[Federal Register Volume 59, Number 107 (Monday, June 6, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-13603]
[[Page Unknown]]
[Federal Register: June 6, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34124; File No. SR-CBOE-93-36]
Self-Regulatory Organizations; Order Approving and Notice of
Filing and Order Granting Accelerated Approval of Amendment No. 1 to a
Proposed Rule Change by the Chicago Board Options Exchange, Inc.,
Relating to the Listing of Regular and Long-Term Index Options on the
S&P/Barra Growth Index and the S&P/Barra Value Index
May 27, 1994.
I. Introduction
On September 9, 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 regular and long-term index options on the S&P/Barra Growth
Index (``Growth Index'') and the S&P/Barra Value Index (``Value
Index'') (each individually an ``Index,'' and collectively the
``Indexes''). The proposed rule change was published for comment in the
Federal Register on November 19, 1993.\3\ No comment letters were
received on the proposed rule change. On May 25, 1994, the CBOE filed
Amendment No. 1 to the proposed rule change.\4\ This order approves the
Exchange's proposal, as amended.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\See Securities Exchange Act Release No. 33192 (November 12,
1993), 58 FR 61117 (November 19, 1993).
\4\In Amendment No. 1, the CBOE proposes to: (1) Establish
position limits for options on the Growth and Value Indexes of
125,000 contracts on the same side of the market, with no more than
75,000 contracts in the series with the nearest expiration month;
(2) establish 225,000 contracts on the same side of the market as
the maximum position size that will be eligible for treatment under
the Exchange's hedge exemption rule provisions; and (3) aggregate
positions in Growth Index options and Value Index options for
purposes of position and exercise limits, including applicable hedge
exemptions. Additionally, Amendment No. 1 amends proposed
Interpretation .01(a)(v) and (vi) to Rule 24.9 to provide that the
strike intervals between Growth Index and Value Index options will
be no less than $2.50 only if the strike prices are less than $200.
See Letter from Eileen Smith, Director, Product Development,
Research Department, CBOE, to Brad Ritter, Attorney, Office of
Derivatives and Equity Oversight, Division of Market Regulation,
Commission, dated May 25, 1994 (``Amendment No. 1'').
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II. Description of Proposal
A. General
The CBOE proposes to trade options on the Growth and Value Indexes,
stock indexes calculated by Standard & Poor's (``S&P'') (or its
designee) and maintained by Barra, Inc. (``Barra'') pursuant to a
license agreement between Barra and S&P. The CBOE also proposes to list
long-term options (``Index LEAPS'') on either the full-value of each
Index or reduced-value Growth and Value Indexes that will be computed
at one-tenth of the value of the respective Indexes. Index LEAPS on the
Growth and Value Indexes will trade independent of and in additional to
regular options on the Indexes traded on the Exchange, however, as
discussed below, position and exercise limits of Index LEAPS and
regular options on the Indexes will be aggregated.
B. Composition and Maintenance of the Index
The Indexes are constructed by sorting the stocks in the S&P 500
Index on the basis of their book-to-price ratios as determined by Barra
twice per year, based on end-of-day information on November 30 and May
31. Starting with the company with the highest book-to-price ratio,
companies are added to the Value Index until that Index contains 50% of
the market capitalization of the S&P 500 Index. The Growth Index is
composed of the remaining companies in the S&P 500 Index. The partition
of the S&P 500 Index using November 30 information becomes effective as
of January 1 of the following year; the partition of the S&P 500 Index
using May 31 information becomes effective July 1 of the same year.
Based on the last partition of the S&P 500 Index, effective January
1, 1994, the Value Index is currently composed of 310 securities. As of
the close of trading on May 3, 1994, the Value Index was valued at
71.65. The market capitalizations of the individual stocks in the Value
Index ranged from a high of $76.05 billion to a low of $97.23 million,
with the mean and median being $5.27 billion and $2.96 billion,
respectively. The market capitalization of all the stocks in the Value
Index was $1.63 trillion. The total number of shares outstanding for
the stocks in the Value Index ranged from a high of 1.24 billion shares
to a low of 8.94 million shares. The price per share of the stocks in
the Value Index on that date ranged from a high of $146.13 to a low of
$4.00. Lastly, no one stock comprised more than 4.65% of the Value
Index's total value and the percentage weighting of the five largest
issues in the Value Index accounted for 15.19% of the Index's value.
