[Federal Register Volume 73, Number 142 (Wednesday, July 23, 2008)]
[Notices]
[Pages 42841-42844]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-16759]



[[Page 42841]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-58171; File No. SR-CBOE-2008-31]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change To List and Trade 
CBOE S&P 500 Three-Month Realized Variance Options and CBOE S&P 500 
Three-Month Realized Volatility Options

July 16, 2008.
    On May 23, 2008, the Chicago Board Options Exchange, Incorporated 
(``Exchange'' or ``CBOE'') 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 list and trade CBOE S&P 500 
three-month realized variance options and CBOE S&P 500 three-month 
realized volatility options. The proposed rule change was published for 
comment in the Federal Register on June 11, 2008.\3\ The Commission 
received no comment letters on the proposed rule change. This order 
approves the proposed rule change.
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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. 57913 (June 3, 
2008), 73 FR 33128 (June 11, 2008).
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I. Description of the Proposed Rule Change

    The proposed rule change will permit the Exchange to list and trade 
cash-settled options having European-style exercise on two statistical 
measurements of market variability: realized variance and realized 
volatility of the S&P 500 Index. These statistical measurements are 
attributes of and based on a broad-based security index (i.e., S&P 500 
Index). Three-month realized variance is a measure of the historical 
variability of the S&P 500 Index, based on actual prices that have been 
reported, or ``realized,'' historically looking back over a three-month 
period. The calculation uses daily returns for the three-month period 
relative to an average (mean) daily price return of zero. Three-month 
realized volatility is the square root of three-month realized 
variance. The Exchange also proposed to make technical changes to some 
of the rules requiring amendment in order to list and trade realized 
variance and realized volatility options.
    Currently, the Exchange lists and trades options on the 30-day 
implied volatility of the S&P 500 Index (CBOE Volatility Index 
(``VIX'') options).\4\ In its proposal, CBOE explained that realized 
variance and realized volatility options, will enable market 
participants to trade options that settle to the actual or realized 
volatility of the S&P 500 Index that has accrued over a three-month 
time period. CBOE further explained that realized variance and realized 
volatility options differ from VIX options in that they will allow 
market participants to take a position on what they anticipate the 
actual volatility of the S&P 500 Index will be at expiration. The 
Exchange also noted that realized variance contracts are a popular and 
successful product in the over-the-counter (``OTC'') market and that a 
listed and standardized market for realized variance and realized 
volatility options would attract investors who desire to trade options 
on realized variance and realized volatility but at the same time 
prefer the certainty and safeguards of a regulated and standardized 
marketplace.
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    \4\ The Exchange also calculates the CBOE S&P 500 Three-Month 
Volatility Index (``VXV''), which measures implied volatility, but 
the Exchange currently does not list VXV options.
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Calculation of Realized Variance and Realized Volatility

    The formula for three-month realized variance and three-month 
realized volatility uses continuously compounded daily returns for a 
three-month period assuming a mean daily price return of zero. The 
calculated realized variance is then annualized assuming 252 business 
days per year.\5\ The exercise-settlement value for CBOE S&P 500 Three-
Month Realized Variance options is 10,000 times the three-month 
realized variance of the S&P 500 Index, and the exercise-settlement 
value for CBOE S&P 500 Three-Month Realized Volatility options is 100 
times the three-month realized volatility of the S&P 500 Index, both of 
which are calculated using the following standardized formula:
    Realized Variance and Realized Volatility Formulas:
    [GRAPHIC] [TIFF OMITTED] TN23JY08.000
    
Where:

Ri = ln (Pi+1/Pi)--Daily return of the S&P 500 Index from 
Pi to Pi+1.
Pi+1 = The final value of the S&P 500 Index used to 
calculate the daily return.
Pi = The initial value of the S&P 500 Index used to calculate the 
daily return.
Ne = Number of expected S&P 500 Index values needed to calculate 
daily returns during the three-month period. The total number of 
daily returns expected during the three-month period is Ne-1.
Na = The actual number of S&P 500 Index values used to calculate 
daily returns during the three-month period. Generally, the actual 
number of S&P 500 Index values will equal the expected number of S&P 
500 Index values (represented by Ne). However, if one or more 
``market disruption events'' occurs during the three-month period, 
the actual number of S&P 500 Index values will be less than the 
expected number of S&P 500 Index values by an amount equal to the 
number of market disruption events that occurred during the three-
month period. The total number of actual daily returns during the 
three-month period is Na-1.

