[Federal Register Volume 68, Number 228 (Wednesday, November 26, 2003)]
[Notices]
[Pages 66516-66518]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-29577]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48807; File No. SR-CBOE-2003-40]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Board Options 
Exchange, Inc. Relating to Options on Certain CBOE Volatility Indices

November 19, 2003.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 12, 2003, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the CBOE. 
On November 18, 2003, the CBOE filed Amendment No. 1 to the proposed 
rule change.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
---------------------------------------------------------------------------

    \1\ U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Jim Flynn, Attorney, CBOE, to Florence 
Harmond, Senior Special Counsel, Division of Market Regulation 
(``Division''), Commission, dated November 18, 2003 (``Amendment No. 
1''). Amendment No. 1 revises the original rule filing by defining 
the reporting authority and terms of these index option contracts, 
including that the interval between strike prices shall be no less 
than $2.50, and accordingly replaces CBOE's original Exhibit A.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange hereby proposes to amend certain of its rules to 
provide for the listing and trading of options on several volatility 
indexes; specifically: the CBOE Volatility Index (``VIX''); the CBOE 
Nasdaq 100'' Volatility Index (``VXN''); and the CBOE Dow Jones 
Industrial Average'' Volatility Index (``VXD''). Options on each index 
would

[[Page 66517]]

be cash-settled and will have European-style expiration. The text of 
the proposed rule change is available at the Office of the Secretary, 
CBOE, 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 CBOE 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 CBOE has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to permit the Exchange 
to list and trade cash-settled, European-style options on the VIX, VXN, 
and VXD. The calculation of each index is based on a recently developed 
methodology that builds upon the calculation of the original CBOE 
Market Volatility Index, which is based on S&P 100'' Index option 
(``OEX'') quotes. Introduced by CBOE in September 2003, the revised VIX 
is an index that uses the quotes of certain S&P 500 Index[reg] 
(``SPX''[reg]) option series to derive a measure of the volatility of 
the U.S. equity market. It provides investors with up-to-the-minute 
market estimates of expected volatility by extracting implied 
volatilities from real-time index option bid/ask quotes. The VIX is 
quoted in percentage points per annum. For example, an index level of 
30.34 (the closing value from December 31, 2002) represents an 
annualized volatility of 30.34%. This new methodology will also be used 
to calculate VXN and VXD values.

Index Design and Calculation

    Each index--VIX, VXN, and VXD--will be calculated using real-quotes 
of the nearby and second nearby index puts and calls of the SPX, the 
Nasdaq 100 Index (``NDX'''), and the Dow Jones Industrial Index 
(``DJX'''), respectively. For options on each respective volatility 
index, the nearby index option series are defined as the series with 
the shortest time to expiration, but with at least eight (8) calendar 
days to expiration. The second nearby index option series are the 
series for the subsequent expiration month. Thus, with eight days left 
to expiration, an index will ``roll'' to the second and third contract 
months.
    For each contract month, CBOE will determine the at-the-money 
strike price. It will then select the at-the-money and out-of-the money 
series with non-zero bid prices and determine the midpoint of the bid-
ask quote for each of these series. The midpoint quote of each series 
is then weighted so that the further away that series is from the at-
the-money strike, the less weight that is accorded to the quote. Then, 
to compute the index level, CBOE will calculate a volatility measure 
for the nearby options and then for the second nearby options. This is 
done using the weighted mid-point of the prevailing bid-ask quotes for 
all included option series with the same expiration date. These 
volatility measures are then interpolated to arrive at a single, 
constant 30-day measure of volatility.
    As described above, each volatility index option will be structured 
as an option on a group of securities, namely options on the SPX, NDX, 
or DJX indexes and by extension the stocks underlying each respective 
index. The CBOE will use the actual quotes of specific index options to 
derive each corresponding volatility index. The underlying index 
options themselves are securities and are based on an index of the 
broader number of underlying securities.\4\ Thus, the pricing 
components underlying the Index options will include the SPX, NDX, or 
DJX options and, by extension, the component stocks of each index. 
These pricing components will provide a measure of the volatility of 
price movements of the SPX, NDX, or DJX stock indexes. This structure 
is similar to the approach used by CBOE for its interest rate 
options.\5\ Those products use the quotes of debt securities to derive 
an interest rate yield, which is converted into a measure that serves 
as the underlying for options. In the case of Index options, quotes 
from index option securities, which reflect a measure of stock price 
movements of the SPX, NDX and DJX stocks, will be used to derive a 
measure of volatility that will be the underlying for the respective 
volatility index options.
---------------------------------------------------------------------------

    \4\ 500 securities in the SPX, 100 securities in the NDX, etc.
    \5\ See Securities Exchange Act Release Nos. 26938 (June 15, 
1989), 54 FR 26285 (June 22, 1989); and 33106 (October 26, 1993), 54 
FR 58358 (November 1, 1993).
---------------------------------------------------------------------------

    The CBOE will compute each index on a real-time basis throughout 
each trading day, from 8:30 AM until 3:15 PM (Chicago Time) CST. CBOE 
has calculated historical index values for the new VIX back to January 
2, 1990. As of December 31, 2002, the closing values for each 
respective index were as follows: (1) VIX: 30.34; (2) VXN: 46.94; and 
(3) VXD: 31.81. Volatility index levels will be calculated by CBOE and 
disseminated at 15-second intervals to market information vendors via 
the Options Price Reporting Authority (``OPRA'').

