[Federal Register Volume 70, Number 39 (Tuesday, March 1, 2005)]
[Notices]
[Pages 10010-10013]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-807]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51244; File No. SR-CBOE-2003-30]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Order Granting Accelerated Approval 
to a Proposed Rule Change and Amendment Nos. 1, 2, 3, and 4 Thereto 
Relating to Position Limits and Exercise Limits

February 23, 2005.
    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 July 9, 2003, the Chicago Board Options Exchange, Incorporated 
(``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 the Exchange. 
On January 8, 2004, the CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ On October 29, 2004, the CBOE filed Amendment No. 2 to the 
proposed rule change.\4\ On February 10, 2005, the CBOE filed Amendment 
No. 3 to the proposed rule change.\5\ On February 15, 2005, the CBOE 
filed Amendment No. 4 to the proposed rule change.\6\ The Commission is 
publishing this notice to solicit

[[Page 10011]]

comments on the proposed rule change, as amended, from interested 
persons and is accelerating approval of the proposed rule change, as 
amended, on a pilot basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from James M. Flynn, Attorney II, Legal Division, 
CBOE, to Sharon Lawson, Senior Special Counsel, Division of Market 
Regulation (``Division''), Commission, dated January 7, 2004 
(``Amendment No. 1'').
    \4\ See letter from Edward J. Joyce, President and Chief 
Operating Officer, CBOE, to Nancy Sanow, Assistant Director, 
Division, Commission, dated October 28, 2004 (``Amendment No. 2'').
    \5\ Amendment No. 3, which replaced and superseded the original 
filing and the first and second amendments in their entireties, 
eliminated, among other things, certain hedge exemptions that were 
proposed in the original filing, requested that the increases to the 
standard position and exercise limits proposed in the filing be 
adopted as a six-month pilot program, and requested accelerated 
approval of the proposed rule change.
    \6\ Amendment No. 4, which replaced and superseded the original 
filing and the previous amendments in their entireties, retained the 
changes made by Amendment No. 3 and made technical corrections to 
the filing.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to amend Exchange Rule 4.11 and Exchange Rule 
4.12 to increase the standard position limits and exercise limits for 
equity option contracts and options on the Nasdaq-100 Index Tracking 
Stock (``QQQQ''). The text of the proposed rule change is available on 
the CBOE's Web site (http://www.cboe.com), at the CBOE's Office of the 
Secretary, 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, the 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 III below. The CBOE 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 CBOE is proposing several changes to Exchange Rule 4.11 
(Position Limits) and, accordingly, to Exchange Rule 4.12 (Exercise 
Limits). Exchange Rule 4.11 subjects equity options to one of five 
different position limits depending on the trading volume and 
outstanding shares of the underlying security. Exchange Rule 4.12 
establishes exercise limits for the corresponding options at the same 
levels as the corresponding security's position limits.\7\
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    \7\ Exchange Rule 4.12 states ``* * * no member shall exercise, 
for any account in which it has an interest or for the account of 
any customer, a long position in any options contract where such 
member or customer, acting alone or in concert with others, directly 
or indirectly * * * has or will have exercised within any five 
consecutive business days aggregate long positions in any class of 
options dealt in on the Exchange in excess of [the established 
limits set by the Exchange]. * * *''
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Standard Position and Exercise Limits

    The Exchange is proposing to adopt a pilot program for a period of 
six months during which the standard position and exercise limits for 
options on the QQQQ and for equity option classes traded on the 
Exchange would be increased to the following levels:

