[Federal Register Volume 70, Number 144 (Thursday, July 28, 2005)]
[Notices]
[Pages 43726-43729]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-4018]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52101; File No. SR-CBOE-2004-86]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Proposed Rule Change Relating to the 
Modified ROS Opening Procedure

July 21, 2005.
    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 December 15, 2004, the Chicago Board Options Exchange, Incorporated 
(``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 
Exchange. On July 5, 2005, the Exchange 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 Form 19b-4, dated July 1, 2005 (``Amendment No. 1''). 
Amendment No. 1 replaced the original filing in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to revise the modified Rapid Opening System 
(``ROS'') opening procedure set forth in CBOE Rule 6.2A.03 to provide a 
greater opportunity for market participants to respond to order 
imbalances in the electronic book and to move the cut-off time for the 
submission of all orders for participation in the modified ROS opening 
procedure from 8:28 a.m. (CT) to 8:25 a.m. (CT). Proposed new language 
is in italics; proposed deletions are in [brackets].
* * * * *

Chicago Board Options Exchange, Incorporated

Rules

* * * * *

Rule 6.2A. Rapid Opening System

    This rule has no applicability to series trading on the CBOE Hybrid 
Opening System. Such series will be governed by Rule 6.2B.
    (a)--(d) No change.
    * * * Interpretation and Policies:
    .01-.02 No change.
    .03 Modified ROS Opening Procedure For Calculation of Settlement 
Prices of Volatility Indexes.
    All provisions set forth in Rule 6.2A and the accompanying 
interpretations and policies shall remain in effect unless superseded 
or modified by this Rule 6.2A.03. To facilitate the calculation of a 
settlement price for futures and options contracts on volatility 
indexes, the Exchange shall utilize a modified ROS opening procedure 
for any index option series with respect to which a volatility index is 
calculated (including any index option series opened under Rule 
6.2A.01). This modified ROS opening procedure will be utilized only on 
the final settlement date of the options and futures contracts on the 
applicable volatility index in each expiration month.
    The following provisions shall be applicable when the modified ROS 
opening procedure set forth in this Rule 6.2A.03 is in effect for an 
index option with respect to which a volatility index is calculated:
    (i) [a]All orders (including public customer, broker-dealer, 
Exchange Market-Maker and away Market-Maker and specialist orders), 
other than contingency orders, will be eligible to be placed on the 
Electronic Book for those option contract months whose prices are used 
to derive the volatility indexes on which options and futures are 
traded, for the purpose of permitting those orders to participate in 
the ROS opening price calculation for the applicable index option 
series[;].
    (ii) [a]All Market-Makers, including any LMMs and SMMs, if 
applicable, who are required to log on to ROS or RAES for the current 
expiration cycle shall be 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 index option class[;].
    (iii) [i]If the ROS system is implemented in an option contract for 
which LMMs have been appointed, the LMMs will collectively set the 
Autoquote values that will be used by ROS[;].
    (iv) ROS contracts to trade for that 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[;].
    (v) All index option orders for participation in the modified ROS 
opening procedure that are related to positions in, or a trading 
strategy involving, volatility index options or futures, and any change 
to or cancellation of any such order
    (A) must be received prior to 8:00 a.m. (CT), and
    (B) may not be cancelled or changed after 8:00 a.m. (CT), unless 
the order is not executed in the modified ROS opening procedure and the 
cancellation or change is submitted after the modified ROS opening 
procedure is concluded (provided that any such order may be changed or 
cancelled after 8:00 a.m. (CT) and prior to 8:25 a.m. (CT) in order to 
correct a legitimate error, in which case the member submitting the 
change or cancellation shall prepare and maintain a memorandum setting 
forth the circumstances that resulted in the change or cancellation and 
shall file a copy of the memorandum with the Exchange no later than the 
next business day in a form and manner prescribed by the Exchange).
    In general, the Exchange shall consider index option orders to be 
related to positions in, or a trading strategy involving, volatility 
index options or futures for purposes of this Rule 6.2A.03(v) if the 
orders possess the following three characteristics:
    (i) The orders are for options series with the expiration month 
that will be used to calculate the settlement price of the applicable 
volatility index option or futures contract.
    (ii) The orders are for options series spanning the full range of 
strike prices in the appropriate expiration month for options series 
that will be used to calculate the settlement price of the applicable 
volatility index option or futures contract, but not necessarily every 
available strike price.
    (iii) The orders are for put options with strike prices less than 
the ``at-the-money'' strike price and for call options with strike 
prices greater than the ``at-the-money'' strike price. The orders may 
also be for put and call options with ``at-the-money'' strike prices.
    Whether index option orders are related to positions in, or a 
trading strategy involving, volatility index options or futures for 
purposes of this Rule 6.2A.03(v) depends upon specific facts and 
circumstances. Order types other than those provided above may also be 
deemed by the Exchange to fall within this category of orders if the 
Exchange determines that to be the case