    For purposes of calculating the respective exercise-settlement 
value to which the options will settle, realized variance and realized 
volatility are calculated from a series of values of the S&P 500 Index 
beginning with the Special Opening Quotation (``SOQ'') of the S&P 500 
Index on the first day of the three-month period, and ending with the 
S&P 500 Index SOQ on the last day of the three-month period.\6\ All 
other

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values in the series are closing values of the S&P 500 Index.
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    \5\ The annualization factor for realized volatility is the 
square root of 252.
    \6\ The SOQ is calculated per normal index calculation 
procedures and uses the opening (first) reported sales price in the 
primary market of each component stock in the index on the last 
business day (usually a Friday) before the expiration date. If a 
stock in the index does not open on the day on which the exercise-
settlement value is determined, the last reported sales price in the 
primary market is used to calculate the exercise-settlement value.
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    CBOE noted that three-month realized variance and three-month 
realized volatility will be calculated using actual daily values of the 
S&P 500 Index, which is a broad-based security index. CBOE added that, 
by extension, products based on statistical measurements that are 
derived from S&P 500 Index values should similarly be treated as 
products based directly on S&P 500 Index values. CBOE represented that, 
for purposes of its rules, it would treat the indicative values for 
three-month realized variance and three-month realized volatility as 
indexes.
    CBOE represented that it calculates indicative values for implied 
and realized variance, and publishes those values daily after the close 
of trading. The CBOE S&P 500 Implied Variance indicator (``IUG'') is a 
measure of the market's expectation of future variance of the S&P 500 
Index that is implied by the daily settlement price of the front-month 
CBOE S&P 500 Three-Month Variance futures contract.\7\ The CBOE S&P 500 
Realized Variance indicator (``RUG'') is a measure of the realized 
variance of the S&P 500 Index from the beginning of the three-month 
period to the current date. IUG and RUG are disseminated through the 
Options Price Reporting Authority (``OPRA'') and are publicly available 
through most price quote vendors.\8\
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    \7\ CBOE Futures Exchange, LLC (``CFE'') currently lists CBOE 
S&P 500 Three-Month Realized Variance future contracts, which 
commenced trading on May 18, 2004.
    \8\ These values can be accessed by typing in the ticker symbol 
(IUG or RUG) at the following Web page: http://cfe.cboe.com/DelayedQuote/SSFQuote.aspx.
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Options Trading

