[Federal Register Volume 77, Number 249 (Friday, December 28, 2012)]
[Notices]
[Pages 76578-76584]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31154]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68504; File No. SR-CBOE-2012-122]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Notice of Filing of a Proposed Rule Change Related to SPX
Combo Orders
December 20, 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 December 6, 2012, the 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 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 procedures for trading SPX
Combo Orders. The text of the rule proposal is available on the
Exchange's Web site (http://www.cboe.org/legal), at the Exchange's
Office of the Secretary and at the Commission.
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 those 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 parts 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 CBOE Rule 24.20, SPX Combination
Orders, to adopt a one-year pilot program containing revised procedures
that the Exchange believes would make
[[Page 76579]]
the trading of certain combination orders in S&P 500 Index option
contracts (SPX) more competitive with the trading of combinations in
S&P 500 Index futures contracts traded on the Chicago Mercantile
Exchange (``CME''). As discussed further below, the Exchange is also
proposing to revise the existing SPX Combo Order text to make certain
clarifying amendments.
Background
When SPX traders and customers trade SPX options, they hedge their
underlying risk with either S&P 500 Index futures traded at CME or with
SPX call and put options traded as combinations at CBOE (for purposes
of this discussion, a ``combination'' is an order involving a number of
call option contracts and the same or equivalent number of put option
contracts in the same underlying security).\3\ In order for SPX traders
and customers to hedge the risk of their options positions using S&P
500 futures, they have to execute two separate trades in two separate
markets.
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\3\ See CBOE Rule 6.53(e). A combination is a long combination
when it combines a long call and a short put on the same series, and
it is a short combination when it combines a short call and a long
put of the same series. An options position can be hedged by trading
the number of combinations equivalent to the delta of the particular
option multiplied by the number of options in the transaction. The
``delta'' is the number of SPX combinations required to establish a
market neutral hedge based on the value of the underlying S&P 500
Index futures contract. See CBOE Rule 24.20(a)(2). For example, a
customer that purchases 100 SPX calls that have a delta of 30
(expressed as 30% or .30) may hedge against a downward movement in
the S&P 500 Index by either selling S&P 500 Index futures on the CME
or by trading short SPX combinations. If combinations are used to
hedge, the customer will need to trade 30 short combinations (.30 x
100). The appropriate ratio of combinations in this example is to
sell 30 SPX calls and buy 30 SPX puts with the same strike price and
expiration date. If futures are used to hedge, the customer will
need to sell 12 S&P 500 Index futures on the CME ((.30 x 100)/2.5 =
12), where 2.5 is the multiplier used to convert SPX options
positions to the equivalent S&P 500 Index futures position (one S&P
500 Index future equals 2.5 SPX combinations).
Example 1: Assume a trader or customer wants to buy the SPX
April 1335 puts and hedge with the April futures contract trading at
1350. First, the SPX April 1335 put option position would be traded
at CBOE. After the options trade, the trader or customer then has to
submit an order to CME to trade the appropriate number of S&P 500
Index April futures contracts to hedge the options trade.
Example 2: Assume a trader or customer wants to trade a
conversion involving the purchase of the SPX April 1335 puts and the
sale of the SPX April 1335 calls with the purchase of the April
futures contract trading at 1350. First the SPX April 1335 put-call
option position would be traded on CBOE. After the options trade,
the trader or customer then has to submit an order to CME to trade
the appropriate number of S&P 500 Index April futures contracts to
hedge the options trade.
Hedging SPX options by using S&P futures in this manner is not
preferred by traders and customers because of the execution risk that
is involved in having to trade in two separate markets. In other words,
the trader or customer is exposed to the risk of the S&P 500 Index
moving significantly before the hedging futures transaction can be
executed (e.g., assume the trader or customer in Example 1 above
completes the purchase of the SPX April 1335 puts but the S&P 500 Index
declines sharply before the futures can be traded. Given the market
decline, the trader or customer must sell the futures at a much lower
price to complete the hedge.) As a result, SPX traders and customers
prefer trading SPX combinations against their SPX options positions in
order to hedge the risk associated with those positions.
