47840 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

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

2 17CFR 240.19b–4.

3Amendment No. 1 states that the Exchange will

notify the Commission if any of the following occur:

the market value of any component stock is less

than $75 million and that component is not options

eligible; less than 80% of the weight of the Index

is represented by component stocks that are eligible

for options trading; 10% or more of the weight of

the index is represented by component stocks

trading less than 20,000 shares per day; the largest

component stock accounts for more than 15% of the

weight of the index or the largest five components

in the aggregate account for more than 50% of the

weight of the Index; and if the Index decreases to

less than 20 component stocks. In addition,

Amendment No. 1 amends CBOE Rule 6.42,

Interpretation and Policy .03, to provide that the

minimum increment for bids and offers for options

on the Dow Jones Industrial Average (‘‘DJIA’’) price

at $3 or above shall be in eighths, unless the

Exchange determines that the minimum increment

should be reduced to sixteenths. Finally, CBOE has

attached to Amendment No. 1 a letter from Dow

Jones & Company, Inc. (‘‘Dow Jones’’) describing its

procedures for replacing Index components and

stating the conflicts-of-interest policy regarding its

employees. See letter from Eileen Smith, Director,

Product Development, CBOE, to John Ayanian,

Special Counsel, Market Regulation, Commission,

dated August 1, 1997 (‘‘Amendment No. 1’’).

4Amendment No. 2 states that with respect to

trading DJIA options in increments of sixteenths of

a dollar for options greater than $3, the CBOE Board

of Directors will make the determination to allow

trading in options on the DJIA in sixteenths. In

addition, CBOE will notify members and member

firms of the Board’s decision to trade DJIA options

in sixteenths at least one week prior to

implementing the change. Also, CBOE will make a

rule change under Section 19(b)(3)(A) of the Act

prior to the time the change goes into effect and will

make any additional filings necessary to conform its

Rules to the fact that trading in DJIA options will

take place in sixteenths. Amendment No. 2 also

deletes the reference to LEAPS on the DJIA from

Rule 24.9(b)(2), the reduced-value LEAPS section,

to reflect the fact that there will be no reducedvalue LEAPS trading on the DJIA. See letter from

Eileen Smith, Director, Product Development,

CBOE, to John Ayanian, Special Counsel, Market

Regulation, Commission, dated August 8, 1997

(‘‘Amendment No. 2’’).

5 ‘‘Dow Jones,’’ and ‘‘Dow Jones Industrial

AverageTM’’ are trademarks of Dow Jones &

Company, Inc. and have been licensed for use for

certain purposes by CBOE. CBOE’s options based

on the Dow Jones Industrial Average are not

sponsored, endorsed, sold or promoted by Dow

Jones, and Dow Jones makes no representation

regarding the advisability of investing in such

products.

the use of an existing separate account

of Anchor National to support the

Polaris II Contracts. Anchor National

filed a new a registration statement on

Form N–4 (333–25473) to issue the

Contracts through such existing separate

account (File No. 811–03859), which

was declared effective on May 14, 1997.

3. The Board of Directors of Anchor

National authorized the dissolution of

Applicant and, pursuant to Arizona

Insurance Law, on June 3, 1997, Anchor

National nullified the establishment of

the Applicant.

4. Applicant has never made a public

offering of its securities and does not

propose to make a public offering of its

securities.

5. Applicant has not held any assets

since its establishment.

6. Accordingly, there were no

securityholders of Applicant as of the

date of the filing of this application;

Applicant has not, within the last 18

months, transferred any of its assets to

a separate trust, the beneficiaries of

which were or are securityholders of

Applicant; no distributors were made to

securityholders of Applicant in

connection with Applicant’s dissolution

and no assets have been retained by the

Applicant.

7. No debts or liabilities of the

Applicant remain outstanding.

8. Applicant is not a party to any

litigation or administrative proceeding.

9. Applicant has not sold any

securities of which it is the issuer and

Applicant is not engaged in, and does

not propose to engage in, any business

activities other than those necessary for

the winding-up of its affairs.

