[Federal Register Volume 77, Number 198 (Friday, October 12, 2012)]
[Notices]
[Pages 62277-62280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-25080]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67992; File No. SR-CBOE-2012-095]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Notice of Filing and Immediate Effectiveness of a
Proposed Rule Change Relating to Closing Rotation Procedures for S&P
500 Index Options
October 5, 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 September 28, 2012, Chicago Board Options Exchange,
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and
Exchange Commission (the ``Commission'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the Exchange. The Exchange has designated the proposal as a ``non-
controversial'' proposed rule change pursuant to Section 19(b)(3)(A) of
the Act \3\ and Rule 19b-4(f)(6) thereunder.\4\ 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.
\3\ 15 U.S.C. 78s(b)(3)(A)(iii).
\4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The filing proposes to adopt Interpretation and Policy .06 under
CBOE Rule 6.2B relating to closing rotation procedures to determine the
month-end closing price for each series of S&P 500 Index options based
on the theoretical fair value of such series. The text of the proposed
rule change is available on the Exchange's Web site at http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx, 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 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
The purpose of the proposed rule change is to codify and formalize
the process by which, at each month-end, the closing price of each
series of S&P 500 Index (``SPX'') options are aligned with the closing
value of (i) the underlying stock index in the cash market, and (ii)
the related SPX futures contracts traded on the Chicago Mercantile
Exchange (``CME'').
Background
Beginning in December 1999, the CME instituted a special settlement
procedure to determine a fair value settlement price of its domestic
stock index futures for the December month-end based on the closing
value of the underlying stock index, rather than the actual closing
price of the index futures contract.\5\ The fair value of each index
futures contract is calculated based on the value of the underlying
stock index as of the cash market close at 3:00 p.m.,\6\ even though
futures trading continues until 3:15 p.m. For these month-end
settlement days, this 3:00 p.m. theoretical fair value replaces the
actual 3:15 p.m. final trading price as the settlement value of the
stock index futures contract for all purposes--including account value
reporting and end-of-day variation margin calls.\7\
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\5\ The CME originally instituted this practice for the December
31, 1999 year-end, but has adopted the practice for each month-end
closing date since January 2001.
\6\ All times referred to herein are Chicago time.
\7\ See generally CME Group, Month-End Fair Value Procedures,
available at http://www.cmegroup.com/trading/equity-index/fairvaluefaq.html.
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The Exchange understands that the CME created this fair value
settlement price at the request of certain institutional investors.
These institutional investors require an independent third-party
valuation of the fair value of their futures positions as of the 3:00
p.m. close of the underlying cash markets. Many market participants are
active in both the futures and cash markets and want the values of
their futures positions to align with the value of their underlying
cash market positions. If the month-end settlement price in their stock
index futures positions were based on the 3:15 p.m.
[[Page 62278]]
close of futures trading, while the month-end closing price of their
cash market positions in the stock index were based on the 3:00 p.m.
cash market close, tracking error would likely occur as 3:15 p.m.
futures prices reflect information that became available after the 3:00
p.m. cash market close.\8\ This tracking error due to the difference in
closing time would cause these institutional investors' financial
reporting to misrepresent their actual overall portfolio performance.
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\8\ The CME has explained the reason for maintaining its 3:00
p.m. fair value procedure as follows:
Stock index products on the [CME] normally close and settle
fifteen minutes after the daily close of trading in cash equities.
The cash/futures basis may be affected to the extent that futures
may fluctuate--sometimes sharply--during those final fifteen
minutes. As such, this may become a difficulty for institutional
traders practicing coordinated cash/futures strategies. Still, the
opportunity to lay off equity market exposure during those fifteen
minutes subsequent to the cash close has proven quite beneficial.
The use of [fair value] settlement procedures is intended to address
this so-called ``tracking error'' while still permitting trade to
continue for fifteen minutes past the 3:00 p.m. cash close.
Conceptually, the fair value settlement is determined when the cash
market closes at 3:00 p.m., since any new information following 3:00
p.m. will not affect the closing price of the stocks and the
indexes. However, information or events subsequent to the cash close
may still impact futures prices. Market participants should be aware
of the possibility that futures may trade at prices apart from fair
value settlement prices between 3:00 p.m. and the close of the
market at 3:15 p.m. on days on which [fair value] settlement
procedures are applied.
See id.
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The market for SPX futures and the market for SPX options are
highly interconnected. Many investors in SPX options traded on the
Exchange are also active in SPX futures contracts traded on the CME,
hedging positions in one with positions in the other. In fact,
investors often calculate the value of SPX options with reference to
the value of the related SPX futures. Since the CME began its month-end
fair value procedure in December 1999, the Exchange determined that it
would be disruptive to fair and orderly markets to allow the closing
prices of SPX options at month-end (based on the actual 3:15 p.m.