Example 3: Assume the S&P 500 Index April futures contract is
trading at 1350 and a customer wants to trade the 30 delta SPX April
1335 puts tied to the April 1350 calls and April 1350 puts (instead
of the April futures contract). Under this scenario, all three legs
of the strategy would be traded on CBOE.
Example 4: Assume a trader or customer wants to trade a
conversion involving the purchase of the SPX April 1335 puts and the
sale of the SPX April 1335 calls tied to the April 1350 calls and
April 1350 puts (instead of the April futures contract). Under this
scenario, all four legs of the strategy would be traded on CBOE.
One reason that the use of combinations by SPX traders and
customers is preferred is obviously that all the required transactions
can be effected as a package in one market, CBOE. Hedging options with
combinations avoids the execution risk and the increased costs involved
in trading in the futures market. Another reason that the use of
combinations is preferred is that an options order can be ``tied'' to a
particular level of the S&P 500 Index in order to establish the hedge
price.\4\ When SPX options are tied to SPX combinations, the underlying
hedge level of the S&P 500 Index is established and traders and
customers can determine the exact implied volatilities of their options
trades.\5\ Hedging options with combinations acts as an incentive for
market-makers to reduce the price width of their markets because they
know that their hedge price has been established and they will not have
to trade in another market. Thus, customers who trade options tied to
combinations enjoy tighter and more liquid markets.
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\4\ Using the example in note 3, supra, the customer will
request a market for the calls that the customer wishes to purchase
based on a specified level of the S&P 500 Index. The customer
specifies an underlying level of the S&P 500 Index to allow market
participants to determine the delta (in this case 30) and a
theoretical value of the calls. A market participant will then give
his or her market for the 30 delta calls and for the component call
and put options that will make up the combination. The combination
portion of the order is equivalent to an order to trade futures at
the underlying value of the S&P 500 Index that has been specified by
the parties. The prices quoted for the call and put components of
the combination establish the hedge price for the transaction. When
the foregoing occurs, SPX traders and customers say that the calls
have been ``tied'' to the combination or ``tied to the combo.''
\5\ Implied volatility is defined as the volatility percentage
that justifies an option's price. When the customer and the market-
maker establish the underlying hedge level of the S&P 500 Index and
a market price for the calls, the market-maker and the customer are
able to use option pricing models to determine the implied
volatility of the calls. Knowing the implied volatility that is
being quoted in the market is useful to customers and traders in
that customers and traders frequently take positions in the market
based on the implied volatility level.
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Occasionally, certain market activity occurs that makes it
difficult to effect these types of trades. If an order for options tied
to a combination receives an initial quote but does not trade
immediately, it remains a live order until the party that submitted the
order cancels it. The order may not trade immediately for any reason,
but some of the more common reasons are that the customer submitting
the order may want to show the order to other market participants in
order to improve the initial quote received, or a Trading Permit Holder
(``TPH'') may need time to locate a customer that it believes might
like to participate in the trade. Specific market activity can occur
hours after an order for options tied to a combination is submitted and
initially quoted that would make the trade desirable to both the
customer and the market-maker to consummate. However, in a volatile
market, the underlying index can move substantially in one direction
such that the originally quoted prices for the options and the
combinations are no longer within the current market quotes. In such
market conditions, the parties would be unable to consummate the trade
because CBOE Rules preclude trading the legs of the options and a
combination strategy outside of the currently prevailing market quotes
in the individual component series legs.\6\ Certain relief currently
applies in the case of an SPX Combo Order executed pursuant to CBOE
Rule 24.20 (the term ``SPX Combo Order'' is defined and discussed in
more detail below). However, this relief is limited and not near [sic]
as accommodating as the rules for trading spreads and combinations on
the futures
[[Page 76580]]
markets. Thus, when it comes to the existence of rule constraints that
may prevent complex, multi-part strategy trades from occurring out-of-
range from the prevailing market quotes in the individual component
series legs, another significant consideration for SPX traders and
market participants is the ease with which an execution can take place
on other markets such as the CME, which offers a comparable alternative
to SPX but is not subject to the same constraints as a national
securities exchange like CBOE.
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\6\ See, e.g., CBOE Rules 6.45B(b)(ii) and 6.53C.
