[Federal Register Volume 62, Number 250 (Wednesday, December 31, 1997)]
[Notices]
[Pages 68327-68330]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-34060]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39480; File No. SR-CBOE-97-36]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval to Proposed Rule Change and 
Notice of Filing and Order Granting Accelerated Approval of Amendment 
No. 1 to Proposed Rule Change Revising the Exchange Rules Governing the 
Halting and Resumption of Trading in Index Options

December 22, 1997.

I. Introduction

    On July 25, 1997, the Chicago Board Options Exchange, Incorporated 
(``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 revise the Exchange rules 
governing the halting and resumption of trading in index options on the 
Exchange.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    The proposed rule change was published for comment in Securities 
Exchange Act Release No. 38962 (Aug. 22, 1997), 62 FR 45890 (Aug. 29, 
1997). No comments were received on the proposal. The Exchange filed 
Amendment No. 1 to the proposed rule change with the Commission on 
September 15, 1997.\3\ This order approves the proposed rule change 
including, on an accelerated basis, Amendment No. 1.
---------------------------------------------------------------------------

    \3\ Amendment No. 1 amends Exchange Rule 24.13, ``Trading 
Rotations,'' Interpretation .03, and eliminates the 50% fixed test 
as a factor in the determination whether an opening rotation in an 
index option class may be delayed. See Letter from Paul E. Dengel, 
Schiff Hardin & Waite, to Michael Walinskas, Senior Special Counsel, 
Division of Market Regulation, Commission, dated September 10, 1997.
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange seeks to amend Exchange Rule 24.7, ``Trading Halts or 
Suspensions,'' to eliminate certain fixed percentage tests that 
presently apply to the decision to halt trading in index options as 
well as the decision to resume trading after such a halt. The proposed 
rule change also makes certain conforming changes to related Exchange 
rules.\4\
---------------------------------------------------------------------------

    \4\ The Commission notes that this proposed rule change does not 
address or impact the Exchange's circuit breaker trading halt rule 
and policy. However, the proposal makes a conforming change to 
Exchange Rule 24.7(c) that amends certain language cross referencing 
the Exchange's circuit breaker trading halt rule, Exchange Rule 
6.3B, ``Trading Halts Due to Extraordinary Market Volatility.''
---------------------------------------------------------------------------

A. Trading Halts

    Currently, under Exchange Rule 24.7(a)(i), one of the enumerated 
factors that the designated Exchange officials may consider in deciding 
whether to halt trading in an index option is whether trading has been 
halted or suspended in underlying stocks whose weighted value presents 
``20% or more of the index value.'' The Exchange has expressed concern 
that by including a fixed percentage test among those factors that 
``may be considered,'' the present rule may imply that it would be 
improper for the designated Exchange officials to consider trading 
interruptions in underlying stocks whose weighted value represents less 
than 20% of the index value.
    The Exchange believes this interpretations conflicts with the 
purpose of Exchange Rule 24.7, which grants designated Exchange 
officials the discretion to halt index option trading whenever they 
``conclude in their judgment that such action is appropriate in the 
interests of a fair and orderly market and to protect investors.'' 
Because Exchange Rule 24.7(a)(i)-(iv) sets forth a non-exclusive list 
of factors that Exchange officials may consider in exercising that 
discretion, the Exchange contends it would be inappropriate to forbid 
those officials from considering trading disruptions in underlying 
stocks that fall below a predetermined level. Accordingly, the proposed 
rule change would clarify that Exchange officials, in evaluating 
whether to halt trading in index options, are not limited to situations 
in which 20% of the underlying stocks have halted, but rather may 
consider ``the extent to which'' trading is not occurring in the 
underlying stocks.
    In addition, the proposed rule change would provide Exchange 
officials with the flexibility to consider not only whether trading in 
underlying stocks has been ``halted or suspended,'' but also whether 
such trading is ``not occurring.'' The term ``halted or suspended'' 
indicates that Exchange authorities have taken formal action to 
discontinue trading in stock. However, in deciding whether to continue 
trading a derivative instrument like an index

