
[Federal Register: June 4, 2010 (Volume 75, Number 107)]
[Notices]               
[Page 31826-31828]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04jn10-99]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-62190; File No. SR-CBOE-2010-021]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change as Modified by 
Amendment No. 1 Thereto Relating to Correlated Instrument Delta Hedge 
Exemption

May 27, 2010.
    On March 19, 2010, 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 (i) expand the delta hedging 
exemption available for equity options position limits; (ii) amend the 
reporting requirements applicable to members relying on the delta 
hedging exemption; and (iii) adopt a delta hedging exemption from 
certain index options position limits. The proposed rule change was 
published for comment in the Federal Register on April 2, 2010.\3\ On 
May 19, 2010, CBOE filed Amendment No. 1 to the proposal.\4\ The 
Commission received no comment letters on the proposal. This order 
approves the proposed rule change, as modified by Amendment No. 1.
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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. 61785 (March 25, 
2010), 75 FR 16888.
    \4\ Amendment No. 1 deleted the word ``or'' from the rule text 
of the proposal and deleted a footnote from the purpose section and 
Exhibit 1 of the proposal. Because the amendment does not affect the 
substance of the rule filing, the amendment does not require notice 
and comment.
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    In December 2007, the Commission approved a CBOE proposal to create 
an exemption from position and exercise limits applicable to equity 
options (stock options and options on exchange-traded funds) for 
positions held by CBOE members and certain non-member affiliates that 
are delta neutral \5\ under a ``permitted pricing model'' \6\ (``Equity 
Exemption'').\7\ When a position is not delta neutral, only the option 
contract equivalent of the net delta \8\ of the position remains 
subject to the position limits in Rule 4.11. Currently, the Equity 
Exemption is available only for securities that directly underlie the 
applicable option position. For example, with respect to options on 
exchange-traded funds (``ETF options''), index options overlying the 
same index on which the ETF is based currently cannot be combined with 
the ETF options to calculate a net delta for purposes of the Equity 
Exemption.
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    \5\ ``Delta neutral'' is defined as a precise term for purposes 
of the Equity Exemption in Rule 4.11.04(c)(A).
    \6\ Under Rule 4.11.04(c)(C), ``permitted pricing model'' for 
purposes of the Equity Exemption is a pricing model: (1) Maintained 
and operated by the Options Clearing Corporation (``OCC Model''); 
(2) maintained and used by a member or its non-member affiliate 
subject to consolidated supervision by the Commission pursuant to 
Appendix E of Rule 15c3-1, 17 CFR 240.15c3-1, under the Act; (3) 
maintained and used by 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; (4) maintained and used by a Commission-registered OTC 
derivatives dealer; or (5) used by a national bank under the 
National Bank Act.
    \7\ See Securities Exchange Act Release No. 56970 (December 14, 
2007), 72 FR 72428 (December 20, 2007) (SR-CBOE-2007-99) 
(``Exemption Approval Order''). In August 2009, the Commission 
approved a CBOE proposal to extend the Equity Exemption to 
customers. See Securities Exchange Act Release No. 60555 (August 21, 
2009), 74 FR 43741 (August 27, 2009) (SR-CBOE-2009-39). The 
Commission notes that the Equity Exemption is not currently 
available to customers. See Securities Exchange Act Release No. 
61857 (April 7, 2010), 75 FR 18931 (April 13, 2010) (SR-CBOE-2010-
30).
    \8\ ``Net delta'' is defined as a precise term for the purposes 
of the Equity Exemption in Rule 4.11.04(c)(B).
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    The proposed rule change would expand the Equity Exemption by 
permitting equity option positions for which the underlying security is 
an ETF that is based on the same index as an index option to be 
combined with any position in the underlying ETF as well as any 
position in an index option and/or a correlated instrument for 
calculation of the Equity Exemption.\9\ The term ``correlated 
instrument'' would

