[Federal Register Volume 61, Number 98 (Monday, May 20, 1996)]
[Notices]
[Pages 25251-25253]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12594]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37198; File No. SR-CROE-96-11]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving Proposed Rule Change Relating to the Listing and 
Trading of Options on the CBOE PC Index

May 10, 1996.
    On March 7, 1996, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commisssion''), pursuant to Section 19(b) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to list and trade options on the 
CBOE PC Index (``CBOE PC Index'' or ``Index''), a narrow-based, equal-
weighted index comprised of eight of the largest personal computer 
manufacturing companies. Notice of the proposed rule change appeared in 
the Federal Register on March 27, 1996.\3\ No comments were received on 
the proposal. This order approves the proposal, as amended.
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    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988 & Supp. V. 1993).
    \2\ 17 CFR Sec. 240.19b-4 (1994).
    \3\ See Securities Exchange Act Release No. 36992 (March 20, 
1996), 61 FR 13548.
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I. Description of the Proposal

    The purpose of the proposed rule change is to permit the Exchange 
to list and trade cash-settled, European-style stock index options on 
the CBOE PC Index, an equal-weighted index consisting of stocks of 
eight of the largest personal computer manufacturing companies. CBOE 
represents that each of these stocks are actively traded and believes 
that options on the Index will provide investors with a low-cost means 
to participate in the performance of the domestic PC industry or a 
means to hedge the risk of investments in that industry. The Exchange 
believes that the small number of Index components should facilitate 
replication of the Index for hedging purposes.
    Index Design. As noted above, the CBOE PC Index consists of eight 
components, all of which trade on the New York Stock Exchange 
(``NYSE'') or Nasdaq.\4\ In addition, the Exchange represents that all 
eight underlying component securities currently meet the Exchange's 
listing criteria for equity options contained in Exchange Rule 5.3 and 
are the subject of options trading on U.S. options exchanges.
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    \4\ The components of the Index are: Apple Computer, AST 
Research, Compaq Computer, Dell Computer, Gateway 2000, Hewlett 
Packard, International Business Machines, and Micron Electronics.
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    As of February 6, 1996, the capitalization of the components ranged 
from a low of $363 million (AST Research) to a high of $65.26 billion 
(IBM). The total capitalization of the Index as of that date was $135.5 
billion; the mean capitalization was $16.9 billion; and the median 
capitalization was $3.34 billion. Because the Index is equal-weighted, 
each component accounts for 12.5% of the weight of the Index at the 
time of rebalancing.
    Calculation. The Index will be calculated by CBOE or its designee 
on a real-time basis using last-sale prices and will be disseminated 
every 15 seconds. The updated Index values will be displayed by the 
Consolidated Tape Association and over the facilities of the Options 
Price Reporting Authority (``OPRA''). If a component is not currently 
being traded on its primary market, the most recent price at which the 
share traded on such market will be used in the Index calculation. The 
value of the Index at the close on February 1, 1996 was 127.65.
    The Index is equal-weighted and reflects changes in the prices of 
the component stocks relative to the Index base date, January 3, 1995 
when the Index was set to 100.00. Specifically, each of the component 
securities is initially represented in equal-dollar amounts, with the 
level of the Index equal to the combined market value of the assigned 
number of shares for each of the Index components divided by the 
current Index divisor. The Index divisor is adjusted to maintain 
continuity in the Index at the time of certain types of changes. 
Changes which may result in divisor changes include, but are not 
limited to, quarterly re-balancing, special dividends, spin-offs, 
certain rights issuances, and mergers and acquisitions.
    Maintenance. The Index will be maintained by CBOE and will be re-
balanced after the close of business on Expiration Fridays on the March 
Quarterly Cycle. The Index will be reviewed regularly and CBOE may 
change the composition of the Index at any time to reflect changes 
affecting the components of the Index or the PC markets generally. If 
it becomes necessary to replace a component, every effort will be made 
to add a component

