03-14829. Self-Regulatory Organizations; Order Approving Proposed Rule Change and Amendments No. 1, 2, 3, 4, 5, 6, 7, and 8 by the Chicago Board Options Exchange, Inc. To Initiate a Pilot Program That Allows the Listing of Strike Prices at One-Point ...

June 5, 2003.

I. Introduction

On December 12, 2001, the Chicago Board Options Exchange, Inc. (“CBOE” or “Exchange”) filed with 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 proposed rule change to initiate a one-year pilot program that will allow the Exchange to list options on selected stocks trading below $20 at one-point intervals (“$1 Strike Pilot Program” or “Pilot Program”). The Exchange filed Amendments No. 1, 2, 3, 4, 5, 6, 7, and 8 to the proposed rule change on March 13, 2002,^[3] June 21, 2002,^[4] December 6, 2002,^[5] March 7, 2003,^[6] March 25, 2003,^[7] April 16, 2003,^[8] April 24, 2003,^[9] and April 25, 2003,^[10] respectively. The proposed rule change, as amended, was published for comment in the Federal Register on May 5, 2003.^[11] The Commission received one comment letter on the proposed rule change.^[12] This order approves the proposed rule change, as amended, through June 5, 2004.

II. Description of the Proposal

CBOE proposes to amend CBOE Rule 5.5, Interpretation and Policy .01 to implement the $1 Strike Pilot Program. The Pilot Program will operate for a one-year period beginning June 5, 2003, and ending on June 5, 2004. The Pilot Program will allow CBOE to list options on selected stocks trading below $20 at one-point intervals, provided that the strike prices are $20 or less, but not less than $3. For an option to be eligible for inclusion in the Pilot Program, the underlying stock must close below $20 in its primary market on the previous business day. CBOE may select up to five individual stocks to be included in its Pilot Program. In addition, CBOE may list $1 strike prices in any equity option included in the $1 strike pilot program of any other options exchange. CBOE will only list $1 strike prices that fall within a $5 range of the underlying stock price. CBOE will not list long-term options series (“LEAPS”) at $1 strike price intervals, nor will CBOE list $1 strike prices at levels that “bracket” existing $2.50 intervals (e.g., $7 and $8 strikes around a $7.50 strike). As the $2.50 intervals are phased-out, the Exchange will introduce the $1 prices that bracket the phased-out prices.

CBOE Rule 5.5, Interpretation and Policy .03 will govern the addition of expiration months for $1 strike series. Upon expiration of the near-term month, CBOE may list an additional expiration month provided that the underlying stock closes below $20 on its primary market on expiration Friday. If the underlying stock closes at or above $20 on expiration Friday, CBOE will not list an additional month for a $1 strike series until the stock again closes below $20.

At any time, CBOE may cease listing $1 strike prices on existing series by submitting a cessation notice to the Options Clearing Corporation (“OCC”). As discussed above, if the underlying stock closes at or above $20 on expiration Friday, CBOE will not list any additional months with $1 strike prices until the stock subsequently closes below $20. If the underlying stock does not subsequently close below $20, thereby precluding the listing of additional strike prices and months, the existing $1 series will eventually expire. When the near-term month is the only series available for trading, the Exchange may submit a cessation notice to OCC. Upon submission of the notice, the underlying stock will no longer count towards the five stocks that CBOE may select for its Pilot Program. Once the Exchange submits the cessation notice, it will not list any additional month for trading with strikes below $20 unless the underlying again closes below $20, and then, only if the CBOE has not already selected a replacement stock.

According to CBOE, the Options Price Reporting Authority (“OPRA”) has the capacity to accommodate the increase in the number of series that would be added pursuant to the Pilot Program. In addition, CBOE notes that it listed approximately 109,000 series in December 2000 and approximately 100,000 series in September 2001. The CBOE believes that the increase in the number of series resulting from the Pilot Program will be substantially lower than the 9,000 series decrease the CBOE experienced.

III. Summary of Comments

The Commission received one comment letter on the proposed rule change, which supports the proposal.^[13] Specifically, the commenter believes that the CBOE's proposal would provide equity investors with the flexibility necessary to hedge their risk as efficiently as possible.

