[Federal Register Volume 70, Number 126 (Friday, July 1, 2005)]
[Notices]
[Pages 38220-38225]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-3456]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51913; File No. SR-ISE-2004-28]


Self-Regulatory Organizations; International Securities Exchange, 
Inc.; Order Approving Proposed Rule Change and Amendments No. 1 and 2 
Relating to Trading Options on Full and Reduced Values of the ISE 250 
Index, the ISE 100 Index and the ISE 50 Index, Including Long-Term 
Options

June 23, 2005.

I. Introduction

    On September 10, 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 trade options on three broad-based 
indexes, the ISE 250 Index, the ISE 100 Index and the ISE 50 Index. The 
ISE submitted Amendments No. 1 and No. 2 to the proposal on January 5, 
2005,\3\ and on March 7, 2005, respectively.\4\ The proposed rule 
change and Amendments No. 1 and No. 2 were published for comment in the 
Federal Register on April 6, 2005.\5\ The Commission received no 
comment letters regarding the proposal. This order approves the 
proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 set forth a list of the underlying 
components of the ISE Indexes.
    \4\ Amendment No. 2 replaced the original filing in its 
entirety, proposed a reduced number of contracts for position and 
exercise limits, addressed one of the events that the Exchange will 
monitor on an annual basis, and made other technical corrections to 
the filing.
    \5\ See Securities Exchange Act Release No. 51447 (March 30, 
2005), 70 FR 17484 (``Notice'').
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II. Description of the Proposal

    The ISE proposes to list and trade cash-settled, European-style, 
index options on full and reduced values of the ISE 250 Index, the ISE 
100 Index and the ISE 50 Index (collectively, the ``ISE Indexes'').\6\ 
Specifically, the Exchange proposes to list options based upon the full 
value of the ISE Indexes (``Full-size ISE Indexes'') as well as one-
tenth of the value of the ISE Indexes (``Mini ISE Indexes'').
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    \6\ A description of each of the ISE Indexes will be available 
on the Exchange's publicly available Web site at http://www.iseoptions.com.
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    A brief description of the proposal appears below; the Notice 
provides a more detailed description of the proposal.

[[Page 38221]]

Index Design and Composition

    The ISE Indexes are designed to track the performance of the most 
highly capitalized publicly traded companies in the United States. Each 
index is a float-adjusted capitalization-weighted index,\7\ whose 
components are all headquartered in the United States and listed on 
either the New York Stock Exchange, Inc. (``NYSE''), the National 
Association of Securities Dealers, Inc. (``NASD''), Automated Quotation 
System (``NASDAQ''), or the American Stock Exchange LLC (``Amex''). All 
companies in the ISE Indexes will either be operating companies or Real 
Estate Investments Trusts. All other companies, such as Closed-end 
Funds, Exchange Traded Funds, Holding Companies, Investment Vehicles 
and Royalty Trusts are not eligible for inclusion.
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    \7\ The calculation of a float-adjusted, market-weighted index 
involves taking the summation of the product of the price of each 
stock in the index and the number of shares available to the public 
for trading, rather than the total shares outstanding for each 
issue. In contrast, a price-weighted index involves taking the 
summation of the prices of the stocks in the index.
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    Companies are selected for inclusion in the ISE Indexes by the 
Exchange based on the Exchange's methodology.\8\ Companies may not 
apply, and may not be nominated, for inclusion. Companies may be added 
or removed by the Exchange based on the methodology described below. In 
order for a company to be eligible for inclusion in the ISE Indexes, it 
must satisfy certain minimum criteria. One of the requirements for 
inclusion is that a company's ratio of cumulative shares traded to 
adjusted shares outstanding must be greater than 0.30 over the past 12 
months. Another requirement that must be met by each company is the 
number of shares in its public float must constitute at least 50% of 
its total number of outstanding shares. To be eligible for inclusion in 
the ISE 100 Index, companies must meet one additional requirement: 
options on the component company's stock must be listed on the 
Exchange.
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    \8\ Rules governing component selection of the ISE Indexes will 
be available on the Exchange's publicly available Web site at http://www.iseoptions.com.
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    The ISE indexes are calculated and maintained by Standard & Poor's 
(``S&P'') pursuant to the Exchange's rules-based methodology and 
instructions.