[[Page 25252]]

that preserves the character of the Index. If no replacement is 
available, or if CBOE determines to decrease the number of component 
stocks, it will submit a proposed rule change pursuant to Section 19(b) 
of the Act prior to opening any new series of Index options for 
trading. Absent prior Commission approval, CBOE will not increase to 
more than ten the number of component stocks in the Index. Finally, if 
at any time any of the components are not options eligible,\5\ the 
Exchange will submit a rule change pursuant to Section 19(b) of the Act 
prior to opening any new series of Index options for trading.
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    \5\ Options eligibility requirements include, among other 
criteria, public float, minimum holder, trading volume, and share 
price requirements. See CBOE Rules 5.3 and 5.4.
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    Index Option trading. The Exchange proposes to base trading in 
options on the CBOE PC Index on the full value of that index. The 
Exchange may list full-value long-term index option series 
(``LEAPS''), as provided in Rule 24.9. The Exchange also may 
provide for the listing of reduced-value LEAPS, for which the 
underlying value would be computed at one-tenth of the value of the 
Index. The current and closing index value of any such reduced-value 
LEAP will, after such initial computation, be rounded to the nearest 
one-hundredth.
    Exercise and Settlement. CBOE PC Index options will have European-
style exercise and will be ``A.M.-settled index options'' within the 
meaning of the Rules in Chapter XXIV, including Rule 24.9, which is 
being amended to refer specifically to CBOE PC Index options. The 
proposed options will expire on the Saturday following the third Friday 
of the expiration month and the last day for trading in an expiring 
series will be the second business day (ordinarily a Thursday) 
preceding the expiration date.
    Exchange Rules Applicable. Except as modified herein, the Rules in 
Chapter XXIV will be applicable to CBOE PC Index options. Index option 
contracts based on the CBOE PC Index will currently be subject to a 
position limit of 9,000 contracts on the same side of the market.\6\ 
Ten reduced-value options will equal one full-value contract for such 
purposes.
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    \6\ CBOE recently increased its position limit tiers applicable 
to narrow-based index options from 5,000, 7,500, and 10,500 
contracts on the same side of the market to 6,000, 9,000, and 12,000 
contracts, respectively.
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    CBOE represents that it has the necessary systems capacity to 
support new series that would result from the introduction of options 
on the Index and has also been informed that OPRA has the capacity to 
support such new series.\7\
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    \7\ See Letter from Joe Corrigan, OPRA, to Eileen Smith, CBOE, 
dated February 21, 1996.
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    Surveillance. The surveillance procedures currently used to monitor 
the trading of options on other Exchange-listed indexes will be used to 
monitor the trading of options on the CBOE PC Index. The Exchange has 
access to trading activity in the underlying securities, all of which 
trade on either the NYSE or Nasdaq, via the Intermarket Surveillance 
Group (``ISG'') Agreement.

