Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47845

40See, e.g., Securities Exchange Act Release No.

30944 (July 21, 1992), 57 FR 33376 (July 28, 1992).

41 Id.

42 15 U.S.C. 78s(b)(2).

43 17 CFR 200.30–3(a) (12) and (51).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3Securities Exchange Act Release No. 38790

(June 30, 1997), 62 FR 36592 (July 8, 1997).

and the guarantee of OCC for all

contracts traded on the Exchange.

The Commission notes that FLEX

index options on the DJIA can be

constructed with expiration exercise

settlement based on the closing values

of the component securities, which

could potentially result in adverse

effects for the markets in these

securities.40 Although the Commission

continues to believe that basing the

settlement of index products on opening

as opposed to closing prices on

Expiration Friday helps alleviate stock

market volatility, 41 these market impact

concerns are reduced in the case of

FLEX options on the DJIA because

expiration of these options will not

correspond to the normal expiration of

any Non FLEX options (including

options overlying the DJIA), stock index

futures, and options on stock index

futures. In particular, FLEX options,

will never expire on any ‘‘Expiration

Friday,’’ because under CBOE rules the

expiration date of a FLEX option may

not occur on a day that is on, or within,

two business days of the expiration date

of a Non-FLEX option. The Commission

believes that this should reduce the

possibility that the exercise of FLEX

options at expiration will cause any

additional pressure on the market for

underlying securities at the same time

Non-FLEX options expire.

Nevertheless, because the position

limits for FLEX index options on the

DJIA are much higher than those

currently proposed for the

corresponding non-FLEX Index options

and open interest in one or more FLEX

options on the DJIA might have an

impact on the securities markets for the

securities underlying FLEX options. The

Commission expects the Exchange to

monitor the actual effect of FLEX

options on the DJIA once trading

commences and take prompt action

(including timely communication with

the self-regulatory organizations

responsible for oversight of trading in

the underlying securities) should any

unusual market effects develop.

Accelerated Approval of Amendment

Nos. 1 and 2. The Commission finds

good cause to approve Amendment Nos.

1 and 2 to the proposed rule change

prior to the thirtieth day after the date

of publication of notice of filing thereof

in the Federal Register. Specifically, by

stating that CBOE will notify the

Commission in certain circumstances

regarding the weighting, capitalization,

and number of DJIA component stocks,

specified above, and by describing Dow

Jones procedures for replacing

component stocks, Amendment No. 1

will help to ensure that the Commission

receives adequate notice of material

changes in component stocks of the

DJIA.

Amendment Nos. 1 and 2 also amend

Interpretation and Policy .03 under

CBOE Rule 6.42 to specify that the DJIA

options priced at $3 or above will be

traded in eighths of a dollar, unless the

CBOE Board of Directors determines

that the minimum increment shall be

sixteenths of a dollar; CBOE will give at

least one week notice to its members

and member firms prior to

implementing such a change and will

file any proposed rule changes

necessary to conform its rules to such a

change. This portion of Amendment

Nos. 1 and 2 clarifies the minimum

trading increment for DJIA options and

the procedure by which CBOE, through

its Board, can modify that increment. It

also ensures that investors will have

adequate notice of any changes in the

trading increments as well as that

proposed rule change(s) under Section

19(b) of the Act will be filed with the

Commission as appropriate. The

Commission further believes that these

proposed amendments raise no new

regulatory issues. Finally, the

Commission notes that no comments

were received on the original CBOE

proposal, which was subject to the full

21-day notice and comment period.

Accordingly, the Commission believes

that it is consistent with Sections 6(b)(5)

and 19(b)(2) of the Act to approve

Amendment Nos. 1 and 2 to the

proposal on an accelerated basis.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning Amendments

Nos. 1 and 2 to the rule proposal.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 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

Room. Copies of such filing also will be

available for inspection and copying at

the principal office of the Exchange. All

submissions should refer to File No.

SR–CBOE–97–26 and should be

submitted by October 2, 1997.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,42 that the

proposed rule change (SR–CBOE–97–

26) including Amendment Nos. 1 and 2,

is approved. In addition, for purposes of

trading FLEX Options on the Index, the

Commission also finds, pursuant to Rule

9b–1 under the Act, that such options

are standardized options for purposes of

the options disclosure framework

established under Rule 9b–1.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.43

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–24038 Filed 9–10–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39013; File No. SR–CBOE–

97–28]

Self-Regulatory Organizations;

Chicago Board Options Exchange,

Inc.; Order Granting Approval to

Proposed Rule Change and Notice of

Filing and Order Granting Accelerated

Approval of Amendment No. 1 to

Proposed Rule Change Relating to

Listing of Regular Options, Full and

Reduced Value Long-Term Index

Options, and FLEX Options on the Dow

Jones Utility Average

September 3, 1997.

