[Federal Register Volume 61, Number 204 (Monday, October 21, 1996)]
[Notices]
[Pages 54693-54695]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-26857]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37815; File No. SR-CBOE-96-61]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Chicago 
Board Options Exchange, Incorporated Relating to the Opening of New 
Series of OEX Index Options

October 11, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on October 9, 1996, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I and II 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 and to grant accelerated approval of the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

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

    The Exchange proposes to amend Rule 24.9, Interpretation and Policy 
.01 regarding the listing of additional series of index options on the 
Standard & Poor's 100 (``S&P 100'' or ``OEX'') Index options in order 
to take into account the signficantly increased levels of the S&P 100 
since the listing procedures were implemented. 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

    1. Purpose. The purpose of the proposed rule change is to amend the 
procedures for listing additional series of index options on the S&P 
100 Index (OEX ) in order to take into account the 
significantly increased levels of the S&P 100 Index since these 
procedures were first put in place. Under existing Interpretation and 
Policy .01 under Exchange Rule 24.9, when the Exchange introduces 
trading in a new expiration month for a class of OEX options, it may 
initially list series of options with strike prices at four strike 
price intervals above and four strike price intervals below the current 
value of the Index. Subsequently, as the value of the Index moves up or 
down, the Exchange may list additional series of options (up until the 
fifth day prior to expiration), such that under ordinary circumstances 
there may be available for trading series of OEX options with a given 
expiration date having strike prices at up to five strike price 
intervals above and up to five strike intervals below the current value 
of the Index. In unusual market conditions (such as at times of 
heightened volatility) additional series may be added at up to six 
strike price intervals above and six strike price intervals below the 
current value of the Index. Of course, series of options previously 
opened continue to be available, so that there may be more than the 
stated number of series traded at strike price intervals opposite to 
the direction in which the index value has moved.
    For example, if a new expiration month is introduced in an OEX 
option at a time when the current value of the S&P 100 Index is 598, so 
long as the strike price interval for OEX options remains at 5 points, 
series of OEX options will be available at 580, 585, 590 and 595 (four 
intervals below the current Index value) and at 600, 605, 610, and 615 
(four intervals above the current Index value). If the value of the 
Index then moves to 608, under normal conditions the Exchange would be 
able to add series with strike prices of 620, 625 and 630, which, 
together with the 610s and the 615s, provide five series above the 
current level of the Index. In unusual market conditions, the Exchange 
could add sixth series with a strike price of 635. In this example, 
there would continue to be traded six series with strike prices below 
the current level of the Index (that is, the 580, 585, 590, 595, 600 
and 605 series).
    When the current methodology for adding series of OEX options was 
adopted in 1992, the S&P Index was at 380. This meant that five 
intervals (25 points) constituted over 6\1/2\% of the value of the 
index, and six intervals (30 points) constituted almost 8% of the index 
value.\3\ Since that time, the value of the S&P 100 Index has increased 
considerably, to the point where it has recently exceeded 670. At this 
level, five strike price intervals constitutes less

[[Page 54694]]

than 3\3/4\%, and six intervals less than 4\1/2\%, of the value of the 
Index.
---------------------------------------------------------------------------

    \3\ This was consistent with the prior methodology for adding 
new series of OEX options, which permitted up to four strike price 
intervals and was adopted at a time when the value of the index was 
265, thus allowing OEX options to be added up to 7\1/2\% away from 
the market.
---------------------------------------------------------------------------

    Application of the current rule, together with a sustained bull 
market, has led to an absence of OEX call series that are more than 
nominally out-of-the-money, since even under unusual market conditions, 
which the Exchange has determined now exist, an OEX call can be only a 
little over 4% out-of-the-money when first opened for trading, as 
contrasted with approximately 8% out-of-the-money at times when the 
level of the Index was lower. And, so long as the Index continues to 
move in a generally upward direction, out-of-the-money calls become 
less out-of-the-money with the passage of time. The adverse 
consequences of this trend is exemplified in at least three ways: (1) 
the number of OEX calls eligible for trading through the Exchange's 
automatic execution system (RAES) is limited; (2) institutional 
customers, which often apply specific parameters to conservative 
options strategies that involve writing out-of-the-money OEX calls, are 
limited in their ability to pursue these strategies; and (3) retail 
customers have fewer low-priced OEX calls available to trade. Each of 
these negative consequences is discussed in turn below.
    (1) Fewer OEX series on RAES. The guidelines followed by the OEX 
Floor Procedure Committee in designating series of OEX options as 
eligible for trading on RAES provide that up to eight series in each of 
the two near term expiration months may be so designated, provided the 
option in any designated series is priced below $7. Historically, when 
the index was at a lower level and thus further out-of-the-money series 
were available as illustrated above, customers have had as many as 
sixteen series \4\ of RAES-eligible OEX calls to choose from. Recently, 
however, there have been as few as six RAES-eligible OEX calls, four in 
the near term month and only two in the next-out expiration. This, of 
course, reflects that at only 4% out-of-the-money an OEX call with any 
significant time remaining until expiration will have a price above the 
$7 cutoff.
---------------------------------------------------------------------------

