[Federal Register Volume 74, Number 136 (Friday, July 17, 2009)]
[Notices]
[Pages 34842-34844]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-17003]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60271; File No. SR-CBOE-2009-039]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Proposed Rule Change and Amendment No. 1 
Thereto To Extend the Delta Hedging Exemption From Equity Options 
Position Limits to Customers

July 9, 2009.
    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 June 19, 2009, the Chicago Board Options Exchange, Incorporated 
(``Exchange'' or ``CBOE'') 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 8, 2009, CBOE filed Amendment No. 1 to the proposed 
rule change. 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend Interpretation and Policy .04 to Rule 4.11 
to extend the delta hedging exemption from equity option position 
limits to customers whose accounts are carried by a member and who use 
the pricing model maintained and operated by The Options Clearing 
Corporation (``OCC''). Although the proposed rule change would not 
amend the text of Rule 4.12, the proposed change would impact that rule 
because Rule 4.12 establishes exercise limits for an option at the same 
level as the option's position limit under Rule 4.11. The text of the 
rule proposal is available on the Exchange's Web site (http://www.cboe.org/legal), at the Exchange's Office of the Secretary and at 
the Commission.

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 self-regulatory organization 
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 those 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 parts of such statements.

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

1. Purpose
    On December 14, 2007, the SEC approved CBOE's rule proposal to 
create a delta-based equity hedging exemption from equity options 
(stock options and options on exchange-traded funds) position limits 
(``Exemption'').\3\ Unlike traditional equity hedging, which requires a 
one-to-one hedge, delta hedging varies the number of shares of the 
underlying security used to hedge an options position based on the 
relative sensitivity of the value of the option contract to a change in 
the price of the underlying security. For example, a stock option 
contract with a delta of .5 will move 50[cent] for every $1.00 move in 
the underlying stock.
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    \3\ See Securities Exchange Act Release No. 34-56970 (December 
14, 2007), 72 FR 72428 (December 20, 2007) (SR-CBOE-2007-99).
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    The Exemption currently only permits members or non-member 
affiliates of a member that use a ``permitted pricing model'' (as 
defined in Rule 4.11.04(c)(C)) to use the Exemption. The purpose of 
this filing is to extend the existing Exemption from equity option 
position limits to customers who use the pricing model maintained and 
operated by OCC.
    In support of this proposal, the Exchange states that the Exchange 
considered including customers when the scope of the original filing to 
create the Exemption was being contemplated. However, based on industry 
discussions, it was determined that a delta hedging exemption for 
customers would be proposed and phased in at a later time. Since the 
adoption of the Exemption over 18 months ago, customers have continued 
to express interest and have repeatedly requested that the Exchange 
seek to extend the Exemption to customers. During the time period 
during which the Exemption has been in effect, the Exchange has not 
encountered any problems and believes that the Exemption has been a 
useful tool for members and non-member affiliates. The Exchange 
believes that it is appropriate to extend the Exemption to customers 
after observing the positive and useful benefit it has had for members 
and non-member affiliates.
    The Exchange believes that extending the Exemption to customers in 
the current market environment is particularly relevant as the Exchange 
has seen a trending of customers holding positions overlying lower-
priced securities bumping up against current position limits. Extending 
the Exemption to customers would provide relief to these customers by 
recognizing this widely accepted method for risk management and would 
not result in an increase to their overall notational exposure.
    To affect the extension of the Exemption from equity options 
position limits to customers, the Exchange proposes to layer the term 
``customer'' into the existing rule and proposes to codify separately 
the obligations of a customer using the Exemption. One key difference 
between members (and non-member affiliates) and customers using the 
Exemption would be that customers

[[Page 34843]]

may only hedge their positions in accordance with the OCC pricing 
model.\4\ Below, the Exchange will specify and describe how the 
existing Exemption rules will apply to customers.
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    \4\ Other permitted pricing models include ones used by (i) a 
member or its affiliate subject to consolidated supervision by the 
SEC pursuant to Appendix E of SEC Rule 15c3-1; (ii) a financial 
holding company (``FHC'') or a company treated as an FHC under the 
Bank Holding Company Act of 1956, or its affiliate subject to 
consolidated holding company group supervision; (iii) an SEC 
registered OTC derivatives dealer; and (iv) a national bank. 
Customers seeking to use the Exemption are not permitted to hedge 
their positions in accordance with these models.
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Delta Neutral-Based Equity Hedge Exemption

