[Federal Register Volume 70, Number 2 (Tuesday, January 4, 2005)]
[Notices]
[Pages 416-419]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-80]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50937; File No. SR-ISE-2004-09]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment Nos. 1 and No. 2 by the International Securities 
Exchange, Inc., Relating to the Listing and Trading of Options on the 
S&P 1000 Index

December 27, 2004.

I. Introduction

    On April 5, 2004, the International Securities Exchange, Inc. 
(``ISE'' 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 proposal to list and trade options based on one-tenth 
and one one-hundredth of the value of the Standard & Poor's 1000 Index 
(``S&P 1000'' or ``Index''). The ISE submitted Amendment Nos. 1 and No. 
2 to the proposal on July 16, 2004,\3\ and August 2, 2004,\4\ 
respectively. The proposed rule change and Amendment Nos. 1 and No. 2 
were published for comment in the Federal Register on November 22, 
2004.\5\ The Commission received no comment letters regarding this 
proposal. This order approves the proposed rule change, as amended.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Michael Simon, Senior Vice President and 
General Counsel, ISE, to Nancy J. Sanow, Assistant Director, 
Division of Market Regulation (``Division''), Commission, dated July 
15, 2004, and accompanying Form 19b-4 (``Amendment No. 1''). 
Amendment No. 1 replaced the filing in its entirety.
    \4\ See letter from Michael J. Simon, Senior Vice President and 
General Counsel, ISE, to Nancy Sanow, Assistant Director, Division, 
Commission, dated July 28, 2004 (``Amendment No. 2''). Amendment No. 
2 made technical changes clarifying the description of the Index and 
the calculation of the Index settlement value.
    \5\ See Securities Exchange Act Release No. 50674 (November 16, 
2003), 69 FR 67974 (``November Release'').
---------------------------------------------------------------------------

II. Description of the Proposal

    The ISE proposes to list and trade the following A.M. cash-settled, 
European-style options: (1) Reduced Value S&P 1000 Options (``Reduced 
Value S&P 1000 Options'' or ``Reduced Value Index Options'') based on 
one-tenth of the value of the Index; (2) Micro S&P 1000 Index Options 
(``Micro S&P 1000 Options'' or ``Micro Index Options'') based on one-
hundredth of the value of the Index; (3) long-term Reduced Value Index 
Options; and (4) long-term Micro Index Options (the Reduced Value Index 
Options, Micro Index Options, long-term Reduced Value Index Options, 
and long-term Micro Index Options may be referred to, collectively, as 
the ``Index Options'').\6\
---------------------------------------------------------------------------

    \6\ Under ISE Rule 2009(b)(2), ``Long-Term Index Options 
Series,'' the ISE may list long-term index options that expire from 
12 to 60 months from the date of issuance. The Exchange will not 
list reduced value long-term index options on either of the Reduced 
Value S&P 1000 Indexes or the Reduced Value Micro S&P 1000 Indexes 
pursuant to ISE Rule 2009(B)(2)(i). Telephone conversation between 
Joseph W. Ferraro III, Associate General Counsel, ISE, and Florence 
Harmon, Senior Special Counsel, Division, Commission, and A. Michael 
Pierson, Attorney, Division, Commission, on November 16, 2004 
(``November 16 Conversation'').
---------------------------------------------------------------------------

    A brief description of the proposal appears below, the November 
Release \7\ provides a more detailed description of the proposal.
---------------------------------------------------------------------------

    \7\ See supra note 5.
---------------------------------------------------------------------------

