[Federal Register Volume 66, Number 213 (Friday, November 2, 2001)]
[Notices]
[Pages 55722-55723]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-27525]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44994; File No. SR-CBOE-2001-22]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange, Incorporated Relating to 
Permanent Approval of the Pilot Program To Eliminate Position and 
Exercise Limits for OEX, SPX, and DJX Index Options and Flex Options on 
These Indexes

October 26, 2001.

I. Introduction

    On May 14, 2001, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934,\1\ and Rule 19b-4 thereunder,\2\ a proposed rule 
change seeking permanent approval of the pilot program eliminating 
position and exercise limits for S&P 500 Index (``SPX''), S&P 100 Index 
(``OEX''), and Dow Jones Industrial Average (``DJX'') as well as for 
FLEX options overlying these indexes.
---------------------------------------------------------------------------

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

    The proposed rule change was published for comment in the Federal 
Register on June 25, 2001.\3\ The Commission received no comments on 
the proposal. This order approves the proposal.
---------------------------------------------------------------------------

    \3\ See Securities Exchange Act Release No. 42862 (May 30, 
2000), 65 FR 36481.
---------------------------------------------------------------------------

II. Description of Proposal

    On January 22, 1999, the Commission approved a two-year pilot 
program (``Pilot Program'') that allowed for the elimination of 
position and exercise limits for options on the OEX, SPX, DJX index 
options as well as for FLEX options overlying these indexes.\4\ On 
January 22, 2001, the Commission extended the Pilot Program until May 
22, 2001.\5\ On May 22, 2001, the Commission again extended the Pilot 
Program until September 22, 2001.\6\ On September 24, 2001, the 
Commission extended the pilot program until March 24, 2002.\7\ The 
Exchange now seeks

[[Page 55723]]

permanent approval of the Pilot Program.
---------------------------------------------------------------------------

    \4\ See Securities Exchange Act Release No. 40969, 64 FR 49111 
(Feb. 1, 1999) (approving SR-CBOE-98-23) (``Pilot Approval Order'').
    \5\ See Securities Exchange Act Release No. 43867, 66 FR 8250 
(January 30, 2001).
    \6\ See Securities Exchange Act Release No. 44335, 66 FR 33728 
(May 25, 2001).
    \7\ See Securities Exchange Act Release No. 44837, 66 FR 49988 
(October 1, 2001).
---------------------------------------------------------------------------

III. Discussion

    After careful review, 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.\8\ 
Specifically, the Commission believes that the proposed rule change is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in facilitating transactions in 
securities and to remove impediments to and perfect the mechanism of a 
free and open market and a national market system.\9\
---------------------------------------------------------------------------

    \8\ In approving this rule proposal, the Commission notes that 
it has also 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).
---------------------------------------------------------------------------

    The Commission believes for the same reasons discussed in the Pilot 
Approval Order, in addition to the lack of any problems identified 
during the pilot period as discussed below, that the pilot should be 
approved on a permanent basis.\10\ The Commission notes that the Pilot 
Approval Order required the Exchange to submit a report to the 
Commission on the status of the Pilot Program so that the Commission 
could use this information to evaluate any consequences of the program 
and to determine whether to approve the elimination of position and 
exercise limits for these products on a permanent basis.\11\ The CBOE 
submitted the required report to the Commission on December 21, 
2000.\12\
---------------------------------------------------------------------------

    \10\ The bases for approving the pilot as discussed in the Pilot 
Approval Order are incorporated herein to this permanent approval 
order.
    \11\ In the prior Approval Order, the Commission stated, ``CBOE 
will provide the Commission with a report detailing the size and 
different types of strategies employed with respect to positions 
established in those classes not subject to position limits. In 
addition, the report will note whether any problems resulted due to 
the no limit approach and any other information that may be useful 
in evaluating the effectiveness of the pilot program. The Commission 
expects that CBOE will take prompt action, including timely 
communication with the Commission and other marketplace self-
regulatory organizations responsible for oversight of trading in 
component stocks, should any unanticipated adverse market effects 
develop.''
    \12\ Letter from Patricia L. Cerny, Director, Office of Trading 
Practices, CBOE, to Elizabeth King, Division of Market Regulation, 
Commission, dated December 21, 2000.
---------------------------------------------------------------------------

    The report represents that during the review period, CBOE did not 
discover any instances where an account maintained an unusually large 
unhedged position. The data from the report found that only 12 accounts 
established positions in excess of 10% of the standard limit applicable 
to each index at the time the Pilot Program was approved. These 
positions were all in SPX and most were established by firms and market 
makers. All of the accounts were hedged, although to different degrees. 
CBOE represented that it did not discover any aberrations caused by 
large unhedged positions during the life of the Pilot Program.\13\
---------------------------------------------------------------------------

