[Federal Register Volume 62, Number 163 (Friday, August 22, 1997)]
[Notices]
[Pages 44739-44740]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-22293]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38939; File No. SR-CBOE-97-16]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving Proposed Rule Change, and Amendment No. 1 
Thereto, Relating to the Trading of FLEX Index Options

August 15, 1997.
    On March 13, 1997, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend its rules governing the 
trading of FLEX Index options. On May 13, 1997, the CBOE submitted an 
amendment to the Commission regarding the proposal.\3\ Notice of the 
proposed rule change, and Amendment No. 1 thereto, appeared in the 
Federal Register on May 22, 1997.\4\ No comments were received on the 
proposal. This order approves the proposal, as amended.
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    \1\ 15 U.S.C. 78s(b)(1) (1988 & Supp. V 1993).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Timothy H. Thompson, Senior Attorney, CBOE, 
to Steve Youhn, Division of Market Regulation, Commission, dated May 
13, 1997 (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 38637 (May 14, 
1997), 62 FR 28084 (May 22, 1997).
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I. Description of the Proposal

    The purpose of the proposed rule change is to make certain changes 
to the Exchange's rules governing the trading of FLEX Index options. 
Specifically, those changes involve a reduction in the percentage of a 
trade to which a Submitting Member indicating an intent to cross is 
entitled, and the establishment of bid-offer spreads for certain FLEX 
Index trades.
    Since their inception,\5\ FLEX Index options have relied on 
Appointed Market-Makers (``AMMs'') to provide liquidity for FLEX 
requests for quotes (``RFQs''). AMMs are required, pursuant to CBOE 
Rule 24A.9(b), to enter a FLEX Quote in response to any RFQ on any FLEX 
option of the class to which the AMM is appointed.
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    \5\ See Securities Exchange Act Release No. 31920 (February 24, 
1993), 58 FR 12280 (March 3, 1993).
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    As an inducement to attract volume that would otherwise be 
transacted in the over-the-counter market, the Exchange established 
percentage entitlements for the Exchange member that initiates FLEX 
bidding and offering by submitting a RFQ (``Submitting Member'') where 
the Submitting Member has indicated an intention to cross or to act as 
principal on the trade and has matched or improved the best bid or 
offer (``BBO''). Generally, with some qualifications, pursuant to CBOE 
Rule 24A.5, the Submitting Member in a FLEX Index option is entitled to 
50% (\1/2\) of the trade in the case where the Submitting Member 
matches the BBO and 66.67% (\2/3\) of the trade where the Submitting 
Member improves the BBO.
    To the extent Submitting Members accept their entire entitlement on 
a FLEX Index option trade, half of the trade or less would remain for 
the other market-makers to share. The Exchange believes, however, that 
these entitlements have discouraged participation by market-makers in 
the FLEX Index product. Accordingly, the Exchange has proposed to amend 
its rules so that the entitlement for Submitting Members would be 
reduced to the greater of 25% or a proportional share of the trade.\6\ 
This means, for example, that if there are four market-makers 
participating on the trade in addition to the Submitting Member, then 
the Submitting Member would be entitled to 25% of the trade because it 
is greater than the proportional share (\1/5\) of the trade. However, 
if there were two market-makers participating on a trade along with a 
Submitting Member, the Submitting Member would be entitled to a 
proportional share of the trade, or \1/3\. This is different from the 
current entitlement for Submitting Members in Flex Equity options, 
under CBOE Rule 24A.5, who are entitled only to 25% of the trade 
regardless of the number of participants to the trade.\7\
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    \6\ The rule currently provides that the Submitting Member is 
entitled to the largest of the percentage of the trade (\1/2\ or \2/
3\), $1 million Underlying Equivalent Value, or the remaining 
Underlying Equivalent Value on a closing transaction valued at less 
than $1 million. These qualifications ($1 million Underlying 
Equivalent Value or the remaining Underlying Equivalent Value) 
remain in the proposed rule.
    \7\ Because the percentage entitlements for Submitting Members 
for both FLEX Equity and FLEX Index options are currently contained 
in one paragraph in CBOE Rule 24A.5, the Exchange's proposal will 
separate the treatment of Flex Equity and Flex Index options into 
different paragraphs.

