[Federal Register Volume 62, Number 139 (Monday, July 21, 1997)]
[Notices]
[Pages 39040-39042]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-19031]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38839; File No. SR-CBOE-97-10]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Chicago Board Options Exchange, Incorporated, Relating to 
Minimum Sizes for Closing Transactions, Exercises, and Responses to 
Requests for Quotes in FLEX Equity Options

July 15, 1997.

I. Introduction

    On February 21, 1997, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed a proposed rule change 
with the Securities and Exchange Commission (``SEC'' or 
``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ to 
amend certain rules pertaining to FLEX Equity Options.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    Notice of the proposal was published for comment and appeared in 
the Federal Register on May 16, 1997.\3\ No comment letters were 
received on the proposed rule change, although the CBOE submitted a 
letter with additional information in support of its proposal.\4\ This 
order approves the Exchange's proposal.
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    \3\ See Securities Exchange Act Release No. 38607 (May 9, 1997), 
62 FR 27083.
    \4\ See Letter from William J. Barclay, Vice President, 
Strategic Planning and International Development, CBOE, to Sharon 
Lawson, Senior Special Counsel, Office of Market Supervision, 
Division of Market Regulation, Commission, dated April 21, 1997 
(``CBOE Letter'').

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[[Page 39041]]

II. Description of the Proposal

    The purpose of the proposed rule change is to reduce from 100 
contracts to 25 contracts the minimum value size of closing 
transactions in and exercises of FLEX Equity Options, and to make a 
comparable reduction in the minimum value size of FLEX Equity Quotes in 
response to a Request for Quotes.
    Currently, Rule 24A.4(a)(4)(iii) imposes a 100 contract minimum on 
all transactions in FLEX Equity Options unless the transaction is for 
the entire remaining position in the account. According to the CBOE, 
based on its experience to date with FLEX Equity Options, it appears 
that the existing 100 contract minimums are too large to accommodate 
the needs of certain firms and their customers.\5\ These firms may 
purchase 100 or more FLEX Equity Options in an opening transaction for 
a single firm account in which more than one of the firm's clients have 
an interest. If one of these clients wants to redeem its investment in 
the account, the firm likely will want to engage in a closing or 
exercise transaction in order to reduce the account's position in those 
FLEX Equity Options by the number being redeemed. Thus, if the 
redeeming client's interest is less than 100 FLEX Equity Options and 
does not represent the total remaining position in the account, Rule 
24A.4(a)(4)(iii) as it stands presently, prevents the firm from closing 
or exercising positions of this size. The CBOE states that this places 
its market at a competitive disadvantage to the over-the-counter 
(``OTC'') customized equity market where no such limitation exists.\6\
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    \5\ The Exchange notes that the existing customer base for FLEX 
Equity Options includes both institutional investors, in particular 
mutual funds, money managers and insurance companies, and high net 
worth individuals who meet the ``sophisticated investor'' criteria 
applied to various clients by Exchange member firms. See CBOE 
Letter, supra note 4.
    \6\ Id.
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    The Exchange believes that the proposed rule change to Rule 
24A.4(4)(iii) would remedy the situation described above, by permitting 
an order to close or exercise as few as 25 FLEX Equity Option 
contracts. The corresponding change to Rule 24A.4(a)(iv), which governs 
the minimum size for FLEX Equity Quotes that may be entered in response 
to Requests for Quotes, is necessary in order to provide the liquidity 
needed to facilitate the execution of closing orders between 25 and 99 
FLEX Equity Option contracts that would be permitted by the proposed 
amendment to Rule 24A.4(4)(iii).\7\
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    \7\ The Commission notes that the minimum size for a opening 
transaction in a request for quotes is 250 contracts for any FLEX 
series in which there is no open interest, and 100 contracts in any 
currently opened FLEX series. See CBOE Rule 24A.4(a)(4) (ii) and 
(iii).
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    The Exchange notes that the Exchange would issue a circular that 
(1) describes the new rule; and (2) reminds all members and member 
firms of their continued responsibility to insure that FLEX Equity 
Options are utilized only by sophisticated investors with the necessary 
financial resources to sustain the possible losses arising from 
transactions in the requisite FLEX Equity Options class size.\8\
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    \8\ See CBOE Letter, supra note 4.
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    The Exchange believes by providing firms and their customers 
greater flexibility to trade FLEX Equity options by lowering from 100 
to 25 the minimum number of contracts required for a closing 
transaction, for exercises, and for FLEX Quotes responsive to a Request 
for Quotes, the proposed rule change is consistent with and furthers 
the objectives of Section 6(b)(5) of the Securities Exchange Act of 
1934 by removing impediments to and perfecting the mechanism of a free 
and open market in securities and otherwise serving to protect 
investors and the public interest.