------------------------------------------------------------------------
 
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   Current equity option contract    Proposed equity option contract
               limit                                   limit
------------------------------------
               13,500                                 25,000
               22,500                                 50,000
               31,500                                 75,000
               60,000                                200,000
               75,000                                250,000
------------------------------------
 Current QQQQ option contract limit  Proposed QQQQ option contract limit
------------------------------------
              300,000                                900,000
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    The standard position limits were last increased on December 31, 
1998.\8\ Since that time there has been a steady increase in the number 
of accounts that, (a) approach the position limit; (b) exceed the 
position limit; and (c) are granted an exemption to the standard limit. 
Several member firms have petitioned the Exchange to either eliminate 
position limits, or in lieu of total elimination, increase the current 
levels and expand the available hedge exemptions. A review of available 
data indicates that the majority of accounts that maintain sizable 
positions are in those option classes subject to the 60,000 and 75,000 
tier limits. There also has been an increase in the number of accounts 
that maintain sizable positions in the lower three tiers. In addition, 
overall volume in the options market has continually increased over the 
past five years. The Exchange believes that the increase in options 
volume and lack of evidence of market manipulation occurrences over the 
past twenty years justifies the proposed increases in the position and 
exercise limits.
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    \8\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (SR-CBOE-98-25) (approval of 
increase in position limits and exercise limits).
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    The Exchange also proposes the adoption of a new equity hedge 
exemption to the existing exemptions currently provided under 
Interpretation and Policy .04 to Exchange Rule 4.11. Specifically, new 
Interpretation and Policy .04(a)(5) to Exchange Rule 4.11 would allow 
for a ``reverse collar'' hedge exemption to apply when a long call 
position is accompanied by a short put position, and the long call 
expires with the short put. In addition, the strike price of the long 
call must equal or exceed the short put, and each long call and short 
put position must be hedged with 100 shares of the underlying security 
(or other adjusted number of shares). Neither side of the long call 
short put can be in-the-money at the time the position is established. 
The Exchange believes this is consistent with the existing 
Interpretation and Policy .04(a)(4) to Exchange Rule 4.11, which 
provides for an exemption for a ``collar,'' and Interpretation and 
Policy .04(a)(2) and (3) to Exchange Rule 4.11, which provide for a 
hedge exemption for reverse conversions and conversions, respectively.

Manipulation

    The CBOE believes that position and exercise limits, at their 
current levels, no longer serve their stated purpose. The Commission 
has previously stated that:

    Since the inception of standardized options trading, the options 
exchanges have had rules imposing limits on the aggregate number of 
options contracts that a member or customer could hold or exercise. 
These rules are intended to prevent the establishment of options 
positions that can be used or might create incentives to manipulate 
or disrupt the underlying market so as to benefit the options 
position. In particular, position and exercise limits are designed 
to minimize the potential for mini-manipulations and for corners or 
squeezes of the underlying market. In addition such limits serve to 
reduce the possibility for disruption of the options market itself, 
especially in illiquid options classes.\9\
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    \9\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998) (SR-CBOE-97-11) (approval of 
increase in position limits and exercise limits for OEX index 
options).

    As the anniversary of listed options trading approaches its thirty-
second year, the Exchange believes that the existing surveillance 
procedures and reporting requirements at the CBOE, other options 
exchanges, and at the several clearing firms are capable of properly 
identifying unusual and/or illegal trading activity. In addition, 
routine oversight inspections of CBOE's regulatory programs by the 
Commission have not uncovered any material inconsistencies or 
shortcomings in the manner in which the Exchange's market surveillance 
is conducted. These procedures utilize daily monitoring of market 
movements via automated surveillance techniques to identify unusual 
activity in both options and in underlying stocks. Furthermore, the 
significant increases in unhedged options capital charges resulting 
from the September 1997 adoption of risk-based haircuts in combination 
with the Exchange margin requirements applicable to these products 
under Exchange rules, serve as a more effective protection than do 
position limits.\10\
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    \10\ See Securities Exchange Act Release No. 38248 (February 6, 
1997), 62 FR 6474 (February 12, 1997) (File No. S7-7-94) (adopting 
risk-based haircuts); and CBOE Rule 12.3 (Margins).

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[[Page 10012]]

    Furthermore, large stock holdings must be disclosed to the 
Commission by way of Schedules 13D or 13G.\11\ Options positions are 
part of any reportable positions and, thus, cannot be legally hidden. 
In addition, Exchange Rule 4.13, which requires members to file reports 
with the Exchange for any customer or member who held aggregate long or 
short positions of 200 or more option contracts of any single class for 
the previous day, will remain unchanged and will continue to serve as 
an important part of the Exchange's surveillance efforts.
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    \11\ 17 CFR 240.13d-1.
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    The Exchange believes that restrictive equity position limits 
prevent large customers, such as mutual funds and pension funds, from 
using options to gain meaningful exposure to individual stocks. This 
can result in lost liquidity in both the options market and the stock 
market. In addition, the Exchange has found that restrictive limits and 
narrow hedge exemption relief restrict member firms from adequately 
facilitating customer order flow and offsetting the risks of such 
facilitations in the listed options market. The fact that position 
limits are calculated on a gross rather than a delta basis also is an 
impediment.