Index Design and Composition

    The Index, which was designed and is maintained by Standard & 
Poor's (``S&P''), is a market capitalization-weighted index that 
combines the S&P MidCap 400 Index and the S&P SmallCap 600 Index. The 
MidCap 400 Index is broad-based index designed to measure the 
performance of the mid-range sector of the U.S. stock market, and the 
S&P SmallCap 600 is a broad-based index designed to measure the 
performance of small capitalization U.S. stocks.\8\ Becausee the Index 
is a combination of the S&P MidCap 400 Index and the S&P SmallCap 600 
Index, the S&P 1000 does not have its own criteria for selecting Index 
components. Instead, the selection criteria for the S&P MidCap 400 
Index and the S&P SmallCap 600 Index determine the components of the 
S&P 1000. The S&P 1000 may not contain any component that is a 
component of the S&P 500 Index.
---------------------------------------------------------------------------

    \8\ See Exchange Act Release Nos. 48587 (October 2, 2003), 68 FR 
58154 (October 8, 2003) (order approving File No. SR-ISE-2003-18) 
(approving the listing and trading of options on the S&P SmallCap 
600 Index) ``S&P SmallCap 600 Order''); and 49696 (May 13, 2004), 69 
FR 28962 (May 19, 2004) (order approving File No. SR-ISE-2004-08) 
(approving the listing and trading of options on the S&P MidCap 400 
Index) (``S&P MidCap 400 Order'').
---------------------------------------------------------------------------

    S&P chooses the components of the S&P MidCap 400 Index and the S&P 
SmallCap 600 Index on the basis of market capitalization, liquidity, 
and industry group representation. As of February 18, 2004, the Index's 
components were listed on the New York Stock Exchange (``NYSE''), 
Nasdaq, or the American Stock Exchange (``Amex''), and components 
representing over 98% of the weight of the Index were options 
eligible.\9\ All of the Index components listed on Nasdaq are 
designated as national market system securities by the National 
Association of Securities Dealers. As described more fully below, the 
Index's components are classified in ten market sectors and no single 
security dominates the Index.
---------------------------------------------------------------------------

    \9\ See infra note 26 for a description of the options 
eligibility standards.
---------------------------------------------------------------------------

Transition to Float-Adjusted Capitalization Weighting

    The S&P 1000 Index currently is a ``full'' market capitalization-
weighted index in which the value of the Index is calculated by 
multiplying, for each component, the total number of shares outstanding 
by the price per share, adding these values together, and dividing the 
result by the Index divisor. On March 1, 2004, S&P announced that it 
would shift its U.S. indexes, including the S&P 1000 to ``float-
adjusted'' market capitalization weighting. As a float-adjusted market 
capitalization weighted index, the value of the Index will be 
calculated by multiplying, for each component, the number of shares of 
the component that are available to investors (rather than all of the 
component's outstanding shares) by the price per share, adding these 
values together, and dividing the resuult by the Index divisor. As 
described more fully on S&P's Internet Web site, S&P's float adjustment 
will exclude from the share available to investors shares held by other 
publicly traded companies and strategic partners, government agencies, 
and control groups.\10\
---------------------------------------------------------------------------

    \10\ See http://www.freefloat.standardand poors.com.
---------------------------------------------------------------------------

    S&P will implement the transition from full market capitalization 
weighting to float-adjusted market capitalization weighting over an 18-
month period. S&P will calculate provisional indexes alongside of the 
regular indexes so that passive indexers (institutional investors that 
model their portfolio construction and weighting according to S&P 
indexes) can control the timing of adjustments. The ISE will not trade 
options on any provisional index calculated during the transition 
period, nor does the ISE expect any securities or futures exchange to 
trade

[[Page 417]]

products based on any provisional index during the transition period.
    In March 2005, the official index series for S&P's U.S. indexes 
will shift to partial float adjustment, using float adjustment factors 
that represent half of the total adjustment. In September 2005, the 
shift to float adjustment will be completed, the official indexes will 
be fully float-adjusted, and the provisional indexes will be 
discontinued. S&P will review float adjustment factors annually in 
September.
    During the transition period, S&P will adjust the divisor of each 
affected index to maintain continuity across the adjustments. As a 
result of the divisor adjustments, the Index value will maintain 
continuity immediately following the adjustments in March 2005 and 
September 2005. Accordingly, the value of Index Options will not change 
as a direct result of the float adjustment.
    The ISE will provide a link on its Internet Web site to the S&P web 
site page where float adjustment information is displayed.

