[Federal Register Volume 62, Number 116 (Tuesday, June 17, 1997)]
[Notices]
[Pages 32846-32848]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15772]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38730; File No. SR-CBOE-97-25]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by Chicago Board Options Exchange, Incorporated Relating to the 
Listing of Options on Mutual Fund Indexes

June 10, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934, 15 U.S.C. 78s(b)(1), notice is hereby given that on June 4, 1997, 
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, 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.

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

    The CBOE proposes to trade options on mutual fund indexes. 
Specifically, CBOE plans to list options on two mutual fund indexes 
designed by Lipper Analytical Services, Inc. in conjunction with 
Salomon Brothers Inc. 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 CBOE 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, Proposed Rule Change

    The purpose of the proposed rule change is to enable the CBOE to 
list options based on mutual fund indexes. CBOE proposes to list 
options on two mutual fund indexes designed by Lipper Analytical 
Services, Inc. (``Lipper Analytical'' or LAS) in 
conjunction with Salomon Brothers Inc.--the Lipper Analytical/Salomon 
Brothers Growth Fund Index (``Growth Fund Index'') and the Lipper 
Analytical/Salomon Brothers Growth & Income Fund Index (``Growth & 
Income Fund Index''). Options on the Indexes will allow investors to 
hedge their risk in mutual funds as well as provide a low-cost means 
for investors to participate in the mutual fund market. Lipper 
analytical is a major provider of mutual fund information and currently 
calculates approximately 100 other mutual fund indexes designed to 
track specific investment objectives.
    Index Design. The Indexes are composed of the 30 largest U.S. funds 
in each investment objective, based on their total net assets as of the 
close on the last trading day of December. The Indexes include only 
those funds that report net asset values (``NAV'') through the 
facilities of the National Association of Securities Dealers Automated 
quotation System (``NASDAQ''). Some mutual funds are composed of more 
than one class which have different fees and expenses. If there is more 
than one class of a specific mutual fund, only the class with the 
highest total net assets will be included. As of December 31, 1996, the 
Growth Fund Index had total net assets (``TNA'') of $218.6 billion, an 
average TNA per component of $7.3 billion and a median TNA per 
component of $4.2 billion. The TNAs ranged from $2.5 billion to $54.0 
billion. As of the same date, the Growth & Income Fund Index had a TNA 
of $241.2 billion, an average TNA per component of $8.0 billion and a 
median TNA per component of $5.0 billion. The TNAs ranged from $2.5 
billion to $30.9 billion.
    Lipper Analytical determines the investment objective of each fund 
by reviewing both the language in the prospectus and the fund's 
investment characteristics as shown in the Lipper-Equity Analysis 
Report on the Weighted Average Holdings of Large Investment Companies. 
A Growth Fund is described as a fund that normally invests in companies 
whose long-term earnings are expected to grow significantly faster

[[Page 32847]]

