[Federal Register Volume 59, Number 9 (Thursday, January 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-877]
[[Page Unknown]]
[Federal Register: January 13, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33442; File No. SR-CBOE-93-49]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the Chicago Board Options Exchange, Inc., Relating to the
Listing of Options and Long-Term Options on the CBOE Gaming Index and
Long-Term Options on a Reduced-Value Gaming Index
January 6, 1994.
I. Introduction
On October 27, 1993, the Chicago Board Options Exchange, Inc.
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide for the listing and
trading of index options on the CBOE Gaming Index (``Gaming Index'' or
``Index''). Notice of the proposal appeared in the Federal Register on
November 18, 1993.\3\ No comment letters were received on the proposed
rule change. This order approves the Exchange's proposal.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1992).
\3\See Securities Exchange Act Release No. 33173 (November 9,
1993), 58 FR 60889 (November 18, 1993).
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II. Description of Proposal
A. General
The CBOE proposes to list and trade options on the CBOE Gaming
Index, an index developed by the CBOE. The CBOE also proposes to list
either long-term options on the full-value Index or long-term options
on a reduced-value Index that will be computed at one-tenth of the
value of the Gaming Index (``Gaming LEAPS'' or ``Index LEAPS'').\4\
Gaming LEAPS will trade independent of and in addition to regular
Gaming Index options traded on the Exchange.\5\
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\4\LEAPS is an acronym for Long-Term Equity Anticipation
Securities. LEAPS are long-term index option series that expire from
twelve to thirty-six months from their date of issuance. See CBOE
Rule 24.9(b)(1).
\5\According to the CBOE, the S&P Gaming Index represents a
segment of the U.S. equity market that is not currently represented
in the derivative markets and, as such, the CBOE concludes, should
offer investors a low-cost means to achieve diversification of their
portfolios toward or away from the gaming industry. The CBOE
believes the Index will provide retail and institutional investors
with a means to benefit from their forecasts of that industry's
market performance. Options on the Index also can be utilized by
portfolio managers and investors to provide a performance measure
and evaluation guide for passively or actively managed gaming
industry funds, as well as a means of hedging the risks of investing
in the gaming industry.
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B. Composition of the Index
The Index is based on fifteen gaming industry stocks. Eight of
those stocks currently trade on the New York Stock Exchange, Inc.
(``NYSE''), and seven currently trade through the facilities of the
National Association of Securities Dealers Automated Quotation System
(``NASDAQ'').\6\ The Index is price-weighted and will be calculated on
a real-time basis using last sale prices.
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\6\All seven NASDAQ component stocks are currently qualified for
and traded on the NASDAQ National Market.
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As of December 31, 1993, the Index was at 244.52. As of October 20,
1993, the market capitalizations of the individual stocks in the Index
ranged from a high of $5.08 billion to a low of $137.123 million, with
the mean and median being $1.305 billion and $447.6 million,
respectively. The market capitalization of all the stocks in the Index
was $19.581 billion. The total number of shares outstanding for the
stocks in the Index ranged from a high of 122.571 million shares to a
low of 9.066 million shares. The average price per share of the stocks
in the Index, for a six-month period between April 1 and September 30,
1993, ranged from a high of $56.15 to a low of $7.92. In addition, the
average daily trading volume of the stocks in the Index, for the same
six-month period, ranged from a high of 1,099,278 shares per day to a
low of 93,627 shares per day, with the mean and median being 384,389
and 351,635 shares, respectively. Lastly, no one stock comprised more
than 16.19% of the Index's total value and the percentage weighting of
the five largest issues in the Index accounted for 55.51% of the
Index's value. The percentage weighting of the lowest weighted stock
was 1.57% of the Index and the percentage weighting of the five
smallest issues in the Index accounted for 16.28% of the Index's value.