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In that regard, CBOE Rule 24.20 was adopted in 2002 to enable the
Exchange to better compete with futures exchanges such as the CME.\7\
The purpose of the rule is to permit the trading of out-of-range ``SPX
Combo Orders'' under certain, limited circumstances. In essence, the
rule sets forth a procedure that allows for an SPX Combo Order to be
executed and reported up to 2 hours after the order is originally
quoted, at the prices originally quoted. Specifically, for purposes of
the rule, an ``SPX Combo Order'' is narrowly defined to be an order to
purchase or sell SPX options and the offsetting number of SPX
combinations defined by the delta. An ``SPX combination'' is defined
[sic] a long SPX call and a short SPX put having the same expiration
date and strike price (contrast this to the general definition of a
``combination'' noted above). A ``delta'' is defined as the positive
(negative) number of SPX combinations that must be sold (bought) to
establish a market neutral hedge with an SPX option position. Under the
rule, when a TPH holding an SPX Combo Order and bidding or offer [sic]
in a multiple of the minimum increment on the basis of a total debit or
credit for the order has determined that the order may not be executed
by a combination of transactions with the bids and offers displayed in
the SPX limit order book or by the displayed quotes of the crowd, then
the SPX Combo Order may be executed at the best net debit or credit so
long as (i) no leg of the SPX Combo Order would trade at a price
outside the currently displayed bids or offers in the trading crowd or
bids and offers in the SPX limit order book; and (ii) at least one leg
of the SPX Combo Order would trade at a price better than the
corresponding bid or offer in the SPX limit order book (which consists
of public customer orders).\8\ If the SPX Combo Order is not executed
immediately, the rule provides that, not withstanding any other rules
of the Exchange, the SPX Combo Order may be executed and printed
outside the current market quotes and at the prices originally quoted
for each component series within 2 hours after the time of the original
quotes (the Exchange refers to this as the ``2-hour window''
procedure).
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\7\ Originally, the Exchange had considered modeling a CBOE rule
after CME Rule 542 (discussed in more detail below). However, the
Exchange ultimately settled on a proposal that would have allowed a
CBOE TPH (referred to as a ``member'' at the time) to execute an SPX
Combo Order immediately or at any time thereafter during the trading
day at the prices originally quoted for each of the component option
series. Thus, the originally quoted prices would have had to have
been within the current market at the time of the original quote,
but a trade could be executed and reported at any time thereafter
during the trading day. This proposal was noticed for comment in
October 2000. Although there were no comments on the proposal, the
Exchange submitted several amendments to the rule filing in order
to, among other things, add a definition of an ``SPX Combo Order,''
provide that if the execution does not occur at the current market
prices originally quoted it may only be executed up to 2 hours after
the time of the original quote, clarify that each component leg of
an SPX Combo Order would be reported using an indicator, and to
include additional information concerning the need for the proposal.
The proposal, as modified, was ultimately approved in February 2002.
See Securities Exchange Act Release Nos. 43452 (October 17, 2000),
65 FR 63658 (October 24, 2000) (SR-CBOE-00-40) and 45389 (February
4, 2002), 67 FR 6291 (February 11, 2002) (SR-CBOE-00-40).
\8\ Stated another way, this provision provides that, if there
are resting public customer orders on all of the legs of the
individual series of the strategy, at least one leg of the order
must trade at a price that is better than the corresponding bid or
offer.
Example 5: Assume the S&P 500 Index April futures contract is
trading at 1350 and a customer wants to trade the 30 delta SPX April
1335 puts tied to the April 1350 calls and April 1350 puts. The TPH
holding the customer's SPX Combo Order receives an original quoted
market at 9:35 a.m. (all times are Chicago time). The TPH can
execute that SPX Combo Order any time up to 11:35 a.m. at the prices
originally quoted (even if the prices are out-of-range from the
current display market at the time the trade is later executed and
reported).\9\
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\9\ For purposes of the example, assume the 30 delta SPX April
1335 put is bid $6.00 and offered $6.20, and the SPX April 1350 call
and April1350 put are each bid $12.00 and offered $12.30. The TPH
agrees to buy 100 of the 1335 puts at $6.20 and, to hedge these,
agrees to buy 30 April 1350 calls at $12.00 and to sell 30 April
1350 puts at $12.00 (30 ``long'' combinations). Before the orders
can be executed, assume that the market rallies to a new futures
level of 1355. The April 1350 call is now trading at $15, the April
1350 put at $10 and the April 1335 put at $ 4.75. Normally the TPH
would not be able to execute the strategy because the component legs
would trade out-of-range of the current displayed market. However,
existing CBOE Rule 24.20 permits an execution at the prices
originally quoted ($6.20 and $12 in the respective series) because
the options would not have traded outside the displayed bids or
offers originally quoted in the crowd and book ($6 bid, $6.20
offered; $12 bid, $12.30 offered).
