[Federal Register Volume 70, Number 37 (Friday, February 25, 2005)]
[Notices]
[Pages 9398-9402]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-770]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51220; File No. SR-CBOE-2004-89]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule 
Change and Amendment Nos. 1 and 2 Thereto Relating to Reduced-Value 
Options on the Russell 2000 Stock Index

February 17, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 9399]]

(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 23, 2004, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by CBOE. On 
February 10, 2005, CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ On February 14, 2005, CBOE filed Amendment No. 2 to the 
proposed rule change.\4\ The Exchange filed the proposed rule change 
pursuant to Section 19(b)(3)(A) of the Act \5\ and Rule 19b-4(f)(6) 
thereunder,\6\ which renders it effective upon filing with the 
Commission. The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Form 19b-4, dated February 10, 2005, which replaced the 
original filing in its entirety (``Amendment No. 1'').
    \4\ See Form 19b-4, dated February 14, 2005, which was a partial 
amendment (``Amendment No. 2''). In Amendment No. 2, CBOE 
represented, in part, that in the event the Frank Russell Company 
ceases to maintain or calculate the Index or if values are not 
disseminated every 15 seconds by a widely available source, CBOE 
will notify the Division of Market Regulation (``Division'').
    \5\ 15 U.S.C. 78s(b)(3)(A).
    \6\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend certain of its rules to provide for the 
listing and trading of reduced-value options on the Russell 
2000[supreg] Index (``Russell 2000'' or ``Index''), a broad-based 
securities index. Options on each index would be cash-settled, a.m.-
settled, and would have European-style expiration. The text of the 
proposed rule change is available on CBOE's Web site (http://www.cboe.com), at the CBOE's principal office, and at the Commission's 
Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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 purpose of the proposed rule change is to amend CBOE rules to 
allow the Exchange to list and trade reduced-value options on the 
Russell 2000.\7\ Specifically, CBOE proposes listing cash-settled, 
a.m.-settled, European-style index options that are based on one-fifth 
(1/5th) and one-tenth (1/10th) the value of the Russell 2000 
(``Reduced-Value Options''). The Russell 2000 is a broad-based 
securities index created in 1984 by the Frank Russell Company for the 
purpose of tracking the performance of small-cap companies. The Russell 
2000 is a capitalization-weighted index and includes only common stocks 
belonging to corporations domiciled in the United States and its 
territories and that are traded on the New York Stock Exchange or the 
American Stock Exchange. The Russell 2000 is completely reconstituted 
annually to ensure that larger stocks do not distort the performance 
and characteristics of the true small-cap market.\8\ The Russell 2000 
includes the smallest 2000 securities in the Russell 3000.\9\ CBOE has 
been trading European-style, cash-settled options on the Russell 2000 
since 1992.
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    \7\ The Exchange currently is approved to list and trade 
European-style, cash-settled options, including long-term index 
option series (``LEAPS''), on the Russell 1000 Index, Russell 2000 
Index, Russell 3000 Index, Russell 1000 Growth Index, Russell 1000 
Value Index, Russell 2000 Growth Index, Russell 2000 Value Index, 
Russell 3000 Growth Index, Russell 3000 Value Index, Russell Midcap 
Index, Russell Midcap Growth Index, Russell Midcap Value Index, 
Russell Top 200[supreg] Index, Russell Top 200[supreg] Growth Index, 