II. 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).\8\ Specifically, the 
Commission finds that the trading of CBOE PC Index options, including 
full-value and reduced-value long-term Index options, will serve to 
promote the public interest and help to remove impediments to a free 
and open securities market by providing investors with an additional 
means to hedge exposure to market risk associated with stocks in the 
personal computer industry.\9\
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    \8\ 15 U.S.C. Sec. 78f(b)(5) (1988).
    \9\ 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 Index will provide investors with a hedging 
vehicle that should reflect the overall movement of the stocks 
representing companies in the networking sector in the U.S. stock 
markets.
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    The trading of options on the Index and on a reduced-value Index, 
however, raises several issues relating to index design, customer 
protection, surveillance, and market impact. The Commission believes, 
for the reasons discussed below, that the CBOE has addressed these 
issues adequately.
    A. Index Design and Structure. The Commission believes it is 
appropriate for the Exchange to designate the Index as a narrow-based 
index for purposes of index options trading. The Index is comprised of 
8 stocks intended to track the personal computer manufacturing sector 
of the stock market. The Commission also finds that the reduced-value 
Index is a narrow-based index because it is composed of the same 
component securities as the Index, and merely dividing the Index value 
by ten will not alter its basic character. Accordingly, the Commission 
believes that it is appropriate for the CBOE to apply its rules 
governing narrow-based index options to trading in the Index options 
and long-term full-value and reduced-value Index options.
    The Commission also believes 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 stocks that comprise the Index are actively traded, with a 
mean and median average monthly trading volume for the period between 
August 1995 and February 1996 of 2.09 million and 2.45 million shares, 
respectively. Second, the market capitalizations of the stocks in the 
Index are very large, ranging from a high of $65.26 billion to a low of 
$363 million as of February 2, 1996, with the mean and median being 
$16.9 billion and $3.3 billion, respectively. Third, because the index 
is equal dollar-weighted, as described above, no one particular stock 
or group of stocks dominates the Index. Specifically, as of February 
6th, each stock accounted for 12.5% of the Index's total value and the 
percentage weighting of the five highest weighted stocks in the Index 
accounted for 62.5% of the Index's value.
    Fourth, the proposed maintenance criteria will serve to ensure 
that: (1) the Index remains composed of liquid highly capitalized 
securities; and (2) the Index is not dominated by one or several 
securities that do not satisfy the Exchange's options listing criteria. 
Specifically in considering changes to the composition of the Index, 
CBOE will submit a rule change prusuant to Section 19(b) of the Act 
prior to the opening of any new series of Index options if at any time 
any of the components are not options eligible.\10\ Finally, the 
Commission believes that the existing mechanisms to monitor trading 
activity in the component stocks of the Index, or options on those 
stocks, will help deter as well as detect any illegal activity.
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    \10\ See supra note 5.
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    B. Customer Protection. The Commission beleives that a regulatory 
system designed to protect public customers must be in place before the 
trading of sophisticated financial instruments, such as Index options 
(including full-value and reduced-value long-term Index options), can 
commence on a national securities

[[Page 25253]]

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 long-term 
full-value and reduced-value options will be subject to the same 
regulatory regime as the other standardized index options currently 
traded on CBOE, the Commission believes that adequate safeguards are in 
place to ensure the protection of investors in Index options and full-
value or reduced-value Index long-term options.
    C. Surveillance. The Commission believes that a surveillance 
sharing agreement between an exchange proposing to list a stock index 
derivative 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.\11\ In this regard, 
the Commission notes that the CBOE, NYSE, and NASD are all members of 
the ISG. The Commission believes that this arrangement ensures the 
availability of information necessary to detect and deter potential 
manipulations and other trading abuses, thereby making the Index 
options and full-value and reduced-value long-term Index options less 
readily susceptible to manipulations.\12\
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    \11\ See Securities Exchange Act Release No. 31243 (September 
28, 1992), 57 FR 45849.
    \12\ See, e.g., Securities Exchange Act Release No. 31243 
(September 28, 1992), 57 FR 45849 (order approving the listing of 
index options and index LEAPS on the CBOE Biotech Index).
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    D. Market Impact. The Commission believes that the listing and 
trading of Index options, including full-value and reduced-value Index 
LEAPS on the CBOE, will not adversely affect the underlying securities 
markets. First, because of the equal-weighting method that will be 
used, no one security or group of securities represented in the Index 
will dominate the weight of the Index immediately following a quarterly 
rebalancing. Second, the Index maintenance criteria ensure that the 
Index will be comprised solely of securities that satisfy the 
Exchange's listing standards for standardized options trading, and that 
one or a few stocks do not dominate the Index. Third, the currently 
applicable 9,000 contract position and exercise limits 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 long-term options will be issued 
and guaranteed by the Options Clearing Corporation just like any other 
standardized option traded in the United States.
    Lastly, the Commission believes that settling expiring Index 
options (including full-value and reduced-value long-term Index 
options) based on the opening prices of component securities is 
reasonable and consistent with the Act. As has been noted previously, 
valuing index options for exercise settlement on expiration based on 
opening rather than closing prices of Index component securities may 
help to reduce adverse effects on markets for such securities.\13\
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    \13\ See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992).
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    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-CBOE-96-11) is approved.

    \14\ 15 U.S.C. Sec. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR Sec. 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12594 Filed 5-17-96; 8:45 am]
BILLING CODE 8010-01-M