Financial Requirements

    The Exchange believes that the current financial requirements 
imposed by the Exchange and by the Commission adequately address 
concerns that a member or its customer may try to maintain an 
inordinately large unhedged position in an equity option. Current 
margin and risk-based haircut methodologies serve to limit the size of 
positions maintained by any one account by increasing the margin and/or 
capital that a member must maintain for a large position held by itself 
or by its customer. It also should be noted that the Exchange has the 
authority under Exchange Rule 12.3(h) and Exchange Rule 12.10 to impose 
higher margin requirements upon a member or member organization when 
the Exchange determines that higher requirements are warranted. Also, 
the Commission's net capital rule, Rule 15c3-1 under the Act,\12\ 
imposes a capital charge on members to the extent of any margin 
deficiency resulting from the higher margin requirement.
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    \12\ 17 CFR 240.15c3-1.
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    Finally, equity position limits have been gradually expanded from 
1,000 contracts in 1973 to the current level of 75,000 contracts for 
options on the largest and most active underlying securities. To date, 
the Exchange believes that there have been no adverse affects on the 
market as a result of these past increases in the limits for equity 
option contracts.

Housekeeping Changes

    The Exchange is proposing to amend Exchange Rule 4.11 by deleting 
the requirement that notice of position limit information be manually 
posted on the Exchange Bulletin Board. With the advance of 
technologies, position limits are now communicated to the membership 
largely through electronic media. Currently, applicable position limits 
are posted on the CBOE Internet site and on the Options Clearing 
Corporation Internet site and are sent electronically via e-mail to 
those member firms that have requested this type of notification. Paper 
copies of the position limits also are available to the trading floor 
community upon request. Posting a paper list, which is quite long and 
consumes a large amount of space, on the Exchange Bulletin Board is an 
outdated requirement that no longer serves a purpose. Therefore, the 
Exchange proposes to amend the language to state that position limit 
information must be posted publicly.
    The Exchange also proposes a minor change to Interpretation and 
Policy .06 to Exchange Rule 4.11 to correct the ``Example'' pertaining 
to the equity hedge exemption. The current Example inaccurately refers 
to the equity hedge exemption being limited to two times the standard 
limit. This limitation was removed in a previous rule filing,\13\ and 
is thus no longer relevant. Currently, there is no position limit 
restriction for qualified hedge strategies under the equity hedge 
exemption policy.
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    \13\ See Securities Exchange Act Release No. 40875 (December 31, 
1998), 64 FR 1842 (January 12, 1999) (SR-CBOE-98-25) (approval of 
increase in position limits and exercise limits).
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with and furthers the objectives of Section 6(b)(5) of the Act,\14\ in 
that it is designed to perfect the mechanisms of a free and open market 
and to protect investors and the public interest.
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    \14\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change would 
impose any burden on competition.

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.

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-CBOE-2003-30 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-2003-30. 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 
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 
publicly available. All submissions should refer to File Number SR-
CBOE-2003-30 and should be submitted on or before March 22, 2005.

[[Page 10013]]

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

    After careful consideration, 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.\15\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\16\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanisms of a free and open 
market and to protect investors and the public interest.
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    \15\ In approving this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \16\ 15 U.S.C. 78f(b)(4).
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    The Commission notes that standard position and exercise limits 
have not been increased in six years, during which time overall options 
market volume has continually increased, and the number of accounts 
that approach the current limits, exceed them, and are granted 
exemptions from the limits has also increased. The CBOE believes, among 
other things, that restrictive position limits result in lost liquidity 
by preventing large customers from using options to gain meaningful 
exposure to individual stocks. In view of the Exchange's 
representations concerning its surveillance procedures and capabilities 
of identifying unusual or illegal trading activity, as well as other 
protections against market manipulation noted in the proposal, the 
Commission believes that it is appropriate at this time to approve the 
proposed increases in position and exercise limits for a pilot program 
of six months.
    The Commission also believes that the proposal to implement the 
``reverse collar'' hedge exemption is consistent with the existing 
hedge exemption relating to the ``collar'' strategy, which has already 
been approved by the Commission. The additional amendments 
appropriately adjust the requirement that the Exchange post reasonable 
notice of new position limits to reflect current technology, and 
eliminate an inaccuracy in the Exchange rules.
    The CBOE has requested that the Commission find good cause for 
approving the proposed rule change prior to the thirtieth day after 
publication of notice thereof in the Federal Register. The Commission 
believes that it is appropriate to accelerate approval of the proposed 
rule change so that the pilot program, intended to ease restrictions 
that inhibit liquidity in the options market, consistent with the 
protection of investors, may begin without delay. Accordingly, the 
Commission finds good cause, pursuant to Section 19(b)(2) of the 
Act,\17\ for approving the proposed rule change, as amended, prior to 
the thirtieth day after the date of publication of notice thereof in 
the Federal Register.
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    \17\ 15 U.S.C. 78s(b)(2).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-CBOE-2003-30), as amended, 
is hereby approved on an accelerated basis for a pilot period to expire 
on August 23, 2005.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-807 Filed 2-28-05; 8:45 am]
BILLING CODE 8010-01-P