[[Page 31827]]

be defined to mean securities and/or other instruments that track the 
performance of or are based on the same underlying index as the index 
underlying the option position. Thus, the proposed rule change would 
allow financial products such as securities index options, index 
futures, and options on index futures to be included along with the ETF 
in an equity option's net delta calculation.\10\
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    \9\ However, this would not include baskets of securities for 
purposes of the delta hedging exemptions.
    \10\ For example, the proposed rule would allow options on 
Standard & Poor's Depositary Receipts (``SPY''), which tracks the 
performance of the S&P 500 index, to be hedged not only with SPY 
shares, but with S&P 500 options, S&P 500 futures, options on S&P 
500 futures or any other instrument that tracks the performance of 
or is based on the S&P 500 index.
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    To accommodate the use of index options and correlated instruments 
in the calculation of the Equity Exemption, the Exchange proposes to 
amend the definition of ``net delta'' in Rule 4.11.04(c)(B) to mean, at 
any time, the number of shares and/or other units of trade (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. The Exchange also proposes 
to amend the definition of the ``option contract equivalent of the net 
delta'' to mean the net delta divided by the number of shares that 
equate to one option contract on a delta basis. Index options and 
equity options (i.e., ETF options) that are eligible to be combined for 
computing a delta-based hedge exemption, along with all securities and/
or other instruments that are based on or track the performance of the 
same underlying security or index, will be grouped and the net delta 
and options contract equivalent of the net delta will be calculated for 
each respective option class based on offsets realized from the 
grouping as a whole.
    In another aspect of the proposal, CBOE proposes to relieve 
Exchange Market-Makers and Designated Primary Market-Makers (``DPMs'') 
using the OCC Model from the reporting requirements of the Equity 
Exemption because, as explained by CBOE, Market-Maker and DPM position 
and delta information can be accessed through the Exchange's market 
surveillance systems. The Exchange noted that this proposal is 
consistent with similar exemptions from the reporting requirements 
under Rule 4.13 and those applicable to broad-based index options and 
FLEX options.
    Finally, CBOE proposes to adopt an exemption from position and 
exercise limits \11\ for positions in index options \12\ held by CBOE 
members, certain of their affiliates, and customers that are delta 
neutral \13\ under a permitted pricing model (``Index Exemption'').\14\ 
The options contract equivalent of the net delta \15\ of such position 
would be subject to the appropriate position limit (subject to the 
availability of any other position limit exemptions).\16\
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    \11\ Exchange Rule 24.5 establishes exercise limits for an index 
option at the same level as the index option's position limit under 
index options position limit rules, therefore no changes are 
proposed to Rule 24.5.
    \12\ The Index Exemption would apply to broad-based index 
options as well as industry index options. See proposed Rules 
24.4.05 and Rule 24.4A.03.
    \13\ The term ``delta neutral'' would be defined as referring to 
an index option position that is hedged, in accordance with a 
permitted pricing model, by a position in one or more correlated 
instruments for the purpose of offsetting the risk that the value of 
the option position will change with incremental changes in the 
value of the underlying index. The term ``correlated instruments'' 
would be defined to mean securities and/or other instruments that 
track the performance of or are based on the same underlying index 
as the index underlying the option position. See proposed Rules 
24.4.05(A). These definitions would allow financial products such as 
ETF options, index futures, options on index futures and ETFs that 
track the performance of or are based on the same underlying index 
to be included in an index option's net delta calculation.
    \14\ The terms ``delta neutral,'' ``permitted pricing model,'' 
and ``options contract equivalent of the net delta'' would be 
defined for the Index Exemption similar to the way these terms are 
defined for the Equity Exemption; with appropriate adjustments. See 
id. and infra note 15.
    \15\ For purposes of the Index Exemption, the term ``options 
contract equivalent of the net delta'' would be defined as the net 
delta divided by ``units of trade that equate to one option contract 
on a delta basis,'' and the term ``net delta'' would be defined as, 
at any time, the number of shares ``and/or other units of trade 
(either long or short)'' required to offset the risk that the value 
of an index option position will change with incremental changes in 
the value of the underlying index, as determined in accordance with 
a permitted pricing model.