The percentage weighting of the lowest weighted stock was 0.01% of the
Index and the percentage weighting of the five smallest issues in the
Index accounted for 0.05% of the Value Index's value.
Based on the last partition of the S&P 500 Index, effective January
1, 1994, the Growth Index is currently composed of the 190 S&P 500
Index securities not included in the Value Index. As of the close of
trading on May 3, 1994, the Growth Index was valued at 60.47. The
market capitalizations of the individual stocks in the Growth Index
ranged from a high of $82.09 billion to a low of $506.63 million, with
the mean and median being $8.43 billion and $4.28 billion,
respectively. The market capitalization of all the stocks in the Growth
Index was $1.60 trillion. The total number of shares outstanding for
the stocks in the Growth Index ranged from a high of 2.30 billion
shares to a low of 14.46 million shares. The price per share of the
stocks in the Growth Index on that date ranged from a high of $736.00
to a low of $4.50. Lastly, no one stock comprised more than 5.12% of
the Growth Index's total value and the percentage weighting of the five
largest issues in the Growth Index accounted for 19.47% of the Index's
value. The percentage weighting of the lowest weighted stock was 0.03 %
of the Growth Index and the percentage weighting of the five smallest
issues in the Index accounted for 0.19% of the Index's value.
C. Calculation of the Index
Like the S&P 500 Index, the Indexes will be capitalization-
weighted, and the methodology used to calculate their value is
identical to the methodology used to calculate the value of the S&P 500
Index. The level of each Index is calculated as follows:
TN06JN94.001
The numeric value of each Index was established at 10 as of the close
of the market on December 31, 1974.
The Indexes are calculated continuously by S&P or its designee, and
their values will be disseminated by the Options Price Reporting
Authority (``OPRA'') no less often than every fifteen seconds. S&P will
also calculate the exercise settlement value for each expiring series
of Value Index options and Growth Index options, and will make these
values available to CBOE for use by the Options Clearing Corporation
(``OCC'') in effecting settlement of exercises and assignments of the
options.
The values of the Indexes, for purposes of settling outstanding
options on the Growth and Value Indexes upon expiration, will be
calculated based upon the regular way opening sale prices for each of
the Indexes' component stocks on the last trading day prior to
expiration.\5\ Once all of the component stocks have opened, the value
of each Index will be determined and that value will be used as the
final settlement value for expiring options contracts on that Index. 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 CBOE Rule 24.9(a)(4).
\6\Id.
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D. Contract Specifications
The proposed options on the Indexes 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 multiplier for
each Index will be 100. The strike price interval will be $2.50 for
Index options with strike prices of less than $200.\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 on
each Index that will expire 12 to 36 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\See Amendment No. 1, supra note 4.
\9\See CBOE Rule 24.9(a)(2).
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Options on each Index (including full-value and reduced-value Index
LEAPS) will expire on the Saturday following the third Friday of the
expiration month (``Expiration Friday''). Because options on the
Indexes 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 supra notes 5 and 6.
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E. Listing of Long-Term Options on the Full-Value or Reduced-Value
Growth and Value Indexes
The Exchange may list Index LEAPS on the Growth and Value Indexes
that expire 12 to 36 months from date of issuance on either the full-
value of the Growth and Value Indexes or reduced-values of the Indexes
that will be computed at one-tenth the value of the full-value
Indexes.\11\ The current and closing values for reduced-value Index
LEAPS on the Indexes 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 Growth Index value of 60.54 would be 6.05
for the Growth Index LEAPS and 60.56 would become 6.06. The reduced-
value Index LEAPS on the Indexes 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.\12\
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\11\See CBOE Rule 24.9(b).
\12\Id.
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The same Exchange rules which are applicable to the trading of
full-value Index LEAPS on the Indexes will be applicable to the trading
of reduced-value Index LEAPS on the Indexes. 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, full-value or reduced-value
Index LEAPS on either Index may be issued at six month intervals and
new strike prices will either be near or bracketing the current value
of each Index. Strike price interval, bid/ask differential, and
continuity rules will not apply to the trading of the full-value or
reduced-value Index LEAPS on the Indexes until their time to expiration
is less than 12 months.\13\ Lastly, Index LEAPS series on each Index
may be added when the value of the underlying Index increases or
decreases by ten to fifteen percent.\14\
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\13\Id.
\14\Id.
