[Federal Register Volume 59, Number 141 (Monday, July 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17952]


[[Page Unknown]]

[Federal Register: July 25, 1994]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34388; International Series Release No. 686; File No. 
SR-CBOE-94-14]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 to Proposed Rule Change by the Chicago Board Options 
Exchange, Inc. Relating to the Listing and Trading of Options and Full-
Value and Reduced-Value Long-Term Options on the Nikkei Stock Index 300

July 15, 1994.

I. Introduction

    On April 19, 1994, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``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 options and long-term options (``LEAPS'')\3\ based on the 
Nikkei Stock Index 300 (``Nikkei 300 Index'' or ``Index''), as well as 
LEAPS based on a reduced-value Index. On June 28, 1994, the Exchange 
filed Amendment No. 1 to the proposed rule change.\4\
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    \1\15 U.S.C. Sec. 78s(b)(1) (1982).
    \2\17 CFR 240.19b-4 (1993).
    \3\``LEAPS'' is an acronym for Long-Term Equity Anticipation 
Securities. LEAPS are long-term index option series that expire from 
12 to 36 months from their date of issuance. See CBOE Rule 
24.9(b)(1).
    \4\In Amendment No. 1, the Exchange (1) lowered the proposed 
position limits for Index options and Index LEAPS to 25,000 
contracts on the same side of the market, provided that no more than 
15,000 contracts are in series in the nearest expiration month; (2) 
specified that the total capitalization of the Index, as of march 
31, 1994, was US$2.25 trillion; and (3) supplied data on the average 
daily trading volume in the component securities for the period 
commencing December 1, 1993 and ending May 31, 1994. See Letter from 
Eileen Smith, Director, Product Development, CBOE, to Thomas 
McManus, Division of Market Regulation, Commission, dated June 28, 
1994.
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    The proposed rule change was published for comment in the Federal 
Register on May 24, 1994.\5\ No comments were received on the proposed 
rule change. This order approves the Exchange's proposal and Amendment 
No. 1 thereto.
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    \5\See Securities Exchange Act Release No. 34077 (May 18, 1994), 
59 FR 26824 (May 24, 1994).
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II. Description of the Proposal

A. General

    The CBOE proposes to trade standardized index option contracts 
based on the Nikkei 300 Index, an index comprised of 300 representative 
stocks of the first section\6\ of the Tokyo Stock Exchange 
(``TSE'').\7\ The CBOE also proposes to list LEAPS on the full-value 
Index and LEAPS on a reduced-value Index that will be computed at one-
tenth of the value of the Index. Nikkei 300 Index LEAPS will trade 
independently of and in addition to regular Nikkei 300 Index options 
traded on the Exchange; however, as discussed below, position and 
exercise limits of Index LEAPS and regular Index options will be 
aggregated.\8\ The Exchange believes that options on the Index, 
including full-value and reduced-value Index LEAPS, will provide 
investors with a low-cost means of participating in the performance of 
the Japanese economy and hedging against the risk of investing in that 
economy.
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    \6\First section stocks are distinguished from second section 
stocks by more stringent listing standards. Telephone conversation 
between Eileen Smith, Director, Product Development, CBOE, and 
Francois Mazur, Attorney, Office of Derivatives and Equity 
Regulation, Division of Market Regulation, Commission (May 16, 
1994).
    \7\The CBOE has represented that the designations ``Nikkei Stock 
Index 300'' and ``Nikkei 300'' are the property of Nihon Keizai 
Shimbun, Inc.
    \8\See infra Section II.F.
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B. Composition and Maintenance of the Index

    The Nikkei 300 Index was designed by Nihon Keizai Shimbun, Inc. 
(``NKS''). The CBOE represents that Index component stocks were 
selected by NKS for their high market capitalizations and their high 
degree of liquidity, and are representative of the industrial 
composition of the broader Japanese equity market. On June 20, 1994, 
the CBOE formally executed a licensing agreement with NKS to list 
options on the Nikkei 300 Index.\9\
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    \9\Telephone conversation between Eileen Smith, Director, 
Product Development, CBOE, and Thomas McManus, Division of Market 
Regulation, Commission (June 28, 1994).
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    As of March 31, 1994, the total capitalization of the Index was 
US$2.25 trillion.\10\ Market capitalizations of the individual stocks 
in the Index ranged from a high of US$76.5 billion to a low of US$875 
million, with a median of US$3.3 billion and a mean of US$7.5 billion. 
In addition, the average daily trading volume of the stocks in the 
Index, for the six-month period ending May 31, 1994, ranged from a high 
of 6,279,901 shares to a low of 11,525 shares, with a median of 
approximately 488,000 shares and a mean of approximately 846,000 
shares. The highest weighted component stock in the Index accounts for 
3.41 percent of the Index. The five largest Index components account 
for approximately 15.14 percent of the Index's value. The lowest 
weighted component stock comprises 0.04 percent of the Index, and the 
five smallest Index components account for approximately 0.20 percent 
of the Index's value.
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    \10\Based on the March 31, 1994 exchange rate of Y102.75 per 
US$1.00.
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    The Index is maintained by NKS. To maintain the continuity of the 
Index, NKS will adjust the Index divisor to reflect certain events 
relating to the component stocks. These events include, but are not 
limited to, changes in the number of shares outstanding, spin-offs, 
certain rights issuances, and mergers and acquisitions. The CBOE 
represents that NKS reviews the composition of the Index periodically.