Index Calculation and Index Maintenance

    The values of the Reduced Value S&P 1000 Index and the Micro S&P 
1000 Index will each be calculated continuously, using the last sale 
price for each component stock in the Index, and will be disseminated 
every 15 second throughout the trading day.\11\ S&P will calculate the 
settlement value for purposes of settling Reduced Value S&P 1000 
Options (``Reduced Value Settlement Value'') and Micro S&P 1000 Options 
(``Micro Settlement Value'') on the basis of opening market prices on 
the business day prior to the expiration date of the options 
(``Settlement Day''). The Settlement Day is normally the Friday 
preceding ``Expiration Saturday.'' \12\ The Exchange will disseminate 
both the Reduced Value Settlement Value and the Micro Settlement 
Value.\13\
---------------------------------------------------------------------------

    \11\ The values of the Reduced Value S&P 1000 and the Micro S&P 
1000 will be calculated by S&P and disseminated to Reuters. The 
Exchange will receive those values from Reuters and disseminate them 
every 15 seconds between the hours of 9:30 a.m. and 4:15 p.m. to the 
Options Price Reporting Authority and to its members. The Index is 
published daily in, among other places, The Wall Street Journal and 
The New York Times, and is available during trading hours from 
quotation vendors such as Reuters. Telephone conversation between 
Joseph W. Ferraro III, Associate General Counsel, ISE, and Florence 
Harmon, Senior Special Counsel, Division, Commission, on November 9, 
2004 (``November 9 Conversation'').
    \12\ For any given expiration month, the Index Options will 
expire on the third Saturday of the month.
    \13\ See supra Amendment No. 2, note 4.
---------------------------------------------------------------------------

    S&P will monitor and maintain S&P 1000. Although the Exchange is 
not involved in the maintenance of the Index, the Exchange represents 
that it will monitor the Index on a quarterly basis and will notify 
staff in the Division, through a proposed rule change filed pursuant to 
Rule 19b-4,\14\ if and when: (i) The number of securities in the Index 
drops by \1/3\rd or more; (ii) 10% or more of the weight of the Index 
is represented by component securities having a market value of less 
than $75 million; (iii) less than 80% of the weight of the Index is 
represented by component securities that are eligible for options 
trading pursuant to ISE Rule 502, ``Criteria for Underlying 
Securities;'' (iv) 10% or more of the weight of the Index is 
represented by component securities trading less than 20,000 shares per 
day; or (v) the largest component security accounts for more than 15% 
of the weight of the Index or the largest five components in the 
aggregate account for more than 50% of the weight of the Index.
    The Exchange will notify the Division immediately in the event S&P 
determines to cease maintaining or calculating the Index or in the 
event the Index values are no longer widely disseminated every 15 
seconds. In the event the Index ceases to be maintained or calculated, 
or widely disseminated every 15 seconds, the Exchange will not list any 
additional series for trading and will limit all transactions in Index 
Options to closing transactions only for the purpose of maintaining a 
fair and orderly market and protecting investors.\15\
---------------------------------------------------------------------------

    \14\ See supra November 9 Conversation, note 11.
    \15\ Id.
---------------------------------------------------------------------------

Contract Specifications

    The ISE proposes to characterize the Index as a broad-based index 
as defined in ISE Rule 2001(j).\16\ Exchange rules applicable to the 
trading of options on broad-based indexes, including margin 
requirements and trading halt procedures, will apply to the trading of 
Index Options.\17\ The Micro S&P 1000 Options will trade independently 
of and in addition to the Reduced Value S&P 1000 Options, and both 
products will be subject to the same rules that presently govern the 
trading of Exchange index options, including, among others, sales 
practice rules, trading rules, and position and exercise limits.
---------------------------------------------------------------------------

