[Federal Register Volume 77, Number 56 (Thursday, March 22, 2012)]
[Notices]
[Pages 16883-16888]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-6863]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-66614; File No. SR-ISE-2012-22]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of Proposed Rule Change To Add an Index Option
Product for Trading on the Exchange
March 16, 2012.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on March 9, 2012, the International Securities Exchange, LLC (the
``Exchange'' or the ``ISE'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I and II 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.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange is proposing to amend its rules to trade options on
the ISE Max SPY TM Index (``ISE Max SPY''), a newly-
developed, ISE proprietary index (patent pending). The ISE Max SPY is
designed to represent 10 times the value of the published prices in the
SPDR[supreg] S&P 500[supreg] ETF Trust. The Exchange also proposes to
list and trade long-term options on the ISE Max SPY. Options on the Max
SPY will be p.m. cash-settled and will have European-style exercise
provisions.
The text of the proposed rule change is available on the Exchange's
Internet Web site at http://www.ise.com, at the principal office of the
Exchange, and at the Commission's Public Reference Room.
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
1. Purpose
The Exchange proposes to amend its Rules 2001, 2004 and 2009 to
provide for the listing and trading of options on the ISE Max SPY
TM index, a newly-developed, ISE proprietary index (patent
pending). The ISE Max SPY is designed to represent 10 times the value
of the published share prices in the SPDR[supreg] S&P 500[supreg] ETF
Trust. In addition to options on the ISE Max SPY, the Exchange may list
long-term options on ISE Max SPY.\3\ Options on the ISE Max SPY will be
P.M. cash-settled and will have European-style exercise provisions.
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\3\ Under ISE Rule 2009(b), ``Long-Term Index Options Series,''
the Exchange may list long-term options that expire from 12 to 60
months from the date of issuance.
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The ISE Max SPY Index is constructed using the share prices of the
SPDR[supreg] S&P 500[supreg] ETF Trust (the ``Trust'', which is
commonly known by its exchange symbol ``SPY''). According to the
Trust's prospectus, SPY is based on the S&P 500[supreg], which is a
capitalization-weighted index of 500 stocks from a broad range of
industries. The component stocks are weighted according to the total
market value of their outstanding shares. The impact of a component's
price change is proportional to the issue's total market share value,
which is the share price times the number of shares outstanding. These
are all summed for all 500 stocks and divided by a predetermined base
value. The base value for the S&P 500[supreg] is adjusted to reflect
changes in capitalization resulting from, among other things, mergers,
acquisitions, stock rights and substitutions. The ISE Max SPY is
calculated by multiplying the share prices of SPY by a factor of 10 and
rounding to the tenths place. For example, if the share price for SPY
is
[[Page 16884]]
112.35 then the ISE Max SPY value would yield a value of 1123.50 for
the ISE Max SPY.
The Exchange believes that the proposed product would benefit
investors in several ways. First, the European exercise style will
allow investors to engage in certain trading strategies involving in-
the-money options without the risk of being assigned prior to
expiration. The Exchange also notes that options with a European
exercise style may exhibit lower premiums than those with an American
exercise style, all other terms being equal, because the risks of early
assignment may contribute to higher prices for options with an American
style exercise. Further, the cash-settlement feature would allow
investors to retain their existing underlying equity or exchange-traded
fund (``ETF'') positions if they engage in short options strategies, as
opposed to physically-settled options that also have American style
exercise where an assignment could require an investor to adjust its
portfolio in the underlying shares.
The Exchange also believes that a large underlying index would
appeal to market participants that have different investment goals. For
example, a smaller index size would appeal to investors seeking lower-
priced options, while a larger index size would appeal to investors
seeking to reduce their transaction costs by having to purchase fewer
contracts.
As proposed, the proposal would become effective on a pilot program
basis for a period of fourteen months. If the Exchange were to propose
an extension of the program or should the Exchange propose to make the
program permanent, then the Exchange would submit a filing proposing
such amendments to the program. The Exchange notes that any positions
established under the pilot would not be impacted by the expiration of
the pilot. For example, a position in a p.m.-settled series that
expires beyond the conclusion of the pilot period could be established
during the 14-month pilot. If the pilot program were not extended, then
the position could continue to exist. However, the Exchange notes that
any further trading in the series would be restricted to transactions
where at least one side of the trade is a closing transaction.
