[Federal Register Volume 59, Number 14 (Friday, January 21, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-1429]


[[Page Unknown]]

[Federal Register: January 21, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33473; File No. SR-CBOE-93-50]

 

Self-Regulatory Organizations; Order Granting Accelerated 
Approval of and Notice of Filing and an Order Granting Accelerated 
Approval to Amendment No. 1 to a Proposed Rule Change by the Chicago 
Board Options Exchange, Inc. Relating to the Listing of Options and 
Long-Term Options on the CBOE Telecommunications Index and Long-Term 
Options on a Reduced-Value Telecommunications Index

January 13, 1994.

I. Introduction

    On October 27, 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 CBOE Telecommunications Index 
(``Telecommunications Index'' or ``Index'').\3\ Notice of the proposal 
appeared in the Federal Register on December 16, 1993.\4\ 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 (1992).
    \3\On January 6, 1994, the CBOE amended the proposal in order to 
request accelerated approval of the proposal pursuant to section 
19(b)(2) of the Act, asserting that the proposal does not raise 
regulatory concerns that have not been previously been addressed by 
the Commission in its consideration and approval of the trading of 
options on a telecommunications index on the American Stock 
Exchange, Inc. (``Amex'') (``Amendment No. 1). See note 29, infra.
    \4\See Securities Exchange Act Release No. 33313 (December 9, 
1993), 58 FR 65744.
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II. Description of Proposal

A. General

    The CBOE proposes to list and trade options on the CBOE 
Telecommunications Index, an index developed by the CBOE. The CBOE also 
proposes to list either long-term options on the full-value Index or 
long-term options on a reduced-value Index that will be computed at 
one-tenth of the value of the Telecommunications Index 
(``Telecommunications LEAPS'' or ``Index LEAPS'').\5\ 
Telecommunications LEAPS will trade independent of and in addition to 
regular Telecommunications Index options traded on the Exchange.\6\
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    \5\LEAPS is an acronym for Long-Term Equity Anticipation 
Securities. LEAPS are long term index option series that expire from 
twelve to thirty-six months from their date of issuance. See CBOE 
rule 24.9(b)(1).
    \6\According to the CBOE, the S&P Telecommunications Index 
represents a segment of the U.S. equity market that is not currently 
represented in the derivative markets and, as such, the CBOE 
concludes, should offer investors a low-cost means to achieve 
diversification of their portfolios toward or away from the 
telecommunications industry. The CBOE believes the Index will 
provide retail and institutional investors with a means to benefit 
from their forecasts of that industry's market performance. Options 
on the Index also can be utilized by portfolio managers and 
investors to provide a performance measure and evaluation guide for 
passively or actively managed telecommunications industry funds, as 
well as a means of hedging the risks of investing in the 
telecommunications industry.
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B. Composition of the Index

    The Index is based on twenty-five telecommunications industry 
stocks. Eleven of those stocks currently trade on the New York Stock 
Exchange, Inc. (``NYSE''), two trade on the American Stock Exchange, 
Inc. (``Amex''), and twelve trade through the facilities of the 
National Association of Securities Dealers Automated Quotation System 
(``NASDAQ'').\7\ The Index is price-weighted and will be calculated on 
a real-time basis using last sale prices.
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    \7\All twelve NASDAQ component stocks are currently qualified 
for and traded on the NASDAQ National Market.
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    As of December 31, 1993, the Index was at 153.59. As of October 20, 
1993, the market capitalizations of the individual stocks in the Index 
ranged from a high of $81.192 billion to a low of $808.32 million, with 
the mean and median being $15.027 billion and $11.4 billion, 
respectively. The market capitalization of all the stocks in the Index 
was $375.68 billion. The total number of shares outstanding for the 
stocks in the Index ranged from a high of 1.348 billion shares to a low 
of 17.12 million shares. The average price per share of the stocks in 
the Index, for a six-month period between April 1 and September 30, 
1993, ranged from a high of $80.52 to a low of $23.15. In addition, the 
average daily trading volume of the stocks in the Index, for the same 
six-month period, ranged from a high of 1.847 million shares per day to 
a low of 70,730 shares per day, with the mean and median being 604,462 
and 457,294 shares, respectively. Lastly, no one stock comprised more 
than 6.91% of the Index's total value and the percentage weighting of 
the five largest issues in the Index accounted for 27.77% of the 
Index's value. The percentage weighting of the lowest weighted stock 
was 2.27% of the Index and the percentage weighting of the five 
smallest issues in the Index accounted for 12.27% of the Index's value.