C. Maintenance
The Index will be maintained by the CBOE. The CBOE may change the
composition of the Index at any time to reflect the conditions in the
gaming industry. If it becomes necessary to replace a stock in the
Index, the Exchange represents that it will make every effort to add
new stocks that are representative of the gaming industry and will take
into account a stock's capitalization, liquidity, volatility, and name
recognition. Further, stocks may be replaced in the event of certain
corporate events, such as takeovers or mergers, that change the nature
of the security. If, however, the Exchange determines to increase the
number of Index component stocks to greater than twenty or reduce the
number of Index component stocks to fewer than ten, the proposal
provides that the CBOE will submit a rule filing with the Commission
pursuant to Section 19(b) of the Act. In addition, in choosing
replacement stocks for the Index, the CBOE will be required to ensure
that at least 90% of the weight of the Index continues to be made up of
stocks that are eligible for standardized options trading.\7\
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\7\See note 22, infra.
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D. Applicability of CBOE Rules Regarding Index Options
Except as modified by this order, the rules in Chapter XXIV of the
CBOE Rules will be applicable to Gaming Index options. Those rules
address, among other things, the applicable position and exercise
limits, policies regarding trading halts and suspensions, and margin
treatment for both broad and narrow-based index options.
E. Calculation of the Index
The CBOE Gaming Index is a price-weighted index and reflects
changes in the prices of the Index component stocks relative to the
Index's base date. Specifically, the Index value is calculated by
adding the prices of the component stocks and them dividing this
summation by a divisor that is equal to the number of stocks in the
Index to get the average price. To maintain the continuity of the
Index, the divisor will be adjusted to reflect non-market changes in
the prices of the component securities as well as changes in the
composition of the Index. Changes which may result in divisor
adjustments include, but are not limited to, stock splits and
dividends, spin-offs, certain rights issuances, and mergers and
acquisitions.
The Index will be calculated continuously and will be disseminated
to the Options Price Reporting Authority (``OPRA'') every fifteen
seconds by the CBOE, based on the last-sale prices of the component
stocks.\8\ OPRA, in turn, will disseminate the Index value to other
financial vendors such as Reuters, Telerate, and Quotron.
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\8\For purposes of the daily dissemination of the Index value,
if a stock included in the Index has not opened for trading, the
CBOE will use the closing value of that stock on the prior trading
day when calculating the value of the Index, until the stock opens
for trading.
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The Index value for purposes of settling outstanding Index options
contracts upon expiration will be calculated based upon the regular way
opening sale prices for each of the Index's component stocks in their
primary market on the last trading day prior to expiration. In the case
of securities traded on and trough the NASDAQ National Market, the
first reported sale price will be used. Once all of the component
stocks have opened, the value of the Index will be determined and that
value will be used as the final settlement value for expiring Index
options contracts. If any of the component stocks do not open for
trading on the last trading day before expiration, then the prior
trading day's (i.e., Thursday's) last sale price will be used in the
Index calculation. In this regard, before deciding to use Thursday's
closing value of a component stock for purposes of determining the
settlement value of the Index, the CBOE will wait until the end of the
trading day on expiration Friday.\9\
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\9\Id.
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F. Contract Specifications
The proposed options on the Index will be cash-settled, European-
style options.\10\ Standard options trading hours (8:30 a.m. to 3:10
p.m.) Central Standard time) will apply to the contracts. The Index
multiplier will be 100. The strike price interval will be $5.00 for
full-value Index options with a duration of one year or less to
expiration.\11\ In addition, pursuant to CBOE Rule 24.9, there will be
six expiration months outstanding at any given time. Specifically,
there will be three expiration months from the March, June, September,
and December cycle plus three additional near-term months so that the
two nearest term months will always be available. As described in more
detail below, the Exchange also intends to list several Index LEAP
series that expire from twelve to thirty-six months from the date of
issuance.
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\10\A European-style option can be exercised only during a
specified period before the option expires.
\11\For a description of the strike price intervals for reduced-
value Index options and long-term Index options, See Section G,
infra.