For the Commission, by the Division of

Investment Management, pursuant to

delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–24139 Filed 9–10–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39011; File No. SR–CBOE–

97–26]

Self-Regulatory Organizations; Order

Granting Approval to Proposed Rule

Change and Notice of Filing and Order

Granting Accelerated Approval to

Amendment Nos. 1 and 2 to the

Proposed Rule Change by the Chicago

Board Options Exchange, Inc.,

Relating to Listing and Trading of

Regular and Long-Term Index Options

and FLEX Options on the Dow Jones

Industrial 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 and trade cash-settled, Europeanstyle stock index options on the Dow

Jones Industrial Average (‘‘DJIA’’ or

‘‘Index’’), a broad-based, price-weighted

index comprised of 30 large companies

traded on the New York Stock Exchange

(‘‘NYSE’’), as more fully described

below. The CBOE is also proposing to

trade long-term index options series

(‘‘LEAPS’’) in the Index as well as

flexible exchange options (‘‘FLEX

Options’’) on the Index.

The proposed rule change, together

with the substance of the proposal, was

published for comment in Securities

Exchange Act Release No. 38789 (June

30, 1997), 62 FR 36588 (July 8, 1997).

No comment letters were received in

response to the proposal. The Exchange

subsequently filed Amendment Nos. 1

and 2 to the proposed rule change on

August 12, 1997 3 and August 12, 1997,4

respectively. This order approves the

proposal, as amended, and solicits

comments on Amendment Nos. 1 and 2.

II. Background and Description

CBOE hereby proposes to amend

certain of its rules to provide for the

listing and trading on the Exchange of

options on the DJIA, a broad-based

index designed by Dow Jones &

Company, Inc. (‘‘Dow Jones TM.5)

Options on the DJIA TM will be cashsettled and will have European-style

exercise provisions. The Exchange also

proposes to amend its rules to provide

for the trading of FLEX Options on the

DJIA. The DJIA is a price-weighted

index of thirty of the largest, most liquid
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47841

6The DJIA currently consists of the following

companies: Allied Signal, Incorporated; Aluminum

Company of America; American Express Company;

AT&T Corporation; Boeing Company; Caterpiller,

Incorporated; Chevron Corporation; Coca Cola

Company; Du Pont Ei de Nemours; Eastman Kodak

Company; Exxon Corporation; General Electric

Company; General Motors Corporation; Goodyear

Tire and Rubber Company; Hewlett Packard

Company; IBM International Business Machines;

International Paper Company; Johnson and

Johnson; JP Morgan and Company, Incorporated;

McDonalds Corporation; Merck and Company,

Incorporated; Minnesota Mining and

Manufacturing; Philip Morris Companies,

Incorporated; Procter and Gamble Company; Sears

Roebuck and Company; Travelers Group,

Incorporated; Union Carbide Corporation; United

Technologies Corporation; Wal Mart Stores,

Incorporated; and Walt Disney Company.

7See 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.’’ A ‘‘transaction reporting plan’’ is

defined in paragraph (a)(2) of this rule as ‘‘any plan

for collecting, processing, making available or

disseminating transaction reports with respect to

transactions in reported securities filed with the

Commission pursuant to, and meeting the

requirements of, this Section.’’

8The Commission notes that an option on the

DJIA, valued at one-one-hundredth of the value of

the DJIA, would have a value approximately equal

to 73.05, assuming an Index value of 7305.29.

9See Amendment No. 1 supra note 3.

10See Amendment No. 1, supra note 3.

11The Exchange is not proposing to trade reduced

value LEAPS on the DJIA.

stocks traded on organized U.S.

securities markets. 6 Options initially

will be based on one-one hundredth of

the DJIA. CBOE’s proposal also permits

it to trade Index options on an

underlying level of one-tenth of the

value of the DJIA. CBOE indicates,

however, that it does not intend to

immediately trade such options

contracts and states in its rule filing that

these contracts may be introduced at a

later date. CBOE stated that its purpose

in getting approval to trade options

based on either one-one-hundredth or

one-tenth of the value of the DJIA is to

offer contracts which appeal to both

retail and institutional investors. If

CBOE were to trade options based on

both one-one-hundredth and one-tenth

the value of the DJIA, each contract

would have a different ticker symbol to

eliminate any potential confusion.