ISE 250 Index

    The ISE 250 Index is designed to track the combined performance of 
the most highly capitalized stocks in the U.S. equity markets and 
specifically includes the top 250 stocks as ranked by market 
capitalization.
    Components of the ISE 250 Index are selected using a rules-based 
methodology that is fully transparent. Its original selection pool 
includes all common stocks listed on the NYSE, Amex and NASDAQ. The 
entire index universe is ranked in descending order by unadjusted 
market capitalization. Companies that do not meet component eligibility 
requirements are removed. If a component has multiple share classes, 
the most liquid issue for that company is included. The top 250 
companies, ranked by market capitalization, are then selected from the 
remaining universe.
    Each component's eligibility and ranking is reviewed twice 
annually, in June and December of each calendar year. Any necessary 
component changes are made after the close on the third Friday of June 
and December, and become effective at the opening on the next trading 
day. Changes to the ISE 250 Index will be announced on ISE's publicly 
available Web site five trading days prior to the effective date.
    In addition to the scheduled reviews, the ISE 250 Index is reviewed 
on an ongoing basis to accommodate extraordinary events and corporate 
actions, such as delistings, bankruptcies, mergers or acquisitions 
involving index components.

ISE 100 Index

    The ISE 100 Index tracks the 100 most actively traded listed 
options classes on the Exchange. Components of the ISE 100 Index are 
selected based on the average daily volume of each options class over a 
six-month period on the Exchange. Its original selection pool includes 
all equity options listed on the Exchange, ranked by average daily 
volume over the previous six month period. Companies that do not meet 
component eligibility requirements are removed. The top 100 companies, 
ranked by average daily volume, are then selected, and the index is 
weighted by float-adjusted market capitalization.
    Similar to the ISE 250 Index, each component's eligibility and 
ranking in the ISE 100 Index is reviewed twice annually, in June and 
December of each calendar year. Any necessary component changes are 
made after the close on the third Friday of June and December, and 
become effective at the opening on the next trading day. Changes to the 
ISE 100 Index will be announced on ISE's publicly available Web site 
five trading days prior to the effective date.
    In addition to the scheduled reviews, the ISE 100 Index is reviewed 
on an ongoing basis to accommodate extraordinary events and corporate 
actions, such as delistings, bankruptcies, mergers or acquisitions 
involving index components.

ISE 50 Index

    The ISE 50 Index is a subset of the ISE 250 Index, such that the 
components of the ISE 50 Index consist of the top 50 components that 
make up the ISE 250 Index, as ranked by market capitalization. Thus, 
the criteria for inclusion into the ISE 50 Index, as well as the 
maintenance of the Index, are identical to those of the ISE 250 Index.

Index Calculation and Index Maintenance

    The base index level of the ISE 250 Index, the ISE 100 Index and 
the ISE 50 Index, as of December 31, 1998, was 250, 100 and 200, 
respectively. On January 3, 2005, the index level of the ISE 250 Index, 
the ISE 100 Index and the ISE 50 Index was 227.48, 86.32, and 156.98, 
respectively. The Exchange proposes to base trading in options on both 
Full-size ISE Indexes and on fractions of Full-size ISE Indexes. In 
particular, the Exchange proposes to list options on Mini ISE Indexes 
that are based on one-tenth of the value of Full-size ISE Indexes.
    The Full-size ISE Indexes' and the Mini ISE Indexes' level shall 
each be calculated continuously, using the last sale price for each 
component stock in the ISE Indexes, and shall be disseminated every 15 
seconds throughout the trading day.\9\
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    \9\ The ISE Index levels shall be calculated by S&P, on behalf 
of the Exchange, and disseminated to the Options Price Reporting 
Authority (``OPRA'') by the Exchange. The Exchange shall also 
disseminate these values to its members. The ISE Indexes will be 
published daily on the Exchange's publicly available Web site and 
through major quotation vendors, such as Reuters.
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    The settlement values for purposes of settling both Full-size ISE 
Indexes (``Full-size Settlement Value'') and Mini ISE Indexes (``Mini 
Settlement Value'') shall be 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 a component 
security in the ISE Indexes does not trade on Settlement Day, the 
closing price from the previous trading day will be used to calculate 
both Full-size Settlement