As noted above, this procedure allowing for a 2-hour window for
trade execution and reporting was adopted in order to allow the
Exchange to try to compete on a more level field with the CME, where
the trading of S&P 500 Index futures contracts is conducted under much
more liberal trading rules designated to facilitate complex, multi-part
order executions. By comparison, CME rules provide that a spread or
combination can trade without regard to the current market prices so
long as each of the respective legs of the spread or combination
transaction is priced within the daily price limits for those contracts
that have price limits. In the case of the S&P 500 Index futures
contract, the daily limit is a 5 percent upside and downside price
limit based on the prior day's settlement price.\10\ In essence, CME
has a market for complex, multi-part order strategies that is entirely
separate from its market for simple order strategies and is bound only
by the daily limit.
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\10\ See, e.g., CME Rule 542, Simultaneous Spread and
Combination Transactions; see also CME Rule 35102.I, Price Limits,
Trading Halts, and/or Trading Hours [sic] (which contains
information on the daily price limits for S&P 500 Index futures
contracts).
Example 6: A CME trader wants to execute an S&P 500 Index
futures contract combination order strategy at 9:35 a.m. (or 9:36
a.m., or 11:35 a.m., or any other time throughout the regular trade
day session). The trader can execute the order at any net price so
long as each respective leg price does not exceed 5 percent of the
upside/downside price limit based on the prior day's settlement
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price.
From CBOE's perspective, the SPX Combo Order rule for options does
not come close to leveling the field with the CME rule for spread and
combination trading. CBOE's rule still requires an SPX Combo Order to
be executed at the prices originally quoted, it just gives a two-hour
window to find liquidity and complete the execution. By comparison, the
CME rule allows spread and combination executions to take place without
regard to market prices and only be bound by the daily limit. Under
these competing frameworks, it can be more difficult for a CBOE market
participant attempting to achieve an execution of a complex SPX option
trading strategy compared to a CME market participant attempting to
achieve an execution of substantially the same strategy using S&P 500
Index futures contracts. While this distinction is particularly
exacerbated during times of market volatility, it can also be an issue
at other times as well. In addition, the Exchange believes market
participants who are looking to frequently trade spreads or
combinations, in general, or as a strategy for hedging risk, in
particular, would tend to utilize a
[[Page 76581]]
market venue where they can more consistently depend on achieving a net
price execution at all times--regardless of the level of market
volatility--which can put CBOE at a competitive disadvantage. The
additional burden placed on CBOE market participants can have the
effect of discouraging trading on CBOE in favor of trading on the CME.
The Exchange believes this competitive disadvantage is not consistent
with just and equitable principles, serves as an impediment to a free
and open market, and may ultimately not serve investors or the public
interest. In order to compete and more effectively achieve certain
strategy executions, as well as manage risk, the Exchange believes that
market participants need more comparable procedures within the CBOE
Rules.
Proposal
The Exchange is now seeking to amend its SPX Combo Order procedures
on a pilot basis in an attempt to further level the field of
competition between market participants trading on CBOE and CME. In
particular, the Exchange is now proposing to replace the existing 2-
hour window procedure (which allows a trade within 2 hours after the
original quotes) with a new 2-hour window procedure (which would allow
a trade to take place so long as it is would have been in the
permissible net price trading range within the preceding 2 hours) on a
one-year pilot basis.
