[Federal Register Volume 69, Number 84 (Friday, April 30, 2004)]
[Notices]
[Pages 23837-23840]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 04-9825]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-49614; File No. SR-CBOE-2004-23]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Chicago Board Options Exchange, Inc. and Amendment No. 1
Thereto To Permanently Approve the Modified ROS Opening Procedure Pilot
Program, Which Occurs on the Settlement Date of Futures and Options on
Volatility Indexes
April 26, 2004.
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 April 21, 2004, the Chicago Board Options Exchange, Inc. (``CBOE''
or ``Exchange'') filed with the Securities Exchange Commission
(``Commission'' or ``SEC'') the proposed rule change as described in
Items I, II and III, below, which Items have been prepared by CBOE. On
April 23, 2004, CBOE filed Amendment No. 1 to the proposed rule
change.\3\ The Commission is publishing this notice to solicit comments
on the proposed rule change, as amended, from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from David Doherty, Attorney, Legal Division,
CBOE, to Terri Evans, Assistant Director, Division of Market
Regulation, Commission, dated April 23, 2004 (``Amendment No. 1'').
In Amendment No. 1, the CBOE deleted its proposed change to the cut-
off time for the submission of orders for placement on the
electronic book. According to CBOE, the CBOE intends to submit the
modification to the cut-off time as a separate proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
CBOE seeks permanent approval of the modified Rapid Opening System
(``ROS'') opening procedure, which was approved by the Commission on a
pilot basis through November 17, 2004.\4\ The proposed rule change
retains the text of CBOE Rule 6.2A.03 as currently approved on a pilot
basis. The text of the proposed rule change is available at the office
of the Secretary, CBOE, and at the Commission.
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\4\ See Securities Exchange Act Release No. 49468 (March 24,
2004), 69 FR 17000 (March 31, 2004) (SR-CBOE-2004-11).
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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, CBOE included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it had received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item III below. CBOE 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
On March 24, 2004, the Commission approved, on a pilot basis, the
implementation of a modified ROS procedure. The modified ROS opening
procedure pilot program facilitates the trading of options and futures
on volatility indexes intended to be traded on CBOE or on the CBOE
Futures Exchange, LLC (``CFE'') by modifying certain of the rules that
govern ROS for index option series whose prices are used to derive the
volatility indexes on which options and futures will be traded. The
modified ROS opening procedure also expanded the types of orders for
these index options that may be included in ROS at the time when
settlement values for volatility index options and futures are being
determined. CBOE believes that the modifications permit a more accurate
determination of these settlement values, and assure that these values
more closely converge with the prices of the index options from which
they are derived. The modified ROS opening procedure pilot program is
due to expire on November 17, 2004. CBOE now proposes that the modified
ROS opening procedure pilot program be approved on a permanent basis.
CBOE requested approval of the modified ROS opening procedure on a
pilot program basis following CBOE's proposal to list and trade options
on several volatility indexes; specifically, the CBOE Volatility Index
(``VIX''); the CBOE Nasdaq 100 Volatility Index (``VXN''); and the CBOE
Dow Jones Industrial Average Volatility Index (``VXD'').\5\ CBOE states
that it may file additional proposed rule changes to provide for the
listing of options on other volatility indexes in the future. CFE,
which is a designated contract market approved by the Commodity Futures
Trading Commission (``CFTC'') and a wholly-owned subsidiary of CBOE,
filed a rule change with the CFTC to provide for the listing and
trading of futures on the VIX on CFE, and may list additional futures
products on other volatility indexes in the future. CBOE believes that
approval of the modified ROS opening procedure pilot program on a
permanent basis will provide certainty as to the settlement process for
market participants that trade those futures and options contract
months on volatility indexes that expire beyond November 17, 2004.
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\5\ See Securities Exchange Act Release Nos. 48807 (November 19,
2003), 68 FR 66516 (November 26, 2003) (Notice of filing of File No.
SR-CBOE-2003-40); 49563 (April 14, 2003), 69 FR 21589 (April 21,
2004) (Order approving File No. SR-CBOE-2003-40).
