[Federal Register Volume 69, Number 112 (Thursday, June 10, 2004)]
[Notices]
[Pages 32644-32645]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13088]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49798; File No. SR-CBOE-2004-23]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendments Nos. 1 and 2 Thereto by the Chicago Board Options 
Exchange, Inc. to Permanently Approve the Modified ROS Opening 
Procedure Pilot Program, Which Occurs on the Settlement Date of Futures 
and Options on Volatility Indexes

June 3, 2004.

I. Introduction

    On April 21, 2004, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to permanently approve its 
modified Rapid Opening System (``ROS'') opening procedure, which was 
approved by the Commission on a pilot basis through November 17, 
2004.\3\ On April 23, 2004, CBOE filed Amendment No. 1 to the proposed 
rule change.\4\ The proposed rule change, as amended, was published for 
comment in the Federal Register on April 30, 2004.\5\ The Commission 
received no comment letters on the proposed rule change. On May 13, 
2004, CBOE filed Amendment No. 2 to the proposed rule change.\6\ This 
order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 49468 (March 24, 
2004), 69 FR 17000 (March 31, 2004) (SR-CBOE-2004-11) (``Modified 
ROS Opening Procedure Pilot Program Approval Order'').
    \4\ See letter from David Doherty, Attorney, Legal Division, 
CBOE, to Terri Evans, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated April 23, 2004 
(``Amendment No. 1'').
    \5\ See Securities Exchange Act Release No. 49614 (April 26, 
2004), 69 FR 23837 (``Notice'').
    \6\ See letter from David Doherty, Attorney, Legal Division, 
CBOE, to Terri Evans, Assistant Director, Division, Commission, 
dated May 12, 2004 (``Amendment No. 2''). In Amendment No. 2, CBOE 
amended the proposed rule text to reflect the immediate 
effectiveness of SR-CBOE-2004-27, which amended the modified ROS 
opening procedure pilot program to change the cut-off time for the 
submission of orders to the electronic book from 8:25 am to 8:28 am. 
See Securities Exchange Act Release No. 49679 (May 11, 2004), 69 FR 
27957 (May 17, 2004) (Notice of Filing and Immediate Effectiveness 
of SR-CBOE-2004-27). The Commission notes that this is a technical, 
non-substantive amendment and not subject to notice and comment.
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II. Description of the Proposal

    On March 24, 2004, the Commission approved the implementation of a 
modified ROS procedure on a pilot basis through November 17, 2004.\7\ 
CBOE now proposes that the modified ROS opening procedure pilot program 
be approved on a permanent basis. According to CBOE, the modified ROS 
opening procedure pilot program facilitates the trading of options and 
futures on volatility indexes (``Volatility Indexes'') by modifying 
certain of the CBOE rules that govern ROS for index option series whose 
prices are used to derive the Volatility Indexes on which options and 
futures are traded.
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    \7\ See Modified ROS Opening Procedure Pilot Program Approval 
Order, supra note 3.
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    According to CBOE, in general, Volatility Indexes 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 quotes of the nearby and second 
nearby index puts and calls on established broad-based market indexes, 
referred to herein as a ``Market Index.'' 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 (``Settlement 
Date''). Generally, the modified ROS opening procedure allows, in part, 
broker-dealer orders, other than contingency orders, to be incorporated 
into the electronic book for purposes of the ROS opening for any index 
options series with respect to which a Volatility Index is calculated. 
The modified ROS opening procedure is 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.\8\
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    \8\ For a detailed description on how the modified ROS opening 
procedure operates, see Notice, supra note 5.
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange.\9\ 
In particular, the Commission believes that the proposed rule change is 
consistent with the requirements of Section 6(b)(5) of the Act \10\ 
that the rules of a national securities exchange, in part, promote just 
and equitable principles of trade, remove impediments to and perfect 
the mechanism of a free and open market and a national market system 
and, in general, protect investors and the public interest.
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    \9\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that futures and options on Volatility Indexes 
with contract months that expire beyond November 2004 are currently 
being traded.\11\ Therefore, the Commission believes that permanent 
approval of the modified ROS opening procedure pilot program should 
provide market participants with greater certainty as to the settlement 
process for those futures and options. The Commission also continues to 
believe that the modified ROS opening should ensure that broker-dealer 
orders are fairly incorporated into the opening,\12\ and thereby enable 
market participants that hedge Volatility Index futures or options 
contract positions against option positions in the

