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Notice

Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendments No. 1, 2, 3, 4, 5, 6, 7, and 8 by the Chicago Board Options Exchange, Inc. To Initiate a Pilot Program That Allows the Listing of Strike Prices at One-Point Intervals for Stocks Trading Under $20

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Start Preamble April 29, 2003.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),[1] and rule 19b-4 thereunder,[2] notice is hereby given that on December 12, 2001, 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 Exchange. The Exchange filed Amendments No. 1, 2, 3, 4, 5, 6, 7, and 8 to the proposed rule change on March 13, 2002,[3] June 21, 2002,[4] December 6, 2002,[5] March 7, 2003,[6] March 25, 2003,[7] April 16, 2003,[8] April 24, 2003,[9] and April 25, 2003,[10] respectively. The Commission is publishing this notice, as amended, 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 CBOE proposes to initiate a one-year pilot program that would allow the listing of strike prices at one-point intervals where the underlying stock trades under $20 (“$1 Strike Pilot Program” or “Pilot Program”). The text of the proposed rule change appears below. Additions are in italics. Deleted text is in [brackets].

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Start Printed Page 23785

CBOE Rule 5.5: Series of Option Contracts Open for Trading

* * * Interpretations and Policies

.01: The interval between strike prices of series of options on individual stocks [will] may be: a. $1.00 or greater (“$1 Strike prices”) provided the strike price is $20.00 or less, but not less than $3. The listing of $1 strike prices shall be limited to options classes overlying no more than 5 individual stocks (“The $1 Strike Pilot Program”) as specifically designated by the Exchange. The Exchange may list $1 strike prices on any other option classes if those classes are specifically designated by other securities exchanges that employ a similar $1 Strike Pilot Program under their respective rules.

To be eligible for inclusion into the $1 Strike Pilot Program, an underlying stock must close below $20 in its primary market on the previous trading day. After a stock is added to the $1 Strike Pilot Program, the Exchange may list $1 strike prices from $3 to $20 that are no more than $5 from the closing price of the underlying on the preceding day. For example, if the underlying stock closes at $13, the Exchange may list strike prices from $8 to $18. The Exchange may not list series with $1.00 intervals within $0.50 of an existing $2.50 strike price (e.g., $12.50, $17.50) in the same series. Additionally, the Exchange may not list long-term option series (“LEAPS®”) at $1 strike price intervals for any option class selected for the $1 Strike Pilot Program.

A stock shall remain in the $1 Strike Pilot Program until otherwise designated by the Exchange. The $1 Strike Pilot Program shall expire on (insert date one-year from approval).

[a.]b. $2.50 or greater where the strike price is $25.00 or less, or where the stock represents an interest in a registered investment company that satisfies the criteria set forth in Interpretation and Policy .06 under rule 5.3 and where the strike price is $200.00 or less; provided, however, that the Exchange may not list $2.50 intervals below $20 (e.g., $12.50, $17.50) for any class included within the $1 Strike Pilot Program if the addition of $2.50 intervals would cause the class to have strike price intervals that are $0.50 apart.

[b.]c. $5.00 or greater where the strike price is greater than $25.00, or where the stock represents an interest in a registered investment company that satisfies the criteria set forth in Interpretation and Policy .06 under Rule 5.3 and where the strike price is more than $200.[,]00;

[c.]d. $10.00 or greater where the strike price is greater than $200.00.

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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 Exchange 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 Exchange 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

1. Purpose

CBOE rule 5.5 establishes the guidelines regarding the addition of series for trading on the Exchange. Under CBOE rule 5.5, the Exchange currently has the ability to list $2.50 intervals for strike prices under $25, $5.00 intervals for strikes between $25 and $200, and $10 intervals for strikes above $200.[11] The CBOE notes that stock prices in general have dropped over the past couple of years, with many individual listings registering precipitous declines. As a result, the CBOE currently lists options on more than 800 stocks trading under $20, including Cisco, Oracle, SunMicrosystems, Lucent, Nortel, JDS Uniphase, Amazon, Nextel, AT&T, Motorola, and Compaq. According to the CBOE, these stocks are among the most widely held and actively traded equities listed on the New York Stock Exchange, Inc. (“NYSE”) or Nasdaq and the options overlying these stocks also trade actively.

The CBOE notes that when a stock underlying an option trades at a lower price, it takes a larger percentage gain in the stock for an option to become in-the-money. For example, when a stock trades at $8 an investor who wants to buy a slightly out-of-the-money call option would have to buy the $10 call. At these levels, the stock price would need to register a 25% change before it reached $10 (i.e., in-the-money status). According to the CBOE, a 25% gain in the underlying is especially large given the lessened degree of volatility that has accompanied many stocks and options over the past several months. Due to the recent preponderance of low priced stocks, member firms have expressed an interest in listing additional strike prices on these classes so that they can provide their customers with greater flexibility in their investment choices. For this reason, the Exchange proposes to implement a one-year Pilot Program, as described below.