Index Design. The DJIA has been

designed to measure the performance of

certain high capitalization stocks. The

DJIA has been calculated by Dow Jones

& Company since 1896 and, according

to CBOE, is the most commonly watch

index of the U.S. stock market. The DJIA

is a price-weighted index with each

stock affecting the Index in proportion

to its market price. Each stock in the

Index is currently trading on the NYSE

and is eligible for options trading. All

component stocks are ‘‘reported

securities,’’ as that term is defined in

Rule 11Aa3–1 of the Act.7

As of June 5, 1997, the 30 stocks in

the Index ranged in capitalization from

$5.9 billion to $200.0 billion. The total

market capitalization of the Index was

$1.7 trillion, the average capitalization

of the firms in the Index was $57.0

billion and the median capitalization

was $40.6 billion. The largest stock

accounted for 6.30% of the total weight

of the Index, while the smallest

accounted for 1.46%. The top 5

components accounted for 26.18% of

the weight of the Index. In addition, the

average daily trading volume for the

component stocks over the six-month

period from December 1996 to May

1997 ranged from a high of

approximately 8.2 million (Philip

Morris) to a low of approximately

515,000 (Goodyear Tire and Rubber

Co.).

Calculation. The DJIA is a priceweighted index. The level of the Index

reflects the total price of the component

stocks divided by the Index Divisor. The

DJIA was first calculated on May 26,

1896 and the Index value was 40.94 on

that date. The Index had a closing value

of 7305.29 on June 5, 1997.8 The daily

calculation of the DJIA Index 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 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

(‘‘CTA’’).

Maintenance. Dow Jones is

responsible for maintenance of the DJIA.

Generally, Index components are

replaced infrequently. The Managing

Editor of The Wall Street Journal is

responsible for component additions

and deletions. The Managing Editor

selects the stocks he believes best reflect

the industrial sector of the economy and

of the stock market; though various data

might be gathered for reference, this is

a subjective decision.9 The stocks are

not formally reviewed on any set

schedule. 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 DJIA 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. These changes

are announced in The Wall Street

Journal and through the Dow Jones

News Service generally three to five

days prior to implementation. The DJIA

has been composed of 30 stocks since

1928 and it is expected that it will

remain at 30 stocks.

In addition, the Exchange will notify

the Commission if any of the following

occur: the market value of any

component stock is less than $75

million and that component is not

options eligible; less than 80% of the

weight of the Index is represented by

component stocks that are eligible for

options trading; 10% or more of the

weight of the Index is represented by

component stocks trading less than

20,000 shares per day; the largest

component stock accounts for more than

15% of the weight of the Index or the

largest five components in the aggregate

account for more than 50% of the

weight of the Index; and the Index

decreases to less than 20 component

stocks.10

Index Option Trading. In addition to

regular Index options, the Exchange

may provide for the listing of long-term

Index option series (‘‘LEAPS’’). For

LEAPS, the underlying value would be

computed by using the same levels as

proposed for the Index options; onetenth or one-one-hundredth of the DJIA,

as applicable.11 The current and closing

Index value of any such LEAP will, after

such initial computation, be rounded to

the nearest one-hundredth.

The Exchange also is proposing 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 The Options Clearing

Corporation (‘‘OCC’’) as issuer and
47842 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

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 3. The

Commission notes that the original proposal was to

have a minimum trading increment for all bids and

offers in the DJIA, regardless of price, in sixteenths

of a dollar.

18See Amendment No. 2, supra note 4.

19Phone conversation between Eileen Smith,

Director, Research and Product Development,

CBOE, and Heather Seidel, Attorney, Market

Regulation, Commission, on June 30, 1997.

20The Commission notes that pursuant to Article

XVII, Section 4 of the 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 and

Exchange Act Release No. 37315 (June 17, 1996), 61

FR 42671 (order approving SR–OCC–95–19).

21The 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, dated

July 14, 1983, amended January 29, 1990. The

members of the ISG are the following: 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. The major stock

index futures exchanges (including the Chicago

Mercantile Exchange and the Chicago Board of

Trade) joined the ISG as affiliate members in 1990.

22See Amendment No. 1, supra note 3.

guarantor.12 The Exchange’s proposal

will allow FLEX option market

participants to designate the following

contract terms for FLEX options on the

DJIA: (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).