[[Page 32645]]

related Market Index to ensure convergence of the value of those two 
positions at the time of settlement. The ROS modified opening procedure 
should allow this convergence by allowing market participants to close 
out their open Market Index option positions and obtain the exact price 
(i.e., the opening price) for those series that will be used to 
calculate the Volatility Index settlement value. The Commission notes 
that the modified ROS opening procedure was used on May 19, 2004 and 
that CBOE represented that generally no problems or issues arose 
regarding its use.\13\
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    \11\ Telephone conversation between David Doherty, Attorney, 
CBOE, and Christopher Solgan, Attorney, Division, Commission, on May 
24, 2004.
    \12\ The Commission notes that it had previously required that 
CBOE develop a workable plan for the electronic incorporation of 
non-bookable orders in ROS. This requirement was waived in light of 
the limited number of non-bookable orders that are present at the 
open and CBOE's forthcoming ability to record information on non-
bookable orders under the Consolidated Options Audit Trail 
(``COATS'') Plan when Phase V of COATS is implemented. CBOE has 
represented as part of this filing that it is still unable to 
incorporate non-bookable orders on a daily basis because of certain 
technological limitations with respect to index products. Telephone 
conversation between David Doherty, Attorney, CBOE, and Christopher 
Solgan, Attorney, Division, Commission, on March 24, 2004. The 
Commission expects that CBOE will continue to actively monitor the 
quality of executions received by non-bookable orders that are not 
incorporated into the modified ROS opening and that CBOE will 
continue to explore methods to electronically incorporate non-
bookable orders in the standard ROS opening in the event that non-
bookable orders are more actively represented in the opening.
    \13\ Telephone conversation between David Doherty, Attorney, 
CBOE, and Christopher Solgan, Attorney, Division, Commission, on May 
28, 2004. CBOE noted that there were two minor issues that arose 
regarding the May 19, 2004 opening. First, that while 138 market 
makers were able to log on to ROS for the modified opening, two 
market makers were unable to participate in the opening because they 
failed to log onto ROS in a timely manner. Second, CBOE is 
investigating whether a broker-dealer violated CBOE Rule 6.2A by 
failing to cancel a broker-dealer order that was not executed during 
the opening as explicitly required by the rule. CBOE has represented 
that these problems did not affect the performance of the modified 
ROS opening. Further, CBOE has represented that it will work with 
market makers to ensure their timely participation in ROS.
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    The Commission notes that CBOE has also submitted supplemental 
surveillance procedures 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 and that 
identify whether any accounts have engaged in manipulative or violative 
activity.\14\
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    \14\ CBOE has represented, and the Commission expects, that CBOE 
will work with the Commission's Office of Compliance Inspections and 
Examinations (``OCIE'') to finalize any surveillance reports used in 
connection with the modified ROS opening in a manner acceptable to 
OCIE. The Commission also expects CBOE to assess its surveillance 
procedures from time to time to determine whether they are adequate 
to ensure that market makers do not engage in manipulative or 
improper trading practices. Further, the Commission expects CBOE to 
consider whether any additional surveillance procedures are 
necessary to prevent manipulative or other improper practices. In 
addition, CBOE stated, and the Commission expects, that it will 
modify 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. CBOE has also represented and the Commission 
expects that prior to implementation of this system change, CBOE 
will file a rule change with the Commission to reflect this system 
change. See Notice, supra note 5.
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-CBOE-2004-23) and Amendment 
Nos. 1 and 2 thereto, are approved.
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    \15\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13088 Filed 6-9-04; 8:45 am]
BILLING CODE 8010-01-P