

[Federal Register: July 31, 2006 (Volume 71, Number 146)]
[Notices]               
[Page 43251-43254]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr31jy06-120]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54192; File No. SR-CBOE-2006-27]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Order Granting Accelerated Approval 
of Proposed Rule Change and Amendment No. 1 Thereto Relating to Strike 
Price Intervals for VIX Options

July 21, 2006.
    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 March 15, 2006, 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 and II below, which Items have been prepared by the Exchange. 
On July 19, 2006, the CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice and order to 
solicit comments on the proposal from interested persons and to approve 
the proposed rule change, as amended, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced and superseded the original rule 
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 rules that would permit the Exchange to list 
and trade VIX options in $1 strike price intervals within certain 
parameters. The text of the proposed rule change, as amended, is below. 
Proposed new language is in italics.
* * * * *
Rule 24.9 Terms of Index Option Contracts
    No change.
    * * * Interpretations and Policies:
    .01 The procedures for adding and deleting strike prices for index 
options are provided in Rule 5.5 and Interpretations and Policies 
related thereto, as otherwise generally provided by Rule 24.9, and 
include the following:
    (a)-(d) No change.
    (e)(i) Notwithstanding paragraph (a), the interval between strike 
prices for options on the CBOE Volatility Index (VIX) will be no less 
than $2.50; provided, that subject to the following conditions, the 
interval between strike prices for VIX will be no less than $1.00:
    (A) The Exchange may open for trading series at $1.00 or greater 
strike price intervals for each expiration on up to 5 VIX option series 
above and 5 VIX option series below the current index level;
    (B) The Exchange may open for trading additional series at $1.00 or 
greater strike price internals for each expiration as the current index 
level of VIX moves from the exercise price of those VIX options series 
that already have been opened for trading on the Exchange so as to 
maintain at least 5 VIX option series above and 5 VIX option series 
below the current index level;
    (C) The Exchange may not open for trading series with $1.00 
intervals within $0.50 of an existing $2.50 strike price with the same 
expiration month; and
    (D) The interval between strike prices for VIX LEAPs will be no 
less than $2.50.
    (ii) For the purposes of adding strike prices on options on VIX at 
$1.00 or greater strike price intervals, as well as at $2.50 or greater 
strike price intervals, the ``current index level'' shall mean the 
implied forward level based on VIX futures prices.
    .02-.14 No change.
* * * * *

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. The 
text of these statements may be examined at the places specified in 
Item III 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
    The purpose of the proposed rule change is to permit the Exchange 
to list and trade options on the CBOE Volatility Index (``VIX'') in $1 
strike price intervals within certain parameters described below.\4\ 
VIX is calculated using real-time quotes of out-of-the-money and at-
the-money nearby and second nearby index puts and calls on the S&P 500 
Index (``SPX''). Generally, VIX provides investors with up-to-the-
minute market estimates of expected volatility of the S&P 500 Index.
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    \4\ The Commission has also granted approval for CBOE to list 
options on the increased-value version of VIX (``Increased-Value 
VIX'') (see Securities Exchange Act Release No. 49698 (May 13, 
2004), 69 FR 29152 (May 20, 2004) (Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change by the 
Chicago Board Options Exchange, Incorporated Relating to Options on 
Certain CBOE Volatility Indexes)). This proposed rule change does 
not apply to options on Increased-Value VIX.
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    VIX is quoted in absolute numbers that represent the volatility of 
the S&P 500 Index in percentage points per annum. For example, an index 
level of 12.66 (the closing value of the VIX on March 7, 2006) 
represents an annualized volatility of 12.66% in the S&P 500 Index. The 
VIX level fluctuates quite differently than individual equity 
securities or indexes of individual equity securities. Specifically, 
the

[[Page 43252]]

