[Federal Register Volume 69, Number 97 (Wednesday, May 19, 2004)]
[Notices]
[Pages 28962-28966]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-11308]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49696; File No. SR-ISE-2004-08]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change and Amendment 
Nos. 1 and 2 Thereto by International Securities Exchange, Inc., 
Relating to Trading Options on the S&P MidCap 400 Index

May 13, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 2, 2004, the International Securities Exchange, Inc. 
(``Exchange'' or ``ISE'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC'') the proposed rule change as 
described in Items I, II, and III below, which items have been prepared 
by the Exchange. ISE amended its proposal on April 19, 2004.\3\ The 
proposal was also amended by ISE on May 13, 2004.\4\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons and is approving the proposal on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Michael J. Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated April 16, 
2004 (``Amendment No. 1''). In Amendment No. 1, the ISE made 
technical corrections to its rule text.
    \4\ See letter from Michael J. Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division, 
Commission, dated May 13, 2004 (``Amendment No. 2''). In Amendment 
No. 2, the ISE provided additional information on the Standard & 
Poor's MidCap 400 Index (``S&P MidCap 400'' or ``Index'') and added 
two exhibits to the proposed rule change. The first exhibit is a 
letter from the Options Price Reporting Authority stating that it 
has the capacity to support the trading of options on the Index on 
the Exchange. The second exhibit is a document that sets forth 
Standard & Poor's criteria for inclusion or exclusion of components 
in the Index.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend its rules to trade options on 
the Index. The text of the proposed rule change, as amended, appears 
below. Additions are italicized; deletions are in [brackets].
* * * * *

Rule 2001. Definitions

    ((a)-(m) No change).

Supplementary Material to Rule 2001

    .01 The reporting authorities designated by the Exchange in respect 
of each index underlying an index options contract traded on the 
Exchange are as provided in the chart below.

------------------------------------------------------------------------
             Underlying index                    Reporting authority
------------------------------------------------------------------------
S&P SmallCap 600 Index....................  Standard & Poor's.
Morgan Stanley Technology Index...........  American Stock Exchange.
S&P MidCap 400 Index......................  Standard & Poor's.
------------------------------------------------------------------------

Rule 2004. Position Limits for Broad-Based Index Options

    (a) Rule 412 generally shall govern position limits for broad-based 
index options, as modified by this Rule 2004. There may be no position 
limit for certain Specified (as provided in Rule 2000) broad-based 
index options contracts. All other broad-based index options contracts 
shall be subject to a contract limitation fixed by the Exchange, which 
shall not be larger than the limits provided in the chart below.

------------------------------------------------------------------------
                                  Standard limit (on
  Broad-based underlying index     the same side of      Restrictions
                                      the market)
------------------------------------------------------------------------
S&P SmallCap 600 Index S&P        100,000             No more than
 MidCap 400 Index.                 contracts45,000     60,000 near-term
                                   contracts.          No more than
                                                       25,000 near-term.
------------------------------------------------------------------------

    ((b)-(c) No change).

Rule 2009. Terms of Index Options Contracts

    ((a)(1)-(3) no change)
    (4) ``European-Style Exercise.'' The following European-style index 
options, some of which may be A.M.-settled as provided in paragraph 
(a)(5), are approved for trading on the Exchange:
    (i) S&P SmallCap 600 Index[.]
    (ii) Morgan Stanley Technology Index
    (iii) S&P MidCap 400 Index
    (5) A.M.-Settled Index Options. The last day of trading for A.M.-
settled index options shall be the business day preceding the last day 
of trading in the underlying securities prior to expiration. The 
current index value at the expiration of an A.M.-settled index option 
shall be determined, for all purposes under these Rules and the Rules 
of the Clearing Corporation, on the last day of trading in the 
underlying securities prior to expiration, by reference to the reported 
level of such index as derived from first reported sale (opening) 
prices of the underlying securities on such day, except that:
    (i) In the event that the primary market for an underlying security 
does not open for trading on that day, the price of that security shall 
be determined, for the purposes of calculating the current index value 
at expiration, as set forth in Rule 2008(g), unless the current index 
value at expiration is fixed in accordance with