I. Introduction

On June 23, 1997, the Chicago Board

Options Exchange, Inc. (‘‘CBOE’’ or ‘‘

Exchange’’) submitted to the Securities

and Exchange Commission

(‘‘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

list regular options, full and reduced

value long-term index options

(‘‘LEAPS’’), and flexible exchange

options (‘‘FLEX’’) on the Dow Jones

Utility Average.

The proposed rule change was

published for comment in the Federal

Register on July 8, 1997.3 No comments

were received on the proposal. On

August 12, 1997, the CBOE submitted
47846 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

4 In Amendment No. 1, the CBOE represents that

it will notify the Commission if the Index fails to

meet maintenance standards identical to those in

CBOE Rule 24.2. In addition, Amendment No. 1

states that the position limits for FLEX options will

be set at 4 times the limits applicable for industry

index options set forth in Rule 24.4(A)(a)(i). Finally,

Amendment No. 1, in an attached letter from Dow

Jones, describes their procedures for replacing

Index components and outlines their conflict of

interest policy. See letter from Eileen Smith,

Director, Product Development, CBOE to John

Ayanian, Special Counsel, Division of Market

Regulation, SEC dated August 1, 1997 (Amendment

No. 1).

5 ‘‘LEAPS’’ is an acronym for Long-Term Equity

Anticipation Securities. LEAPS are long-term index

option series that expire from 12 to 36 months from

their date of issuance. See CBOE Rule 24.9(b)(1).

6FLEX options are standardized options that

provide investors with the ability to customize

basic option features, including size, expiration

date, exercise style, and exercise price.

7The DJUA currently consists of the following

companies: American Electric Power Co., Inc.,

Columbia Gas System, Inc., Consolidated Natural

Gas Co., Duke Power Co., Consolidated Edison Co.

of New York, Edison International Inc., Enron

Corp., Noram Energy Corp., PG and E Corp., Peco

Energy Co., Public Service Enterprise Group, Inc.,

Southern Co., Texas Utilities Co., Unicom Corp. and

Williams Companies, Inc.

8See 17 CFR 240.11Aa3–1. A ‘‘reported security’’

is defined in paragraph (a)(4) of this Rule as ‘‘any

listed equity security or NASDAQ security for

which transaction reports are required to be made

on a real-time basis pursuant to an effective

transaction reporting plan.’’

9The DJUA was first calculated on January 2,

1929 and the index value was 85.64 on that date.

Amendment No. 1 to the proposed rule

change.4 This order approves the

proposal, as amended, and solicits

comment on Amendment No. 1.

II. Description of the Proposal

A. General

The CBOE proposes to list and trade

options on the Dow Jones Utility

Average (‘‘DJUA’’ or ‘‘Index’’), an index

developed by Dow Jones & Company.

The options on the Index will be based

on the full value of the Index. The CBOE

also proposes to list LEAPS on a full

value index level (‘‘full value LEAPS’’)

and reduced-value LEAPS on the

Index.5 For reduced-value LEAPS, the

underlying value would be computed at

one-tenth of the Index level. Reduced or

full value LEAPS will trade

independent of and in addition to

regular Index options traded on the

CBOE. The CBOE will also provide for

the trading of FLEX Options on the

Index.6

B. Composition of the Index

The DJUA was first calculated on

January 2, 1929, and is based on 15 of

the largest, most liquid U.S. utility

industry stocks. All fifteen of the stocks

in the Index currently trade on the New

York Stock Exchange, Inc. (‘‘NYSE’’).7

All of the component stocks are

‘‘reported securities’’ as that term is

defined in Rule 11Aa3–1 of the Act.8

The Index is price weighted and will be

calculated on a real-time basis using last

sale prices.

As of the close of trading on June 5,

1997, the Index had a closing value of

221.11.9 Also, as of the close of trading

on June 5, 1997, the market

capitalizations of the individual

securities in the Index ranged from a

high of $14.1 billion (Southern Co.) to

a low of $2.1 billion (Noram Energy

Corp.), with a mean and median of $7.2

billion and $6.9 billion, respectively.