    \16\ ISE Rule 2001(j) defines a ``market index'' or a ``broad-
based index'' to mean an index designed to be representative of a 
stock market as a whole or of a range of companies in unrelated 
industries.
    \17\ See ISE Rules 2000 through 2012.
---------------------------------------------------------------------------

    The ISE proposes to set strike price intervals at 2\1/2\ points for 
certain near-the-money series in near-term expiration months when the 
Index is below 200, at 5-point intervals for other Index Options series 
with expirations up to one year, and at 25- to 50-point intervals for 
longer-term Index Options. For example, if the level of the Reduced 
Value S&P 1000 is 337.1, the ISE would set strike price intervals at 
five points for Reduced Value S&P 1000 Options. Because the level of 
the Micro S&P 1000 would be 33.71, the ISE would set strike price 
intervals at 2\1/2\-points for Micro S&P 1000 Options.
    The ISE proposes to list both Reduced Value S&P 1000 Options and 
Micro S&P 1000 Options in the three consecutive near-term expiration 
months plus up to three successive expiration months in the March 
cycle. For example, consecutive expirations of January, February, 
March, plus June, September, and December expirations would be 
listed.\18\ In addition, long-term Index Options series having up to 60 
months to expiration may be traded.\19\ The interval between expiration 
months for Reduced Value S&P 1000 Index Options or Micro S&P 1000 Index 
Options will not be less than six months.
---------------------------------------------------------------------------

    \18\ See ISE Rule 2009(a)(3).
    \19\ See ISE Rule 2009(b)(1).
---------------------------------------------------------------------------

    The Exchange proposes to establish aggregate position limits for 
Reduced Value S&P 1000 Options at 50,000 Reduced Value S&P 1000 Options 
contracts on the same side of the market, provided no more than 30,000 
of such Reduced Value S&P 1000 Options contracts are in the nearest 
expiration month series. The Exchange also proposes to establish 
aggregate position limits for Micro S&P 1000 Options at 500,000 Micro 
S&P 1000 Options contracts on the same side of the market, provided 
that no more than 300,000 of the Micro S&P 1000 Options contracts are 
in the nearest expiration month series. Reduced Value S&P 1000 Options 
contracts will be aggregated with the Micro S&P 1000 Options contracts, 
where 10 Micro S&P 1000 Options contracts equal one Reduced Value S&P 
1000 Options contract.\20\ Positions in long-term Reduced Value S&P 
1000 Options and Micro S&P 1000 Options will be aggregated with 
positions in Reduced Value S&P 1000 Options and Micro S&P 1000 Options 
that expire in less than 12 months.\21\
---------------------------------------------------------------------------

    \20\ The same limits that apply to position limits will apply to 
exercise limits for these products. See supra November 16 
Conversation, note 6.
    \21\ Telephone conversation between Joseph W. Ferraro III, 
Associate General Counsel, ISE, and Yvonne Fraticelli, Special 
Counsel, Division, Commission, on December 27, 2004.

---------------------------------------------------------------------------

[[Page 418]]

Surveillance and Capacity

    The ISE represents that it has an adequate surveillance program for 
index options, and that it intends to apply to Index Options the same 
program procedures that it applies to the ISE's other index options. In 
addition, the ISE notes that it is a member of the Intermarket 
Surveillance Group (``ISG''), which includes all of the registered 
national securities exchanges and the NASD. The ISE notes that members 
of the ISG work together to coordinate surveillance and investigative 
information sharing in the stock and options markets.
    In a confidential submission to the Commission, the Exchange 
provided an analysis supporting its representation that it has the 
system capacity to adequately handle all options series that could be 
listed pursuant to this proposal, including long-term Reduced Value 
Index Options and long-term Micro Index Options.\22\
---------------------------------------------------------------------------

