[Federal Register Volume 69, Number 84 (Friday, April 30, 2004)]
[Notices]
[Pages 23837-23840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-9825]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49614; File No. SR-CBOE-2004-23]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. and Amendment No. 1 
Thereto To Permanently Approve the Modified ROS Opening Procedure Pilot 
Program, Which Occurs on the Settlement Date of Futures and Options on 
Volatility Indexes

April 26, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 21, 2004, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities Exchange Commission 
(``Commission'' or ``SEC'') the proposed rule change as described in 
Items I, II and III, below, which Items have been prepared by CBOE. On 
April 23, 2004, CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from David Doherty, Attorney, Legal Division, 
CBOE, to Terri Evans, Assistant Director, Division of Market 
Regulation, Commission, dated April 23, 2004 (``Amendment No. 1''). 
In Amendment No. 1, the CBOE deleted its proposed change to the cut-
off time for the submission of orders for placement on the 
electronic book. According to CBOE, the CBOE intends to submit the 
modification to the cut-off time as a separate proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE seeks permanent approval of the modified Rapid Opening System 
(``ROS'') opening procedure, which was approved by the Commission on a 
pilot basis through November 17, 2004.\4\ The proposed rule change 
retains the text of CBOE Rule 6.2A.03 as currently approved on a pilot 
basis. The text of the proposed rule change is available at the office 
of the Secretary, CBOE, and at the Commission.
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    \4\ See Securities Exchange Act Release No. 49468 (March 24, 
2004), 69 FR 17000 (March 31, 2004) (SR-CBOE-2004-11).
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CBOE included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it had received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III below. CBOE has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    On March 24, 2004, the Commission approved, on a pilot basis, the 
implementation of a modified ROS procedure. The modified ROS opening 
procedure pilot program facilitates the trading of options and futures 
on volatility indexes intended to be traded on CBOE or on the CBOE 
Futures Exchange, LLC (``CFE'') by modifying certain of the rules that 
govern ROS for index option series whose prices are used to derive the 
volatility indexes on which options and futures will be traded. The 
modified ROS opening procedure also expanded the types of orders for 
these index options that may be included in ROS at the time when 
settlement values for volatility index options and futures are being 
determined. CBOE believes that the modifications permit a more accurate 
determination of these settlement values, and assure that these values 
more closely converge with the prices of the index options from which 
they are derived. The modified ROS opening procedure pilot program is 
due to expire on November 17, 2004. CBOE now proposes that the modified 
ROS opening procedure pilot program be approved on a permanent basis.
    CBOE requested approval of the modified ROS opening procedure on a 
pilot program basis following CBOE's proposal to list and trade options 
on several volatility indexes; specifically, the CBOE Volatility Index 
(``VIX''); the CBOE Nasdaq 100 Volatility Index (``VXN''); and the CBOE 
Dow Jones Industrial Average Volatility Index (``VXD'').\5\ CBOE states 
that it may file additional proposed rule changes to provide for the 
listing of options on other volatility indexes in the future. CFE, 
which is a designated contract market approved by the Commodity Futures 
Trading Commission (``CFTC'') and a wholly-owned subsidiary of CBOE, 
filed a rule change with the CFTC to provide for the listing and 
trading of futures on the VIX on CFE, and may list additional futures 
products on other volatility indexes in the future. CBOE believes that 
approval of the modified ROS opening procedure pilot program on a 
permanent basis will provide certainty as to the settlement process for 
market participants that trade those futures and options contract 
months on volatility indexes that expire beyond November 17, 2004.
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    \5\ See Securities Exchange Act Release Nos. 48807 (November 19, 
2003), 68 FR 66516 (November 26, 2003) (Notice of filing of File No. 
SR-CBOE-2003-40); 49563 (April 14, 2003), 69 FR 21589 (April 21, 
2004) (Order approving File No. SR-CBOE-2003-40).
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Volatility Index Description
    In general, CBOE states that volatility indexes (including, without 
limitation, the VIX, VXN and VXD (each, a ``Volatility Index'')) 
provide investors with up-to-the-minute market estimates of expected 
near-term volatility of the prices of a broad-based group of stocks by 
extracting volatilities from real-time index option bid/ask quotes. 
Volatility Indexes are calculated using real-time

