[Federal Register Volume 60, Number 166 (Monday, August 28, 1995)]
[Notices]
[Pages 44524-44526]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21272]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36124; File No. SR-CBOE-95-42]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Chicago Board Options Exchange, Inc. To Add Two Position
and Exercise Limit Tiers for Qualifying Equity Option Classes and To
Expand the Equity Option Hedge Exemption
August 18, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on August 7, 1995, the Chicago Board Options Exchange (``CBOE'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the CBOE. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1994).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The CBOE proposes to amend Rule 4.11 (Position Limits) and Rule
4.12 (Exercise Limits) for equity options to add two upper position and
exercise limit tiers for those equity option classes that meet certain
criteria for high liquidity in the underlying stocks. In addition, CBOE
proposes to expand the current equity option hedge exemption from twice
to three times the standard or base position limit. The text of the
proposed rule change is available at the Office of the Secretary, CBOE,
and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
Text of these statements may be examined at the places specified in
Item IV below. The CBOE has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In 1994, the CBOE and the American Stock Exchange initiated
discussions with Commission staff on the effect of increasing the
number of position and exercise limit \3\ tiers for equity options
[[Page 44525]]
from three to five, in response to feedback from customers and member
firms that existing position and exercise limits for certain classes
were too low. The discussions also included whether investors,
particularly investors with sizeable assets or accounts, could benefit
from an expansion of the equity hedge exemption contained in Rule 4.11,
Interpretation and Policy .04, from a maximum allowable position of
twice the standard or base limit to three times the limit.\4\ As set
forth in greater detail in a recent report prepared by the Exchange
(``Study''),\5\ the CBOE determined that position and exercise limit
tiers can be added and that the equity hedge exemption can be expanded
to benefit investors without increasing the potential for market
disruption.
\3\ Position limits impose a ceiling on the aggregate number of
option contracts on the same side of the market that an investor, or
investors acting in concert, can hold or write. Similarly, exercise
limits impose a ceiling on the aggregate long positions in option
contracts that an investor, or investors acting in concert, can or
will have exercised within five consecutive business days.
The equity option position limits provided in Exchange Rule 4.11
are set at 4,500 or 7,500 or 10,500 contracts, and were increased to
these levels in December 1993. Inadvertently, according to the
Exchange, the corresponding exercise limits in Exchange Rule 4.12
were not increased at the same time from the Previous 3,000 or 5,500
or 8,000 contract levels. The CBOE has proposed to increase the
exercise limits accordingly, and to make other amendments to the
equity option position and exercise limit rules. See Securities
Exchange Act Release No. 35759 (May 24, 1995), 60 FR 28432 (May 31,
1995) (notice of File No. SR-CBOE-95-22).
\4\ The equity hedge exemption exempts certain specified equity
options positions from the stated (or base) position limits in
Exchange Rule 4.11 where the option contracts are hedged by 100
shares of stock or securities convertible into such stock (or hedged
by the same number of shares represented by an adjusted option
contract), up to a maximum allowable position of twice the standard
or base limit.
\5\ The purpose of the Study was to analyze the market impact of
increased limits and an expanded hedge exemption. See Letter from
Mary Bender, Senior Vice President, Division of Regulatory Services,
CBOE, to Holly Smith, Associate Director, Office of Market
Supervision, Division of Market Regulation, Commission, dated April
28, 1995.
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The CBOE is proposing to add two tiers above the current position
and exercise limit tiers for equity options provided in Exchange Rules
4.11 and 4.12, at 20,000 and 25,000 contract levels.\6\ The criterion
to qualify for the proposed 20,000 contract limit will be that the
underlying security must have at least 240 million shares outstanding
with 60 million shares traded in the past six months, or have 80
million shares traded in the past six months. To qualify for the
proposed 25,000 contract limit, the underlying security must have at
least 300 million shares outstanding with 75 million shares traded in
the past six months, or 100 million shares traded in the past six
months.
