[Federal Register Volume 67, Number 17 (Friday, January 25, 2002)]
[Notices]
[Pages 3757-3760]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-1906]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45309; File No. SR-CBOE-2001-44]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to Proposed Rule Change by the Chicago 
Board Options Exchange, Incorporated Increasing Position and Exercise 
Limits on QQQ Options

January 18, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange act of 
1934,\1\ and rule 19b-4 thereunder,\2\ notice is hereby given that on 
August 9, 2001, 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. 
On December 19, 2001, the CBOE filed Amendment No. 1 to the proposed 
rule change,\3\ and on January 14, 2002, the CBOE filed Amendment No. 2 
to the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 supercedes and replaces the original 19b-4 
filing in its entirety.
    \4\ Amendment No. 2 removes language added to Rule 4.13(b) by 
the proposed rule change that increased the reporting requirement 
level specified in Rule 4.13 for QQQ options.
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    The Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons. For the 
reasons discussed below, the Commission is granting accelerated 
approval of the proposed rule change, as amended.

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

    The Exchange hereby proposes to increase position and exercise 
limits for Nasdaq-100 Index Tracking StockSM (``QQQ'') 
options. The Exchange represents that its reporting requirements for 
QQQ options will serve to identify options holdings and information 
concerning the hedging of these positions.
    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

[[Page 3758]]

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

1. Purpose
    The Commission has stated that position and exercise limits ``must 
not be established at levels that are so low as to discourage 
participation in the options market by institutions and other investors 
with substantial hedging needs or to prevent specialists and market-
makers from adequately meeting their obligations to maintain a fair and 
orderly market.'' \5\
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    \5\ See H.R. Rep. No. IFC-3, 96th Cong., 1st Sess. At 189-91 
(Comm. Print 1978).
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    The Exchange represents that the QQQs are by far the most actively-
traded options product. Average daily trading volumes for the QQQs and 
QQQ options from January 1, 2001 to April 30, 2001 were 70.5 million 
shares and 189,046 contracts, respectively. The current standard 
position and exercise limits for QQQ options were recently adjusted 
from 75,000 contracts to 150,000 contracts, due to a 2-for-1 split in 
the value of the underlying QQQ. In January 2002, however, the current 
limits are scheduled to revert to 75,000 contracts.
    Based on the large trading volume in both the underlying QQQ and 
QQQ options, the Exchange believes that position and exercise limits of 
the QQQ option are too restrictive and may adversely affect the 
Exchange's ability to provide liquidity in this popular product. In 
addition, the CBOE believes that current base limits for the QQQ 
options may not be adequate in many instances for the hedging needs of 
certain institutions which engage in trading strategies differing from 
those covered under the equity hedge exemption policy in Interpretation 
.04 to Exchange Rule 4.11 (e.g., delta hedges; OTC vs. listed hedges).
    To accommodate the need for continued liquidity in this product, 
the Exchange proposes to increase position and exercise limits for QQQ 
options to 300,000 contracts. The Exchange will require both that 
member organizations report all QQQ options positions exceeding 200 
contracts pursuant to existing Exchange Rule 4.13(a), and that they 
report information on the hedging of all positions in excess of 10,000 
contracts on the same side of the market, pursuant to an amended 
Exchange Rule 4.13(b). The Exchange believes that increasing position 
limits for this product will lead to a more liquid and competitive 
market environment for QQQ options that will benefit customers 
interested in the product.

Reporting Requirements

    Consistent with Exchange Rule 4.13(b), the Exchange will require 
that each member or member organization that maintains a position on 
the same side of the market in excess of 10,000 contracts in the QQQ 
option, for its own account or for the account of a customer report 
certain information. This data would include, but would not be limited 
to, the option position, whether such position is hedged and if so, a 
description of the hedge and if applicable, the collateral used to 
carry the position. Exchange market-makers (including DPMs) would 
continue to be exempt from this reporting requirement as market-maker 
information can be accessed through the Exchange's market surveillance 
systems. Once the 10,000 contract reporting threshold is attained, 
member or member organizations must similarly report each increase of 
2,500 contracts on the same side of the market for customer accounts 
and each increase of 5,000 contracts on the same side of the market for 
proprietary accounts. In addition, the general reporting requirement 
for customer accounts that maintain a position in excess of 200 
contracts will remain at this level for QQQ options.\6\ Lastly, it is 
important to note that the 10,000 contract reporting requirement is 
above and beyond what is currently required in the OTC market. NASD 
member firms are only required to report options positions in excess of 
200 contracts and are not required to report any related hedging 
information.
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    \6\ See Exchange Rule 4.13(a).
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \7\ in general and furthers the objectives 
of Section 6(b)(5) \8\ in particular in that it 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, to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system, to protect investors and the 
public interest and is not designed to permit unfair discrimination 
between customers, issuers, brokers, or dealers.
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    \7\ 15 U.S.C. 78f(b).
    \8\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition not necessary or appropriate in furtherance of 
purposes of the Act.

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 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 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 Section. Copies of such filing will also 
be available for inspection and copying at the office of the CBOE. All 
submissions should refer File No. SR-CBOE-2001-44 and should be 
submitted by February 15, 2002.

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

    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. In 
particular, the Commission believes the proposal is consistent with the 
requirements of section 6(b)(5) of the Act \9\ in that it is

[[Page 3759]]

designed to promote just and equitable principles of trades, 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.
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    \9\ 15 U.S.C. 78f(b)(5). In approving this rule change, the 
Commission notes that it has considered the proposal's impact on 
efficiency, competition, and capital formation, consistent with 
Section 3 of the Act. Id. at 78c(f).
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    Position and exercise limits serve as a regulatory tool designed to 
address potential manipulative schemes and adverse market impact 
surrounding the use of options. In the past, the Commission has stated 
that:

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate 
or disrupt the underlying market so as to benefit the options 
position. In particular, position and exercise limits are designed 
to minimize the potential for mini-manipulations and for corners or 
squeezes of the underlying market. In addition such limits serve to 
reduce the possibility for disruption of the options market itself, 
especially in illiquid options classes.\10\

    \10\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998).

