[Federal Register Volume 59, Number 7 (Tuesday, January 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 93-622]


[[Page Unknown]]

[Federal Register: January 11, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33428; File No. SR-CBOE-93-42]

 

Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving a Proposed Rule Change by the Chicago Board 
Options Exchange, Inc. Relating to the Listing of Regular and Long-Term 
Options on the Nasdaq 100 Index

January 5, 1994.

I. Introduction

    On September 22, 1993, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'') or ``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 index options on the Nasdaq 100 Index (``Nasdaq Index'' or 
``Index'').\3\ The proposed rule change was published for comment in 
Securities Exchange Act Release No. 33166 (November 8, 1993), 58 FR 
60710 (November 17, 1993). No comment letters were received on the 
proposed rule change. This order approves the Exchange's proposal.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
    \3\The CBOE amended the rule change proposal on October 27, 1993 
to include an updated list of the securities comprising the Nasdaq 
100 Index. This list of securities became the basis of calculations 
of the value of the Nasdaq 100 Index as of October 26, 1993. See 
letter from Robert B. Wilcox, Jr., Schiff Hardin & Waite to Michael 
A. Walinskas, Staff Attorney, Division of Market Regulation, SEC, 
dated October 27, 1993 (``Amendment No. 1'').
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II. Description of Proposal

A. General

    The CBOE proposes to trade options on the Nasdaq Index, a stock 
index calculated and maintained by the Nasdaq Stock Market, Inc. 
(``Nasdaq''), a subsidiary of the National Association of Securities 
Dealers, Inc. (``NASD''). The CBOE also proposes to list long-term 
options (``LEAPS'') on the Index. Index LEAPS will trade independent of 
and in addition to regular Index options traded on the Exchange.

B. Composition of the Index

    The Index contains one hundred of the largest non-financial 
securities issued by U.S. issuers and traded on the Nasdaq National 
Market. Nasdaq will use a capitalization-weighted method to calculate 
the Index.\4\ As of January 3, 1994 the Index was at 398.28.
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    \4\See infra Section D entitled ``Calculation of the Index'' for 
a description of this calculation method.
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    As of October 25, 1993, the market capitalizations of the 
individual stocks in the Index ranged from a high of $26.8 billion to a 
low of $437 million, with the mean and median being $2.54 billion and 
$1.3 billion, respectively. The market capitalization of all the stocks 
in the Index was $253.8 billion. The total number of shares outstanding 
for the stocks in the Index ranged from a high of 536 million shares to 
a low of 15.1 million shares. The average price per share of the stocks 
in the Index, for a six-month period between April 1, 1993 and 
September 1, 1993, ranged from a high of $103.29 to a low of $6.15. In 
addition, the average daily trading volume of the stocks in the Index, 
for the same six-month period, ranged from a high of 2.853 million 
shares per day to a low of 10,579 shares per day, with the mean and 
median being 631,631 and 407,639 shares, respectively. Lastly, no one 
stock comprised more than 10.54% of the Index's total value and the 
percentage weighting of the five largest issues in the Index accounted 
for 33.27% of the Index's value. The percentage weighting of the lowest 
weighted stock was 0.17% of the Index and the percentage weighting of 
the five smallest issues in the Index accounted for 1.12% of the 
Index's value.

C. Maintenance

    The Index will be maintained by Nasdaq. Nasdaq has notified the 
CBOE that it recently updated the list of securities comprising the 
Index and will continue to make revisions to the Index on an annual 
basis. Nasdaq also, in its discretion, will make special adjustments to 
the securities comprising the Index to reflect such events as stock 
splits or reverse splits, spinoffs, stock dividends, reorganizations, 
recapitalizations, and similar events, upon their occurrence.

D. Calculation of the Index

    The Index will be calculated using a capitalization-weighting 
methodology. The representation of each security in the Index will be 
proportional to the security's last sale price times the total number 
of shares outstanding, in relation to the total market value of all of 
the securities in the Index. The level of the Index is calculated as 
follows:

