[Federal Register Volume 63, Number 131 (Thursday, July 9, 1998)]
[Notices]
[Pages 37153-37155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-18146]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40158; File No. SR-CBOE-98-23]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Chicago Board Options Exchange, Inc., Relating to the
Elimination of Position and Exercise Limits for Options on Broad-Based
Indexes
July 1, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Exchange Act'' or ``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on June 11, 1998, the Chicago Board Options
Exchange, Inc. (``CBOE'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission'' or ``SEC'') the proposed rule
change as described in Items I, II and III below, which Items have been
prepared by the self-regulatory organization. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The CBOE proposes to eliminate position and exercise limits for
broad-based index options. The current reporting procedures, with
slight modifications, which serve to identify large option holdings and
hedging information, will remain in place.
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
1. Purpose
The CBOE is proposing the elimination of position and exercise
limits for broadbased index options for the reasons detailed below. The
Exchange will, however, still require that member organizations file
reports with the Exchange in the event that they maintain proprietary
or customer positions in excess of Exchange established reporting
thresholds in the different broad-based index option products.
Manipulation. The CBOE believes that position and exercise limits
in broad-based index options no longer serve their stated purpose. The
Commission has stated that:
Since the inception of standardized options trading, the options
exchanges have had rules imposing limits on the aggregate number of
options contracts that a member or customer could hold or exercise.
These rules are intended to prevent the establishment of options
positions that can be used or might create incentives to manipulate
or disrupt the underlying market so as to benefit the options
position. In particular, position and exercise limits are designed
to minimize the potential for mini-manipulations and for corners or
squeezes of the underlying market. In addition such limits serve to
reduce the possibility for disruption of the options market itself,
especially in illiquid options classes.\3\
\3\ Exchange Act Release No. 39489 (December 24, 1997), 63 FR
276 (January 5, 1998) (SR-CBOE-97-11) (order approving an increase
in OEX position and exercise limits).
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On the fifteenth anniversary of listed index options trading, the
Exchange believes that the size of the market underlying broad-based
index options is so large as to dispel any concerns regarding market
manipulation. To date, there has not been a single disciplinary action
involving manipulation in any broad-based index product listed on the
Exchange. The Exchange believes that its fifteen years of experience
conducting surveillance of index options and program trading activity
is sufficient to identify improper activity. The CBOE believes that
routine oversight inspections of CBOE's regulatory programs by the
Commission have not uncovered any inconsistencies or shortcomings in
the manner in which index option surveillance is conducted. These
procedures entail a daily monitoring of market movements via automated
surveillance techniques to identify unusual activity in both the
options and underlying stock basket components. Moreover, the CBOE
believes that current NYSE Market on Open and Market on Close
procedures facilitate the orderly unwinding of large index program
trades.\4\ Further, the significant increases in unhedged options
capital charges resulting from the September 1997 adoption of risk-
based haircuts and the high margin requirements applicable to these
products under Exchange rules serves as a more effective protection
than position limits ever have or ever could.\5\
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\4\ See NYSE Informational Memo Number 96-34 (November 8, 1996).
\5\ See Exchange Act Release No. 34-38248 (February 6, 1997), 62
FR 6474 (February 12, 1997) (adopting Risk-Based Haircuts); and CBOE
Rule 24.11 Margins.
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Competition. The Commission has stated that ``limits must not be
established at levels that are so low as to discourage participation in
the options market by institutions and other investors with substantial
hedging needs or to prevent specialists and market-makers from
adequately meeting their obligations to maintain a fair and orderly
market.'' \6\ However, in today's market, the Exchange believes that
position and exercise limits severely hamper CBOE's ability to compete
with the OTC and futures markets. Investors who trade listed options on
the CBOE are placed at a serious disadvantage in comparison to the OTC
market where index options and other types of index based derivaties
(e.g., forwards and swaps) are not subject to position and exercise
limits. Member firms continue to express concern to the Exchange that
position limits on CBOE products are an impediment to their business
and that they have no choice but to move their
[[Page 37154]]
business to the OTC market where position limits are not an issue.
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\6\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. At 189-91
(Comm. Print 1978).
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Position and exercise limits restrict legitimate options use. The
Exchange believes that the current base limit for broad-based index
options \7\ is not adequate for the hedging needs of institutions which
engage in trading strategies differing from those covered under the
index hedge exemption policy (e.g., delta hedges, OTC vs. listed
hedges). Moreover, the current index hedge exemption, which requires a
daily monitoring of positions and reports to the exchange is too
cumbersome. CBOE and member firm compliance staff devote an inordinate
amount of time monitoring a firm's position, when in fact, the firm is
more than adequately capitalized to carry such sizeable option
positions. The CBOE believes that, with the elimination of position
limits for these products, staff resources could be better utilized
elsewhere.
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\7\ The base limits for broad-based index options are set forth
in paragraph (a) of Rule 24.4. The limits range from 25,000
contracts in OEX to 1,000,000 contracts on options based on the Dow
Jones Industrial Average (``DJIA''), which is a contract that is
based on one-one hundredth of the value of the DJIA.
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Financial requirements. The Exchange believes that financial
requirements imposed by the Exchange and by the Commission adequately
address concerns that a member or its customer may try to maintain an
inordinately large unhedged position in a broad-based index option.