Strike prices for options based on oneone-hundredth of the Index will be set

to bracket the Index in 1⁄2 point

increments or greater. CBOE notes that

these 1⁄2 point increments correspond to

5-point increments in other broad-based

index options, such as the Standard &

Poor’s 100 (‘‘S&P 100’’) Index and

Standard & Poor’s 500 (‘‘S&P 500’’)

Index, because the size of the contract

will be approximately one-tenth of the

size of the option contracts on those

other broad-based indexes. Strike prices

for options based on one-tenth of the

Index will be set in 5-point increments.

The trading hours for options on the

Index will be from 8:30 a.m. to 3:15 p.m.

Chicago time. Options based on the

DJIA will be listed in up to three nearterm months plus up to three months

from the March quarterly cycle.

The Exchange is also proposing to add

an interpretation to Rule 6.42 to

establish that the minimum increment

for bids and offers in the DJIA priced at

or above $3 shall be in eighths of a

dollar, unless the Exchange determines

that the minimum increment for these

options should be reduced to sixteenths

of a dollar.17 Rule 6.42 currently

requires bids and offers to be expressed

in eights of $1, except for those series

trading below $3. Under CBOE’s

proposal, the Board of Directors will

have the authority to allow the trading

of DJIA options in sixteenths of a dollar,

and CBOE will notify its members and

member firms at least one week prior to

implementing such a change. In

addition, CBOE will make a rule change

filing under Section 19(b)(3)(A) of the

Act prior to the time the change goes

into effect, and will make any additional

filings necessary to conform its Rules to

the fact that trading in DJIA options will

be changed from increments of eighths

to sixteenths of a dollar.18

Exercise and Settlement. 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 3:15 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 19 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.20

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.

Surveillance. The Exchange will use

the same surveillance procedures

currently utilized for each of the

Exchange’s other index options to

monitor trading in Index options and

Index LEAPS. In addition, the Exchange

will use the same surveillance

procedures currently utilized for each of

the Exchange’s other FLEX index

options to monitor trading in FLEX

options on the DJIA. 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 23,

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

Position Limits. The Exchange

proposes to establish position limits for

options on the DJIA at 1,000,000

contracts on either side of the market for

option contracts that are based on oneone hundredth of the value of the DJIA

and 100,000 for contracts based on onetenth of the value of the DJIA. Positions

in options based on either level of the

DJIA will be aggregated for purposes of

determining compliance with position

limits; positions in options based on

one-tenth of the value of the DJIA must

be multiplied by a factor of 10, then

aggregated with options based on oneone hundredth of the value of the DJIA.

The broad-based index hedge exemption

will be 2,500,000 contracts for options

based on one-one hundredth of the DJIA

and 250,000 contracts for options based

on one-tenth of the DJIA. These limits

are roughly equivalent, in dollar terms,

to the limits applicable to options on the

S&P 500 Index, a broad-based A.M.-

settled index option.
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47843

23See Exhibit D.

24 15 U.S.C. 78f(b)(5).

25See discussion infra regarding FLEX options on

the DJIA.

26Pursuant to Section 6(b)(5) of the Act, the

Commission must predicate approval of any new

securities product upon a finding that the

introduction of such product is in the public

interest. Such a finding would be difficult with

respect to a product 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 Index options will

provide investors with a hedging vehicle that

should reflect the overall market of stocks

representing a substantial segment of the U.S.

securities market.

27 In approving this rule, the Commission notes

that it has considered the proposed rule’s impact on

efficiency, competition, and capital formation. 15

U.S.C. 78c(f).

28See Notice Release. The Exchange’s option

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 million shares; (2) there must be

a minimum of 2,000 stockholders; (3) trading

volume must have been at least 2.4 million shares

over the preceding twelve months; and (4) the

market price per share must have been at least $7.50

for a majority of business days during the preceding

three calendar months. See Interpretation .01 to

Exchange Rule 5.3.

29The 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.

30See Amendment No. 1, supra note 3. The

Commission recognizes that the capitalization and

daily trading volume of the Index’s components

currently far exceed these standards. Nonetheless,

Continued

FLEX Option Trading. The Exchange

is proposing changes to its FLEX rules

to provide for the trading of FLEX

options on the DJIA. The proposed

changes include an amendment to the

FLEX Index option position limits. The

change would apply the same limits to

positions in FLEX options on the DJIA

that exist for positions in other broadbased indexes in the FLEX program; the

limits are 200,000 contracts on the same

side of the market. For purposes of

determining compliance with these

limits, every ten option contracts based

on the one-one hundredth of the DJIA

will be counted as one contract.