Pilot Program Eligibility: The Exchange proposes to amend Interpretation and Policy .01 to CBOE rule 5.5 to allow the CBOE to list series with $1 strike price intervals on equity option classes that overlie up to five individual stocks, provided that the strike prices are $20 or less, but not less than $3. The appropriate Exchange committee would make the determination of which underlying stocks are to be included in the Pilot Program. A class becomes eligible for inclusion in the Pilot Program when the underlying stock price closes below $20 in its primary market on the previous business day. Underlying stocks trading under $20 that are not a part of the Pilot Program would continue to be eligible for trading in $2.50 and $5.00 intervals.

Although CBOE may select only up to five individual stocks to be included in the Pilot Program, the Exchange would not be precluded from also listing options on other individual stocks at $1 strike price intervals if other options exchanges listed those series pursuant to their respective $1 strikes pilot programs.

Procedures for Adding $1 Strike Price Intervals: The procedures for adding $2.50 or $5.00 strikes currently are provided in Exchange rule 5.5.[12] The Exchange proposes to amend CBOE rule 5.5 to delineate these standards to accommodate the addition of $1 strike price intervals. Under this proposal, the closing price of the underlying stock serves as the reference point for determining which $1 strike prices the Exchange may open for trading.

To minimize the unnecessary proliferation of series, the Exchange will only list $1 strike prices that fall within a $5 range of the underlying stock price, and no strike prices will be added outside of the $5 range. For example, if Start Printed Page 23786the underlying stock trades at $6, the Exchange could list $1 strikes from $3 to $11.[13] The CBOE believes that this proposed range-format will significantly restrict the number of series that may be added at any one time.

Under existing Interpretation and Policy .01(a) to CBOE rule 5.5, the Exchange may list strike prices with $2.50 intervals when an underlying stock trades below $25. Accordingly, several option classes have $7.50, $12.50, and $17.50 strike prices (the “$2.50 series” or “$2.50 intervals”). To further avoid the proliferation of series, the Exchange does not intend to list $1 strike prices at levels that “bracket” existing $2.50 intervals (e.g., $7 and $8 strikes around a $7.50 strike). Accordingly, the Exchange does not intend to list $7, $8, $12, $13, $17, and $18 levels in an expiration month where there is a corresponding $2.50 level. As the $2.50 intervals are “phased-out,” as described below, the Exchange would introduce the $1 levels that bracket the phased-out price. For example, when the $7.50 series expires, the Exchange would replace it by issuing a new month with $7 and $8 intervals.

Procedures for Phasing-out $2.50 Strike Price Intervals: When a stock becomes part of the $1 Strike Pilot Program, the Exchange will begin the corresponding process of phasing-out the existing $2.50 intervals on the same stock in favor of $1 intervals. To phase-out the $2.50 intervals, the Exchange would first delist those $2.50 series for which there is no open interest. Second, the Exchange would no longer add new expiration months at $2.50 intervals below $20 when the existing months expire. This would cause the $2.50 strike price intervals below $20 to be phased-out when the farthest-out month with a $2.50 interval eventually expires.

$1 Strikes for LEAPS: CBOE will not list LEAPS in equity option classes at $1 strike price intervals.

Procedures for Adding Expiration Months: Interpretation and Policy .03 to CBOE rule 5.5 will govern the addition of expiration months for $1 strike series. Pursuant to this rule, the Exchange generally opens up to four expiration months for each class upon initial listing of an options class for trading. Upon expiration of the near-term month, the Exchange may list an additional expiration month provided, however, that the underlying stock price closes below $20 on its primary market on expiration Friday. If the underlying closes at or above $20 on expiration Friday, the Exchange would not list an additional month for a $1 strike series until the stock again closes below $20.

Procedures for Deleting $1 Strike Price Intervals: At any time, the Exchange may cease listing $1 strike prices on existing series by submitting a cessation notice to the Options Clearing Corporation (“OCC”).[14] As discussed above, if the underlying closes at or above $20 on expiration Friday, the Exchange would not list any additional months with $1 strike prices until the stock subsequently closed below $20. If the underlying does not subsequently close below $20, thereby precluding the listing of additional strike prices and months, the existing $1 series will eventually expire. When the near-term month is the only series available for trading, the Exchange may submit a cessation notice to OCC. Upon submission of that notice, the underlying stock would no longer count towards the 5 stock Pilot Program, thereby allowing the Exchange to list classes on an additional stock. Once the Exchange submits the cessation notice, it would not list any additional months for trading with strikes below $20 (unless the underlying once again closed below $20).[15]

OPRA Capacity: CBOE represents that OPRA has the capacity to accommodate the increase in the number of series added pursuant to the Pilot Program. The Exchange notes that in December 2000 it listed approximately 109,000 series. By September 2001, this number declined almost 10% to approximately 100,000. The increase in the number of series quoted would be substantially below the 9,000 series decrease the CBOE experienced.

