[Federal Register Volume 65, Number 110 (Wednesday, June 7, 2000)]
[Notices]
[Pages 36185-36187]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14257]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42857; File No. SR-CBOE-00-02]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by the Chicago 
Board Options Exchange, Inc. Governing the Final Settlement Value of 
Index Options in the Event of a Primary Market Closure

May 30, 2000.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on February 15, 2000, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On February 25, 2000, the CBOE submitted Amendment No. 1 to 
the proposed rule change. \3\ The Commission is publishing this notice 
to solicit comments on the proposed rule change from interested persons 
and to approve the proposal on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the CBOE corrected the filing number, 
changing it from SR-CBOE-99-02. See letter from Christopher R. Hill, 
Attorney, Office of Enforcement, CBOE, to Nancy Sanow, Assistant 
Director, Division of Market Regulation, Commission, dated February 
24 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to amend its rules governing the settlement 
procedures for its index options in certain unusual circumstances. The 
text of the proposed rule change is available at the CBOE and at the 
Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
CBOE has prepared summaries, set forth in Sections A, B, and C below, 
of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Based on recent events, the Exchange proposes to change settlement 
procedures for index options when a primary market for underlying 
stocks in an index does not open on the scheduled settlement day. Under 
such circumstances, the proposed rule change will allow the use of the 
next available opening prices for the affected underlying securities to 
calculate the settlement value of the index options.
    On Thursday, September 16, 1999, it was feared that the New York 
Stock Exchange, Inc. (``NYSE'') would not open for business the next 
day as Hurricane Floyd traveled up the Eastern seaboard. In the event 
that the NYSE had not opened on Friday, September 17, an expiration 
Friday, the settlement of index options and futures contracts would 
have been affected. A review of this situation demonstrates the 
critical need for this rule change.
    Current CBOE index option settlement rules do not expressly address 
a situation when an entire primary market, such as the NYSE, fails to 
open for business. The closest applicable rules, such as CBOE Rule 
24.9(a)(4), provide that a specific underlying security in an index 
does not open, the last reported sale price of such a security will be 
used to determine the

[[Page 36186]]

settlement price of index options. Thus, if Hurricane Floyd had 
prevented the NYSE from opening on Friday, September 17, the final 
settlement value of September index options would have been established 
by looking backward to the previous day's closing prices for NYSE 
stocks (i.e., the closing prices on Thursday, September 16.)
    This `backward focus' of the CBOE index option settlement rules 
threatened to cause severe difficulties during the Hurricane Floyd 
situation, both for investors who traded stock index options against 
the underlying stocks as well as those who traded the index options 
against index futures. Both groups of investors rely upon the final 
settlement value of index options to converge with the corresponding 
values of the underlying stock index or stock index future. For both 
groups, however, the backward focus of the CBOE index option settlement 
rules threatened to prevent this convergence in September.
    Many public customers and market makers use stock index options to 
hedge ``cash'' positions they hold in the stocks which make up the 
index. Because current CBOE settlement rules would have looked 
backwards to the Thursday, September 16, closing prices of NYSE stocks 
to determine the final settlement value of September stock index 
options if the NYSE had not opened on Friday, September 17, investors 
who wished to make sure their stock position converged with their 
option position in the event of a Friday NYSE closure would have had to 
exit their NYSE stock positions that Thursday.
    Obviously, however, no investor could know for certain on Thursday 
whether weather conditions on Friday would prevent the opening of the 
NYSE. Thus, the backward focus of the current CBOE settlement rule 
forced investors who wished to stay hedged to guess about the future. 
If they guessed that Hurricane Floyd would keep the NYSE closed on 
Friday, they would have to exit their stock positions on Thursday. If 
they guessed that Floyd would not close the NYSE, they would hold their 
stock positions until Friday. Either way, if they guessed wrong, their 
stock and option positions would not converge at expiration, and they 
would be exposed to the very market risk they had sought to use options 
to avoid.
    Public customers and market makers that trade index options against 
stock index futures faced similar difficulties. For example, numerous 
investors trade the SPX (the index option based on the S&P 500 Stock 
Index) against the S&P 500 future, which trades at the Chicago 
Mercantile Exchange, Inc. (``CME''). Unlike CBOE's settlement rules, 
the CME's settlement rules for the S&P 500 future are forward-focused. 
If a primary market for a component stock in the S&P 500 Index does not 
open on the day scheduled for determination of the Final Settlement 
price of the S&P 500 future, then the price of that stock is 
determined, for the purposes of calculating the Final Settlement Price 
of the future, based on the opening price of that stock on the next day 
that its primary market is open for trading.\4\
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    \4\ See CME Rule 4003.A. In part, CME Rule 4003.A states, ``If 
the primary market for a component stock in the index does not open 
on the day scheduled for determination of the Final Settlement 
Price, then the price of that stock shall be determined, for the 
purposes of calculating the Final Settlement Price, based on the 
opening price of that stock on the next day that its primary market 
is open for trading.''
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    Thus, if Hurricane Floyd had prevented the NYSE from opening on 
Friday, September 17, the final settlement value of the September S&P 
500 futures would have been established under CME rules according to 
the opening price that following Monday, September 20, of those stocks 
which had not traded on Friday. At the same time, the final settlement 
value of the SPX options would have been established under CBOE rules 
according to the closing price of those stocks on Thursday, September 
16. In other words, the final settlement values of the September SPX 
options and the September S&P 500 futures would most likely have 
differed, rather than converged.
    Had this occurred, the Exchange believes that it would have 
affected a significant number of SPX traders (both public customers and 
market makers) because a lot of them hedge their option positions with 
S&P 500 futures contracts. Had the S&P futures and the SPX not 
converged at expiration on Friday, September 17, these traders could 
have faced significant unexpected exposure to market risk.
    The problems detailed above can be prevented if the CBOE changes 
its index option settlement rules to be forward-focused. If such a rule 
had been in place for SPX options on Thursday, September 16, no public 
customer or market maker would have been forced to guess on Thursday 
about the impact of Hurricane Floyd on Friday. If weather had shut the 
NYSE down until Monday, September 20, the final settlement value of the 
September SPX options would be calculated using the Monday opening 
prices of the NYSE stocks. Any investor using SPX options to hedge 
stock positions in the S&P 500 Index could have held their stock 
positions until they knew what was going to happen on Friday. Even if 
the NYSE had been closed that day, they could have simply exited their 
stock positions with confidence on Monday simply by entering ``Market 
on Open'' orders for all affected stocks. Further, a forward-focused 
settlement rule in cases of primary market closure would also have 
assured convergence at settlement between the value of index options 
and index futures.
    For all the above reasons, there is a strong consensus among market 
participants consulted by the Exchange that the Exchange should change 
its index option settlement rules to be forward-focused, and this 
proposed rule change achieves that in its amendment of CBOE Rule 
24.9(a)(4) and its addition of the new CBOE Rule 24.7(e). The provision 
set forth in the proposed new Rule 24.7(e) would apply to all index 
options traded on the Exchange. In the event that a primary market for 
one or more securities underlying a current index does not open for 
trading on a given day, the price of such securities shall be 
determined, for purposes of calculating the current index value at 
expiration, by reference to the opening price of those securities on 
the next day that their primary market reopens for trading.
    This provision also recognizes the authority of the Options 
Clearing Corporation (``OCC'') to establish a final settlement value 
for index options in the event of a primary market closure pursuant to 
its Rules and By-Laws. The proposed rule change makes clear that such 
action by the OCC would take precedence in determining any final index 
settlement value.
2. Statutory Basis
    CBOE believes that the proposed changes to CBOE Rules 24.7 and 
24.9(a)(4) are consistent with and in furtherance of the provisions of 
section 6(b)(5) \5\ of the Act. By establishing a CBOE Rule which 
defines current index option settlement values in the event of a 
primary market closure, and does so with a forward rather than a 
backward focus, this filing will help public customers and market 
makers alike to be better able to use stock index options to 
predictably hedge their transactions in stock index futures and/or the 
underlying stocks themselves. The Exchange believes that this will 
improve the efficiency of, remove impediments to, and perfect the 
mechanisms of, a free and open market and a national market system, 
thus better protecting investors and the public interest.
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    \5\ 15 U.S.C. 78f(b)(5).

