[Federal Register Volume 61, Number 159 (Thursday, August 15, 1996)]
[Notices]
[Pages 42455-42457]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-20788]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37540; File No. SR-CBOE-96-29]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by Chicago Board Options Exchange, Incorporated Relating to the
Exercise of American-style Index Options
August 8, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934, 15 U.S.C. 78s(b)(1), notice is hereby given that on April 26,
1996, the Chicago Board Options Exchange, Incorporated (``CBOE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the CBOE. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to adopt new CBOE Rule 24.18 which prohibits
the exercise of an American-style index option series after the holder
has entered into an offsetting closing sale (writing) transaction. 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, CBOE 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 CBOE has prepared summaries, set forth in sections
A, B, and C below, of the most significant aspects of such statements.
[[Page 42456]]
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
As noted in CBOE's Regulatory Circular RG 96-11,\1\ the rules and
procedures of The Options Clearing Corporation (``OCC'') permit a
holder of an American-style option to exercise that option at any time
up to the exercise cut-off time on any day, other than the final
trading day, even if the holder had entered into an offsetting closing
sale transaction earlier that day. This result stems from the fact that
on such days OCC processes opening purchase transactions and exercises
before it processes closing sales transactions, so that option
purchasers remain holders of their options on OCC's books for the
purpose of exercise without regard to their closing sales that day.
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\1\ See Securities Exchange Act Release No. 36797 (January 31,
1996), 61 FR 4691 (February 7, 1996) (File No. SR-CBOE-96-03).
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The Exchange is concerned that this result may be confusing to
investors--because it may give the appearance that investors are able
to exercise the same options which they have previously sold--and lead
to a perception that this result is unfair to writers of American-style
index options that are in the money by subjecting them to a potentially
increased ``timing risk'' of the type described under ``Special Risks
of Index Options'' on pages 73-74 of the risk disclosure document
entitled ``Characteristics and Risks of Standardized Options''
(February 1994).
Additionally, the Exchange believes that the average retail
customer might not understand how investors could exercise options
which they believed they no longer owned. The Exchange represents that,
during the period from November 1993, through December 1995, almost all
of the gross exercises in customers' accounts were effected at one
clearing firm on behalf of a single customer that is a foreign
professional trading account. The Exchange believes that retail
customers might view the gross exercise ability as giving professional
traders an unfair advantage over retail customers and that such
perception could lead to the diminished popularity of OEX options for
retail customers.\2\
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\2\ See Letter from Michael L. Meyer, Attorney, Schiff Hardin &
Waite, to John Ayanian, Attorney, Office of Market Supervision
(``OMS''), Division of Market Regulation, (``Market Regulation''),
Commission, dated June 17, 1996.
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To eliminate this possible perception of unfairness, the proposed
rule would prohibit CBOE members from effecting an exercise of an
American-style index option series, whether on the member's own behalf
or on behalf of a customer, if the member knew or had reason to know
that the exercise was for more option contracts than the ``net long
position'' of the account for which the exercise is to be made. For
this purpose, the ``net long position'' in an account is the net
position of the account in options of a given series at the opening of
business of the day of exercise, plus the total number of such options
purchased on that day in opening purchase transactions up to the time
of exercise, less the total number of such options sold on that day in
closing sale transactions up to the time of exercise. OEX options are
the only American-style index options now traded on CBOE, and thus are
the only options that would currently be affected by the proposed rule.
In order to prevent persons from circumventing the proposed rule by
designating a sale as ``opening'' so as to maintain a net long position
capable of being exercised, and the redesignating the sale as
``closing'' by means of an adjustment later in the day if in fact the
long position has not been exercised, the rule would prohibit a member
from adjusting the designation of an opening transaction to a closing
transaction except to remedy mistakes or errors made in good faith.
A market maker's transactions are not required to be marked as
opening or closing. Rather, a market maker's purchase and sales
transactions are netted by OCC every day after exercises are processed.
As a result, it is impossible to tell whether a particular transaction
by a market maker is intended as an opening or closing transaction.