The total market capitalization of the

securities in the index was $107.5

billion. The total number of shares

outstanding for the issuers in the index

range from a high of 674 million shares

(Southern Co.) to a low of $5 million

shares (Columbia Gas System, Inc.). The

price per share of the securities in the

Index ranged from a high of $65.75

(Columbia Gas System, Inc.) to a low of

$15 (Noram Energy Corp.) with a sixmonth mean and median, for the period

ending June 5, 1997 of $33.267 and $29,

respectively. In addition, the average

daily trading volume for securities in

the Index ranged from a high of

1,261,386 shares (PG and E Corp.) to a

low of 203,472 shares (Columbia Gas

System, Inc.), with the mean and

median 670,171 and 733,286,

respectively. Lastly, no one security

accounted for more than 13.18 percent

of the Index’s total value (Columbia Gas

System, Inc.), and the percentage

weighting of the five largest issues in

the Index accounted for 49.81 percent of

the Index’s value. The percentage

weighting of the lowest weighted

component was 3.01 percent (Noram

Energy Corp.) and the percentage

weighting of the five smallest issues

accounted for 20.07 percent of the

Index’s value. Finally, all of the

component stocks in the Index are

options eligible and currently the

subject of trading in equity options.

C. Maintenance

Dow Jones & Company is responsible

for maintenance of the DJUA. Dow Jones

& Company may change the

composition of the Index at any time to

reflect the conditions in the utilities

industry. The Managing Editor of the

Wall Street Journal is responsible for

component additions and deletions. The

components of the Index are not

formally reviewed on any set schedule.

The Managing Editor of the Wall Street

Journal selects stocks that he believes

best reflect the utility sector of the

economy and of the stock market. The

Managing Editor usually consults one to

three senior editors of The Wall Street

Journal about prospective changes.

Though various data might be gathered

for reference, this is a subjective

decision. Index maintenance includes

monitoring and completing the

adjustments for company additions and

deletions, stock splits, stock dividends

(other than an ordinary cash dividend),

and stock price adjustments due to

company restructuring or spinoffs. In

almost all instances, a stock is removed

immediately from the DJUA when the

company files for protection under

bankruptcy laws. If required, the Index

Divisor will be adjusted to account for

any of the above changes. Changes to

the Index are announced in the Wall

Street Journal and through the Dow

Jones New Service generally two to

three trading days prior to

implementation. Generally, Index

components are replaced infrequently.

The Index is currently composed of 15

stocks and it is expected that it will

remain at 15.

The Exchange has represented that it

will notify the Commission in the event

that the following maintenance criteria

are not met: (1) the market value of any

component stock is less than $75

million except that the lowest weighted

components comprising not more than

10% of the weight of the index cannot

have market values less than $50

million; (2) less than 90% of the weight

of the Index is represented by

component stocks that are options

eligible or less than 80% of the number

of components are options eligible; (3)

if any component stock trades less than

500,000 shares per month in each of the

last 6 months, except that for the lowest

weighted components comprising not

more than 10% of the weight of the

index, volume must be at least 400,000

shares in each of the last 6 months; (4)

the largest component stock accounts

for more than 25% of the weight of the

index or the largest 5 component stocks

in the aggregate account for more than

60% of the weight of the index and (5)

the number of stocks in the index is

increased or decreased by more than 1⁄3.

D. Applicability of CBOE Rules

Regarding Index Options

As modified herein, the rules in

Chapter XXIV of the CBOE Rules will be

applicable to DJUA Index options, fullvalue and reduced-value Index LEAPS

and FLEX options. Those rules address,

among other things, the applicable

position and exercise limits, policies

regarding trading halts and suspensions,

and margin treatment for narrow-based

index options.
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47847

10A European-style option can be exercised only

during a specified period before the option expires.

11The Commission notes that pursuant to Article

XVII, Section 4 of the Options Clearing

Corporation’s (‘‘OCC’’) by-laws, OCC is empowered

to fix an exercise settlement amount in the event

it determines a current index value is unreported

or otherwise unavailable. Further, OCC has the

authority to fix an exercise settlement amount

whenever the primary market for the securities

representing a substantial part of the value of an

underlying index is not open for trading at the time

when the current index value (i.e., the value used

for exercise settlement purposes) ordinarily would

be determined. See Securities Exchange Act Release

No. 37315 (June 17, 1996), 61 FR 42671 (order

approving SR–OCC–95–19).

