[Federal Register Volume 68, Number 34 (Thursday, February 20, 2003)]
[Notices]
[Pages 8316-8318]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-4046]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47346; File No. SR-CBOE-2002-26]


Self Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Granting Approval to Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment No. 1 to 
the Proposed Rule Change Increasing Position and Exercise Limits for 
Options on the DIAMONDS Trust

February 11, 2003.

I. Introduction

    On May 20, 2002, the Chicago Board Options Exchange, Inc. 
(``CBOE'') filed with the Securities and Exchange Commission 
(``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 increase position and exercise limits for 
options on the DIAMONDS Trust (``DIA''). The proposed rule change was 
published for comment in the Federal Register on November 6, 2002.\3\ 
The Commission received no comments on the proposal. On February 4, 
2003, the CBOE filed Amendment No. 1 to the proposed rule change.\4\ 
This order approves the proposed rule change, and notices and grants 
accelerated approval to Amendment No. 1 to the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 46743 (October 30, 
2002), 67 FR 67673 (November 6, 2002).
    \4\ See Letter from Christopher R. Hill, Attorney II, Legal 
Division, CBOE, to Nancy Sanow, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated February 3, 2003 
(``Amendment No. 1''). In Amendment No. 1, the CBOE corrected 
erroneous text in CBOE Rule 4.13(b) to maintain the reporting 
requirement level for DIA options specified in CBOE Rule 4.13 at 
10,000 contracts. Amendment No. 1 also corrected similar references 
to the reporting requirement level that were contained in the SEC 
Rule 19b-4 filing.
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II. Description of the Proposal

    The CBOE proposes to increase position and exercise limits for 
options on the DIA from 75,000 to 300,000 contracts on the same side of 
the market. Consistent with the reporting requirement for QQQ options, 
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 DIA option class, 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

[[Page 8317]]

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. In addition, the general 
reporting requirement for customer accounts that maintain a position in 
excess of 200 contracts will remain at this level for DIA options.\5\
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    \5\ See CBOE Rule 4.13(a).
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III. Discussion

    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 \6\ and, in 
particular, the requirements of section 6 of the Act \7\ and the rules 
and regulations thereunder. The Commission finds specifically that the 
proposed rule change is consistent with section 6(b)(5) of the Act \8\ 
because it is designed to promote just and equitable principles of 
trade, to remove impediments to, and perfect the mechanism of a free 
and open market and, in general, to protect investors and the public 
interest.
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    \6\ In approving this proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \7\ 15 U.S.C. 78f.
    \8\ 15 U.S.C. 78f(b)(5).
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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.\9\
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    \9\ 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 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 an index. These same concerns exist for 
the underlying portfolio securities held by exchange-traded fund 
shares, which track indexes such as the DIA. 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.\10\
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    \10\ Id.
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    The Commission has carefully considered the CBOE's proposal to 
increase position and exercise limits for DIA 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 DIA options and the underlying cash 
market in DIAs, the Commission believes it is permissible to 
significantly raise position and exercise limits for DIA options 
without risk of disruption to the options or underlying cash markets. 
Specifically, the Commission believes that it is appropriate to 
increase position and exercise limits from 75,000 contracts to 300,000 
contracts for DIA options for several reasons.
    First, the Commission believes that the structure of the DIA 
options and the considerable liquidity of both the underlying cash and 
options market for DIA 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 
DIA, based on the Dow Jones Industrial Average, is among the most 
actively traded exchange-traded funds, averaging 4.5 million shares per 
day during the first six months of 2002. Moreover, the components 
comprising the fund are themselves among the most actively traded and 
widely held securities listed in the U.S. These factors provide support 
for higher limits for the DIA options and differentiate them from other 
equity options (including options on other exchange-traded fund 
shares).
    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 margin 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 
DIA 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 will help protect against 
potential manipulation. 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 DIA option class, 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. In addition, the general reporting requirement for customer 
accounts that maintain a position in excess of 200 contracts will 
remain at this level for DIA options.\11\ 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.
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    \11\ See CBOE Rule 4.13(a).
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    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 DIA options and the underlying 
DIA noted above, warrant approval of the Exchange's proposal.\12\
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    \12\ Of course, 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 the underlying DIA, should any unanticipated 
adverse market effects develop due to the increased limits.

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[[Page 8318]]

    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Amendment No. 1 
corrects an error in the proposed rule language and in the Rule 19b-4 
rule filing to affirm that the reporting requirement level for DIA 
options will be set at 10,000 contracts. This is the current level 
under CBOE rules and remains unchanged. The Commission, therefore, 
believes that there is good cause to grant accelerated approval of 
Amendment No. 1, consistent with Section 6(b)(5) of the Act \13\ and 
section 19(b)\14\ of the Act.
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    \13\ 15 U.S.C. 78f(b)(5).
    \14\ 15 U.S.C. 78s(b).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether it 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 at the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-CBOE-2002-26 and should be 
submitted by March 13, 2003.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\15\, that the proposed rule change (SR-CBOE-2002-26), as amended, be 
and hereby is approved.
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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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-4046 Filed 2-19-03; 8:45 am]
BILLING CODE 8010-01-P