[[Page 23838]]

quotes of the nearby and second nearby index puts and calls on 
established broad-based market indexes, referred to herein as a 
``Market Index.'' For example, the VIX measures the near-term 
volatility of the S&P 500 Index (``SPX''), the VXN measures the near-
term volatility of the Nasdaq 100 Index (``NDX'') and the VXD measures 
the near-term volatility of the Dow Jones Industrial Average (``DJX''). 
The futures and options on a Volatility Index expire on the Wednesday 
immediately prior to the third Friday of the month that immediately 
precedes the month in which the options used in the calculation of that 
index expire (the ``Settlement Date''). For example, May 2004 VIX 
futures and options would expire on Wednesday, May 19, 2004, which is 
the Wednesday immediately prior to the third Friday of May, which is 
the month preceding the expiration of the June 2004 SPX options. Since 
Volatility Indexes will be A.M.-settled, CBOE uses the modified ROS 
functionality to facilitate the calculation of a settlement price for 
futures and options contracts on Volatility Indexes.
Market Index Opening Procedures
    ROS is CBOE's automated system for opening classes of options at 
the beginning of the trading day or for re-opening classes of options 
during the trading day. In brief, the current ROS opening procedure 
involves market-makers participating on ROS by logging on each morning 
and identifying the classes of options in which they will participate 
for the opening. If ROS is being employed in a Designated Primary 
Market-Maker (``DPM'') or Lead Market-Maker (``LMM'') trading crowd, 
the DPM and LMM are required to participate on ROS. A single opening 
price for each option series is calculated based on the orders 
contained in the electronic book and on the Autoquote values set by the 
DPM, LMM, or other market-maker, as applicable, which Autoquote values 
may be adjusted based on input from other LMMs and market-makers 
present at the opening. ROS then determines an opening price based on 
an algorithm that maximizes the number of public customer orders able 
to be executed at the opening. Currently, public customer orders, other 
than public customer contingency orders, are the only orders that can 
be placed in the electronic book for ROS. To ensure the participation 
of broker-dealer orders in the opening price calculation, CBOE Rule 
6.2A(ii) requires the member representing a broker-dealer order to 
inform the DPM or Order Book Official (``OBO''), as applicable, and the 
logged-in ROS market-makers of the terms of such orders prior to the 
time the class is locked. However, under current ROS opening 
procedures, these broker-dealer orders are not eligible to be entered 
in the electronic book that is used by ROS to calculate opening prices.
Modified ROS Opening Procedure Pilot Program
    Since ROS partially calculates the opening prices of Market Index 
option series based upon orders contained in the electronic book, and 
since these opening prices will be used to derive the settlement values 
of corresponding Volatility Indexes for purposes of Volatility Index 
options and futures, CBOE believes it is necessary to modify the ROS 
opening procedures to permit all orders (including public customer, 
broker-dealer, CBOE market-maker and away market-maker and specialist 
orders), other than contingency orders, to be eligible to be placed on 
the electronic book solely for the purpose of the ROS opening. These 
orders may be placed on the book in those Market Index option contract 
months the prices of which are used to derive the volatility indexes on 
which options and futures will be traded. CBOE believes that expanding 
the scope of orders eligible for entry into the electronic book for 
purposes of the ROS opening will make it easier for all market 
participants to participate fully in the establishment of the 