[[Page 68328]]

option, Exchange officials should be able to consider the full extent 
to which underlying stocks are not trading, whether trading is not 
occurring because of formal exchange action, systemic problems, market 
emergencies, or other cause. The proposed rule change would clarify 
that in determining whether to halt index option trading, Exchange 
officials may consider the extent to which ``trading is not occurring'' 
in the underlying stocks, without limiting that consideration to formal 
halts or suspensions.
    The Exchange also believes that Exchange Rule 24.7 may imply that 
the Exchange is required to calculate, on an ongoing basis, the extent 
to which stocks underlying a subject index are trading. The Exchange 
contends that such calculations would be difficult to perform on a real 
time basis for those indexes comprised of a large number of stocks 
(e.g., the Russell 2000, which consists of 2000 stocks), or those 
indexes for which data on trading halts is not readily available (e.g., 
NDX, an index based on over-the-counter stocks). The removal of the 
fixed percentage tests from Exchange Rule 24.7 is expected to rectify 
any misperception regarding the Exchange's duty to maintain and 
calculate trading information for stocks underlying an index on which 
options are traded.

B. Resumption Of Trading After Trading Halts

    The proposed rule change would eliminate the provision in Exchange 
Rule 24.7(b) that makes trading in a fixed percentage of stocks 
underlying an index a prerequisite to the resumption of index options 
trading after a trading halt. Currently, trading may resume when the 
designated Exchange officials determine either (i) that the conditions 
that led to the halt no longer are present; or (ii) that the interests 
of a fair and orderly market are served by a resumption of trading. 
However, Exchange Rule 24.7(b) provides that in no event may trading 
resume until the Exchange has determined that trading is occurring in 
underlying stocks whose weighted value presents more than 50% of the 
index value.
    The Exchange has represented that it would continue its practice of 
assessing the extent to which underlying stocks are trading in deciding 
whether to resume trading after an index options trading halt. However, 
the Exchange believes it is inappropriate to delay the resumption of 
trading until the level of trading in stocks underlying an index has 
reached a predetermined, fixed level, particularly since it often may 
be difficult to make a precise determination of trading activity for 
indexes with a large number of constituent stocks.
    Accordingly, the proposed rule change would eliminate the 50% fixed 
test and instead would specify that one of the factors that Exchange 
officials may consider in determining whether the ``interests of a fair 
and orderly market are served by a resumption of trading'' is ``the 
extent to which trading is occurring in stocks underlying the index.'' 
According to the Exchange, the proposed rule change would enable the 
Exchange to resume trading as soon as conditions warrant, without 
interposing an artificial barrier that might result from a fixed 
percentage test. The Exchange believes the proposed rule change 
continues to provide Exchange officials with the opportunity to give 
appropriate weight to the extent to which underlying stocks are 
trading.
    In addition, the proposed rule change would clarify that index 
options trading may resume only upon a determination by the designated 
Exchange officials that such a resumption is in the interests of a fair 
and orderly market. The present form of Exchange Rule 24.7(b) allows 
trading to resume (subject to the 50% requirement) when the designated 
Exchange officials determine either (i) that the conditions that led to 
the halt no longer are present; or (ii) that a resumption of trading 
would serve the interests of a fair and orderly market. Read literally, 
Exchange Rule 24.7(b) would permit trading to resume if the conditions 
that led to the halt no longer are present, even if a resumption of 
trading would be contrary to the interests of a fair and orderly 
market. Such an interpretation would conflict with the Exchange's 
practice and run counter to the Act. Accordingly, the proposed rule 
change would state that: (1) index options trading may resume only if 
the designated Exchange officials determine that such a resumption 
would be in the interests of a fair and orderly market,\5\ and (2) the 
fact that the conditions leading to the halt no longer are present is 
one of several factors which Exchange officials may consider in 
determining whether the interests of a fair and orderly market would be 
served by a resumption of trading.
---------------------------------------------------------------------------

    \5\ A similar change has been made to Exchange Rule 6.3(b), 
``Trading Halts,'' which generally governs the resumption of trading 
after a trading halt in an equity option class. As a result, trading 
in an equity option class that has been the subject of a halt may 
resume only upon a determination by two Floor Officials that such a 
resumption is in the interests of a fair and orderly market. See 
Securities Exchange Act Release No. 39292 (Nov. 3, 1997), 62 FR 
60738 (Nov. 12, 1997).
---------------------------------------------------------------------------