    Under the proposal, the exercise-settlement value for CBOE S&P 500 
Three-Month Realized Variance options will be 10,000 times the three-
month realized variance of the S&P 500 Index. Realized variance will be 
quoted in variance points and fractions and one point will equal $50. 
The minimum tick size for all series will be 0.10 point ($5.00) and the 
minimum strike price interval will be $5.00.\9\
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    \9\ See Rules 5.5 and 24.9.
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    The exercise-settlement value for CBOE S&P 500 Three-Month Realized 
Volatility options will be 100 times the three-month realized 
volatility of the S&P 500 Index. Realized volatility will be quoted in 
volatility points and fractions and one point will equal $100. The 
minimum tick size for series trading below 3.00 will be 0.05 point 
($5.00) and the minimum tick for series trading at and above 3.00 will 
be 0.10 point ($10.00). The minimum strike price interval will be 
$1.00.
    The Exchange proposed to list series at $1 or greater strike price 
intervals on CBOE S&P 500 Three-Month Realized Volatility options. CBOE 
noted that traders will likely use the related CBOE S&P 500 Three-Month 
Variance futures contract price as a proxy for the ``current index 
level,'' because, according to CBOE, the futures contract price 
reflects: (i) The realized variance of the S&P 500 Index experienced to 
date; and (ii) the market's expectation of the future variance of the 
S&P 500 Index at expiration of the respective contract.\10\
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    \10\ The Commission has approved the listing of options and 
LEAPS in $1 strike intervals, and the use of futures prices in 
setting those strike intervals, for all other implied volatility 
products approved for listing and trading on the Exchange. See Rule 
24.9.01(e)(ii). See also Securities Exchange Act Release Nos. 54192 
(July 21, 2006), 71 FR 43251 (July 31, 2006) (SR-CBOE-2006-27) ($1 
strikes for VIX options); 55425 (March 8, 2007), 72 FR 12238 (March 
15, 2007) (SR-CBOE-2006-73) ($1 strikes for RVX options); 56813 
(November 19, 2007), 72 FR 66211 (November 27, 2007) (SR-CBOE-2007-
52) ($1 strikes for VXD and VXN options and $1 strikes for RVX, VIX, 
VXD and VXN LEAPS).
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    Under the proposal, the CBOE initially will list at least two 
strike prices above and two strike prices below the square root of the 
related CBOE S&P 500 Three-Month Variance futures contract price at or 
about the time a series is opened for trading on the Exchange. As part 
of this initial listing, the Exchange will list strike prices that are 
within 5 points from the square root of the related CBOE S&P 500 Three-
Month Variance futures contract price on the preceding day.
    As for additional series, the Exchange will be permitted to add 
additional series when the Exchange deems it necessary to maintain an 
orderly market, to meet customer demand or when the square root of the 
related CBOE S&P 500 Three-Month Variance futures contract price moves 
substantially from the initial exercise price or prices. To the extent 
that any additional strike prices are listed by the Exchange, such 
additional strike prices shall be within thirty percent (30%) above or 
below the square root of the related CBOE S&P 500 Three-Month Variance 
futures contract price. The Exchange will also be permitted to open 
additional strike prices that are more than 30% above or below the 
square root of the related CBOE S&P 500 Three-Month Variance futures 
contract price, provided that demonstrated customer interest exists for 
such series, as expressed by institutional, corporate or individual 
customers or their brokers. Market-makers trading for their own account 
will not be considered when determining customer interest. In addition 
to the initial listed series, the Exchange proposed to list up to sixty 
(60) additional series per expiration month for each series in CBOE S&P 
500 Three-Month Realized Volatility options. Further, LEAPS on CBOE S&P 
500 Three-Month Realized Volatility options will not be listed at 
intervals less than $1.
    The Exchange also proposed a delisting policy with respect to CBOE 
S&P 500 Three-Month Realized Volatility options. Specifically, the 
Exchange will, on a monthly basis, review series that are outside a 
range of five (5) strikes above and five (5) strikes below the square 
root of the related CBOE S&P 500 Three-Month Variance futures contract 
price and delist series with no open interest in both the put and the 
call series having a: (i) Strike higher than the highest strike price 
with open interest in the put and/or call series for a given expiration 
month; and (ii) strike lower than the lowest strike price with open 
interest in the put and/or call series for a given expiration month.
    Notwithstanding the proposed delisting policy, CBOE represented 
that it would grant customer requests to add strikes and/or maintain 
strikes in CBOE S&P 500 Three-Month Realized Volatility option series.
    The Exchange also proposed to add new Interpretation and Policy .11 
to Rule 5.5, Series of Option Contracts Open for Trading, which will be 
an internal cross reference stating that the intervals between strike 
prices for CBOE S&P 500 Three-Month Realized Volatility options series 
will be determined in accordance with proposed new Interpretation and 
Policy .01(g) to Rule 24.9.