[[Page 28963]]

the Rules and By-Laws of the Clearing Corporation; and
    (ii) In the event that the primary market for an underlying 
security is open for trading on that day, but that particular security 
does not open for trading on that day, the price of that security, for 
the purposes of calculating the current index value at expiration, 
shall be the last reported sale price of the security.
    The following A.M.-settled index options are approved for trading 
on the Exchange:
    (i) S&P SmallCap 600 Index
    (ii) Morgan Stanley Technology Index
    (iii) S&P MidCap 400 Index
    (b) Long-Term Index Options Series.
    ((1)(i) and (ii) no change)
    (2) Reduced Value Long Term Options Series.
    (i) Reduced-value long term options series on the following stock 
indices are approved for trading on the Exchange:
    (A) S&P SmallCap 600 Index
    (B) Morgan Stanley Technology Index
    (C) S&P MidCap 400 Index
    (ii) Expiration Months. Reduced-value long term options series may 
expire at six-month intervals. When a new expiration month is listed, 
series may be near or bracketing the current index value. Additional 
series may be added when the value of the underlying index increases or 
decreases by ten (10) to fifteen (15) percent.
    (c) Procedures for Adding and Deleting Strike Prices. The 
procedures for adding and deleting strike prices for index options are 
provided in Rule 504, as amended by the following:
    (1) The interval between strike prices will be no less than $5.00; 
provided, that in the case of the following classes of index options, 
the interval between strike prices will be no less than $2.50:
    (i) S&P SmallCap 600, if the strike price is less than $200.00[.]
    (ii) Morgan Stanley Technology Index, if the strike price is less 
than $200.00
    (iii) S&P MidCap 400 Index, if the strike price is less then 
$200.00
    ((c)(2)-(e) no change)
* * * * *

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 ISE included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change, as 
amended. The text of these statements may be examined at the places 
specified in Item III below. The ISE 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, the Proposed Rule Change

