[Federal Register Volume 59, Number 141 (Monday, July 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17952]
[[Page Unknown]]
[Federal Register: July 25, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34388; International Series Release No. 686; File No.
SR-CBOE-94-14]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 1 to Proposed Rule Change by the Chicago Board Options
Exchange, Inc. Relating to the Listing and Trading of Options and Full-
Value and Reduced-Value Long-Term Options on the Nikkei Stock Index 300
July 15, 1994.
I. Introduction
On April 19, 1994, 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 proposed rule change to provide for the listing and
trading of options and long-term options (``LEAPS'')\3\ based on the
Nikkei Stock Index 300 (``Nikkei 300 Index'' or ``Index''), as well as
LEAPS based on a reduced-value Index. On June 28, 1994, the Exchange
filed Amendment No. 1 to the proposed rule change.\4\
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\1\15 U.S.C. Sec. 78s(b)(1) (1982).
\2\17 CFR 240.19b-4 (1993).
\3\``LEAPS'' is an acronym for Long-Term Equity Anticipation
Securities. LEAPS are long-term index option series that expire from
12 to 36 months from their date of issuance. See CBOE Rule
24.9(b)(1).
\4\In Amendment No. 1, the Exchange (1) lowered the proposed
position limits for Index options and Index LEAPS to 25,000
contracts on the same side of the market, provided that no more than
15,000 contracts are in series in the nearest expiration month; (2)
specified that the total capitalization of the Index, as of march
31, 1994, was US$2.25 trillion; and (3) supplied data on the average
daily trading volume in the component securities for the period
commencing December 1, 1993 and ending May 31, 1994. See Letter from
Eileen Smith, Director, Product Development, CBOE, to Thomas
McManus, Division of Market Regulation, Commission, dated June 28,
1994.
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The proposed rule change was published for comment in the Federal
Register on May 24, 1994.\5\ No comments were received on the proposed
rule change. This order approves the Exchange's proposal and Amendment
No. 1 thereto.
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\5\See Securities Exchange Act Release No. 34077 (May 18, 1994),
59 FR 26824 (May 24, 1994).
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II. Description of the Proposal
A. General
The CBOE proposes to trade standardized index option contracts
based on the Nikkei 300 Index, an index comprised of 300 representative
stocks of the first section\6\ of the Tokyo Stock Exchange
(``TSE'').\7\ The CBOE also proposes to list LEAPS on the full-value
Index and LEAPS on a reduced-value Index that will be computed at one-
tenth of the value of the Index. Nikkei 300 Index LEAPS will trade
independently of and in addition to regular Nikkei 300 Index options
traded on the Exchange; however, as discussed below, position and
exercise limits of Index LEAPS and regular Index options will be
aggregated.\8\ The Exchange believes that options on the Index,
including full-value and reduced-value Index LEAPS, will provide
investors with a low-cost means of participating in the performance of
the Japanese economy and hedging against the risk of investing in that
economy.
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\6\First section stocks are distinguished from second section
stocks by more stringent listing standards. Telephone conversation
between Eileen Smith, Director, Product Development, CBOE, and
Francois Mazur, Attorney, Office of Derivatives and Equity
Regulation, Division of Market Regulation, Commission (May 16,
1994).
\7\The CBOE has represented that the designations ``Nikkei Stock
Index 300'' and ``Nikkei 300'' are the property of Nihon Keizai
Shimbun, Inc.
\8\See infra Section II.F.
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B. Composition and Maintenance of the Index
The Nikkei 300 Index was designed by Nihon Keizai Shimbun, Inc.
(``NKS''). The CBOE represents that Index component stocks were
selected by NKS for their high market capitalizations and their high
degree of liquidity, and are representative of the industrial
composition of the broader Japanese equity market. On June 20, 1994,
the CBOE formally executed a licensing agreement with NKS to list
options on the Nikkei 300 Index.\9\
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\9\Telephone conversation between Eileen Smith, Director,
Product Development, CBOE, and Thomas McManus, Division of Market
Regulation, Commission (June 28, 1994).
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As of March 31, 1994, the total capitalization of the Index was
US$2.25 trillion.\10\ Market capitalizations of the individual stocks
in the Index ranged from a high of US$76.5 billion to a low of US$875
million, with a median of US$3.3 billion and a mean of US$7.5 billion.
In addition, the average daily trading volume of the stocks in the
Index, for the six-month period ending May 31, 1994, ranged from a high
of 6,279,901 shares to a low of 11,525 shares, with a median of
approximately 488,000 shares and a mean of approximately 846,000
shares. The highest weighted component stock in the Index accounts for
3.41 percent of the Index. The five largest Index components account
for approximately 15.14 percent of the Index's value. The lowest
weighted component stock comprises 0.04 percent of the Index, and the
five smallest Index components account for approximately 0.20 percent
of the Index's value.