    \22\ The ISE clarified that its capacity analysis included long-
term Reduced Value Index Options and long-term Micro Index Options. 
Telephone conversation between Florence Harmon, Senior Special 
Counsel, Division, Commission, and Joseph Ferraro III, Associate 
General Counsel, ISE, on November 6, 2004.
---------------------------------------------------------------------------

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, 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) of the Act.\23\ The Commission finds that the trading of 
Reduced Value S&P 1000 Options, Micro S&P 1000 Options, long-term 
Reduced Value S&P 1000 Options, and long-term Micro S&P 1000 Options 
will permit investors to participate in the price movements of the 
securities that comprise the Index. The Commission also believes that 
the trading of the Index Options will allow investors holding positions 
in some or all of the securities underlying the Index to hedge the 
risks associated with their portfolios. Accordingly, the Commission 
believes that Index Options will provide investors with an important 
trading and hedging mechanism. By broadening the hedging and investment 
opportunities of investors, the Commission believes that the trading of 
Index Options will serve to protect investors, promote the public 
interest, and contribute to the maintenance of fair and orderly 
markets.\24\
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78f(b)(5). 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).
    \24\ Pursuant to section 6(b)(5) of the Act, the Commission must 
predicate approval of any new option or warrant proposal upon a 
finding that the introduction of such new derivative instrument is 
in the public interest. Such a finding would be difficult for a 
derivative instrument 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 
Commission believes that the Index Options will provide investors 
with a hedging and investment vehicle that should reflect the 
overall movement of a substantial segment of the U.S. equity market.
---------------------------------------------------------------------------

    The trading of Index Options, however, raises several issues, 
including issues related to index design, customer protection, 
surveillance, and market impact. For the reasons discussed below, the 
Commission believes that the ISE has adequately addressed these issues.

A. Index Design and Structure

    The Commission finds that it is appropriate and consistent with the 
Act to classify the Index as broad-based for purposes of index options 
trading, and therefore appropriate to permit ISE rules applicable to 
the trading of broad-based options to apply to the Index Options. 
Specifically, the Commission believes that the Index is broad-based 
because it reflects a substantial segment of the U.S. equity market. 
First, as described more fully above, the Index is comprised of the 400 
component stocks of the S&P MidCap 400 Index, which is designed to 
measure the performance of the mid-range sector of the U.S. stock 
market, and the 600 component stocks of the S&P SmallCap 600 Index, 
which is designed to measure the performance of small capitalization 
U.S. stocks. Both the S&P MidCap 400 Index and the S&P SmallCap 600 
Index are broad-based indexes.\25\ According to the ISE, as of February 
18, 2004, components representing over 98% of the weight of the Index 
were options eligible.\26\ Second, as of March 25, 2004, the Index's 
components were classified in ten market sectors, which were weighted 
in the Index as follows: energy (6.37%); materials (4.32%); industrials 
(13.96%); consumer discretionary (18.52%); consumer staples (4.45%); 
health care (12.15%); financials (18.15%); information technology 
(16.06%); telecommunications services (0.51%); and utilities (5.51%). 
Third, as of February 18, 2004, the total capitalization of the Index 
was approximately $1.47 trillion, the capitalization of the Index's 
components ranged from approximately $11.80 billion to approximately 
$72.11 million, and the mean capitalization of the Index's components 
was approximately $1.47 billion. As of February 18, 2004, the largest 
Index component accounted for 0.80% of the weight of the Index, and the 
five highest weighted securities accounted for 3.14% of the weight of 
the Index. Fourth, because the Index is a combination of two broad-
based indexes, the S&P MidCap 400 Index and the S&P SmallCap 600 Index, 
and the selection and maintenance criteria for S&P MidCap 400 Index and 
the S&P SmallCap 600 Index determine the components of the S&P 1000, 
the selection and maintenance criteria for the S&P MidCap 400 Index and 
the S&P SmallCap 600 Index should serve to ensure that the Index 
maintains its broad representative sample of stocks.\27\
---------------------------------------------------------------------------