The new 2-hour window procedure would be reflected in proposed new
Interpretation and Policy .01 to Rule 24.20, which would replace the
existing 2-hour window procedure reflected in existing Rule
24.20(b)(2), for a pilot period ending one-year after this rule change
filing is approved. The new Interpretation and Policy would provide
that, notwithstanding any other rules of the Exchange, an SPX Combo
Order may be transacted in open outcry in the following manner: A TPH
holding an SPX Combo Order may execute the order at the best net debit
or credit price, which may be outside the current derived net market so
long as (i) the best net debit or credit price would have been at or
within the derived net market over the preceding 2 hours of trading
that day, (ii) no leg of the order would trade at a price outside the
displayed bids or offers in the trading crowd or in the SPX limit order
book (which contains public customer orders) for that series at a point
in time over the preceding 2 hour period, and (iii) at least one leg of
the order would trade at a price that is better than the corresponding
bid or offer in the SPX limit order book (which contains public
customer orders) at the same point in time over the preceding 2 hour
period.\11\ The ``derived net market'' will be defined as the
Exchange's best bids and offers displayed in the individual option
series legs for the strategy at any one point in time.
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\11\ Stated another way, this provision provides that, if there
are resting public customer orders on all of the legs of the
individual series of the strategy at the same point in time, at
least one leg of the order must trade at a price that is better than
the corresponding bid or offer.
Example 7: Assume the S&P 500 Index April futures contract is
trading at 1350 and a TPH wants to trade the 30 delta SPX April 1335
puts tied to the April 1350 calls and April 1350 puts. Assume the
TPH wants to buy 100 SPX April 1335 puts at $6.20 tied to a purchase
of 30 April 1350 calls at $12 and sale of 30 April 1350 puts at $12
at 9:35 a.m. At the time, assume the current displayed market for
the April 1335 puts is $6.00-$6.20, for the April 1350 calls is
$12.10-$12.50, and for the April 1350 puts is $12.10-$12.50. As a
result, the SPX Combo Order is priced ``out-of-range'' from the
current derived net market ($12 is outside the $12.10 bid, $12.50
offered markets for the April 1350 calls and April 1350 puts). The
TPH can execute the SPX Combo Order at the desired net price so long
as it is the best net price and the net price would have been in
range over the preceding 2 hours of trading that day. In particular,
the net price must be at or within the derived net market price
range over the preceding 2 hours of trading that day, each component
series leg must trade at a price at or within the displayed bids or
offers at a point in time over the preceding 2 hour period, and at
least one leg must trade at a price that is better than the
corresponding bid or offer in the SPX limit order book at the same
point in time. (In this particular example, the derived net market
range would be based on the markets that existed from 8:30 a.m.-9:35
a.m., since the market was open for less than 2 hours). Assume, for
example, if the displayed market at 9:20 a.m. for the April 1335
puts was $5.90-$6.30, for the April 1350 calls was $12.00-$12.60,
and for the April 1350 puts was $12.00-$12.60 and there are not
public customer orders displayed at the best price in all of the
component series, then the SPX Combo Order could be executed at the
desired net price because it would have been net priced at or within
the derived net market over the preceding two hours of trading, the
individual component leg prices are at or within the displayed
component series prices, and at least one leg would trade at [sic]
price that improves corresponding public customer orders in the SPX
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limit order book.
It should be noted that the derived net market would be calculated
based on the displayed prices in each of the component series that
exist at a single point in time over the preceding 2-hour window, not
separate points in time for each series (e.g., a TPH cannot use the
prices of the April 1335 puts at 9:20 a.m. and the prices of the April
1350 calls and puts at 9:30 a.m. to calculate a derived net market).
The net execution price must have been ``in range'' over the prior 2-
hour window of trading. To be ``in range,'' as noted above, the net
price must have been at or within the derived net market over the
preceding 2-hour period, and each leg of the order must ``line up'' and
trade at a price that would have been at or inside the best bids and
offers displayed in the individual option series legs at a single point
in time over the 2-hour window and at least one leg must trade at a
price that is better that corresponding public customer orders in the
SPX limit order book at the same point in time.
This procedure is generally modeled after CME Rule 542 (e.g., an
SPX Combo Order may be executed out-of-range from the current market
prices in the individual component option series legs), except that
under CBOE's proposed pilot the reported net price and related
component series prices must [sic] in range within the preceding 2
hours. By comparison, the CME rule only requires the reported price of
each component futures contract leg to be within the daily limit price
(a number that is, by definition, generally much wider than the 2-hour
derived net market range proposed by CBOE).
