[Federal Register Volume 65, Number 25 (Monday, February 7, 2000)]
[Notices]
[Pages 5921-5922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-2606]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42371; File No. SR-CBOE-99-63]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Chicago 
Board Options Exchange, Inc. Relating to Exercise Price Intervals for 
FLEX Equity Options

January 31, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 10, 1999, the Chicago Board Options Exchange, Inc. 
(``CBOE'') 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 Exchange. The 
Commission is publishing this notice and order to solicit comments on 
the proposed rule change from interested persons and to approve the 
proposal on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    CBOE proposes to delete Interpretation .01 of CBOE Rule 24A.4(c)(2) 
\3\ which limits exercise price intervals and exercise prices for FLEX 
Equity call options to those that apply to Non-FLEX Equity call 
options. The text of the proposed rule change is available at the 
Office of the Secretary, CBOE and at the Commission.
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    \3\ The Commission approved this Interpretation in 1996. See 
Release No. 34-37726 (September 25, 1996), 61 FR 51474 (October 2, 
1996).
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 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 III 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, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to delete Interpretation 
.01 under CBOE Rule 24A.4(c)(2). This interpretation limits the 
exercise price intervals and exercise prices available for FLEX Equity 
call options to those intervals and prices that are available for Non-
FLEX Equity call options pursuant to Interpretation and Policy .01 
under CBOE Rule 5.5. This policy was intended to eliminate uncertainty 
concerning what constitutes a ``qualified'' covered call for certain 
purposes under the Internal Revenue Code pending clarification of this 
tax issue.
    Currently, under Section 1092(c)(4)(B) of the Internal Revenue 
Code, certain covered short positions in call options qualify for 
advantageous tax treatment if the options are not in the money by more 
than a specified amount at the time they are written. One measure used 
to determine whether a call option is qualified is whether its exercise 
or ``strike'' price is no lower than the ``lowest qualified benchmark 
price,'' which is generally the highest strike price available for 
trading that is less than the current price of the underlying stock. 
Since the exercise prices of FLEX Equity Options are not subject to the 
same intervals that apply to Non-FLEX Equity Options, this has raised 
the question whether the existence of a series of FLEX Equity Options 
with a strike price of, for example, 58 when the price of the 
underlying stock is 59 would disqualify a Non-FLEX call option with a 
strike price of 55, which would otherwise be the highest strike price 
available that is less than the price of the stock.

[[Page 5922]]

    The Internal Revenue Service (``IRS'') reviewed this issue and 
proposed rulemaking that would not require that strike prices 
established by equity options with flexible terms be taken into account 
in determining whether standard term equity options are too deep in the 
money to receive qualified covered call treatment.\4\ The IRS approved 
this proposal on January 25, 2000.\5\ The effect of the IRS rulemaking 
and the Exchange's proposed withdrawal of the limitation on the 
exercise price of Equity FLEX call options is that certain taxpayers, 
particularly institutional and other large investors, can engage in 
transactions in Equity FLEX call options with a wider range of exercise 
prices (as was originally intended) without affecting the applicability 
of Section 1092 of the Internal Revenue Code for qualified covered call 
options involving equity options with standard terms.
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    \4\ Department of the Treasury, IRS REG-104641-97, 63 FR 34616 
(June 25, 1998).
    \5\ Department of the Treasury, IRS REG-104641-97, 65 FR 3812 
(January 25, 2000).
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    The Exchange believes that the proposed rule change, by eliminating 
a restriction on Equity FLEX call options which has restricted their 
usefulness as a risk managing mechanism, will remove impediments to and 
perfect the mechanism of a free and open market in FLEX Equity Options, 
and thus is consistent with the objectives of Section 6(b)(5) \6\ of 
the Act.
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    \6\ 15 U.S.C. 78f(b)(5).
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with and furthers the objectives of Section 6(b)(5) \7\ of the Act in 
that it is designed to remove impediments to a free and open market and 
to protect investors and the public interest.
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    \7\ Id.
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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. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
is consistent wit the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. 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 Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CBOE. All submissions should refer to File No. SR-CBOE-99-63 and should 
be submitted by February 28, 2000.

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

    After careful review, the Commission finds that the proposal is 
consistent with the requirements of the Act.\8\ In particular, the 
Commission finds the proposal is consistent with Section 6(b)(5) \9\ of 
the Act. Section6(b)(5) requires, among other things, that the rules of 
an exchange be designed to remove impediments to a free and open market 
and to protect investors and the public interest.
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    \8\ In addition, pursuant to Section 3(f) of the Act, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposal allows sophisticated, 
high net-worth investors to take full advantage of FLEX options. In 
part, FLEX options were created to allow investors to manage their 
risks by having the ability to negotiate strike prices, contract terms 
for exercise style (i.e., American, European, or capped), and 
expiration dates. However, because of the potential adverse tax effect 
on qualified covered calls, the Exchange limited FLEX call strike 
prices to those available for standardized equity calls. Now that the 
tax issue has been clarified, this limitation is being removed. With 
the removal of this limitation, the Commission believes that 
sophisticated, high net-worth investors will better be able to take 
advantage of the risk-management mechanisms provided by FLEX options. 
\10\
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    \10\ The Commission expects that the Options Disclosure Document 
(``ODD'') will promptly be amended to reflect the removal of the 
risk strike price limitation for FLEX equity call options. See 
October 1996 Supplement to the ODD. Telephone call between Timothy 
Thompson, Director, Regulatory Affairs, CBOE, and Katherine A. 
England, Assistant Director, Division of Market Regulation, 
Commission, on January 31, 2000.
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    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. A virtually identical proposal, 
SR-CBOE-98-39, was published in the Federal Register for the full 21-
day comment period and the Commission received no public comment.\11\ 
CBOE later withdrew SR-CBOE-98-39 because the IRS had not yet acted on 
its proposed rulemaking. The current proposal mirrors the changes that 
were originally proposed in SR-CBOE-98-39. In addition, the proposal 
allows FLEX options to be used as they were originally intended to be 
used, and therefore raises no new regulatory issues. The Commission 
believes, therefore, that granting accelerated approval to the proposed 
rule change is appropriate and consistent with Section 6 of the 
Act.\12\
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    \11\ See Release No. 34-40584 (October 21, 1998), 63 FR 58080 
(October 29, 1998) (notice of filing of SR-CBOE-98-39.)
    \12\ 15 U.S.C. 78f.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-98-39) is hereby 
approved on an accelerated basis.

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

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12)

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-2606 Filed 2-4-00; 8:45 am]
BILLING CODE 8010-01-M