[Federal Register Volume 61, Number 98 (Monday, May 20, 1996)]
[Notices]
[Pages 25251-25253]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12594]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37198; File No. SR-CROE-96-11]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Inc.; Order Approving Proposed Rule Change Relating to the Listing and
Trading of Options on the CBOE PC Index
May 10, 1996.
On March 7, 1996, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'' or ``Commisssion''), pursuant to Section 19(b) of
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to list and trade options on the
CBOE PC Index (``CBOE PC Index'' or ``Index''), a narrow-based, equal-
weighted index comprised of eight of the largest personal computer
manufacturing companies. Notice of the proposed rule change appeared in
the Federal Register on March 27, 1996.\3\ No comments were received on
the proposal. This order approves the proposal, as amended.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988 & Supp. V. 1993).
\2\ 17 CFR Sec. 240.19b-4 (1994).
\3\ See Securities Exchange Act Release No. 36992 (March 20,
1996), 61 FR 13548.
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I. Description of the Proposal
The purpose of the proposed rule change is to permit the Exchange
to list and trade cash-settled, European-style stock index options on
the CBOE PC Index, an equal-weighted index consisting of stocks of
eight of the largest personal computer manufacturing companies. CBOE
represents that each of these stocks are actively traded and believes
that options on the Index will provide investors with a low-cost means
to participate in the performance of the domestic PC industry or a
means to hedge the risk of investments in that industry. The Exchange
believes that the small number of Index components should facilitate
replication of the Index for hedging purposes.
Index Design. As noted above, the CBOE PC Index consists of eight
components, all of which trade on the New York Stock Exchange
(``NYSE'') or Nasdaq.\4\ In addition, the Exchange represents that all
eight underlying component securities currently meet the Exchange's
listing criteria for equity options contained in Exchange Rule 5.3 and
are the subject of options trading on U.S. options exchanges.
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\4\ The components of the Index are: Apple Computer, AST
Research, Compaq Computer, Dell Computer, Gateway 2000, Hewlett
Packard, International Business Machines, and Micron Electronics.
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As of February 6, 1996, the capitalization of the components ranged
from a low of $363 million (AST Research) to a high of $65.26 billion
(IBM). The total capitalization of the Index as of that date was $135.5
billion; the mean capitalization was $16.9 billion; and the median
capitalization was $3.34 billion. Because the Index is equal-weighted,
each component accounts for 12.5% of the weight of the Index at the
time of rebalancing.
Calculation. The Index will be calculated by CBOE or its designee
on a real-time basis using last-sale prices and will be disseminated
every 15 seconds. The updated Index values will be displayed by the
Consolidated Tape Association and over the facilities of the Options
Price Reporting Authority (``OPRA''). If a component is not currently
being traded on its primary market, the most recent price at which the
share traded on such market will be used in the Index calculation. The
value of the Index at the close on February 1, 1996 was 127.65.
The Index is equal-weighted and reflects changes in the prices of
the component stocks relative to the Index base date, January 3, 1995
when the Index was set to 100.00. Specifically, each of the component
securities is initially represented in equal-dollar amounts, with the
level of the Index equal to the combined market value of the assigned
number of shares for each of the Index components divided by the
current Index divisor. The Index divisor is adjusted to maintain
continuity in the Index at the time of certain types of changes.
Changes which may result in divisor changes include, but are not
limited to, quarterly re-balancing, special dividends, spin-offs,
certain rights issuances, and mergers and acquisitions.
Maintenance. The Index will be maintained by CBOE and will be re-
balanced after the close of business on Expiration Fridays on the March
Quarterly Cycle. The Index will be reviewed regularly and CBOE may
change the composition of the Index at any time to reflect changes
affecting the components of the Index or the PC markets generally. If
it becomes necessary to replace a component, every effort will be made
to add a component
[[Page 25252]]
that preserves the character of the Index. If no replacement is
available, or if CBOE determines to decrease the number of component
stocks, it will submit a proposed rule change pursuant to Section 19(b)
of the Act prior to opening any new series of Index options for
trading. Absent prior Commission approval, CBOE will not increase to
more than ten the number of component stocks in the Index. Finally, if
at any time any of the components are not options eligible,\5\ the
Exchange will submit a rule change pursuant to Section 19(b) of the Act
prior to opening any new series of Index options for trading.
