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
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47851

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 JDTA currently consists of the following

companies: Airborne Freight Corp., Alaska Air

Group, Inc., AMR Corp., APL Ltd., Burlington

Northern Santa Fe Corp., Caliber System, Inc., CNF

Transportation, Inc., CSX Corp., Delta Air Lines,

Inc., Federal Express Corp., Illinois Central Corp.,

Norfolk Southern Corp. Ryder System, Inc.,

Southwest Airlines Co., US Airways Group, Inc.,

UAL Corp., Union Pacific Corp., US Freightways

Corp., XTRA Corp. and Yellow Corp.

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 DJTA was first calculated on September 8,

1896 and the index value was 48.55 on that date.

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

Transportation Average (‘‘DJTA’’ or

‘‘Index’’), an index developed by Dow

Jones & Company. The options on the

Index will be based on one-tenth of the

value of the Index. The CBOE also

proposes to list LEAPS on a one-tenth

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-one-hundredth of the Index level, or

one-tenth of the value of full-value

options. 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 DJTA was first calculated on

September 8, 1996, and is based on 20

of the largest, most liquid U.S.

transportation industry stocks. Eighteen

of the stocks in the Index currently trade

on the New York Stock Exchange, Inc.,

(‘‘NYSE’’) and two trade through the

facilities of the National Association of

Securities Dealers Automated Quotation

System (‘‘Nasdaq’’).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

2683.55.9 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 $16.7 billion (Union Pacific

Corp.) to a low of $352 million (Alaska

Air Group, Inc.), with a mean and

median of $5.1 billion and $2.5 billion,

respectively. The total market

capitalization of the securities in the

index was $101.9 billion. The total

number of shares outstanding for the

issuers in the index range from a high

of 244 million shares (Union Pacific

Corp.) to a low of 14 million shares

(Alaska Air Group, Inc.). The price per

share of the securities in the Index

ranged from a high of $97.625 (AMR

Corp.) to a low of $19.625 (Yellow

Corp.) with a six-month mean and

median, for the period ending June 5,

1997 of $49.475 and $36.813,

respectively. In addition, the average

daily trading volume for securities in

the Index ranged from a high of 971,439

shares (US Airways Group, Inc.) to a

low of 17,242 shares (XTRA Corp.), with

the mean and median 379,153 and

336,908, respectively. Lastly, no one

security accounted for more than 9.87

percent of the Index’s total value (AMR

Corp.), and the percentage weighting of

the five largest issues in the Index

accounted for 45.02 percent of the

Index’s value. The percentage weighting

of the lowest weighted component was

1.98 percent (Yellow Corp.) and the

percentage weighting of the five

smallest issues accounted for 12.8

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 DJTA. Dow Jones

& Company may change the

composition of the Index at any time to

reflect the conditions in the

transportation 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

transportation 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 DJTA 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 News Service generally two to

three trading days prior to

implementation. Generally, Index

components are replaced infrequently.

The Index is currently composed of 20

stocks and it is expected that it will

remain at 20.

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)

10% or more of the weight of the index

is represented by stocks trading less

than 15,000 shares per day over the

previous 6 month period; (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 DJTA 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.

E. Calculation of the Index

The DJTA 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 DJTA 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
47852 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

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.

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.

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 DJTA

Index

The Exchange’s proposal provides

that the Exchange may list longer term

option series having up to thirty-six

months to expiration on one-tenth

(1⁄10th) the Index’s full value, which is

the same value used to calculate regular

options on the Index. In lieu of such

long-term options on a one-tenth value

Index level, the Exchange may instead

list long-term, reduced value put and

call options based on one-onehundredth (1⁄100th) the Index’s full

value. The current and closing index

value of any such reduced-value LEAP

will, after such initial computation, be

rounded to the nearest one-hundredth.

In either event, the interval between

expiration months for either a long-term

option or reduced value long-term

option will not be less than six months.

The trading of any long term options

would be subject to the same rules

which govern the trading of all the

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 DJTA. 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

DJTA: (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 DJTA. 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

DJTA.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

position and exercise limits,19 and

trading halt procedures 20 that are

applicable to trading of narrow-based
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47853

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 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 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 transportation sector in the U.S.

stock markets.

26See supra notes 18 through 20, and

accompanying text.

27The Commission notes that one of the

securities in the Index, XTRA Corp., had an average

daily trading volume of 17,242 shares. To prevent

the Index from being dominated by illiquid

securities, the Exchange has agreed to notify the

Commission in the event that 10% or more of the

weight of the Index is represented by stocks trading

less than 15,000 shares per day over the previous

6 month period. See note 29 and accompanying

text.

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.