[[Page 38222]]

Value and Mini Settlement Value. Accordingly, trading in the ISE 
Indexes will normally cease on the Thursday preceding an Expiration 
Saturday. S&P shall calculate, and the Exchange shall disseminate, both 
Full-size Settlement Value and Mini Settlement Value in the same manner 
as S&P shall calculate, and the Exchange shall disseminate, both Full-
Size ISE Indexes' and Mini ISE Indexes' levels.
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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, options on the ISE Indexes 
will expire on the third Saturday of the month.
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    S&P will monitor and maintain the ISE Indexes pursuant to ISE's 
methodology and instructions. S&P is responsible for making all 
necessary adjustments to the ISE 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. The number of common 
shares outstanding for each component stock will be reviewed every 
Friday. Share changes of less than 5% will be updated on a quarterly 
basis, becoming effective after the close on the third Friday of March, 
June, September and December of each calendar year. The index divisor 
is adjusted at that time to compensate for the share changes. Share 
changes greater than 5% will be adjusted after the close on the 
Wednesday of the following week. The index divisor change also becomes 
effective after the close on that day. Changes will be announced on the 
Exchange's publicly available Web site prior to the effective date. 
Unscheduled share changes due to corporate actions may be processed the 
same day they are announced, depending on the time the details are 
received by S&P. In such cases, the index divisor changes may become 
effective that same day and immediately announced on the Exchange's 
publicly available Web site.
    The eligibility of each component of the ISE Indexes will be 
reviewed in June and December of each calendar year. Components that 
fail to meet the eligibility requirements are replaced with new 
component companies. Component changes may also occur between review 
periods if a specific corporate action makes an existing component 
ineligible. The Exchange maintains a Component Replacement Pool 
(``CRP'') for the ISE Indexes at all times for contingency purposes. 
The CRP contains at least ten companies that meet the eligibility 
requirements for the ISE Indexes, ranked by market capitalization for 
the ISE 250 Index and the ISE 50 Index, and six-month average trading 
volume for the ISE 100 Index. Components removed from the ISE Indexes 
are replaced with those from the CRP. Component changes are made after 
the close on the third Friday of June and December of each calendar 
year, and become effective at the opening on the next trading day. All 
such changes will be announced on the Exchange's publicly available Web 
site at least five trading days prior to the effective date.
    The Exchange represents that the ISE Indexes currently satisfy the 
maintenance criteria and further states that it will monitor and 
maintain the ISE Indexes on a quarterly basis, at which point the 
Exchange will notify the Commission's Division of Market Regulation 
(``Division''), and will cease trading options on the NYSE Indexes if 
and when: (i) The number of securities in the ISE Indexes drops by \1/
3\ or more; (ii) 10% or more of the weight of the ISE Indexes is 
represented by component securities having a market value of less than 
$75 million; (iii) less than 80% of the weight of the ISE Indexes is 
represented by component securities that are eligible for options 
trading pursuant to ISE Rule 502; (iv) 10% or more of the weight of the 
ISE Indexes 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 ISE Indexes or the largest five 
components in the aggregate account for more than 40% of the weight of 
the ISE Indexes.\12\ In the event the Indexes fail at any time to 
satisfy the maintenance criteria, the ISE will not open for trading any 
additional series of options on the Indexes unless such failure is 
determined by the Exchange not to be significant and the Commission 
concurs in that determination, or unless the continued listing of 
options on each respective Index has been approved by the Commission 
under Section 19(b)(2) of the Exchange Act.\13\
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    \12\ The timeframe for monitoring the ISE Indexes was changed 
from an annual to a quarterly basis. Telephone conversation between 
Samir Patel, Assistant General Counsel, ISE, and Mia Zur, Attorney, 
Division, Commission (March 22, 2005).
    \13\ Telephone conversation between Samir Patel, Assistant 
General Counsel, ISE, and Mia Zur, Attorney, Division, Commission 
(March 22, 2005).
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Contract Specifications

