[Federal Register Volume 62, Number 188 (Monday, September 29, 1997)]
[Notices]
[Pages 50970-50973]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25689]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39116; File No. SR-CBOE-96-76]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 1, 2, and 3 to the Proposed Rule Change by the Chicago
Board Options Exchange, Incorporated Relating to the Listing and
Trading of Packaged Vertical Spreads
September 22, 1997.
I. Introduction
On December 16, 1996, the Chicago Board Options Exchange, Inc.
(``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 list for trading
Packaged Vertical Spreads based upon the S&P 100 and the S&P 500
Indexes.
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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 February 4, 1997.\3\ The Exchange filed with
the commission Amendment Nos. 1,\4\ 2,\5\ and 3\6\ to the proposal on
March 18, May 2, and June 5 1997, respectively.
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\3\ See Securities Exchange Act Release No. 38213 (January 28,
1997), 62 FR 5265 (February 4, 1997).
\4\ In Amendment No. 1, the Exchange provided a new definition
for ``vertical spread interval'' and several technical non-
substantive revisions to the margin rules. See Letter from Tim
Thompson, Senior Attorney, CBOE, to John Ayanian, Special Counsel,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Market Regulation''), Commission, dated March 18, 1997
(``Amendment No. 1'').
\5\ In Amendment No. 2, the Exchange amended its spread rules
for margin when the short index option of a spread position is a
Packaged Vertical Spread, as described more fully herein. Amendment
No. 2 also verified that CBOE will list and add series for Packaged
Vertical Spreads in accordance with Rule 24.9, Interpretation and
Policy .01(c). Finally, in Amendment No. 2, the Exchange indicated
that position limits for Packaged Vertical Spreads based on the S&P
500 and 100 will be the same as existing position limits for the
respective index options and will be aggregated with other option
contracts on the same index. See Letter from William M. Speth, Sr.
Research Analyst, Product Development, Research Department, CBOE, to
Howard L. Kramer, Senior Associate Director, OMS, Market Regulation,
Commission, dated May 2, 1997 (``Amendment No. 2'').
\6\ In Amendment No. 3, the Exchange made several non-
substantive changes to the proposal. In addition, added Rule 24.4(e)
to reflect that position limits for Packaged Vertical Spreads with
multipliers of 500 would have position limits equal to 1/5th of the
position limits for products with multipliers of 100. The Exchange
also clarified that for Packaged Vertical Spreads with multipliers
of 500, the spread rules for margin would only apply when there are
5 contracts with a 100 multiplier offsetting one contract with a 500
multiplier. Finally, the Exchange also clarified its policy for
changing the multiplier and/or the vertical spread intervals, as
described more fully herein. See vertical spread intervals, as
described more fully herein. See Letter from Eileen Smith, Director,
Product Development, Research Department, CBOE, to John Ayanian,
Special Counsel, OMS, Market Regulation, Commission, dated June 4,
1997 (``Amendment No. 3'').
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No comment letters were received on the proposed rule change. This
order approves the Exchange's proposal, as amended.
II. Description of the Proposal
The Exchange proposes to list for trading Packaged vertical Spreads
based upon the S&P 100 index and the S&P 500 index (``Indexes''). A
Packaged Vertical Spread is a packaged European-style option that
replicates the behavior and payout of a vertical spread \7\ composed of
standard index option contracts. The Exchange proposes that the
Packaged Vertical Spreads may have a multiplier of 100 (as with
standard index options overlying the S&P 100 and the S&P 500) or a
multiplier of 500. To date, the Exchange has not determined whether
Packaged Vertical Spreads will initially have a multiplier of 100 or
500. The Exchange, however, does not intend to simultaneously open
series with both a 100 and a 500 multiplier. If the Exchange introduces
Packaged Vertical Spreads with a new multiplier with a new tricker
symbol, it will only result in a brief period (1 or 2 months) of open
series with both a 100 and a 500 multiplier. The Exchange represents
further that it will notify the Commission so that it can be determined
what appropriate steps should be taken prior to listing Packaged
Vertical Spreads with the different multiplier.\8\
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\7\ A vertical spread is the combination of one long and one
short options position having the same expiration. A call vertical
spread will have a lower strike price on the long options and a put
spread will have a higher strike price on the long option. For
example, a call vertical spread might consist of one long December
(expiration month) 700 (strike price) call option and one short
December 690 call option.
\8\ See Amendment No. 3, supra note 6.