III. Discussion

    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) of the Act.\9\ Further, 
for the reasons discussed below, the Commission believes that 
consistent with 6(b)(5) of the Act, the proposal should facilitate 
transactions in securities in FLEX Equity Options consistent with 
investor protection and the public interest.\10\
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    \9\ 15 U.S.C. 78f(b)(5).
    \10\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
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    The Commission believes that the Exchange's proposal to reduce from 
100 contracts to 25 contracts the minimum value size of closing 
transactions in and exercises of FLEX Equity Options, and to make a 
comparable reduction in the minimum value size of FLEX Equity Quotes in 
response to a Request for Quotes reasonably addresses the Exchange's 
desire to meet the demands of sophisticated investors, portfolio 
managers and other institutional investors who may want to use FLEX 
Equity Options, but find the minimum size requirements for closing 
transactions too restrictive for their investment needs and may 
therefore choose to use the OTC market. As previously noted by the 
Commission, the benefits of the Exchanges' FLEX options market include, 
but are not limited to, a centralized market center, an auction market 
with posted transparent market quotations and transaction reporting, 
parameters and procedures for clearance and settlement, and the 
guarantee of The Options Clearing Corporation for all contracts traded 
on the Exchange.\11\
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    \11\ See Securities Exchange Act Release No. 36841 (February 14, 
1996) (``Original FLEX Equity Option Approval Order'').
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    The Commission notes that market participants wanting to execute an 
opening transaction in a particular series of FLEX Equity Options will 
still have to meet the 250 or 100 minimum contract requirement.\12\ 
This should help to ensure that transactions in FLEX Equity Options 
remain of substantial size and, therefore, the product is geared to an 
institutional, rather than a retail, market. In originally approving 
FLEX Equity Options, the Commission stated that the minimum value sizes 
for opening transactions in FLEX Equity Options are designed to appeal 
to institutional investors, and it is unlikely that most retail 
investors would be able to engage in options transactions at that 
size.\13\
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    \12\ See supra note 7.
    \13\ See Original FLEX Equity Option Approval Order, supra note 
11.
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    The Commission notes that, in approving the proposal, adequate 
surveillance guidelines should be in place to ensure that only 
sophisticated investors with the necessary financial resources to 
sustain the possible losses arising from transactions in the requisite 
FLEX Equity Options class size are utilizing this product. The 
Commission's staff has reviewed CBOE's surveillance program and 
believes it provides a reasonable framework in which to monitor such 
investor open interest.
    The Commission requests, however, that the Exchange provide a 
report to the Commission's Division of Market Regulation describing the 
nature of investor participation (i.e., retail vs. institutional) in 
FLEX Equity Options for one year from the implementation date for the 
rule change.\14\ If the

[[Page 39042]]

Exchange determines in the interim that the proposed rule change has 
resulted in a pattern of retail investor participation in FLEX Equity 
Options, it should notify the Commission's Division of Market 
Regulation to determine if the minimum closing transaction sizes should 
be restored to the original levels.
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    \14\ The Commission notes that the CBOE had previously committed 
to providing the Commission with a report on the usage of FLEX 
Equity Options after the first year of trading. Because that report 
is due shortly and, the changes adopted herein could potentially 
change the nature of investor participation, the Commission requests 
that the Exchange update its report one year from the implementation 
date for this rule change.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (File No. SR-CBOE-97-10) is 
approved.

    \15\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30,3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-19031 Filed 1-18-97; 8:45 am]
BILLING CODE 8010-01-M