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F. Position and Exercise Limits, Margin Requirements, and Trading Halts
Position limits for the options (including Index LEAPS) on the
Growth and Value Indexes will be set at no more than 125,000 contracts
on the same side of the market, provided that no more than 75,000 of
such contracts are in series in the nearest expiration month, and
further provided that options positions in the Indexes will be
aggregated.\15\ Exercise limits will be set at the same level as
position limits.\16\ For purposes of calculating applicable position
and exercise limits, positions in reduced-value options on the Growth
and Value Indexes will be aggregated with each other and 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. Also, CBOE hedge exemption provisions will
apply to options and Index LEAPS on both Indexes.\17\
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\15\See Amendment No. 1, supra note 4.
\16\See CBOE Rule 24.5.
\17\See CBOE Rule 24.4(a); Interpretation .01 to Rule 24.4; and
Amendment No. 1, supra note 4.
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Exchange rules applicable to options on the Growth and Value
Indexes will be identical to the rules applicable to other broad-based
index options for purposes of trading rotations, halts, and
suspensions,\18\ and margin treatment.\19\
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\18\See CBOE Rule 24.7.
\19\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 on the Growth and Value
Indexes. These procedures include complete access to trading activity
in the underlying securities.
H. Disclaimer
The CBOE has agreed with S&P to revise the disclaimer of liability
on behalf of S&P that is currently in the Exchange's rules so that it
covers Barra as well as S&P, and the growth Index and Value Index. The
disclaimer would provide that S&P, Barra, and all of their affiliates
do not make any warranties as to the results obtained from the Growth
and Value Indexes, any opening, intra-day or closing value therefore,
any related data, or any errors or delays in calculating or
disseminating the value of either Index, in connection with the trading
of option contracts based on the Indexes.\20\
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\20\See CBOE Rule 24.14.
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III. Commission Findings and Conclusions
The Commission has reviewed the proposal to list and trade options
and full-value and reduced-value Index LEAPS on the Growth and Value
Indexes. 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 Indexes are broad-based, the proposed
options are designed to reduce the potential for manipulation, and the
proposal to list and trade options and Index LEAPS on the Growth and
Value Indexes is consistent with the CBOE's obligation to promote
investor protection.\21\
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\21\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
members of the ISG are: the Amex; the Boston Stock Exchange, Inc.;
the CBOE; the Chicago Stock Exchange, Inc.; the National Association
of Securities Dealers, Inc.; the New York Stock Exchange, Inc.; the
Pacific Stock Exchange, Inc.; and the Philadelphia Stock Exchange,
Inc. Because of potential opportunities for trading abuses involving
stock index futures, stock options, and the underlying stock and the
need for greater sharing of surveillance information for these
potential intermarket trading abuses, the major stock index futures
exchanges (e.g., the Chicago Mercantile Exchange and the Chicago
Board of Trade) joined the ISG as affiliate members in 1990. The
Commission understands that the ISG Agreement, as amended, covers
investigations and inquiries regarding trading activity in options
on the Indexes and component securities of the Indexes.
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The Commission finds that the trading of options on the Indexes,
including full-value and reduced-value Index LEAPS, will permit
investors to participate in the price movements of the securities on
which the respective Indexes are based. Further, trading of options on
each Index will allow investors holding positions in some or all of the
securities underlying that Index to hedge the risks associated with
their portfolios. Accordingly, the Commission, believes options on the
Growth and Value Indexes will provide investors with an important
trading and hedging mechanism that should reflect accurately the
overall movement of the securities contained in this partition of the
S&P 500 Index. By broadening the hedging and investment opportunities
of investors, the Commission believes that the trading of options on
the Growth and Value Indexes will serve to protect investors, promote
the public interest, and contribute to the maintenance of fair and
orderly markets.\22\
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\22\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 Growth and Value Indexes will
provide investors with a hedging vehicle that should reflect the
overall movement of securities contained in the Indexes.
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The trading of options on the Growth and Value Indexes, 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 DBOE has addressed
these concerns adequately.
A. Index Design and Structure
The Commission finds that the Indexes are broad-based indexes,\23\
and thus it is appropriate to permit Exchange rules applicable to the
trading of broad-based index options to apply to options on the
Indexes, including Index LEAPS. Specifically, the Commission believes
the Indexes are broad-based because they (1) are a partition of the S&P
500 Index, which is a broad-based index on which options have been
approved for trading since 1983,\24\ and (2) reflect a substantial
segment of the U.S. equities market.
