

[Federal Register: November 27, 2007 (Volume 72, Number 227)]
[Notices]               
[Page 66211-66213]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27no07-125]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56813; File No. SR-CBOE-2007-52]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of Proposed Rule Change as 
Modified by Amendment No. 1 Thereto Relating to $1 Strikes for VXD and 
VXN Options and $1 Strikes for RVX, VIX, VXD and VXN LEAPs

November 19, 2007.

I. Introduction

    On July 11, 2007, 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 permit the Exchange to: (i) List and trade 
CBOE Dow Jones Industrial Average Volatility Index (``VXD'') options 
and Nasdaq-100 Volatility Index (``VXN'') options in $1 strike price 
intervals; and (ii) list and trade CBOE Russell 2000 Volatility Index 
(``RVX''), VXD, VXN and CBOE Volatility Index (``VIX'') LEAPs in $1 
strike price intervals. On August 20, 2007, CBOE filed Amendment No. 1 
to the proposed rule change. The proposed rule change, as modified by 
Amendment No. 1, was published for comment in the Federal Register on 
September 24, 2007. \3\ The Commission received one comment letter 
regarding the proposal. \4\ 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\ See Securities Exchange Act Release No. 56449 (September 17, 
2007), 72 FR 54306 (``Notice'').
    \4\ See Letter from John C. Nagel, Director & Associate General 
Counsel, Citadel Investment Group, L.L.C. (``Citadel'') to Nancy 
Morris, Secretary, Commission, dated November 2, 2007 (``Citadel 
Comment'').
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II. Description of the Proposal

    In its proposal, CBOE proposed rules to permit the Exchange to list 
and trade options on the CBOE Dow Jones Industrial Average Volatility 
Index (``VXD'') and the Nasdaq-100 Volatility Index (``VXN'') in $1 
strike price intervals within certain parameters described below. \5\ 
Additionally, the rule change proposed to permit the Exchange

[[Page 66212]]

to list and trade CBOE Russell Volatility Index (``RVX''), CBOE 
Volatility Index (``VIX''), VXD, and VXN LEAPs in $1 strike price 
intervals within certain parameters also described below.
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    \5\ The Commission previously approved the listing and trading 
of VXD and VXN options, which the Exchange anticipates trading 
shortly. See Securities Exchange Act Release No. 49563 (April 14, 
2004), 69 FR 21589 (April 21, 2004) (approving SR-CBOE-2003-40).
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 $1 Strikes for VXD and VXN Options

    Similar to other volatility indexes, VXD and VXN are calculated 
using real-time quotes of out-of-the-money and at-the-money and second 
nearly index puts and calls on the Dow Jones Industrial Index 
(``DJIA'') and the Nasdaq-100 Index (``NDX'') respectively. VXD and VXN 
are quoted in absolute numbers that represent the volatility of the 
DJIA and the NDX respectively in percentage points per annum. For 
example, a VXD level of 11.63 (the closing value of the VXD on April 
26, 2007) represents an annualized volatility of 11.63% in the DJIA 
Index and a VXN level of 15.97 (the closing value of the VXN on April 
26, 2007) represents an annualized volatility of 15.97% in the NDX. \6\
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    \6\ In its original filing, CBOE inadvertently reported 
annualized volatility percentages of 11.637% (rather than 11.63%) 
and 15.77% (rather than 15.97%). Telephone conversation between 
Jennifer Yeadon, Senior Attorney, CBOE and Geoffrey Pemble, Special 
Counsel, Division of Market Regulation, Commission, on November 15, 
2007.
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    According to CBOE, as with other proprietary CBOE volatility 
indexes, VXD and VXN levels fluctuate quite differently than individual 
equity securities or indexes of individual equity securities. 
Specifically, indexes such as VXD and VXN that track volatility are 
``mean-reverting,'' a statistical term used to describe 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 represented by CBOE, volatility indexes such as VXD and 
VXN 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 
VXD, the historical average index value since January 2, 2002 is 16.92. 
Since January 2002, VXD has fluctuated in a range between 9.28 and 
41.85. Furthermore, VXD closed under 25 for 85% of the days on which 
the level was calculated since 2002 (1,171 days out of a total of 1,372 
days) and has closed under 30 for 91% of the days on which the level 
was calculated since 2002 (1,245 days out of a total of 1,372 days). 
VXD has closed between 10 and 25 for 82% of the days on which the level 
was calculated since 2002 (1,130 days out of a total of 1,372 days).
    In the case of VXN, the historical average index value since 
January 2, 2002 is 26.14. Since January 2002, VXN has fluctuated in a 
range between 12.61 and 60.66. Furthermore, VXN closed under 25 for 61% 
of the days on which the level was calculated since 2002 (822 days out 
of a total of 1,355 days) and has closed under 30 for 73% of the days 
on which the level was calculated since 2002 (987 days out of a total 
of 1,355 days). VXN has closed between 15 and 30 for 66% of the days on 
which the level was calculated since 2002 (895 days out of a total of 
1,355 days).
    Because of the generally limited range in which VXD and VXN have 
fluctuated, CBOE proposed to list series at $1 or greater strike price 
intervals for each expiration on up to 5 VXD and VXN option series 
above and 5 VXD and VXN option series below the current index level. 
\7\ As the current index level of VXD and VXN moves from the exercise 
price of those VXD and VXN option series that already have been opened 
for trading on the Exchange, the Exchange may open for trading 
additional series at $1.00 or greater strike price intervals for each 
expiration on up to 5 VXD and VXN option series above and 5 VXD and VXN 
option series below the current index level.
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    \7\ The Commission previously approved the listing of VIX and 
RVX options at $1 strike intervals. See Securities Exchange Act 
Release No. 54192 (July 21, 2006), 71 FR 43251 (July 31, 2006) 
(approving SR-CBOE-2006-27); see also Securities Exchange Act 
Release No. 55425 (March 8, 2007), 72 FR 12238 (March 15, 2007) 
(approving SR-CBOE-2006-73).
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    Additionally, the Exchange proposed that it would not list series 
with $1 intervals within $0.50 of an existing $2.50 strike price with 
the same expiration month (e.g., if there is an existing 12.50 strike, 
the Exchange would not list a 12 or 13 strike).