1. Purpose
    The ISE proposes to amend its rules to provide for the listing and 
trading on the Exchange of cash-settled, European-style index options 
and LEAPS, including reduced value LEAPS, on the S&P MidCap 400. 
Options on the Index are currently trading on the American Stock 
Exchange LLC (``Amex'').\5\ ISE states that the proposed rule changes 
adopt the same standards and product specifications that are currently 
applied for options traded on the S&P MidCap 400 on Amex.
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    \5\ See Exchange Act Release No. 30290 (February 3, 1992) (order 
approving Amex to trade options on the S&P MidCap 400 Index, 
hereinafter the ``1992 Order'').
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    Index Design and Composition. The S&P MidCap 400 Index measures the 
performance of the mid-range sector of the U.S. stock market. The Index 
is based on 400 stocks chosen on the basis of market capitalization, 
liquidity, and industry group representation. The Index is market value 
(capitalization) weighted.\6\ The Index was introduced on June 19, 
1991.\7\ The Index is composed of 400 domestic stocks from the ten 
market sectors. Following are the ten market sectors along with their 
respective weightings in the Index, as of February 26, 2004: Energy 
(5.5%); Materials (6.3%); Industrials (14.5%); Consumer Discretionary 
(16.3%); Consumer Staples (4.5%); Health Care (9.5%); Financials 
(16.5%); Information Technology (19.0%); Telecommunications Services 
(0.8%); and Utilities (7.3%). A complete list of the 400 component 
stocks in the Index is available at the Exchange, on the Amex website, 
and on the S&P Web site.
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    \6\ The calculation of a market capitalization-weighted index 
involves taking the summation of the product of the price of each 
stock in the index and the shares outstanding for each issue. In 
contrast, a price-weighted index involves taking the summation of 
the prices of the stocks in the index. (See 1992 Order.)
    \7\ See Amex--The Standard & Poors MidCap 400 Index Option 
Specifications on the Amex Web site at: http://www.amex.com and the 
S&P Web site at: http://www.standardandpoors.com. The product 
specifications and the index components, as well as select data 
related to the components, shall be listed on the ISE Web site at 
http://www.iseoptions.com.
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    As of January 6, 2004, 286 companies in the Index are listed on the 
New York Stock Exchange, Inc. (``NYSE''), 112 on the National 
Association of Securities Dealers, Inc. (``NASD''), Automated Quotation 
System (``Nasdaq''), and 2 on the Amex. All Nasdaq stocks in the Index 
are designated as national market system securities by the NASD, 
meaning, among other things, that real-time last sale reports are 
available for these stocks. As of January 6, 2004, no one stock 
comprises more than 1.23% of the Index's total value, and the 
percentage weighting of the 5 largest components in the Index accounts 
for only 4.66% of the Index's value. Additionally, 344 (86%) of the 400 
stocks included in the Index, representing 88.1% of the total weight of 
the Index, are the subject of standardized options trading, and many of 
the other Index component stocks are eligible for options trading (as 
of January 6, 2004).
    As of January 6, 2004, the market capitalization of the stocks in 
the Index ranged from a high of $11.8 billion to a low of $336.2 
million, with the mean and median being $2.4 billion and $2.1 billion, 
respectively. The total number of shares outstanding for the stocks in 
the Index ranges from a high of 471.4 million shares to a low of 9.5 
million shares. The price per share of the stocks in the Index ranges 
from a high of $796.51 to a low of $3.55. Finally, the trading volume 
of the stocks in the Index ranges from a high of 11,489,282 average 
shares per day to a low of 7,605 average shares per day, with the 
median and mean being 437,107 and 724,445, respectively.
    For the six-month period ending January 6, 2004, 398 of the 400 
(99.5%) companies within the Index had an average daily trading volume 
greater than 30,000 shares per day. Those companies represent 99.25% of 
the market capitalization of the Index. The average daily trading 
volume of the 20 most heavily traded companies in the Index, 
representing 7.51% of the market capitalization of the Index, was 
3,784,032 shares per day.
    Index Calculation and Index Maintenance. The S&P MidCap 400 is 
calculated continuously,\8\ using the last sale price for each 
component stock in the Index, and is disseminated every 15 seconds 
throughout the trading day.\9\ To

[[Page 28964]]