[[Page 43727]]

based upon the applicable facts and circumstances.
    The provisions of this Rule 6.2A.03(v) may be suspended by two 
Floor Officials in the event of unusual market conditions.
    (vi) [a]All other index option orders for participation in the 
modified ROS opening procedure, and any change to or cancellation of 
any such order, must be received prior to 8:25 a.m. [8:28 a.m.] (C[S]T) 
in order to participate at the ROS opening price for the applicable 
[that] index option series[;].
    (vii) [a]All orders for participation in the modified ROS opening 
procedure must be submitted electronically, except that Market-Makers 
on the Exchange's trading floor may submit paper tickets for market 
orders only[; and].
    (viii) [until the Exchange implements a] The ROS system [change 
that] shall automatically generate[s] cancellation orders immediately 
prior to the opening of the applicable index option series for Exchange 
Market-Maker, away Market-Maker, specialist, and broker dealer orders 
which remain on the Electronic Book following the modified ROS opening 
procedure[, any such orders that were entered in the Electronic Book 
but were not executed in the modified ROS opening procedure must be 
cancelled immediately following the opening of the applicable option 
series].
    (ix) Any imbalance of contracts to buy over contracts to sell in 
the applicable index option series, or vice versa, as indicated on the 
Electronic Book, will be published as soon as practicable after 8 a.m. 
(CT) and thereafter at approximately 8:20 a.m. (CT) on days that the 
modified ROS opening procedure is utilized.
* * * * *