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The Exchange believes Packaged Vertical Spreads on the Indexes will
provide advantages to the investing public that are not provided for by
standard index options. First, the Exchange believes the Packaged
Vertical Spreads on the Indexes will offer investors a relatively low
risk security which results because Packaged Vertical Spreads, by their
nature, have a maximum gain and loss that can be realized regardless of
the movement in the index level. These options are the equivalent of
standard vertical spreads (i.e., the combination of one long and one
short options position with the same expiration) traded as a single
security. Second, the ``packaging'' of a strategy of two option
positions into one option product reduces transaction-related expenses
because the investor will only have to enter into one transaction. In
the case of Packaged Vertical Spreads with a multiplier of 500, the
transaction-related expenses would be substantially reduced from a
comparable trade involving standard index options which currently have
a 100 multiplier. Third, in the case of Packaged Vertical Spreads
overlying the S&P 100, the investor will have the opportunity to invest
in an option product that has European-style exercise.\9\ Standard S&P
100 options (``OEX'') have American-style exercise.\10\ Accordingly,
with Packaged Vertical Spreads there is no early exercise risk. The
Exchange expects Packaged Vertical Spreads on the Indexes to be
supported enthusiastically by market-makers because vertical spread
trading is a familiar strategy to professional traders and the Packaged
Vertical Spreads can be easily incorporated into the overall risk
profile of the market-maker's trading strategy in standard index
options.
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\9\ Only European-style Packaged Vertical Spreads will be
available to investors. A European-style option is one that may be
exercised only during a limited period of time prior to expiration.
\10\ An American-style option is one that may be exercised at
any time prior to expiration.
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The Exchange proposes to amend Rule 24.1 to describe the new
product \11\ as well as the term ``vertical spread interval''.\12\
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\11\ See Amendment No. 3, supra note 6.
\12\ Specifically, the ``vertical spread interval'' means a
value specified by the Exchange which, when added to the exercise
price for call series or subtracted from the exercise price for put
series defines the index level over which (for calls) and under
which (for puts) the value of the contract will have its maximum
value at expiration. See Amendment No. 1, supra note 4.
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[[Page 50971]]
Position and Exercise Limits
The Exchange is proposing position limits for Packaged Vertical
Spreads overlying the S&P 100 of 25,000 contracts. The Exchange is
proposing position limits for Packaged Vertical Spreads overlying the
S&P 500 of 100,000 contracts. For position limit purposes, Packaged
Vertical Spreads will be aggregated with option contracts on the same
index. These position limits are consistent with the position limits
that have been established for standard index options on the S&P 100
and 500 indexes, respectively. The exercise limits for Packaged
Vertical Spreads will be equal to the position limits set forth above
in accordance with the terms of CBOE Rule 24.5.
To the extent that the Exchange lists and a member holds Packaged
Vertical Spread positions with multipliers other than 100 (e.e., 500),
the contract will be counted for position limit purposes as the number
of contracts times the contract multiplier divided by 100. For example,
each Packaged Vertical Spread based on the S&P 100 with a multiplier of
500 would count as 5 Packaged Vertical Spread contracts for the purpose
of determining compliance with the position limits.\13\ In addition, if
a member holds Packaged Vertical Spread positions with different
multipliers, that overlie the same index, these positions would be
aggregated in determining compliance with the position limits.
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\13\ See Amendment No. 3, supra note 6.
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Margin
With respect to margin requirements, risk exposure is limited in
Packaged Vertical Spreads, and therefore, the maximum margin
requirements should not exceed the maximum exposure amount which, for
each Vertical Spread option contract equals the vertical spread
interval times the index multiplier. The proposed amendments state that
the maximum margin required for a put or call Vertical Spread option
contract carried in a short position shall not exceed this maximum
exposure amount. In addition, the amendment provides that for each put
or call Vertical Spread option contract carried in a short position in
a cash account, the customer must deposit cash equal to the maximum
exposure amount. The rules will also provide that the required margin
for a spread when the exercise price of the long call index option is
greater than the exercise price of the short call index option where at
least one leg of the spread is a CAPS or Vertical Spread would be the
lesser of (1) The difference in the aggregate exercise prices or (2)
the cap interval or the vertical spread interval as appropriate. For
Packaged Vertical Spreads with multipliers of 500, the spread rules for
margin would only apply when there are 5 contracts with a 100
multiplier offsetting a contract with a 500 multiplier.\14\
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\14\ See Amendment No. 3, supra note 6.