IV. Discussion

After careful review, 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.^[14] In particular, the Commission believes that the proposed rule change is consistent with section 6(b)(5) of the Act,^[15] which requires, among other things, that the rules of a national securities exchange be designed to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest. Specifically, the Commission believes that the proposed listing of one point strike price intervals in selected equity options on a pilot basis should provide investors with more flexibility in the trading of equity options overlying stocks trading at less than $20, thereby furthering the public interest by allowing investors to establish equity options positions that are better tailored to meet their investment objectives. The Commission also believes that the Exchange's limited Pilot Program strikes a reasonable balance between the Exchange's desire to accommodate market participants by offering a wide array of investment opportunities and the need to avoid unnecessary proliferation of options series. The Commission expects the Exchange to monitor the applicable equity options activity closely to detect any proliferation of illiquid options series resulting from the narrower strike price intervals and to act promptly to remedy this situation should it occur. In addition, the Commission requests that CBOE monitor the trading volume associated with the additional options series listed as a result of the Pilot Program and the effect of these additional series on market fragmentation and on the capacity of the Exchange's, OPRA's, and vendors' automated systems.

As noted above, the Commission is approving the CBOE's proposal on a one-year pilot basis. In the event that CBOE proposes to extend the Pilot Program beyond June 5, 2004, expand the number of options eligible for inclusion in the Pilot Program, or seek permanent approval of the Pilot Program, it should submit a Pilot Program report to the Commission along with the filing of such proposal.^[16] The report must cover the entire time the Pilot Program was in effect, and must include: (1) Data and written analysis on the open interest and trading volume for options (at all strike price intervals) selected for the Pilot Program; (2) delisted options series (for all strike price intervals) for all options selected for the Pilot Program; (3) an assessment of the appropriateness of $1 strike price intervals for the options the CBOE selected for the Pilot Program; (4) an assessment of the impact of the Pilot Program on the capacity of the CBOE's, OPRA's, and vendors' automated systems; (5) any capacity problems or other problems that arose during the operation of the Pilot Program and how the CBOE addressed them; (6) any complaints that the CBOE received during the operation of the Pilot Program and how the CBOE addressed them; and (7) any additional information that would help to assess the operation of the Pilot Program.

V. Conclusion

For the foregoing reasons, the Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and rules and regulations thereunder.

It is therefore ordered, pursuant to section 19(b)(2) of the Act,^[17] that the proposed rule change (SR-CBOE-2001-60) is approved, on a pilot basis, through June 5, 2004.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[18]

J. Lynn Taylor,

Assistant Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See letter from Steve Youhn, Attorney, CBOE, to Deborah Flynn, Assistant Director, Division of Market Regulation (“Division”), Commission, dated March 12, 2002 (“Amendment No. 1”).

4.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Elizabeth King, Associate Director, Division, Commission, dated June 20, 2002 (“Amendment No. 2”).

5.  See letter from Steve Youhn, Attorney, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated December 5, 2002 (“Amendment No. 3”).

6.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated March 6, 2003 (“Amendment No. 4”).

7.  On March 25, 2003, the Exchange filed Amendment No. 5, which supercedes the original filing and Amendments No. 1, 2, 3, and 4 in their entirety.

8.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 15, 2003 (“Amendment No. 6”).

9.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 22, 2003 (“Amendment No. 7”).

10.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 25, 2003 (“Amendment No. 8”).

11.  See Securities Exchange Act Release No. 47753 (April 29, 2003), 68 FR 23784.

12.  See letter from Steven Dillinger, Cornerstone Partners, LP, to Margaret H. McFarland, Deputy Secretary, Commission, dated May 26, 2003 (“Cornerstone Letter”).

13.  See Cornerstone Letter, supra note 12.

14.  In approving this proposed rule change, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

15.  15 U.S.C. 78f(b)(5).

16.  The Commission expects the CBOE to submit a proposed rule change at least 60 days before the expiration of the Pilot Program in the event the CBOE wishes to extend, expand, or seek permanent approval of the Pilot Program.

17.  15 U.S.C. 78s(b)(2).

18.  17 CFR 200.30-3(a)(12).