Chicago Mercantile Exchange: Proposed Amendments Establishing a Report-Based Contract Month Cycle for the Live Hog and Frozen Pork Bellies Futures Option Contracts

COMMODITY FUTURES TRADING COMMISSION

Chicago Mercantile Exchange: Proposed Amendments Establishing a

Report-Based Contract Month Cycle for the Live Hog and Frozen Pork

Bellies Futures Option Contracts

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of Proposed Contract Market Rule Change.

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SUMMARY: The Chicago Mercantile Exchange (CME) has submitted proposed

amendments to its live hogs and frozen pork bellies futures option

contracts. The proposed amendments will establish a ``report-based''

contract month trading cycle. Trading in each contract month of the

cycle will occur only during a two-week period immediately preceding

the release of the United States Department of Agriculture's (USDA's)

quarterly ``Hogs and Pigs'' report.

In accordance with section 5a(a)(12) of the Commodity Exchange Act

and acting pursuant to the authority delegated by Commission Regulation

140.96, the Acting Director of the Division of Economic Analysis

(Division) of the Commodity Futures Trading Commission (Commission) has

determined, on behalf of the Commission, that publication of the

proposed amendments is in the public interest. On behalf of the

Commission, the Division is requesting comment on this proposal.

DATES: Comments must be received on or before June 2, 1994.

ADDRESSES: Interested persons should submit their views and comments to

Jean A. Webb, Secretary, Commodity Futures Trading Commission, 2033 K

Street, NW., Washington, DC 20581. Reference should be made to the

report-based contract month cycle for the live hog and frozen pork

bellies futures option contracts.

FOR FURTHER INFORMATION CONTACT: Frederick V. Linse, Division of

Economic Analysis, Commodity Futures Trading Commission, 2033 K Street,

NW., Washington, DC 20581, telephone (202) 254-7303.

SUPPLEMENTARY INFORMATION: Under the existing terms of the live hogs

and pork bellies futures option contracts, the CME lists ``regular

cycle'' option contract months which are exercisable into each of the

contract months listed by the CME for the underlying live hogs and pork

bellies futures contracts.1 Currently, all live hogs option

contract months expire on the first Friday of the underlying futures

contract month. All but one of the contract months listed for the pork

bellies option contract expire on the last Friday that precedes by at

least three days the first business day of the underlying futures

contract month.2 The CME presently lists for trading at all times

the nearest five live hogs option contract months and the nearest four

pork bellies option contract months.3

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\1\For the live hogs futures contract, the CME currently lists

the following annual cycle of contract months: February, April,

June, July, August, October and December. For the pork bellies

futures contract, the CME currently lists contracts months in the

following annual cycle: February, March, May, July and August.

\2\In the case of pork bellies, there currently are two option

contract months based on the underlying February futures contract

month: one contract month that expires on the last Friday that is

more than three business days prior to the first business day of

February and a contract month which expires on the third Friday of

the November which immediately precedes the underlying February

futures contract month.

\3\For the pork bellies option contract, the CME lists the

nearest five option contract months when one of the nearest five

contract months is the existing option month that is based on the

February futures contract month but expires during the preceding

November.

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The pork bellies option contract's existing terms provide for the

listing of 11 strike prices in intervals of two cents per pound at the

commencement of trading in a contract month, including the strike price

nearest to the previous day's settlement price and the next five strike

prices above and the next five strike prices below that strike price.

The pork bellies option contract currently provides for the listing of

additional strike prices as necessary to maintain the listing of at

least the next five strike prices above and the next five strike prices

below the prevailing prices for the underlying futures contract month.

The live hogs option contract currently provides for the listing at

the commencement of trading in a contract month of all strike prices in

intervals of two cents per pound that fall within the range of ten

cents above and ten cents below the previous day's settlement price for

the underlying futures contract month. In addition, the live hogs

option contract currently provides that, when a contract month becomes

the next-to-expire contract month, all strike prices that fall within a

range of six cents per pound above or six cents per pound below the

previous day's settlement price will be listed in intervals of one cent

per pound. The live hogs option contract's existing terms also provide

for the listing of additional strike prices as necessary to ensure that

all strike prices at the specified price intervals are listed within

the above-noted ranges of ten and, as appropriate, six cents above and

below the prevailing prices for the underlying futures contract month.

The proposed amendments would provide for the listing of a

``report-based'' cycle of contract months for the live hog and frozen

pork bellies option contracts, in addition to the listing of the

``regular cycle'' of option contract months currently provided for in

the contracts' rules.4 Each report-based option will have a

trading life of two weeks. Specifically, a report-based option contract

month will be listed on the first business day of the calendar week

preceding the week in which the USDA releases the quarterly ``Hogs and

Pigs'' report5 and will expire on the last business day of the

week in which the report is released.6

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\4\Under the proposals, the regular cycle option contract months

for pork bellies will include both of the above-noted existing

option contract months that are based on the February futures

contract month.