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\10\Based on the March 31, 1994 exchange rate of Y102.75 per
US$1.00.
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The Index is maintained by NKS. To maintain the continuity of the
Index, NKS will adjust the Index divisor to reflect certain events
relating to the component stocks. These events include, but are not
limited to, changes in the number of shares outstanding, spin-offs,
certain rights issuances, and mergers and acquisitions. The CBOE
represents that NKS reviews the composition of the Index periodically.
C. Calculation of the Index
The Nikkei 300 Index is capitalization-weighted and reflects
changes in the prices of the Index component securities relative to the
base data of the Index (October 1, 1982). The value of the Index is
calculated by multiplying the price of each component security by the
number of shares outstanding of each such security, adding the
products, and dividing by the current Index divisor. The Index divisor
is adjusted to reflect certain events relating to the component
stocks.\11\ The Index had a closing value of 303.99 on June 24, 1994.
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\11\See supra Section II.B. The Index divisor was get to give
the Index a value of 100 on its base date.
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Because trading does not occur on the TSE during the CBOE's trading
hours, the CBOE calculates the Index once each day based on the most
recent official closing price of each Index component security as
reported by the TSE. This closing value will be disseminated throughout
the trading day on the CBOE.
D. Contract Specifications
The proposed options on the Nikkei 300 Index will be cash-settled,
European-style options.\12\ The CBOE is proposing to trade options on
the Index from 8:00 a.m. to 3:15 p.m. (Chicago Time). The proposed
starting time for Index options is one-half hour earlier than trading
in options normally begins at the CBOE. The multiplier for the Index
will be 100. Strike prices on Index options and full-value Index LEAPS
will be set to bracket the Index level at $5.00 intervals. The Exchange
intends to list options series with expirations in the three near-term
calendar months, plus up to three additional calendar months in the
March, June, September, December cycle. As described in more detail
below, the Exchange also intends to list Index LEAPS, and LEAPS on a
reduced-value Index, that will expire from 12 to 36 months from the
date of the issuance.
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\12\A European-style option can be exercised only during a
specified period before the option expires.
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Options on the Index (including full-value and reduced-value Index
LEAPS) will expire on the Saturday following the third Friday of the
expiration month. The last trading day in an option series normally
will be the second to last business day preceding the Saturday
following the third Friday of the expiration month (normally a
Thursday). Trading in expiring options will cease at the close of
trading on the last trading day. The exercise settlement value for all
of the Index's expiring options will be calculated based upon the most
recent official closing price of each of the component securities as
reported by the TSE at the close of the regular Friday sessions in
Japan (ordinarily at 3:00 p.m. Tokyo time). When expirations are moved
in accordance with Exchange holidays, such as when the CBOE is closed
on the Friday before expiration, the last trading day for expiring
options will be Wednesday and the exercise settlement value of expiring
Index options will be determined at the close of the regular Thursday
trading sessions in Japan, even if the Japanese markets are open on
Friday. If the Japanese markets will be closed on the Friday before
expiration but the CBOE will not be closed, the last trading day for
expiring options will be Wednesday and the exercise settlement value of
expiring Index options will be determined at the close of the regular
Thursday trading sessions in Japan.
E. Listing of Long-Term Options on the Full-Value or Reduced-Value
Index
The Exchange may list series of LEAPS on the Nikkei 300 Index that
expires from 12 to 36 months from the date of their issuance on either
the full-value Index or a reduced-value Index computed at one-tenth of
the full-value index, subject to existing Exchange requirements
applicable to full-value and reduced-value LEAPS.\13\ The current and
closing values for reduced-value Index LEAPS on the Index will be
computed by dividing the value of the full-value Index by ten and
rounding the resulting figure to the nearest one-hundredth. For
example, a Nikkei 300 Index value of 303.99 would be 30.40 for the
reduced-value Index LEAPS, and 303.94 would become 30.39. The reduced-
value Index LEAPS will have a European-style exercise and will be
subject to the same rules that govern trading of all of the Exchange's
index options, including sales practices rules, margin requirements,
and floor trading procedures. Strike price intervals for the reduced-
value Index LEAPS will be no less than $2.50, instead of $5.00.\14\
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\13\See CBOE Rule 24.9(b).
\14\See CBOE Rule 24.9(b)(2)(B).
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F. Position and Exercise Limits, Margin Requirements, and Trading Halts
Position limits for options (including Index LEAPS) on the Nikkei
300 Index will be set at no more than 25,000 contracts on the same side
of the market, provided that no more than 15,000 of such contracts are
in series in the nearest expiration month.\15\ Exercise limits will be
set at the same level as position limits.\16\ For purpose of
calculating applicable position and exercise limits, positions in
reduced-value options on the Index will be aggregated with each other
and with positions in the full-value Index options.\17\ Ten reduced-
value contracts will equal one full-value contract for purposes of
aggregating these positions.\18\
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\15\See CBOE Rule 24.4(a)(i).