Under OCC's processing procedures, unmarked market makers' transactions
are in effect treated as opening transactions prior to the processing
of exercises and as closing transactions thereafter. For the purpose of
applying the prohibition of the proposed rule, every market maker
transaction would be treated as a closing transaction to the extent the
market maker has pre-existing positions (including positions resulting
from transactions effected earlier that day) which could be netted
against the transaction. For example, if a market maker is long 10
option contracts of a series and sells 15 contracts of that series, the
sale will be deemed, under the proposed rule, to be a closing sale
transaction for 10 contracts and an opening sale transaction for 5
contracts, resulting in a net short position of 5 contracts. If the
market maker then purchases 20 contracts, the purchase will be deemed a
closing purchase for 5 contracts and an opening purchase for 15
contracts, resulting in a net long position of 15 contracts. Under the
proposed rule, the market maker would be permitted to exercise only
those 15 contracts. In the absence of the proposed rule, the market
maker would have been able to exercise 30 contracts, representing his
gross long position, before netting against this position the 15
contracts sold.
The Exchange notes that the proposed rule is not intended to affect
OCC's processing rules and procedures. If a member submitted an
exercise notice to OCC in violation of the proposed CBOE rule, the
exercise would be processed by OCC in accordance with its procedures.
In that case, the proposed CBOE rule would be enforced solely through
the Exchange's disciplinary procedures.
The Exchange emphasizes that the proposed rule has been adopted to
eliminate the perception that a holder's ability to exercise options
that had been the subject of closing transactions might create enhanced
risk to writers of OEX options. However, it is not clear that the
writers of in-the-money OEX options will, in fact, be subject to less
risk as the result of the proposed rule. Such writers should continue
to anticipate that they could be assigned an exercise of their options
positions, especially as expiration approaches. (For example, the
proposed rule would not prohibit the exercise of an OEX option held in
a net long position before--even seconds before--an opening sales
transaction in that option has been effected.) It is possible that the
early exercise of OEX options will continue at the same level after the
proposed rule becomes effective as before.
Upon the effectiveness of the proposed rule, the Exchange would
modify Regulatory Circular RG 96-11 to describe the proposed rule.
Three examples were given in the Regulatory Circular as originally
published on January 17, 1996. These three examples would be modified
to read as follows (italicized language is proposed to be added;
language in brackets is proposed to be deleted):
Example 1: Investor X is long 15 call option contracts of a
series at the opening of a trading day other than the final trading
day. During that day, X purchases 20 contracts of that series in
opening purchase transactions and sells 10 contracts in closing sale
transactions. X will be able under OCC's rules to exercise 35
contracts of that series that day. However, in the case of American-
style index options only (i.e., OEX options), CBOE Rule 24.18 would
prohibit a member who know or has reason to know of the closing sale
transactions from exercising on X's behalf more than the net long
position of
[[Page 42457]]
25 contracts at any time at or after the closing sale of 10
contracts.
Example 2: Investor Y is short 20 call option contracts of a
series at the opening of such a trading day. During the day, Z
purchases 20 contracts of that series in opening purchase
transactions. Y will be able to exercise 20 contracts of that series
that day, and will remain short the 20 contracts. However, in the
case of OEX option contracts, if Y's transactions had been effected
in a market-marker's account, the purchase would have been deemed to
have been a closing transaction for the purposes of CBOE Rule 24.18
and would have been offset by Y's short position, resulting in no
net long position to exercise.
Example 3: Market-maker Z is short 100 call options contracts at
the opening of that trading day. During the day, X purchases 100
contracts and sells 100 contracts of that series, and Z does not
mark the transactions as opening or closing]. Z will be able to
exercise 100 contracts of that series that day under OCC's rules.
However, in the case of OEX option contracts, CBOE Rule 24.18 would
prohibit Z from exercising any contracts without regard to the sale
transactions, since the purchase transactions would be deemed to be
closing transactions, and would be netted against his beginning
short position, resulting in no net long position to exercise.
The Exchange believes that the proposed rule change is consistent
with, and furthers the objectives of, Section 6(b)(5) of the Securities
Exchange Act of 1934 in that, by eliminating a possible source of
confusion to investors concerning the terms applicable to the exercise
of American-style index options, it will promote just and equitable
principles of trade and contribute to the protection of investors and
the public interest.
B. Self-Regulatory Organization's Statement on Burden on Competition
CBOE does not believe that the proposed rule change will impose any
burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received from Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
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. 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 Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such filing will also be available
for inspection and copying at the principal office of CBOE. All
submissions should refer to File No. SR-CBOE-96-29 and should be
submitted by September 5, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\3\
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\3\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-20788 Filed 8-14-96; 8:45 am]
BILLING CODE 8010-01-M