Exchange Rules Applicable. As

modified herein, the Rules in Chapter

XXIV will be applicable to options on

the DJIA. Broad-based margin rules will

apply to the Index. The Exchange is

proposing to amend Chapter XXIV, Rule

24.14, Disclaimers, to identify Dow

Jones and Company, Inc. as the index

reporting authority for the DJIA and

other Dow Jones products.

Capacity. CBOE believes it has the

necessary systems capacity to support

new series that would result from the

introduction of options on the DJIA.

CBOE has also been informed that

OPRA also has the capacity to support

the new series.23 In making this

determination, the Exchange notes that

OPRA has made, and is in the process

of making, significant enhancements to

its capacity. These enhancements

include: upgrades to computers;

additional lines to firms, vendors and

exchanges; and the introduction of new

technology incorporating high speed

data transmission. All of these

enhancements will be in place prior to

the scheduled introduction of these

options contracts and will give more

than sufficient capacity to deal with

these and other new products.

III. Discussion

The Commission finds that the

proposed rule changes are consistent

with the requirements of the Act and the

rules and regulations thereunder

applicable to a national securities

exchange, and, in particular, with the

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

Specifically, the Commission finds that

the trading of options on the DJIA,

including FLEX options 25 and fullvalue LEAPS, will serve to promote the

public interest as well as to help remove

impediments to a free and open

securities market. The Commission also

believes that the trading of options on

the Index will allow investors holding

positions in some or all of the securities

underlying the Index to hedge the risks

associated with their portfolios.

Accordingly, the Commission believes

that DJIA Index options will provide

investors with an important trading and

hedging mechanism.26 By broadening

the hedging and investment

opportunities of investors, the

Commission believes that the trading of

options on the DJIA will serve to protect

investors, promote the public interest,

and contribute to the maintenance of

fair and orderly markets.27

Nevertheless, the trading of options,

including FLEX Options and full-value

LEAPS, on the DJIA raises several issues

related to the design and structure of the

Index, customer protection,

surveillance, and market impact. The

Commission believes, however, for the

reasons discussed below, that the CBOE

has adequately addressed these issues.

Index Design and Structure. The

Commission believes that it is

appropriate for the Exchange to

designate the DJIA as a broad-based

index for purposes of index option

trading. Specifically, the Commission

believes that the Index is broad-based

because it reflects a substantial segment

of the U.S. equities market. First, the

Index represents various diverse

segments of the U.S. securities markets,

with 19 different industries represented

by the Index’s components, such as

chemicals and allied products, motion

picture production, eating and drinking

places, transportation equipment, and

industrial/commercial machinery and

computer equipment. Second, the Index

consists of 30 actively-traded stocks that

are currently all options eligible.28

Third, the Index, which is designated to

track the overall U.S. Market, is

composed of highly capitalized, actively

traded securities. Specifically, the total

capitalization of the Index as of June 5,

1997, was approximately $1.7 trillion,

representing approximately one-fifth of

the U.S. equity market. Market

capitalization of the individual stocks

ranges from $5.9 billion to $200 billion,

with an average capitalization of $57

billion. As of the same date, the sixmonth average daily trading volume for

each component in the Index ranged

from a low of approximately 515,000 to

a high of 8.2 million. Fourth, no stock

or group of stocks dominates the Index.

Specifically, no single stock accounted

for more than 6.30% of the total price

weight of the Index, and the five highest

weighted securities accounted for

26.18% of the price weight of the Index.

Accordingly, the Commission believes

that it is appropriate for the Exchange to

classify the Index as broad-based and

apply its rules governing broad-based

index options to trading in the Index

options.