C. Maintenance

    The Index will be maintained by the CBOE. The CBOE may change the 
composition of the Index at any time to reflect the conditions in the 
telecommunications industry. If it becomes necessary to replace a stock 
in the Index, the Exchange represents that it will make every effort to 
add new stocks that are representative of the telecommunications 
industry and will take into account a stock's capitalization, 
liquidity, volatility, and name recognition. Further, stocks may be 
replaced in the event of certain corporate events, such as takeovers or 
mergers, that change the nature of the security. If, however, the 
Exchange determines to increase the number of Index component stocks to 
greater than thirty-three or reduce the number of Index component 
stocks to fewer than seventeen, the proposal provides that the CBOE 
will submit a rule filing with the Commission pursuant to section 19(b) 
of the Act. In addition, in choosing replacement stocks for the Index, 
the CBOE will be required to ensure that at least 90% of the weight of 
the Index continues to be made up of stocks that are eligible for 
standardized options trading.\8\
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    \8\See note 23, infra.
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D. Applicability of CBOE Rules Regarding Index Options

    Except as modified by this order, the rules in Chapter XXIV of the 
CBOE Rules will be applicable to Telecommunications Index options. 
Those rules address, among other things, the applicable position and 
exercise limits, policies regarding trading halts and suspensions, and 
margin treatment for both broad and narrow based index options.

E. Calculation of the Index

    The CBOE Telecommunications Index is a price-weighted index and 
reflects changes in the prices of the Index component stocks relative 
to the Index's base date. Specifically, the Index value is calculated 
by adding the prices of the component stocks and then dividing this 
summation by a divisor that is equal to the number of stocks in the 
Index to get the average price. To maintain the continuity of the 
Index, the divisor will be adjusted to reflect non-market changes in 
the prices of the component securities as well as changes in the 
composition of the Index. Changes which may result in divisor 
adjustments include, but are not limited to, stock splits and 
dividends, spin-offs, certain rights issuances, and mergers and 
acquisitions.
    The Index will be calculated continuously and will be disseminated 
to the Options Price Reporting Authority (``OPRA'') every fifteen 
seconds by the CBOE, based on the last-sale prices of the component 
stocks.\9\OPRA, in turn, will disseminate the Index value to other 
financial vendors such as Reuters, Telerate, and Quotron.
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    \9\For purposes of the daily dissemination of the Index value, 
if a stock included in the Index has not opened for trading, the 
CBOE will use the closing value of that stock on the prior trading 
day when calculating the value of the Index, until the stock opens 
for trading.
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    The Index value for purposes of settling 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 in their 
primary market on the last trading day prior to expiration. In the case 
of securities traded on and through the NASDAQ National Market, the 
first reported sale price will be used. 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 prior 
trading day's (i.e., Thursday's) last sale price will be used in the 
Index calculation. In this regard, before deciding to use Thursday's 
closing value of a component stock for purposes of determining the 
settlement value of the Index, the CBOE will wait until the end of the 
trading day on expiration Friday.\10\
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    \10\Id.
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F. Contract Specifications

    The proposed options on the Index will be cash-settled, European-
style options.\11\ Standard options trading hours (8:30 a.m. to 3:10 
p.m. Central Standard time) will apply to the contracts. The Index 
multiplier will be 100. The strike price interval will be $5 for full-
value Index options with a duration of one year or less to 
expiration.\12\ In addition, pursuant to CBOE rule 24.9, there will be 
six expiration months outstanding at any given time. Specifically, 
there will be three expiration months from the March, June, September, 
and December cycle plus three additional near-term months so that the 
two nearest term months will always be available. As described in more 
detail below, the Exchange also intends to list several Index LEAP 
series that expire from twelve to thirty-six months from the date of 
issuance.
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    \11\A European-style option can be exercised only during a 
specified period before the option expires.
    \12\For a description of the strike price intervals for reduced-
value Index options and long-term Index options, see section G, 
infra.
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    Lastly, the options on the Index will expire on the Saturday 
following the third Friday of the expiration month (``Expiration 
Friday''). Accordingly, since options on the Index will settle based 
upon 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).