settlement values of Volatility Indexes in an efficient and automated 
manner. This modified ROS opening procedure will be used only on the 
final Settlement Date of the options and futures contracts on the 
applicable Volatility Index in each expiration month, which is when 
Volatility Index settlement values are determined. The ROS opening 
procedures currently set forth in the CBOE rules will continue to 
govern ROS openings of Market Index option classes on all other days.
    To ensure market-maker participation in the modified ROS opening 
procedure, the modified ROS opening procedure pilot program provides 
that all market-makers, including LMMs and Supplemental Market-Makers 
(``SMMs''),\6\ if applicable, who are required to log on to ROS or 
Retail Automatic Execution System (``RAES'') for the current expiration 
cycle are required to log on to ROS during the modified ROS opening 
procedure if the market-maker is physically present in the trading 
crowd for that Market Index option class. Although it has previously 
been CBOE's observation that few, if any, non-bookable orders 
(including broker-dealer orders) are represented by firms for 
participation in the ROS opening,\7\ CBOE believes that CBOE market-
makers and other broker-dealers that trade Volatility Index futures and 
options and that use Market Index options for hedging purposes will 
want their Market Index option orders to be included in ROS to ensure 
the convergence of the values of their settled Volatility Index 
positions with the values of their positions in related Market Index 
options. For example, a market participant that opens a position in a 
VIX futures contract may hedge that position by opening a position in 
SPX options, which prices are used in the calculation of VIX. If the 
market participant holds the VIX futures contract through settlement, 
the market participant must close out the hedge position that remains 
open in the SPX options. Since the settlement value of the VIX futures 
and options contracts are based on the opening prices of certain SPX 
option series, CBOE believes that the hedge will only be fully 
effective if the prices at which the market participant closes its SPX 
option positions converge with the corresponding prices of the SPX 
option series that determine the settlement value of the VIX. The ROS 
modified opening procedure pilot program allows this convergence to be 
achieved by allowing market participants to close out their open SPX 
positions and obtain the exact prices (i.e., the opening prices) for 
those SPX series that will be used to calculate the VIX settlement 
value.
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    \6\ CBOE Rule 8.15 and Interpretation .02 to CBOE Rule 24.13 
permit the appropriate Market Performance Committee to appoint one 
or more market-makers in good standing with an appointment in an 
option class for which a DPM has not been appointed as an LMM and 
SMM.
    \7\ See Securities Exchange Act Release No. 48529 (September 24, 
2003), 68 FR 56658 (October 1, 2003) (SR-CBOE-2002-55) (``ROS 
Permanent Approval Order'').
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    To participate in the modified ROS opening procedure pilot program 
on Settlement Date, all orders for placement on the electronic book are 
required to be submitted electronically. For market-makers on CBOE's 
trading floor, compliance with this requirement may be fulfilled 
through the submission of the order to a floor broker that has access 
to CBOE's Order Routing System or through the submission of the order 
through a hand-held terminal that has futures and options routing 
functionality. CBOE will also permit market-makers on the trading floor 
to submit paper ticket market orders to the OBO for placement in the 
electronic book. Paper ticket limit orders may not be submitted because 
CBOE believes these orders, which would rest on the electronic book if 
not executed at the