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Lastly, the options on the Index will expire on the Saturday
following the third Friday of the expiration month (``Expiration
Friday''). Accordingly, since options on the Index will settle based
upon opening prices of the component stocks on the last trading day
before expiration (normally a Friday), the last trading day for an
expiring Index option series will normally be the second to the last
business day before expiration (normally a Thursday).
G. Listing of Long-Term Options on the Full-Value or Reduced-Value
Gaming Index
The proposal provides that the Exchange may list long-term Index
options that expire from 12 to 36 months from listing on the full-value
Gaming Index or a reduced-value Gaming Index that will be computed at
one-tenth the value of the full-value Index. Existing Exchange
requirements applicable to full-value and reduced-value LEAPS will
apply to full-value and reduced-value Index LEAPS.\12\ Also, the
current and closing Index value for reduced-value Gaming LEAPS will be
computed by dividing the value of the full-value Index by 10 and
rounding the resulting figure to the nearest one-hundredth. For
example, a Index value of 185 185.46 would be 18.55 for the Index LEAPS
and 185.43 would become 18.54. The reduced-value Index LEAPS will have
a European-style exercise and will be subject to the same rules that
govern the trading of all the Exchange's index options, including sales
practice rules, margin requirements and floor trading procedures. The
strike price interval for the reduced-value Index LEAPS will be no less
than $2.50 instead of $5.00.
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\12\See CBOE Rule 24.9(b).
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H. Position and Exercise Limits, Margin Requirements, and Trading Halts
Because the Index is classified as an Industry Index under CBOE
rules, Exchange rules that are applicable to the trading of options on
narrow-based indexes will apply to the trading of Gaming Index options
and Gaming Index LEAPS. Specifically, Exchange rules governing margin
requirements,\13\ position and exercise limits,\14\ and trading halt
procedures\15\ that are applicable to the trading of narrow-based index
options will apply to options traded on the Index. The proposal further
provides that, for purposes of determining whether a given position in
reduced-value Index options complies with applicable position and
exercise limits, positions in reduced-value Index options will be
aggregated with positions in the full-value Index options. For these
purposes, tend reduced-value contracts will equal one full-value
contract for purposes of aggregating these positions.
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\13\Pursuant to CBOE Rule 24.11, the margin requirements for the
Index options will be: (1) For short options positions, 100% of the
current market value of the options contract plus 20% of the
underlying aggregate Index value, less any out-of-the-money amount,
with a minimum requirement of the options premium plus 10% of the
underlying Index value; and (2) for long term options positions,
100% of the options premium paid.
\14\Pursuant to CBOE Rules 24.4A and 24.5, respectively, the
position and exercise limits for the Index options will be 6,000
contracts, unless the Exchange determines, pursuant to Rules 24.4A
and 24.5 that a lower limit is warranted.
\15\Pursuant to CBOE Rule 24.7, the trading on the CBOE of Index
options may be halted or suspended whenever trading in underlying
securities whose weighted value represents more than 20% of the
Index value are halted or suspended.
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I. Surveillance
Surveillance procedures currently used to monitor trading in each
of the Exchange's other index options will also be used to monitor
trading in full-value and reduced-value Index options. These procedures
include complete access to trading activity in the underlying
securities. Further, the Intermarket Surveillance Group Agreement,
dated July 14, 1983, as amended on January 29, 1990, will be applicable
to the trading of options on the Index.\16\
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\16\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.
See Intermarket Surveillance Group Agreement, July 14, 1983. The
most recent amendment to the ISG Agreement, which incorporates the
original agreement and all amendments made thereafter, was signed by
ISG members on January 29, 1990. See Second Amendment to the
Intermarket Surveillance Group Agreement, January 29, 1990.