    In general, the Commission has taken a gradual, evolutionary 
approach toward expansion of the position and exercise limits. The 
Commission has been careful to balance two competing concerns when 
considering the appropriate level at which to set position and exercise 
limits. The Commission has recognized that the limits must be 
sufficient to prevent investors from disrupting the market in the 
component securities comprising the indexes. At the same time, the 
Commission has determined that limits must not be established at levels 
that are so low as to discourage participation in the options market by 
institutions and other investors with substantial hedging needs or to 
prevent specialists and market makers from adequately meeting their 
obligations to maintain a fair and orderly market.\11\
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    \11\ Id.
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    The Commission has carefully considered the CBOE's proposal to 
increase position and exercise limits for QQQ options. At the outset, 
the Commission notes that it still believes the fundamental purpose of 
position and exercise limits are being served by their existence. 
However, given the surveillance capabilities of the Exchange and the 
depth and liquidity in both the QQQ options and the underlying cash 
market in QQQs, the Commission believes it is permissible to 
significantly raise position limits for QQQ options without risk of 
disruption to the options or underlying cash markets. Specially, the 
Commission believes that it is appropriate to increase position and 
exercise limits from 75,000 contracts to 300,000 contracts for QQQ 
options for several reasons.
    First, the Commission believes that the structure of the QQQ 
options and the considerable liquidity of both the underlying cash and 
options market for QQQ options lessen the opportunity for manipulation 
of this product and disruption in the underlying market that a lower 
position limit may protect against. In this regard, the CBOE notes that 
the average daily trading volumes for the QQQs and QQQ options from 
January 1, 2001 to April 30, 2001 were 70.5 million shares and 189,046 
contracts, respectively. CBOE has also noted that the QQQ option is the 
most actively-traded option in the U.S. markets, and the underlying QQQ 
is the most actively-traded equity security in the U.S. markets.\12\ 
These factors provide support for higher limits for the QQQ options and 
differentiate them from other equity options.
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    \12\ As noted by the CBOE, the QQQ is designed to closely track 
the performance of the Nasdaq-100 Index. As of November 30, 2001, 
the market capitalization of the securities underlying the Nasdaq-
100 Index was $1.875 trillion.
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    Second, the Commission notes that current margin and risk-based 
haircut methodologies serve to limit the size of positions maintained 
by any one account by increasing the margins and/or capital that a 
member must maintain for a large position held by itself or by its 
customer. Further, the CBOE, under CBOE Rules 4.13 and 12.10, may 
impose additional margin on options positions if it determines that 
this is warranted. The Commission believes that these financial 
requirements should help to address concerns that a member or its 
customer may try to maintain an inordinately large unhedged position in 
QQQ options and will help to reduce risks if such a position is 
established.
    Finally, the Commission believes that the reporting requirements 
imposed by the Exchange under CBOE Rule 4.13, which will continue to 
require that each member or member organization that maintains a 
position on the same side of the market in excess of 10,000 contracts 
in the QQQ option, for its own account or for the account of a customer 
report certain information, will help protect against potential 
manipulation. The Exchange also requires members to report subsequent 
incremental increases in positions, thus assuring that positions are 
regularly monitored by the Exchange. In particular, information that 
must be reported includes, among other things, whether or not the 
options position is hedged, and if so, a description of the hedge. This 
information should help the CBOE to monitor accounts and determine 
whether it is necessary to impose additional margin for under-hedged 
positions, as provided under its rules.
    In summary, the financial and reporting requirements noted above 
should allow the Exchange to detect and deter trading abuses arising 
from the increased position and exercise limits, and will also allow 
the Exchange to monitor large positions in order to identify instances 
of potential risk and to assess additional margin and/or capital 
charges, if deemed necessary. These requirements, coupled with the 
special trading characteristics of the QQQ options and the underlying 
QQQ noted above, warrant approval of the Exchange's proposal.\13\
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    \13\ Of course, the Commission expects that CBOE will take 
prompt action, including timely communicational with the Commission 
and other marketplace self-regulatory organizations responsible for 
oversight of trading in the underlying QQQ, should any unanticipated 
adverse market effects develop due to the increased limits.
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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 the 
notice of filing thereof in the Federal Register. The Commission notes 
that under the current CBOE rules, the position and exercise limits 
applicable to QQQ options is 75,000 contracts. However, due to a 50% 
reduction in the value of the underlying QQQ on March 20, 2000, the 
limit was adjusted to 150,000 contracts. The position and exercise 
limits are scheduled to revert back to 75,000 contracts after the 
January options expiration occurring on January 18, 2002. The Exchange 
has represented to the Commission that limits of 75,000 contracts for 
the QQQ options could substantially reduce depth and liquidity in the 
QQQ market. The Commission believes for the reasons noted above that it 
is appropriate to approve this proposed rule change increasing the 
position and exercise limits to 300,000 contracts on January 18, 2002. 
Accordingly, the Commission finds that there is good cause, consistent 
with section 6(b)(5) of the Act,\14\ to approve the proposal on an 
accelerated basis.
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    \14\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-CBOE-2001-

[[Page 3760]]

44) is hereby approved on an accelerated basis.
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    \15\ 15 U.S.C. 78s(b)(2).

    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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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-1906 Filed 1-24-02; 8:45 am]
BILLING CODE 8010-01-M