As is the case for the existing SPX Combo Order trading procedure
today, SPX Combo Orders executed under the proposed new pilot procedure
would continue to be identified with a special indicator on each
component leg that would be price reported to the trading floor and the
Options Price Reporting Authority (``OPRA''). This indicator acts as
notice to the public that the reported prices are part of an SPX Combo
Order trade. Therefore, the Exchange believes that price discovery
should not be adversely affected by the operation of CBOE Rule 24.20,
as proposed to be modified. In addition, as is the case today, the
proposed procedure under CBOE Rule 24.20 would not lessen the
obligations of TPHs to obtain best execution of options orders for
their customers. Therefore, with the approval of the proposed rule
change, CBOE will issue a regulatory circular to its TPHs explaining
the operation of CBOE Rule 24.20, as amended. In the regulatory
circular, CBOE will remind TPHs that CBOE 24.20 does not lessen the
obligation of TPHs to obtain best execution of options orders for their
customers.
If the Exchange were to propose an extension of the proposed pilot
program, or should the Exchange propose to make the program permanent,
the Exchange would submit,
[[Page 76582]]
along with any filing proposing such amendments to the program, a pilot
program report that would provide an analysis of the program covering
the period during which the program was in effect. This report would
include information on the number of SPX Combo trades and best bid or
offer trade through/trade at analysis of such SPX Combo trades. The
report will also include information on the SPX options class and other
broad-based index option products, including information on average
contract value, average daily volume, open interest, average order
size, percentage of complex orders, percentage of volume from complex
orders, and average daily notional value traded. The report would be
submitted to the Commission at least two months prior to the expiration
date of the pilot program and would be provided on a confidential
basis.
The Exchange believes the proposed pilot procedure will facilitate
the orderly execution of SPX Combo Orders at all times, including
during volatile markets, in a manner that is more competitive with the
existing CME process. In addition, the Exchange believes the proposed
pilot procedure will continue to address customers' desire to show an
order to other market participants to seek price improvement or
additional liquidity. The Exchange also believes the proposed pilot
procedure will continue to create an incentive for market-makers to
reduce the price width of their markets because they know that their
hedge price has been established and they will not have to trade in
another market. Thus, customers who trade options tied to combinations
will continue to enjoy tighter and more liquid markets
In proposing to introduce this pilot, CBOE is cognizant of the need
for market participants to have substantial options transaction
capacity and flexibility to hedge their trading activity in SPX, on the
one hand, and priority principles common to securities exchanges, on
the other. CBOE is also cognizant of the CME market, in which similar
restrictions do not apply. In light of these considerations, CBOE
believes the proposed pilot procedure is appropriate and reasonable and
would provide market participants with additional flexibility in
achieving desired SPX Combo Order strategies and in determining whether
to execute their options on CBOE or a comparable product on CME. In
that regard, the Exchange notes that the proposed new procedure
outlined above does not go as far as what exists today on CME and
instead represents what the Exchange believes is only an incremental
change to an existing trading process that is already very narrowly
tailored. For the foregoing reasons, CBOE believes that the proposed
pilot procedure for trading SPX Combo Orders is reasonable and
appropriate, would promote just and equitable principles of trade, and
would facilitate transactions in securities while continuing to foster
the public interest and investor protection.
The S&P 500 Index is widely regarded as the best single gauge of
investable U.S. equities. There is over $4.83 trillion benchmarked to
the index, of which index assets comprise approximately $1.1 trillion.
The index includes 500 leading companies with an aggregate market
capitalization of $12.4 trillion, which represents approximately 80% of
the available market capitalization of all U.S. equities.\12\ Aggregate
trading activity in S&P 500 component securities averages 2.7 billion
shares per day, roughly four times the aggregate average daily volume
of components of the Nasdaq-100, Russell 2000 Indexes and the Dow Jones
Industrial Average.
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\12\ See http://us.spindices.com/indices/equity/sp-500. In
comparison, the aggregate market capitalization [sic] other popular
broad-based indexes are: Nasdaq-100 Index--$2.9 trillion, Russell
2000 Index--$1.3 trillion and the Dow Jones Industrial Average--$3.8
trillion.