As part of the pilot program, the Exchange would also submit a
pilot program report to the Commission at least two months prior to the
expiration date of the program (the ``annual report''). As described
below, the annual report would contain an analysis of volume, open
interest and trading patterns. The analysis would examine trading in
the proposed option product as well as trading in the securities that
comprise the S&P 500[supreg] index. In addition, for series that exceed
certain minimum open interest parameters, the annual report would
provide analysis of index price volatility and share trading activity.
The annual report would be provided to the Commission on a confidential
basis.
The annual report would contain the following volume and open
interest data:
(1) Monthly volume aggregated for all trades;
(2) monthly volume aggregated by expiration date;
(3) monthly volume for each individual series;
(4) month-end open interest aggregated for all series;
(5) month-end open interest for all series aggregated by expiration
data [sic]; and
(6) month-end open interest for each individual series.
In addition to the annual report, the Exchange would provide the
Commission with interim reports of the information listed in Items (1)
through (6) above periodically as required by the Commission while the
pilot is in effect. These interim reports would also be provided on a
confidential basis. Additionally, the annual report would contain the
following analysis of trading patterns in Expiration Friday, p.m.-
settled ISE Max SPY options series in the pilot:
(1) A time series analysis of open interest; and
(2) An analysis of the distribution of trade sizes.
Also, for series that exceed certain minimum parameters, the annual
report would contain the following analysis related to index price
changes and underlying share trading volume at the close on Expiration
Fridays:
(1) A comparison of index price changes at the close of trading on
a given Expiration Friday with comparable price changes from a control
sample. The data would include a calculation of percentage price
changes for various time intervals and compare that information to the
respective control sample. Raw percentage price change data as well as
percentage price change data normalized for prevailing market
volatility, as measured by the CBOE Volatility Index (VIX), would be
provided; and
(2) A calculation of share volume of a sample set of the component
securities representing an upper limit on share trading that could be
attributable to expiring in-the-money series. The data would include a
comparison of the calculated share volume for securities in the sample
set to the average daily trading volumes of those securities over a
sample period.
The minimum open interest parameters, control sample, time
intervals, method for randomly selecting the component securities, and
sample periods would be determined by the Exchange and the Commission.
Index Design and Composition
The ISE Max SPY Index is designed to provide larger scale exposure
to, and is calculated using, the share prices of SPY. Each Trust unit,
(i.e., each share of SPY) represents an undivided ownership interest in
the Trust. Shares of SPY trade like any other equity security, and are
listed and traded on NYSE Arca.
As discussed above, the ISE Max SPY is calculated by multiplying
the share prices of SPY by a factor of 10 and rounding to the tenths
place. For example, if the share price for SPY is 112.35 then the ISE
Max SPY value would yield a value of 1123.50 for the ISE Max SPY.
Index Calculation and Index Maintenance
Real-time index levels for the ISE Max SPY shall be calculated by
ISE or its agent, and shall be disseminated by ISE every 15 seconds
during the Exchange's regular trading hours to market information
vendors via the Options Price Reporting Authority (``OPRA'').\4\ The
settlement value for the ISE Max SPY Index is calculated using the Net
Asset Value (``NAV'') of the fund, as calculated by the Exchange, on a
per share basis, times ten.\5\ The NAV of an ETF is the per-share
dollar amount of the fund which is calculated by dividing the total
value of all the securities in its portfolio, less any liabilities, by
the number of fund shares outstanding. In general, equity ETFs use the
closing
[[Page 16885]]
prices of each of the fund's holdings to determine the total value of
all the securities in its portfolio. In the case of SPY, the closing
prices of the portfolio securities are determined by the closing
auction processes of the NYSE for each of those securities.
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\4\ The Exchange will also disseminate these values to its
members.
\5\ The settlement value that the Exchange calculates may be
different from the NAV published by the trustee of the Trust.
According to the prospectus of the Trust, the trustee may deem
prices of the Trust's portfolio securities to be inappropriate, and
may use the prices of another market other than the NYSE, or may
appraise the value of the securities itself. Additionally, the Trust
uses the NYSE's closing prices of all the portfolio securities even
though several of those securities are not listed on the NYSE (as of
the close on February 24, 2012, one hundred components of the SPY
portfolio, which represented 20% of the total portfolio count and
21.74% of the weighting, were listed on Nasdaq). In calculating ISE
Max SPY, the Exchange uses the published closing prices from the
primary market of those securities.