\5\These quarterly reports are released late in the months of

March, June, September and December. The exact dates on which the

reports will be released during a given year are published by the

USDA during the last calendar quarter of the preceding year.

\6\In some cases, the USDA Hogs and Pigs report will be released

after trading ceases on the last trading day for the proposed

report-based options. For example, the most recent Hogs and Pigs

report was released at 2 p.m., Central Time, on Friday, March 25,

1994 (the USDA releases all Hogs and Pigs reports at 2 p.m., Central

Time, on the scheduled release day, which typically is either a

Thursday or Friday). The release time for this report would have

followed the 1 p.m., Central Time, close of trading for live hogs

and pork bellies on the last trading day of the report-based options

for that month if such options had been available for listing during

March 1994. In such cases, persons who hold report-based option

positions after trading ends on the last trading day would have the

right to choose whether to exercise such options into the underlying

futures contract after the USDA report is released. In this respect,

the option contracts' current terms permit persons holding option

positions after trading ceases on the last trading day to submit to

the CME a notice that they wish to exercise their report-based

option positions until 7 p.m., Central Time, on the last trading

day. For persons holding in-the-money report-based options, the

option contracts' existing rules provide that such options will be

automatically exercised by the CME unless instructions to the

contrary are submitted to the CME by the option holder by 7 p.m. on

the last trading day.

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For report-based options in live hogs, the underlying futures

contract will be the second-nearest futures contract to delivery. For

example, the underlying futures contract for a report-based option that

is listed in March in connection with the release of the March Hogs and

Pigs report would be the June futures contract month. Similarly, the

underlying futures contracts for the other report-based options to be

listed during the calendar year are: the August futures contract month

for the option listed during June; the December futures contract month

for the option listed in September; and the April futures contract

month for the option listed in December. The CME shall list initially,

and thereafter maintain, put and call live hogs report-based options

with strike prices at one-cent intervals in a range of six-cents above

and below the previous day's settlement price of the underlying futures

contract, and at two-cent intervals in a range 10 cents above and below

the previous day's settlement price of the underlying futures contract.

The underlying futures contract months for pork bellies report-

based options are: the May futures contract month for the option listed

in March; the August futures contract month for the option listed in

June; the February futures contract month for the option listed in

September; and the March futures contract month for the option listed

in December. The CME shall list initially and maintain pork bellies

report-based put and call options at eleven strike prices listed in

two-cent intervals, including the strike price that is nearest the

previous day's settlement price of the underlying futures contract, and

the next five higher, and the next five lower strike prices.

The proposed amendments will continue to specify the listing of the

``regular cycle'' of option contract months and the listing of strike

prices for such months in the same manner as provided for in the

contracts' existing terms.

In support of the proposed amendments, the CME states the

following:

Options on futures allow hedgers to shield themselves from the

adverse impact of a [``Hogs and Pigs''] report while retaining much

of the ability to benefit from a favorable market response. However,

for hedgers using options on the more distant contract months, the

high cost of buying an option--due to the large time value component

of the option premium--can outweigh the benefits of protection from

an unfavorable market reaction. As a result, many potential hedgers

are effectively priced out of the option market.

Short-dated options would address this problem. Since these

options would be traded for such a short time, the time value

component of the option premium would be negligible, and therefore

the total premium would be substantially less than for a traditional

long-dated option, all other things being the same. This would make

short-dated options an attractive risk-management tool for hedgers

who require protection around the release of these critical reports,

and particularly those whose usage of options is currently limited

due to the cost of the premium.

Copies of the proposed amendments will be available for inspection

at the Office of the Secretariat, Commodity Futures Trading Commission,

at the above address. Copies of the amended terms and conditions can be

obtained through the Office of the Secretariat by mail at the same

address or by telephone at (202) 254-6314.

The materials submitted by the CME in support of the proposed

amendments may be available upon request pursuant to the Freedom of

Information Act (5 U.S.C. 552) and the Commission's regulations

thereunder (17 CFR part 145 (1987)). Requests for copies of such

materials should be made to the FOI, Privacy and Sunshine Act

Compliance Staff of the Office of the Secretariat at the above address

in accordance with CFR 145.7 and 145.8.

Any person interested in submitting written data, views, or

arguments on the proposed amendments should send such comments to Jean

A. Webb, Secretary, Commodity Futures Trading Commission, at the above

address by the specified date.

Issued in Washington, DC on April 26, 1994.

Blake Imel,

Acting Director, Division of Economic Analysis.

[FR Doc. 94-10464 Filed 5-2-94; 8:45 am]

BILLING CODE 6351-01-P