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The S&P 500 serves as the underlying interest for the most liquid
and actively-traded derivatives contracts globally, in both listed and
over-the-counter markets. As a result, S&P 500 index derivatives are
widely recognized, and used, by institutional investors as efficient
and cost-effective tools to quickly gain or reduce exposure to U.S.
equities. The average order size in SPX options of 152 contracts, for
instance, represents an economic exposure of over $20 million. CBOE
estimates that activity in over-the-counter S&P 500 contracts is
between 4 to 6 times the size of listed activity, yet competition among
dealers typically results in narrower spreads than comparable over-the-
counter (``OTC'') instruments overlying other leading U.S. equity
benchmarks.
As shown in the following table, trading activity and open interest
in listed S&P 500 derivative contracts is at least ten times the
activity and open interest of other leading broad-based index contracts
in terms of both contracts and notional value.\13\
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\13\ ``Notional Value'' is the product of contracts times
contract multiplier times underlying index value.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Avg. daily
Avg. daily % ADV notional value % Avg. daily Open interest % Open
volume (ADV) ($Millions) notional value (10/31/12) interest
--------------------------------------------------------------------------------------------------------------------------------------------------------
S&P 500 Index........................................... 2,793,369 82 $253,003 84 18,133,151 89
Nasdaq-100 Index........................................ 297,295 9 24,457 8 867,724 4
Russell 2000 Index...................................... 205,087 6 16,489 5 1,078,110 5
Dow Jones Industrial Average............................ 128,435 4 8,140 3 354,232 2
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Total............................................... 3,424,187 .............. 302,089 .............. 20,433,217 ..............
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Cash-settled SPX options and S&P 500 futures and futures options
account for 2.8 million contracts per day, or 82% of the average daily
volume traded in the leading equity index contracts. Additionally, S&P
500-based derivatives account for over $250 billion average daily
notional value traded, or 84% of average daily notional in the leading
index contracts. Open interest in S&P 500 index contracts as of October
31, 2012 was over 18 million contracts with a notional value of over $2
trillion, which is ten times greater than the open interest in the
other leading index contracts combined.
The transparency and liquidity of S&P 500 index options has given
rise to substantial activity in volatility trading. CBOE understands
that equity volatility trading globally is predominantly based on 3
indexes: S&P 500 Index (U.S.), EuroStoxx 50 Index (Europe) and Nikkei
225 Index (Japan, Asia); most of that activity is based on the S&P 500
Index. Futures and options on the CBOE Volatility Index (VIX), based on
S&P 500 index option prices, are by far the most active listed
volatility contracts in the world. CBOE understands VIX-related
activity currently represents the majority of all S&P 500-based
volatility trading (listed and OTC).
[[Page 76583]]
CBOE understands that combination orders in SPX, including SPX
Combo Orders, are also used as a way to trade volatility. By trading an
SPX position ``delta-neutral'' with an offsetting combination in SPX,
traders virtually eliminate market risk, leaving implied volatility as
the predominant risk factor.
The Exchange is also proposing to revise the existing SPX Combo
Order text to make certain clarifying amendments. In particular, the
Exchange is proposing to revise the definition of an ``SPX
combination.'' As noted above, currently an SPX combination is defined
as ``a long SPX call and a short SPX put having the same expiration
date and strike price.'' The Exchange is proposing to revise the
definition to include a short SPX call and a long SPX put having the
same expiration date and strike price. By definition, both strategies
are permissible under the existing rule (otherwise one would never have
a contra-side with which to trade; also, this clarification is
consistent with other provisions of the rule that recognize both buy-
side and sell-side interest). In addition, instead of using the terms
``long'' and ``short,'' the Exchange is proposing to use the terms
``purchase'' and ``sale'' to be consistent with the language in the
existing definitions of ``SPX Combo'' and ``delta'' (which are noted
above). Thus, as revised, an ``SPX combination'' would be defined as
``a purchase (sale) of an SPX call and a sale (purchase) of an SPX put
having the same expiration date and strike price.'' The Exchange is
also proposing to revise the definition of an ``SPX Combo'' to replace
the phrase ``SPX options'' with ``an SPX option position'' (as revised,
the definition would be ``an order to purchase or sell an SPX option
position and the offsetting number of SPX combinations defined by the
delta''). The use of the phrase ``an SPX option position'' is
consistent with the language in the existing definition of delta (which
is defined as ``the positive (negative) number of SPX combinations that
must be sold (bought) to establish a market neutral hedge with an SPX