\6\As stated previously, the current position limits in Rule
4.11 are 4,500, 7,500, and 10,500 contracts with the position limits
for any particular class of options determined as follows: (1) to be
eligible for the 10,500 contract limit, either the most recent six-
month trading volume of the underlying security must have totalled
at least 40 million shares, or the most recent six-month trading
volume of the underlying security must have totalled at least 30
million shares and the underlying security must have at least 120
mullion shares outstanding; (2) to be eligible for the 7,500
contract limit, either the most recent six-month trading volume of
the underlying security must have totalled at least 20 million
shares, or the most recent six-month trading volume of the
underlying security must have totalled at least 15 million shares
and the underlying security must have at least 40 mullion shares
outstanding; and (3) to be eligible for the 4,500 contract limit,
the underlying security must not satisfy the criteria for a higher
limit. See CBOE Rule 4.11, Interpretation and Policy .02.
According to the Exchange, the number of equity option classes
currently listed at the CBOE that would qualify for one of these higher
position and exercise tiers is small. The Exchange represents that
based on available statistics as of June 30, 1995, approximately 73
classes would meet the above shares outstanding and six month trading
volume criteria for the 25,000 contract tier, and approximately 22
classes would qualify for the 20,000 contract tier, out of
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approximately 580 equity option classes currently listed on the CBOE.
In preparing the Study, the CBOE compiled information relating to
the market impact of increased position and exercise limits for equity
options, and addressed among other things: (1) The maximum underlying
dollar value of an at-limit (hedged) position; (2) the percentage of
shares outstanding that could be controlled under the proposed,
expanded limits (unhedged position); (3) how contract volume compares
between institutional and retail customers in those classes eligible
for the new tiers; (4) position limit violation and exemption history
for the existing three tiers; and (5) other evidence supporting an
expansion of the current position limit tiers.
The CBOE believes that the findings set forth in the Study should
alleviate concerns that the new position limit tiers and expanded
equity hedge exemption may increase exposure to market disruption.\7\
These findings are summarized below. For a fully hedged position
utilizing the expanded equity hedge exemption, although the maximum
underlying dollar value of an at-limit position under the increased
limits will obviously be greater than under the increased limits will
obviously be greater than under the current limits, the largest dollar
value controlled in any equity option class would not exceed 2.06% of
the total market capitalization of the underlying equity. The CBOE
noted in the Study that the actual underlying dollar value controlled
will be less than that implied by the calculation because the at-limit
position is at least two-thirds hedged with the underlying security.
\7\ The CBOE notes that the Study examined data that is based on
contract limits well in excess of the limits actually proposed by
CBOE herein (i.e., proposed tiers of 40,000 and 20,000 contracts).
Accordingly, the Exchange believes that an added measure of comfort
can be drawn from the fact that if no material market disruption
likelihood could be detected at the higher limits used in the Study,
the same should remain true, and the potential for market disruption
should be less likely, at the proposed 20,000 and 25,000 contract
limits.
Further, for an unhedged position under the limits proposed in the
Study, the maximum percentage that could be controlled by any one
investor or group of investors acting in concert would not exceed 7.2%
of outstanding shares in any eligible equity option class, in
comparison to a maximum of 10.92% of outstanding shares that currently
can be controlled in an option class in the 10,500 contract tier. With
respect to current classes in which the percentage of shares controlled
exceeds 5%, the CBOE represents that to date there have been no
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position or exercise limit violations.
The CBOE states that the Study also elucidated a need for expanded
position and exercise limits. First, the Exchange represents that the
majority of both institutional and retail customer volume is equity
options traded on the Exchange is transacted in equity option classes
qualifying for one of the expanded tiers. Second, for calendar year
1994, the CBOE notes that all but one of approximately 80 position
limit violations occurred in equity option classes qualifying for the
10,500 contract tier, and that all but seven of approximately 340
market-maker exemptions granted were also for equity option classes in
the 10,500 contract tier. Third, as noted in the Study, the CBOE
received letters and comments affirming the need to increase the
current position limits.\8\
\8\ See infra note 11.