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Listing of Series
The Exchange expects to list contracts having vertical spread
intervals of ranging from 10 to 50 points. The Exchange does not intend
to simultaneously open series with more than one vertical spread
interval. However, the CBOE may introduce a new series with a new
vertical spread interval with a new ticker symbol resulting in a brief
period (1 or 2 months) of open series with two vertical spread
intervals.\15\
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\15\ The Exchange represents that it would not allow margin
offset, pursuant to Rule 24.11(c), between spreads with different
spread intervals. See Amendment No. 3, supra note 6.
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Initially, the Exchange intends to list an at-the-money and various
strikes around the at-the-money in the first two near-term months in
accordance with Rule 24.9, Interpretation and Policy .01(c).\16\ New
strikes will be added when the underlying trades through the highest or
lowest strike available.
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\16\ See Amendment No. 2, supra note 5.
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Settlement
The expiration date for Packaged Vertical Spreads will be the
Saturday immediately following the third Friday of the expiration
month. Exercise will result in the delivery of cash on the business day
following expiration. The exercise settlement amount will be equal to
the difference between the OEX or SPX settlement value, as appropriate,
and the strike price of the Packaged Vertical Spread contract; or the
amount of the spread interval, whichever is less, multiplied by the
multiplier, i.e., either $100 or $500. As noted above, Packaged
Vertical Spreads will have a European-style of exercise.
Miscellaneous
CBOE will use the same surveillance methods it currently employs
with respect to their broad-based index options.
CBOE has also been informed that the Options Price Reporting
Authority recently added another outgoing high speed line from OPRA
processor and thus, has the capacity to support the new series
associated the listing of Packaged Vertical Spreads.\17\
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\17\ See Memorandum from Joe Corrigan, OPRA, to Eileen Smith,
CBOE, dated November 21, 1996.
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By adopting rules that will provide for the trading of index
options that will provide investors with certain advantages over
current products in the way of reduced transaction costs and risk
reduction, CBOE believes the proposed rule change is consistent with
and furthers the objectives of Section 6(b)(5) of the Act in that it is
designed to perfect the mechanisms of a free and open market and to
protect investors and the public interest.
III. Commission Finding 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) of the Act.\18\
Moreover, the Exchange's proposal to list and trade Package Vertical
Spreads on the S&P 100 and S&P 500 indexes strikes a reasonable balance
between the Commission's mandates under Section 6(b)(5) to remove
impediments to and perfect the mechanism of a free and open market and
a national market system, while protecting investors and the public
interest.\19\ Specifically, the Commission finds that the Packaged
Vertical Spreads are an innovative financial product that will provide
investors with additional choices and flexibility in their use of
derivatives,\20\ In addition, Packaged Vertical Spreads offer both
holders and writers of options a means to participate in the options
markets at a predetermined maximum gain or loss. Under the terms of
Packaged Vertical Spreads, the option writer's (holder's) maximum loss
(gain) is established at the time of the investment by the option's
vertical spread interval. Accordingly, Packaged Vertical Spreads permit
investors to participate in the
[[Page 50972]]
options market at a known cost. In addition, the Commission believes
that Packaged Vertical Spreads, which replicate the combination of two
options at different exercise prices, on the same underlying interest
and expiration, likely will benefit investors by providing them with a
more efficient and cost effective method of executing spread
transactions.
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\18\ 15 U.S.C. 78f(b)(5).
\19\ 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).
\20\ 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 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 Packaged Vertical Spreads will provide
investors with another hedging vehicle that should reflect the
overall movement of the U.S.-listed stock market.
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The Commission also finds that the specific rules proposed by the
CBOE to accommodate Packaged Vertical Spreads are consistent with the
Act.\21\ Specifically, the Commission believes that it is reasonable
for the Exchange to set a vertical spread interval range from 10 to 50
points. In response to the Commission's concerns that having series of
Packaged Vertical Spreads simultaneously open with different vertical
spread intervals might be confusing to investors, the Exchange does not
intend to simultaneously open series with more than one vertical spread
interval. However, the CBOE may introduce a new series with a new
vertical spread interval with a new ticker symbol resulting in a brief
period (1 or 2 months) of open series with two vertical spread
intervals.\22\ The Commission notes that the Exchange may submit a
``noncontroversial filing'' pursuant to Section 19(b)(3)(A) of the Act
and Rule 19b-4(e)(6) thereunder if it decided to change the present
vertical spread range (currently 10 to 50 points) and the proposal does
not raise any other regulatory issues.
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\21\ The Commission notes that CBOE Rule 24.1, as amended,
defines Packaged Vertical Spreads. Because the current Exchange
proposed definition is limited to Packaged Vertical Spreads on the
S&P 500 and 100 Indexes, the Commission believes the Exchange is
required to submit a rule filing pursuant to Section 19(b) of the
Act in order to list Packaged Vertical Spreads on another stock
index or individual security.