Exercise and Settlement

    The proposed options will expire on the Saturday following the 
third Friday of the expiring month. Trading in the expiring contract 
month will normally cease at 3:15 p.m. Chicago time on the business day 
preceding the last day of trading (ordinarily the Thursday before 
expiration Saturday, unless there is an intervening holiday). When the 
last trading day is moved because of an Exchange holiday (such as when 
CBOE is closed on the Friday before expiration), the last trading day 
for expiring options will be Thursday. As

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described above, the exercise-settlement value will be calculated from 
a series of values of the S&P 500 Index beginning with the SOQ of the 
S&P 500 Index on the first day of the three-month period, and ending 
with the S&P 500 Index SOQ on the last day of the three-month period. 
All other values in the series are closing values of the S&P 500 Index.
    The exercise-settlement amount is equal to the difference between 
the exercise-settlement value and the exercise price of the option 
multiplied by $50 for CBOE S&P 500 Three-Month Realized Variance 
options and multiplied by $100 for CBOE S&P 500 Three-Month Realized 
Volatility options.

Surveillance

    The Exchange represented that it would use the same surveillance 
procedures currently utilized for each of the Exchange's other index 
options to monitor trading in CBOE S&P 500 Three-Month Realized 
Variance options and CBOE S&P 500 Three-Month Realized Volatility 
options. The Exchange represents that these surveillance procedures are 
adequate to monitor trading in options on these option products. For 
surveillance purposes, the Exchange further represented that it would 
have complete access to information regarding trading activity in the 
pertinent underlying securities (i.e., S&P 500 Index component 
securities).

Position Limits

    The Exchange did not propose any position limits for CBOE S&P 500 
Three-Month Realized Variance options and CBOE S&P 500 Three-Month 
Realized Volatility options. Because realized variance and realized 
volatility are calculated using values of the S&P 500 Index, the 
Exchange argued that the position and exercise limits for these new 
products should be the same as those for broad-based index options 
(e.g., SPX, for which there are no position limits). According to CBOE, 
CBOE S&P 500 Three-Month Realized Variance options and CBOE S&P 500 
Three-Month Realized Volatility options will be subject to the same 
reporting and other requirements triggered for other options dealt in 
on the Exchange.\11\
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    \11\ See Rule 4.13, Reports Related to Position Limits.
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Exchange Rules Applicable

    As stated above, for purposes of CBOE's rules, the indicative 
values for three-month realized variance and three-month realized 
volatility will be treated as indexes. Except as modified by the 
proposal, the rules in Chapters I through XIX, XXIV, XXIVA, and XXIVB 
will equally apply to CBOE S&P 500 Three-Month Realized Variance 
options and CBOE S&P 500 Three-Month Realized Volatility options.
    CBOE S&P 500 Three-Month Realized Variance options and CBOE S&P 500 
Three-Month Realized Volatility options will be margined as ``broad-
based index'' options, and under CBOE rules, especially, Rule 
12.3(c)(5)(A), the margin requirement for a short put or call shall be 
100% of the current market value of the contract plus up to 15% of the 
respective underlying indicative value. Additional margin may be 
required pursuant to Exchange Rule 12.10.
    The Exchange proposed that CBOE S&P 500 Three-Month Realized 
Variance options and CBOE S&P 500 Three-Month Realized Volatility 
options be eligible for trading as Flexible Exchange Options as 
provided for in Chapters XXIVA (Flexible Exchange Options) and XXIVB 
(FLEX Hybrid Trading System).

Capacity

    CBOE represented that it has analyzed its capacity and believes 
that it and the Options Price Reporting Authority have the necessary 
systems capacity to handle the additional traffic associated with the 
listing of new series that will result from the introduction of CBOE 
S&P 500 Three-Month Realized Variance options and CBOE S&P 500 Three-
Month Realized Volatility options.