Exchange states that indices such as VIX that track volatility are 
``mean-reverting,'' which is a statistical way of saying that there is 
a strong tendency for the volatility index to move toward its long-term 
historical average level. In other words, at historically low 
volatility index levels, there is a higher probability that the next 
big move will be up rather than down. Conversely, at historically high 
volatility index levels, the next big move is more likely to be down 
rather than up.
    Thus, as exemplified by VIX, the Exchange states volatility indexes 
tend to move within set ranges, and even when a level moves outside 
that range, the tendency towards mean-reversion often results in the 
volatility index returning to a level within the range. In the case of 
VIX, the historical average of VIX since 1990 is 19.4 and has closed at 
levels from a low of 9.3 to a high of 45.7. Since January 1, 2004, VIX 
has fluctuated in a narrow range between a level of 10.2 and a level of 
21.6. Furthermore, VIX closed under 25 for 82% of the days on which the 
level was calculated since 1990 (3,360 days out of a total of 4,078 
days) and has closed under 30 for 93% of the days on which the level 
was calculated since 1990 (3,791 days out of a total of 4,078 days).
    Under current CBOE rules, the Exchange may only list strikes on VIX 
options with intervals no less than $2.50. Therefore, the Exchange 
currently lists strikes on puts and calls on VIX options at 10, 12.50, 
15, 17.50, 20, 22.5 and 25. However, because of the generally limited 
range in which VIX has fluctuated, the Exchange believes that investors 
will be better served if the Exchange is able to list $1 strike price 
intervals in VIX option series. To address this, the Exchange is 
proposing to list series at $1 or greater strike price intervals for 
each expiration on up to 5 VIX option series above and 5 VIX option 
series below the current index level. Additional series at $1.00 or 
greater strike price internals could be listed for each expiration as 
the current index level of VIX moves from the exercise price of the VIX 
options series that already have been opened for trading on the 
Exchange in order to maintain at least 5 VIX option series above and 5 
VIX option series below the current index level. For purposes of adding 
strike prices at $1.00 or greater strike price intervals, as well as at 
$2.50 or greater strike price intervals, the ``current index level'' 
would be defined as the ``implied forward level'' of VIX for each 
expiration.\5\ The Exchange intends to determine implied forward levels 
of VIX through the use of VIX futures prices. Its reasons for using 
this approach are explained below.
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    \5\ With respect to $2.50 or greater strikes, the $2.50 or 
greater strike price intervals will be reasonably related to the 
current index value of VIX at or about the time such series are 
first opened for trading. The term ``reasonably related to the 
current index value of the underlying index'' means that the 
exercise price is within 30% of the current index value. The 
Exchange may also open additional $2.50 or greater strike price 
series that are more than 30% away from the current index value, 
provided that demonstrated customer interest exists for such series, 
as expressed by institutional, corporate, or individual customers or 
their brokers. See Interpretations and Policies .01(d) and .04 of 
Rule 24.9.
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    By way of background, the Exchange states that option prices 
reflect the market's expectation of the price of the underlying at 
expiration, which is referred to as the ``forward'' level. For stock 
indexes such as the SPX and the S&P 100 (``OEX''), the best estimate of 
the forward level is the current, or ``spot,'' price adjusted for the 
``carry,'' which is the financing cost of owning the component stocks 
in the index less the dividends paid by those stocks. For VIX, the 
Exchange states that a better estimate than the standard ``cash and 
carry'' model for calculating the forward levels of VIX at each 
expiration is reflected in the prices of the options that will be used 
to calculate VIX on that expiration day. For example, September SPX 
options will be used to calculate VIX on the August VIX expiration 
date. Likewise, November VIX options are tied to the implied volatility 
of December SPX options, and so on.
    The Exchange states that one important property of implied 
volatility is that it exhibits a ``term structure.'' In other words, 
the VIX volatility of options expiring on different dates can trade at 
different levels and can move independently. Another property related 
to the term structure is that implied volatility tends to trend toward 
the market's expectation of a long-term ``average'' value. As a result, 
the Exchange states that a large spike in one-month implied volatility 
might not affect implied volatility of longer-dated options very much 
at all. For example, the following table illustrates the recent 
behavior of forward VIX levels relative to dramatic change in the 
current VIX price.

----------------------------------------------------------------------------------------------------------------
                                                                    VIX forward     VIX forward
         VIX expiration month             Based on SPX options     prices (5/5/   prices  (5/19/      Change
                                            expiring in . . .           06)             06)
----------------------------------------------------------------------------------------------------------------
Spot VIX..............................  ........................           11.62           17.18           +5.56
June 2006.............................  July 2006...............           12.55           14.86           +2.31
August 2006...........................  September 2006..........           13.66           14.67           +1.01
November 2006.........................  December 2006...........           14.59           15.10           +0.51
February 2007.........................  March 2007..............           15.27           15.46           +0.19
May 2007..............................  June 2007...............           15.75           15.93           +0.18
May 2008..............................  June 2008...............           17.13           17.36           +0.36
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    On May 5, 2006, ``spot'' VIX closed at 11.62. Forward VIX levels at 
different points along the term structure ranged from 12.55 (June 2006) 
to 17.13 (May 2008). Two weeks later, spot VIX closed at 17.18--a gain 
of more than 5.5 points from the May 5th spot VIX. However, June 
forward VIX levels increased by only 2.31 points, August forward VIX 
rose by 1.01 points, and November rose by 0.51 point. The increase in 
forward levels for contracts expiring 9 months and longer was only 
approximately 0.2 points.
    The Exchange notes that many traders use VIX futures prices as a 
proxy for forward VIX levels. The CBOE Futures Exchange, LLC (CFE) 
lists VIX futures corresponding to each VIX options expiration month. 
CBOE believes that using these prices is an accurate and transparent 
method for determining the ``current index level'' used to center the 
limited range in which $1 or greater strikes in VIX options will be 
listed and the broader range in which $2.50 or greater strikes in VIX 
options will be listed. Thus, the Exchange will use the corresponding 
VIX futures prices as a method for determining the ``current index 
level'' for listing series with both $1 and $2.50 strikes in VIX 
options.
    Additionally, the Exchange is proposing that it would not list 
series with $1 intervals within $0.50 of an existing $2.50 strike price 
with the same