calculate the Index, the sum of the market value of the stocks in the 
Index is divided by the base period market value (divisor), and the 
result is multiplied by 100. In order to provide continuity for the 
Index's value, the divisor is adjusted periodically to reflect such 
events as changes in the number of common shares outstanding for 
component stocks, company additions or deletions, corporate 
restructurings, and other capitalization changes.
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    \8\ The S&P MidCap 400 is calculated for S&P by Kinetic 
Information Systems. Reuters' Bridge Data Division also calculates 
the S&P MidCap 400, and its calculation is used in the event that 
the Kinetic Information Systems' calculation of the Index value is 
unavailable.
    \9\ The Index is disseminated by Amex over the Consolidated Tape 
Association's Network B. ISE will also disseminate every fifteen 
seconds the Index to its members. The Index is published daily in, 
among other places, The Wall Street Journal (``WSJ'') and The New 
York Times, and is available during trading hours from quotation 
vendors such as Reuters and Bloomberg. The Index criteria for 
inclusion or exclusion of components from the Index, attached as 
Exhibit 2, is included in a document entitled Standard & Poor's U.S. 
Indices: the S&P MidCap 400 and S&P SmallCap 600 dated April 8, 2004 
available on the S&P Web site at http://www.standardandpoors.com. In 
particular, the Standard & Poor's requires that a component be an 
``operating company and not a closed-end fund, holding company, 
partnership, investment vehicle or royalty trust.'' Also, ``Real 
Estate Investment Trusts are eligible for inclusion in [the 
Index].''
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    The Index value for purposes of settling S&P MidCap 400 options 
(``Settlement Value'') is calculated on the basis of opening market 
prices on the business day prior to the expiration date of such options 
(``Settlement Day'').\10\ The Settlement Day is normally the Friday 
preceding ``Expiration Saturday.''\11\ In the event that a component 
security in the Index does not trade on Settlement Day, the closing 
price from the previous trading day is used to calculate the Settlement 
Value. Accordingly, trading in S&P MidCap 400 options will normally 
cease on the Thursday preceding an Expiration Saturday.
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    \10\ The aggregate exercise value of the option contract is 
calculated by multiplying the Index value by the Index multiplier, 
which is 100.
    \11\ For any given expiration month, the Index Options will 
expire on the third Saturday of the month.
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    In order to ensure that the S&P MidCap 400 contains a 
representative sample of the stocks that represent the performance of 
the middle-capitalization segment of the market, S&P selects component 
securities based on the following market and economic criteria.\12\ 
First, the company's market capitalization must be between $1 billion 
and $4 billion.\13\ Second, the company must have adequate liquidity 
and reasonable price (the ratio of annual dollar value traded to market 
capitalization should be 0.3 or greater).\14\ Third, corporate insiders 
must not hold stock representing more than 60% of the value of the 
company, and the company cannot have 50% or more of its stock held by 
other corporations.\15\
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    \12\ S&P makes four major weighting adjustments during the year, 
usually near the end of a calendar quarter and monitors each S&P 
MidCap 400 component stock on a daily basis for individual weighting 
adjustments and for corporate actions which may have an impact on 
the Index. (See 1992 Order.)
    \13\ See S&P's U.S. Indices: the S&P 500, S&P MidCap400 and S&P 
SmallCap 600 (November 17, 2003) on the S&P Web site at: http://www.standardandpoors.com.
    \14\ The liquidity ratio is determined by dividing a company's 
trading volume for the previous 12 months by the average number of 
total common shares outstanding. For example, if a company's average 
monthly trading volume over the previous 12 months was 500,000, and 
there were 12 million shares outstanding, then the company's 
liquidity ratio would be 0.50. (See 1992 Order.)
    \15\ S&P, in making the determination as to whether a company 
has 50% or more of its stock held by other corporations, includes in 
its determination investment companies with greater than 5% 
ownership, but does not include broker-dealers holding shares in 
``street name.'' (See 1992 Order.)
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    In addition, S&P considers industry group representation in 
selecting stocks for the S&P MidCap 400. Moreover, in order to avoid 
``overweighting'' of utility and financial stocks, electric utilities 
and regional bank stocks are selected on the basis of their geographic 
representation as well as the above criteria.\16\ Finally, any stocks 
already in the S&P 500 Stock Index are excluded from the S&P MidCap 
400. Then, the components selected are weighted by market 
capitalization.\17\
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    \16\ In addition, some potential companies are eliminated from 
inclusion in the S&P MidCap 400 for various reasons. For example, 
investment companies, such as closed-end mutual funds, are not 
included in the Index because their equity performance reflects the 
performance of a portfolio of securities rather than industry or 
company specific fundamentals. In addition, foreign companies are 
not included in the Index, except for some Canadian industrial 
companies which conduct a significant proportion of their business 
within the U.S. market and for which the majority of trading 
activity occurs on U.S. exchanges. Moreover, S&P excludes real 
estate investment companies and other investment trusts that allow 
investors to participate indirectly in the performance of real 
assets such as commercial or residential property. Finally, S&P 
excludes limited partnerships because their ownership and 
capitalization structure exposes investors to liabilities and tax 
treatment not found in corporate equity securities. (See 1992 
Order.)
    \17\ Telephone Conversation between Joseph Ferraro, ISE, and 
Florence Harmon, Senior Special Counsel, Division, Commission, on 
April 15, 2004.
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    The Exchange shall notify the Market Regulation Division of the 
Commission immediately in the event S&P determines to cease maintaining 
or calculating the Index. In the event the Index ceases to be 
maintained or calculated, the Exchange may determine not to list any 
additional series for trading or limit all transactions in such options 
to closing transactions only for the purpose of maintaining a fair and 
orderly market and protecting investors.
    Contract Specifications. The Exchange states that the S&P MidCap 
400 is a broad-based index, as defined in ISE Rule 2001(j). The 
Exchange proposes that the contract specifications for Index options 
listed on the Exchange will be identical to the contract specifications 
for the Index options listed on Amex. Accordingly, Exchange rules that 
are applicable to the trading of options on broad-based indexes will 
apply to the trading of options on the Index.\18\ Specifically, among 
others, Exchange rules governing margin requirements and trading halt 
procedures that are applicable to the trading of broad-based index 
options will apply to options traded on the Index. In addition, the 
Exchange shall establish position limits of 45,000 contracts on the 
same side of the market, provided no more than 25,000 of such contracts 
are in the nearest expiration month series and no more than 25,000 of 
such contracts are used for index arbitrage. The product specifications 
of the options on the Index proposed to be traded on the Exchange will 
be identical to the product specifications of the options on the Index 
traded on Amex. Specifically, options on the Index are European-style 
and cash-settled. The Exchange's standard trading hours for index 
options (9:30 a.m. to 4:15 p.m., New York time), as set forth in ISE 
Rule 2008(a), will apply to Index options. Index options listed on Amex 
also trade from 9:30 a.m. to 4:15 p.m., New York time.
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    \18\ See Exchange Rules 2000 through 2012.
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    The minimum customer margin for uncovered writers shall be 100% of 
the market value of the option plus 15% of the aggregate Index value 
less any out-of-the-money amount, subject to a minimum of 100% of the 
market value of the option plus 10% of the aggregate Index value.
    The Exchange proposes to use strike price intervals of 2\1/2\ 
points for certain near-the-money series in near-term expiration months 
when the Index is at a level below 200, and 5 point strike price 
intervals for other options series with expirations up to one year, and 
25 to 50 point strike price intervals for longer-term options. The 
Exchange also proposes to list S&P MidCap 400 options in the four 
consecutive near-term expiration months plus two successive expiration 
months in the March cycle. For example, consecutive expirations of 
January, February, March and April plus June and September expirations 
would be listed. In addition, longer-term option series having up to 
thirty-six months to expiration may be traded. In lieu of such long-
term options based on the full-value of the Index, the Exchange may 
instead list long-term, reduced-value put and call options based on 
one-tenth (\1/10\th) of the Index's full value. In either event, the 
interval between expiration months for either a full-value or reduced-
value long-term Index option will not be less than six