and the Russell Top 200[supreg] Value Index. See Securities Exchange 
Act Release Nos. 49388 (March 10, 2004), 69 FR 12720 (March 17, 
2004); 48591 (October 2, 2003), 68 FR 58728 (October 10, 2003); 
31382 (October 30, 1992), 67 FR 52802 (November 5, 1992).
    \8\ See http://www.russell.com or http://www.cboe.com for 
further description and background of the Index.
    \9\ The Russell 3000[supreg] Index contains the largest 3,000 
companies incorporated in the United States and the U.S. 
territories. The companies are ranked by total market 
capitalization.
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    The proposed rule change will allow CBOE to attract additional 
business from customers that may not otherwise be able to invest in 
regular Russell 2000 options. Over the years, the value of the Russell 
2000 has significantly increased such that, as of December 15, 2004, 
the value of the index stood at approximately 643. Accordingly, the 
premium for Russell 2000 options also has increased proportionately, 
making the use of Russell 2000 options as a hedging tool cost-
prohibitive for some retail investors. To make trading Russell 2000 
options accessible to a greater range of investors, CBOE proposes to 
introduce two new options contracts that are based on one-fifth (1/5th) 
and one-tenth (1/10th) the value of the Russell 2000, respectively. For 
example, a January (2005) Russell 2000 640 call would cost an investor 
approximately $1,560, whereas, with adoption of the proposed reduced-
value contracts, the 1/5th version of the same call would cost an 
investor $312.00 and a 1/10th version of the call would cost only 
$156.00.\10\ CBOE will make no modifications to the Russell 2000 index 
methodology or calculation, for which the Frank Russell Company is the 
reporting authority. In addition to regular index options, the Exchange 
also may provide for the listing of LEAPS in accordance with CBOE Rule 
24.9.\11\
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    \10\ Estimates are based on a randomly selected last sale price 
(intra-day) for the 2005 January 640 call on the Russell 2000 during 
the December 15, 2004 trading day. The approximate cost to an 
investor does not include applicable fees or commissions that may be 
incurred in the execution of trades.
    \11\ This is consistent with the Exchange's ability to list 
LEAPS on all other Russell Indexes. See supra note 7.
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    The Exchange believes that offering reduced-value Russell 2000 
options will provide an important opportunity for investors to hedge 
and speculate upon the market risks associated with the stocks 
comprising the Russell 2000, without having to extend great outlays of 
capital. This should attract a wider range of investors and, in turn, 
create a more active and liquid trading environment for all options on 
the Russell 2000. The Exchange will continue listing and trading the 
existing Russell 2000 options contracts, and the reduced-value Russell 
2000 options will trade under their own trading symbols that are 
different than Russell 2000 trading symbol (RUT).
    The Commission and the Options Clearing Corporation will be 
notified of the trading symbol, and CBOE will issue a circular 
detailing the option contract specifications to CBOE membership prior 
to the listing of options series on the reduced-value Russell 2000. In 
addition, the Exchange will disseminate prices for the reduced-value 
Russell 2000 contracts every 15 seconds through the Option Price 
Reporting Authority. The Exchange will notify the Division of Market 
Regulation immediately in the event the Frank Russell Company ceases to 
maintain or calculate the Index or if the Index values are not 
disseminated every 15 seconds by a widely available source.\12\ CBOE 
further represents that,

