[Federal Register Volume 60, Number 46 (Thursday, March 9, 1995)]
[Notices]
[Pages 12991-12994]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-5702]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35437; File No. SR-CBOE-95-14]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to Buy-
Write Options Unitary Derivatives

March 2, 1995.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on February 
1, 1995, the Chicago Board Options Exchange, Inc. (``CBOE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in items I, II 
and III below, which Items have been prepared by the self-regulatory 
organization. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange, pursuant to Rule 19b-4 under the Act, proposes to 
amend its rules to permit trading in Buy-Write Options Unitary 
Derivatives (``BOUNDs''). As described in more detail below, BOUNDs are 
long term options which the CBOE believes have the same economic 
characteristics as a covered call writing strategy.
    The text of the proposed rule change is available at the Office of 
the Secretary, CBOE and at the Commission. [[Page 12992]] 

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The CBOE believes the purchase of a BOUND will be substantially 
equivalent to a ``buy-write'' transaction (i.e., the simultaneous 
writing of a call option and purchase of the underlying stock). Unlike 
an actual buy-write transaction, however, the purchase of a BOUND is 
effected in a single exchange transaction. The Options Clearing 
Corporation (``OCC'') will be the issuer of all BOUNDs traded on the 
Exchange.
    As with OCC issued options, BOUNDs will be created when an opening 
buy and an opening sell order are executed. The execution of every such 
order will increase BOUNDs open interest. Except as described herein, 
BOUNDs will be subject to the rules governing standardized options.
    A BOUND holder will be in essentially the same economic position as 
a covered call writer except that a BOUND is not subject to exercise 
before expiration. BOUND holders will profit from the stock's movement 
up to the strike price and will receive payments equivalent to the cash 
dividends paid on the underlying stocks. On the ex-date for a stock 
dividend, OCC will debit all short BOUND accounts and credit all long 
BOUND accounts with an amount equal to the dividend on the underlying 
stock.
    Like put and call options, BOUNDS will trade in standardized 
contract units of 100 shares of underlying stock per BOUND contract. At 
expiration, BOUND holders will receive 100 shares of the underlying 
stock for each BOUND contract held if on the last day of trading, the 
underlying stock closes at or below the strike price. However, if at 
expiration the underlying stock closes above the strike price, the 
BOUND holder will receive a payment equal to 100 times the BOUND's 
strike price for each BOUND contract held. Persons who have sold BOUND 
contracts will be required to deliver either 100 shares of the 
underlying stock for each BOUND contract or the strike price multiplied 
by 100 at expiration, depending on the price of the underlying stock at 
that time. This is the same economic result that accrues to a covered 
call writer who holds the position to the expiration of the call 
option.
    For example, if the XYZ BOUND has a strike price of $50 and XYZ 
stock closes at $50 or less at expiration, the holder of an XYZ BOUND 
contract will receive 100 shares of XYZ stock. This is the same result 
as if the call option in a buy-write position had expired out of the 
money; i.e., the option would expire worthless and the writer would 
retain the underlying stock. If XYZ closes above $50 per share, then 
the holder of an XYZ BOUND contract will receive $5,000 in cash (100 
times the $50 strike price). This mimics the economic result to the 
covered call writer when the call is in the money at expiration and is 
exercised, i.e., the writer would receive an amount equal to 100 shares 
times the strike price and, because he would be required to deliver the 
stock, would forfeit any appreciation above that price.
    The criteria for stocks underlying BOUNDs will be the same as the 
criteria for stocks underlying stock options. The Exchange anticipates 
that it will list BOUNDs on the same underlying securities on which 
Long-Term Equity Option Series (``LEAPs'') are listed. BOUNDs will be 
listed at the same strike prices and expiration dates as their 
respective LEAPs except that BOUNDs will be listed only at strike 
prices that are at (or very near) or below the then current price of 
the underlying stock. BOUNDs will be listed with up to 39 months until 
expiration.
    It is anticipated that the sum of the market prices of a LEAP and a 
BOUND on the same underlying stock with the same expiration date and 
exercise price will approximate the market price of the underlying 
stock. If the combined price of the LEAP and BOUND diverge from that of 
the underlying stock, it is anticipated that arbitrage activity will 
tend to bring the price relationships back into line.
    There is also a relationship between the settlement at expiration 
of a LEAP and a BOUND having the same underlying security, strike price 
and expiration date. If at expiration the underlying stock closes at or 
below the strike price, the LEAP call will expire worthless, and the 
holder of a BOUND contract will receive 100 shares of stock from the 
seller of a BOUND position. if, on the other hand, the LEAP call is in 
the money at expiration, the holder of the LEAP call is entitled to 100 
shares of stock from a short LEAP upon payment of the strike price, and 
the holder of a BOUND contract is entitled to the strike price times 
100 in cash from the short BOUND. While it seems unlikely that an 
investor would be long both a LEAP and a BOUND at expiration, it is 
illustrative to consider how such a position would be settled. To 
continue with the above example where XYZ closes above the $50 strike 
price at expiration, an investor long both a LEAP and a BOUND contract 
would be entitled to receive $5,000 in cash from the short BOUND and, 
upon exercise of the LEAP, would be obligated to pay $5,000 to receive 
100 shares of XYZ stock.
    The settlement of the LEAP and BOUND at expiration are equally well 
harmonized from the perspective of the writer. For example, if a writer 
of both instruments is covered with the underlying stock and the stock 
closes above the strike price, at expiration, the writer delivers the 
stock to the long LEAP call and receives in return payment of the 
strike price times 100, which amount is then delivered to the long 
BOUND. A covered writer's position, therefore, effectively is closed 
upon the delivery of the covering stock. If a writer of both 
instruments has deposited cash or securities other than the underlying 
stock as margin for a short LEAP call and BOUND, then the writer 
delivers 100 shares of stock (purchased on the open market) to the long 
LEAP call upon payment of the strike price times 100. The writer of the 
BOUND then delivers 100 times the strike price to the holder of the 
long BOUND.
    It should be noted that LEAPs are American-style options whereas 
BOUNDs are European-style in that they cannot be ``exercised'' prior to 
expiration.\1\ The Exchange believes that a European-style BOUND will 
have greater acceptance among investors than an American-style product 
since a European-style BOUND will permit purchasers to enjoy the 
enhanced yield that the BOUND provides for a certain period of time. 
Furthermore, because some type of performance--either delivery of the 
underlying stock or payment of the strike price--is always required at 
expiration, the CBOE believes that notice of exercise is not necessary 
and, therefore, will not be required.