    \4\ The proposed rule change as originally filed incorrectly 
states that in the example above, customers have had as many as 
fourteen series of RAES-eligible OEX calls to choose from. Telephone 
conversation between Tim Thompson, CBOE, and John Ayanian, SEC on 
October 11, 1996.
---------------------------------------------------------------------------

    (2) Institutional covered writing curtailed. The Exchange has 
recently observed a decline in institutional OEX activity. When looking 
into possible causes, the Exchange learned that some institutional 
customers follow strategies involving the writing of out-of-the-money 
OEX calls as a hedge against a diversified stock portfolio. In some 
cases, these strategies require that the calls written must be at least 
5% out-of-the-money. Obviously, if the furthest out-of-the-money OEX 
call is only 4% out-of-the-money, this strategy cannot be pursued.
    (3) Lower-priced OEX series unavailable for retail customers. The 
Exchange has long noticed that OEX order flow from retail customers is 
concentrated in options priced below $5, and that when the number of 
available lower priced options increases, so does retail order flow. 
Under current index levels in light of the existing restrictions under 
Interpretation and Policy 24.9.01, there are a few low price OEX call 
options available with any significant time remaining before 
expiration, such that at times there are no OEX calls available at less 
than $6 premiums having more than two months remaining until 
expiration. For example, recently the least expensive third month OEX 
call was offered at 6\5/8\, and the least expensive fourth month call 
at 9\1/2\. The effect of this is to preclude retail investors from 
participating in the OEX call market, except at higher than desired 
price levels.
    In response to these concerns, CBOE is now proposing to change the 
measure of when additional series of OEX options may be traded from the 
current inflexible test based on the number of strike price intervals 
away from the market to a more flexible test which measures the extent 
to which an away from the market series may be opened by reference to a 
percentage of the current value of the index. Based on historical 
patterns, it is proposed that under ordinary conditions the Exchange 
should be able to add additional series of OEX options that are as much 
as 8% away from the market, and under unusual conditions it should be 
able to add series that are as much as 10% away from the market.\5\ 
Applying these percentages to current index levels, there could be as 
many as ten series \6\ of OEX options above and below the market under 
normal circumstances, and up to 13 series in unusual circumstances.
---------------------------------------------------------------------------

    \5\ This proposed test would apply only to OEX. All other index 
options are currently subject to Interpretation and Policy .05 under 
Rule 24.9, which applies a percentage test, subject to a maximum 
number of points, to adding away from the market series. Under that 
test, for all but long term options, the percentages are 15% under 
normal conditions and 30% where there is ``demonstrated customer 
interest'' in additional strike prices.
    \6\ The proposed rule change, as originally filed, incorrectly 
states that there would be eight strikes at current values. 
Telephone conversation between Tim Thompson, CBOE, and Janice 
Mitnick, SEC on October 10, 1996.
---------------------------------------------------------------------------

    The number of additional series that will result from this proposed 
rule change, which affects OEX options only, will not be significant. 
For this reason, CBOE does not believe that the proposed change raises 
any capacity issues. In any event, with prior notice CBOE would 
continue to have the ability to delist series that become inactive if 
the market were to move away from exercise price levels at which the 
series were previously opened. Indeed, CBOE has recently acted to 
delist over 400 inactive series on this basis.
    2. Statutory basis. By responding to the current historically high 
values of the S&P 100 Index in a manner that will increase the 
availability to investors of lower priced OEX options, the proposed 
rule change is consistent with the provisions of Section 6 of the Act, 
and Section 6(b)(5) in particular, in that it will promote just and 
equitable principles of trade, will protect investors and the public 
interest, and will remove impediments to and perfect the mechanisms of 
a free and open market.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange states that it believes that the proposed rule change 
will impose no 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 solicited or received with respect to the 
proposed rule change.

III. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    The Exchange has requested that the proposed rule change be given 
accelerated effectiveness pursuant to Section 19(b)(2) of the Act. 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, with 
the requirements of Section 6(b) of the Act. Specifically, the 
Commission believes that the proposal will enable the CBOE to respond 
to changing market conditions, and list index options series that 
provide market participants with an effective means to transfer risk 
and implement their trading strategies. The Commission believes that 
the discretion to list

[[Page 54695]]

additional series of index options will help to ensure the consistent 
availability of index options series tailored to meet the needs of 
investors during periods of market volatility. In addition, the 
Commission notes the CBOE's proposal is similar to Rule 24.9, 
Interpretation and Policy .05 which applies a percentage test, subject 
to a maximum of 15%, for adding away from the market series.\7\ 
Further, the rule allows CBOE to use a maximum of 30% for adding series 
when there is ``demonstrated consumer interest'' in additional strike 
prices.\8\ Finally, American Stock Exchange (``Amex'') Rule 930C(b) 
allows the Amex to list additional series of the same class of index 
options as the numerical index value of the underlying stock index 
moves substantially from the initial exercise price or prices.
---------------------------------------------------------------------------