$1 Strike LEAPs for RVX, VIX, VXN and VXD

    Similarly, the Exchange proposed rules to permit $1 strike 
intervals for RVX, VIX, VXD and VXN LEAPs. According to CBOE, typically 
LEAPs strike prices moves in increments of $2.50 and $5.00 and such 
incremental pricing is suited for long-term contracts on traditional 
equity and stock index products. However, as discussed above, the 
levels of volatility indexes fluctuate quite differently than equities 
and stock indexes. As a ``mean-reverting'' product, volatility indexes 
gravitate towards their historical average levels; thus, limiting the 
range of movement.
    Consequently, the Exchange proposed to list series at $1 or greater 
strike price intervals for each expiration on up to 5 RVX, VIX, VXD and 
VXN LEAPs series above and 5 RVX, VIX, VXD and VXN LEAPs series below 
the current index level. As the current index level of RVX, VIX, VXD 
and VXN moves from the exercise price of those RVX, VIX, VXD and VXN 
LEAPs series that already have been opened for trading on the Exchange, 
the Exchange may open for trading additional series at $1.00 or greater 
strike price intervals for each expiration on up to 5 RVX, VIX, VXD and 
VXN LEAPs series above and 5 RVX, VIX, VXD and VXN LEAPs 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 RVX, VIX, VXN and VXD for each expiration. \8\
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    \8\ See Notice, supra n. 3, for further discussion of this 
methodology.
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Capacity

    CBOE represented that it has analyzed its capacity and represents 
that it believes the Exchange and the Options Price Reporting Authority 
have the necessary systems capacity to handle the additional traffic 
associated with the listing and trading of the $1 strikes for VXD and 
VXN option and of the $1 strikes for RVX, VIX, VXD and VXN LEAPs.

III. Summary of Comment Received

    The Commission received one comment letter regarding the proposed 
rule change, from Citadel. Citadel supported the adoption of the 
proposal and, in general, the expansion of $1 strike price intervals, 
stating that expansion of products available to exchanges and investors 
was ``fundamentally pro-competitive'' and that, moreover, ``$1 strike 
price intervals allow traders and investors to customize the risk 
profiles of their trading positions more precisely, and thus reduce the 
cost of trading.'' \9\ Citadel commented favorably about the 
Commission's prior pilot program to allow $1 strike intervals,\10\ and 
advocated that the Commission ``promote the expansion of $1 strike 
programs even if doing so requires curtailing or slowing further 
expansion of penny quoting.'' \11\ With regard to the

[[Page 66213]]

proposal, Citadel noted that ``permitting CBOE to list and trade 
options that are the subject of the Proposal in $1 strike intervals 
would benefit the public, including retail investors,'' for many of the 
same reasons $1 strike options do, as well as for reasons specific to 
volatility options, such a the ``mean-reverting'' characteristics of 
volatility indexes.\12\ Similarly, Citadel supported the listing and 
trading of LEAPs on certain volatility indexes, as proposed by CBOE, 
arguing that the ``case for strike-intervals for LEAPs on volatility 
indexes is even stronger than the case for narrow-interval LEAPs on 
single stocks.''
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    \9\ See Citadel Comment at 1.
    \10\ Id. at 2.
    \11\ Id. at 3.
    \12\ Id.
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IV. Discussion

    After careful review, the Commission finds that CBOE's proposal to 
(i) list and trade CBOE Dow Jones Industrial Average Volatility Index 
(``VXD'') options and Nasdaq-100 Volatility Index (``VXN'') options in 
$1 strike price intervals; and (ii) list and trade CBOE Russell 2000 
Volatility Index (``RVX''), VXD, VXN and CBOE Volatility Index 
(``VIX'') LEAPs in $1 strike price intervals is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange \13\ and, in particular, 
the requirements of section 6 of the Act \14\ and the rules and 
regulations thereunder. The Commission believes that CBOE's proposal 
gives options investors the ability to make additional investment 
choices in a manner consistent with the requirements of section 6(b)(5) 
of the Act. \15\ The Commission further believes that trading options 
and LEAPs in $1 strike price intervals on these volatility indexes 
provides investors with an important trading and hedging mechanism.
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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.
    \15\ 15 U.S.C. 78f(b)(5).
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    As explained by CBOE, volatility indexes such as the RVX, VIX, VXD 
and VXN fluctuate in a narrow range, and thus, the Commission believes 
that the implementation of $1 strike price intervals on options and 
LEAPs based on these indexes, within the parameters detailed in CBOE's 
proposal, is appropriate.
    The Commission also notes CBOE's representations that it possesses 
the necessary systems capacity to support new series that would result 
from the introduction of $1 strikes for VXD and VXN options and of the 
$1 strikes for RVX, VIX, VXD and VXN LEAPs and that CBOE also has been 
informed that OPRA has the capacity to support such offerings.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-CBOE-2007-52), as amended, 
be, and hereby is, approved.
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    \16\ 15 U.S.C. 78s(b)(2).
    \17\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-23003 Filed 11-26-07; 8:45 am]

BILLING CODE 8011-01-P