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\5\ Options eligibility requirements include, among other
criteria, public float, minimum holder, trading volume, and share
price requirements. See CBOE Rules 5.3 and 5.4.
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Index Option trading. The Exchange proposes to base trading in
options on the CBOE PC Index on the full value of that index. The
Exchange may list full-value long-term index option series
(``LEAPS''), as provided in Rule 24.9. The Exchange also may
provide for the listing of reduced-value LEAPS, for which the
underlying value would be computed at one-tenth of the value of the
Index. The current and closing index value of any such reduced-value
LEAP will, after such initial computation, be rounded to the nearest
one-hundredth.
Exercise and Settlement. CBOE PC Index options will have European-
style exercise and will be ``A.M.-settled index options'' within the
meaning of the Rules in Chapter XXIV, including Rule 24.9, which is
being amended to refer specifically to CBOE PC Index options. The
proposed options will expire on the Saturday following the third Friday
of the expiration month and the last day for trading in an expiring
series will be the second business day (ordinarily a Thursday)
preceding the expiration date.
Exchange Rules Applicable. Except as modified herein, the Rules in
Chapter XXIV will be applicable to CBOE PC Index options. Index option
contracts based on the CBOE PC Index will currently be subject to a
position limit of 9,000 contracts on the same side of the market.\6\
Ten reduced-value options will equal one full-value contract for such
purposes.
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\6\ CBOE recently increased its position limit tiers applicable
to narrow-based index options from 5,000, 7,500, and 10,500
contracts on the same side of the market to 6,000, 9,000, and 12,000
contracts, respectively.
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CBOE represents that it has the necessary systems capacity to
support new series that would result from the introduction of options
on the Index and has also been informed that OPRA has the capacity to
support such new series.\7\
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\7\ See Letter from Joe Corrigan, OPRA, to Eileen Smith, CBOE,
dated February 21, 1996.
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Surveillance. The surveillance procedures currently used to monitor
the trading of options on other Exchange-listed indexes will be used to
monitor the trading of options on the CBOE PC Index. The Exchange has
access to trading activity in the underlying securities, all of which
trade on either the NYSE or Nasdaq, via the Intermarket Surveillance
Group (``ISG'') Agreement.
II. Findings and Conclusions
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).\8\ Specifically, the
Commission finds that the trading of CBOE PC Index options, including
full-value and reduced-value long-term Index options, will serve to
promote the public interest and help to remove impediments to a free
and open securities market by providing investors with an additional
means to hedge exposure to market risk associated with stocks in the
personal computer industry.\9\
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\8\ 15 U.S.C. Sec. 78f(b)(5) (1988).
\9\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option 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 on the Index will provide investors with a hedging
vehicle that should reflect the overall movement of the stocks
representing companies in the networking sector in the U.S. stock
markets.
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The trading of options on the Index and on a reduced-value Index,
however, raises several issues relating to index design, customer
protection, surveillance, and market impact. The Commission believes,
for the reasons discussed below, that the CBOE has addressed these
issues adequately.
A. Index Design and Structure. The Commission believes it is
appropriate for the Exchange to designate the Index as a narrow-based
index for purposes of index options trading. The Index is comprised of
8 stocks intended to track the personal computer manufacturing sector
of the stock market. The Commission also finds that the reduced-value
Index is a narrow-based index because it is composed of the same
component securities as the Index, and merely dividing the Index value
by ten will not alter its basic character. Accordingly, the Commission
believes that it is appropriate for the CBOE to apply its rules
governing narrow-based index options to trading in the Index options
and long-term full-value and reduced-value Index options.
The Commission also believes that the large capitalizations, liquid
markets, and relative weightings of the Index's component stocks
significantly minimize the potential for manipulation of the Index.