    The Exchange proposes to extend the existing Exemption from equity 
options position and exercise limits \5\ to positions held by customers 
that are ``delta neutral.'' Rule 4.11.04(c)(A) currently provides that 
the term ``delta neutral'' refers to an equity option position that is 
hedged in accordance with a permitted pricing model by a position in 
the underlying security or one or more instruments relating to the 
underlying security, for the purpose of offsetting the risk that the 
value of the option position will change with incremental changes in 
the price of the security underlying the option position. The Exchange 
is proposed to amend the existing definition of the term ``delta 
neutral'' by requiring that customers seeking to use the Exemption may 
only hedge their positions in accordance with the pricing model 
maintained and operated by The Options Clearing Corporation (``OCC 
Model'').
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    \5\ Exchange Rule 4.12 establishes exercise limits for an option 
at the same level as the option's position limit under Rule 4.11, 
therefore no changes are proposed to Rule 4.12.
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    Any equity option position that is not delta neutral would be 
subject to position and exercise limits, subject to the availability of 
other exemptions. Only the ``option contract equivalent of the net 
delta'' of such position would be subject to the appropriate position 
limit.\6\
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    \6\ Under Rule 4.11.04(c)(B), the term ``options contract 
equivalent of the net delta'' is defined as the net delta divided by 
the number of shares underlying the option contract, and the term 
``net delta'' is defined as, at any time, the number of shares 
(either long or short) required to offset the risk that the value of 
an equity option position will change with incremental changes in 
the price of the security underlying the option position, as 
determined in accordance with a permitted pricing model (which will 
be limited to the OCC Model for customers).
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    Only financial instruments relating to the security underlying an 
equity options position are included in any determination of an equity 
options position's net delta or whether the options position is delta 
neutral. In addition, (as with members) customers may not use the same 
equity or other financial instrument position in connection with more 
than one hedge exemption. Therefore, a stock position used as part of a 
delta hedging strategy could not also serve as the basis for any other 
equity hedge exemption.

Aggregation of Accounts

    Rule 4.11.04(c)(D) sets forth the aggregation requirements \7\ for 
those seeking to rely on the Exemption. The Exchange proposes to amend 
this rule so that it extends to customers. Specifically, those eligible 
to rely on the Exemption are required to ensure that the permitted 
pricing model (OCC Model only for customers) is applied to all 
positions in or relating to the security underlying the relevant 
options position that are owned or controlled by the member and its 
affiliates or customers.
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    \7\ Rules 4.11 and 4.12 require that positions maintained in 
accounts directly or indirectly controlled by the same individual or 
entity be aggregated for position and exercise limit purposes. 
Pursuant to Rule 4.11, control exists when an individual or entity 
makes investment decisions for an account or accounts, or materially 
influences directly or indirectly the actions of any person who 
makes investment decisions. Control is also presumed in the 
following circumstances: (a) Among all participants of a joint 
account who have authority to act on behalf of the account; (b) 
among all general partners to a partnership account; (c) when an 
individual or entity holds an ownership interest of 10% or more in 
an entity, or shares in 10% or more of profits and/or losses of an 
account; (d) when accounts have common directors or management; and 
(e) where an individual or entity has authority to execute 
transactions in an account.
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    However, the net delta of an option position held by an entity 
entitled to rely on the Exemption, or by a separate and distinct 
trading unit of such entity, may be calculated without regard to 
positions in or relating to the security underlying the option position 
held by an affiliated entity or by another trading unit within the same 
entity, provided that: (i) The entity demonstrates to the Exchange's 
satisfaction that no control relationship, as defined in Rule 4.11.03, 
exists between such affiliates or trading units, and (ii) the entity 
has provided (by the member carrying the account as applicable) the 
Exchange written notice in advance that it intends to be considered 
separate and distinct from any affiliate, or, as applicable, which 
trading units within the entity are to be considered separate and 
distinct from each other for purposes of the Exemption.
    Any member, non-member affiliate or customer relying on the 
Exemption must designate, by prior written notice to the Exchange (to 
be obtained and provided by the member carrying the account as 
applicable), each trading unit or entity whose options positions are 
required by Exchange rules to be aggregated with the options positions 
of such member, non-member affiliate or customer relying on the 
Exemption for purposes of compliance with Exchange position or exercise 
limits.