C. Calculation of the Index

    The Nikkei 300 Index is capitalization-weighted and reflects 
changes in the prices of the Index component securities relative to the 
base data of the Index (October 1, 1982). The value of the Index is 
calculated by multiplying the price of each component security by the 
number of shares outstanding of each such security, adding the 
products, and dividing by the current Index divisor. The Index divisor 
is adjusted to reflect certain events relating to the component 
stocks.\11\ The Index had a closing value of 303.99 on June 24, 1994.
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    \11\See supra Section II.B. The Index divisor was get to give 
the Index a value of 100 on its base date.
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    Because trading does not occur on the TSE during the CBOE's trading 
hours, the CBOE calculates the Index once each day based on the most 
recent official closing price of each Index component security as 
reported by the TSE. This closing value will be disseminated throughout 
the trading day on the CBOE.

D. Contract Specifications

    The proposed options on the Nikkei 300 Index will be cash-settled, 
European-style options.\12\ The CBOE is proposing to trade options on 
the Index from 8:00 a.m. to 3:15 p.m. (Chicago Time). The proposed 
starting time for Index options is one-half hour earlier than trading 
in options normally begins at the CBOE. The multiplier for the Index 
will be 100. Strike prices on Index options and full-value Index LEAPS 
will be set to bracket the Index level at $5.00 intervals. The Exchange 
intends to list options series with expirations in the three near-term 
calendar months, plus up to three additional calendar months in the 
March, June, September, December cycle. As described in more detail 
below, the Exchange also intends to list Index LEAPS, and LEAPS on a 
reduced-value Index, that will expire from 12 to 36 months from the 
date of the issuance.
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    \12\A European-style option can be exercised only during a 
specified period before the option expires.
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    Options on the Index (including full-value and reduced-value Index 
LEAPS) will expire on the Saturday following the third Friday of the 
expiration month. The last trading day in an option series normally 
will be the second to last business day preceding the Saturday 
following the third Friday of the expiration month (normally a 
Thursday). Trading in expiring options will cease at the close of 
trading on the last trading day. The exercise settlement value for all 
of the Index's expiring options will be calculated based upon the most 
recent official closing price of each of the component securities as 
reported by the TSE at the close of the regular Friday sessions in 
Japan (ordinarily at 3:00 p.m. Tokyo time). When expirations are moved 
in accordance with Exchange holidays, such as when the CBOE is closed 
on the Friday before expiration, the last trading day for expiring 
options will be Wednesday and the exercise settlement value of expiring 
Index options will be determined at the close of the regular Thursday 
trading sessions in Japan, even if the Japanese markets are open on 
Friday. If the Japanese markets will be closed on the Friday before 
expiration but the CBOE will not be closed, the last trading day for 
expiring options will be Wednesday and the exercise settlement value of 
expiring Index options will be determined at the close of the regular 
Thursday trading sessions in Japan.

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

    The Exchange may list series of LEAPS on the Nikkei 300 Index that 
expires from 12 to 36 months from the date of their issuance on either 
the full-value Index or a reduced-value Index computed at one-tenth of 
the full-value index, subject to existing Exchange requirements 
applicable to full-value and reduced-value LEAPS.\13\ The current and 
closing values for reduced-value Index LEAPS on the Index will be 
computed by dividing the value of the full-value Index by ten and 
rounding the resulting figure to the nearest one-hundredth. For 
example, a Nikkei 300 Index value of 303.99 would be 30.40 for the 
reduced-value Index LEAPS, and 303.94 would become 30.39. The reduced-
value Index LEAPS will have a European-style exercise and will be 
subject to the same rules that govern trading of all of the Exchange's 
index options, including sales practices rules, margin requirements, 
and floor trading procedures. Strike price intervals for the reduced-
value Index LEAPS will be no less than $2.50, instead of $5.00.\14\
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    \13\See CBOE Rule 24.9(b).
    \14\See CBOE Rule 24.9(b)(2)(B).
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F. Position and Exercise Limits, Margin Requirements, and Trading Halts