First, the stocks that comprise the Index are actively traded, with a
mean and median average monthly trading volume for the period between
August 1995 and February 1996 of 2.09 million and 2.45 million shares,
respectively. Second, the market capitalizations of the stocks in the
Index are very large, ranging from a high of $65.26 billion to a low of
$363 million as of February 2, 1996, with the mean and median being
$16.9 billion and $3.3 billion, respectively. Third, because the index
is equal dollar-weighted, as described above, no one particular stock
or group of stocks dominates the Index. Specifically, as of February
6th, each stock accounted for 12.5% of the Index's total value and the
percentage weighting of the five highest weighted stocks in the Index
accounted for 62.5% of the Index's value.
Fourth, the proposed maintenance criteria will serve to ensure
that: (1) the Index remains composed of liquid highly capitalized
securities; and (2) the Index is not dominated by one or several
securities that do not satisfy the Exchange's options listing criteria.
Specifically in considering changes to the composition of the Index,
CBOE will submit a rule change prusuant to Section 19(b) of the Act
prior to the opening of any new series of Index options if at any time
any of the components are not options eligible.\10\ Finally, the
Commission believes that the existing mechanisms to monitor trading
activity in the component stocks of the Index, or options on those
stocks, will help deter as well as detect any illegal activity.
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\10\ See supra note 5.
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B. Customer Protection. The Commission beleives that a regulatory
system designed to protect public customers must be in place before the
trading of sophisticated financial instruments, such as Index options
(including full-value and reduced-value long-term Index options), can
commence on a national securities
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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 risks of options trading are engaged in such trading;
and (3) special compliance procedures are applicable to options
accounts. Accordingly, because the Index options and Index long-term
full-value and reduced-value options will be subject to the same
regulatory regime as the other standardized index options currently
traded on CBOE, the Commission believes that adequate safeguards are in
place to ensure the protection of investors in Index options and full-
value or reduced-value Index long-term options.
C. Surveillance. The Commission 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.\11\ In this regard,
the Commission notes that the CBOE, NYSE, and NASD are all members of
the ISG. The Commission believes that this arrangement ensures the
availability of information necessary to detect and deter potential
manipulations and other trading abuses, thereby making the Index
options and full-value and reduced-value long-term Index options less
readily susceptible to manipulations.\12\
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\11\ See Securities Exchange Act Release No. 31243 (September
28, 1992), 57 FR 45849.
\12\ See, e.g., Securities Exchange Act Release No. 31243
(September 28, 1992), 57 FR 45849 (order approving the listing of
index options and index LEAPS on the CBOE Biotech Index).
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D. Market Impact. The Commission believes that the listing and
trading of Index options, including full-value and reduced-value Index
LEAPS on the CBOE, will not adversely affect the underlying securities
markets. First, because of the equal-weighting method that will be
used, no one security or group of securities represented in the Index
will dominate the weight of the Index immediately following a quarterly
rebalancing. Second, the Index maintenance criteria ensure that the
Index will be comprised solely of securities that satisfy the
Exchange's listing standards for standardized options trading, and that
one or a few stocks do not dominate the Index. Third, the currently
applicable 9,000 contract position and exercise limits 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 Index long-term options will be issued
and guaranteed by the Options Clearing Corporation just like any other
standardized option traded in the United States.
Lastly, the Commission believes that settling expiring Index
options (including full-value and reduced-value long-term Index
options) based on the opening prices of component securities is
reasonable and consistent with the Act. As has been noted previously,
valuing index options for exercise settlement on expiration based on
opening rather than closing prices of Index component securities may
help to reduce adverse effects on markets for such securities.\13\
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\13\ See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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It therefore is ordered, pursuant to Section 19(b)(2) of the
Act,\14\ that the proposed rule change (SR-CBOE-96-11) is approved.
\14\ 15 U.S.C. Sec. 78s(b)(2) (1988).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR Sec. 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12594 Filed 5-17-96; 8:45 am]
BILLING CODE 8010-01-M