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The Exchange will also notify the staff of the Division of Trading
and Markets of the Commission immediately in the event values of the
ISE Max SPY Index are not disseminated every 15 seconds by a widely
available source. In the event the ISE Max SPY Index ceases to be
maintained or calculated, or its values are not disseminated every 15
seconds by a widely available source, the Exchange will not list any
additional series for trading and will limit all transactions in such
options to closing transactions only for the purpose of maintaining a
fair and orderly market and protecting investors.
Exercise and Settlement Value
Options on the ISE Max SPY will expire on the Saturday following
the third Friday of the expiration month. Trading in options on the ISE
Max SPY will normally cease at 4:15 p.m. (EST), except for expiring
contracts, which will cease trading at 4 p.m. (EST) on the Friday
preceding an expiration Saturday. Non-expiring contracts will continue
to trade until 4:15 p.m. (EST). The index value for exercise of the ISE
Max SPY options will be calculated by ISE based on the NAV of the fund,
on a per share basis, times ten.
The Commission recently determined that it was appropriate to
reintroduce p.m.-settlement to cash-settled index options when it
approved C2 Options Exchange, Incorporated's (``C2'') SPXPM.\6\ As
discussed above, settlement value of the ISE Max SPY utilizes the
prices of the stocks held in the SPDR[supreg] S&P 500[supreg] ETF
Trust. These stocks are also used in the calculation of the S&P
500[supreg] index underlying C2's SPXPM. Therefore, all the arguments
supporting p.m.-settlement in the order approving SPXPM apply here.
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\6\ See Securities Exchange Act Release No. 65256 (September 2,
2011), 76 FR 55969 (September 9, 2011) (SR-C2-2011-008) (``SPXPM
Filing'').
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Reintroduction of P.M. Settlement
When cash-settled \7\ index options were first introduced in the
1980s, they generally utilized closing-price settlement procedures
(i.e., p.m.-settlement).\8\ The Commission became concerned about the
impact of p.m.-settlement on cash-settled index options on the markets
for the underlying stocks at the close on expiration Fridays.\9\ These
concerns were heightened during the quarterly expirations of the third
Friday of March, June, September and December when options, index
futures, and options on index futures all expire simultaneously. P.m.-
settlement was believed to have contributed to above average volume and
added market volatility on those days, which sometimes led to sharp
price movements during the last hour of trading.\10\ As a consequence,
the close of trading on the quarterly expiration Friday became known as
the ``triple witching hour.'' Besides contributing to investor anxiety,
heightened volatility during the expiration periods created the
opportunity for manipulation and other abusive trading practices in
anticipation of the liquidity constraints.\11\
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\7\ The seller of a ``cash settled'' index option pays out the
cash value of the applicable index on expiration or exercise. A
``physically settled'' option, like equity and ETF options, involves
the transfer of the underlying asset rather than cash. See
Characteristics and Risks of Standardized Options, available at:
http://www.theocc.com/components/docs/riskstoc.pdf, for a discussion
of settlement.
\8\ The exercise settlement value for a p.m.-settled index
option is generally determined by reference to the reported level of
the index as derived from the closing prices of the component
securities (generally based on the closing prices as reported by the
primary exchange on which the stock is listed) on the last business
day before expiration (e.g., the Friday before Saturday expiration).
See Characteristics and Risks of Standardized Options, available at:
http://www.theocc.com/components/docs/riskstoc.pdf, for a discussion
of settlement value.