[[Page 28965]]

months. The trading of any long-term Index options will be subject to 
the same rules which govern the trading of all the Exchange's index 
options, including sales practice rules, margin requirements, and 
trading rules. Position limits on reduced-value long-term Index options 
will be equivalent to the position limits for regular (full-value) 
Index options and will be aggregated with such options. For example, if 
the position limit for the full-value options on the Index is 45,000 
contracts on the same side of the market (as they currently are on 
Amex), then the position limit for the reduced-value options will be 
450,000 contracts on the same side of the market.
    Surveillance and Capacity. The Exchange has an adequate 
surveillance program in place for Index options and intends to apply 
those same program procedures that it applies to the Exchange's other 
index options (at present, options on the S&P SmallCap 600 Index and 
Morgan Stanley Technology Index). Additionally, the Exchange is a 
member of the Intermarket Surveillance Group (``ISG'') under the 
Intermarket Surveillance Group Agreement (dated June 20, 1994). The 
members of the ISG include all of the U.S. registered stock and options 
markets: the Amex, the Boston Stock Exchange, Inc. (``BSE''), the 
Chicago Board Options Exchange, Inc. (``CBOE''), the Chicago Stock 
Exchange, Inc. (``CHX''), the Cincinnati Stock Exchange, Inc. 
(``CSE''), the NASD, the NYSE, the Pacific Exchange, Inc. (``PSE'') and 
the Philadelphia Stock Exchange, Inc. (``PHLX''). The ISG members work 
together to coordinate surveillance and investigative information 
sharing in the stock and options markets. In addition, the major 
futures exchanges are affiliated members of the ISG, which allows for 
the sharing of surveillance information for potential intermarket 
trading abuses.
    The Exchange states that it has the necessary systems capacity to 
support new series that will result from the introduction of S&P MidCap 
400 Index options. ISE has also been informed that the Options Price 
Reporting Authority believes that it has the capacity to support such 
new series.
2. Statutory Basis
    The ISE believes that the proposed rule change, as amended, is 
consistent with and furthers the objectives of section 6(b)(5) of the 
Act,\19\ 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 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, to remove impediments to 
and perfect the mechanism for a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest. In particular, ISE states that the proposed rule change will 
permit trading in options based on the S&P MidCap 400 pursuant to rules 
designed to prevent fraudulent and manipulative acts and practices and 
promote just and equitable principals of trade.
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    \19\ 15 U.S.C. 78(f)(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The ISE does not believe that the proposed rule change, as amended, 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the 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, as amended.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-ISE-2004-08 on the subject line.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-ISE-2004-08. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
Exchange. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-ISE-
2004-08 and should be submitted on or before June 9, 2004.