Exchange close) to significantly diverge from the settlement value of
the related SPX futures (determined based on the fair value at the 3:00
p.m. cash market close). Such a divergence would cause numerous
difficulties for investors active in both SPX options and SPX futures,
including: (i) Month-end portfolio reports would misrepresent an
investor's overall positions because the value of the investor's SPX
options and SPX futures positions would reflect different moments in
time, falsely indicating tracking error or the level of offsetting
hedges, and (ii) an investor that is perfectly hedged between its SPX
options and its SPX futures positions could nonetheless (A) be called
for additional unnecessary margin, or (B) have necessary margin
returned to them, because the futures settlement value (and therefore
margin calculation) was based on the 3:00 p.m. fair value, while the
SPX options closing prices were based on the actual 3:15 p.m. Exchange
close.
One potential approach to prevent this divergence would have been,
on the last business day of each month, to end trading in SPX options
series at 3:00 p.m. This would cause the closing prices on the Exchange
to naturally align with the 3:00 p.m. fair value assigned to SPX
futures by the CME. However, the Exchange determined that this would
itself be disruptive, as it would result in the market for SPX futures
on the CME being open for trading at a time when the market for SPX
options on the Exchange was closed. This misalignment would disrupt the
trading activities of many market participants, leaving them unable to
actively hedge their SPX futures positions in SPX options. The Exchange
therefore adopted a practice to align the closing price of SPX options
with the settlement value of SPX futures.
Current Procedures
Throughout each trading day, the Exchange disseminates bid and
offer quotations in each series of SPX options traded on the Exchange.
Upon receipt of the final quotations from the Exchange, the Options
Clearing Corporation (``OCC'') determines the final closing price of
each series of SPX options by calculating the midpoint between the
final bid and final offer quotations. Generally, the final quotations
disseminated by the Exchange on each day reflect the final quotations
as of 3:15 p.m. However, pursuant to Exchange Rules 6.2, 6.2A, 6.2B and
24.13, the Exchange determined to deviate from normal rotation policy
and procedure in the interest of a fair and orderly markets on those
month-end business days when the CME adopted a 3:00 p.m. fair value as
the settlement price. On these days, the Exchange holds special non-
trading closing rotations to determine the closing price of each SPX
options series based on the theoretical fair value at the 3:00 p.m.
cash market close.\9\ After the 3:15 p.m. Exchange close, the Exchange,
based on quotes provided by the Lead Market-Maker (``LMM''), conducts a
non-trading closing rotation solely to determine the ``fair value''
closing prices of its SPX options based on all relevant inputs,
including the settlement value for the related SPX futures contract
announced by the CME and the views of any other market participants.
Shortly after 3:15 p.m., the Exchange then disseminates non-tradable
final bid and offer quotations, and their midpoint equals the fair
value price. Upon receipt of these post-3:15 p.m. final quotations, the
OCC calculates the closing price based on the midpoint, which equals to
the 3:00 p.m. fair value.
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\9\ The Exchange has kept the market informed of this procedure
through frequent Regulatory Circulars. See CBOE Regulatory Circular
RG99-233 (Dec. 21, 1999), available at https://www.cboe.org/publish/regcir/rg99-233.pdf; CBOE Regulatory Circular RG00-049 (Mar. 29,
2000), available at https://www.cboe.org/publish/regcir/rg00-049.pdf; CBOE Regulatory Circular RG01-014 (Jan. 25, 2001),
available at http://www.cboe.com/publish/RegCir/RG01-014.pdf; CBOE
Regulatory Circular RG01-040 (Mar. 29, 2001), available at https://www.cboe.org/publish/regcir/rg01-040.pdf; CBOE Regulatory Circular
RG01-058 (Apr. 27, 2001), available at https://www.cboe.org/publish/regcir/rg01-058.pdf; CBOE Regulatory Circular RG02-019 (Apr. 4,
2002), available at http://www.cboe.com/publish/RegCir/RG02-019.pdf;
CBOE Regulatory Circular RG02-039 (June 12, 2002), available at
http://www.cboe.com/publish/RegCir/RG02-039.pdf; CBOE Regulatory
Circular RG02-073 (Sept. 17, 2002), available at http://www.cboe.com/publish/RegCir/RG02-073.pdf; CBOE Regulatory Circular
RG02-118 (Dec. 19, 2002), available at http://www.cboe.org/publish/regcir/rg02-118.pdf; CBOE Regulatory Circular RG03-016 (Mar. 19,
2003), available at http://www.cboe.com/publish/RegCir/RG03-016.pdf;
CBOE Regulatory Circular RG03-039 (June 11, 2003), available at
http://www.cboe.com/publish/RegCir/RG03-039.pdf; CBOE Regulatory
Circular RG03-075 (Sept. 10, 2003), available at http://www.cboe.com/publish/RegCir/RG03-075.pdf; CBOE Regulatory Circular
RG03-082 (Sept. 22, 2003), available at http://www.cboe.com/publish/RegCir/RG03-082.pdf; CBOE Regulatory Circular RG03-110 (Dec. 17,
2003), available at http://www.cboe.com/publish/RegCir/RG03-110.pdf;
CBOE Regulatory Circular RG04-132 (Dec. 30, 2004), available at
http://www.cboe.com/publish/RegCir/RG04-132.pdf; CBOE Regulatory
Circular RG05-130 (Dec. 29, 2005), available at http://www.cboe.com/publish/RegCir/RG05-130.pdf; CBOE Regulatory Circular RG06-130 (Dec.