Index Option Trading

    Strike prices will be set to bracket the index in 2\1/2\ point 
increments; thus, the interval between strike prices will be no less 
than $2.50.\6\ The minimum tick size for series trading below $3 will 
be 0.05 and for series trading above $3 the minimum tick will be 0.10. 
The trading hours for options on the volatility indexes will be from 
8:30 a.m. to 3:15 p.m. (Chicago Time) CST.\7\
---------------------------------------------------------------------------

    \6\ See supra note 3.
    \7\ See Exhibit B to the proposed rule change filed by CBOE, 
presents proposed contract specifications for VIX options, Exhibit C 
presents proposed contract specifications for VXN options; and, 
Exhibit D presents proposed contract specifications for VXD options, 
of the proposed rule filing, which set out the contract 
specifications for each product.
---------------------------------------------------------------------------

Exercise and Settlement

    The proposed options on each index will expire 30 days prior to the 
expiration date of the options used in the calculation of that index. 
For example, September 2003 VIX options would expire on Wednesday, 
September 17, 2003, exactly 30 days prior to the expiration of the 
October 2003 SPX options, which would be the only options used in the 
VIX calculation on that date. Trading in the expiring contract month 
will normally cease at 3:15 PM (Chicago Time) (CST) on the last day of 
trading. Exercise will result in delivery of cash on the business day 
following expiration. VIX, VXN and VXD options will be A.M.-settled. 
The exercise settlement value will be determined by a Special Opening 
Quotation (``SOQ'') of each respective volatility index calculated from 
the sequence of opening prices of the options that comprise that index. 
The opening price for any series in which there is no trade shall be 
the average of that option's bid price and ask price as determined at 
the opening of trading.
    The exercise-settlement amount is equal to the difference between 
the exercise-settlement value and the exercise price of the option, 
multiplied by $100. When the last trading day is moved because of 
Exchange holidays, the last trading day for expiring options

[[Page 66518]]

will be the day immediately preceding the last regularly-scheduled 
trading day.

Surveillance

    The Exchange states that it will use the same surveillance 
procedures currently utilized for each of the Exchange's other index 
options to monitor trading in options on each volatility index. The 
Exchange represents that these surveillance procedures are adequate to 
monitor the trading of options on these volatility index. For 
surveillance purposes, the Exchange will have complete access to 
information regarding trading activity in the pertinent underlying 
securities.

Position Limits

    The Exchange proposes to establish position limits for options on 
each volatility index--VIX, VXN and VXD--at 25,000 contracts on either 
side of the market and no more than 15,000 of such contracts may be in 
series in the nearest expiration month.\8\ The Exchange states that 
this is consistent with Exchange Rule 24.4 (Position Limits for Broad-
Based Index Options).
---------------------------------------------------------------------------

    \8\ This is consistent with Exchange 24.4 (Position Limits for 
Broad-Based Index Options).
---------------------------------------------------------------------------

Exchange Rules Applicable

    Except as modified herein, the Exchange Rules in Chapter XXIV will 
be applicable to the VIX, VXN, and VXD options. Each volatility index 
will be classified as a ``broad-based index'' and, under CBOE margin 
rules, specifically, Exchange Rule 12.3(c)(5)(A), the margin 
requirement for a short put or call on the respective volatility 
indexes shall be 100% of the current market value of the contract plus 
up to 15% of the respective underlying index value.
    Additionally, CBOE affirms that it possesses the necessary systems 
capacity to support new series that would result from the introduction 
of VIX, VXN and VXD options. CBOE also has been informed that OPRA has 
the capacity to support such new series.\9\
---------------------------------------------------------------------------

    \9\ See Exhibit E to the proposed rule change filed by CBOE, 
which set out the contract specifications for each product.
---------------------------------------------------------------------------

2. Statutory Basis
    CBOE believes that the proposed rule change, as amended, is 
consistent with Section 6(b) of the Act \10\ in general and furthers 
the objectives of Section 6(b)(5),\11\ in particular, in that it will 
permit trading in options based VIX, VXN, and VXD on the volatility 
indices pursuant to rules designed to prevent fraudulent and 
manipulative acts and practices and to promote just and equitable 
principles of trade, and thereby will provide investors with the 
ability to invest in options based on an additional index.
---------------------------------------------------------------------------

    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the CBOE consents, the Commission will:
    A. By order approve the proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-CBOE-2003-40 and should be submitted by December 17, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
---------------------------------------------------------------------------

    \12\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-29577 Filed 11-25-03; 8:45 am]
BILLING CODE 8010-01-P