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

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

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

1. Purpose
    Current CBOE Rule 6.2A.03 sets forth certain procedures that modify 
the normal operation of ROS \4\ on the final settlement date of futures 
and options contracts on volatility indexes.\5\ The final settlement 
date of futures and options contracts on volatility indexes occurs on 
the Wednesday that is 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''). The 
proposed rule change would implement additional procedures for certain 
option orders that are entered on the Exchange's electronic book on the 
Settlement Date.
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    \4\ ROS is the Exchange's automated system for opening certain 
classes of options at the beginning of the trading day or for re-
opening those classes of options during the trading day. The 
procedures related to ROS are set forth in CBOE Rule 6.2A. The 
modified ROS opening procedure set forth in Rule 6.2A.03 modifies 
the general ROS opening procedures for index options that are used 
to calculate a volatility index to facilitate the settlement of 
futures contracts and options contracts on those volatility indexes.
    \5\ 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. For example, 
the CBOE Volatility Index measures the near-term volatility of 
options on the S&P Index (``SPX'') and the CBOE DJIA Volatility 
Index measures the near-term volatility of options on the Dow Jones 
Industrial Average (``DJX''). Futures contracts on the CBOE 
Volatility Index and the CBOE DJIA Volatility Index are currently 
trading on the Exchange's wholly-owned subsidiary, CBOE Futures 
Exchange, LLC. The Commission has approved for trading on the 
Exchange option contracts on volatility indexes and the Exchange may 
also list those contracts for trading.
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    The modified ROS opening procedure permits 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 book on the Settlement Date solely for the purpose 
of the modified ROS opening procedure. These orders may be placed on 
the book in those index option contract months whose prices are used to 
derive the volatility indexes on which options and futures are traded. 
For example, since the launch of futures on the CBOE Volatility Index 
(``VIX futures''), market participants actively trading in VIX futures 
have taken advantage of the modified ROS opening procedure to place SPX 
option orders on the book on the Settlement Date to unwind hedge 
strategies involving SPX options that were initially entered into upon 
the purchase or sale of VIX futures. In particular, the commonly-used 
hedge for VIX futures involves holding a portfolio of the SPX options 
that will be used to calculate the settlement value of the VIX futures 
contract on the Settlement Date. Traders holding hedged VIX futures 
positions to settlement can be expected to trade out of their SPX 
options on the Settlement Date. Traders who hold short, hedged VIX 
futures would liquidate that hedge by selling their SPX options, while 
traders holding long, hedged VIX futures would liquidate their hedge by 
buying SPX options. In order to seek convergence with the VIX futures 
final settlement value, these traders would be expected to liquidate 
their hedges by submitting market orders or limit orders\6\ in the 
appropriate SPX option series during the SPX opening on the Settlement 
Date of the VIX futures contract. To the extent (i) traders who are 
liquidating hedges predominately are on one side of the market (e.g., 
seek to buy the particular SPX options) and (ii) those traders' orders 
predominate over other orders during the SPX opening on Settlement 
Date, trades to liquidate hedges may contribute to an order imbalance 
during the SPX opening on Settlement Date. The purpose of the proposed 
rule filing is to implement changes to the modified ROS opening 
procedure that are intended to encourage additional participation in 
the modified ROS opening procedure among market participants who may 
wish to place off-setting orders against the imbalances. Information 
regarding the imbalances would be published on the Exchange's Web site 
at least two times prior to 8:25 a.m. (CT) on the Settlement Date. The 
first publication will occur as soon as practicable after 8 a.m. (CT) 
and the second publication will occur approximately at 8:20 a.m. (CT).
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    \6\ The Exchange understands that some market participants 
choose to unwind their hedges using limit orders to ensure that the 
hedge is effected at a certain price.
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    To encourage more participation in the volatility index futures and 
options settlement process, proposed CBOE Rule 6.2A.03(v) would require 
that all index option orders for participation in the modified ROS 
opening that are related to positions in, or a trading strategy 
involving, volatility index options or futures, and any changes or 
cancellations to these orders, be received prior to 8 a.m. (CT). Under 
the proposed rule change, in general, the

[[Page 43728]]