TN11JA94.005

    The numerical value of the Index was established at 250 prior to 
the opening of the market on February 1, 1985. At the close of the 
market on December 31, 1993, the Index was at 796.56. Then, effective 
January 3, 1994, the Index value was halved, creating an Index level of 
398.28 at the market opening on January 3, 1994. The Index is 
calculated and disseminated every fifteen seconds to market information 
vendors. Nasdaq will also calculate the exercise settlement value for 
each expiring series of Nasdaq Index options and make this value 
available to the CBOE for use by the Options Clearing Corporation in 
effecting settlement of exercises and assignments of the options.
    The Index value, for purposes of setting outstanding Index options 
contracts upon expiration, will be calculated based upon the regular 
way opening sale prices for each of the Index's component stocks on the 
last trading day prior to expiration.\5\ Once all of the component 
stocks have opened, the value of the Index will be determined and that 
value will be used as the final settlement value for expiring Index 
options contracts. If any of the component stocks do not open for 
trading on the last trading day before expiration, then the last 
reported sale price of such security will be used in any case where 
that security does not trade on that day.\6\
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    \5\See CBEO Rule 24.9(a)(4).
    \6\Id.
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E. Contract Specifications

    The proposed options on the Index will be cash-settled, European-
style options.\7\ Standard options trading hours (9:30 a.m. to 4:15 
p.m. New York time) will apply to the contracts. The Index multiplier 
will be 100. The strike price interval will be $5.00 for full-value 
Index options with a duration of one year or less to expiration.\8\ The 
Exchange intends to list up to three near-term calendar months and 
three additional calendar months at three month intervals.\9\ As 
described in more detail below, the Exchange also intends to list Index 
LEAPS that will expire twelve to thirty-six months from the date of 
their issuance.
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    \7\A European-style option can be exercised only during a 
specified period before the option expires.
    \8\For a description of the strike price intervals for full-
value and reduced-value Index LEAPS, See, Section F, infra.
    \9\See CBOE Rule 24.9(a)(2).
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    Index options (including full-value and reduced-value Index LEAPS) 
will expire on the Saturday following the third Friday of the 
expiration month (``Expiration Friday''). Since options on the Index 
will settle based upon the opening prices of the component stocks on 
the last trading day before expiration (normally a Friday), the last 
trading day for an expiring Index option series will normally be the 
second to the last business day before expiration (normally a 
Thursday).\10\
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    \10\See notes 5 and 6, supra.
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F. Listing of Long-Term Options on the Full-Value or Reduced-Value 
Nasdaq Index

    The Exchange may list LEAPS that expire 12 to 36 months from date 
of issuance on the full-value Nasdaq Index or a reduced-value Nasdaq 
Index that will be computed on one-tenth the value of the full-value 
Index.\11\ The current and closing Index value for reduced-value Nasdaq 
LEAPS will be computed by dividing the value of the full-value Index by 
10 and rounding the resulting figure to the nearest one-hundredth. For 
example, a Index value of 185.46 would be 18.55 for the Index LEAPS and 
185.43 would become 18.54. The reduced-value LEAPS will have a 
European-style exercise and will be subject to the same rules that 
govern the trading of all the Exchange's index options, including sales 
practice rules, margin requirements and floor trading procedures. The 
strike price interval for the reduced-value Index LEAPS will be no less 
than $2.50 instead of $5.00.
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    \11\See CBOE Rule 24.9(b).
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    The same Exchange rules which are applicable to the trading of 
full-value LEAPS will be applicable to the trading of reduced-value 
Index LEAPS. For example, both full-value and reduced-value Index LEAPS 
may expire from 12 to 36 months from the date of issuance, and there 
may be up to six expiration months beyond one year to expiration. 
Moreover, either full-value or reduced-value Index LEAPS may be issued 
at six month intervals and new strike prices will either be near or 
bracketing the current Index value. Strike price interval, bid/ask 
differential, and continuity rules will not apply to the trading of the 
full-value or reduced-value Index LEAPS until their time to expiration 
is less than 12 months. The strike price interval for reduced-value 
Index LEAPS will be no less than $2.50, instead of $5.00 for full-value 
Index LEAPS. Lastly, additional LEAPS series may be added when the 
value of the underlying Index increases or decreases by ten to fifteen 
percent.

G. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Position limits for the Index options Index LEAPS 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.\12\ Exercise limits will be set at the same level as 
position limits.\13\ CBOE hedge exemption provisions will apply to 
Index options and Index LEAPS.\14\ Also, for purposes of determining 
whether a given position in reduced-value Index options complies with 
applicable position and exercise limits, positions in reduced-value 
Index options will be aggregated with positions in the full-value Index 
options. For these purposes, ten reduced-value contracts will equal one 
full-value contract for purposes of aggregating these positions.
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    \12\See CBOE 24.4.
    \13\See CBOE Rule 24.5.
    \14\See CBOE Rule 24.4(a) and Interpretation .01 to Rule 24.4.
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    Exchange rules applicable to the Nasdaq Index options will be 
identical to the rules applicable to other broad-based index options 
for purposes of trading rotations, halts, and suspensions,\15\ and 
margin treatment.\16\
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    \15\See CBOE Rule 24.7.
    \16\See CBOE Rule 24.11.
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H. Surveillance

    The Exchange will use the same surveillance procedures currently 
utilized for each of the Exchange's other index options to monitor 
trading in Nasdaq Index options and Index LEAPS. These procedures 
include complete access to trading activity in the underlying 
securities.

I. Disclaimer

    The CBOE has proposed placing in its Rules a disclaimer of 
liability made by Nasdaq and its affiliates that Nasdaq and such 
affiliates do not make any warranties as to the results obtained from 
the Nasdaq index, any opening, intra-day or closing value therefore, 
any related data, or any errors or delays in calculating or 
disseminating the Index, in connection with the trading of option 
contracts based on the Index. The disclaimer is similar to other 
disclaimers made on behalf of Standard & Poor's Frank Russell Company, 
and LIFFE Administration & Management, that are currently in the CBOE's 
Rules.\17\
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    \17\See CBOE Rule 24.14.
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III. Commission Findings and Conclusions

    The Commission has reviewed the proposal to list and trade Nasdaq 
Index options and Index LEAPS. As discussed below, the Commission 
believes 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. In particular, the Index 
is broad-based, the proposed options are designed to reduce the 
potential for manipulation, and the proposal to list and trade Nasdaq 
Index options and Index LEAPS is consistent with the CBOE's obligation 
to promote investor protection.\18\ The Commission finds that the 
trading of options on the Index, including full-value and reduced-value 
Index LEAPS, will permit investors to participate in the price 
movements of the 100 securities on which the Index is based. Further, 
trading of options on the Index will allow investors holding positions 
in some or all of the securities underlying the Index to hedge the 
risks associated with their portfolios. Accordingly, the Commission, 
believes the Nasdaq Index options will provide investors with an 
important trading and hedging mechanism that should reflect accurately 
the overall movement of 100 of the largest non-financial stocks listed 
on the Nasdaq National Market. By broadening the hedging and investment 
opportunities of investors, the Commission believes that the trading of 
Nasdaq Index options will serve to protect investors, promote the 
public interest, and contribute to the maintenance of fair and orderly 
markets.\19\
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    \18\The CBOE is a member of the Intermarket Surveillance Group 
(``ISG''), which was formed on July 14, 1983 to, among other things, 
coordinate more effectively surveillance and investigative 
information sharing arrangements in the stock and options markets. 
See Intermarket Surveillance Group Agreement, July 14, 1983. The 
most recent amendment to the ISG Agreement, which incorporates the 
original agreement and all amendments made thereafter, was signed by 
ISG members on January 29, 1990. See Second Amendment to the 
Intermarket Surveillance Group Agreement, January 29, 1990. The 
Commission understands that the ISG Agreement, as amended, covers 
investigations and inquiries regarding trading activity in Nasdaq 
Index options and component securities.
    \19\Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option or warrant 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 Nasdaq Index will provide investors 
with a hedging vehicle that should reflect the overall movement of 
100 of the largest non-financial stocks listed on the Nasdaq 
National Market. The Commission also believes that these options 
will provide investors with a means by which to make investment 
decisions in the utilities equity market, allowing them to establish 
positions or increase existing positions in utilities stocks in a 
cost effective manner.
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    The trading of options on the Nasdaq Index, including the trading 
of full-value and reduced-value Index LEAPS, however, raises several 
concerns, namely issues related to index design, customer protection, 
surveillance, and market impact. The Commission believes, for the 
reasons discussed below, that the CBOE has addressed these concerns 
adequately.