19, 2006), available at http://www.cboe.org/publish/regcir/rg06-130.pdf; CBOE Regulatory Circular RG08-004 (Jan. 8, 2008), available
at http://www.cboe.com/publish/RegCir/RG08-004.pdf; CBOE Regulatory
Circular RG09-151 (Dec. 30, 2009), available at http://www.cboe.org/publish/regcir/rg09-151.pdf; and CBOE Regulatory Circular RG12-023
(Jan. 30, 2012), available at http://www.cboe.org/publish/regcir/rg12-023.pdf.
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Thus, unlike other trading days where the SPX options closing
prices are based on the final actual quotes as of 3:15 p.m., for these
month-end dates, the SPX options closing prices are based on the
theoretical 3:00 p.m. fair value. As with the CME, on the days when
this procedure is used, although no actual trades occur at these
prices, these theoretical fair value closing prices are treated as the
closing prices for all purposes, including dissemination through the
Options Price Reporting
[[Page 62279]]
Authority (``OPRA'') and OCC margin calculations.
Proposed Interpretation
The Exchange proposes to adopt Interpretation and Policy .06 to
Rule 6.2B (the ``Interpretation'') to codify in its rulebook the
Exchange's existing practice with respect to the end-of-month SPX
options fair value procedures.
The Exchange continues to believe that it is integral to fair and
orderly markets in SPX options that the closing price of each series of
SPX options traded on the Exchange be based on the value as of the same
time as the closing price of the related SPX futures traded on the CME.
Because the CME has made a practice of determining the closing price of
SPX futures on the last business day of each month based on the 3:00
p.m. fair value, the Exchange believes the closing price of each
related SPX options series should similarly be based on the 3:00 p.m.
price. Investors active in both the options and futures markets would
face numerous difficulties if the closing values of SPX options and SPX
futures were allowed to significantly diverge. For example, as noted
above, if the closing price of a series of SPX options was to be based
on the 3:15 close of trading, while the related SPX futures settlement
price was based on the 3:00 p.m. fair value, an investor that was
perfectly hedged between the options and futures could nonetheless be
subject to potentially significant margin calls due to market movements
between 3:00 p.m. and 3:15 p.m.--even though such market movement would
not actually impact the level of risk of the perfectly hedged
portfolio.
As discussed above, on those days when the CME has instituted its
3:00 p.m. fair value settlement procedure, the Exchange determined to
deviate from normal rotation policies and procedures in the interest of
fair and orderly markets and conduct fair value closing rotations. The
Exchange has done so on a regular basis in response to changes in CME
procedures, in order to prevent any disruption to fair and orderly
markets that would occur from the closing price of SPX options being
determined as of the 3:15 p.m. close and the settlement value of SPX
futures being determined as of 3:00 p.m. fair value. However, the CME
appears to have adopted its 3:00 p.m. fair value procedure on a
permanent basis for each month-end trading date.\10\ Therefore, rather
than continuing to rely on its authority to deviate from normal
rotation policies and procedures, the Exchange has determined to adopt
the Interpretation to codify the Exchange's existing practice in its
rulebook.
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\10\ The Exchange notes, however, that the CME does not appear
to maintain a specific rule in connection with its fair value
procedure, and therefore may change its practice at any time.
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The Interpretation codifies the Exchange's current procedures
without material change. Specifically, on the last business day of each
calendar month, following the 3:15 p.m. close of trading in SPX
options, the Exchange will conduct special non-trading closing
rotations for each series of SPX options in order to determine their
theoretical fair value as of the 3:00 p.m. close of the cash market.
The LMM for each series of SPX options will be responsible for
calculating the fair value of that series.
The ``fair value'' of a series of SPX options represents the price
at which the series should theoretically trade in relation to cash
values in the absence of transaction costs. It is typically calculated
as a function of the underlying index value plus the financing cost of
owning the underlying stock portfolio, less dividends paid up to the
expiration of the option.