    \7\ The 15% maximum applies to all index options (excluding 
OEX), but not to long term options. CBOE Rule 24.9, Interpretation 
and Policy .05. See Securities Exchange Act Release No. 31683 
(December 31, 1992), 58 FR 3307 (order approving SR-CBOE-92-36).
    \8\ CBOE Rule 24.9, Interpretation and Policy .05. Again, this 
standard applies to all index options (except OEX), but not to long 
term options.
---------------------------------------------------------------------------

    The Commission believes that the CBOE's proposal strikes a 
reasonable balance between accommodating the needs of market 
participants and avoiding the excessive proliferation of options 
series. In this regard, the proposal provides that the options price of 
each series of options opened for trading shall be reasonably related 
to the current value of the underlying index, as discussed below. The 
proposed rule change also allows the Exchange to open additional series 
of index options for trading only after a substantial movement in the 
value of the underlying index.\9\
---------------------------------------------------------------------------

    \9\ The Commission notes, however, that the Exchange is not 
obligated to open new series every time the index value changes. 
Opening of new series must be done in a manner that is consistent 
with the maintenance of a fair and orderly market.
---------------------------------------------------------------------------

    The Commission believes that the change in the level of the S&P 100 
Index since the series listing rules were put into place has affected 
the availability of series of options on the index. More specifically, 
CBOE states that when the methodology for adding series of options was 
adopted in 1992, the S&P 100 Index was at 380. At that time, the 
options available under normal market conditions, five intervals (25 
points), constituted over 6\1/2\% of the value of the index. Further, 
the options available under the standard for unusual market conditions, 
six intervals (30 points), constituted almost 8% of the index value at 
the time the standards were implemented.
    The S&P 100 Index has recently exceeded 670. Under the current 
standard, five strike price intervals constitute less than 3\3/4\% of 
the index, and six intervals constitute less than 4\1/2\% of the value 
of the index. The proposed rule will permit the addition of options 
series at 8% away from the market and, under unusual market conditions, 
as much as 10% away from the market. Using current index levels, there 
could be as many as ten series of OEX options above and below the 
market under normal circumstances, and up to 13 series in unusual 
market conditions. The Commission believes that these requirements 
provide the Exchange with the flexibility to open additional index 
options series and, at the same time, appropriately limit the number of 
index options series that may be outstanding at any one time. In 
addition, the Commission notes that although the proposal permits the 
CBOE to open additional index option series, the CBOE retains the 
discretion to list fewer series than those allowed under the 
proposal.\10\
---------------------------------------------------------------------------

    \10\ See supra note 9.
---------------------------------------------------------------------------

    The CBOE has represented that due to the fact that this proposed 
rule change applies only to OEX options, the number of additional 
series will not be significant. The Options Price Reporting Authority 
has represented that CBOE's current system capacity is sufficient to 
meet the expected demands of the additional strike prices.\11\ 
Nevertheless, the Commission requests that the CBOE monitor the volume 
of additional series listed as a result of this rule change and the 
effect of these additional series on the capacity of CBOE's, and OPRA's 
and vendors' automated systems. The Commission encourages the CBOE to 
exercise its available discretion when appropriate to delist inactive 
series that have no open interest.
---------------------------------------------------------------------------

    \11\ See Letter from Joe Corrigan, OPRA, to Mike Walinskas, 
Senior Special Counsel, Office of Market Supervision, Division of 
Market Regulation, SEC, dated October 11, 1996.
---------------------------------------------------------------------------

    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. Specifically, as stated above, 
the Commission previously approved a CBOE rule similar to the proposed 
rule,\12\ and believes that the proposed rule change raises no new 
regulatory issues. Further, the Commission believes that the proposed 
rule will help the CBOE to accommodate the needs of investors by 
helping to ensure the availability of a proper range of option strikes. 
Accordingly, the Commission believes, consistent with Section 6(b)(5) 
of the Act, that good cause exists to approve the proposed rule change 
on an accelerated basis.
---------------------------------------------------------------------------

    \12\ Securities Exchange Act Release No. 31683 (December 31, 
1992), 58 FR 3307 (approving CBOE-92-36).
---------------------------------------------------------------------------

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. Sec. 552, will be available for inspection and copying at 
the Commission's Public Reference Room. Copies of such filing will also 
be available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to File No. SR-CBOE-96-61 and 
should be submitted by November 12, 1996.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-96-61) is hereby 
approved on an accelerated basis.

    \13\ 15 U.S.C. Sec. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
---------------------------------------------------------------------------

    \14\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret McFarland,
Deputy Secretary.
[FR Doc. 96-26857 Filed 10-18-96; 8:45 am]
BILLING CODE 8010-01-M