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

Continued

index options will apply to options

traded on the Index. Position limits on

reduced value long-term DJTA 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. Findings and Conclusions

The Commission finds that the

proposed rule change is consistent with

the requirements of the Act and the

rules and regulations thereunder

applicable to a national securities

exchange,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 Index LEAPS, 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

transportation sector.25 The trading of

options in the DJTA, however, raises

several issues relating to index design,

investor protection, surveillance, and

market impact. The Commission

believes, for the reasons discussed

below, that CBOE has adequately

addressed the issues.

A. Index Design and Structure

The DJTA is comprised of only twenty

stocks, all of which are within one

industry segment, the transportation

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 379,153 and 336,908

shares, respectively.27 Second, the

market capitalizations of the stocks in

the Index are very large, ranging from

$352 million to $16 billion, with the

mean and median being $5 billion and

$2.5 billion, respectively. Third,

although the Index is only comprised of

twenty component stocks, no one stock

or group of stocks dominates the Index.

Specifically, no one stock comprises

more than 9.87% of the Index total

value and the percentage weighting of

the five largest issues in the Index

accounts for 45.02% of the Index’s

value. Fourth, all of the stocks in the

Index are currently the subject of equity

option 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)

10% or more of the weight of the index

is represented by stocks trading less

than 15,000 shares per day over the

previous 6 month period; (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.

In the 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.29 These maintenance
47854 Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices

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 a large majority of the component

stocks helps address the manipulative concerns that

may arise due to the price weighting.

32See Securities 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 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.

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

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

39 Id.

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 DJTA 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 Commission 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 products 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-profic 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 LEAPS, reduced-value

LEAPS, 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 DJTA 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 DJTA

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 DJTA 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 those

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 DJTA because

expiration of these options will not

correspond to the normal expiration of

any non-FLEX options (including

options overlying the DJTA), stock

index futures, and options on stock
Federal Register / Vol. 62, No. 176 / Thursday, September 11, 1997 / Notices 47855

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

41 17 CFR 200.30–3(a) (12) and (51).

1The NASD granted an extension of the time for

Commission action on this rule filing until thirtyfive days after NASD Regulation filed an

amendment advising of the action of the NASD

Board of Governors. Letter from Craig L. Landauer,

Associate General Counsel, NASD Regulation, Inc.,

to Katherine A. England, Assistant Director,

Division of Market Regulation, SEC, dated June 24,

1997. The NASD Board of Governors reviewed this

proposed rule change on June 26, 1997. Letter from

Craig L. Landauer, Associate General Counsel,

NASD Regulation, Inc., to Katherine A. England,

Assistant Director, Division of Market Regulation,

SEC, dated June 27, 1997.

2 15 U.S.C. § 78s(b)(1).

3 17 CFR 240.19b–4.

4Securities Exchange Act Release No. 38781

(June 26, 1997), 62 FR 35870.

5Letter from Allen W. Croessmann, President,

BankBoston Investor Services, to Jonathan G. Katz,

Secretary, SEC, dated July 22, 1997 and Letter from

Joseph P. Savage, Assistant Counsel, Investment

Company Institute, to Jonathan G. Katz, Secretary,

SEC, dated July 22, 1997.

6See NASD Rule 3010(g)(2).

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

DJTA are much higher than those

currently proposed for the

corresponding non-FLEX Index (i.e., 4

times the existing 15,000 contract

limits) options and open interest in one

or more FLEX option series could grow

to significant levels, it is possible that

FLEX options on the DJTA 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 DJTA 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 not 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

nearly 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–97–27 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–

27) 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. 97–24132 Filed 9–10–97; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39019; File No. SR–NASD–

97–41]

Self-Regulatory Organizations; Order

Approving Proposed Rule Change by

National Association of Securities

Dealers, Inc. Relating to the Definition

of Branch Office

September 4, 1997.

I. Introduction

On June 17, 1997,1 the National

Association of Securities Dealers, Inc.

(‘‘NASD’’ or ‘‘Association’’) submitted

to the Securities and Exchange

Commission (‘‘SEC’’ or ‘‘Commission’’),

pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’)2 and Rule 19b–4 thereunder,3 a

proposed rule change to amend Rule

3010 of the NASD’s Conduct Rules to

create another exception to the

definition of branch office. A notice of

the proposed rule change appeared in

the Federal Register on July 2, 1997.4

The Commission received two comment

letters endorsing the proposed rule

change.5 The Commission is approving

the proposed rule change.

II. Description of the Proposal

The definition of a branch office,

found in NASD Rule 3010, includes any

location identified by any means to the

public or customers as a location at

which the member conducts an

investment banking or securities

business, subject to several exceptions.6

If a business location of a member meets

the definition of a branch office, such

office must be identified to the NASD

through the filing of a Schedule E to