[[Page 23839]]

opening, may not be able to be cancelled within the time period set 
forth in CBOE Rule 6.2A.03, as further explained below. In all 
circumstances, orders for placement on the electronic book must be 
received by 8:25 a.m.
    The current ROS procedures pursuant to CBOE Rule 6.2A(i) would then 
take effect and calculate the opening price, at which point the maximum 
number of orders (including broker-dealer or market-maker orders) would 
be crossed and the balance of orders, if any, to be traded at the 
opening price will be assigned to participating market-makers. If the 
ROS system is implemented in an option contract for which LMMs have 
been appointed, the LMMs will review the order imbalances and 
collectively set the Autoquote values that will be used by ROS in 
calculating the opening prices for the Market Index option series. CBOE 
believes that having all of the LMMs participate in this process will 
contribute toward the establishment of a fair and accurate final 
settlement price for the Volatility Index futures and options since it 
will allow for the primary market-makers in the applicable Market Index 
option contract, as reflected by their designation as LMMs, to all have 
input in the ROS calculation that will ultimately derive that price. 
Other than the role of collectively setting the Autoquote values that 
will be used by ROS, LMMs are treated the same as market-makers in all 
respects under the modified ROS opening procedure provided for in CBOE 
Rule 6.2A.03.
    Pursuant to CBOE Rule 6.2A.03(iv), contracts traded in ROS for a 
Market Index option series will be assigned equally, to the greatest 
extent possible, to all logged-on market-makers, including any LMMs and 
SMMs if applicable.\8\ Any customer orders not executed at the ROS 
opening will remain in the electronic book.
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    \8\ For example, if the opening imbalance is twenty contracts 
and ten market-makers are logged on to ROS, each market-maker will 
be assigned two contracts. If the opening imbalance is twenty-one 
contracts and ten market-makers are logged on to ROS, the algorithm 
will assign the greatest amount to the first market-maker chosen in 
the rotation (three contracts) with each remaining nine market-
makers receiving two contracts.
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    CBOE states that it is in the process of modifying the ROS system 
software to prevent a market-maker who is logged on to ROS from trading 
against an order on behalf of the market-maker or the market-maker firm 
that may be resting in the electronic book.\9\ CBOE states that it will 
also implement a ROS system change to automatically generate 
cancellation orders for those broker-dealer and market-maker orders 
that are not executed during the ROS opening. CBOE expects this work to 
be completed in approximately five months. Meanwhile, CBOE will use an 
interim process whereby market-maker and broker-dealer orders remaining 
on the electronic book because they were not executed in ROS (e.g., 
limit orders) would be required to be cancelled immediately following 
the opening of those option contracts to prevent market-maker and 
broker-dealer orders from remaining in the electronic book. In 
interpreting the requirement of immediate cancellation in this context, 
CBOE expects market-makers and broker-dealers to make a good faith 
effort to cancel these orders as soon as possible, taking into 
consideration the applicable circumstances. For example, it may take a 
member slightly longer to cancel an order submitted through a floor 
broker than if the member has a hand-held terminal with futures and 
options routing functionality.
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    \9\ CBOE has represented that prior to implementation of the 
system change, it will file a rule change with the Commission 
pursuant to Section 19(b)(3)(A) of the Act to amend proposed CBOE 
Rule 6.2A.03 to reflect this system change. See Securities Exchange 
Act Release No. 49468, supra note 4.
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Surveillance

    As described in the Commission's order granting permanent approval 
to the ROS system,\10\ CBOE currently has in place surveillance 
procedures that are designed to ensure, among other things, that 
market-makers exercise their discretion to set certain Autoquote values 
consistent with their obligation to price options fairly. CBOE has also 
established supplemental ROS surveillance procedures for the modified 
ROS opening.\11\ In addition to these procedures, CBOE's Department of 
Market Regulation will conduct surveillance to identify any broker-
dealer or market-maker orders that may have been improperly executed on 
the electronic book which should have been cancelled following the 
modified ROS opening procedure. CBOE will also work with the 
Commission's Office of Compliance and Inspections and Examinations 
(``OCIE'') to finalize any surveillance reports used in connection with 
the modified ROS opening procedure that is acceptable to OCIE.
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    \10\ See ROS Permanent Approval Order, supra note 7.
    \11\ See letter from David Doherty, Attorney, Legal Division, 
CBOE, to Terri Evans, Assistant Director, Division, dated March 24, 
2004 (``Supplemental ROS Surveillance Procedures''). CBOE requested 
confidential treatment for these surveillance procedures pursuant to 
17 CFR 200.83.
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2. Statutory Basis
    CBOE states that the proposed rule change is designed to facilitate 
the calculation of the final settlement values of Volatility Indexes in 
an efficient and automated fashion that reflects all buying and selling 
interest in the associated Market Index. Permanent approval of the 
proposed rule change will provide certainty as to the settlement 
process for market participants that trade those futures and options 
contract months on Volatility Indexes that expire beyond the Pilot's 
expiration of November 17, 2004. Accordingly, CBOE believes that the 
proposed rule change is consistent with section 6(b) of the Act,\12\ in 
general, and furthers the objectives of section 6(b)(5) of the Act,\13\ 
in particular, in that it should promote just and equitable principles 
of trade, to remove impediments to and perfect the mechanism of a free 
and open market and a national market system, and, in general, to 
protect investors and the public interest.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change would impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

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

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and

[[Page 23840]]

arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:
    Electronic comments:
     Use the Commission's Internet comment form 
(http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please 
include File Number SR-CBOE-2004-23 on the subject line.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549-0609.
    All submissions should refer to File Number SR-CBOE-2004-23. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of CBOE. 
All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-CBOE-2004-23 
and should be submitted on or before May 21, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-9825 Filed 4-29-04; 8:45 am]
BILLING CODE 8010-01-P