12The Commission has previously designated

FLEX index options as standardized options for the

purposes of the options disclosure framework

established under Rule 9b–1 of the Act. See

Securities Exchange Act Release No. 31910

(February 23, 1993), 58 FR 12056 (March 2, 1993).

In addition, the Commission has approved the

listing by CBOE of FLEX Index options on the S&P

100 (‘‘OEX’’), S&P 500 (‘‘SPX’’), Nasdaq 100, and

Russell 2000 Indexes. See Securities Exchange Act

Release Nos. 31920 (February 24, 1993), 58 FR

12280 (March 3, 1993) (approval of FLEX options

on the SPX and OEX indexes); 34052 (May 12,

1994), 59 FR 25972 (May 18, 1994) (approval of

FLEX options on the Nasdaq 100 index); and 32694

(July 29, 1993), 58 FR 41814 (August 5, 1993)

(approval of FLEX options on the Russell 2000

index).

13An American-style option is one that may be

exercised at any time on or before the expiration

date.

14A European-style option is one that may be

exercised only during a limited period of time prior

to expiration of the option.

15A capped-style index option is one that is

automatically exercised prior to expiration when

the cap index value is less than or equal to the

index value for calls or when the cap index value

is greater than or equal to the index value for puts.

16The expiration date of a FLEX option may not

fall on a day that is on, or within two business days,

of the expiration date of a Non-FLEX option.

17See Amendment No. 1, supra note 4.

18Pursuant to CBOE Rule 24.11, the margin

requirements of the Index options will be: (1) for

short 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.

E. Calculation of the Index

The DJUA is a price-weighted index.

The level of the Index reflects the total

price of the component stocks divided

by the Index Divisor. The daily

calculation of the DJUA is computed by

dividing the aggregate price of the

companies in the Index by the Index

Divisor. The Divisor keeps the Index

comparable over time and is adjusted

periodically to maintain the Index. The

values of the Index will be calculated

continuously by Dow Jones & Company

or its designee and will be disseminated

at 15-second intervals during regular

CBOE trading hours to market

information vendors via the Options

Price Reporting Authority (‘‘OPRA’’) or

the Consolidated Tape Association.

F. Contract Specifications

The proposed options will be cashsettled, European-style options.10 The

trading hours for options on the Index

will be from 8:30 a.m. to 3:02 p.m.

Chicago time. Strike prices will be set to

bracket the index in 21⁄2 point

increments or greater. In addition,

pursuant to CBOE rule 24.9, there may

be up to six expiration months

outstanding at any given time.

Specifically, there may be up to three

expiration months from the March,

June, September, and December cycle,

plus up to 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 LEAPS series that expire from 12

to 36 months from the date of issuance.

G. Settlement of Index Options

The proposed options on the Index

will expire on the Saturday following

the third Friday of the expiration

month. Trading in the expiring contract

month will normally cease at 3:02 p.m.

(Chicago time) on the business day

preceding the last day of trading in the

component securities of the Index

(ordinarily the Thursday before

expiration Saturday, unless there is an

intervening holiday). The exercise

settlement value of the Index at option

expiration will be calculated by Dow

Jones based on the opening prices of the

component securities on the business

day prior to expiration. If a stock fails

to open for trading, the last available

price on the stock will be used in the

calculation of the index, as is done for

currently listed indexes.11 When the last

trading day is moved because of

Exchange holidays (such as when CBOE

is closed on the Friday before

expiration), the last trading day for

expiring options will be Wednesday and

the exercise settlement value of Index

options at expiration will be determined

at the opening of regular Thursday

trading.

H. Listing of Long-Term Options on the

Full-Value or Reduced Value DJUA

Index

The Exchange’s proposal provides

that the Exchange may list longer term

option series having up to thirty-six

months to expiration on the Index’s full

value. In lieu of such long-term options

on a full value Index level, the Exchange

may instead list long-term, reduced

value put and call options based on onetenth (1⁄10th) the Index’s full value. The

current and closing index value of any

such reduced-value LEAP will, after

initial computation, be rounded to the

nearest one-hundredth. In either event,

the interval between expiration months

for either a full value or reduced longterm option will not be less than six

months. The trading of any longer term

options would be subject to the same

rules which govern the trading of all

Exchange’s index options, including

sales practice rules, margin

requirements and floor trading

procedures and all options will have

European-style exercise.