IV. Commission's Findings and Order Granting Approval of the Proposed 
Rule Change

    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, the requirements of section 6(b)(5).\20\ The Commission 
finds that the trading of options on the Index, including full-value 
and reduced-value Index LEAPS, will permit investors to participate in 
the price movements of the 400 securities on which the Index is based. 
The Commission also believes that the trading of options on the Index 
will allow investors holding positions in some or all of the underlying 
securities in the Index to hedge the risks associated with their 
portfolios more efficiently and effectively. Accordingly, the 
Commission believes MidCap 400 options will provide investors with an 
important trading and hedging mechanism that should reflect accurately 
the overall movement of stocks in the middle-capitalization range of 
U.S. equity securities.
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    \20\ 15 U.S.C. 78f(b)(5) (1988).
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    The trading of MidCap 400 options, however, raises several issues, 
namely, issues related to index classification, index design, 
surveillance, and market impact. The Commission believes, for the 
reasons discussed below, that the ISE has adequately addressed these 
issues.

A. Broad-Based Index

    The Commission finds that classifying the Index as broad-based, 
and, thus,

[[Page 28966]]

permitting Exchange rules applicable to the trading of broad-based 
index options to apply to MidCap 400 options is appropriate. 
Specifically, the Commission believes it is consistent with the Act to 
designate the Index as broad-based because the MidCap 400 reflects a 
substantial segment of the U.S. equities market, in general, and mid-
level capitalized U.S. securities, in particular. The Index consists of 
400 of the most actively traded middle-capitalized securities in the 
United States.\21\ In addition, as of January 6, 2004, the total 
capitalization of the Index was approximately $962.075 billion. The 
MidCap 400 also includes stocks of companies from ten market sectors, 
no one of which dominates the Index.\22\ Moreover, the Index represents 
a broad cross-section of domestic mid-level capitalized stocks, with no 
single stock comprising more than 1.23% of the Index's total value (as 
of January 6, 2004). The percentage weighting of the five largest 
components in the Index also accounts for only 4.66% of the Index's 
value. Finally, 344 (86%) of the 400 stocks included in the Index, 
representing 88.1% of the total weight of the Index, are the subject of 
standardized options trading, and many of the other Index component 
stocks are eligible for options trading (as of January 6, 2004).
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    \21\ Specifically, the mean and median capitalization for the 
400 companies, as of January 6, 2004, was $ 2.4 billion and $ 2.1 
billion, respectively.
    \22\ Specifically, as of February 26, 2004, the ten market 
sectors along with their respective weighting in the Index was as 
follows: (1) energy, 5.5%; (2) materials, 6.3%; (3) industrials, 
14.5%; (4) consumer discretionary, 16.3%; (5) consumer staples, 
4.5%; (6) health care, 9.5%; (7) financials, 16.5%; (8) information 
technology, 19%; (9) telecommunications services, 0.8%; and (10) 
utilities, 7.3%.
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B. Index Design and Structure