    \25\ See supra S&P SmallCap 600 Order and S&P MidCap 400 Order, 
note 8.
    \26\ The option listing standards, which are uniform among the 
U.S. options exchanges, provide that a security underlying an option 
must, among other things, meet the following requirements: (1) The 
public float must be at least 7 million shares; (2) there must be a 
minimum of 2,000 holders of the underlying security; (3) the issuer 
must be in compliance with any applicable requirements of the 
Exchange Act; (4) trading volume must have been at least 2.4 million 
shares over the preceding 12 months; and (5) the market price per 
share must meet specified levels. See, e.g., ISE Rule 502.
    \27\ As noted above, the S&P 1000 Index does not have its own 
selection criteria. Instead, the selection criteria for the S&P 
MidCap 400 Index and the S&P SmallCap 600 Index determine the 
components of the S&P 1000 Index.
---------------------------------------------------------------------------

    The Commission also believes that the general broad 
diversification, capitalizations, liquidity, and relative weighting of 
the Index's component securities minimize the potential for 
manipulation of the Index. First, the Index is comprised of 1000 
components listed and traded on the NYSE, Nasdaq, or the Amex, and no 
single security dominates the Index. Second, as of February 18, 2004, 
the total Index capitalization was approximately $1.47 trillion, the 
median and mean capitalizations of the Index's components were 
approximately $1.02 billion and $1.47 billion, respectively, and the 
capitalizations of the Index's components ranged from a high of 
approximately $11.80 billion for the highest-weighted component (which 
represented .80% of the weight of the Index) to a low approximately 
$72.11 million for the lowest-weighted Index component (which 
represented .005% of the weight of the Index). As of February 18, 2004, 
the capitalizations of the Index's five most heavily weighted 
components, which represented 3.14% of the weight of the Index, ranged 
from approximately $11.80 billion to approximately $9.3 billion. Third, 
as of

[[Page 419]]

February 18, 2004, mean and median six-month average daily trading 
volume of the Index's components was 466,190 shares and 252,180 shares, 
respectively, and 93.6% of the Index's components had six-month average 
daily trading volume of at least 50,000 shares. Fourth, as of February 
18, 2004, components representing over 98% of the weight of the Index 
were options eligible.\28\ Fifth, the ISE has represented that it will 
monitor the Index on a quarterly basis and will notify Division staff, 
by a rule filing made pursuant to Rule 19b-4,\29\ if and when: (1) The 
number of securities in the Index drops by \1/3\rd or more; (2) 10% or 
more of the weight of the Index is represented by component securities 
having a market value of less than $75 million; (3) less than 80% of 
the weight of the Index is represented by component securities that are 
eligible for options trading pursuant to ISE Rule 502; (4) 10% or more 
of the weight of the Index is represented by component securities 
trading less than 20,000 shares per day; or (5) the largest component 
security accounts for more than 15% of the weight of the Index or the 
largest five components in the aggregate account for more than 50% of 
the weight of the Index.
---------------------------------------------------------------------------

    \28\ See supra note 26 for a description of the ISE's options 
eligibility standards.
    \29\ See supra November 9 Conversation, note 11.
---------------------------------------------------------------------------

    The Commission believes that these factors minimize the potential 
for manipulation because it is unlikely that attempted manipulations of 
the prices of the Index's components would affect significantly the 
Index's value. Moreover, the surveillance procedures discussed below 
should detect as well as deter potential manipulations and other 
trading abuses.
    Finally, the Commission believes that the position and exercise 
limits for the Index Options are designed to minimize the potential for 
manipulation and other market impact concerns. The position and 
exercise limits for the Index Options are comparable to the position 
and exercise limits approved for other broad-based index options.\30\
---------------------------------------------------------------------------

