 FLEX Options.''\22\
In addition, OPRA represents that, ``regarding FLEX options on the
Nasdaq-100 index, additional traffic generated by this product is
within OPRA's capacity.''\23\
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\22\See Letter from Charles J. Henry, CBOE, to Thomas McManus,
Division of Market Regulation, Commission, dated May 11, 1994.
\23\See Letter from Eileen Smith, Director of Product
Development, CBOE, to Thomas McManus, Division, SEC, dated April 22,
1994, incorporating a memorandum from Joseph P. Corrigan, Executive
Director, OPRA, to Eileen Smith, Director of Product Development,
CBOE, dated April 22, 1994.
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IV. Conclusion
For the reasons discussed above, the Commission finds that the
proposal is consistent with the Act, and, in particular, sections 6 and
11A of the Act. In addition, the Commission also finds, pursuant to
Rule 9b-1 under the Act, the Flex Options based on the Nasdaq 100 are
standardized options for purposes of the options disclosure framework
established under Rule 9b-1.\24\
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\24\As part of the original approval process of the FLEX Options
framework, the Commission delegated to the Director of the Division
the authority to authorize the issuance of orders designating
securities as standardized options pursuant to Rule 9b-1(a)(4) under
the Act. See Securities Exchange Act Release No. 31911 (February 23,
1993), 58 FR 11792 (March 1, 1993). On May 4, 1993, then-Chairman
Richard Breeden, pursuant to Public Law 87-592, 76 Stat. 394 [15
U.S.C. Secs. 78d-1, 78d-2], and Article 30-3 of the Commission's
Statement of Organization; Conduct and Ethics; and Information and
Requests [17 CFR 200.30-3), designated that persons serving in the
position of Deputy Director, Associate Director, and Assistant
Director in the Division be authorized to issue orders designating
securities as ``standardized options'' pursuant to Rule 9b-1(a)(4).
Accordingly, this subdelegation provides the Division with the
necessary authority for designating Nasdaq 100 FLEX Options as
``standardized options.'' See Designation of Personnel to Perform
Delegated Functions in the Division of Market Regulation, dated May
4, 1993.
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-CBOE-93-46) is approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\25\
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\25\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-12045 Filed 5-17-94; 8:45 am]
BILLING CODE 8010-01-M