2. Statutory Basis

The Exchange believes that the addition of $1 strike prices would stimulate customer interest in options overlying lower-priced stocks by creating greater trading opportunities and flexibility. The Exchange further believes that $1 strike prices would provide customers with the ability to more closely tailor investment strategies to the precise movement of the underlying security. For these reasons, the Exchange believes the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to a national securities exchange and, in particular, the requirements of section 6(b) of the Act.[16] Specifically, the Exchange believes the proposed rule change is consistent with the section 6(b)(5)[17] requirements that the rules of an exchange be designed to promote just and equitable principles of trade, to prevent fraudulent and manipulative acts and, in general, 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 not necessary or appropriate in furtherance of the purposes of the Act.

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

No written comments were solicited or received.

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

Within 35 days of the date of publication of this notice in the Federal Register or within such longer 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 Exchange consents, the Commission will:

(A) By order approve such 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, including whether the proposed rule change, as amended, is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 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 Start Printed Page 23787communications 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 Exchange. All submissions should refer to File No. SR-CBOE-2001-60 and should be submitted by May 27, 2003.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[18]

Start Signature

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble

Footnotes

3.  See letter from Steve Youhn, Attorney, CBOE, to Deborah Flynn, Assistant Director, Division of Market Regulation (“Division”), Commission, dated March 12, 2002 (“Amendment No. 1”). In Amendment No. 1, the Exchange provides additional information on the proposal, including information regarding Options Price Reporting Authority (“OPRA”) capacity.

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4.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Elizabeth King, Associate Director, Division, Commission, dated June 20, 2002 (“Amendment No. 2”). Amendment No. 2 discusses the need for $1 strikes and provides information regarding market data vendor capacity.

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5.  See letter from Steve Youhn, Attorney, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated December 5, 2002 (“Amendment No. 3”). In Amendment No. 3, the Exchange proposed to reduce the number of underlying stocks included in the pilot program to 25 and list only $1 strikes that fall within a $5 range of the underlying stock price.

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6.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated March 6, 2003 (“Amendment No. 4”). In Amendment No. 4, the Exchange proposed to: (1) Reduce the number of underlying stocks included in the pilot program to five stocks; (2) list $1 strike prices on options classes include in the $1 strike price program of other options exchanges; and (3) provide that the CBOE would not list Long Term Equity Option Series (“LEAPS”) in equity option classes at $1 strike price intervals.

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7.  On March 25, 2003, the Exchange filed Amendment No. 5, which supercedes the original filing and Amendments No. 1, 2, 3, and 4 in their entirety.

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8.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 15, 2003 (“Amendment No. 6”). In Amendment No. 6, the Exchange made a correction to the proposed rule text and to the purpose section of the proposal.

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9.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 22, 2003 (“Amendment No. 7”). In Amendment No. 7, the Exchange submitted a revised Exhibit A to the proposed rule change, which replaces all previous versions of Exhibit A.

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10.  See letter from James M. Flynn, Attorney II, Legal Division, CBOE, to Deborah Flynn, Assistant Director, Division, Commission, dated April 25, 2003 (“Amendment No. 8”). In Amendment No. 8, the Exchange submitted a revised Exhibit A to the proposed rule change, which replaces all previous versions of Exhibit A.

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11.  Interpretation and Policy .01 to CBOE rule 5.5. Additionally, Interpretation and Policy .05 to CBOE rule 5.5 establishes guidelines for listing $2.50 strikes for a set number of classes with series trading between $25 and $50.

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12.  CBOE rule 5.5(c) provides for the addition of series “when the Exchange deems it necessary to maintain an orderly market, to meet customer demand, or when the market price of the underlying stock moves substantially from the initial exercise price or prices.” If the Exchange initiates options trading on a new class whose underlying stock is below $20, rule 5.5(b) governs the establishment of strike prices.

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13.  As indicated above, strike prices for options included in the Pilot Program may not be greater than $20 or less than $3.

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14.  Among the reasons for submitting a cessation notice are the expiration of available $1 strikes (i.e., underlying stock price remains at or above $20), series proliferation concerns, and delisting because of low price, merger, takeover, or other events. In any event, with prior notice to the membership and customers, CBOE would continue to have the ability to cease trading series that become inactive and have no open interest.

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15.  If the underlying stock trades below $20 after submission of the cessation notice by the Exchange, CBOE could list $1 strike prices again provided it included the class as one of the five classes permitted under the Pilot Program.

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[FR Doc. 03-10957 Filed 5-2-03; 8:45 am]

BILLING CODE 8010-01-P