\9\ See, e.g., Securities Exchange Act Release Nos. 45956 (May
17, 2002), 67 FR 36740 (May 24, 2002) (adopting release concerning
cash settlement and regulatory halt requirements for security
futures products) (``Regulators and self-regulators were concerned
that the liquidity constraints faced by the securities markets to
accommodate expiration related buy or sell programs at the market
close on expiration Fridays could exacerbate ongoing market swings
during an expiration and could provide opportunities for entities to
anticipate these pressures and enter orders as part of manipulative
or abusive trading practices designed to artificially drive up or
down share prices.''); 24367 (April 17, 1987), 52 FR 13890 (April
27, 1987) (SR-CBOE-87-11) (order approving a proposal for S&P 500
index options with an exercise settlement value based on an index
value derived from opening, rather than closing, prices); and 32868
(September 10, 1993), 58 FR 48687 (September 10, 1993) (notice of
filing and order granting accelerated approval of proposed rule
change by the New York Stock Exchange, Inc. (``NYSE'') relating to
changes in auxiliary closing procedures for expiration days)
(stating, ``[a]s long as some index derivative products continue to
expire based on closing stock prices on expiration Fridays, the
Commission agrees with the NYSE that such procedures are necessary
to provide a mechanism to handle the potential large imbalances that
can be engendered by firms unwinding index derivative related
positions''). The cash settlement provisions of stock index futures
and options contracts facilitated the growth of sizeable index
arbitrage activities by firms and professional traders and made it
relatively easy for arbitrageurs to buy or sell the underlying
stocks at or near the market close on expiration Fridays (i.e., the
third Friday of the expiration month) in order to ``unwind''
arbitrage-related positions. These types of unwinding programs at
the close on expiration Fridays often severely strained the
liquidity of the securities markets as the markets, and in
particular the specialists on the NYSE, faced pressure to attract
contra-side interest in the limited time that was permitted to
establish closing prices. See Securities Exchange Act Release No.
44743 (August 24, 2001), 66 FR 45904 (August 30, 2001) (File No. S7-
15-01) (proposing release concerning cash settlement and regulatory
halt requirements for security futures products).
\10\ See, e.g., Securities Exchange Act Release Nos. 24276
(March 27, 1987); 52 FR 10836 (April 3, 1987) (notice of filing and
order granting accelerated approval to a proposed rule change by the
NYSE relating to opening price settlement of expiring NYSE Composite
and Beta Index options); 37894 (October 30, 1996), 61 FR 6987 [sic]
(November 5, 1996) (notice of filing and order granting accelerated
approval of proposed rule change by the NYSE permanently approving
the expiration day auxiliary closing procedures pilot program); and
45956 (May 17, 2002), 67 FR 36740 (May 24, 2002) (adopting release
concerning cash settlement and regulatory halt requirements for
security futures products) (reaffirming the Commission's view of the
advantages of a.m. settlement). See also Hans Stoll and Robert
Whaley, Expiration Day Effects of Index Options & Futures (March 15,
1986) (noting that share volume on the NYSE was much higher in the
last hour of a quarterly expiration Friday when both options and
futures expire than on non-expiration Fridays).
\11\ See, e.g., Securities Exchange Act Release No. 45956 (May
17, 2002), 67 FR 36740 (May 24, 2002) (adopting release concerning
cash settlement and regulatory halt requirements for security
futures products) (explaining that entities could take advantage of
illiquidity resulting from the unwinding of arbitrage-related
positions on expiration Fridays to manipulate share prices).
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In light of the concerns with p.m.-settlement and to help
ameliorate the price effects associated with expirations of p.m.-
settled, cash-settled index products, in 1987, the Commodity Futures
Trading Commission (``CFTC'') approved a rule change by the Chicago
Mercantile Exchange to provide for a.m.-settlement for index futures,
including futures on the S&P 500[supreg] index.\12\ The Commission
subsequently approved a rule change by the Chicago Board Options
Exchange (``CBOE'') to list and trade a.m.-settled S&P 500[supreg]
index options.\13\ In 1992, the
[[Page 16886]]
Commission approved CBOE's proposal to transition all of its European-
style cash-settled options on the S&P 500[reg] index to a.m.-
settlement.\14\ Thereafter, the Commission approved proposals by the
options markets to transfer most of their cash-settled index products
to a.m.-settlement.\15\
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\12\ See Proposed Amendments Relating to the Standard and Poor's
500, the Standard and Poor's 100 and the Standard Poor's OTC Stock
Price Index Futures Contract, 51 FR 47053 (December 30, 1986)
(notice of proposed rule change from the Chicago Mercantile
Exchange). See also Securities Exchange Act Release No. 24367 (April
17, 1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11) (noting that
the Chicago Mercantile Exchange moved the S&P 500[supreg] futures
contract's settlement value to opening prices on the delivery date).
