[Federal Register Volume 68, Number 212 (Monday, November 3, 2003)]
[Notices]
[Pages 62337-62339]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-27536]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48681; File No. SR-CBOE-2003-14]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change and Amendment No. 1 Thereto by the Chicago Board 
Options Exchange, Incorporated Relating to Options on a Reduced Value 
NYSE Composite Index

October 22, 2003.

I. Introduction

    On March 25, 2003, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') 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 permit the trading of options 
on the reduced value, Revised NYSE Composite Index. On August 6, 2003, 
the CBOE submitted Amendment No.1 to the proposed rule change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Jim Flynn, Attorney II, CBOE, to Nancy 
Sanow, Assistant Director, Division of Market Regulation, Commission 
dated August 5, 2003 (``Amendment No. 1''). In Amendment No. 1, CBOE 
replaced its proposed rule change in its entirety.
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    The proposed rule change, as amended, was published for comment in 
the Federal Register on September 5, 2003.\4\ The Commission received 
no comments on the proposal. This order approves the proposed rule 
change, as amended.
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    \4\ See Securities Exchange Act Release No. 48416 (August 27, 
2003), 68 FR 52804.
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II. Description of the Proposal

    In January 2003, the New York Stock Exchange, Inc. (``NYSE'') 
announced that it would replace the NYSE Composite Index (``Old 
Index''), which was designed to measure the performance of securities 
listed on the NYSE (with the exception of preferred securities), with a 
Revised NYSE Composite Index.\5\ The Revised NYSE Composite Index has 
700 fewer components than the Old Index and, according to the NYSE, 
should create an index that is more representative of investable equity 
securities tracked on

[[Page 62338]]

the NYSE. In addition, the Revised NYSE Composite Index would be 
calculated using a float-adjusted market capitalization weighting 
method instead of a full-market capitalization weighting, as was used 
in the Old Index.\6\ The float-adjusted market capitalization method is 
used to reflect only the number of shares that are actually available 
to investors.\7\ The Revised NYSE Composite Index will be maintained 
and calculated by the Dow Jones. Maintenance includes monitoring and 
implementing the adjustments for company additions and deletions, share 
changes, stock splits, stock dividends, corporate restructurings, spin-
offs and other corporate actions.
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    \5\ The Revised NYSE Composite Index would continue to measure 
the performance of all NYSE-listed common stock, American Depository 
Receipts (``ADRs''), tracking stocks and real estate investment 
trusts (``REITs''), but would exclude closed-end investment 
companies, exchange traded funds (``ETFs''), derivatives, preferred 
stocks, shares of beneficial interest, trust units and limited 
partnerships.
    \6\ The CBOE states that all option series on the Old Index have 
expired and no new series in Old Index Options have been added or 
will be added.
    \7\ In calculating this number of shares, the float-adjusted 
market capitalization methodology will reduce each underlying 
issuer's market share in the Revised NYSE Composite Index by the 
market capitalization value represented by those shares held through 
5% or more block ownership. The following types of ownership are 
considered block ownership: cross ownership (shares that are owned 
by other companies); government ownership (shares that are owned by 
governments or their agencies; private ownership (shares that are 
closely held by individuals, families or charitable trusts and 
foundations); and restricted shares (shares that are not allowed to 
be traded during a certain period of time).
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    The CBOE has proposed to list and trade options based on one-tenth 
(1/10th) the value of the Revised NYSE Composite Index as well as LEAPS 
and reduced-value LEAPS on the Revised NYSE Composite Index. The 
Revised NYSE Composite Index, unlike the Old Index, is a broad-based 
index designed to reflect the actual number of shares available to 
investors, and will be treated as a broad-based index under CBOE Rules. 
All other material terms to the options on the Revised NYSE Composite 
Index remain the same as those of the Old Index. Accordingly, options 
on the index would continue to have a.m., European style settlement, 
the same position and exercise limits as the Old Index options and 
broad based index options margin.