    Position limits for options (including Index LEAPS) on the Nikkei 
300 Index 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.\15\ Exercise limits will be 
set at the same level as position limits.\16\ For purpose of 
calculating applicable position and exercise limits, positions in 
reduced-value options on the Index will be aggregated with each other 
and with positions in the full-value Index options.\17\ Ten reduced-
value contracts will equal one full-value contract for purposes of 
aggregating these positions.\18\
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    \15\See CBOE Rule 24.4(a)(i).
    \16\See CBOE Rule 24.5.
    \17\See CBOE Rule 24.4(e).
    \18\Id.
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    Exchange rules applicable to options on the Index will be identical 
to the rules applicable to other broad-based index options for purposes 
of trading rotations, halts, and suspensions,\19\ and margin 
treatment.\20\
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    \19\See CBOE Rule 24.7.
    \20\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. The Exchange currently is 
pursuing a market surveillance agreement with the TSE, which agreement 
the Exchange expects will enable it to better carry out its regulatory 
responsibilities with respect to the surveillance of trading in the 
stocks comprising the Index.\21\
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    \21\See infra Section III.C.
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III. Commission 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) of the Act.\22\ 
Specifically, the Commission finds that the trading of options based on 
the Nikkei 300 Index will serve to protect investors, 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 the Japanese equity market and provide a 
surrogate instrument for trading in the Japanese securities market.\23\ 
The trading of options based on the Nikkei 300 Index should provide 
investors with a valuable hedging vehicle that should reflect 
accurately the overall movement of the Japanese equity market.
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    \22\15 U.S.C. Sec. 78f(b)(5) (1988).
    \23\Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of any new securities product upon a finding that 
the introduction of such product is in the public interest. Such a 
finding would be difficult with respect to an option 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.
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    In addition, the Commission believes, for the reasons discussed 
below, that the CBOE has adequately addressed issues related to 
customer protection, index design, surveillance, and market impact of 
Nikkei 300 Index options.

A. Index Design and Structure

    The Commission finds that it is appropriate and consistent with the 
Act to classify the Index as a broad-based index. Specifically, the 
Commission believes the Index is broad-based because it reflects a 
substantial segment of the Japanese equity market, and, among other 
things, it contains a large number of stocks that trade in that market. 
First, the Index consists of 300 actively-traded stocks traded on the 
first section of the TSE. Second, the market capitalizations of the 
stocks comprising the Index are very large. Specifically, the total 
capitalization of the Index, as of March 31, 1994, was US$2.25 
trillion, with the market capitalization of the individual stocks in 
the Index ranging from a high of US$76.5 billion to a low of US$875 
million, with a median value of US$3.3 billion and a mean of US$7.5 
million. Third, no one particular stock or group of stocks dominates 
the Index. Specifically, no single stock comprises more than 3.41 
percent of the Index's total value, and the percentage weighting of the 
five largest issues in the Index accounts for 15.14 percent of the 
Index's value. Accordingly, the Commission believes it is appropriate 
to classify the Index as broad-based.
    In addition, because none of the Index component stocks are traded 
in the United States in any form, and the primary market for component 
stocks is closed throughout the CBOE's trading day, the Commission 
believes it is not unreasonable for the Exchange to decide to begin 
trading Index options at 8:00 a.m. (Chicago time).

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 Nikkei 300 Index options 
(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 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 Nikkei 300 Index options and full-value and reduced-
value Nikkei 300 Index LEAPS.