Current margin, and risk-based haircut methodologies serve to limit the
size of positions maintained by any one account by increasing the
margin and/or capital that a member must maintain for a large position
held by itself or by its customer.\8\ It should also be noted that the
Exchange has the authority under paragraph (h) of Rules 12.3 and 12.10
to impose a higher margin requirement upon the member of member
organization when the Exchange determines a higher requirement is
warranted. In addition, the Commission's net capital rule, Rule 15c3-1
under the Exchange Act, imposes a capital charge on members to the
extent of any margin deficiency resulting from the higher margin
requirement.
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\8\ Exchange Act Rule 15c3-1 requires a capital charge equal to
the maximum potential loss on a broker-dealer's aggregate index
position over a +(-) 10% market move. Exchange margin rules require
margin on naked index options which are in or at-the-money equal to
a 15% move in the underlying index; and a minimum 10% charge for
naked out-of-the money contracts. At an index value of 9,000 this
approximates to a $135,000 to $90,000 requirement per each unhedged
contract. This compares to an approximate $36,000 requirement for an
equivalent index futures contract position.
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FLEX Equity options. In 1997, the SEC approved the elimination of
position and exercise limits in FLEX Equity options under a two-year
pilot program.\9\ To date, there have been no adverse effects on the
market as a result of the elimination of position and exercise limits.
Member firms have commented favorably on this change and believe that
it is the first step towards eliminating position and exercise limits
in all option products. In its release approving the elimination of
FLEX equity option limits for a two-year pilot, period, the Commission
stated that the elimination of position limits will allow the listed
options markets to better compete with the OTC market.\10\
\9\ Exchange Act Release No. 39032 (September 9, 1997), 62 FR
48683 (September 16, 1997) (order approving SR-CBOE-96-79).
\10\ Id.
[T]he elimination of position and exercise limits for FLEX
equity options allows the Exchanges to better compete with the
growing OTC market in customized equity options, thereby encouraging
fair competition among brokers and exchange markets. The attributes
of the Exchanges' options markets 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,
parameters and procedures for clearance and settlement, and the
guarantee of the OCC for all contracts traded on the Exchanges.\11\
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\11\ Id. at 48685. The Commission notes that approval of the
elimination of position and exercise limits for FLEX equity options
for a two-year pilot period and was based on several other factors
including, in large part, additional safeguards adopted by the
exchanges to allow them to monitor large options positions.
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Reporting requirements. The Exchange will require that each member
or member organization that maintains a position on the same side of
the market in excess of 100,000 contracts in any broad based index
option class, for its own account or for the account of a customer
report certain information. This data would include, but would not be
limited to, the option position, whether such position is hedged, and,
if so, a description of the hedge and if applicable, the collateral
used to carry the position. Exchange market-makers would continue to be
exempt from this reporting requirement as market-maker information can
be accessed through the Exchange's market surveillance systems. The
Exchange proposes to increase the reporting level to 100,000 contracts
\12\ from the current levels (i.e., 45,000 for SPX and 65,000 for OEX)
for the following reasons. To date, information collected shows that
member firms and customer accounts are hedged with either futures,
options on futures or index options. This information can be obtained
either through in-house surveillance systems, from the Chicago
Mercantile Exchange or by contacting the member firm. Considering that
the CBOE currently lists sixteen (16) different broad-based index
option products, imposing a uniform reporting number will eliminate
confusion. The CBOE believes that an increase in the reporting level to
100,000 contracts for all broad based index products will result in the
collection of more meaningful information, and will lessen the
administrative burden for member firms and for the Exchange staff. In
addition, the general reporting requirement for customer accounts that
maintain a position in excess of 200 contracts will remain at this
level for broad based index options.\13\ Last, it is important to note
that the proposed 100,000 contract reporting requirement is above and
beyond what is currently required in the OTC market. NASD member firms
are only required to report index option positions in excess of 200
contracts and are not required to report any related hedging
information.
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\12\ Currently only OEX and SPX are subject to reporting
requirements beyond those required by Exchange Rule 4.13. The
Exchange would expand this revised reporting requirement to all
broad-based index options.
\13\ See Exchange Rule 4.13 Reports Related to Position Limits.
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2. Basis
The Exchange believes that the proposal is consistent with Section
6(b)\14\ of the Act, in general, and Section 6(b)(5)\15\ of the Act, in
particular, in that it is designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to foster cooperation and coordination with
persons engaged in facilitating transactions in securities, and to
remove impediments to and perfect the mechanism of a free and open
market and a national market system.
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\14\ 15 U.S.C. 78f(b).
\15\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange believes that the proposed rule changes are consistent
with Section 6(b) of the Act in general, and further the objectives of
Section 6(b)(5), in particular, in that they are designed to promote
just and equitable principles of trade and to protect investors and the
public interest.
[[Page 37155]]
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments on the proposed rule change were neither solicited
nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. 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 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 in the
Commission's Public Reference Room, located at the above address.
Copies of such filing will also be available for inspection and copying
at the principal office of the self-regulatory organization. All
submissions should refer to File No. SR-CBOE-98-23 and should be
submitted by July 30, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-18146 Filed 7-8-98; 8:45 am]
BILLING CODE 8010-01-M
