[Federal Register Volume 60, Number 211 (Wednesday, November 1, 1995)]
[Notices]
[Pages 55617-55619]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27132]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36418; File No. SR-CBOE-95-60]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Chicago Board Options 
Exchange, Inc., Relating to the Calculation of Bid/Ask Values for 
Certain Indexes

October 25, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on October 
20, 1995, the Chicago Board Options Exchange, Inc. (``CBOE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the self-
regulatory organization. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to amend CBOE Rule 8.7, ``Obligations of Market 
Makers,'' by adopting Interpretation and Policy .08, which will allow 
the Exchange or its agent to calculate and disseminate bids and asks 
for various indexes for the purpose of determining permissible bid/ask 
differentials for in-the-money options on those indexes. The values 
will be calculated by determining the weighted average of the bids and 
asks for the components of the corresponding index.
    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 self-regulatory organization 
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 self-regulatory organization 
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

    Currently, CBOE Rule 8.7(b)(iv) states that the bid/ask 
differentials provided in CBOE Rule 8.7(b)(iv) shall not apply to in-
the-money series where the underlying securities market is wider than 
the differentials set forth in CBOE Rule 8.7(b)(iv). For those series, 
CBOE Rule 8.7(b)(iv) provides that the bid/ask differential may be as 
wide as the quotation on the primary market of the underlying security.
    The purpose of the proposal is to permit the bid/ask values of 
certain indexes, as calculated by the CBOE or its authorized agent, to 
be used to determine the allowable bid/ask differential for options on 
the corresponding index, as is currently permitted under CBOE Rule 
8.7(b) for equity options. The indexes for which the Exchange currently 
will provide bid/ask values are the CBOE Biotech Index, the Standard & 
Poor's (``S&P'') Banking Index, the S&P Chemicals Index, the CBOE 
Computer Software Index, the CBOE Environmental Index, the CBOE Gaming 
Index, the S&P Health Care Index, the S&P Insurance Index, the CBOE 
Israel Index, the CBOE Mexico Index, the S&P Retail Index, the S&P 
Transportation Index, the S&P Telecommunications Index, the CBOE Global 
Telecommunications Index, and the CBOE Real Estate Investment Trust 
(``REIT'') Index. The CBOE may make additions or deletions to this list 
as conditions warrant. The CBOE represents that any additions to the 
list will be communicated to the Exchange's membership by means of a 
regulatory circular.
    The Exchange notes that CBOE Rule 8.7 specifies the obligations of 
a market maker in maintaining a fair and orderly market, including 
pricing option contracts fairly. In order to price option contracts 
fairly, CBOE Rule 8.7(b) requires market makers to make bids and offers 
so that a difference of no more than \1/4\ of $1 is created between the 
bid and offer for each option contract for which the bid is less than 
$2. The allowable differential between the bid and the offer increases 
in steps as the price of the bid increases, so that the bid/ask 
differential can be as large as $1 where the bid is more than $20. An 
exception exists with respect to these specified numerical 
differentials, however, for in-the-money option series where the 
underlying securities market is wider than the differentials set forth 
in CBOE Rule 8.7(b). For these series, CBOE Rule 8.7(b)(iv) permits the 
bid/

[[Page 55618]]
ask differential on the option to be as wide as the quotation on the 
market of the ``underlying security.''
    According to the CBOE, the language of CBOE Rule 8.7(b)(iv), which 
permits spreads on the options to be as wide as the spread on the 
underlying security, does not apply to the indexes traded on the CBOE 
because these indexes are not ``underlying securit[ies].'' As a result, 
the Exchange states that it generally has required market makers in 
options on these indexes to a maintain bid/ask differential in line 
with the specified numerical differentials set forth in CBOE Rule 
8.7(b)(iv).\1\ For a variety of reasons, however, the Exchange notes 
that bid/ask values on the components of the index may be quite wide. 
As a result, market makers may be discouraged from making quotes on 
options on these indexes if they are forced to make quotes within 
narrow spreads.\2\ The liquidity in these options will in turn be 
affected.