To reach this fair value, each LMM will consider various inputs,
including the prevailing interest rates, expected dividends, and input
from market participants. Additionally, because the fair value of the
related futures contract reflects a similar calculation, the Exchange
expects that particular weight will be given to the as-of 3:00 p.m.
fair value of the related SPX futures contract disseminated by the CME.
Upon determination of the fair value, the LMMs will calculate bid and
offer quotations, the midpoint of which will equal the calculated fair
value, and provide these non-tradable quotations to the Exchange.
The Exchange will disseminate these non-tradable fair value
quotations via OPRA after the 3:15 close, within approximately three to
five minutes of closing. The OCC will then determine the final closing
price of each series of SPX options by calculating the midpoint between
these final fair value bid and final fair value offer quotations, which
will equal fair value. This fair value closing price will be used as
the closing price for all purposes, including the OCC's calculation of
variation margin requirements.
The Exchange recognizes that LMMs may have an interest in the
outcome of the month-end value determination based on the composition
of their own proprietary positions. For example, an LMM may have an
incentive to lean their fair value determination in a direction that
would minimize the potential variation margin the LMM would be called
for by the OCC with respect to their proprietary holdings. However, the
Exchange believes that this risk is limited because, as a mathematical
formula, fair value can be generally approximated by third parties,
allowing for independent checks on the LMMs' calculations. In addition,
the Exchange does and will conduct robust surveillance and oversight of
LMMs' fair value quotations activities to monitor for potential
attempts at manipulation.
Finally, as described above, the need to disseminate after 3:15
p.m. the fair value closing quotations for SPX options based on the
3:00 p.m. fair value on the last business day of each month is due to
the current CME procedures in place for SPX futures. However, the
Exchange cannot predict whether the CME may determine to forego its
special month-end fair value procedure at any time in the future. The
proposed interpretation therefore provides the Exchange with discretion
not to disseminate the 3:00 p.m. fair value quotations as determined by
the LMMs after the 3:15 p.m. close, if not doing so would be in the
interest of fair and orderly markets. The Exchange anticipates that it
would only not do so in the event that the CME determines not to apply
its special month-end fair value settlement procedure for SPX futures,
either on a particular month-end trading date or otherwise. In such an
event, the Exchange anticipates allowing the actual 3:15 p.m. closing
quotations to act as the final quotations, as occurs on other trading
days, so that both the closing quotations of SPX options at such a
month-end and the settlement value of the related SPX futures would
each reflect the same end of trading time.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with the Securities Exchange Act of 1934 (the ``Act'') \11\ and the
rules and regulations thereunder and, in particular the requirement of
Section 6(b) of the Act.\12\ Specifically, the Exchange believes the
proposed rule change furthers the objectives of Section 6(b)(5) \13\ 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, and to remove impediments to and perfect
the mechanism of a free and open market and a national market
[[Page 62280]]
system. In particular, the proposed rule change furthers the interest
of fair and orderly markets by avoiding the artificial tracking error
that could result if the underlying value of the closing price of SPX
options were allowed to significantly diverge at month-end from the
closing value of the underlying stock index and the settlement value of
the related SPX futures contract. Additionally, the proposed rule
change is designed to improve the Exchange's ability to prevent
fraudulent and manipulative practices by adopting a surveillance
program to monitor the LMMs' month-end fair value quoting activities.
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\11\ 15 U.S.C. 78a.
\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 will 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 neither solicited nor received comments on the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Because the foregoing proposed rule change does not:
A. Significantly affect the protection of investors or the public
interest;
B. Impose any significant burden on competition; and
C. Become operative for 30 days from the date on which it was
filed, or such shorter time as the Commission may designate,
it has become effective pursuant to Section 19(b)(3)(A) \14\ of the Act
and Rule 19b-4(f)(6) \15\ thereunder.\16\
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\14\ 15 U.S.C. 78s(b)(3)(A).
\15\ 17 CFR 240.19b-4(f)(6).
\16\ In addition, Rule 19b-4(f)(6)(iii) requires a self-
regulatory organization to provide the Commission with written
notice of its intent to file the proposed rule change, along with a
brief description and text of the proposed rule change, at least
five business days prior to the date of filing of the proposed rule
change, or such shorter time as designated by the Commission. The
Exchange has satisfied this requirement.
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At any time within 60 days of the filing of this proposed rule
change, the Commission summarily may temporarily suspend such rule
change if it appears to the Commission that such action is necessary or
appropriate in the public interest, for the protection of investors, or
otherwise in furtherance of the purposes of the Act.
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-CBOE-2012-095 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-CBOE-2012-095. 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
10:00 a.m. and 3:00 p.m. Copies of such 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-CBOE-2012-095 and should be
submitted on or before November 2, 2012.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\17\
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\17\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-25080 Filed 10-11-12; 8:45 am]
BILLING CODE 8011-01-P