    The ISE Indexes are each broad-based indexes, as defined in ISE 
Rule 2001(j).\14\ Options on the ISE Indexes are European-style and 
A.M. 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 the ISE Indexes. Exchange rules that are 
applicable to the trading of options on broad-based indexes will apply 
to both Full-size ISE Indexes and Mini ISE Indexes.\15\
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    \14\ 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.
    \15\ See ISE Rules 2000 through 2012.
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    Specifically, the trading of Full-size ISE Indexes and Mini ISE 
Indexes will be subject to, among others, Exchange rules governing 
margin requirements and trading halt procedures for index options.
    For each of the Full-size ISE Indexes, the Exchange proposes to 
establish aggregate position and exercise limits at 50,000 contracts on 
the same side of the market, provided no more than 30,000 of such 
contracts are in the nearest expiration month series. For position and 
exercise limit purposes, Full-size ISE Indexes contracts shall be 
aggregated with Mini ISE Indexes contracts, where ten (10) Mini ISE 
Indexes contracts equal one (1) Full-size ISE Index contract.
    The Exchange proposes to set strike price intervals at 21/2 points 
for certain near-the-money series in near-term expiration months when 
each of the ISE Indexes is at a level below 200, and 5 point strike 
price intervals for other options series with expirations up to one 
year, and 10 point strike price intervals for longer-term options. The 
minimum tick size for series trading below $3 shall be 0.05, and for 
series trading at or above $3 shall be 0.10.
    The Exchange proposes to list options on the ISE Indexes 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.\16\ In addition, 
longer-term option series (``LEAPS'') having up to thirty-six (36) 
months to expiration may be traded.\17\ The interval between expiration 
months on the ISE Indexes shall not be less than six months. The 
trading of any long-term ISE Indexes shall be subject to the same rules 
that govern the trading of all the Exchange's index options, including 
sales practice

[[Page 38223]]

rules, margin requirements, trading rules and position and exercise 
limits.
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    \16\ See ISE Rule 2009(a)(3).
    \17\ See ISE Rule 2009(b)(1). LEAPS will be available on the 
Full and Reduced Value ISE Indexes. However, the Exchange is not 
listing reduced value LEAPS on the Reduced Value ISE Indexes 
pursuant to ISE Rule 2009(b)(2). Telephone conversation between 
Samir Patel, Assistant General Counsel, ISE, and Mia Zur, Attorney, 
Division, Commission (March 11, 2005).
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Surveillance and Capacity

    The ISE represents that it has an adequate surveillance program in 
place for options traded on the ISE Indexes, and intends to apply those 
same program procedures that it applies to the Exchange's other index 
options. 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., the Chicago Board Options Exchange, the Chicago 
Stock Exchange, Inc., the National Stock Exchange, Inc., the NASD, the 
NYSE, the Pacific Stock Exchange, Inc. and the Philadelphia Stock 
Exchange, Inc. 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 represented that it has the system capacity to 
adequately handle all series that would be permitted to be added by 
this proposal, including LEAPS on the Full and Reduced Value ISE 
Indexes. The Exchange provided to the Commission information in a 
confidential submission that supports its system capacity 
representations that will result from the introduction of both Full-
size ISE Indexes and Mini ISE Indexes.