    \13\ In its latest filing extending the pilot program, CBOE 
again represented that it had not discovered any aberrations caused 
by large unhedged positions during the pilot program. See supra note 
7.
---------------------------------------------------------------------------

    In addition to no identifiable problems during the pilot program, 
the Commission also believes that the factors for approval of the pilot 
program continue to be met. For example, in approving the pilot, the 
Commission stated, among other things, that the enormous capitalization 
of and deep, liquid markets for the underlying securities contained in 
the OEX, SPX and DJX significantly reduces concerns regarding market 
manipulation or disruption in the underlying market. In this regard, we 
note that the indexes continue to have enormous capitalizations. 
Indeed, the current capitalizations' of the indexes are currently 
higher than the capitalizations we relied on in originally approving 
the pilot.\14\
---------------------------------------------------------------------------

    \14\ The Pilot Approval Order stated that, as of August 1998, 
the market capitalizations for the SPX, OEX, and DJX were $8.5 
trillion, $3.8 trillion and $2.2 trillion, respectively. As of 
October 2001, these figures had increased to $9.81 trillion, $5.7 
trillion and $3.23 trillion, respectively.
---------------------------------------------------------------------------

    The Commission also continues to believe that the financial 
requirements imposed by CBOE and the Commission help to address 
concerns that a CBOE member or is customer may try to maintain an 
inordinately large unhedged position in the indexes. As noted in the 
Pilot Approval Order, the CBOE has the authority to impose additional 
margin and/or assess capital charges and should be able to monitor 
accounts to determine when such action is warranted.\15\
---------------------------------------------------------------------------

    \15\ As originally noted in the Pilot Approval Order, the 
Commission's net capital rule, Rule 15c3-1 under the Exchange Act, 
imposes a capital charge on members to the extent of any margin 
deficiency. More specifically, Exchange Act Rule 15c3-1 requires a 
capital change equal to the maximum potential loss on a broker-
dealer's aggregate index position over a +(-) 10% market move. 
Exchange margin rules require margin on naked index options which 
are in or at-the-money equal to a 15% move in the underlying index; 
and a minimum 10% charge for naked out-of-the money contracts. At an 
index value of 9,000 this approximates to a $135,000 to $90,000 
requirement per each unhedged contract.
---------------------------------------------------------------------------

    Finally, in addition to the other basis for approval of the pilot 
as discussed in the Pilot Approval Order, the Commission relied heavily 
on the enhanced surveillance \16\ and reporting safeguards that would 
allow CBOE to detect and deter trading abuses arising from the 
elimination of position and exercise limits in options and Flex options 
on the subject indexes.\17\ The Commission continues to believe that 
these enhanced procedures are critical in our determination to 
permanently approve the pilot. While the pilot did not note any 
aberrations or concerns about large unhedged positions, the Commission 
continues to believe that these procedures will enable the CBOE to 
adequately assess and respond to market concerns at an early stage. In 
this regard the Commission continues to expect CBOE to take prompt 
action, including timely communication with the Commission and other 
marketplace self-regulatory organizations responsible for oversight of 
trading in component stocks, should any unanticipated adverse market 
effects develop.
---------------------------------------------------------------------------

    \16\ It is inappropriate to discuss the details of CBOE's 
enhanced surveillance program because the disclosure of specific 
surveillance procedures could provide market participants with 
information that could aid potential attempts at avoiding regulatory 
detection of inappropriate trading activity.
    \17\ CBOE's reporting requirements subject SPX, OEX and FLEX 
options on those indexes to a 100,000 contract hedge reporting 
requirement, and DJX, which is one-tenth the size of a full value 
index contract, and FLEX options on the DJX, are subject to a 1 
million contract hedge reporting threshold. Each member or member 
organization that maintains a position on the same side of the 
market in excess of these contract thresholds for its own account or 
for the account of a customer must file a report that includes, but 
is not limited to, data related to the option position, whether such 
position is hedged and if so, a description of the hedge. If 
applicable, the report must contain information concerning 
collateral used to carry the position.
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-CBOE-2001-22) is approved.
---------------------------------------------------------------------------

    \18\ 15 U.S.C. 78f(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
---------------------------------------------------------------------------

    \19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-27525 Filed 11-1-01; 8:45 am]
BILLING CODE 8010-01-M