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In addition to the proposed 25,000 and 20,000 contract tiers, the
CBOE is also proposing to expand the equity hedge exemption provided in
Exchange Rule 4.11, Interpretation and Policy .04, so that the maximum
allowable position, after exempting from the base position limit
specified positions where the option contract is hedged by 100 shares
of stock or securities convertible into stock, will be three times
instead of twice the standard or base limit currently provided. For
example, the maximum position allowed in a single equity option class
in the proposed 25,000 contract tier will be 75,000 contracts, of which
50,000 contracts must be hedged. The CBOE believes that its data
supports this proposal. The proposed increase in the maximum hedge
exemption will apply to all position limit tiers, not just the proposed
25,000 and 20,000 contract tiers. The CBOE notes that in the Study,
approximately 30 to 35 customer accounts and 25 market-maker/member
[[Page 44526]]
firm accounts, representing approximately 35 equity option classes,
used the equity hedge exemption on a consistent basis in 1994.
Moreover, the Study indicated that many institutions had significant
positions both in equity options qualifying for the expanded tiers and
in the underlying securities. As noted below, the CBOE also received
comments in support of expanding the equity hedge exemption.\9\
\9\ Id.
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For the above reasons, the CBOE is requesting approval of the
proposed 20,000 and 25,000 position and exercise limit tiers for
qualifying equity option classes and an expansion of the current equity
option hedge exemption from two to three times the base position limit.
The CBOE strongly believes that the investing community--institutions,
retail customers and member firms across the board--will benefit from
the proposed increases in equity option position limits and the equity
option hedge exemption, particularly investors with sizeable holdings,
accounts, or assets who employ equity options to hedge large stock
holdings, and who have found the existing equity option position limit
tiers and hedge exemption to be too restrictive. The CBOE does not
believe, based on existing data, that the increased position limits and
equity hedge exemption proposed herein will increase the risk of or
exposure to market disruption resulting from the higher numbers of
equity option contracts permitted to be under common control.
The Exchange believes that the proposed rule change is consistent
with Section 6 of the Act, in general, and furthers the objectives of
Section 6(b)(5) of the Act,\10\ in particular, in that it is designed
to remove impediments to and perfect the mechanism of a free and open
market and a national market system by providing investors with
enhanced hedging capabilities.
\10\ 15 U.S.C. 78f(b)(5) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any inappropriate burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
The CBOE states that it received six letters from member firms
nothing that the current position limits are too low and supporting an
increase in the current position limit levels, particularly for
institutional clients.\11\ The CBOE states that it has also received
comments from member firm representatives and customers that, with
respect to sizeable portfolios or assets, they do not have adequate
hedging capabilities under the current position limit tiers for equity
options. Further, the CBOE represents that money managers have
commented that the current equity option position limits are too
restrictive with respect to the size of assets managed.
\11\ See Letter to Karen Charleston, CBOE, from Alfred Scerbo,
Compliance Department, Bear, Stearns & Co., Inc., dated October 6,
1994; letter to Patricia Cerny, CBOE, from Heather Wood, Branch
Manager, Prudential Securities, dated January 18, 1995; letter to
Patricia Cerny, CBOE, from William McGowan, Senior Vice President,
Mesirow Financial, dated December 20, 1994; letter to Karen
Charleston, CBOE, from Scott Kilrea, LETCO, dated October 3, 1994;
letter to Patricia Cerny, CBOE, from Lyn Lane, Vice President,
Rauscher Pierce Refsnes, Inc., dated December 8, 1994; and letter to
Patricia Cerny, CBOE, from W. Thomas Clark, Managing Director,
Morgan Stanley, dated January 11, 1995.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission will:
(a) By order approve such proposed rule change, or
(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, 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 in 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 CBOE. All
submissions should refer to File No. SR-CBOE-95-42 and should be
submitted by September 18, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
\12\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-21272 Filed 8-25-95; 8:45 am]
BILLING CODE 8010-01-M