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.\18\ The Commission finds that the trading of 
options on full and reduced values of the ISE Indexes will permit 
investors to participate in the price movements of the securities that 
comprise the Indexes. The Commission also believes that the trading of 
options on the ISE Indexes 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 options on the ISE Indexes 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 options on the ISE Indexes will serve to protect investors, 
promote the public interest, and contribute to the maintenance of fair 
and orderly markets.\19\
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    \18\ 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).
    \19\ 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 options on the ISE Indexes will provide 
investors with a hedging and investment vehicle that should reflect 
the overall movement of a substantial segment of the capital 
markets.
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    The trading of options on the ISE Indexes, 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 ISE Indexes as broad-based for purposes of index 
options trading, and therefore appropriate to permit ISE rules 
applicable to the trading of broad-based index options to apply to the 
new ISE Index options. As noted above, the ISE 250 Index is comprised 
of the top 250 stocks in the U.S. capital markets as ranked by market 
capitalization; the ISE 100 is comprised of the equity securities 
underlying the most actively traded listed options classes on the ISE; 
and the ISE 50 is comprised of a subset of the ISE 250 Index, such that 
the components of the ISE 50 Index consist of the top 50 components 
that make up the ISE 250 Index, as ranked by market capitalization.
ISE 250 Index
    The Commission believes that the ISE 250 Index is broad-based 
because it reflects a substantial segment of the U.S. equity markets. 
First, the Index represents various diverse segments of the U.S. 
securities markets. Second, the Index, which is designed to track the 
overall U.S. market, is composed of highly capitalized, actively traded 
securities. According to the ISE, as of June 11, 2004, 99.2% of the 
components were options eligible, as measured by weighting, and 97.2% 
of the components were options eligible, as measured by number. As of 
June 11, 2004, the total capitalization of all of the components in the 
Index was $8.63 trillion, and the mean capitalization of the Index's 
components was approximately $34.51 billion. Third, no single stock or 
group of stocks dominate the index with the largest Index component 
accounting for 3.8% of the weight of the Index, and the five highest 
weighted securities accounting for 15.9% of the weight of the Index, as 
of June 11, 2004. Based on the above, the Commission believes the ISE 
250 Index is appropriately classified as a broad based index under ISE 
rules.
    The Commission also believes that the general broad 
diversification, capitalizations, liquidity, and relative weighting of 
the component securities of the ISE 250 Index minimize the potential 
for manipulation of the Index. First, the Index is comprised of 250 
components listed and actively traded on the NYSE, NASDAQ or Amex, and 
no single security dominates the Index. Second, as of June 11, 2004, 
the total Index capitalization was approximately $8.63 trillion, the 
median and mean capitalizations of the Index's components were 
approximately $16.85 billion and $34.51 billion, respectively, and the 
capitalizations of the Index's components ranged from a high of 
approximately $328.14 billion for the highest-weighted component (which 
represented 3.8% of the weight of the Index) to a low of approximately 
$5.47 billion for the lowest-weighted Index component (which 
represented 0.1% of the weight of the Index). As of June 11, 2004, the 
capitalizations of the Index's five most heavily weighted components, 
which represented 15.9% of the weight of the Index, ranged from 
approximately $241 billion to approximately $328 billion. Third, as of 
June 11, 2004, mean and median six-month average daily trading volume 
of the Index's components was 5.292 million shares and 2.81 million 
shares, respectively, and 100% of the Index's components had six-month 
average daily trading volume of at least 50,000 shares. Fourth, as of 
June 11, 2004, components representing 99.2% of the weight of the Index 
were options eligible. Fifth, the ISE has represented that it will 
monitor and maintain the Index on a quarterly basis at which point the 
Exchange will notify the Division, and will cease trading options on 
the Index if and when: (i) The number of securities in the Index drops 
by \1/3\rd or more; (ii)

[[Page 38224]]