I. FLEX Option Trading

The Exchange proposes to list FLEX

Index options on the DJIA. FLEX

options give investors the ability, within

specified limits, to designate certain of

the terms of the options. In recent years,

an over-the-counter (‘‘OTC’’) market in

customized options has developed

which permits participants to designate

the basic terms of the options, including

size, term to expiration, exercise style,

exercise price, and exercise settlement

value, in order to meet their individual

investment needs. Participants in this

OTC market are typically institutional

investors, who buy and sell options in

large-size transactions through a

relatively small number of securities

dealers. To compete with this growing

OTC market in customized options, the

CBOE permits FLEX index options

trading in an exchange auction market

environment, with OCC as issuer and

guarantor.12 The Exchange’s proposal

will allow FLEX option market

participants to designate the following

contract terms for FLEX options on the

DJUA: (1) Exercise price; (2) exercise

style (i.e., American,13 European,14 or

capped 15); (3) expiration date; 16 (4)

option type (put, call, or spread); and (5)

form of settlement (A.M., P.M. or

average).

The Exchange is proposing changes to

its FLEX rules to provide for the trading

of FLEX options on the DJUA. The

proposed changes include an

amendment to the FLEX Option

position limits. Position limits would be

as established by the Exchange but in no

event would be greater than four times

the limits for standard options on the

DJUA.17

J. Position and Exercise Limits, Margin

Requirements, and Trading Halts

The proposal provides that Exchange

rules that are applicable to the trading

of narrow-based index options will

apply to the trading of options on the

Index. Specifically, Exchange rules

governing margin requirements, 18
47848 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

19Pursuant to CBOE Rules 24.4A and 24.5,

respectively, the position and exercise limits for the

Index options will be 15,000 contracts, unless the

Exchange determines, pursuant to Rules 24.4A and

24.5 that a lower limit is warranted. 20Pursuant to CBOE Rule 24.7, the trading of

options on the Index will be halted or suspended

whenever trading in underlying securities whose

weighted value represents more than 20% of the

Index’s value is halted or suspended. 21 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.

The members of the ISG are: the American Stock

Exchange, Inc.; the Boston Stock Exchange, Inc.; the

CBOE; the Chicago Stock Exchange, Inc.; the

National Association of Securities Dealers, Inc.; the

NYSE; the Pacific Stock Exchange, Inc.; and the

Philadelphia Stock Exchange, Inc. Because of

potential opportunities for trading abuses involving

stock index futures, stock options, and the

underlying stock, and the need for greater sharing

of surveillance information for these potential

intermarket trading abuses, the major stock index

futures exchanges (e.g., the Chicago Mercantile

Exchange and the Chicago board of Trade) joined

the ISG as affiliate members in 1990.

22See Amendment No. 1, supra note 4. 23 In approving this rule, the Commission has

considered the proposed rule’s impact on

efficiency, competition, and capital formation. 15

U.S.C. § 78c(f). 24 15 U.S.C. 78f(b)(5). 25Pursuant 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 Index will provide investors

with a hedging vehicle that should reflect the

overall movement of the stocks representing

companies in the utility sector in the U.S. stock

markets. 26See supra notes 18 through 20, and

accompanying text.

27 In addition, for the six-month period ending

June 5, 1997, all of the companies comprising the

Index had an average daily trading volume of at

least 203,472 shares per day.

28The 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.

position and exercise limits, 19 and

trading halt procedures 20 that are

applicable to trading of narrow-based

index options will apply to options

traded on the Index. Position limits on

reduced value long-term DJUA Index

options will be equivalent to the

position limits for regular (full value)

Index options and would be aggregated

with such options (for example, if the

position limit for the full value options

is 15,000 contracts on the same side of

the market, then the position limit for

the reduced value options will be

150,000 contracts on the same side of

the market).

