[Federal Register Volume 70, Number 173 (Thursday, September 8, 2005)]
[Notices]
[Pages 53401-53402]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-4875]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52367; File No. SR-CBOE-2004-86]


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

August 31, 2005.

I. Introduction

    On December 15, 2004, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission'') a proposed rule change pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder,\2\ to amend the Exchange's Rapid Opening 
System (``ROS'') \3\ modified opening procedure set forth in CBOE Rule 
6.2A.03. On July 5, 2005, the Exchange filed Amendment No. 1 to the 
proposed rule change.\4\ The proposed rule change was published for 
comment in the Federal Register on July 28, 2005.\5\ The Commission 
received no comments on the proposal. 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\ 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.
    \4\ See Form 19b-4, dated July 1, 2005 (``Amendment No. 1''). 
Amendment No. 1 replaced the original filing in its entirety.
    \5\ See Securities Exchange Act Release No. 52101 (July 21, 
2005), 70 FR 43726 (``Notice'').
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II. Description of the Proposed Rule Change

    Current CBOE Rule 6.2A.03 sets forth certain procedures that modify 
the normal operation of ROS for index options with respect to which 
volatility indexes are calculated, to be utilized on the final 
settlement date (``Settlement Date'') of futures and options contracts 
that are traded on the applicable volatility index.\6\ Specifically, 
the modified ROS opening procedure provides that on such Settlement 
Date, all orders, other than contingency orders, are eligible to 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 the purposes of permitting those orders to participate 
in the ROS opening price calculation for the applicable index option 
series.\7\
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    \6\ 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.
    \7\ See CBOE Rule 6.2A.03. See also Securities Exchange Act 
Release Nos. 49468 (March 24, 2004), 69 FR 17000 (March 31, 2004); 
and 49798 (June 3, 2004), 69 FR 32644 (June 10, 2004).
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    In setting forth the purpose of the proposed rule change, CBOE 
cites the example of market participants actively trading futures on 
the CBOE Volatility Index (``VIX futures''), who have utilized the 
modified ROS opening procedure to place orders for options on the S&P 
500 Index (``SPX'') on the book on the Settlement Date of the VIX 
futures contract to unwind hedge strategies involving SPX options that 
were initially entered into upon the purchase or sale of the 
futures.\8\ According to CBOE, to the extent that (i) traders who are 
liquidating hedges predominately are on one side of the market 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.
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    \8\ See Notice. In particular, CBOE states, 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. Id.
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    CBOE proposes to implement changes to the modified ROS opening 
procedure to encourage additional participation by market participants 
who may wish to place off-setting orders against the imbalances. 
Currently, all orders for participation in the modified procedure must 
be received by 8:28 a.m. (CT).\9\ The proposed rule change would amend 
Rule 6.2A.03 to 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).\10\ In addition, the proposed rule would require information 
regarding any order

[[Page 53402]]

imbalances to be published as soon as practicable after 8 a.m. (CT), 
and thereafter at approximately 8:20 a.m. (CT), on the Settlement 
Date.\11\
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    \9\ See current CBOE Rule 6.2A.03(v).
    \10\ The proposed rule change includes provisions setting forth 
generally the criteria by which the Exchange would consider index 
options orders to be related to positions in, or a trading strategy 
involving, volatility index options or futures for purposes of the 
rule. See Notice.
    \11\ The Exchange represents that it would publish the imbalance 
on its Web site. See Notice.
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    The proposed rule change also provides a limited exception that 
would permit cancellations and changes to booked orders falling under 
this provision that are made to correct a legitimate error. 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 the new rule in the event 
of unusual market conditions.\12\
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    \12\ For example, the CBOE states that if a significant market 
event occurs between 8:00 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.
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    The Exchange also proposes (i) to move the cut-off time for the 
submission of all other index option orders for participation in the 
modified ROS opening on Settlement Date mornings from 8:28 a.m. (CT) to 
8:25 a.m. (CT); (ii) to change the time standards reflected in the rule 
from CST to CT, since Chicago is in the Central Time zone; and (iii) to 
revise the rule language in current CBOE Rule 6.2A.03(viii) to reflect 
that the Exchange has recently implemented a systems 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.

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 applicable to a national securities exchange.\13\ In 
particular, the Commission believes that the proposed rule change is 
consistent with the requirements on Section 6(b)(5) of the Act \14\ 
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, to protect investors and the public interest.
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    \13\ 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).
    \14\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that the proposed rule change will improve 
the modified ROS opening procedure by exposing for a longer period of 
time order imbalances in index options resulting from the unwinding of 
hedged volatility index future positions. The Exchange further believes 
that the market participants to whom the proposed rule change applies 
would not be materially affected by the 8 a.m. (CT) cut-off time, 
because the last day of trading in volatility index futures in the 
applicable expiring month occurs on the day before Settlement Date, and 
holders of open volatility index futures are generally aware before 8 
a.m. (CT) of the related index options series that they need to place 
on the book in order to adequately unwind their hedges. The Commission 
believes that the proposed rule change may serve the intended benefit 
without imposing an undue burden on these participants. The Commission 
notes that it has approved a similar rule in another context.\15\
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    \15\ See NYSE Rule 123C(6). See, e.g., Securities Exchange Act 
Release No. 25804 (June 15, 1988), 53 FR 23474 (June 22, 1988) 
(order approving File Nos. SR-NYSE-87-11 and 88-04).
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    The proposed rule change would also modify the deadline for 
submitting all other index options orders for participation in the 
modified ROS opening procedure, and any changes to or cancellations of 
any orders, from 8:28 a.m. (CT) to 8:25 a.m. (CT). The Exchange 
believes that this rule change would give Lead Market-Makers on the 
CBOE additional time to review order imbalances on the book in order to 
setting the Autoquote values that are used in the modified ROS opening 
procedures. The Commission believes this proposed adjustment is 
reasonable to achieve the intended benefit.
    The Commission further believes that the other associated aspects 
of the proposed rule change are appropriate to clarify the application 
of the rule and to provide for its reasonable implementation.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-CBOE-2004-86), as amended by 
Amendment No. 1, is approved.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-4875 Filed 9-7-05; 8:45 am]
BILLING CODE 8010-01-P