Technical Changes

    The Exchange also proposed to make technical changes to Rules 
24.4.03, 24.4.04, and 24.5, Exercise Limits by adding ``VIX, VXN and 
VXD'' to the rule text.\12\ The Exchange proposed to make technical 
changes to Rules 24A.7(b), 24A.8(a), 24B.7(b), and 24B.8(a), by adding 
the parenthetical phrase, ``including reduced-value option contracts'' 
to the rule text. These FLEX rules already contemplate reduced-value 
option contracts, and the proposed changes are consistent with the 
treatment of non-FLEX reduced-value option contracts.\13\
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    \12\ The Exchange inadvertently neglected to request the 
Commission's approval to add ``VIX, VXN and VXD'' to the respective 
rule text when the position limits for these products were 
eliminated. See Securities Exchange Act Release No. 54019 (June 20, 
2006), 71 FR 36569 (June 27, 2006) (SR-CBOE-2006-55).
    \13\ See Securities Exchange Act Release No. 56350 (September 4, 
2007), 72 FR 51878 (September 11, 2007) (SR-CBOE-2007-79).
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II. Discussion

    After careful review, the Commission finds that CBOE's proposal to 
permit trading in CBOE S&P 500 three-month realized variance options 
and CBOE S&P 500 three-month realized volatility options is consistent 
with the Act and the rules and regulations thereunder applicable to a 
national securities exchange,\14\ and, in particular, the requirements 
of Section 6 of the Act \15\ and the rules and regulations thereunder. 
The Commission finds that the CBOE's proposal gives options investors 
the ability to make an additional investment choice in a manner 
consistent with the requirements of Section 6(b)(5) of the Act.\16\
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    \14\ 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).
    \15\ 15 U.S.C. 78f.
    \16\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that it has previously approved listing and 
trading of broad-based index options on similar statistical 
measurements,\17\ and that permitting the listing and trading of 
options on CBOE S&P 500 three-month realized variance options and CBOE 
S&P 500 three-month realized volatility options will provide investors 
with an expanded choice of trading and hedging mechanisms. As CBOE has 
noted, unlike other broad-based options on statistical measurements, 
realized variance and realized volatility options will allow market 
participants to take a position on what they anticipate the actual 
volatility of the S&P 500 Index will be at expiration.
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    \17\ See e.g., Securities Exchange Act Release No. 55425 (March 
8, 2007), 72 FR 12238 (March 15, 2007) (order approving SR-CBOE-
2006-73 to list and trade RVX and VXD options); Securities Exchange 
Act Release No. 49563 (April 14, 2004) 69 FR 21589 (April 21, 2004) 
(order approving SR-CBOE-2003-40 to list and trade VIX, VXN and VXD 
options).
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    The Commission therefore finds that it is consistent with the Act 
for the CBOE to apply its rules for trading of broad-based index 
options, including its rules regarding position limits, exercise limits 
and margin requirements, to CBOE S&P 500 three-month realized variance 
options and CBOE S&P 500 three-month realized volatility options
    The Commission also finds that CBOE has adequate surveillance 
procedures in place to monitor for manipulation of the volatility index 
options. 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

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surveillance procedures are adequate to monitor the trading of options 
on this volatility index. For surveillance purposes, the Exchange will 
have complete access to information regarding trading activity in the 
pertinent underlying securities.
    The Commission also believes the CBOE's trading rules and other 
product specifications are appropriate, including the minimum tick size 
and strike price intervals for each product. In addition, the 
Commission notes that IUG and RUG are disseminated through OPRA.
    The Commission also notes CBOE's representation that it possesses 
the necessary systems capacity to support new series that will result 
from the introduction CBOE S&P 500 three-month realized variance 
options and CBOE S&P 500 three-month realized volatility options.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-CBOE-2008-31) be, and it hereby is, 
approved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-16759 Filed 7-22-08; 8:45 am]
BILLING CODE 8010-01-P