    \30\ See, e.g., Securities Exchange Act Release Nos. 48884 
(December 5, 2003), 68 FR 69753 (December 15, 2003) (File No. SR-
PHLX-2003-66) (order approving the listing and trading of Nasdaq 
1000 Index options, with position limits of 50,000 contracts on 
either side of the market and no more than 30,000 contracts in 
series in the nearest expiration month); and 31382 (October 30, 
1992), 57 FR 52802 (November 5, 1992) (File No. SR-CBOE-92-02) 
(approving the listing and trading of options on the Russell 2000 
Index, with position limits of 50,000 contracts on either side of 
the market and no more than 30,000 contracts in series in the 
nearest expiration month).
---------------------------------------------------------------------------

B. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as the Index Options, can 
commence on a national securities exchange. The Commission notes that 
the trading of standardized, exchange-traded options occurs in an 
environment that is designed to ensure, among other things, that: (1) 
The special risks of options are disclosed to public customers; (2) 
only investors capable of evaluating and bearing the risks of options 
trading are engaged in such trading; and (3) special compliance 
procedures are applicable to options accounts. Accordingly, because the 
Index Options will be subject to the same regulatory regime as the 
other standardized options traded currently on the ISE, the Commission 
believes that adequate safeguards are in place to ensure the protection 
of investors in Index Options.
    As described more fully above, S&P plans to modify the weighting 
methodology for its U.S. indexes, including the S&P 1000, so that by 
September 2005 the Index will be a float-adjusted market capitalization 
weighted index. The ISE notes that S&P plans to modify the Index 
divisor to maintain the continuity of the Index and, for that reason, 
the value of Index Options will not change as a direct result of the 
float adjustment. In addition, the ISE represents that it will provide 
a link on its Internet web site to the S&P Internet web site page 
displaying float adjustment information. Accordingly, the Commission 
believes that investors will be able to obtain information regarding 
the float adjustment and that the transition to float-adjusted market 
capitalization should not affect the value of Index Options.

C. Surveillance

    The Commission generally believes that a surveillance sharing 
agreement between an exchange proposing to list a stock index 
derivative product and the market(s) trading the stocks underlying the 
derivative product is an important measure for the surveillance of the 
derivative product and the 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. In this regard, the ISE and the NYSE, the NASD, and the 
Amex are members of the ISG and the ISG Agreement will apply to the 
trading of Index Options.\31\ In addition, the ISE will apply to the 
Index Options the same surveillance procedures it uses currently for 
existing index options trading on the ISE.
---------------------------------------------------------------------------

    \31\ The ISG was formed on July 14, 1983, to, among other 
things, coordinate more effectively surveillance and investigative 
information sharing arrangements in the stock and options markets. 
All of the registered national securities exchanges and the NASD are 
members of the ISG. In addition, futures exchanges and non-U.S. 
exchanges and associations are affiliate members of ISG.
---------------------------------------------------------------------------

D. Market Impact

    The Commission believes that the listing and trading of Index 
Options will not adversely impact the underlying securities 
markets.\32\ First, the Index is broad-based and comprised of 1000 
component securities, no one of which dominates the Index. Second, as 
described above, the Index is highly capitalized and its components are 
actively traded. Third, the position and exercise limits applicable to 
the Index Options should serve to minimize potential manipulation and 
market impact concerns. Fourth, the risk to investors of contra-party 
non-performance will be minimized because the Index Options, like other 
standardized options traded in the U.S., will be issued and guaranteed 
by the Options Clearing Corporation (``OCC''). Fifth, existing ISE 
index options rules and surveillance procedures will apply to the Index 
Options.
---------------------------------------------------------------------------

    \32\ As noted above, the ISE represented in a confidential 
submission to the Commission that it has the necessary systems 
capacity to support the introduction of the Index Options.
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\33\ that the proposed rule change (SR-ISE-2004-09), as amended, is 
approved.
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\34\
---------------------------------------------------------------------------

    \34\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 05-80 Filed 1-3-05; 8:45 am]
BILLING CODE 8010-01-M