\22\ The Exchange represents that it would not allow margin
offset, pursuant to Rule 24.11(c), between spreads with different
spread intervals. See Amendment No. 3, supra note 6.
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Similarly, the Commission believes it is reasonable for the
Exchange to list Packaged Vertical Spreads with either a 100 or 500
multiplier. In response to the Commission's concerns that having series
of Packaged Vertical Spreads simultaneously open with different
multipliers might be confusing to investors, the Exchange does not
intend to simultaneously open series with two different multipliers.
However, the CBOE may introduce a new series with a new multiplier with
a new ticker symbol resulting in a brief period (1 or 2 months) of open
series with two multipliers. The Commission notes that it will be
notified by the Exchange to determine what appropriate steps should be
taken prior to listing Packaged Vertical Spreads with the different
multiplier.\23\
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\23\ See Amendment No. 3, supra note 6.
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The Commission also notes that Packaged Vertical Spreads on the S&P
500 and S&P 100 indexes will be subject to the same position and
exercise limit requirements that currently apply to S&P 500 and S&P 100
index options, respectively. In particular, Packaged Vertical Spreads
on the S&P 500 will be aggregated with all other S&P 500 index options,
subject to a 100,000 contract limit under Rule 24.4(b). Packaged
Vertical Spreads on the S&P 100 index will be aggregated with all other
S&P 100 index options, subject to a 25,000 contract limit under Rule
24.4(b).\24\
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\24\ If the Exchange introduces Packaged Vertical Spreads with a
multiplier of 500, it will count each Packaged Vertical Spreads as 5
Packaged Vertical Spread contracts for the purpose of determining
compliance with the position limits.
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The Commission believes that the proposed margin treatment for
Packaged Vertical Spreads in cash and margin accounts is consistent
with the Act. Specifically, the Commission believes that, similar to
short capped options positions,\25\ it is reasonable to permit short
Packaged Vertical Spreads positions in a cash account so long as the
maximum exposure (the vertical spreads interval) is deposited. This
position is the equivalent of a completely covered position, because
the maximum risk of loss is already on deposit. In addition, the
Commission believes that the proposed margin requirements for Packaged
Vertical Spreads in margin accounts is reasonable because they are
virtually identical to the margin requirements for traditional short
stock index options positions held in margin accounts, except that a
limit equal to the maximum exposure to the option writer is placed on
the margin requirement. It is reasonable to limit the margin in this
way because the margin would cover 100% of the writer's exposure,
thereby requiring no additional margin calls.
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\25\ See Securities Exchange Act Release No. 29865 (October 28,
1991), 56 FR 56255 (November 1, 1991).
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The Commission also believes that the proposed margin treatment for
a spread transaction where: (1) The short leg of the spread is a
Packaged Vertical Spread; (2) the long leg of the spread is a long call
index option (not a Packaged Butterfly Spread); \26\ and (3) the
exercise price of the long call index option is greater than the
exercise price of the short call Packaged Vertical Spread is consistent
with the Act. Specifically, it is reasonable to limit the margin in
this case to the lesser of the difference in aggregate exercise prices
or the vertical spread interval because the margin would cover 100% of
the writer's exposure, thereby requiring no additional margin
calls.\27\ For example, a spread involving a long 670 S&P 500 index
call option and a short 650 Packaged Vertical Spread on the S&P 500,
with a vertical spread interval of 10, the margin deposit requirement
would be the lesser of: (1) The difference in aggregate exercise prices
((670-650) x 100 = $2,000)) and (2) the vertical spread interval
times the multiplier (i.e., 10 x 100 = $1,000). The margin
requirement in this case would be $1,000. The writer's maximum exposure
is when the current index level is 650, and is limited to $1,000.
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\26\ For any long Packaged Butterfly Spread position which is
offset by a short option position of any type, the minimum margin
required on such a position shall be the full purchase price on the
Packaged Butterfly Spread plus the margin required in Rule 24.11(b)
for the short position. See Rule 24.11(c)(1)(D). In addition, for
any long Packaged Vertical Spread position which is offset by short
position that is not a capped option or a Packaged Vertical Spread,
the minimum margin required on such a position is the full purchase
price of the long Packaged Vertical Spread position plus the margin
required in Rule 24.11(b) for the short position. See Rule
24.11(c)(1)(C).
\27\ In addition, the long contract must be paid in full. The
proceeds from the short option can be used to pay for the long
contract.