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III. Findings and Conclusions
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5).\17\ Specifically, the
Commission finds that the trading of Gaming Index options, including
full-value and reduced-value Index LEAPS, will serve to promote the
public interest and help to remove impediments to a free and open
securities market by providing investors with a means to hedge exposure
to market risk associated with securities in the gaming industry.\18\
The trading of options on the Gaming Index, including full-value and
reduced-value LEAPS on the Index, however, raises several concerns,
namely issues related to index design, customer protection,
surveillance, and market impact. The Commission believes, for the
reasons discussed below, that the CBOE adequately has addressed these
concerns.
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\17\15 U.S.C. 78f(b)(5) (1988).
\18\Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument is in the pubic
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 trading of
listed options on the Gaming Index will provide investors with a
hedging vehicle that should reflect the overall movement of the
stocks comprising the gaming industry in the U.S. stock markets. The
Commission also believes that these Index options will provide
investors with a means by which to make investment decisions in the
gaming industry sector of the U.S. stock markets, allowing them to
establish positions or increase existing positions in such markets
in a cost effective manner. Moreover, the Commission believes that
the reduced-value Index LEAPS, that will be traded on an index
computed at one-tenth the value of the Gaming Index, will serve the
needs of retail investors by providing them with the opportunity to
use a long-term option to hedge their portfolios from long-term
market moves at a reduced cost.
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A. Index Design and Structure
The Commission finds that the Gaming Index and reduced-value Gaming
Index are narrow-based indices. The Gaming Index is comprised of only
fifteen stocks, all of which are within one industry--the gaming
industry. In addition, the basic character of the reduced-value Gaming
Index, which is comprised of the same component securities as the
Gaming Index and calculated by dividing the Gaming Index value by ten,
is essentially identical to the Gaming Index.\19\ Accordingly, the
Commission believes it is appropriate for the CBOE to apply its rules
governing narrow-based index options to trading in the Index
options.\20\
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\19\See generally Securities Exchange Act Release No. 29994
(November 26, 1991), 56 FR 63536 (December 4, 1991) (order
designating the PSE Technology Index as a broad-based index rather
than a narrow-based index).
\20\See supra notes 13 through 15, and a accompanying text.
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The Commission also finds that the large capitalizations, liquid
markets, and relative weightings of the Index's component stocks
significantly minimize the potential for manipulation of the Index.
First, the overwhelming majority of the stocks that comprise the Index
are actively traded, with a mean and median average daily trading
volume of 384,389 and 351,635 shares, respectively.\21\ Second, the
market capitalizations of the stocks in the Index are very large,
ranging from a high of $5.08 billion to a low of $37.123 million as of
October 20, 1993, with the mean and median being $1.305 billion and
$447.566 million, respectively. Third, although the Index is only
comprised of fifteen component stocks, no one particular stock or group
of stocks dominates the Index. Specifically, no one stock comprises
more than 16.19% of the Index's total value and the percentage
weighting of the three largest issues in the Index accounting for
37.75% of the Index's value. Fourth, all fifteen stocks in the Index
currently are eligible for options trading.\22\ The proposed CBOE
maintenance requirement that 90% of the weighting of the Index be
comprised of stocks that are eligible for options trading will ensure
that the Index is almost completely comprised of options eligible
stocks. Fifth, if the CBOE increases the number of component stocks to
more than twenty or decreases that number to less than ten, the CBOE
will be required to seek Commission approval pursuant to Section
19(b)(2) of the Act before listing new strike price or expiration month
series of Gaming Index options. This will help protect against material
changes in the composition and design of the Index that might adversely
affect the CBOE's obligations to protect investors and to maintain fair
and orderly markets in Gaming Index options. Finally, the Commission
believes that the expense of attempting to manipulate the value of the
Gaming Index in any significant way through trading in component stocks
(or options on those stocks) coupled with, as discussed below, existing
mechanisms to monitor trading activity in those securities, will help
deter such illegal activity.
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\21\In addition, for the six-month period between April 1 and
September 30, 1993, all of the companies comprising the Index had an
average daily trading volume greater than 93,627 shares per day.