\16\See CBOE Rule 24.5.
\17\See CBOE Rule 24.4(e).
\18\Id.
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Exchange rules applicable to options on the Index will be identical
to the rules applicable to other broad-based index options for purposes
of trading rotations, halts, and suspensions,\19\ and margin
treatment.\20\
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\19\See CBOE Rule 24.7.
\20\See CBOE Rule 24.11.
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G. Surveillance
The Exchange will use the same surveillance procedures currently
utilized for each of the Exchange's other index options to monitor
trading in Index options and Index LEAPS. The Exchange currently is
pursuing a market surveillance agreement with the TSE, which agreement
the Exchange expects will enable it to better carry out its regulatory
responsibilities with respect to the surveillance of trading in the
stocks comprising the Index.\21\
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\21\See infra Section III.C.
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III. Commission 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) of the Act.\22\
Specifically, the Commission finds that the trading of options based on
the Nikkei 300 Index will serve to protect investors, promote the
public interest, and help to remove impediments to a free and open
securities market by providing investors with a means to hedge exposure
to market risk associated with the Japanese equity market and provide a
surrogate instrument for trading in the Japanese securities market.\23\
The trading of options based on the Nikkei 300 Index should provide
investors with a valuable hedging vehicle that should reflect
accurately the overall movement of the Japanese equity market.
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\22\15 U.S.C. Sec. 78f(b)(5) (1988).
\23\Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new securities product upon a finding that
the introduction of such product is in the public interest. Such a
finding would be difficult with respect to an option 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.
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In addition, the Commission believes, for the reasons discussed
below, that the CBOE has adequately addressed issues related to
customer protection, index design, surveillance, and market impact of
Nikkei 300 Index options.
A. Index Design and Structure
The Commission finds that it is appropriate and consistent with the
Act to classify the Index as a broad-based index. Specifically, the
Commission believes the Index is broad-based because it reflects a
substantial segment of the Japanese equity market, and, among other
things, it contains a large number of stocks that trade in that market.
First, the Index consists of 300 actively-traded stocks traded on the
first section of the TSE. Second, the market capitalizations of the
stocks comprising the Index are very large. Specifically, the total
capitalization of the Index, as of March 31, 1994, was US$2.25
trillion, with the market capitalization of the individual stocks in
the Index ranging from a high of US$76.5 billion to a low of US$875
million, with a median value of US$3.3 billion and a mean of US$7.5
million. Third, no one particular stock or group of stocks dominates
the Index. Specifically, no single stock comprises more than 3.41
percent of the Index's total value, and the percentage weighting of the
five largest issues in the Index accounts for 15.14 percent of the
Index's value. Accordingly, the Commission believes it is appropriate
to classify the Index as broad-based.
In addition, because none of the Index component stocks are traded
in the United States in any form, and the primary market for component
stocks is closed throughout the CBOE's trading day, the Commission
believes it is not unreasonable for the Exchange to decide to begin
trading Index options at 8:00 a.m. (Chicago time).
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as Nikkei 300 Index options
(including full-value and reduced-value Index LEAPS), can commence on a
national securities 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
LEAPS will be subject to the same regulatory regime as the other
standardized options currently traded on the CBOE, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in Nikkei 300 Index options and full-value and reduced-
value Nikkei 300 Index LEAPS.
C. Surveillance
As a general matter, the Commission believes that comprehensive
surveillance sharing agreements between the relevant foreign and
domestic exchanges are important where an index product comprised of
foreign securities is to be traded in the United States. In most cases,
in the absence of such a comprehensive surveillance sharing agreement,
the Commission believes that it would not be possible to conclude that
a derivative product, such as a Nikkei 300 Index option, was not
readily susceptible to manipulation.
Although the CBOE and the TSE do not yet have a written
surveillance sharing agreement that covers the trading of Nikkei 300
Index options,\24\ a number of factors support approval of the proposal
at this time. First, while the size of an underlying market is not
determinative of whether a particular derivative product based on that
market is readily susceptible to manipulation, the size of the market
for the securities underlying the Nikkei 300 Index makes it less likely
that the proposed Index options are readily susceptible to
manipulation.\25\ In addition, the Commission notes that the TSE is
under the regulatory oversight of the Japanese Ministry of Finance
(``MOF''). The MOF has responsibility for both the Japanese securities
and derivatives markets. Accordingly, the Commission believes that the
ongoing oversight of the trading activity on the TSE by the MOF will
help to ensure that the trading of Nikkei 300 Index options will be
carefully monitored with a view toward preventing unnecessary market
disruptions.