The exercise settlement value for an a.m.-settled index option is
determined by reference to the reported level of the index as
derived from the opening prices of the component securities on the
business day before expiration.
\13\ See Securities Exchange Act Release No. 24367 (April 17,
1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11) (order approving
a proposal for S&P 500 index options with an exercise settlement
value based on an index value derived from opening, rather than
closing, prices). At the time it approved CBOE's introduction of
a.m.-settlement for cash settled index options, the Commission
identified two benefits to a.m.-settlement for cash-settled index
options. See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09). First, it
provides additional time to test price discovery, as market
participants have the remainder of the regular trading day to adjust
to opening session price movements and determine whether those
movements reflect changes in fundamental values or short-term supply
and demand conditions. Second, it provides more opportunity to trade
out of positions acquired during the opening auction. In this
respect, attracting contra-side interest to a single-priced auction
to offset an order imbalance (such as those attributable to index
arbitrage) may more readily be achieved in an opening auction on
Friday morning than a closing auction on Friday afternoon because
the morning session allows market participants that have provided
that liquidity to have the remainder of the regular trading day to
liquidate their positions. In contrast, positions acquired in a
Friday afternoon closing auction generally cannot be liquidated as
readily and efficiently until the following Monday. Holding
positions overnight, or over a weekend, may entail greater risk than
holding intraday positions. To accept such risk (real or perceived),
market participants generally will require a greater premium, which
may translate into greater price concessions, and thus lead to
greater volatility in the closing auction. In other words, a
consequence of p.m.-settlement may be enhanced volatility at the
close. See, e.g., Securities Exchange Act Release No. 44743 (August
24, 2001), 66 FR 45904 at 45908 (August 30, 2001) (``Steep discounts
(premiums) were necessary in part because traders who bought (sold)
stocks to offset unwinding programs had to maintain their newly
acquired long (short) positions over the weekend--during which time
they were subject to considerable market risk.'').
\14\ See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09) (order approving
CBOE's proposal relating to position limits for SPX index options
based on the opening price of component securities).
\15\ CBOE's index options on the S&P 100[supreg] (OEX), however,
kept their p.m.-settlement. See Securities Exchange Act Release No.
30944 (July 21, 1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09).
No futures or options on futures trade on the S&P 100 index. Other
types of options utilize p.m.-settlement, including physically-
settled single-stock options and options on ETFs.
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The Commission and the CFTC noted the benefits of a.m.-settlement
in a 2001 joint release concerning securities futures, where they
observed that ``the widespread adoption of opening-price settlement
procedures in index futures and options has served to mitigate the
liquidity strains that had previously been experienced in the
securities markets on expirations.'' \16\
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\16\ See Securities Exchange Act Release No. 44743 (August 24,
2001), 66 FR 45904 at 45908 (August 30, 2001) (proposing release for
a joint rule between the Commission and the CFTC generally
stipulating, among other provisions, that the final settlement price
for each cash-settled security futures product fairly reflect the
opening price of the underlying security or securities). See also
Securities Exchange Act Release No. 45956 (May 17, 2002), 67 FR
36740 at 36741-42 (May 24, 2002) (adopting release concerning cash
settlement and regulatory halt requirements for security futures
products in which the Commission reaffirmed the advantages of a.m.-
settlement) (``[O]pening price settlement procedures offered several
features that enabled the securities markets to better handle
expiration-related unwinding programs.'').
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Since 1992, the Commission has approved proposals that provide for
cash-settled index options with p.m.-settlement on a limited basis for
options products that generally are characterized by lower relative
volume and that generally do not involve settlement on the third Friday
of a month.\17\ At the time of each approval, the Commission stated
that limited approvals on a pilot basis would allow the exchange and
the Commission to monitor the potential for adverse market effects and
modify or terminate the pilots, if necessary. Notably, with the
exception of FLEX Index options, these recently-approved p.m.-settled
contracts do not involve expiration on the third Friday of the month.
These new contracts, including FLEX, have also been characterized by
limited volume, and would not be expected to have a pronounced effect
on volatility in the underlying securities at the close as a result.