A. Index Design and Structure

    The Commission finds that the Nasdaq Index and reduced-value Nasdaq 
Index are broad-based indices, and thus it is appropriate to permit 
Exchange rules applicable to the trading of broad-based index options 
to apply to the Index options, including Index LEAPS. Specifically, the 
Commission believes the Index is broad-based because it reflects a 
substantial segment of the U.S. equities market. In addition, the basic 
character of the reduced-value Nasdaq Index, which is comprised of the 
same component securities as the Nasdaq Index and calculated by 
dividing the Nasdaq Index by ten, is essentially identical to the 
Nasdaq Index.
    The Commission also finds 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 Index represents and consists of the common stock values of 
100 actively traded U.S. companies. Second, no one particular stock or 
group of stocks dominates the Index. Specifically, no one stock 
comprises more than 10.54% of the Index's total value and the 
percentage weighting of the five largest issues in the Index accounts 
for 33.27% of the Index's value. Third, the overwhelming majority of 
the stocks that comprise the Index are actively traded, with a mean and 
median average daily trading volume of 631,631 and 407,639 shares, 
respectively. Fourth, the market capitalizations of the stocks in the 
Index are very large, ranging from a high of $26.8 billion to a low of 
$437 million as of October 25, 1993, with the mean and median being 
$2.54 billion and $1.3 billion, respectively. Fifth, the Index is 
comprised of stocks representing a diverse group of industries, the 
most heavily represented by Index weight including computer software 
products and service, semiconductors, telephone equipment and service, 
broadcasting, and retail. Sixth, 97 out of the 100 component stocks in 
the Index, comprising 98.82% of the weighting of the Index, currently 
are eligible for options trading.\20\ Finally, the Commission believes 
that, as discussed below, existing mechanisms to monitor trading 
activity in those securities will help deter as well as detect illegal 
trading activity involving the index option.
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    \20\The CBOE's options listing standards, which are uniform 
among the options exchanges, provide that a security underlying an 
option must, among other things, meet the following requirements: 
(1) The public float must be at least 7,000,000; (2) there must be a 
minimum of 2,000 stockholders; (3) trading volume must have been at 
least 2.4 million over the preceding twelve months; and (4) the 
market price must have been at least $7.50 for a majority of the 
business days during the preceding three calendar months. See CBOE 
Rule 5.3, Interpretation .01.
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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 Nasdaq Index options 
(including full-value and reduced-value 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 Nasdaq Index options and Nasdaq Index LEAPS.

C. Surveillance

    The Commission generally believes that a surveillance sharing 
agreement between an exchange proposing to list a stock index 
derivative 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.\21\ In this regard, 
the NASD, which currently is the primary market for all of the Index's 
component securities, is a member of the Intermarket Surveillance Group 
(``ISG''), which provides for the exchange of all necessary 
surveillance information.\22\
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    \21\See Securities Exchange Act Release No. 31243, 57 FR 45849 
(October 5, 1992).
    \22\See note 18, supra.
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D. Market Impact

    The Commission believes that the listing and trading on the CBOE of 
Nasdaq Index options, including full-value and reduced-value Index 
LEAPS, will not adversely impact the underlying securities markets.\23\ 
First, as described above, the Index is broad-based and comprised of 
100 stocks with no one stock dominating the Index. Second, as noted 
above, the stocks contained in the Index have relatively large 
capitalizations and are relatively actively traded. Third, the 25,000 
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 will be issued and guaranteed by the Options Clearing 
Corporation just like any other standardized option traded in the 
United States. Fifth, existing CBOE stock index options rules and 
surveillance procedures will apply to Nasdaq Index options.
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    \23\In addition, the CBOE has represented that the CBOE and the 
Options Price Reporting Authority (``OPRA'') have the necessary 
systems capacity to support those new series of index options that 
would result from the introduction of Index options and Index LEAPS. 
See letter from Charles J. Henry, President and Chief Operating 
Officer, CBOE, to Sharon Lawson, Assistant Director, Division of 
Market Regulation, SEC, dated January 4, 1993 and memorandum from 
Joe Corrigan, Executive Director, OPRA, to Eileen Smith, CBOE, dated 
January 4, 1993.
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    Lastly, the Commission believes that settling expiring Nasdaq Index 
options (including full-value and reduced-value Index LEAPS) based on 
the opening prices of component securities is reasonable and consistent 
with the Act. As noted in other contexts, valuing expiring index 
options for exercise settlement purposes based on opening prices rather 
than closing prices may help reduce adverse effects on the securities 
underlying options on the Index.\24\
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    \24\Securities Exchange Act Release No. 30944, 57 FR 33376 (July 
28, 1992).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\25\ that the proposed rule change (SR-CBOE-93-42) is approved.
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    \25\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
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    \26\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 93-622 Filed 1-10-93; 8:45 am]
BILLING CODE 8010-01-M