[Federal Register Volume 63, Number 12 (Tuesday, January 20, 1998)]
[Notices]
[Pages 3009-3010]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1180]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39524; File No. SR-CBOE-97-57]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Granting Approval to Proposed Rule Change Relating to an 
Extension of the Permissible Maturity Term of FLEX Equity Options

January 8, 1998.

I. Introduction

    On October 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 permit a FLEX equity option to 
have a term of five years in certain circumstances.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on November 14, 1997.\3\ No comments were received on the 
proposal. This order approves the proposal.
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    \3\ Exchange Act Release No. 39305 (November 6, 1997), 62 FR 
61156 (November 14, 1997).
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II. Description

    The CBOE is proposing to allow FLEX equity options \4\ traded on 
the Exchange to have a maturity beyond three years and up to five years 
when the longer term is requested by a submitting member and the FLEX 
Post Official \5\ determines that sufficient liquidity exists among 
Equity FLEX Qualified Market Makers. Currently, FLEX equity options, by 
operation of Rule 24A.4(a)(4)(i), are limited to a maturity of three 
years.
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    \4\ FLEX equity options are flexible exchange-traded options 
contracts which overlie equity securities. In addition, FLEX equity 
options provide investors with the ability to customize basic option 
features including size, expiration date, exercise style, and 
certain exercise prices.
    \5\ Under CBOE Rule 24A.1(g), a FLEX Post Official is the 
Exchange employee designated pursuant to Rule 24A.12 to perform the 
FLEX post functions set forth in that rule.
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    When the Exchange filed for permission to list and trade FLEX 
equity options \6\ it determined to limit the maturity of these options 
to three years because, unlike FLEX Index options which had been traded 
on the Exchange since February 1993 and which could have a maturity of 
up to five years, the Exchange was concerned that there would not be 
sufficient liquidity in many equity option classes to support series 
with a longer term to expiration. The CBOE represents, however, that 
since it has traded FLEX equity options, the Exchange has had numerous 
requests from broker-dealers to extend the maturity of FLEX equity 
options to five years. According to the Exchange, among the reasons the 
broker-dealer firms have been interested in seeking an extension in the 
allowable maturity is that such longer expiration FLEX equity options 
might be used to hedge a firm's issuance of long-term structured 
products linked to returns of an individual stock. The Rule would 
permit the longer term FLEX equity options (up to a maximum of five 
years) to be listed when requested by the submitting member if the FLEX 
Post

[[Page 3010]]

Official determined that sufficient liquidity existed among Equity FLEX 
Qualified Market Makers. The CBOE believes that by allowing for the 
extension of the maturity of FLEX equity options to five years in 
situations where there is demand for a longer term expiration and where 
there is sufficient liquidity among Exchange qualified market-makers to 
support the request, the proposed rule change will better serve the 
needs of CBOE's customers and the Exchange members who make a market 
for such customers.
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    \6\ SR-CBOE-95-43 approved in Exchange Act Release No. 36841 
(February 14, 1996), 61 FR 6666 (February 21, 1996).
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, with the requirements of Section 6(b) of the Act.\7\ 
Specifically, the Commission believes the proposal is consistent with 
the Section 6(b)(5) \8\ requirement 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 to protect investors and the public 
interest.\9\
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    \7\ 15 U.S.C. 78f(b).
    \8\ 15 U.S.C. 78f(b)(5).
    \9\ 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).
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    The Commission believes it is appropriate to extend the maximum 
permissible maturity term of FLEX equity options to five years for 
several reasons. First, FLEX equity options with a maturity term of up 
to five years should benefit investors by allowing them to hedge 
positions on a longer term basis through investment in one options 
series, rather than having to roll shorter term expirations into new 
series to remain hedged on a longer basis. In this regard, the 
Commission notes that the FLEX equity options market is characterized 
by large, sophisticated institutional investors (or extremely high net 
worth individuals) who have the experience, ability and, in many cases, 
need to engage in negotiated, customized transactions.\10\ The longer-
term FLEX equity options will allow investors to customize their 
portfolios further over an extended period of time. Second, the 
extension of the permissible maturity term for FLEX equity options to 
five years potentially could expand the depth and liquidity of the FLEX 
equity market without significantly increasing concerns regarding 
intermarket manipulations or disruptions of the options or the 
underlying securities.\11\ Third, under the rule, FLEX equity options 
with maturity terms between three and five years could only be issued 
if a FLEX Post Official determines that there is sufficient liquidity 
among Equity FLEX Qualified Market Makers. This will help to ensure 
that there is not a proliferation of longer term FLEX equity options 
series where no interest in trading such options exist. Finally, as 
with all exhange-traded options, the Options Clearing Corporation will 
act as the counter-party guarantor, thereby ensuring that obligations 
will be met over the long-term.\12\
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    \10\ For example, with a required minimum size of 250 contracts 
to open a transaction in a new series, FLEX equity options are 
designed to appeal to institutional investors. See Exchange Act 
Release No. 36841 (February 14, 1996), 61 FR 6666, 6669 (February 
21, 1996); see also Exchange Act Release No. 37336 (June 19, 1996), 
61 FR 33558, 33560, (June 27, 1996).
    \11\ Position and exercise limits for FLEX equity options have 
recently been eliminated. See Exchange Act Release No. 39032 (Sept. 
9, 1997), 62 FR 48683 (Sept. 16, 1997). In eliminating these limits, 
the Exchange adopted several important safeguards to monitor large 
positions in order to identify instances of potential risk and to 
assess additional margin and/or capital charges, if necessary. These 
safeguards also continue to apply to large positions in FLEX equity 
options regardless of the term of the option.
    \12\ As to any future proposal to permit options instruments 
with terms longer than five years, the Commission would need to re-
evaluate several issues including margin requirements, disclosure, 
sales practices, and other legal and regulatory issues.
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    For the foregoing reasons, the Commission finds that CBOE's 
proposal to extend the permissible maturity term of certain FLEX equity 
options, as described above, is consistent with the requirements of the 
Act and the rules and regulations thereunder.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-97-57) is approved.

    \13\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-1180 Filed 1-16-98; 8:45 am]
BILLING CODE 8010-01-M