    The proposed rule change also conforms the cross reference to 
Exchange Rule 6.3B that appears in Exchange Rule 24.7(c) to the current 
language of the referenced rule. Exchange Rule 6.3B sets forth the 
Exchange's circuit breaker trading halt policy, the text of which was 
recently amended.\6\
---------------------------------------------------------------------------

    \6\ See Securities Exchange Act Release No. 38221 (Jan. 31, 
1997), 62 FR 5871 (Feb. 7, 1997).
---------------------------------------------------------------------------

    Finally, the proposed rule change would add Interpretation .02 to 
Exchange Rule 24.7 to address the manner in which trading is to resume 
after a trading halt. This topic is not directly addressed under 
current Exchange Rule 24.7, although the last sentence of existing 
Exchange Rule 24.7(b) contemplates that a rotation will be used. 
Proposed Interpretation .02 would adopt the identical procedure that 
now governs the resumption of trading after a circuit breaker halt. The 
procedure is set forth in Interpretation .02 to Exchange Rule 6.3B and 
provides that trading will resume by a rotation after a trading halt 
unless the designated Exchange officials conclude that a different 
method of reopening is appropriate under the circumstances. The 
officials may determine, among other things, not to employ a rotation, 
to use an abbreviated rotation, or otherwise to vary the manner of the 
rotation. The Exchange seeks to adopt proposed Interpretation .02 so 
that comparable rules govern the resumption of trading after circuit 
breaker halts as well as halts effected for other reasons.

III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange, and with the requirements of Section 6(b).\7\ In 
particular, the Commission believes the proposed rule change is 
consistent with the Section 6(b)(5) requirements that the rules of an 
exchange be designed to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and, in general, to protect 
investors and the public interest.
---------------------------------------------------------------------------

    \7\ 15 U.S.C. Sec. 78f(b).
---------------------------------------------------------------------------

    While the current language of Exchange Rule 24.7(a) states that the 
20% fixed test is one of several factors that may be considered in 
determining whether to halt index options trading, the Exchange has 
expressed concern that the test may be interpreted as having a 
mandatory rather than

[[Page 68329]]

permissive application.\8\ The Commission finds that the Exchange is 
justified in its efforts to clarify Exchange policy regarding the 
halting of index options trading. Market participants should possess a 
clear understanding of the rules and procedures which the Exchange is 
bound to observe when considering the halting of trading in index 
options.
---------------------------------------------------------------------------

    \8\ Uncertainty regarding the nature of the 20% fixed test dates 
back to 1988 when the Commission approved a proposed rule change 
that modified Exchange Rule 24.7. The Commission allowed the 
Exchange to revise its trading halt policy so that the 20% benchmark 
would no longer be the primary test but, instead, one of the facts 
to be considered when deciding whether to halt trading in index 
options. Although the Commission permitted the Exchange to 
reconfigure Exchange Rule 24.7 to make the 20% fixed test 
permissive, rather than mandatory, the Commission said it ``believes 
the proposed amendment does not reflect a change in CBOE's trading 
halt policy.'' See Securities Exchange Act Release No. 26198 (Oct. 
19, 1988), 53 FR 41637 (Oct. 24, 1988).
---------------------------------------------------------------------------