[[Page 9400]]

if the Russell 2000 Index ceases to be maintained or calculated, or if 
the Index values are not disseminated every 15 seconds by a widely 
available source, it will not list any additional series for trading 
and will limit all transactions in such options to closing transactions 
only for the purpose of maintaining a fair and orderly market and 
protecting investors.
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    \12\ See Amendment No. 2.
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    Strike prices for the reduced-value Russell 2000 contracts will be 
set to bracket the index in 2\1/2\ point increments for strikes at or 
below 200 and in 5-point increments for strikes above 200. The minimum 
tick size for series trading below $3 will be $0.05 and for series 
trading above $3 the minimum tick will be $0.10. The trading hours for 
reduced-value options on the Russell 2000 will be 8:30 a.m. to 3:15 
p.m. (c.s.t).
    Position and Exercise Limits. Consistent with CBOE Rule 24.4(d), 
positions in reduced-value index options shall be aggregated with 
positions in full-value indices. As such, the position and exercise 
limits applicable to the one-fifth value and one-tenth value Russell 
2000 options shall be, conversely, increased by a factor of 5 and 10, 
respectively. To illustrate, for the purposes of determining the 
applicable position limits for the one-tenth value Russell 2000, ten 
reduced-value Russell 2000 contracts would be equal to one Russell 2000 
contract and, for the one-fifth value Russell 2000, five reduced-value 
Russell 2000 contracts would be equal to one Russell 2000 contract. 
Reducing the contract size of the Russell 2000 Index option by one-
tenth (or one-fifth) while increasing the position limit from 50,000 
contracts to 500,000 contracts (or from 50,000 contracts to 250,000), 
would have no effect on the monetary value of the portfolio that could 
be controlled by a particular person or firm. This also is consistent 
with previous filings in which the Exchange introduced reduced-value 
versions of other broad-based indexes.\13\
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    \13\ See Securities Exchange Act Release No. 43000 (June 30, 
2000), 65 FR 42409 (July 10, 2000) (notice of filing and immediate 
effectiveness of rule change SR-CBOE-00-15) (proposing the listing 
of options on reduced-value versions of the Nasdaq 100 Stock Index).
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    The Exchange also proposes making a technical correction to Rule 
24.4(d), which provides, ``[p]ositions in reduced-value index options 
shall be aggregated with positions in full-value indices. For such 
purposes, ten (10) reduced-value contracts shall equal one contract.'' 
The latter sentence in this rule presumes that all reduced-value index 
options shall be reduced only to one-tenth the value of the original 
index. The Exchange believes that it is more appropriate to amend this 
sentence in the form of an example to illustrate the calculations to 
make based on the ratio of the reduced-value contract being proposed. 
As such, the rule will now provide two examples; one in which the index 
would be reduced by one-tenth and one in which the index would be 
reduced by one-fifth.
    Exercise and Settlement. Exercise and settlement on the reduced-
value Russell 2000 options will be identical to existing options on the 
Russell 2000. The reduced-value options will expire on the Saturday 
following the third Friday of the expiration month. Trading in the 
expiring contract month will normally cease at 3:15 p.m. (CST) on the 
business day preceding the last day of trading in the component 
securities of the Index (ordinarily the Thursday before expiration 
Saturday, unless there is an intervening holiday). The exercise 
settlement value of the Index at option expiration will be calculated 
by Reuters, on behalf of the Frank Russell Company, based on the 
opening prices of the component securities on the last business day 
prior to expiration. If a component security fails to open for trading, 
the exercise settlement value will be determined in accordance with 
CBOE Rules 24.7(e) and 24.9(a)(4). When the last trading day is moved 
because of Exchange holidays (such as when CBOE is closed on the Friday 
before expiration), the last trading day for expiring options will be 
Wednesday, and the exercise settlement value of index options at 
expiration will be determined at the opening of regular trading on 
Thursday.
    Maintenance. Because the Russell 2000 is to be monitored and 
maintained by the Frank Russell Company, the Frank Russell Company will 
be responsible for making all necessary adjustments to the indexes to 
reflect component deletions, share changes, stock splits, stock 
dividends (other than an ordinary cash dividend), and stock price 
adjustments due to restructuring, mergers, or spin-offs involving the 
underlying components. Some corporate actions, such as stock splits and 
stock dividends, require simple changes to the available shares 
outstanding and the stock prices of the underlying components. Other 
corporate actions, such as share issuances, change the market value of 
the Index and would require the use of an index divisor to effect 
adjustments.
    The Russell 2000 is re-constituted annually on June 30, based on 
prices and available shares outstanding as of the preceding May 31. New 
index components are added only as part of the annual re-constitution, 
after which, should a stock be removed from an index for any reason, it 
cannot be replaced until the next re-constitution.
    Although CBOE is not involved in the maintenance of the Russell 
2000, the Exchange represents that it will monitor the Russell 2000 on 
a quarterly basis and will notify the Staff in the Division by filing a 
rule change pursuant to Rule 19b-4 if: (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 CBOE Rule 5.3; (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 each Index or the largest five components in 
the aggregate account for more than 50% of the weight of the Index. 
These are, generally, similar maintenance procedures that were adopted 
by CBOE for the monitoring of several other Russell Indexes.\14\
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    \14\ See Securities Exchange Act Release No. 48591 (October 2, 
2003), 68 FR 58727 (October 10, 2003) (order approving SR-CBOE-2003-
17) (listing and trading of options on 11 Russell Indexes).
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    Surveillance. Because the index underlying the reduced-value 
options remains unchanged, the Exchange represents that CBOE's 
surveillance procedures are adequate to monitor the trading in reduced-
value options and LEAPS on the Russell 2000. Further, the Exchange 
shall have complete access to the information regarding the trading 
activity of the underlying securities.
    Margin. The Russell 2000 is a ``broad-based index'' and, under CBOE 
margin rules, the margin requirement for a short put or call on each 
respective reduced-value Russell 2000 option contract shall be 100% of 
the current market value of the contract, plus up to 15% of the 
respective underlying index value.\15\ More specifically, for purchases 
of puts or calls with more than 9 months until expiration, customers 
must deposit and continue to maintain 75% of the total cost of the 
option's current market value.\16\ When the time until expiration 
reaches 9 months, the option no longer has value for margin 
purposes.\17\ Purchases of puts or calls with 9 months or less until 
expiration must be paid for