than earnings of the stocks represented in the major unmanaged stock 
indexes. A Growth & Income Fund is described as a fund that combines a 
growth of earnings orientation and an income requirement for level and/
or rising dividends.
    Calculation. The Indexes are equal-weighted and re-balanced 
quarterly after the close on expiration Fridays in March, June, 
September, and December. The Index value is calculated in essentially 
the same manner as other equal-weighted indexes. The total number of 
shares for each component is calculated by dividing $1,000 by the 
closing NAV, adjusted for distributions, of the component on the re-
balancing date and rounding to two decimal places. The share amount is 
held constant throughout the quarter. The Indexes are calculated by 
summing the product of the current NAV adjusted for distributions and 
the share amount for each component and then dividing by the index 
divisor. The divisors were calculated to produce a value of 150.00 for 
the Growth Fund Index and 250.00 for the Growth and Income Fund Index 
as of December 31, 1996, the base date. The Indexes are calculated once 
per day as soon as the NAVs for each of the components are 
available.\1\ The Index values will be disseminated by CBOE through the 
facilities of the Options Price Reporting Authority (``OPRA'') prior to 
the opening on the next business day.
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    \1\ Index values are updated only at the close of trading each 
day because that is the only time when the fund net asset values 
comprising the Indexes are determined and disseminated. The Exchange 
believes that this should not pose an obstacle to options trading, 
any more than it prevents investors from entering intra-day orders 
to purchase or redeem shares of the funds themselves at closing net 
asset values that are unknown at the time the orders are entered. 
Further, insofar as options trading is concerned, this would not be 
the only example of options on indexes that are available only one 
time per day, albeit for different reasons. Options on the AMEX 
Japan Index and the AMEX Hong Kong 30 Index are traded in the United 
States when the underlying markets are closed, and the trading of 
these options has amply demonstrated that options markets can 
function effectively when only one index value is available during 
the trading day. Indeed, because the U.S. stock markets in which the 
component funds of the Lipper Analytical Indexes invest will be 
trading at the same time as the options are traded, the Exchange 
feels that conditions for options trading on the Lipper Analytical 
Indexes would be more favorable than for options trading on foreign 
indexes when the underlying markets are closed. In the cases of the 
Lipper Analytical Indexes, investors will be able to base their 
trading decisions on the observation of real-time movements in the 
value of market indexes and individual securities that have tended 
to move in regular relationship with the Indexes. This is the basis 
on which funds themselves are traded, and we see no reason why 
options on indexes of funds should not be available to investors on 
the same basis.
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    Lipper has informed the Exchange that it has not had any difficulty 
in obtaining net asset values for the funds in the Indexes. The funds 
comprising the Indexes are among the largest funds in existence. In the 
unlikely event that any of these funds do not comply with Rule 22c-1 
under the Investment Company Act of 1940, which requires daily 
computation of a fund's current net asset value, the Exchange would 
follow the same procedure it uses for dissemination of standard indexes 
when a component price is unavailable; it will use the last available 
price.
    Maintenance. Lipper Analytical has the sole responsibility of 
maintaining the Indexes. Salomon Brothers acted as an adviser to 
provide technical support, including advice on index design and the 
methodology of index construction. Lipper Analytical reviews the 
components annually after the close on the last trading day of December 
to include the thirty largest funds by total net assets. Any component 
changes resulting from the annual review will be announced by LAS and 
CBOE at least two weeks prior to implementation which will occur after 
the close on expiration in March. The index calculation reflects 
reinvestment of all distributions of component funds. Generally, there 
will be no need for any other adjustments intra-quarter.
    Index Option Trading. The Exchange proposes to base trading in 
options on the Lipper Analytical Indexes on the full-value of each 
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. Options on the Indexes will be European-
style and settle based on the closing NAVs of the component funds two 
business days prior to expiration. The proposed options will expire on 
the Saturday following the third Friday of the expiration month. Thus, 
the last day for trading in an expiring series will be two business 
days (ordinarily a Thursday) preceding the expiration date. The 
settlement value (which is the same as Thursday's closing value) will 
be disseminated prior to the opening on Friday.
    Exchange Rules Applicable. Except as modified herein, the Rules in 
Chapter XXIV will be applicable to mutual fund index options. Index 
option contracts based on the Lipper Analytical Indexes will be subject 
to a position limit of 75,000 contracts on the same side of the market. 
Ten reduced-value options will equal one full-value contract for such 
purposes. The Exchange believes that the proposed position limits are 
reasonable and appropriate for this product, and are consistent with 
the position limits that apply to other index options.
    Rule 24.9 Interpretation and Policy .01(a) is being amended to 
include 2\1/2\ point strike price intervals for mutual fund indexes 
with strike prices less than $200. Broad-based margins will apply to 
mutual fund index options. CBOE is amending Rule 24.1(e) to reflect the 
fact that mutual funds can underlie indexes.
    Surveillance. As with any other option product, the CBOE will 
closely monitor activity in these options and therefore, should be able 
to identify any potentially unusual activity in the options. It should 
be noted that with respect to the component funds that comprise the 
Indexes, trading in the funds themselves has no effect on the value of 
the Indexes. Instead, the value of the Indexes depends entirely on the 
net asset values of the component funds, which in turn depends on the 
values of the stocks held in the portfolios of the various funds. With 
this in mind, there are a few reasons why the concerns with 
manipulative activity are not as great with respect to options on these 
Indexes as they are on other index options. First, the Indexes are 
equal-weighted, thus no single component dominates the Index. Therefore 
any person attempting to manipulate the Indexes would have to 
manipulate the NAVs of a majority of the Index components. Second, in 
order to manipulate the NAVs of the component funds, a persons would 
have to have knowledge of the component securities held by the funds. 
This information is not disseminated to the public until after the fact 
(generally only quarterly), thus it would be nearly impossible for any 
individual to know, with any degree of certainty, the components of 
enough of the funds to make any manipulative efforts worthwhile. If it 
became necessary to examine activity in the underlying stocks, the CBOE 
could use the information available for the time period that was being 
examined.
    Miscellaneous. The Exchange is aware of Commission concerns with 
respect to the degree in which fund portfolio managers should be 
allowed to trade options on the Lipper Analytical Indexes. CBOE 
believes that question of permissible trading activities of fund 
managers are properly to be answered by each fund's management, 
consistent

[[Page 32848]]

with guidance provided by the Commission. We do point out, However, 
that because the Indexes will be re-balanced each quarter to ensure 
that no single fund makes up more than 3.33% of an Index, there is 
little likelihood that any one fund will ever have a significant 
influence over the value of the Index of which it is a part. Thus the 
conflict of interest that may be thought to exist when a portfolio 
manager trades the same securities in which his or her fund may be 
interested should not exist in respect of the portfolio manager's 
activities in options on the Lipper Analytical Indexes.
    CBOE has the necessary systems capacity to support new series that 
would result from the introduction of the Lipper Analytical/Salomon 
Brothers Index options. CBOE has also been informed that OPRA has the 
capacity to support such new series.
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Securities Exchange Act of 1934 in general and 
Section 6(b)(5) in particular in that it is designed to foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities 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 solicited or received with respect to the 
proposed rule change.

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 self-regulatory organization 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 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of CBOE. All submissions 
should refer to File No. SR-CBOE-97-25 and should be submitted by July 
8, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\2\
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    \2\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-15772 Filed 6-16-97; 8:45 am]
BILLING CODE 8010-02-M