C. Surveillance

    As a general matter, the Commission believes that comprehensive 
surveillance sharing agreements between the relevant foreign and 
domestic exchanges are important where an index product comprised of 
foreign securities is to be traded in the United States. In most cases, 
in the absence of such a comprehensive surveillance sharing agreement, 
the Commission believes that it would not be possible to conclude that 
a derivative product, such as a Nikkei 300 Index option, was not 
readily susceptible to manipulation.
    Although the CBOE and the TSE do not yet have a written 
surveillance sharing agreement that covers the trading of Nikkei 300 
Index options,\24\ a number of factors support approval of the proposal 
at this time. First, while the size of an underlying market is not 
determinative of whether a particular derivative product based on that 
market is readily susceptible to manipulation, the size of the market 
for the securities underlying the Nikkei 300 Index makes it less likely 
that the proposed Index options are readily susceptible to 
manipulation.\25\ In addition, the Commission notes that the TSE is 
under the regulatory oversight of the Japanese Ministry of Finance 
(``MOF''). The MOF has responsibility for both the Japanese securities 
and derivatives markets. Accordingly, the Commission believes that the 
ongoing oversight of the trading activity on the TSE by the MOF will 
help to ensure that the trading of Nikkei 300 Index options will be 
carefully monitored with a view toward preventing unnecessary market 
disruptions.
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    \24\The Exchange represents that it currently is pursuing a 
surveillance sharing agreement with the TSE, which the Exchange 
expects will enable it to better carry out its regulatory 
responsibilities with respect to the surveillance of trading in the 
stocks comprising the Index.
    \25\In evaluating the manipulative potential of a proposed index 
derivative product, as it relates to the securities that comprise 
the index and the index product itself, the Commission has 
considered several factors, including (1) the number of securities 
comprising the index or group; (2) the capitalizations of those 
securities; (3) the depth and liquidity of the group or index; (4) 
the diversification of the group or index; (5) the manner in which 
the index or group is weighted; and (6) the ability to conduct 
surveillance on the product. See Securities Exchange Act Release No. 
31016 (August 11, 1992), 57 FR 37012 (August 17, 1992).
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    Finally, the Commission and the MOF have concluded a Memorandum of 
Understanding (``MOU'') that provides a framework for mutual assistance 
in investigatory and regulatory matters.\26\ Moreover, the Commission 
also has a longstanding working relationship with the MOF on these 
matters. Based on the longstanding working relationship between the 
Commission and the MOF and the existence of the MOU, the Commission is 
confident that it and the MOF could acquire information from one 
another similar to that which would be available in the event that a 
comprehensive surveillance sharing agreement were executed between the 
CBOE and the TSE with respect to transactions in TSE-traded stocks 
related to Nikkei 300 Index option transactions on the CBOE.\27\
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    \26\See Memorandum of United States Securities and Exchange 
Commission and the Securities Bureau of the Japanese Ministry of 
Finance on the Sharing of Information, dated May 23, 1986.
    \27\It is the Commission's expectation that this information 
would include transaction, clearing, and customer information 
necessary to conduct an investigation.
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    Nevertheless, the Commission continues to believe strongly that a 
comprehensive surveillance sharing agreement between the TSE and the 
CBOE covering Nikkei 300 Index options would be an important measure to 
deter and detect potential manipulations or other improper or illegal 
trading involving Nikkei 300 Index options. Accordingly, the Commission 
believes it is critical that the TSE and the CBOE continue to work 
together to consummate a formal comprehensive surveillance sharing 
agreement to cover Nikkei 300 Index options, and the component 
securities, as soon as practicable.\28\
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    \28\See supra note 24.
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D. Market Impact

    The Commission believes that the listing and trading on the CBOE of 
Nikkei 300 Index options, including full-value and reduced-value Index 
LEAPS, will not adversely impact the securities markets in the United 
States or Japan.\29\ First, as described above, the Index is broad-
based and presently is comprised of 300 stocks with no one stock 
dominating the Index. Second, as noted above, the stocks contained in 
the Index have large capitalizations and are actively-traded. Third, 
the proposed position and exercise limits of 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, will serve to 
minimize potential manipulation and market impact concerns. Lastly, 
existing CBOE stock index options rules and surveillance procedures 
will apply to options on the Index.
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    \29\In addition, the CBOE and the Options Price Reporting 
Authority (``OPRA'') have both represented that they have the 
necessary systems capacity to support those new series of options 
that would result from the introduction of Index options (including 
full-value and reduced-value Index LEAPS). See Letter from Joseph P. 
Corrigan, Executive Director, OPRA, to Eileen Smith, CBOE, dated 
June 28, 1994.
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E. Accelerated Approval of Amendment No. 1

    The Commission finds good cause for approving Amendment No. 1 to 
the Exchange's proposed rule change prior to the thirtieth day after 
the date of publication on notice of filing thereof in the Federal 
Register. Amendment No. 1 reduces the proposed position limits with 
respect to Nikkei 300 Index options from 50,000 contracts on the same 
side of the market to 25,000 contracts (provided that no more than 
15,000 contracts, as opposed to 30,000 contracts as originally 
proposed, are in series in the nearest expiration month). By reducing 
the position limits, this amendment will serve to protect investors and 
the public interest, and further minimize the potential for 
manipulation. Further, the proposal containing the higher position 
limits was published for the full 21-day comment period, and no 
comments were received. Therefore, the Commission finds that no new 
regulatory issues are raised by Amendment No. 1. Accordingly, the 
Commission believes it is consistent with Sections 19(b)(2) and 6(b)(5) 
of the Act to approve Amendment No. 1 to the Exchange's proposal on an 
accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1 to the proposed rule change. 
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 foregoing that 
are filed with the Commission, and all written communications relating 
to the foregoing 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. Sec. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. Copies of such filings also will be available 
for inspection and copying at the principal office of the above-
mentioned self-regulatory organization. All submissions should refer to 
File No. SR-CBOE-94-14, and should be submitted by August 15, 1994.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-CBOE-94-14), as amended, is 
approved.

    \30\15 U.S.C. Sec. 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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-17952 Filed 7-22-94; 8:45 am]
BILLING CODE 8010-01-M