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\17\ In particular, in 1993, the Commission approved CBOE's
proposal to list and trade p.m.-settled, cash-settled options on
certain broad-based indexes expiring on the first business day of
the month following the end of each calendar quarter (``Quarterly
Index Expirations''). See Securities Exchange Act Release No. 31800
(February 1, 1993), 58 FR 7274 (February 5, 1993) (SR-CBOE-92-13).
In 2006, the Commission approved, on a pilot basis, CBOE's listing
of p.m.-settled index options expiring on the last business day of a
calendar quarter (``Quarterly Options Series''). See Securities
Exchange Act Release No. 54123 (July 11, 2006), 71 FR 40558 (July
17, 2006) (SR-CBOE-2006-65). In January 2010, the Commission
approved CBOE's listing of p.m.-settled FLEX options on a pilot
basis. See Securities Exchange Act Release No. 61439 (January 28,
2010), 75 FR 5831 (February 4, 2010) (SR-CBOE-2009-087) (order
approving rule change to establish a pilot program to modify FLEX
option exercise settlement values and minimum value sizes). FLEX
options provide investors with the ability to customize basic option
features including size, expiration date, exercise style, and
certain exercise prices. Prior to 2010, only a.m.-settlement based
on opening prices of the underlying components of an index could be
used to settle a FLEX index option if it expired on, or within two
business days of, a third-Friday-of-the month expiration (``Blackout
Period''). Last year, the Commission approved a pilot program to
permit FLEX index options with p.m.-settlement that expire within
the Blackout Period. See Securities Exchange Act Release No. 61439
(January 28, 2010), 75 FR 5831 (February 4, 2010) (SR-CBOE-2009-
087). In September 2010, the Commission approved CBOE's listing of
p.m.-settled End of Week expirations (expiring on each Friday, other
than the third Friday) and End of Month expirations (expiring on the
last trading day of the month) for options on broad-based indexes,
also on a pilot basis. See Securities Exchange Act Release No. 62911
(September 14, 2010), 75 FR 57539 (September 21, 2010) (SR-CBOE-
2009-075).
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The concerns from 18 years ago that led to the transition to a.m.-
settlement for index derivatives have been largely mitigated.
Expiration pressure in the underlying cash markets at the close has
been greatly reduced with the advent of multiple primary listing and
unlisted trading privilege markets and trading is now widely dispersed
among many market centers. Further, opening procedures in the 1990s
were deemed acceptable to mitigate one-sided order flow driven by index
option expiration and that [sic] today's more sophisticated automated
closing procedures should afford a similar, if not greater, level of
comfort. Specifically, many markets, notably The NASDAQ Stock Market
LLC (``Nasdaq'') and the NYSE, now utilize automated closing cross
procedures and have closing order types that facilitate orderly
closings, and that [sic] these closing procedures are well equipped to
mitigate imbalance pressure at the close. In addition, ISE believes
that after-hours trading now provides market participants with an
alternative to help offset market-on-close imbalances.
Also, as noted in the SPXPM Filing, for roughly five years (1987-
1992) CBOE listed both a.m.- and p.m.-settled SPX and did not observe
any related market disruptions during that period in connection with
the dual a.m./p.m.-settlement.\18\ Finally, ISE believes that p.m.-
settled options predominate in the over-the-counter (``OTC'') market,
and ISE is not aware of any adverse effects in the underlying cash
markets attributable to the considerable volume of OTC trading. ISE is
merely trying to offer a p.m.-settled product in an exchange
environment which offers the benefit of added transparency, price
discovery and stability. The ISE asserts that given the changes since
the 1980s, concerns with p.m.-settlement are not applicable in today's
market because closing procedures on the cash equities markets have
become more automated with real time data feeds that are distributed to
a wider array of market participants.
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\18\ See SPXPM Filing, supra note 6, at 55974.
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Finally, in the SPXPM Filing, C2 estimates that 95% of OTC options
based on the S&P 500[supreg] index are p.m.-settled,\19\ therefore ISE
Max SPY will attract some of that trading interest. ISE notes that
doing so would be consistent with the objectives of the Dodd-Frank Wall
Street Reform and Consumer Protection Act and could help mitigate
[[Page 16887]]
counterparty risks faced by OTC market participants.
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\19\ Id. At 55975.
