Self-Regulatory Organizations; Order Granting Accelerated Approval of and Notice of Filing and an Order Granting Accelerated Approval to Amendment No. 1 to a Proposed Rule Change by the Chicago Board Options Exchange, Inc. Relating to the Listing of Options and Long-Term Options on the CBOE Telecommunications Index and Long-Term Options on a Reduced-Value Telecommunications Index

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33473; File No. SR-CBOE-93-50]

Self-Regulatory Organizations; Order Granting Accelerated

Approval of and Notice of Filing and an Order Granting Accelerated

Approval to Amendment No. 1 to a Proposed Rule Change by the Chicago

Board Options Exchange, Inc. Relating to the Listing of Options and

Long-Term Options on the CBOE Telecommunications Index and Long-Term

Options on a Reduced-Value Telecommunications Index

January 13, 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 Telecommunications Index

(``Telecommunications Index'' or ``Index'').\3\ Notice of the proposal

appeared in the Federal Register on December 16, 1993.\4\ 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\On January 6, 1994, the CBOE amended the proposal in order to

request accelerated approval of the proposal pursuant to section

19(b)(2) of the Act, asserting that the proposal does not raise

regulatory concerns that have not been previously been addressed by

the Commission in its consideration and approval of the trading of

options on a telecommunications index on the American Stock

Exchange, Inc. (``Amex'') (``Amendment No. 1). See note 29, infra.

\4\See Securities Exchange Act Release No. 33313 (December 9,

1993), 58 FR 65744.

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II. Description of Proposal

A. General

The CBOE proposes to list and trade options on the CBOE

Telecommunications 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 Telecommunications Index

(``Telecommunications LEAPS'' or ``Index LEAPS'').\5\

Telecommunications LEAPS will trade independent of and in addition to

regular Telecommunications Index options traded on the Exchange.\6\

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\5\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).

\6\According to the CBOE, the S&P Telecommunications 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

telecommunications 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 telecommunications industry funds, as

well as a means of hedging the risks of investing in the

telecommunications industry.

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B. Composition of the Index

The Index is based on twenty-five telecommunications industry

stocks. Eleven of those stocks currently trade on the New York Stock

Exchange, Inc. (``NYSE''), two trade on the American Stock Exchange,

Inc. (``Amex''), and twelve trade through the facilities of the

National Association of Securities Dealers Automated Quotation System

(``NASDAQ'').\7\ The Index is price-weighted and will be calculated on

a real-time basis using last sale prices.

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\7\All twelve 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 153.59. As of October 20,

1993, the market capitalizations of the individual stocks in the Index

ranged from a high of $81.192 billion to a low of $808.32 million, with

the mean and median being $15.027 billion and $11.4 billion,

respectively. The market capitalization of all the stocks in the Index

was $375.68 billion. The total number of shares outstanding for the

stocks in the Index ranged from a high of 1.348 billion shares to a low

of 17.12 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 $80.52 to a low of $23.15. In addition, the

average daily trading volume of the stocks in the Index, for the same

six-month period, ranged from a high of 1.847 million shares per day to

a low of 70,730 shares per day, with the mean and median being 604,462

and 457,294 shares, respectively. Lastly, no one stock comprised more

than 6.91% of the Index's total value and the percentage weighting of

the five largest issues in the Index accounted for 27.77% of the

Index's value. The percentage weighting of the lowest weighted stock

was 2.27% of the Index and the percentage weighting of the five

smallest issues in the Index accounted for 12.27% 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

telecommunications 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 telecommunications

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 thirty-three or reduce the number of Index component

stocks to fewer than seventeen, 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.\8\

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\8\See note 23, 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 Telecommunications 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 Telecommunications 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 then 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.\9\OPRA, in turn, will disseminate the Index value to other

financial vendors such as Reuters, Telerate, and Quotron.

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\9\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 through 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.\10\

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\10\Id.

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F. Contract Specifications

The proposed options on the Index will be cash-settled, European-

style options.\11\ 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 for full-

value Index options with a duration of one year or less to

expiration.\12\ 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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\11\A European-style option can be exercised only during a

specified period before the option expires.

\12\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

Telecommunications 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

Telecommunications Index or a reduced-value Telecommunications 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.\13\

The current and closing Index value for reduced-value

Telecommunications 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 185.46 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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\13\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 Telecommunications

Index options and Telecommunications Index LEAPS. Specifically,

Exchange rules governing margin requirements,\14\ position and exercise

limits,\15\ and trading halt procedures\16\ 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, ten reduced-value

contracts will equal one full-value contract for purposes of

aggregating these positions.

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\14\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.

\15\Pursuant to CBOE rules 24.4A and 24.5, respectively, the

position and exercise limits for the Index options will be 8,000

contracts, unless the Exchange determines, pursuant to Rules 24.4A

and 24.5 that a lower limit is warranted.