    \1\A European-style option may only be exercised during a 
limited period of time before the option expires. An American-style 
option may be exercised at any time prior to its 
expiration. [[Page 12993]] 
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    Customer Margin. The Exchange proposes to apply options margin 
treatment to BOUNDs as explained below.

A. Long BOUND Positions

    Long BOUND positions will be given no loan value and payment in 
full will be required at the time of purchase. As described more fully 
below, however, there will be a credit for long BOUNDs in BOUND spread 
positions.
B. Short BOUND Positions

    The BOUND seller receives the full value of the BOUND at the time 
of the initial sale and receives no further payment when the contract 
is settled either by payment of the strike price or delivery of the 
underlying stock. Short BOUND positions, therefore, will be margined in 
an amount equal to the current market price of the BOUND plus an amount 
equal to the ``add on'' percentage used to margin short call options 
times the market value of the BOUND. Since the maximum obligation of 
the seller of a BOUND cannot exceed the strike price, however, the 
amount of margin will never exceed the strike value. Examples of the 
margin treatment for a short BOUND position follow:
    1. Assume a stock price of $50, a margin add-on percent of 20%  and 
the BOUND trading at $40. In this case, the short seller would have to 
pay $48 to margin the position, i.e., $40 BOUND price plus 20% of $40 
($8), or $48.
    2. Assume a stock price of $60, an exercise price of $50, a margin 
add-on of 20% and the BOUND trading at $45. In this case, the 
calculated margin would be $54, i.e., $45 BOUND price plus 20% of $45 
($9) or $54. However, since the maximum margin for a short BOUND is the 
strike value, the margin would be $50.
    3. Assume a stock price of $40, an exercise price of $50, a margin 
add-on percent of 20% and the BOUND trading at $35. In this case, the 
margin would be $42, i.e., $35 BOUND price plus 20% of $35 ($7), or 
$42.

C. Covered Positions

    Short BOUND positions offset by the equivalent number of shares of 
the underlying stock will not require any additional margin since the 
seller's obligation to the buyer will, in all cases, be covered by the 
position in the underlying stock. Further, since the sum of the prices 
of a LEAP and a BOUND will be approximately equal to the price of the 
underlying stock, a long stock position is cover for both a short BOUND 
and a short LEAP position.

D. Spread Positions

Same Expiration--Different Strike Prices
    There will be no margin requirement for BOUND positions which are 
long the higher strike price and short the lower strike price since the 
long BOUND more than covers the obligation of the short side of the 
position. For positions short the higher strike price and long the 
lower strike, a customer will be required to post the difference 
between the strike prices.
Different Expiration--Same Strike Price
    No margin will be required for positions long the nearest 
expiration and short the longer expiration since the value of the long 
BOUND will cover the obligation on the short leg of the position. 
Positions that are short the near expiration and long the distant 
expiration will require full margin on the short position less 80% of 
the market value of the long position.
Different Expiration--Different Strike Prices
    There will be no margin required for positions that are long the 
near expiration and short the distant expiration when the strike price 
on the near expiration is higher than the strike on the distant 
expiration. For positions which are long the near expiration and short 
the distant expiration when the strike price on the near expiration is 
lower than the strike on the distant contract, the margin will be the 
difference in the strike between the near term and distant strikes. For 
positions which are short the near expiration and long the distant 
expiration, full margin will be required on the short position less 80% 
of the market value of the long position.

Sales Practices

    BOUNDs will be subject to the sales practice and suitability rules 
applicable to standardized options.

Adjustments for Corporate Transactions

    BOUNDs will be subject to adjustments for corporate and other 
actions in accordance with the rules of The Options Clearing 
Corporation.
Positions Limits

    BOUNDS will be subject to the position limits for equity options 
set forth in Exchange Rule 4.11. In addition, BOUNDs will be aggregated 
with equity options on the same underlying stock for the purpose of 
calculating position limits. However, since BOUND, to the holder, is a 
``bullish'' position (i.e., it is the equivalent of a short put 
position where the strike price has been prepaid), long BOUNDS will be 
aggregated with long call and short put positions. Similarly, since the 
BOUND, to the seller, is a ``bearish'' position (i.e., it is the 
equivalent of a long put position where the strike price has been 
prepaid), short BOUNDS will be aggregated with short call and long put 
positions.
    The CBOE believes the proposed rule change is consistent with 
Section 6(b) of the Act in general and furthers the objectives of 
Section 9(b)(5) in particular in that it is designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in facilitating transactions in securities, 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.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    Comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the publication of this notice in the Federal 
Register or within such other period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve the proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, S.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule [[Page 12994]] 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 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 
CBOE. All submissions should refer to the file number in the caption 
above and should be submitted by March 30, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\2\

    \2\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-5702 Filed 3-8-95; 8:45 am]
BILLING CODE 8010-01-M