\22\The CBOE's options listing standards, which are uniform
among the 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 7,000,000; (2) there must be a
minimum of 2,000 stockholders; (3) trading volume must have been at
least 2.4 million over the preceding twelve months; and (4) the
market price must have been at least $7.50 for a majority of the
business days during the preceding three calendar months. See CBOE
Rule 5.3.
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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 Gaming Index options
(including full-value and reduced-value Gaming LEAPS), 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
and Index LEAPS will be subject to the same regulatory regime as the
other standardized options currently traded on the CBOE, the Commission
believes that adequate safeguards are in place to ensure the protection
of investors in Gaming Index options and Gaming Index LEAPS.
C. Surveillance
The Commission believes that a surveillance sharing agreement
between an exchange proposing to list a stock index derivative product
and the exchange(s) trading the stocks underlying the derivative
product is an important measure for surveillance of the derivative and
underlying securities markets. Such agreements ensure the availability
of information necessary to detect and deter potential manipulations
and other trading abuses, thereby making the stock index product less
readily susceptible to manipulation.\23\ In this regard, the CBOE,
NYSE, and NASD are all members of the Intermarket Surveillance Group
(``ISG''), which provides for the exchange of all necessary
surveillance information.\24\
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\23\Securities Exchange Act Release No. 31243 (September 28,
1992), 57 FR 45849 (October 5, 1992).
\24\See note 16, supra. Although the Index currently does not
contain ADRs, the proposal provides that the Index could contain
ADRs representing gaming industry stocks. If the composition of the
Index would change so that greater than 20% of the Index was
represented by ADRs whose underlying securities were not subject to
a comprehensive surveillance sharing arrangement, then it would be
difficult for the Commission to reach the conclusions reached in
this order and the Commission would have to determine whether it
would be suitable to continue to trade options on the Index. The
CBOE should, accordingly, notify the Commission immediately if more
than twenty percent of the numerical value of the Index is
represented by ADRs whose underlying securities are not subject to a
comprehensive surveillance sharing agreement. Such a change in the
composition of the Index may warrant the submission of a rule filing
pursuant to Section 19 under the Act.
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D. Market Impact
The Commission believes that the listing and trading of Gaming
Index options, including full-value and reduced-value Index LEAPS on
the CBOE will not adversely impact the underlying securities
markets.\25\ First, as described above, for the most part, no one stock
or group of stocks dominates the Index. Second, because 90% of the
numerical value of the Index must be accounted for by stocks that meet
the options listing standards, the component securities generally will
be actively-traded, highly-capitalized stocks.\26\ Third, the position
and exercise limits applicable to Index options and Index LEAPS will
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 and Index LEAPS will be issued and
guaranteed by the Options Clearing Corporation just like any other
standardized option traded in the United States.
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\25\In addition, the CBOE has represented that the CBOE and the
Options Price Reporting Authority (``OPRA'') have the necessary
systems capacity to support those new series of index options that
would result from the introduction of Index options and Index LEAPS.
See letter from Nancy L. Nielsen, Assistant Corporate Secretary,
CBOE, to Sharon Lawson, Assistant Director, Division of Market
Regulation, SEC, dated October 26, 1993, and memorandum from Joe
Corrigan, Executive Director, OPRA, to Eileen Smith, CBOE, dated
October 22, 1993.
\26\See note 22, supra.
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Lastly, the Commission believes that settling expiring Gaming Index
options (including full-value and reduced-value Index LEAPS) based on
the opening prices of component securities is consistent with the Act.
As noted in other contexts, valuing options for exercise settlement on
expiration based on opening prices rather than closing prices may help
reduce adverse effects on markets for securities underlying options on
the Index.\27\
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\27\See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992).
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\28\ that the proposed rule change (SR-CBOE-93-49) is approved.
\28\15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-877 Filed 1-12-94; 8:45 am]
BILLING CODE 8010-01-M