\16\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.\17\

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\17\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).\18\ Specifically, the

Commission finds that the trading of Telecommunications 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

telecommunications industry.\19\ The trading of options on the

Telecommunications 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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\18\15 U.S.C. 78f(b)(5) (1988).

\19\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 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 trading of

listed options on the Telecommunications Index will provide

investors with a hedging vehicle that should reflect the overall

movement of the stocks comprising the telecommunications 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 telecommunications 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 Telecommunications 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 Telecommunications Index and reduced-

value Telecommunications Index are narrow-based indices. The

Telecommunications Index is comprised of only twenty-five stocks, all

of which are within one industry--the telecommunications industry. In

addition, the basic character of the reduced-value Telecommunications

Index, which is comprised of the same component securities as the

Telecommunications Index and calculated by dividing the

Telecommunications Index value by ten, is essentially identical to the

Telecommunications Index.\20\ 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.\21\

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\20\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).

\21\See supra notes 14 through 16, and 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 604,462 and 457,294 shares, respectively.\22\ Second, the

market capitalizations of the stocks in the Index are very large,

ranging from a high of $18.192 billion to a low of $808.32 million as

of October 20, 1993, with the mean and median being $15.027 billion and

$11.4 billion, respectively. Third, although the Index is only

comprised of twenty-five component stocks, no one particular stock or

group of stocks dominates the Index. Specifically, no one stock

comprises more than 6.91% of the Index total value and the percentage

weighting of the three largest issues in the Index accounting for

17.77% of the Index's value. Fourth, all twenty-five stocks in the

Index currently are eligible for options trading.\23\ 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 thirty-three or decreases that number to less than seventeen,

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 Telecommunications 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

Telecommunications Index options. Finally, the Commission believes that

the expense of attempting to manipulate the value of the

Telecommunications 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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\22\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 70,730 shares per day.

\23\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 Telecommunications Index

options (including full-value and reduced-value Telecommunications

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 Telecommunications Index options and

Telecommunications Index LEAPS.

C. Surveillance

The Commission believes that a surveillance sharing agreement

between an exchange proposing to list a stock index derivate 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.\24\ In this regard, the CBPE,

NYSE, Amex, and NASD are all members of the Intermarket Surveillance

Group (``ISG''), which provides for the exchange of all necessary

surveillance information.\25\

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\24\Securities Exchange Act Release No. 31243 (September 28,

1992), 57 FR 45849 (October 5, 1992).

\25\See note 17, supra. Although the Index currently does not

contain ADRs, the proposal provides that the Index could contain

ADRs representing telecommunications 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 of the Act.

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D. Market Impact

The commission believes that the listing and trading of

Telecommunications Index options, including full-value and reduced-

value index LEAPS on the CBOE will not adversely impact the underlying

securities markets.\26\ First, as described above, for the most part,

no one stock or group of stocks dominates 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.\27\ Third, the contract 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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\26\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.

\27\See note 23, supra.

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Lastly, the Commission believes that settling expiring

Telecommunications 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.\28\

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\28\See Securities Exchange Act Release No. 30944 (July 21,

1992), 57 FR 33376 (July 28, 1992).

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The Commission finds good cause for approving the proposed rule

change, including Amendment No. 1, prior to the thirtieth day after the

date of publication of notice of filing thereof in the Federal Register

in order to allow the Exchange to list Telecommunications Index options

without delay. The Commission notes that the proposal is very similar

to other narrow-based index option proposals that have been recently

approved by the Commission.\29\ In addition, the Commission notes the

proposal (excluding Amendment No. 1) was published for the full 21-day

comment period and no comments opposing the proposal were received by

the Commission. With regard to Amendment No. 1, the Commission finds

good cause for approving this amendment on an accelerated basis because

the amendment does not affect the substance of the proposed rule

change. It merely requests accelerated approval of the entire proposal

pursuant to section 19(b)(2) of the Act.

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\29\See Securities Exchange Act Release No. 33442 (January 6,

1994), 59 FR 1973 (January 13, 1994) (CBOE Gaming Index); and

Securities Exchange Act Release No. 33191 (November 12, 1993), 58 FR

61719 (November 22, 1993) (Amex Telecommunications Index).

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IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning Amendment No. 1. Persons making written

submissions should file six copies thereof with the Secretary,

Securities and Exchange Commission, 450 Fifth Street, NW., Washington,

DC 20549. 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 at the Commission's Public Reference Section, 450 Fifth Street,

NW., Washington, DC. Copies of such filing will also be available for

inspection and copying at the principal office of the above-mentioned

self-regulatory organization. All submissions should refer to the file

number in the caption above and should be submitted by February 11,

1994.

It is therefore ordered, Pursuant to section 19(b)(2) of the

Act,\30\ that the proposed rule change (SR-CBOE-93-50), as amended, is

approved.

\30\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.\31\

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\31\17 CFR 200.30-3(a)(12) (1993).

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[FR Doc. 94-1429 Filed 1-19-94; 4:15 pm]

BILLING CODE 8010-01-M