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; (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 40% of the weight of the ISE Indexes.\20\ In the event 
the Index fails at any time to satisfy the maintenance criteria, the 
ISE will not open for trading any additional series of options on the 
Index unless such failure is determined by the Exchange not to be 
significant and the Commission concurs in that determination, or unless 
the continued listing of options on the Index has been approved by the 
Commission under Section 19(b)(2) of the Exchange Act.\21\
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    \20\ The timeframe for monitoring the ISE Indexes was changed 
from an annual to a quarterly basis. Telephone conversation between 
Samir Patel, Assistant General Counsel, ISE, and Mia Zur, Attorney, 
Division of Market Regulation (``Division''), Commission (March 22, 
2005).
    \21\ Telephone conversation between Samir Patel, Assistant 
General Counsel, ISE, and Mia Zur, Attorney, Division, Commission 
(March 22, 2005).
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    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 options on the ISE 250 Index are designed to minimize the 
potential for manipulation and other market impact concerns. The 
position and exercise limits for the options on the ISE 250 Index is 
comparable to the position and exercise limits approved for other index 
options.\22\
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    \22\ 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); 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); and 50937 (December 27, 2004), 70 FR 416 (January 4, 2005) 
(File No. SR-ISE-2004-09) (order approving the listing and trading 
of options on the S&P 1000 Index).
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ISE 100 Index
    The Commission believes that the ISE 100 Index is broad-based 
because it reflects a substantial segment of the U.S. equity markets. 
First, the Index represents various diverse segments of the U.S. 
securities markets. Second, the Index, which is designed to track the 
overall U.S. market, is composed of highly capitalized, actively traded 
securities. According to the ISE, as of June 11, 2004, 100% of the 
components were options eligible, as measured by weighting, and 100% of 
the components were options eligible, as measured by number. Second, as 
of June 11, 2004, the total capitalization of the Index was 
approximately $5.36 trillion. Third, no single stock or group of stocks 
dominate the index with the largest Index component accounting for 6.1% 
of the weight of the Index, and the five highest weighted securities 
accounting for 25.6% of the weight of the Index, as of June 11, 2004. 
Based on the above, the Commission believes the ISE 100 Index is 
appropriately classified as a broad based index under ISE rules.
    The Commission also believes that the general broad 
diversification, capitalizations, liquidity, and relative weighting of 
the component securities of the ISE 100 Index minimize the potential 
for manipulation of the Index. First, the Index is comprised of 100 
components listed and actively traded on the NYSE, NASDAQ or Amex, and 
no single security dominates the Index. Second, as of June 11, 2004, 
the total Index capitalization was approximately $5.36 trillion, the 
median and mean capitalizations of the Index's components were 
approximately $26.09 billion and $53.65 billion, respectively, and the 
capitalizations of the Index's components ranged from a high of 
approximately $328.14 billion for the highest-weighted component (which 
represented 6.1% of the weight of the Index) to a low of approximately 
$104.44 billion for the lowest-weighted Index component (which 
represented 0.002% of the weight of the Index). As of June 11, 2004, 
the capitalizations of the Index's five most heavily weighted 
components, which represented 25.6% of the weight of the Index, ranged 
from approximately $241 billion to approximately $328 billion. Third, 
as of June 11, 2004, mean and median six-month average daily trading 
volume of the Index's components was 11.58 million shares and 6.84 
million shares, respectively, and 100% of the Index's components had 
six-month average daily trading volume of at least 50,000 shares. 
Fourth, as of June 11, 2004, 100% of the components were options 
eligible, as measured by weighting, and 100% of the components were 
options eligible, as measured by number. Fifth, the ISE has represented 
that it will monitor the Index on a quarterly basis at which point the 
Exchange will notify the Division, and will cease trading options on 
the Index 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 40% of the weight of the Index.
    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 options on the ISE 100 Index are designed to minimize the 
potential for manipulation and other market impact concerns. The 
position and exercise limits for the options on the ISE 100 Index is 
comparable to the position and exercise limits approved for other index 
options.\23\
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    \23\ See supra note 22.
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ISE 50 Index
    The Commission believes that the ISE 50 Index is broad-based 
because it, as a subset of the ISE 250 Index, likewise reflects a 
substantial segment of the U.S. equity markets. First, the Index 
represents various diverse segments of the U.S. securities markets. 
Second, the Index, which is designed to track the overall U.S. market, 
is composed of highly capitalized, actively traded securities. 
According to the ISE, as of June 11, 2004, 100% of the components were 
options eligible, as measured by weighting, and 100% of the components 
were options eligible, as measured by number. As of June 11, 2004, the 
total capitalization of the Index was approximately $5.18 trillion. 
Third, no single stock or group of stocks dominate