The Commission also believes that the

general broad diversification,

capitalization, and highly liquid

markets of the Index’s component stocks

significantly minimize the potential for

manipulation of the Index. First, as

discussed above, the Index represents a

broad cross-section of domestically

traded high capitalization stocks, with

no single industry group or stock

dominating the Index.29 Second, all of

the stocks that comprise the Index are

actively traded. Third, CBOE has

represented that it will notify the staff

of the Commission when: (1) less than

80% of the weight of the Index is

options eligible; (2) 10% or more of the

weight of the Index is represented by

stocks trading less than 20,000 shares

per day; (3) the market capitalization of

any component falls below $75 million

at a time the component is not options

eligible; (4) the largest component of the

Index is greater than 15% of the weight

of the Index, or the top five components

are greater than 50% of the weight of the

Index; or (5) if the Index decreases to

less than 20 component stocks.30 In the
47844 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

the is similar to minimum maintenance criteria

utilized in maintaining a variety of index products

to ensure an adequate level of liquidity in the

component stocks.

31 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.

32The Commission notes that although the actual

number of contracts is much larger than that of

other indexes, the dollar value position and

exercise limits are roughly equivalent to similar

broad-based indexes, such as the S&P 500 and 100

index options.

33See, e.g., Securities Exchange Act Release No.

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

5, 1992) (CBOE–91–51) (order approving the listing

of options on the CBOE Biotech Index).

34See supra note 14.

35See Amendment No. 1, supra note 3.

36 In addition, the CBOE has represented that it

and OPRA have the necessary systems capacity to

support those new series of index options that

would result from the introduction of Index options

and FLEX Options.

37Should 10% or more of the weight of the Index

be composed of stocks trading at less than 20,000

per day, CBOE will notify Commission staff. See

Amendment No. 1, supra note 3.

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

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

(CBOE–92–09) (order approving position limits for

European-style Standard & Poor’s 500 Stock Index

options settled based on the opening prices of

component securities).

39As noted above, FLEX options allow investors

to customize certain terms, including size, term to

expiration, exercise style, exercise price, and

exercise settlement value.

event the Index fails to satisfy any of the

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.31

Fifth, the Exchange has proposed

reasonable position and exercise limits

for the Index options that will serve to

minimize potential manipulation and

other market impact concerns. The

position limits, at 1,000,000 contracts

on either side of the market for options

valued at one-one-hundredth of the

DJIA, are roughly equivalent in dollar

terms to the limits applicable to options

on other similar indices.32 Accordingly,

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.

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

DJIA (including full-value FLEX

Options and 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, including 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 options on the

DJIA.

Surveillance. The Commission

generally believes that a surveillancesharing agreement between an exchange

proposing to list a stock index

derivative and the exchange(s) trading

the stocks underlying the derivative

product is an important measure for the

surveillance of the derivatives and

underlying securities markets. Such

agreements ensure the availability of

information necessary to detect and to

deter potential manipulations and other

trading abuses, thereby making the stock

index product less readily susceptible to

manipulation.33 In this regard, the

market upon which all of the Index

component stocks trade, the NYSE, is a

member of the ISG.34 Similarly, the

options on the individual component

securities trade on markets which are

ISG members.

In addition, the Exchange will apply

the same surveillance procedures as

those used for existing broad-based

index option trading on the CBOE. 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.35

Market-Impact. The Commission

believes that the listing and trading of

options, including full-value LEAPS, on

the DJIA will not adversely impact the

underlying securities markets.36 First, as

described above, the Index is broadbased and comprised of 30 stocks, with

no one stock dominating the Index.

Second, as noted above, the stocks

contained in the Index have large

capitalizations and are actively-traded.

Specifically, as noted above, the average

daily trading volume for the component

stocks over the six month period from

December 1996 to May 1997 ranged

from a high of 8.2 million to a low of

515,000.37 Third, the 1,000,000 contract

position and exercise limits for

contracts based on one-one-hundredth

of the value of the DJIA will serve to

minimize potential manipulation and

market impact concerns. Fourth,

currently all stocks comprising the

Index are options eligible and CBOE

will notify the Commission if less than

80% of the Index continues to be

eligible for options trading. Fifth, the

risk to investors of contra-party nonperformance will be minimized because

the Index options and LEAPS will be

issued and guaranteed by the OCC,

similar to all other standardized options

traded in the United States.

Lastly, the Commission believes that

settling expiring 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 on closing prices may help

reduce adverse effects on markets for

stocks underlying options on the

Index.38

FLEX Options. The Commission also

believes that the proposal to list DJIA

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 DJIA

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.39 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,
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