K. 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 options on

the Index. These procedures include

complete access to trading activity in

the underlying securities. Further, the

Intermarket Surveillance Group (‘‘ISG’’)

Agreement, dated July 14, 1983, as

amended on January 29, 1990, will be

applicable to the trading of options on

the Index.21

Dow Jones & Company also has a

policy in place to prevent the potential

misuse of material, non-public

information by members of the Wall

Street Journal managerial and editorial

staff in connection with the

maintenance of the Index. Specifically,

the managerial and editorial staff of the

Wall Street Journal are subject to the

Dow Jones & Company conflicts-ofinterest policy which prohibits, upon

penalty of dismissal, the use or

dissemination of any vital information

prior to publication.22

III. Findingcard Conclusions

The Commission find 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,23 and, in particular, with the

requirements of Section 6(b)(5).24

Specifically, the Commission finds that

the trading of options on the Index,

including full-value and reduced value

Index LEAPS and FLEX options, will

serve to promote the public interest and

help to remove impediments to a free

and open securities market by providing

investors with an additional means to

hedge exposure to market risk

associated with stocks in the utility

sector.25 The trading of options in the

DJUA, however, raises several issues

relating to index design, investor

protection, surveillance, and market

impact. The Commission believes, for

the reasons discussed below, that the

CBOE has adequately addressed the

issues.

A. Index Design and Structure

The DJUA is comprised of only fifteen

stocks, all of which are within one

industry segment, the utility industry

segment. Accordingly, the Commission

believes that it is appropriate for the

CBOE to apply its rules governing

narrow-based index options to trading

in the Index options including for

margin and position and exercise limit

purposes.26

The Commission also believes that the

liquid markets, large capitalizations,

and relative weightings of the index’s

component stocks significantly

minimize the potential for manipulation

of the Index. First, as of June 5, 1997,

the overwhelming majority of the stocks

that comprise the Index are actively

traded, with a mean and median daily

trading volume 670,171 and 733,268

shares, respectively.27 Second, the

market capitalizations of the stocks in

the Index are very large, ranging from

$2.1 billion to $14.1 billion, with the

mean and median being $7.2 billion and

$6.9 billion, respectively. Third,

although the Index is only comprised of

fifteen component stocks, no one stock

or group of stocks dominates the Index.

Specifically, no one stock comprises

more than 13.18% of the Index total

value and the percentage weighting of

the five largest issues in the Index

accounts for 49.81% of the Index’s

value. Fourth, all of the stocks in the

Index are currently the subject of equity

options trading.28 Fifth, the Exchange

has represented that it will notify the

Commission in the event that the

following maintenance criteria are not

met: (1) the market value of any

component stock is less than $75

million except that the lowest weighted

components comprising not more than

10% of the weight of the index cannot

have market values less than $50

million; (2) less than 90% of the weight

of the Index is represented by

component stocks that are options

eligible or less than 80% of the number

of components are options eligible; (3)

if any stock trades less than 500,000

shares per month in each of the last 6

months, except that for the lowest

weighted components comprising not

more than 10% of the weight of the

index, volume must be at least 400,000

shares in each of the last 6 months; (4)

the largest component stock accounts

for more than 25% of the weight of the

index or the largest 5 component stock

accounts for more than 25% of the

weight of the index or the largest 5

component stocks in the aggregate

account for more than 60% of the

weight of the index; and (5) the number

of stocks in the index is increased or

decreased by more than 1⁄3. In the event

the Index fails to satisfy any of the
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47849

29 In addition, if the composition of the Index’s

underlying securities was to substantially change,

the Commission’s decision regarding the

appropriateness of the Index’s current maintenance

standards would be reevaluated, and whether

additional approval under Section 19(b) of the Act

is necessary to continue to trade the product.

30These maintenance standards are similar to

those applied to other index products. See CBOE

Rule 24.2(c).

31The Commission believes that, even though the

Index is price weighted, the high capitalization and

active trading of the component stocks minimize

any manipulative concerns that may arise due to

the price weighting.

32See Securities and Exchange Act Release No.

31243 (September 28, 1992), 57 FR 45849 (October

5, 1992).

33See supra note 21 and accompanying text.

34See Amendment No. 1, supra note 4.

35 In addition, CBOE and OPRA have represented

that CBOE and OPRA have the necessary systems

capacity to support those new series of index

options that would result from the introduction of

options on the Index. See Letter from Joe Corrigan,

Executive Director, OPRA, to Eileen Smith, Director

of Research and Product Development, CBOE, dated

June 12, 1997.

36Securities and Exchange Act Release No. 30944

(July 21, 1992), 57 FR 33376 (July 28, 1992).

