[Federal Register Volume 67, Number 223 (Tuesday, November 19, 2002)]
[Notices]
[Pages 69775-69776]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-29240]


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SECURITIES AND EXCHANGE COMMISSION


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to an 
Extension of the Permissible Maturity of Flexible Exchange Index 
Options to Ten Years

November 12, 2002.

[Release No. 34-46815; File No. SR-CBOE-2002-23)]

    On April 30, 2002, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed 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\ a proposed rule change to revise CBOE Rule 24A.4, 
``Terms of FLEX Options,'' to provide a maximum term of up to ten years 
for Flexible Exchange (``FLEX'') index options \3\ under certain 
circumstances.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ FLEX index options allow investors to customize certain 
option terms, including size, expiration date, exercise style, and 
exercise price.
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    The proposed rule change was published for comment in the Federal 
Register on August 21, 2002.\4\ No comments were received regarding the 
proposal. This order approves the proposed rule change.
    Currently, CBOE Rule 24A.4(a)(4)(i) provides a maximum term of five 
years for FLEX index options. The CBOE proposes to amend CBOE Rule 
24A.4(a)(4)(i) to provide a maximum term of up to ten years for FLEX 
index options, provided that the FLEX Post Official determines that 
sufficient liquidity exists among FLEX index participating members to 
support a request for a quote for such options. To determine whether 
sufficient liquidity exists to support a request for a quote, the FLEX 
Post Official will ask FLEX index market makers and other FLEX index 
traders (including the Submitting Member) whether they are interested 
in making a two-sided market in the proposed series for the size 
requested.\5\ If the FLEX index market makers and FLEX index traders 
respond affirmatively, the FLEX Post Official will open a Request for 
Quotes for the proposed series, which will trade pursuant to the 
provisions of CBOE Rule 24A.5, ``FLEX Trading Procedures and 
Principles.''\6\ The CBOE believes that this requirement will help to 
prevent the proliferation of longer-term FLEX index options where there 
is no interest in trading such options.
    The margin requirements for the proposed FLEX index options will be 
the same as the margin requirements that apply currently to existing 
FLEX index options and to other listed options.\7\ Thus, the required 
minimum initial and maintenance margin for a proposed FLEX index option 
with more than nine months to expiration will be at least 75% of the 
current market value of the option.\8\ The required minimum initial and 
maintenance margin for a short position in the proposed FLEX index 
options will be the same as the margin required for short positions in 
other listed broad-based index options.\9\
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    \4\ See Securities Exchange Act Release No. 46363 (August 15, 
2002), 67 FR 54243.
    \5\ See letter from Jaime Galvan, Attorney II, CBOE, to Yvonne 
Fraticelli, Division of Market Regulation, Commission, dated October 
14, 2002 (``October 14 Letter'').
    \6\ See October 14 Letter, supra note 5.
    \7\ See October 14 Letter, supra note 5.
    \8\ See CBOE Rule 12.3(c)(4)(B).
    \9\ See October 14 Letter, supra note 5. Under the CBOE's rules, 
the required minimum initial and maintenance margin for an unhedged 
position in a listed broad-based index option carried short in a 
customer's account is 100% of the current market value of the option 
plus 15% of the product of the current index group value and the 
applicable index multiplier, reduced by any out-of-the-money amount, 
with a minimum margin requirement equal to 100% of the current 
market value of the option plus 10% of the product of the current 
index group value and the applicable index multiplier. See CBOE Rule 
12.3(c)(5)(A).
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    According to the CBOE, the Exchange has received numerous requests 
from broker-dealers to extend the maturity of FLEX index options to ten 
years to permit their institutional customers that trade or issue 
securities with five-to ten-year terms to hedge their long-term risk. 
The CBOE states that the proposal will allow institutions to use long-
term FLEX

[[Page 69776]]

index options to protect their portfolios from long-term market moves 
at a known and limited cost. In addition, the CBOE believes that the 
proposal will better serve the long-term hedging needs of institutional 
investors and provide those investors with an alternative to hedging 
their portfolios with off-exchange customized index options and 
warrants.
    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, with the requirements of section 6(b) of the Act \10\ and 
the rules and regulations thereunder. Specifically, the Commission 
finds that the proposal is consistent with the requirements under 
section 6(b)(5) of the Act \11\ that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and to protect investors and the 
public interest.\12\
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
    \12\ In approving this proposal, the Commission 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 extending the permissible maturity of 
FLEX index options to a maximum term of up to ten years will help to 
meet the long-term hedging requirements of institutional investors and 
other market participants.\13\ The proposal should benefit market 
participants with long-term hedging needs by allowing them to hedge 
positions on a long-term basis through an investment in one option 
series, rather than having to roll shorter-term expirations into new 
series to remain hedged over an extended period of time. In addition, 
the proposal will allow market participants to hedge long-term risk 
with an exchange-traded option, thereby providing an alternative to 
hedging positions with over-the-counter (``OTC'') products and 
extending the benefits of a listed, exchange market to longer-term 
index options.\14\ The extension of the permissible maturity term for 
FLEX index options to up to ten years also could help to expand the 
depth and liquidity of the FLEX index option market.
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    \13\ FLEX index options are designed to appeal to institutional 
investors or extremely high net worth individuals who have the 
experience and ability to engage in negotiated, customized 
transactions. In this regard, the Commission notes that the required 
minimum size for an opening transaction in any FLEX index option 
series in which there is no open interest is $10 million Underlying 
Equivalent Value (the aggregate underlying monetary value covered by 
that number of contracts, derived by multiplying the index 
multiplier by the current index value times the given number of FLEX 
index options). See CBOE Rule 24A.4(a)(4)(ii).
    \14\ As the Commission has noted previously, the benefits of the 
CBOE's market versus an OTC market include, but are not limited to, 
a centralized market center, an auction market with posted 
transparent market quotations and transaction reporting, 
standardized contract specifications, parameters and procedures for 
clearance and settlement, and the guarantee of the Options Clearing 
Corporation (``OCC'') for all contracts traded on the CBOE. See 
Securities Exchange Act Release No. 31920 (February 24, 1993), 58 FR 
12280 (March 3, 1993) (File No. SR-CBOE-92-17) (approving the CBOE's 
proposal to list and trade FLEX options on the S&P 500 Index and the 
S&P 100 Index).
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    The Commission notes that a series of the proposed FLEX index 
options may be issued only if a FLEX Post Official determines that 
there is sufficient liquidity among FLEX index participating members to 
support the request for a quote for such options. This requirement 
should help to prevent the proliferation of longer term FLEX index 
options series where there is no interest in trading such options. In 
addition, as with all exchange-traded options, the OCC will act as the 
counter-party guarantor, thereby ensuring that obligations will be met 
over the long term. In approving this proposal, the Commission notes 
that the extension to ten years is based, in part, on the nature of the 
FLEX market, which is geared toward institutional investors and high 
net worth individuals.\15\ The Commission believes that because of 
their experience, these market participants may be better able to 
assess the risks of longer term index option products.\16\
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    \15\ See note 13, supra.
    \16\ See also note 12 in Securities Exchange Act Release No. 
39524 (January 8, 1998), 63 FR 3009 (January 20, 1998) (order 
approving File No. SR-CBOE-97-57) (noting certain concerns that may 
be raised by long-term options).
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    For the foregoing reasons, the Commission finds that the proposal 
is consistent with the requirements of the Act and rules and 
regulations thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-CBOE-2002-23) is approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-29240 Filed 11-18-02; 8:45 am]
BILLING CODE 8010-01-P