[[Page 9401]]

in full. Writers of uncovered puts or calls must deposit and continue 
to maintain 100% of the option proceeds plus 15% of the aggregate 
contract value (current index level x $100) minus the amount, if any, 
by which the option is out-of-the-money, subject to a minimum for calls 
of option proceeds plus 10% of the aggregate contract value and a 
minimum for puts of option proceeds plus 10% of the aggregate exercise 
price amount.\18\
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    \15\ See CBOE Rule 12.3(c)(5)(A).
    \16\ See CBOE Rule 12.3(c)(4)(B).
    \17\ See id.
    \18\ For calculating maintenance margin, the option's current 
market value, as opposed to the total cost/option proceeds method, 
must be used. Additional margin may be required pursuant to Exchange 
Rule 12.10.
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    Other Exchange Rules Applicable. Except as modified herein, the 
Rules in Chapter XXIV will govern the trading of options on the 
aforementioned Russell Indexes on the Exchange. Additionally, in 
accordance with CBOE Rule 24A.4(b) (Special Terms for FLEX Index 
Options), CBOE reserves the right to approve and open for trading FLEX 
options on the reduced-value versions of the Russell 2000, and, in 
accordance with Rule 24A.7(a)(i), because the Russell 2000 is a broad-
based index, there shall be no position or exercise limits for these 
FLEX index options. Finally, CBOE affirms that it possesses the 
necessary systems capacity to support new series that would result from 
the introduction of the reduced-value Russell Index options, including 
LEAPS. The Exchange will consider the potential impact on system 
capacity before listing FLEX reduced-value options on the Russell 2000. 
The Exchange also, concurrent with this the submission of this rule 
filing, provided the Division with a letter that describes the 
potential impact that the introduction of these options will have on 
quoting capacity.
2. Statutory Basis
    CBOE believes that the proposed rule change is consistent with 
Section 6 of the Act,\19\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\20\ in particular, in that it is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, and, in general, to protect 
investors and the public interest.
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    \19\ 15 U.S.C. 78f.
    \20\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose 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 either solicited or received with respect 
to the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not:
    (i) Significantly affect the protection of investors or the public 
interest;
    (ii) impose any significant burden on competition; and
    (iii) become operative for 30 days from the date on which it was 
filed, or such shorter time as the Commission may designate, it has 
become effective pursuant to Section 19(b)(3)(A) of the Act \21\ and 
Rule 19b-4(f)(6) thereunder.\22\ In addition, the Exchange provided the 
Commission with written notice of its intent to file the proposed rule 
change, along with a brief description and text of the proposed rule 
change, at least five business days prior to the date of the filing of 
the proposed rule change, as required by Rule 19b-4(f)(6). At any time 
within 60 days of the filing of the proposed rule change, the 
Commission may summarily abrogate such rule change if it appears to the 
Commission that such action is necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Act.\23\
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    \21\ 15 U.S.C. 78s(b)(3)(A).
    \22\ 17 CFR 240.19b-4(f)(6).
    \23\ For purposes of calculating the 60-day abrogation period, 
the Commission considers the proposal to have been filed on February 
14, 2005, the date the CBOE filed Amendment No. 2.
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    CBOE asked the Commission to waive the 30-day operative delay 
contained in Rule 19b-4(f)(6)(iii) under the Act.\24\ The Commission 
believes that such waiver is consistent with the protection of 
investors and the public interest, since the proposed rule change 
merely allows CBOE to begin listing and trading additional versions of 
the Russell 2000 index option, which has previously been approved by 
the Commission. The Commission does not believe that the filing raises 
any new regulatory issues. Therefore, the Commission hereby waives the 
30-day operative delay.\25\
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    \24\ 17 CFR 240.19b-4(f)(6)(iii).
    \25\ For purposes only of waiving the 30-day pre-operative 
period, the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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IV. 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-CBOE-2004-89 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-CBOE-2004-89. 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 Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of the CBOE. 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-CBOE-2004-89 and should be submitted on or before March 
18, 2005.
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    \26\ 17 CFR 200.30-3(a)(12).


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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-770 Filed 2-24-05; 8:45 am]
BILLING CODE 8010-01-P