Exchange would consider index option orders to be related to positions 
in, or a trading strategy involving, volatility index options or 
futures for purposes of proposed CBOE Rule 6.2A.03(v) if the orders 
possess the following three characteristics:
    (i) The orders are for options series with the expiration month 
that will be used to calculate the settlement price of the applicable 
volatility index option or futures contract.
    (ii) The orders are for options series spanning the full range of 
strike prices in the appropriate expiration month for options series 
that will be used to calculate the settlement price of the applicable 
volatility index option or futures contract, but not necessarily every 
available strike price.
    (iii) The orders are for put options with strike prices less than 
the ``at-the-money'' strike price and for call options with strike 
prices greater than the ``at-the-money'' strike price. The orders may 
also be for put and call options with ``at-the-money'' strike prices.
    Whether index option orders are related to positions in, or a 
trading strategy involving, volatility index options or futures for 
purposes of proposed CBOE Rule 6.2A.03(v) depends upon specific facts 
and circumstances. Under the proposed rule change, order types other 
than those provided above may also be deemed by the Exchange to fall 
within this category of orders if the Exchange determines that to be 
the case based upon the applicable facts and circumstances.
    The proposed rule change also provides a limited exception that 
would permit cancellations and changes to these booked orders solely to 
correct a legitimate error (e.g., side, size, symbol, price or 
duplication of an order). Under the proposed rule change, the member 
submitting the change or cancellation would be required to prepare and 
maintain a memorandum setting forth the circumstances that resulted in 
the change or cancellation and would be required to file a copy of the 
memorandum with the Exchange no later than the next business day in a 
form and manner prescribed by the Exchange. In addition, two Floor 
Officials would have the ability to suspend proposed CBOE Rule 
6.2A.03(v) in the event of unusual market conditions. For example, if a 
significant market event occurs between 8 a.m. (CT) and 8:25 a.m. (CT), 
Floor Officials may determine to suspend the rule provision in the 
interest of maintaining a fair and orderly market so that limit orders 
placed in the book to unwind hedged volatility index futures positions 
are not unfairly disadvantaged as a result of a significant market move 
that would result in limit orders going unexecuted.\7\
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    \7\ Id.
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    Separately, the Exchange proposes to move the cut-off time for the 
submission of all orders for participation in the ROS opening on 
Settlement Date mornings from 8:28 a.m. (CT) to 8:25 a.m. (CT). Lead 
Market-Makers, who collectively set the Autoquote values for the SPX 
options on the Settlement Date, have noted to the Exchange that they 
desire additional time to review the order imbalances on the book in 
order to set the Autoquote values that are used in the modified ROS 
opening procedure. The Exchange believes that the earlier cut-off time 
will be beneficial to all index option classes that are used to settle 
volatility index futures and options.
    The Exchange notes that since the last day of trading in volatility 
index futures in the applicable expiring month occurs on the day before 
Settlement Date, holders of open volatility index futures are generally 
aware before 8 a.m. (CT) of the related index option series that they 
would need to place on the book in order to adequately unwind their 
hedges. Therefore, the Exchange believes the index option market 
participants who would be subject to these proposed rules would not be 
materially affected by the 8 a.m. (CT) cut-off time.
    The Exchange also notes that it has filed with the Commission 
surveillance procedures to monitor whether index option orders that are 
subject to the proposed rule change are submitted for placement on the 
electronic book in accordance with the proposed rule.
    In addition, the Exchange is making certain technical changes to 
current CBOE Rule 6.2A.03 to change the time standards reflected in the 
rule from CST to CT, since Chicago is in the Central Time zone. The 
Exchange is also revising the rule language in current CBOE Rule 
6.2A.03(viii) to reflect that the Exchange has recently implemented a 
system change to ROS that automatically generates cancellation orders 
for Exchange market-maker, away market-maker, specialist, and broker 
dealer orders which remain on the electronic book following the 
modified ROS opening procedure. Therefore, members will no longer need 
to submit cancellations for these orders following the opening of the 
applicable index option series.
2. Statutory Basis
    The Exchange believes the proposed rule change will improve the 
modified ROS opening procedure by exposing for a longer period of time 
order imbalances resulting from the unwinding of hedged volatility 
index futures positions. The Exchange believes this will allow market 
participants a greater opportunity to review these order imbalances and 
to place off-setting orders in the book, thereby resulting in the 
reflection of additional market participant interest in the applicable 
index option opening. For these reasons, the Exchange believes the 
proposed rule change is consistent with the Act and the rules and 
regulations under the Act applicable to a national securities exchange 
and, in particular, the requirements of section 6(b) of the Act.\8\ 
Specifically, the Exchange believes the proposed rule change is 
consistent with the section 6(b)(5)\9\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, to prevent fraudulent and manipulative acts and, in general, to 
protect investors and the public interest.
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    \8\ 15 U.S.C. 78(f)(b).
    \9\ 15 U.S.C. 78(f)(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change does not 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 Exchange 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 
arguments concerning the foregoing, including whether the proposed rule

[[Page 43729]]

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-2004-86 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-CBOE-2004-86. 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. Copies of 
such filing also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CBOE-2004-86 and should be submitted on or before August 
18, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-4018 Filed 7-27-05; 8:45 am]
BILLING CODE 8010-01-P