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For the same spread transaction where the vertical spread interval
is 50, the margin deposit requirement would be the lesser of: (1) The
difference in aggregate exercise prices ((670-650) x 100 = $2,000)
and (2) the vertical spread interval times the multiplier (i.e., 50 x
100 = $5,000). The margin deposit requirement in this case would be
$2,000. The writer's maximum exposure is when the current index level
is 700, and is limited to $2,000.\28\
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\28\ The writer's maximum exposure for this spread position is
determined as follows:
short loss-long gain = maximum exposure
$5,000-(700-670) x 100
$5,000-(30) x 100
$5,000-$3,000 = ($2,000)
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In summary, the Commission believes that the Packaged Vertical
Spreads on the S&P 500 and S&P 100 Indexes will provide investors with
additional choices and flexibility in their use of derivatives and
offer both holders and writers of options a means to participate in the
options markets at a predetermined maximum gain or loss. Further, the
Commission notes that in order to promote investor protection and to
ensure adequate disclosure in connection with Packaged Vertical
Spreads, the rules pertaining to standardized options and the
requirements of Exchange Act Rule 9b-1 will apply to trading in
Packaged
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Vertical Spreads. The Commission believes it is important to provide
investors with information regarding the rights and characteristics of
Packaged Vertical Spreads. In this regard, Packaged Vertical Spread
investors will receive a special supplement to the Options Clearing
Corporation's (``OCC'') Options Disclosure Document (``ODD
Supplement'') explaining in detail the risks and characteristics of
Packaged Spreads.\29\
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\29\ In reviewing any disclosure materials submitted, the
Commission intends to assure that the materials specifically
describe the risks and characteristics associated with trading
Packaged Spreads. The trading of Packaged Vertical Spreads is
expressly contingent upon the Commission's approval of such an ODD
supplement.
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The Commission finds good cause for approving Amendment Nos. 1, 2,
and 3 prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. Specifically,
Amendment No. 1 to CBOE's proposal set forth a new definition for
``vertical spread interval'' and several technical non-substantive
revisions to the margin rules.
Amendment No. 2 to CBOE's proposal describes changes to its spread
rules for margin when the short index option of a spread position is a
Packaged Vertical Spread, as described above; (2) verifies that CBOE
will list and add series for Packaged Vertical Spreads in accordance
with Rule 24.9, Interpretation and Policy .01(c); and (3) sets position
limits for Packaged Vertical Spreads based on the S&P 500 and 100 to
equal existing position limits for the respective index options.\30\
The Commission believes the Exchange's proposed reduction in position
limits from those originally proposed presents no new regulatory issues
and can be approved on an accelerated basis. Further, the originally
proposed higher position limits were subject to the full 21-day comment
period without any comments being received by the Commission. Amendment
No. 3 to CBOE's proposal also makes several technical non-substantive
changes. In addition, the Exchange amended the definition of Packaged
Vertical Spread to further clarify the structure of the product.
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\30\ As described above, Packaged Vertical Spreads on the S&P
500 and 100 indexes will be aggregated with other options on the
same index.
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The Commission believes that the changes proposed in Amendment Nos.
1, 2, and 3, unless otherwise stated above, merely clarify in the rule
text what was originally proposed by the Exchange and will help to
ensure that investors understand the specifications and trading
characteristics of the Packaged Vertical Spread contracts. In addition,
the Commission notes that the original proposal was published for the
full 21-day comment period without any comments being received by the
Commission.
Accordingly, the Commission finds good cause, consistent with
Sections 6(b)(5) and 19(b)(2) of the Act, to approve Amendment Nos. 1,
2 and 3 to the proposed rule change, on an accelerated basis.
VI. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1, 2, and 3 to the proposed rule
change. 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 Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing will also be available for inspection and copying
at the principal office of the CBOE. All submissions should refer to
SR-CBOE-96-76 and should be submitted by October 20, 1997.
V. Conclusion
Based upon the aforementioned factors, the Commission finds that
the proposed changes relating to the listing and trading of Packaged
Vertical Spreads on the S&P 500 and 100 are consistent with the
requirements of Section 6(b)(5) and the rules and regulations
thereunder. The initiation of Packaged Vertical Spread trading,
however, is conditioned upon the issuance of an order approving an ODD
Supplement, pursuant to Rule 9b-1 of the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\31\ that the proposed rule change (File No. SR-CBOE-96-76), as
amended, is approved.
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\31\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\32\
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\32\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25689 Filed 9-26-97; 8:45 am]
BILLING CODE 8010-01-M