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Volatility Index Description
In general, CBOE states that volatility indexes (including, without
limitation, the VIX, VXN and VXD (each, a ``Volatility Index''))
provide investors with up-to-the-minute market estimates of expected
near-term volatility of the prices of a broad-based group of stocks by
extracting volatilities from real-time index option bid/ask quotes.
Volatility Indexes are calculated using real-time
[[Page 23838]]
quotes of the nearby and second nearby index puts and calls on
established broad-based market indexes, referred to herein as a
``Market Index.'' For example, the VIX measures the near-term
volatility of the S&P 500 Index (``SPX''), the VXN measures the near-
term volatility of the Nasdaq 100 Index (``NDX'') and the VXD measures
the near-term volatility of the Dow Jones Industrial Average (``DJX'').
The futures and options on a Volatility Index expire on the Wednesday
immediately prior to the third Friday of the month that immediately
precedes the month in which the options used in the calculation of that
index expire (the ``Settlement Date''). For example, May 2004 VIX
futures and options would expire on Wednesday, May 19, 2004, which is
the Wednesday immediately prior to the third Friday of May, which is
the month preceding the expiration of the June 2004 SPX options. Since
Volatility Indexes will be A.M.-settled, CBOE uses the modified ROS
functionality to facilitate the calculation of a settlement price for
futures and options contracts on Volatility Indexes.
Market Index Opening Procedures
ROS is CBOE's automated system for opening classes of options at
the beginning of the trading day or for re-opening classes of options
during the trading day. In brief, the current ROS opening procedure
involves market-makers participating on ROS by logging on each morning
and identifying the classes of options in which they will participate
for the opening. If ROS is being employed in a Designated Primary
Market-Maker (``DPM'') or Lead Market-Maker (``LMM'') trading crowd,
the DPM and LMM are required to participate on ROS. A single opening
price for each option series is calculated based on the orders
contained in the electronic book and on the Autoquote values set by the
DPM, LMM, or other market-maker, as applicable, which Autoquote values
may be adjusted based on input from other LMMs and market-makers
present at the opening. ROS then determines an opening price based on
an algorithm that maximizes the number of public customer orders able
to be executed at the opening. Currently, public customer orders, other
than public customer contingency orders, are the only orders that can
be placed in the electronic book for ROS. To ensure the participation
of broker-dealer orders in the opening price calculation, CBOE Rule
6.2A(ii) requires the member representing a broker-dealer order to
inform the DPM or Order Book Official (``OBO''), as applicable, and the
logged-in ROS market-makers of the terms of such orders prior to the
time the class is locked. However, under current ROS opening
procedures, these broker-dealer orders are not eligible to be entered
in the electronic book that is used by ROS to calculate opening prices.
Modified ROS Opening Procedure Pilot Program
Since ROS partially calculates the opening prices of Market Index
option series based upon orders contained in the electronic book, and
since these opening prices will be used to derive the settlement values
of corresponding Volatility Indexes for purposes of Volatility Index
options and futures, CBOE believes it is necessary to modify the ROS
opening procedures to permit all orders (including public customer,
broker-dealer, CBOE market-maker and away market-maker and specialist
orders), other than contingency orders, to be eligible to be placed on
the electronic book solely for the purpose of the ROS opening. These
orders may be placed on the book in those Market Index option contract
months the prices of which are used to derive the volatility indexes on
which options and futures will be traded. CBOE believes that expanding
the scope of orders eligible for entry into the electronic book for
purposes of the ROS opening will make it easier for all market
participants to participate fully in the establishment of the
settlement values of Volatility Indexes in an efficient and automated
manner. This modified ROS opening procedure will be used only on the
final Settlement Date of the options and futures contracts on the
applicable Volatility Index in each expiration month, which is when
Volatility Index settlement values are determined. The ROS opening
procedures currently set forth in the CBOE rules will continue to
govern ROS openings of Market Index option classes on all other days.