option position'') and also is intended to make it clear that an SPX
Combo Order is intended to consist of an SPX combination (which has two
component legs) that hedges an SPX option position (which can consist
of one or more component legs). Finally, the Exchange is proposing to
change a reference in the rule from ``SPX combination'' to the word
``order.'' \14\ This change is intended to clarify the existing
application of the rule. The use of the word ``order'' (which is
intended to capture the broader SPX Combo order) is consistent with the
terminology used elsewhere in the existing rule text \15\ and with the
Exchange's general priority provisions for any complex order.\16\
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\14\ The current text of Rule 24.2(b)(1) [sic] provide [sic] in
relevant part as follows: ``When a Trading Permit Holder holding an
SPX Combo Order and bidding or offering in a multiple of the minimum
increment on the basis of a total debit or credit for the order has
determined that the order may not be executed by a combination of
transactions with the bids and offers displayed in the SPX limit
order book or by the displayed quotes of the crowd, then the order
may be executed at the best net debit or credit so long as (A) no
leg of the order would trade at a price outside the currently
displayed bids or offers in the trading crowd or bids or offers in
the SPX limit order book and (B) at least one leg of the SPX
combination would trade at a price that is better than the
corresponding bid or offer in the SPX limit order book.'' (emphasis
added). As proposed to be revised, the phrase ``SPX combination''
would be replaced with the word ``order.''
\15\ Id.
\16\ See, e.g., Rules 6.45A(b) and 6.45B(b).
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2. Statutory Basis
The Exchange believes that the proposed rule change will allow for
the orderly execution of SPX Combo Orders and will be beneficial to
both customers and traders. Accordingly, the Exchange believes the
proposed rule change is consistent with and furthers the objectives of
Section 6(b) of the Act,\17\ in general, and Section 6(b)(5) of the
Act,\18\ in particular, in that it should promote just and equitable
principles of trade, serve to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and
protect investors and the public interest.
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\17\ 15 U.S.C. 78f(b).
\18\ 15 U.S.C. 78f(b)(5).
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As noted above, the Exchange believes the proposed pilot procedure
will facilitate the orderly execution of SPX Combo Orders at all times,
including during volatile markets, in a manner that is more competitive
with the existing CME process. In addition, the Exchange believes the
proposed pilot procedure will continue to address customers' desire to
show an order to other market participants to seek price improvement or
additional liquidity. The Exchange also believes the proposed pilot
procedure will continue to create an incentive for market-makers to
reduce the price width of their markets because they know that their
hedge price has been established and they will not have to trade in
another market. Thus, customers who trade options tied to combinations
will continue to enjoy tighter and more liquid markets.
In proposing the pilot, CBOE is cognizant of the need for market
participants to have substantial options transaction capacity and
flexibility to hedge their trading activity in SPX, on the one hand,
and priority principles common to securities exchanges, on the other.
CBOE is also cognizant of the CME market, in which similar restrictions
do not apply. In light of these considerations, CBOE believes the
proposed pilot procedure is appropriate and reasonable and would
provide market participants with additional flexibility in achieving
desired SPX Combo Order strategies and in determining whether to
execute their options on CBOE or a comparable product on CME. In that
regard, the Exchange notes that the proposed pilot procedure outlined
above does not go as far as what exists today on CME and instead
represents what the Exchange believe [sic] is only an incremental
change to an existing trading process that is already very narrowly
tailored. For the foregoing reasons, CBOE believes that the proposed
new procedure for trading SPX Combo Orders is reasonable and
appropriate, would promote just and equitable principles of trade, and
would facilitate transactions in securities while continuing to foster
the public interest and investor protection. Finally, the Exchange
believes that the proposed revisions to the existing SPX Combo Order
text will provide clarity on the existing application of the SPX Combo
Order provisions.
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 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
proposal.
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
[[Page 76584]]
(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
argument 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 rule-comments@sec.gov. Please include
File Number SR-CBOE-2012-122 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-2012-122. 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 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 offices 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-2012-122, and should be submitted on or before
January 18, 2013.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-31154 Filed 12-27-12; 8:45 am]
BILLING CODE 8011-01-P