G. Listing of Long-Term Options on the Full-Value or Reduced-Value 
Telecommunications Index

    The proposal provides that the Exchange may list long-term Index 
options that expire from 12 to 36 months from listing on the full-value 
Telecommunications Index or a reduced-value Telecommunications Index 
that will be computed at one-tenth the value of the full-value Index. 
Existing Exchange requirements applicable to full-value and reduced-
value LEAPS will apply to full-value and reduced-value Index LEAPS.\13\ 
The current and closing Index value for reduced-value 
Telecommunications 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 Index 
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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    \13\See CBOE Rule 24.9(b).
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H. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Because the Index is classified as an Industry Index under CBOE 
rules, Exchange rules that are applicable to the trading of options on 
narrow-based indexes will apply to the trading of Telecommunications 
Index options and Telecommunications Index LEAPS. Specifically, 
Exchange rules governing margin requirements,\14\ position and exercise 
limits,\15\ and trading halt procedures\16\ that are applicable to the 
trading of narrow-based index options will apply to options traded on 
the Index. The proposal further provides that, 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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    \14\Pursuant to CBOE rule 24.11, the margin requirements for the 
Index options will be: (1) For short options positions, 100% of the 
current market value of the options contract plus 20% of the 
underlying aggregate Index value, less any out-of-the-money amount, 
with a minimum requirement of the options premium plus 10% of the 
underlying Index value; and (2) for long term options positions, 
100% of the options premium paid.
    \15\Pursuant to CBOE rules 24.4A and 24.5, respectively, the 
position and exercise limits for the Index options will be 8,000 
contracts, unless the Exchange determines, pursuant to Rules 24.4A 
and 24.5 that a lower limit is warranted.
    \16\Pursuant to CBOE rule 24.7, the trading on the CBOE of Index 
options may be halted or suspended whenever trading in underlying 
securities whose weighted value represents more than 20% of the 
Index value are halted or suspended.
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I. Surveillance

    Surveillance procedures currently used to monitor trading in each 
of the Exchange's other index options will also be used to monitor 
trading in full-value and reduced-value Index options. These procedures 
include complete access to trading activity in the underlying 
securities. Further, the Intermarket Surveillance Group Agreement, 
dated July 14, 1983, as amended on January 29, 1990, will be applicable 
to the trading of options on the Index.\17\
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    \17\ISG 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.
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III. 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).\18\ Specifically, the 
Commission finds that the trading of Telecommunications Index options, 
including full-value and reduced-value Index LEAPS, will serve to 
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 securities in the 
telecommunications industry.\19\ The trading of options on the 
Telecommunications Index, including full-value and reduced-value LEAPS 
on the Index, 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 
adequately has addressed these concerns.
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    \18\15 U.S.C. 78f(b)(5) (1988).
    \19\Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option 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 Telecommunications Index will provide 
investors with a hedging vehicle that should reflect the overall 
movement of the stocks comprising the telecommunications industry in 
the U.S. stock markets. The Commission also believes that these 
Index options will provide investors with a means by which to make 
investment decisions in the telecommunications industry sector of 
the U.S. stock markets, allowing them to establish positions or 
increase existing positions in such markets in a cost effective 
manner. Moreover, the Commission believes that the reduced-value 
Index LEAPS, that will be traded on an index computed at one-tenth 
the value of the Telecommunications Index, will serve the needs of 
retail investors by providing them with the opportunity to use a 
long-term option to hedge their portfolios from long-term market 
moves at a reduced cost.
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A. Index Design and Structure

    The Commission finds that the Telecommunications Index and reduced-
value Telecommunications Index are narrow-based indices. The 
Telecommunications Index is comprised of only twenty-five stocks, all 
of which are within one industry--the telecommunications industry. In 
addition, the basic character of the reduced-value Telecommunications 
Index, which is comprised of the same component securities as the 
Telecommunications Index and calculated by dividing the 
Telecommunications Index value by ten, is essentially identical to the 
Telecommunications Index.\20\ Accordingly, the Commission believes it 
is appropriate for the CBOE to apply its rules governing narrow-based 
index options to trading in the Index options.\21\
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    \20\See generally Securities Exchange Act Release No. 29994 
(November 26, 1991), 56 FR 63536 (December 4, 1991) (order 
designating the PSE Technology Index as a broad-based index rather 
than a narrow-based index).
    \21\See supra notes 14 through 16, and accompanying text.
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    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 overwhelming majority of the stocks that comprise the Index 
are actively traded, with a mean and median average daily trading 
volume of 604,462 and 457,294 shares, respectively.\22\ Second, the 
market capitalizations of the stocks in the Index are very large, 
ranging from a high of $18.192 billion to a low of $808.32 million as 
of October 20, 1993, with the mean and median being $15.027 billion and 
$11.4 billion, respectively. Third, although the Index is only 
comprised of twenty-five component stocks, no one particular stock or 
group of stocks dominates the Index. Specifically, no one stock 
comprises more than 6.91% of the Index total value and the percentage 
weighting of the three largest issues in the Index accounting for 
17.77% of the Index's value. Fourth, all twenty-five stocks in the 
Index currently are eligible for options trading.\23\ The proposed CBOE 
maintenance requirement that 90% of the weighting of the Index be 
comprised of stocks that are eligible for options trading will ensure 
that the Index is almost completely comprised of options eligible 
stocks. Fifth, if the CBOE increases the number of component stocks to 
more than thirty-three or decreases that number to less than seventeen, 
the CBOE will be required to seek Commission approval pursuant to 
section 19(b)(2) of the Act before listing new strike price or 
expiration month series of Telecommunications Index options. This will 
help protect against material changes in the composition and design of 
the Index that might adversely affect the CBOE's obligations to protect 
investors and to maintain fair and orderly markets in 
Telecommunications Index options. Finally, the Commission believes that 
the expense of attempting to manipulate the value of the 
Telecommunications Index in any significant way through trading in 
component stocks (or options on those stocks) coupled with, as 
discussed below, existing mechanisms to monitor trading activity in 
those securities, will help deter such illegal activity.
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    \22\In addition, for the six-month period between April 1 and 
September 30, 1993, all of the companies comprising the Index had an 
average daily trading volume greater than 70,730 shares per day.
    \23\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.
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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 Telecommunications Index 
options (including full-value and reduced-value Telecommunications 
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 Telecommunications Index options and 
Telecommunications Index LEAPS.