To ensure market-maker participation in the modified ROS opening
procedure, the modified ROS opening procedure pilot program provides
that all market-makers, including LMMs and Supplemental Market-Makers
(``SMMs''),\6\ if applicable, who are required to log on to ROS or
Retail Automatic Execution System (``RAES'') for the current expiration
cycle are required to log on to ROS during the modified ROS opening
procedure if the market-maker is physically present in the trading
crowd for that Market Index option class. Although it has previously
been CBOE's observation that few, if any, non-bookable orders
(including broker-dealer orders) are represented by firms for
participation in the ROS opening,\7\ CBOE believes that CBOE market-
makers and other broker-dealers that trade Volatility Index futures and
options and that use Market Index options for hedging purposes will
want their Market Index option orders to be included in ROS to ensure
the convergence of the values of their settled Volatility Index
positions with the values of their positions in related Market Index
options. For example, a market participant that opens a position in a
VIX futures contract may hedge that position by opening a position in
SPX options, which prices are used in the calculation of VIX. If the
market participant holds the VIX futures contract through settlement,
the market participant must close out the hedge position that remains
open in the SPX options. Since the settlement value of the VIX futures
and options contracts are based on the opening prices of certain SPX
option series, CBOE believes that the hedge will only be fully
effective if the prices at which the market participant closes its SPX
option positions converge with the corresponding prices of the SPX
option series that determine the settlement value of the VIX. The ROS
modified opening procedure pilot program allows this convergence to be
achieved by allowing market participants to close out their open SPX
positions and obtain the exact prices (i.e., the opening prices) for
those SPX series that will be used to calculate the VIX settlement
value.
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\6\ CBOE Rule 8.15 and Interpretation .02 to CBOE Rule 24.13
permit the appropriate Market Performance Committee to appoint one
or more market-makers in good standing with an appointment in an
option class for which a DPM has not been appointed as an LMM and
SMM.
\7\ See Securities Exchange Act Release No. 48529 (September 24,
2003), 68 FR 56658 (October 1, 2003) (SR-CBOE-2002-55) (``ROS
Permanent Approval Order'').
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To participate in the modified ROS opening procedure pilot program
on Settlement Date, all orders for placement on the electronic book are
required to be submitted electronically. For market-makers on CBOE's
trading floor, compliance with this requirement may be fulfilled
through the submission of the order to a floor broker that has access
to CBOE's Order Routing System or through the submission of the order
through a hand-held terminal that has futures and options routing
functionality. CBOE will also permit market-makers on the trading floor
to submit paper ticket market orders to the OBO for placement in the
electronic book. Paper ticket limit orders may not be submitted because
CBOE believes these orders, which would rest on the electronic book if
not executed at the
[[Page 23839]]
opening, may not be able to be cancelled within the time period set
forth in CBOE Rule 6.2A.03, as further explained below. In all
circumstances, orders for placement on the electronic book must be
received by 8:25 a.m.
The current ROS procedures pursuant to CBOE Rule 6.2A(i) would then
take effect and calculate the opening price, at which point the maximum
number of orders (including broker-dealer or market-maker orders) would
be crossed and the balance of orders, if any, to be traded at the
opening price will be assigned to participating market-makers. If the
ROS system is implemented in an option contract for which LMMs have
been appointed, the LMMs will review the order imbalances and
collectively set the Autoquote values that will be used by ROS in
calculating the opening prices for the Market Index option series. CBOE
believes that having all of the LMMs participate in this process will
contribute toward the establishment of a fair and accurate final
settlement price for the Volatility Index futures and options since it
will allow for the primary market-makers in the applicable Market Index
option contract, as reflected by their designation as LMMs, to all have
input in the ROS calculation that will ultimately derive that price.
Other than the role of collectively setting the Autoquote values that
will be used by ROS, LMMs are treated the same as market-makers in all
respects under the modified ROS opening procedure provided for in CBOE
Rule 6.2A.03.
Pursuant to CBOE Rule 6.2A.03(iv), contracts traded in ROS for a
Market Index option series will be assigned equally, to the greatest
extent possible, to all logged-on market-makers, including any LMMs and
SMMs if applicable.\8\ Any customer orders not executed at the ROS
opening will remain in the electronic book.
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\8\ For example, if the opening imbalance is twenty contracts
and ten market-makers are logged on to ROS, each market-maker will
be assigned two contracts. If the opening imbalance is twenty-one
contracts and ten market-makers are logged on to ROS, the algorithm
will assign the greatest amount to the first market-maker chosen in
the rotation (three contracts) with each remaining nine market-
makers receiving two contracts.