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Contract Specifications
The contract specifications for options on the ISE Max SPY are set
forth in Exhibit 3-2. Options on the ISE Max SPY are European-style and
p.m.-settled. The Exchange's standard trading hours for broad-based
index options (9:30 a.m. to 4:15 p.m., New York time), as set forth in
Rule 2008(a), will apply to the trading of options on the ISE Max SPY.
Exchange rules that are applicable to the trading of options on broad-
based indexes will also apply to the trading of ISE Max SPY
options.\20\ Specifically, the trading of ISE Max SPY options will be
subject to, among others, Exchange rules governing margin requirements
and trading halt procedures for index options. Further, ISE Max SPY
options shall be quoted and traded in U.S. dollars.
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\20\ See ISE Rules 2000 through 2013.
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For options on the ISE Max SPY, the Exchange proposes that there
would be no position limits since the index is based on the published
prices of the stocks held in the SPDR[supreg] S&P 500[supreg] ETF
Trust.\21\ As discussed above, C2 received approval to list and trade
cash-settled S&P 500[supreg] index options with no position limits.\22\
The Exchange believes that ISE Max SPY should have no position limits
for the same reasons suggested by C2 for SPXPM.\23\ The settlement
value calculated by ISE would use the portfolio components of the SPY
Trust, which are the same as the components of the S&P 500[supreg]
index. C2 has stated that the settlement value it is using for SPXPM is
based on the closing value of the S&P 500[supreg] which is calculated
using the closing prices of the index components. Similarly, ISE would
be calculating the settlement value using the published closing prices
of the portfolio securities of the SPDR[supreg] S&P 500[supreg] ETF
Trust, thereby benefitting from the same considerable aggregate
capitalization.
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\21\ There would be reporting requirements pursuant to Rule 415,
Reports Related to Position Limits.
\22\ See note 6.
\23\ Id.
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To determine appropriate position limits for this product, the
Commission requested that the Exchange apply a model, such as the Dutt-
Harris model,\24\ whereby the authors developed a model to determine
appropriate position limits for cash settled index derivatives. The
authors concluded that position limits are not as important for broad-
based index derivative contracts that are cash settled because they are
composed of highly liquid and well-followed securities. As such, the
authors note that it would require very high trading volumes to
manipulate the underlying securities and, consequently, any attempted
manipulation would be more easily detectable and prosecutable. The
position limits suggested by the Dutt-Harris model for an S&P
500[supreg]-based index option would be so large as to be irrelevant
and position limits of such magnitude would attract scrutiny from
surveillance systems that would, as a consequence, serve as an
effective substitute for position limits. The premise of this
conclusion is based upon the broad range and deep liquidity of
securities that comprise the S&P 500[supreg], which are the same
portfolio securities whose published prices are used to calculate the
settlement value of the ISE Max SPY.
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\24\ See The Journal of Futures Markets, Vol. 25, no. 10, 945-
965 (2005) (Position Limits for Cash-Settled Derivative Contracts by
Hans R. Dutt and Lawrence E. Harris) (``Dutt-Harris Paper'').
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The Exchange believes that the existing surveillance procedures and
reporting requirements at ISE, other options exchanges, and at the
clearing firms are capable of properly identifying unusual and/or
illegal trading activity. In addition, routine oversight inspections of
the Exchange's regulatory programs by the Commission have not uncovered
any material inconsistencies or shortcomings in the manner in which the
Exchange's market surveillance is conducted. These procedures utilize
daily monitoring of market movements via automated surveillance
techniques to identify unusual activity in both options and underlying
stocks.\25\ Accordingly, ISE's market surveillance has been and will
continue to be rigorous and more than adequate to address any
manipulation concerns.
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\25\ These procedures have been effective for the surveillance
of SPY options trading and will continue to be employed.
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The Exchange proposes to apply broad-based index margin
requirements for the purchase and sale of options on the ISE Max SPY.
Accordingly, purchases of put or call options with 9 months or less
until expiration must be paid for in full. Writers of uncovered put or
call options must deposit/maintain 100% of the option proceeds, plus
15% of the aggregate contract value (current index level x $100), less
any out-of-the-money amount, subject to a minimum of the option
proceeds plus 10% of the aggregate contract value for call options and
a minimum of the option proceeds plus 10% of the aggregate exercise
price amount for put options.