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[[Page 44740]]

    The proposed rule change also amends the language of sub-paragraphs 
(e)(iii) (A) and (B) of CBOE Rule 24A.5 to state that a submitting 
member ``will have priority to execute'' the specified share of a trade 
that is the subject of a RFQ, instead of the term ``be permitted to 
execute.'' The Exchange initially adopted this rule language in 
Securities Exchange Act Release No. 37337 in order to clarify that a 
member may cross more than the designated share as to which he has 
priority if no one else is willing to trade at the same or a better 
price.\8\ The current filing inadvertently utilized the old rule 
language. Amendment No. 1 to the filing clarifies that the original 
rule language will remain unchanged.
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    \8\ See Securities Exchange Act Release No. 37337 (June 19, 
1996), 61 FR 33561 (June 27, 1996).
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    The Exchange is also proposing to impose maximum bid-offer spreads 
on certain FLEX Index options. Currently, under CBOE Rule 24A.9 (d), 
market-makers are not required to quote a minimum bid-offer spread in 
FLEX options because of the unique nature of the product in which new 
series are established periodically by the submission of a RFQ. Based 
on experience over the last four years, however, the Exchange has 
determined that it is appropriate to establish maximum bid-offer 
spreads for Index FLEX AMMs when quoting European-exercise FLEX options 
overlying the S&P 100 Index (``OEX'') or the S&P 500 Index (``SPX') 
with a time to expiration of more than two weeks and less than two 
years.\9\ The Exchange expects that the establishment of these spreads 
will increase customer confidence in the CBOE markets for these 
products. The CBOE also believes that the establishment of these 
maximum bid-offer spreads will ensure tight markets for the majority of 
the Index FLEX RFQs submitted to the CBOE floor; the proposed spreads 
would have applied to 77% of the RFQs submitted in 1996. The Exchange 
also believes that if, as expected, the reduction in the entitlement of 
a trade to a Submitting Member encourages more active participation by 
market-makers in the quoting process, then bid-offer spreads, through 
competition, should decrease in any event.
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    \9\ Options with a time to expiration greater than two weeks and 
less than or equal to one year shall have the following bid/ask 
spreads:

                                                                        
               Where Bid Is                   Maximum Bid/Ask Spread Is 
                                                                        
Less than $5..............................  \3/4\ of $1                 
At least $5, but not more   than $10......  $1                          
At least $10, but not   more than $20.....  $1.50                       
At least $20..............................  $2                          
                                                                        
  Options with a time to expiration greater than one year and less than 
 two years shall have the following maximum bid/ask spreads:            
                                                                        
Where Bid Is                                  Maximum Bid/Ask Spread Is 
                                                                        
Less than $10.............................  $1.50                       
At least $10, but not   more than $20.....  $2                          
At least $20, but not   more than $40.....  $3                          
At least $40..............................  $4                          
                                                                        
  Compare CBOE Rule 8.7 regarding maximum bid/ask spreads for non-Flex  
 options.                                                               
                                                                        

    Because the proposed rules should encourage more active 
participation of market-makers in the establishment of bid-ask spreads 
as well as require the quoting of spreads on FLEX Index options within 
a certain range, CBOE believes that the proposed rules are consistent 
with and further the objectives of Section 6(b)(5) of the Act in that 
they are designed to improve communications to and from the Exchange's 
trading floor in a manner that promotes just and equitable principles 
of trade, prevents fraudulent and manipulative acts and practices, and 
maintains fair and orderly markets.

II. 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).\10\ The Commission 
finds that CBOE's proposal to reduce the Submitting Member's 
entitlement rate to the greater of 25% or a proportional share of the 
trade should serve to encourage more active participation by market-
makers in FLEX Index options. Specifically, because participating 
market-makers will be entitled to a greater share of the FLEX trade, 
they should have more incentive to make markets in FLEX Index options. 
More active participation should, in turn, result in increased 
liquidity for the product, which would serve to enhance the market for 
FLEX Index options.\11\ Accordingly, the Commission believes that this 
portion of the CBOE filing is consistent with the Act in that it should 
facilitate transactions in securities consistent with investor 
protection and in furtherance of the public interest.\12\
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    \10\ 15 U.S.C. 78f(b)(5) (1988).
    \11\ The Commission notes that the current entitlement for 
Submitting Members in FLEX Equity options will remain unchanged at 
25% of the trade regardless of the number of participants to the 
trade.
    \12\ The Commission also believes that the proposed rule change 
will not result in any injury to public customers as customer orders 
on parity will not receive a smaller participation than any other 
crowd participant.
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    The Commission also believes that CBOE's proposal to impose maximum 
bid-offer spreads for Index FLEX AMMs when quoting European-style FLEX 
options overlying the OEX or the SPX should serve to potentially 
tighten spreads as well as to ensure that the spreads are no larger 
than the predetermined range. The Commission believes that the 
potential for tighter markets in FLEX OEX and SPX contracts as a result 
of the adoption of maximum bid-ask spreads should serve to increase 
investors' confidence that the quoted market for these options 
represents fair and indicative prices. In this regard, the CBOE may 
wish to adopt maximum bid-ask spreads for other FLEX options. 
Accordingly, the Commission believes the Exchange's proposal to impose 
maximum bid-offer spreads for certain FLEX Index options is consistent 
with the Act in that it should facilitate trading in securities.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-97-16), as amended, is 
approved.

    \13\ 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.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-22293 Filed 8-21-97; 8:45 am]
BILLING CODE 8010-01-M