37As noted above, FLEX options allow investors

to customize certain terms, including size, term to

expiration, exercise style, exercise price, and

exercise settlement value.

criteria, CBOE will notify the

Commission to determine the

appropriate regulatory response,

including but not limited to, prohibiting

opening transactions, removal of the

securities from the Index, or

discontinuing the listing of new series

of Index options.29 These maintenance

standards should 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 DJUA Index

options.30 Finally, the Commission

believes these factors minimize the

potential for manipulation because it is

unlikely that attempted manipulations

of the prices of the Index components

would affect significantly the Index’s

value. Moreover, the surveillance

procedures discussed below should

detect as well as deter potential

manipulation and other trading

abuses.31

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 options

on the Index, 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

options on the Index 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

options on the Index. Finally,

replacements of component securities in

the Index are published in the Wall

Street Journal two to three trading days

before they are implemented to notify

the public of changes in the

composition of the Index. The

Commission believes this should help to

protect investors and avoid investor

confusion.

C. Surveillance

The Exchange 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.32 In this regard, markets

on which all of the components of the

Index currently trade are members of

the ISG, which provides for the

exchange of all necessary surveillance

information.33

As noted above, Dow Jones &

Company also has a policy in place to

prevent the potential misuse of material,

non-public information by members of

the Wall Street Journal managerial and

editorial staff in connection with the

maintenance of the Index.34

D. Market Impact

The Commission believes that the

listing and trading of options on the

Index, including long-term full-value

and reduced-value Index options and

FLEX options, on the CBOE will not

adversely impact the underlying

securities markets.35 First, as described

above, due to the ‘‘price weighting’’

methodology, no one stock or group of

stocks dominates the Index. Second, as

noted above, the stocks contained in the

Index have relatively large

capitalizations and are relatively

actively traded. Third, the currently

applicable 15,000 contract position and

exercise limits will serve to minimize

potential manipulation and market

impact concerns. Fourth, the risk to

investors of contraparty nonperformance will be minimized because

the options on the Index will be issued

and guaranteed by OCC just like any

other standardized exchange-listed

option traded in the United States.

Lastly, the Commission believes that

settling expiring options on the Index

(including long-term full-value and

reduced-value Index options) based on

the opening prices of component

securities is reasonable and 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

stocks underlying options on the

Index.36

E. FLEX Options Trading

The Commission also believes that the

proposal to list DJUA FLEX options

should encourage fair competition

among brokers and dealers and

exchange markets, by allowing the

Exchange to compete with the growing

OTC market in customized index

options.

The Commission believes the

Exchange’s proposal reasonably

addresses its desire to meet the

demands of sophisticated portfolio

managers and other institutional

investors who are increasingly using the

OTC market in order to satisfy their

hedging needs. Additionally, the

Commission believes that the

Exchange’s proposal will help promote

the maintenance of a fair and orderly

market, consistent with Sections 6(b)(5)

and 11(a) of the Act, because the

purpose of the proposal to list DJUA

FLEX options is to extend the benefits

of a listed, exchange market to index

options that are more flexible than

current listed options and that currently

trade OTC.37 The benefits of the

Exchange’s options market include, but

are not limited to, a centralized market

center, an auction market with posted

transparent market quotations and

transaction reporting, parameters and

procedures for clearance and settlement,

and the guarantee of OCC for all

contracts traded on the Exchange.

The Commission notes that FLEX

index options on the DJUA can be

constructed with expiration exercise

settlement based on the closing values

of the component securities, which

could potentially result in adverse

effects for the markets in these
47850 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

38See, e.g., Securities Exchange Act Release No.

30944 (July 21, 1992), 57 FR 33376 (July 28, 1992).

39 Id. 40 15 U.S.C. 78s(b)(2).

41 17 CFR 200.30–3(a) (12) and (51).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3Securities Exchange Act Release No. 38790

(June 30, 1997), 62 FR 36592 (July 8, 1997).