    The Exchange currently may halt trading in index options classes 
when the designated Exchange officials have determined that ``such 
action is appropriate in the interests of a fair and orderly market and 
to protect investors.'' The 20% fixed test represents one of several 
non-exhaustive factors that may be considered by Exchange officials 
when determining whether to halt trading pursuant to Exchange Rule 
24.7. It provides Exchange officials and market participants notice 
that it may be appropriate to effect a trading halt in index options 
trading whenever a number of component securities underlying a 
substantial value of the index are not trading. The proposed rule 
change continues to provide such notice, albeit without a specific 
numerical guideline.
    Accordingly, the Commission believes it is appropriate for the 
Exchange to replace the 20% fixed test with language indicating that 
Exchange officials may consider the extent to which ``trading is not 
occurring'' in stocks underlying an index when deciding whether to halt 
index options trading. The revised language properly reflects that in 
determining whether to halt index options trading pursuant to Exchange 
Rule 24.7, Exchange officials may consider all types of events that 
disrupt trading including, for example, formal halts or suspensions, 
systemic problems, market emergencies, or natural disasters.
    The Commission also believes it is reasonable for the Exchange to 
remove the mandatory 50% fixed test from Exchange Rule 24.7(b) and 
include ``the extent to which trading is occurring in stocks underlying 
the index'' as a factor to be considered when deciding whether to 
resume index options trading. The Exchange believes that the 
determination whether trading should resume after a halt can be made 
without regard to fixed thresholds by evaluating whether key stocks 
have reopened, and by examining the speed with which stocks in general 
are reopening. The Commission recognizes that adherence to a mandatory, 
fixed percentage test prevents the Exchange from relying primarily on 
such indicators. As a result, the Exchange could remain closed to 
market participants longer than desirable. The revised language permits 
Exchange officials to use their expert judgment in determining whether 
to resume trading from a halt. Exchange Rule 24.7 will continue to 
require Exchange officials to consider the extent to which trading is 
occurring in the stocks underlying the index, but absent the strict 50% 
fixed test.
    Although the Commission recognizes the Exchange's need for flexible 
trading halt rules, it expects the Exchange to apply revised Exchange 
Rule 24.7 in a manner which ensures that trading is occurring in a 
substantial number of stocks underlying an index before trading in 
index options is allowed to resume. As the Commission has previously 
noted, ``[i]t is questionable whether fair markets can be maintained in 
derivative index products when many of the index's component securities 
are not trading'' \9\ The Commission is concerned that unless a 
substantial number of stocks underlying an index are trading, the 
related index options may be mispriced and fail to accurately reflect 
the current market value of all underlying stocks. While it would be 
counterproductive for the Commission to define ``substantial'' in 
numerical terms, or discuss what constitutes an acceptable level of 
trading in stocks underlying an index, the Commission nonetheless 
expects the Exchange to maintain fair markets in its index option 
products.
---------------------------------------------------------------------------

    \9\ The October 1987 Market Break: A Report by the Division of 
Market Regulation, February, 1988, at 8-22.
---------------------------------------------------------------------------

    The Commission further believes it is reasonable for the Exchange 
to establish procedures governing the resumption of trading in index 
options after a trading halt. Although the current text of Exchange 
Rule 24.7(b) contemplates the use of a rotation in such circumstances, 
the Commission recognizes the need for definite procedures, 
particularly because confusion may still linger from the event that 
precipitated the trading halt. Furthermore, by adopting the identical 
procedure that currently governs the resumption of trading following a 
circuit breaker halt, the Exchange's policies and rules will be 
consistent with respect to the resumption of trading after halts.
    The Commission finds good cause for approving proposed Amendment 
No. 1 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. The Commission notes 
that Amendment No. 1 makes a conforming change to Exchange Rule 24.13, 
``Trading Rotations,'' Interpretation .03, that is consistent with the 
Exchange's decision to eliminate fixed percentage thresholds from the 
determination whether index options trading should be halted or 
resumed. In place of a 50% fixed test, Amendment No. 1 substitutes 
``the extent to which trading is not occurring'' as a factor in 
deciding whether to delay an opening rotation in index options. The 
Commission believes that Amendment No. 1 helps establish uniformity 
among the Exchange's rules and procedures relating to halts and delays 
in index options trading. Accordingly, the Commission believes it is 
consistent with Section 6(b)(5) of the Act \10\ to approve Amendment 
No. 1 to the proposed rule change on an accelerated basis.
---------------------------------------------------------------------------

    \10\ 15 U.S.C. Sec. 78f(b)(5).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1 to the proposed rule change. 
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 submissions, 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 persons, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. Sec. 552, will 
be available for inspection and copying in the Commission's Public 
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of such filing will also be available for inspection and copying 
at the principal office of the Exchange. All submissions should refer 
to File No. SR-CBOE-97-36 and should be submitted by January 21, 1998.

[[Page 68330]]

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\11\ that the proposed rule change (SR-CBOE-97-36), as amended, is 
approved.

    \11\ 15 U.S.C. Sec. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
---------------------------------------------------------------------------

    \12\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-34060 Filed 12-30-97; 8:45 am]
BILLING CODE 8010-01-M