III. Discussion

    The Commission has carefully reviewed the CBOE's proposed rule 
change and finds that the proposal is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to a 
national securities exchange \8\ and with the requirements of section 
6(b) of the Act.\9\ In particular, the Commission finds that the 
proposed rule change is consistent with section 6(b)(5) \10\ of the Act 
which requires that the Exchange's rules be designed to prevent 
fraudulent and manipulative acts and practices, 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, 
in general, to protect investors and the public interest. While the 
Exchange does not believe that these changes will result in any 
material differences in the manner in which options on the Reduced 
Value Index will trade, the Commission believes that certain issues 
need to be addressed, including the float-adjusted market 
capitalization method for the index.
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    \8\ In approving this proposed rule change, 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.
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that index options on the Revised NYSE 
Composite Index should be beneficial to members that want to track the 
New York Stock Exchange equity markets, and could provide a useful 
hedging vehicle for such investors.\11\ Because the Revised NYSE 
Composite Index is intending to track the NYSE's equity markets as a 
whole, the index is appropriately treated as a broad-based index option 
under CBOE rules, and for regulatory purposes.
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    \11\ Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of any new securities product upon a finding that 
the introduction of such product is in the public interest. Such a 
finding would be difficult with respect to a product that served no 
hedging or other economic function because any benefits that might 
be derived by market participants likely would be outweighed by the 
potential for manipulation, diminished public confidence in the 
integrity of the markets, and other valid regulatory concerns. In 
this regard, the trading of index options on the Revised NYSE 
Composite Index will provide investors with a hedging vehicle for 
all equity securities traded on the NYSE.
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    As noted above, the float-adjusted market capitalization eliminates 
certain holdings that are not freely available from the capitalization 
calculation. This is the first index option CBOE will be trading using 
this method of calculation for the underlying index. The Commission 
believes that this newly-developed method for calculating the index 
value could help to relieve the potential price distortions that could 
result from including in the index the entire capitalization of a 
company with limited free float. While this somewhat reduces the 
overall capitalization of the Revised NYSE Composite Index, the 
capitalization of this index will still remain extremely large.
    The Commission also notes that while the Exchange's proposal to 
list and trade options at one-tenth (1/10th) of the value of the 
underlying index represents a departure from the calculation used in 
the Old Index, the Commission does not believe that this should raise 
concerns. The purpose behind this change is to reduce the extremely 
large contract size that would result from pairing the standard 
contract multiplier with such a high underlying index level.\12\ Such a 
reduction will provide investors with product offerings that are 
consistent with those available for the Old Index. Because the 
reduction in contract size is intended to have the index value be 
reduced to levels similar to the contract size on the Old Index, the 
Commission has determined that it is appropriate to apply the same 
position and exercise limits applicable to the Old Index options to the 
new option contracts on the Revised NYSE Composite Index. Further, the 
45,000-contract limit with a reduction to 25,000 contracts in the near-
term months, is equivalent to the position and exercise limits 
applicable to other similar broad-based indices.
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    \12\ The Old Index was calculated to a base of 500 and, after 
multiplying by the standard $100 contract multiplier, the contract 
size was $50,000. The Revised NYSE Composite Index is calculated to 
a base of 5,000, which, after multiplying by the standard $100 
contract multiplier, yields a contract size of $500,000. To address 
this extremely large contract size, the CBOE has proposed to list 
and trade options based on 1/10th of the value of the Revised NYSE 
Composite Index. This translates to a contract size of $50,000, 
which is the same as that of the Old Index.
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    The Commission notes that margin requirements and other material 
terms of the options, such as a.m. settlement, will remain unchanged, 
and, as such, the trading of options on the Revised NYSE Composite 
Index does not raise any new issues in these areas. CBOE has stated 
that it will apply its existing surveillance procedures to monitor 
trading in options on the Revised NYSE Composite Index. The Commission 
believes that these procedures should be sufficient to detect as well 
as deter manipulation and other trading abuses.
    Finally, the CBOE has agreed to send a circular to members 
discussing the Revised NYSE Composite Index and the index options that 
will be traded on CBOE on the Revised NYSE Composite Index. The 
circular will discuss the new float-adjusted market capitalization 
method. The Commission believes that this will be useful since the Old 
Index had a different calculation method and this is the first time 
that CBOE will be trading index options using a float-adjusted market 
capitalization method. The Revised NYSE Composite Index will also have 
a different symbol than the one used for the Old Index. These efforts 
should help to avoid investor confusion relating to options on the Old 
Index and the Revised NYSE Composite Index.

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    In summary, the Commission notes that the Revised NYSE Composite 
Index is a broad-based index and that listing options on the Revised 
NYSE Composite Index will provide an opportunity for investors to hedge 
the market risk associated with the trading of equity securities on the 
NYSE.

IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\13\ that the proposed rule change, as amended (SR-CBOE-2003-14) 
be, and it hereby is, approved.
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    \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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-27536 Filed 10-31-03; 8:45 am]
BILLING CODE 8010-01-P