    The broad diversification, large capitalization, and liquid markets 
of the Index's component stocks significantly minimizes the potential 
for manipulation of the Index. First, as discussed above, the Index 
represents a broad cross-section of domestic mid-level capitalized 
stocks, with no single industry group or stock dominating the Index. 
Second, the overwhelming majority of the stocks that comprise the Index 
are actively traded, with a mean and median average daily trading 
volume of 437,107 and 724,445 shares, respectively.\23\
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    \23\ For the six-month period ending January 2004, 398 of the 
400 (99.5%) companies within the Index had an average daily trading 
volume greater than 30,000 shares per day. Those companies represent 
99.25% of the market capitalization of the Index. The average daily 
trading volume of the 20 most heavily traded companies in the Index, 
representing 7.51% of the market capitalization of the Index, was 
3,784,032 shares per day.
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    Third, S&P has developed procedures and criteria designed to ensure 
that the Index maintains its broad representative sample of stocks in 
the middle-capitalization range of securities.\24\ Accordingly, the 
Commission believes it is unlikely that attempted manipulations of the 
prices of a small number of issues would affect significantly the 
Index's value.
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    \24\ See supra notes 11-14 and accompanying text.
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C. Surveillance

    The Exchange represents that it has an adequate surveillance 
program in place for the Exchange's other index options (at present, 
options on the S&P SmallCap 600 Index) and intends to apply those same 
program procedures to the options on the Index. Additionally, the 
Exchange is a member of the Intermarket Survelliance Group (``ISG''), 
which allows for the sharing of surveillance information for potential 
intermarket trading abuses pursuant to the Intermarket Surveillance 
Group Agreement (the ``Agreement'').\25\ The members of the ISG include 
all of the U.S. registered stock and options markets. The Commission 
believes that a surveillance sharing agreement between an exchange 
proposing to list a stock index derivative product and the exchanges 
trading the stocks underlying the derivative product is an important 
measure for surveillance of the derivative and underlying securities 
markets. Such agreements ensure the availability of information 
necessary to detect and deter potential manipulations and other trading 
abuses, thereby making the stock index product less readily susceptible 
to manipulation.
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    \25\ ISG was formed on July 14, 1983, among other things, to 
coordinate more effectively surveillance and investigative 
information sharing arrangements in the stock and options markets. 
See Intermarket Surveillance Group Agreement, July 14, 1983. The 
participation of exchanges within the ISG and their sharing of 
surveillance information is governed by the Agreement. The most 
recent amendment to the Agreement, which incorporates the original 
agreement and all amendments made thereafter, was signed by members 
January 29, 1990. See Second Amendment to Intermarket Surveillance 
Group Agreement, January 29, 1990.
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D. Market Impact

    The Commission believes that the listing and trading of MidCap 400 
options, including LEAPS and reduced-value LEAPS, on the Exchange will 
not adversely impact the underlying securities markets. First, as 
described above, the Index is broad-based and no one stock or industry 
group dominates the Index. Second, as noted above, the stocks contained 
in the Index have large capitalizations and are actively traded. Third, 
existing ISE stock index options rules and surveillance procedures will 
apply to MidCap 400 options. Fourth, the Exchange has established 
position and exercise limits for the MidCap 400 options that will serve 
to minimize potential manipulation and market impact concerns. Fifth, 
the risk to investors of contra-party non-performance will be minimized 
because the Index options and Index LEAPS will be issued and guaranteed 
by the Options Clearing Corporation just like other standardized 
options traded in the United States.
    Finally, the Commission believes that the ISE's other proposed rule 
changes to accommodate the trading of S&P MidCap 400 options, such as 
strike price intervals, are consistent with the Act. Based on 
representations from the ISE, the Commission also believes that the 
Exchange will have sufficient capacity to accommodate the anticipated 
order flow. The Commission also believes the Amex's proposed expiration 
cycle for the S&P MidCap 400 options is reasonable because it provides 
investors sufficient flexibility to establish their desired options 
positions.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\26\ that the proposed rule change, as amended, (SR-ISE-2004-08) is 
hereby approved on an accelerated basis.

    \26\ 15 U.S.C. 78o-3(b)(6) and 78s(b)(2).


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-11308 Filed 5-18-04; 8:45 am]
BILLING CODE 8010-01-P