    \1\Under CBOE rule 8.7(b)(iv), the CBOE's Market Performance 
Committee may establish differences other than those stated in 
paragraph (iv) for one or more option series.
    \2\The CBOE states that if market makers are required to make 
markets that are narrower than the underlying index, they will have 
difficulty in profitably hedging their positions with a basket in 
the underlying securities if it is necessary to do so.
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    To protect market makers from having to make bid/ask quotes on the 
index options that have an inordinately small differential in 
comparison to the bid/ask differentials of the components of the index, 
the Exchange proposes to add Interpretation and Policy .08 to Exchange 
Rule 8.7. This interpretation will permit the Exchange to disseminate 
an index bid/ask differential to provide a basis for an exception to 
the numerical limits provided in CBOE Rule 8.7(b)(iv) for in-the-money 
option series, thus giving the market makers of these index options the 
same protections offered by CBOE Rule 8.7(b)(iv) to equity option 
market makers. The Exchange states that it will nonetheless encourage 
its market makers to make markets as narrow as possible in these 
indexes, particularly in the lower priced series.
    The CBOE recognizes that in the limited circumstances of a slightly 
in-the-money index option approaching expiration, the index bid/ask 
differential may not be an appropriate measure for the maximum 
permitted bid/ask spread on the option. However, the Exchange does not 
expect the adoption of proposed Interpretation and Policy .08 to result 
in unduly wide spreads for index options in this circumstance. Instead, 
the Exchange is confident that competition among market makers on the 
Exchange and, in the case of multiply listed options, on other 
exchanges, together with arbitrage possibilities that would exist if 
the spreads for slightly in-the-money options were to become too wide, 
will act to keep bid/ask spreads for index options within narrow limits 
even in the circumstances where proposed Interpretation and Policy .08 
would appear to allow wider spreads. The Exchange notes that this has 
been the CBOE's experience under existing CBOE Rule 8.7(b)(iv) as it 
applies to high priced stocks in the $300 to $700 range, where CBOE 
Rule 8.7(b)(iv) might also appear to permit unrealistically wide 
spreads for low-priced, slightly in-the-money options, but where in 
fact spreads have remained within reasonably narrow limits.
    To calculate the bid/ask values on these certain indexes, the 
Exchange or its agent will calculate a bid and an ask for the index 
that is simply a weighted average of the bids and asks of the 
components of the index. These values will be calculated in the same 
method that the index itself is calculated. For example, if the index 
is calculated by a price-weighted method using the closing prices, then 
the bids and asks on the index will be calculated using the same 
formula and the same weights but using the last bids and the last asks, 
respectively, instead of the closing price. These index bid/ask values 
will then be disseminated to the public and to the trading floor by way 
of the Options Price Reporting Authority (``OPRA''). OPRA has 
represented that it has the capacity to disseminate these values.\3\

    \3\See Memorandum from Joseph Corrigan, Executive Director, 
OPRA, to Eileen Smith, dated September 20, 1995 (``September 20 
Memorandum''). Specifically, in its September 20 Memorandum, OPRA 
represents that is has the capacity to disseminate underlying index 
values based on the bid and ask values of the stocks in the index 
for the indexes that the CBOE is currently authorized to send to 
OPRA. In addition, the September 20 Memorandum states that for new 
index filings, OPRA will review its capacity when the filing is 
made. Accordingly, the Commission expects the CBOE to obtain a 
capacity representation from OPRA prior to listing bid/ask 
differentials for a new index.
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    The CBOE notes that although the Exchange will disseminate bid/ask 
values in the indexes, it will not make a market in the underlying 
basket of stocks representing the indexes. In addition, the Exchange 
represents that although it will take appropriate precautions to assure 
the accuracy of the bid/ask values which it disseminates, the CBOE will 
not guarantee the accuracy of the bid/ask values because the 
calculations necessarily require the collection of data from many 
sources. Consequently, the Exchange is also specifying in proposed 
Interpretation and Policy .08 that the Exchange will not be liable for 
any errors, omissions, or delays in the provision or calculation of the 
index bids and asks. The Exchange believes that this limitation of 
liability is reasonable because it is consistent with the current 
limitation of liability for the calculation of the index itself and 
because these values are being provided only for the express and 
limited purpose of determining permissible bid/ask differentials.
    The CBOE believes that the proposed rule change will contribute to 
more liquid markets in the options on the indexes by providing market 
makers in these series with the same protections that are afforded 
market makers in equity options. Therefore, the CBOE believes that the 
proposal is consistent with Section 6(b) of the Act, in general, and, 
in particular, with Section 6(b)(5), in that it provides rules designed 
to perfect the mechanisms of a free and open market and to protect 
investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants or Others

    No written comments were either solicited or received with respect 
to the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing rule change: (1) does not significantly 
affect the protection of investors or the public interest; (2) does not 
impose any significant burden on competition; (3) was provided to the 
Commission for its review at least five business days prior to the 
filing date; and (4) does not become operative for 30 days after 
October 20, 1995, it has become effective pursuant to Section 
19(b)(3)(A) of the Act and Rule 19b-4(e)(6) thereunder. In particular, 
the Commission believes that the proposal does not significantly affect 
the protection of investors or the public interest and does not impose 
any significant burden on competition. At any time within 60 days of 
the filing of such proposed rule change, the Commission may summarily 
abrogate such rule change if it appears to the Commission that such 
action is necessary or appropriate in the public 

[[Page 55619]]
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Act.

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, N.W., Washington, D.C. 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, N.W., 
Washington, D.C. 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 November, 22, 
1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\4\

    \4\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-27132 Filed 10-31-95; 8:45 am]
BILLING CODE 8010-01-M