The Exchange proposes to set minimum strike price intervals for ISE
Max SPY options at 1 point intervals. The minimum tick size for series
trading below $3 shall be $0.05, and for series trading at or above $3
shall be $0.10.
The Exchange proposes to list options on the ISE Max SPY in the
twelve consecutive near-term expiration months.\26\ In addition, long-
term option series having up to sixty months to expiration may be
traded.\27\ The trading of long-term ISE Max SPY options shall also be
subject to the same rules that govern the trading of all the Exchange's
index options, including sales practice rules, margin requirements, and
trading rules.
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\26\ See Rule 2009(a)(3).
\27\ See Rule 2009(b)(1).
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Chapter 6 of the Exchange's rules is designed to protect public
customer trading and shall apply to the trading of options on the ISE
Max SPY. Specifically, ISE Rules 608(a) and (b) prohibit Members from
accepting a customer order to purchase or write an option unless such
customer's account has been approved in writing by a designated Options
Principal of the Member. Additionally, ISE's Rule 610 regarding
suitability is designed to ensure that options are only sold to
customers capable of evaluating and bearing the risks associated with
trading in this instrument. Further, ISE Rule 611 permits members to
exercise discretionary power with respect to trading options in a
customer's account only if the Member has received prior written
authorization from the customer and the account had been accepted in
writing by a designated Options Principal. ISE Rule 611 also requires
designated Options Principals or Representatives of a Member to approve
and initial each discretionary order on the day the discretionary order
is entered. Finally, ISE Rule 609, Supervision of Accounts, Rule 612,
Confirmation to Customers, and Rule 616, Delivery of Current Options
Disclosure Documents and Prospectus, will also apply to trading in of
[sic] options on the ISE Max SPY.
Surveillance and Capacity
The Exchange represents that it has an adequate surveillance
program in place for options traded on the ISE Max SPY. The ISE Market
Surveillance Department conducts routine surveillance in approximately
30 discrete areas. Index products and their respective symbols are
integrated into the Exchange's existing surveillance system
architecture and are thus subject to the relevant surveillance
processes.
[[Page 16888]]
This is true for both surveillance system processing and manual
processes that support the ISE's surveillance program.
Finally, the Exchange has the necessary systems capacity to support
new options series that will result from the introduction of options on
the ISE Max SPY, including Leaps.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with Section 6(b) of the Act in general, and the rules and regulations
thereunder, and, in particular, the requirements of Section 6(b) of the
Act.\28\ In particular, the Exchange believes the proposed rule change
is consistent with Section 6(b)(5) \29\ requirements that the rules of
an exchange [sic] designed to promote just and equitable principles of
trade, to remove impediments to and to perfect the mechanism for a free
and open market and a national market system, and in general, to
protect investors and the public interest. The Exchange believes that
p.m.-settlement for the subject index option in the manner proposed
does not raise any meaningful regulatory concerns. Further, the
Exchange believes that the proposal will not adversely impact fair and
orderly markets on expiration Fridays for the underlying stocks
comprising SPY. As discussed in Section (a) of Item 3 of this filing
(the purpose section), the handling of orders at the close on the stock
markets has matured considerably since concerns were initially raised
in the late 1980s. Additionally, the proposed rule change would provide
Members and investors with additional opportunities to trade S&P
500[supreg] options with a p.m.-settlement feature in an exchange
environment and subject to transparent exchange-based rules, and that
[sic] investors would also benefit from the opportunity to trade in
association with this product on Expiration Fridays thereby removing
impediments to a free and open market consistent with the Act.
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\28\ 15 U.S.C. 78f(b).
\29\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The proposed rule change does not 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
The Exchange has not solicited, and does not intend to solicit,
comments on this proposed rule change. The Exchange has not received
any unsolicited written comments from members or other interested
parties.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 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 or disapprove 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 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 email to [email protected]. Please include
File Number SR-ISE-2012-22 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-ISE-2012-22. This file
number should be included on the subject line if email 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 Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of the filing also will be available for
inspection and copying at the principal office of the Exchange. 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-ISE-2012-22 and should be
submitted on or before April 12, 2012.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\30\
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\30\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-6863 Filed 3-21-12; 8:45 am]
BILLING CODE 8011-01-P