[[Page 43253]]

expiration month (e.g., if there is an existing 12.50 strike, the 
Exchange would not list a 12 or 13 strike). Finally, the interval 
between strike prices for VIX long-term option series 
(``LEAPs[reg] '') will continue to be no less than $2.50.
    The Exchange states that the $1 strike price intervals will more 
closely bracket the level of VIX when it remains locked within a static 
range, as currently exists and will enable investors to assume more 
dynamic volatility index option positions that reflect greater 
possibilities of settling in-the-money.
    Finally, CBOE has analyzed its capacity and represents that it 
believes the Exchange and the Options Price Reporting Authority 
(``OPRA'') have the necessary systems capacity to handle the additional 
traffic associated with the listing and trading of $1 strike VIX 
options as proposed herein.
2. Statutory Basis
    CBOE believes the proposed rule change is consistent with the Act 
\6\ 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.\7\ Specifically, the Exchange believes the 
proposed rule change is consistent with the Section 6(b)(5) \8\ 
requirements that the rules of an exchange be designed to promote just 
and equitable principles of trade, and to protect investors and the 
public interest.
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    \6\ 15 U.S.C. 78a et seq.
    \7\ 15 U.S.C. 78(f)(b).
    \8\ 15 U.S.C. 78(f)(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
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. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
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 rule-comments@sec.gov. Please include 

File Number SR-CBOE-2006-27 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2006-27. 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. Copies of such 
filing also will be available for inspection and copying at the 
principal offices 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-2006-27 and should be submitted on or before August 
21, 2006.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, 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 finds that the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act,\10\ which requires, among other things, that the rules of a 
national securities exchange be designed to 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 protect 
investors and the public interest.
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    \9\ In approving this rule change, the Commission notes that it 
has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that this proposal, as amended, is a 
reasonable means of providing investors with greater flexibility to 
establish investment positions that can be better tailored to meet 
their objectives. Specifically, the Commission believes that the 
implementation of $1 strike price intervals for VIX options is designed 
to better serve investors in that product in that it will provide more 
dynamic strike levels that better reflect movements in the VIX. As 
explained by CBOE, the VIX level fluctuates much differently than 
individual equity securities or indexes of individual equity securities 
and has generally remained in a relatively narrow range since its 
inception. Because of these unique characteristics of the VIX, the 
Commission believes that the implementation of $1 strike price 
intervals in the VIX option product, within the parameters detailed in 
CBOE's proposal, is appropriate. The Commission notes that CBOE's 
proposed use of VIX futures as a proxy for the ``implied forward 
level'' of VIX used to calculate the ``current index value'' for 
purposes of adding strike price intervals is a methodology reasonably 
designed to reflex the unique properties of the VIX. The Commission 
further notes that CBOE has represented that the Exchange and OPRA have 
the necessary systems capacity to absorb the additional options traffic 
caused by the introduction of VIX $1 strikes.
    The Exchange has requested accelerated approval of the proposed 
rule change. The Commission finds good cause, consistent with Section 
19(b)(2) of the Act,\11\ for approving this proposed rule change before 
the thirtieth day after the publication of notice thereof in the 
Federal Register. The Commission believes that allowing the Exchange to 
list and trade options on the VIX in $1 strike price intervals 
immediately will provide investors with new means of managing their 
risk exposures and carrying out their investment objectives, and that 
any potential concerns about VIX $1 strikes are mitigated by the 
parameters detailed in the proposal.
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    \11\ 15 U.S.C. 78s(b)(2).

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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-CBOE-2006-27), as amended, 
is approved on an accelerated basis.
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    \12\ Id.
    \13\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-12155 Filed 7-28-06; 8:45 am]

BILLING CODE 8010-01-P