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\23\The reduced-value Growth and Value Indexes, which are
composed of the same components as the Growth and Value Indexes,
respectively, and calculated by dividing the full-value Index values
by 10, are identical to the full-value Growth and Value Indexes.
\24\See Securities Exchange Act Release No. 19907 (June 24,
1983), 48 FR 30814 (July 5, 1983).
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The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the component stocks of each Index
significantly minimize the potential for manipulation of either Index.
First, the Indexes collectively represent and consist of the common
stock values of 500 actively traded U.S. companies. Second, no one
particular stock or group of stocks dominates either Index.
Specifically, as of May 3, 1994, no one stock comprised more than 4.65%
of the Value Index's total value or 5.12% of the Growth Index's total
value, and the percentage weighting of the five largest issues in the
Indexes accounted for 15.19% of the Value Index's value and 19.47% of
the Growth Index's value. Third, the market capitalizations of the
stocks in the Indexes are very large. Specifically, the market
capitalizations (1) for the Value Index ranged from a high of $76.05
billion to a low of $97.23 million as of May 3, 1994, with the mean and
median being $5.27 billion and $2.96 billion, respectively, and (2) for
the Growth Index ranged from a high of $82.09 billion to a low of
$506.63 million as of that date, with the mean and median being $8.43
billion and $4.28 billion, respectively. Fifth, each Index is comprised
of stocks representing a diverse group of industries, including, among
others, pharmaceuticals, communications, entertainment, various
consumer and computer products and services. Sixth, an overwhelming
proportion of the component stocks in each Index currently are eligible
for options trading.\25\ 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 options on the Indexes.
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\25\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 options on the Growth and
Value Indexes (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
options and Index LEAPS on the Growth and Value Indexes 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
options and Index LEAPS on the Indexes.
C. Surveillance
The Commission generally believes that a surveillance sharing
agreement between an exchange proposing to list a stock index
derivative product and the exchanges trading the stocks underlying the
derivative product is an important measure for the surveillance of the
derivatives 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.\26\ In this regard,
the New York Stock Exchange, the American Stock Exchange, and the
National Association of Securities Dealers, Inc. Automated Quotation
system (``NASDAQ''), which currently are the primary markets for all of
the component securities in the Indexes, are members of the ISG, which
provides for the exchange of all necessary surveillance
information.\27\
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\26\See Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\27\See supra note 21.
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D. Market Impact
The Commission believes that the listing and trading on the CBOE of
options on the Growth and Value Indexes, including full-value and
reduced-value Index LEAPS, will not adversely impact the underlying
securities markets.\28\ First, as described above, the Indexes are
broad-based and each is presently comprised of at least 190 stocks with
no one stock dominating either Index. Second, as noted above, the
stocks contained in the Indexes have large capitalizations and are
actively traded. Third, the proposed position and exercise limits,
coupled with the requirement that positions in both Indexes be
aggregated, 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 OCC just like any other standardized option
traded in the United States. Fifth, existing CBOE stock index options
rules and surveillance procedures will apply to options on the Growth
and Value Indexes.
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\28\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 options and LEAPS on the
Growth and Value Indexes. 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 options on
the Growth and Value Indexes (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 Indexes.\29\
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\29\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 Amendment No. 1 prior
to the thirtieth day after the date of publication of notice of filing
thereof in the Federal Register. Specifically, Amendment No. 1
maintains the proposed options position limits on the Indexes but
requires that positions in options on the Indexes (including Index
LEAPS) be aggregated for purposes of position and exercise limits. As
stated above, the Commission believes that these position and exercise
limits have the effect of minimizing the potential for market
manipulation and other adverse impacts on the market for the securities
underlying the Indexes as a result of the trading of options on the
Indexes. Amendment No. 1 also clarifies that strike intervals of $2.50
will only be used for strike prices of less than $200 for full-value
options and Index LEAPS on the Indexes. This amendment merely conforms
the proposal to existing CBOE rules.\30\ As a result, the Commission
believes that good cause exists for approving Amendment No. 1 on an
accelerated basis.
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\30\See CBOE Rule 24.9, Interpretation and Policy .01(a).
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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 SR-CBOE-93-36 and should be submitted by June 27, 1994.
It Is Therefore Ordered, pursuant to section 19(b)(2) of the
Act,\31\, that the proposed rule change (SR-CBOE-93-36) is approved, as
amended.
\31\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.\32\
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\32\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-13603 Filed 6-3-94; 8:45 am]
BILLING CODE 8010-01-M