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[[Page 36187]]

3. Statutory Basis
    The CBOE believes the proposed rule change is consistent with and 
furthers the objectives of section 6(b)(5) \6\ of the Act in that it is 
designed to remove impediments to a free and open market and to protect 
investors and the public interest.
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    \6\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Member, Participants, or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-00-02 and should be 
submitted by June 28, 2000.

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

    After careful review, the Commission finds that the proposal is 
consistent with the requirements of the Act.\7\ In particular, the 
Commission finds the proposal is consistent with section 6(b)(5) \8\ of 
the Act. Section 6(b)(5) requires, among other things, that the rules 
of an exchange be designed to promote just and equitable principles of 
trade and to protect investors and the public interest.
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    \7\ In addition, pursuant to section 3(f) of the Act, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \8\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the proposal promotes just and 
equitable principles of trade. In particular, the proposal clarifies 
index settlement procedures in the unusual situation when a primary 
market where component stocks trade is closed on the index settlement 
day. By way of example, the CBOE discusses a situation in the fall of 
1999 when some people thought the NYSE would be closed on the 
settlement day. This closure would have affected many index options 
traded on CBOE, including S&P 500 index options. If the market did not 
open, CBOE's settlement rules would have required the Exchange and the 
OCC to look at the previous closing prices for component stocks that 
traded on the NYSE. This procedure varied from the settlement 
procedures of a futures exchange that traded futures on the S&P 500 
index. Moreover, the settlement procedure also placed investors in S&P 
500 index options in the unusual situation of having to guess as to 
whether the NYSE would open on the settlement day. By relying on the 
opening price of a security on the next day the primary market is open, 
the proposal helps clarify CBOE index settlement procedures and also 
makes these procedures conform to industry practice in the futures 
markets. Further, the proposal helps reduce investor confusion by 
implementing rules that foster investor certainty in the unusual 
situation when a primary market where component stocks trade is closed 
on the index settlement day.
    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice thereof in the Federal Register. A virtually identical proposal, 
SR-OCC-00-01, was published in the Federal Register for the full 21-day 
comment period and the Commission received no public comments.\9\ The 
current proposal mirrors the changes that were proposed by the OCC in 
SR-OCC-00-01. The Commission believes, therefore, that granting 
accelerated approval to the proposed rule change is appropriate and 
consistent with section 6 of the Act.\10\
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    \9\ See Release No. 34-42769 (May 9, 2000), 65 FR 31036 (May 15, 
2000) (order approving SR-OCC-00-01.)
    \10\ 15 U.S.C. 78f.
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    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-CBOE-00-02), as amended, is 
hereby approved on an accelerated basis.
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    \11\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14257 Filed 6-6-00; 8:45 am]
BILLING CODE 8010-01-M