[[Page 38225]]

the index with the largest Index component accounting for 6.3% of the 
weight of the Index, and the five highest weighted securities 
accounting for 26.5% of the weight of the Index, as of June 11, 2004. 
Based on the above, the Commission believes the ISE 50 Index is 
appropriately classified as a broad based index under ISE rules.
    The Commission also believes that the general broad 
diversification, capitalizations, liquidity, and relative weighting of 
the component securities of the ISE 50 Index minimize the potential for 
manipulation of the Index. First, the Index is comprised of a subset of 
the ISE 250 Index, such that the components of the ISE 50 Index consist 
of the top 50 components that make up the ISE 250 Index, as ranked by 
market capitalization, and no single security dominates the Index. As 
noted above, the components are comprised of the 50 most highly 
capitalized stocks that are actively traded on the NYSE, NASDAQ or 
Amex. Second, as of June 11, 2004, the total Index capitalization was 
approximately $5.18 trillion, the median and mean capitalizations of 
the Index's components were approximately $73.7 billion and $103.5 
billion, respectively, and the capitalizations of the Index's 
components ranged from a high of approximately $328.14 billion for the 
highest-weighted component (which represented 6.3% of the weight of the 
Index) to a low of approximately $24.86 billion for the lowest-weighted 
Index component (which represented 0.5% of the weight of the Index). As 
of June 11, 2004, the capitalizations of the Index's five most heavily 
weighted components, which represented 26.5% of the weight of the 
Index, ranged from approximately $271.9 billion to approximately 
$328.14 billion. Third, as of June 11, 2004, mean and median six-month 
average daily trading volume of the Index's components was 11.63 
million shares and 6.64 million shares, respectively, and 100% of the 
Index's components had six-month average daily trading volume of at 
least 50,000 shares. Fourth, as of June 11, 2004, 100% of the 
components were options eligible, as measured by weighting, and 100% of 
the components were options eligible, as measured by number. Fifth, the 
ISE has represented that it will monitor the Index on a quarterly basis 
at which point the Exchange will notify the Division, and will cease 
trading options on the Index 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 40% of the weight of the Index.
    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 options on the ISE 50 Index are designed to minimize the 
potential for manipulation and other market impact concerns. The 
position and exercise limits for options on the ISE 50 Index is 
comparable to the position and exercise limits approved for other index 
options.\24\
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    \24\ See supra note 22.
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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 options on the ISE 
Indexes, 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 
options on the ISE Indexes 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 options on the ISE Indexes.

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.\25\ In addition, the ISE will apply to the 
options on the ISE Indexes the same surveillance procedures it uses 
currently for existing index options trading on the ISE.
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    \25\ The ISG was formed on July 14, 1983, to, among other 
things, coordinate more effectively surveillance and investigate 
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.
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D. Market Impact

    The Commission believes that the listing and trading of options on 
the ISE Indexes will not adversely impact the underlying securities 
markets.\26\ First, as described above, the ISE Indexes are highly 
capitalized and their underlying components are actively traded. 
Second, the position and exercise limits applicable to the options on 
the ISE Indexes should serve to minimize potential manipulation and 
market impact concerns. Third, the risk to investors of contra-party 
non-performance will be minimized because the options on the ISE 
Indexes, like other standardized options traded in the U.S., will be 
issued and guaranteed by the Options Clearing Corporation. Fourth, 
existing ISE Index options rules and surveillance procedures will apply 
to the options on the ISE Indexes.
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    \26\ 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 options on the ISE Indexes.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-ISE-2004-28), as amended, is 
approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-3456 Filed 6-30-05; 8:45 am]
BILLING CODE 8010-01-P