C. Surveillance

    The Commission believes that a surveillance sharing agreement 
between an exchange proposing to list a stock index derivate product 
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.\24\ In this regard, the CBPE, 
NYSE, Amex, and NASD are all members of the Intermarket Surveillance 
Group (``ISG''), which provides for the exchange of all necessary 
surveillance information.\25\
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    \24\Securities Exchange Act Release No. 31243 (September 28, 
1992), 57 FR 45849 (October 5, 1992).
    \25\See note 17, supra. Although the Index currently does not 
contain ADRs, the proposal provides that the Index could contain 
ADRs representing telecommunications industry stocks. If the 
composition of the Index would change so that greater than 20% of 
the Index was represented by ADRs whose underlying securities were 
not subject to a comprehensive surveillance sharing arrangement, 
then it would be difficult for the Commission to reach the 
conclusions reached in this order and the Commission would have to 
determine whether it would be suitable to continue to trade options 
on the Index. The CBOE should, accordingly, notify the Commission 
immediately if more than twenty percent of the numerical value of 
the Index is represented by ADRs whose underlying securities are not 
subject to a comprehensive surveillance sharing agreement. Such a 
change in the composition of the Index may warrant the submission of 
a rule filing pursuant to Section 19 of the Act.
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D. Market Impact

    The commission believes that the listing and trading of 
Telecommunications Index options, including full-value and reduced-
value index LEAPS on the CBOE will not adversely impact the underlying 
securities markets.\26\ First, as described above, for the most part, 
no one stock or group of stocks dominates the Index must be accounted 
for by stocks that meet the options listing standards, the component 
securities generally will be actively-traded, highly-capitalized 
stocks.\27\ Third, the contract position and exercise limits applicable 
to Index options and Index LEAPS 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 and Index LEAPS will be issued and guaranteed by the Options 
Clearing Corporation just like any other standardized option traded in 
the United States.
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    \26\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 Nancy L. Nielsen, Assistant Corporate Secretary, 
CBOE, to Sharon Lawson, Assistant Director, Division of Market 
Regulation, SEC, dated October 26, 1993 and memorandum from Joe 
Corrigan Executive Director, OPRA, to Eileen Smith, CBOE, dated 
October 22, 1993.
    \27\See note 23, supra.
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    Lastly, the Commission believes that settling expiring 
Telecommunications Index options (including full-value and reduced-
value Index LEAPS) based on the opening prices of component securities 
is consistent with the Act. As noted in other contexts, valuing options 
for exercise settlement on expiration based on opening prices rather 
than closing prices may help reduce adverse effects on markets for 
securities underlying options on the Index.\28\
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    \28\See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
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    The Commission finds good cause for approving the proposed rule 
change, including Amendment No. 1, prior to the thirtieth day after the 
date of publication of notice of filing thereof in the Federal Register 
in order to allow the Exchange to list Telecommunications Index options 
without delay. The Commission notes that the proposal is very similar 
to other narrow-based index option proposals that have been recently 
approved by the Commission.\29\ In addition, the Commission notes the 
proposal (excluding Amendment No. 1) was published for the full 21-day 
comment period and no comments opposing the proposal were received by 
the Commission. With regard to Amendment No. 1, the Commission finds 
good cause for approving this amendment on an accelerated basis because 
the amendment does not affect the substance of the proposed rule 
change. It merely requests accelerated approval of the entire proposal 
pursuant to section 19(b)(2) of the Act.
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    \29\See Securities Exchange Act Release No. 33442 (January 6, 
1994), 59 FR 1973 (January 13, 1994) (CBOE Gaming Index); and 
Securities Exchange Act Release No. 33191 (November 12, 1993), 58 FR 
61719 (November 22, 1993) (Amex Telecommunications Index).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 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 at the Commission's Public Reference Section, 450 Fifth Street, 
NW., Washington, DC. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to the file 
number in the caption above and should be submitted by February 11, 
1994.
    It is therefore ordered, Pursuant to section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-CBOE-93-50), as amended, is 
approved.

    \30\15 U.S.C. 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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[FR Doc. 94-1429 Filed 1-19-94; 4:15 pm]
BILLING CODE 8010-01-M