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\24\The Exchange represents that it currently is pursuing a
surveillance sharing agreement with the TSE, which the Exchange
expects will enable it to better carry out its regulatory
responsibilities with respect to the surveillance of trading in the
stocks comprising the Index.
\25\In evaluating the manipulative potential of a proposed index
derivative product, as it relates to the securities that comprise
the index and the index product itself, the Commission has
considered several factors, including (1) the number of securities
comprising the index or group; (2) the capitalizations of those
securities; (3) the depth and liquidity of the group or index; (4)
the diversification of the group or index; (5) the manner in which
the index or group is weighted; and (6) the ability to conduct
surveillance on the product. See Securities Exchange Act Release No.
31016 (August 11, 1992), 57 FR 37012 (August 17, 1992).
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Finally, the Commission and the MOF have concluded a Memorandum of
Understanding (``MOU'') that provides a framework for mutual assistance
in investigatory and regulatory matters.\26\ Moreover, the Commission
also has a longstanding working relationship with the MOF on these
matters. Based on the longstanding working relationship between the
Commission and the MOF and the existence of the MOU, the Commission is
confident that it and the MOF could acquire information from one
another similar to that which would be available in the event that a
comprehensive surveillance sharing agreement were executed between the
CBOE and the TSE with respect to transactions in TSE-traded stocks
related to Nikkei 300 Index option transactions on the CBOE.\27\
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\26\See Memorandum of United States Securities and Exchange
Commission and the Securities Bureau of the Japanese Ministry of
Finance on the Sharing of Information, dated May 23, 1986.
\27\It is the Commission's expectation that this information
would include transaction, clearing, and customer information
necessary to conduct an investigation.
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Nevertheless, the Commission continues to believe strongly that a
comprehensive surveillance sharing agreement between the TSE and the
CBOE covering Nikkei 300 Index options would be an important measure to
deter and detect potential manipulations or other improper or illegal
trading involving Nikkei 300 Index options. Accordingly, the Commission
believes it is critical that the TSE and the CBOE continue to work
together to consummate a formal comprehensive surveillance sharing
agreement to cover Nikkei 300 Index options, and the component
securities, as soon as practicable.\28\
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\28\See supra note 24.
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D. Market Impact
The Commission believes that the listing and trading on the CBOE of
Nikkei 300 Index options, including full-value and reduced-value Index
LEAPS, will not adversely impact the securities markets in the United
States or Japan.\29\ First, as described above, the Index is broad-
based and presently is comprised of 300 stocks with no one stock
dominating the Index. Second, as noted above, the stocks contained in
the Index have large capitalizations and are actively-traded. Third,
the proposed position and exercise limits of 25,000 contracts on the
same side of the market, provided that no more than 15,000 of such
contracts are in series in the nearest expiration month, will serve to
minimize potential manipulation and market impact concerns. Lastly,
existing CBOE stock index options rules and surveillance procedures
will apply to options on the Index.
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\29\In addition, the CBOE and the Options Price Reporting
Authority (``OPRA'') have both represented that they have the
necessary systems capacity to support those new series of options
that would result from the introduction of Index options (including
full-value and reduced-value Index LEAPS). See Letter from Joseph P.
Corrigan, Executive Director, OPRA, to Eileen Smith, CBOE, dated
June 28, 1994.
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E. Accelerated Approval of Amendment No. 1
The Commission finds good cause for approving Amendment No. 1 to
the Exchange's proposed rule change prior to the thirtieth day after
the date of publication on notice of filing thereof in the Federal
Register. Amendment No. 1 reduces the proposed position limits with
respect to Nikkei 300 Index options from 50,000 contracts on the same
side of the market to 25,000 contracts (provided that no more than
15,000 contracts, as opposed to 30,000 contracts as originally
proposed, are in series in the nearest expiration month). By reducing
the position limits, this amendment will serve to protect investors and
the public interest, and further minimize the potential for
manipulation. Further, the proposal containing the higher position
limits was published for the full 21-day comment period, and no
comments were received. Therefore, the Commission finds that no new
regulatory issues are raised by Amendment No. 1. Accordingly, the
Commission believes it is consistent with Sections 19(b)(2) and 6(b)(5)
of the Act to approve Amendment No. 1 to the Exchange's proposal on an
accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 1 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to the foregoing that
are filed with the Commission, and all written communications relating
to the foregoing 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. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. Copies of such filings also will be available
for inspection and copying at the principal office of the above-
mentioned self-regulatory organization. All submissions should refer to
File No. SR-CBOE-94-14, and should be submitted by August 15, 1994.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\30\ that the proposed rule change (SR-CBOE-94-14), as amended, is
approved.
\30\15 U.S.C. Sec. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\31\
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\31\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17952 Filed 7-22-94; 8:45 am]
BILLING CODE 8010-01-M