Obligations of Member

    The Exchange proposes to add new subparagraph (4) to Rule 
4.11(c)(E) to set forth the obligations of a member carrying an account 
that includes an equity option position for a customer who intends to 
rely on the Exemption. Specifically, the member would be required to 
obtain from the customer a written certification to the Exchange that 
the customer is using the OCC Model. In addition, the member would be 
required to obtain from the customer a written statement confirming 
that such customer: (a) Is relying on the Exemption; (b) will use only 
the OCC Model for purposes of calculating the net delta of the 
customer's option positions for purposes of the Exemption; (c) will 
promptly notify the member if the customer ceases to rely on the 
Exemption; and (d) in connection with using the OCC Model, has duly 
executed and delivered to the Exchange such documents as the Exchange 
may require to be executed and delivered to the Exchange as a condition 
to reliance on the Exemption.

Reporting

    The Exchange is not proposing to amend the existing rule text of 
Rule 4.11.04(c)(F). This is because the Exchange believes that the 
existing rule text would apply to members carrying customer accounts. 
Specifically, each member that holds or carries an account that relies 
on the Exemption shall report, in accordance with Rule 4.13,\8\ (i) all 
equity option positions (including those that are delta neutral) that 
are reportable thereunder, and (ii) on its own behalf or on behalf of a 
designated aggregation unit pursuant to Rule 4.11.04(c)(D), for each 
such account that holds an equity option position subject to the 
Exemption in excess of the levels specified in Rule 4.11, the net delta 
and the options contract equivalent of the net delta of such position.
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    \8\ Exchange Rule 4.13 requires, among other things, that 
members report to the Exchange aggregate long or short positions on 
the same side of the market of 200 or more contracts of any single 
class of options contracts dealt in on the Exchange.

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[[Page 34844]]

Records

    The Exchange proposes to amend existing Rule 4.11.04(c)(G) 
governing records so that it extends to members carrying customer 
accounts. Specifically, each member relying on the Exemption would be 
required to (i) retain, and would be required to undertake reasonable 
efforts to ensure that any non-member affiliate of the member or 
customer relying on the Exemption retains, a list of the options, 
securities and other instruments underlying each options position net 
delta calculation reported to the Exchange hereunder, and (ii) produce 
such information to the Exchange upon request.

Clarifying Minor Revisions to Existing Rule Text

    The Exchange is taking this opportunity to propose certain minor 
changes to the existing text of Rule 4.11.04(c) to clarify that the 
affirmative obligations codified in connection with relying on the 
Exemption belong to members. For example, any written documentation 
required to be provided to the Exchange in connection with the 
Exemption must be provided by the member relying on the Exemption or 
provided by the member who carries the account of a non-member 
affiliate or customer relying on the Exemption. The Exchange states 
that all communications regarding reliance on the Exemption by non-
member affiliates or customers will be had with the member carrying 
such accounts and not with such non-member affiliates or customers.
    The Exchange will not implement a delta-based equity hedge 
exemption for customers until it provides a representation to the 
Office of Compliance Inspections and Examinations (``OCIE'') that it 
can adequately surveill for such an exemption.\9\
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    \9\ See Amendment No. 1 to the proposed rule change.
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Act \10\ and the rules and regulations thereunder and, in 
particular, the requirements of Section 6(b) of the Act.\11\ 
Specifically, the Exchange believes the proposed rule change is 
consistent with the Section 6(b)(5) \12\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, to prevent fraudulent and manipulative acts, to remove 
impediments to and to perfect the mechanism for a free and open market 
and a national market system, and, in general, to protect investors and 
the public interest. The Exchange believes that extension of the 
Exemption from equity options and exercise limits to customers is 
appropriate in that it is based on a widely accepted risk management 
method used in options trading.
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    \10\ 15 U.S.C. 78s(b)(1).
    \11\ 15 U.S.C. 78f(b).
    \12\ 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 will impose any 
burden on competition 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

    The Exchange neither solicited nor received comments on the 
proposal.

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 
arguments concerning the foregoing, including whether the proposed rule 
change 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-2009-039 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2009-039. 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 Room, on official business 
days between the hours of 10 a.m. and 3 p.m. Copies of the 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-2009-039 and should be submitted on or before August 7, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-17003 Filed 7-16-09; 8:45 am]
BILLING CODE 8010-01-P