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CBOE states that it is in the process of modifying the ROS system
software to prevent a market-maker who is logged on to ROS from trading
against an order on behalf of the market-maker or the market-maker firm
that may be resting in the electronic book.\9\ CBOE states that it will
also implement a ROS system change to automatically generate
cancellation orders for those broker-dealer and market-maker orders
that are not executed during the ROS opening. CBOE expects this work to
be completed in approximately five months. Meanwhile, CBOE will use an
interim process whereby market-maker and broker-dealer orders remaining
on the electronic book because they were not executed in ROS (e.g.,
limit orders) would be required to be cancelled immediately following
the opening of those option contracts to prevent market-maker and
broker-dealer orders from remaining in the electronic book. In
interpreting the requirement of immediate cancellation in this context,
CBOE expects market-makers and broker-dealers to make a good faith
effort to cancel these orders as soon as possible, taking into
consideration the applicable circumstances. For example, it may take a
member slightly longer to cancel an order submitted through a floor
broker than if the member has a hand-held terminal with futures and
options routing functionality.
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\9\ CBOE has represented that prior to implementation of the
system change, it will file a rule change with the Commission
pursuant to Section 19(b)(3)(A) of the Act to amend proposed CBOE
Rule 6.2A.03 to reflect this system change. See Securities Exchange
Act Release No. 49468, supra note 4.
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Surveillance
As described in the Commission's order granting permanent approval
to the ROS system,\10\ CBOE currently has in place surveillance
procedures that are designed to ensure, among other things, that
market-makers exercise their discretion to set certain Autoquote values
consistent with their obligation to price options fairly. CBOE has also
established supplemental ROS surveillance procedures for the modified
ROS opening.\11\ In addition to these procedures, CBOE's Department of
Market Regulation will conduct surveillance to identify any broker-
dealer or market-maker orders that may have been improperly executed on
the electronic book which should have been cancelled following the
modified ROS opening procedure. CBOE will also work with the
Commission's Office of Compliance and Inspections and Examinations
(``OCIE'') to finalize any surveillance reports used in connection with
the modified ROS opening procedure that is acceptable to OCIE.
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\10\ See ROS Permanent Approval Order, supra note 7.
\11\ See letter from David Doherty, Attorney, Legal Division,
CBOE, to Terri Evans, Assistant Director, Division, dated March 24,
2004 (``Supplemental ROS Surveillance Procedures''). CBOE requested
confidential treatment for these surveillance procedures pursuant to
17 CFR 200.83.
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2. Statutory Basis
CBOE states that the proposed rule change is designed to facilitate
the calculation of the final settlement values of Volatility Indexes in
an efficient and automated fashion that reflects all buying and selling
interest in the associated Market Index. Permanent approval of the
proposed rule change will provide certainty as to the settlement
process for market participants that trade those futures and options
contract months on Volatility Indexes that expire beyond the Pilot's
expiration of November 17, 2004. Accordingly, CBOE believes that the
proposed rule change is consistent with section 6(b) of the Act,\12\ in
general, and furthers the objectives of section 6(b)(5) of the Act,\13\
in particular, in that it should 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.
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\12\ 15 U.S.C. 78f(b).
\13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
CBOE does not believe that the proposed rule change would impose
any burden on competition that is 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 with respect to the
proposed rule change.
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 self-regulatory organization 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
[[Page 23840]]
arguments concerning the foregoing, including whether the proposed rule
change, as amended, is consistent with the Act. Comments may be
submitted by any of the following methods:
Electronic comments:
Use the Commission's Internet comment form
(http://www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please
include File Number SR-CBOE-2004-23 on the subject line.
Paper comments:
Send paper comments in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 20549-0609.
All submissions should refer to File Number SR-CBOE-2004-23. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). 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 in the Commission's Public Reference Section, 450 Fifth
Street, NW., Washington, DC 20549. Copies of such filing also will be
available for inspection and copying at the principal office of CBOE.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number SR-CBOE-2004-23
and should be submitted on or before May 21, 2004.
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. 04-9825 Filed 4-29-04; 8:45 am]
BILLING CODE 8010-01-P