4 In Amendment No. 1, the CBOE represents that

it will notify the Commission if the Index fails to

meet maintenance standards substantially similar to

those in CBOE Rule 24.2. In addition, Amendment

No. 1 states that the position limits for FLEX

options will be set at 4 times the limits applicable

for industry index options set forth in Rule

24.2(A)(a)(i). Finally, Amendment No. 1, in an

attached letter from Dow Jones, describes their

procedures for replacing Index components and

outlines their conflict of interest policy. See letter

from Eileen Smith, Director, Product Development,

CBOE to John Ayanian, Special Counsel, Division

of Market Regulation, SEC dated August 1, 1997

(Amendment No. 1).

securities.38 Although the Commission

continues to believe that basing the

settlement of index products on opening

as opposed to closing prices on

Expiration Friday helps alleviate stock

market volatility,39 these market impact

concerns are reduced in the case of

FLEX options on the DJUA because

expiration of these options will not

correspond to the normal expiration of

any non-FLEX options (including

options overlying the DJUA), stock

index futures, and options on stock

index futures. In particular, FLEX

options, will never expire on any

‘‘Expiration Friday’’ because the

expiration date of a FLEX option may

not occur on a day that is on, or within,

two business days of the expiration date

of a Non-FLEX option. The Commission

believes that this should reduce the

possibility that the exercise of FLEX

options at expiration will cause any

additional pressure on the market for

underlying securities at the same time

that Non-FLEX options expire.

Nevertheless, because the position

limits for FLEX index options on the

DJUA are much higher than those

currently proposed for the

corresponding non-FLEX Index options

(i.e., 4 times the existing 15,000 contract

limit) and open interest in one or more

FLEX option series could grow to

significant levels, it is possible that

FLEX options on the DJUA might have

an impact on the securities markets for

the securities underlying FLEX options.

The Commission expects the Exchange

to monitor the actual effect of FLEX

options on the DJUA once trading

commences and take prompt action

(including timely communication with

the self-regulatory organizations

responsible for oversight of trading in

the underlying securities) should any

unusual market effects develop.

F. Accelerated Approval of Amendment

No. 1

The Commission finds good cause for

approving Amendment No. 1 to the

proposed rule change prior to the

thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register. Amendment No. 1,

does raise any novel issues. It merely

states that the Exchange will notify the

Commission in the event that the Index

fails to meet a set of maintenance

standards that are substantially similar

to existing maintenance standards for

narrow-based indices. These

representations are identical in all

material respects to those made by the

Exchange in connection with similar

proposals to list options on stock

indexes. In addition, Amendment No. 1

sets position limits for FLEX options at

4 times the limits applicable for

industry index options and includes an

attached letter from Dow Jones &

Company describing their procedures

for replacing Index components and

outlining their conflict of interest

policy. The Commission believes,

therefore, that Amendment No. 1 further

strengthens and clarifies the proposal,

and raises no new regulatory issues.

Further, the Commission notes that the

original proposal was published for the

full 21-day comment period and no

comments were received by the

Commission. Accordingly, the

Commission believes it is consistent

with Sections 19(b)(2) and 6(b)(5) of the

Act to approve Amendment No. 1 to the

Exchange’s proposal on an accelerated

basis.

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, N.W.,

Washington, D.C. 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

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the abovementioned self-regulatory organization.

All submissions should refer to File No.

SR–CBOE–97–28 and should be

submitted by October 2, 1997.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,40 that the

proposed rule change (SR–CBOE–97–

28) is approved, as amended. In

addition, for purposes of trading FLEX

options on the Index, the Commission

also finds, pursuant to Rule 9b–1 under

the Act, that such options are

standardized options for purposes of the

options disclosure framework

established under Rule 9b–1.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.41

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–24039 Filed 9–10–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39012; File No. SR–CBOE–

97–27]

Self-Regulatory Organizations;

Chicago Board Options Exchange,

Inc.; Order Granting Approval to

Proposed Rule Change and Notice of

Filing and Order Granting Accelerated

Approval of Amendment No. 1 to

Proposed Rule Change Relating to

Listing of Regular Options, Full and

Reduced Value Long-Term Index

Options, and FLEX Options on the Dow

Jones Transportation Average

September 3, 1997.

I. Introduction

On June 23, 1997, the Chicago Board

Options Exchange, Inc. (‘‘CBOE’’ or

‘‘Exchange’’) submitted to the Securities

and Exchange Commission

(‘‘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

list regular options, full and reduced

value long-term index options

(‘‘LEAPS’’), and flexible exchange

options (‘‘FLEX’’) on the Dow Jones

Transportation Average.

The proposed rule change was

published for comment in the Federal

Register on July 8, 1997.3 No comments

were received on the proposal. On

August 12, 1997, the CBOE submitted

Amendment No. 1 to the proposed rule

change.4 This order approves the