    \16\ See proposed Rule 24.4.05(B). The Commission notes that 
Rule 24.4 provides for multiple, independent hedge exemptions. Of 
course, to the extent that a position is used to hedge for the 
purpose of one exemption from position limit requirements, such as 
the Index Exemption, such position cannot be used to take advantage 
of another exemption from position limit requirements.
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    A member that intends to employ, or whose non-member affiliate or 
customer intends to employ, the Index Exemption would be required to 
provide a written certification to CBOE stating that the member, its 
affiliate, and/or its customer will use a permitted pricing model.\17\ 
In addition, members that carry an account that includes an index 
option position for a non-member affiliate would be required to obtain 
and provide to the Exchange a written statement from the non-member 
affiliate confirming that the affiliate: (1) Is relying on this 
exemption; (2) will use only a permitted pricing model for purposes of 
calculating the net delta of its option positions for purposes of this 
exemption; (3) will promptly notify the member if it ceases to rely on 
this exemption; (4) authorizes the member, upon request, to provide to 
the Exchange or the Options Clearing Corporation such information 
regarding positions of the non-member affiliate as part of the 
Exchange's confirmation or verification of the accuracy of the net 
delta calculation under this exemption; and (5) if the non-member 
affiliate is using the OCC Model, has duly executed and delivered to 
the member such documents as the Exchange may require as a condition to 
reliance on this exemption.\18\ Members that carry an account that 
includes an index option position for a customer would be required to 
obtain and provide to the Exchange a written statement from the 
customer confirming that the customer: (1) Is relying on this 
exemption; (2) will use only the OCC Model for purposes of calculating 
the net delta of the customer's options positions for purposes of this 
exemption; (3) will promptly notify the member if the customer ceases 
to rely on this exemption; and (4) in connection with using the OCC 
Model, has duly executed and delivered to the member such documents as 
the Exchange may require as a condition to reliance on this 
exemption.\19\
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    \17\ See proposed Rule 24.4.05(E)(1)(i), (3)(i), and (4)(i). The 
Commission notes that customers relying on the Index Exemption would 
be permitted to hedge their positions only in accordance with the 
OCC Model. See proposed Rule 24.4.05(A). In addition, the Commission 
notes that, consistent with the Equity Exemption, the Exchange will 
not make the Index Exemption available to customers until the 
Exchange provides a representation to the Commission's Office of 
Compliance Inspections and Examinations that it can adequately 
surveil for such a customer exemption. Telephone conversation 
between Andrew Spiwak, Director Legal Division and Chief Enforcement 
Attorney, CBOE, and Theodore S. Venuti, Special Counsel, Division of 
Trading and Markets, Commission, on May 27, 2010. See also supra 
note 7.
    \18\ See proposed Rule 24.4.05(E)(3)(ii).
    \19\ See proposed Rule 24.4.05(E)(4)(ii).
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    Furthermore, any member would be required to report, in accordance 
with Rule 4.13, all index options positions (including those that are 
delta neutral) that are reportable under that rule, and also would be 
required to report on its own behalf or on behalf of a designated 
aggregation unit \20\ the net delta and

[[Page 31828]]

options contract equivalent of the net delta of such positions for a 
each account that holds an index option position subject to the delta 
hedging exemption in excess of the levels specified in 24.4 (and Rule 
24.4A, in the case of industry index options).\21\ Each member relying 
on the exemption would be required to retain, and undertake reasonable 
efforts to ensure that its non-member affiliates or customers relying 
on the exemption retain, a list of the options, securities, and other 
instruments underlying each option position net delta calculation 
reported to the Exchange; and to produce such information to the 
Exchange upon request.\22\ In addition, the options positions of a non-
member relying on the exemption would be required to be carried by a 
member with which it is affiliated.\23\
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    \20\ See proposed Rule 24.4.05(D), which provides, under certain 
conditions, that the net delta of an options position held by an 
entity entitled to rely on the exemption could be calculated without 
regard to positions in correlated instruments held by an affiliated 
entity or another trading unit within the same entity, provided 
that, among other things, no control relationship exists between 
such affiliates or trading units and the entity has designated in 
writing in advance the affiliates or trading units that are to be 
considered separate and distinct from each other.
    \21\ See proposed Rule 24.4.05(F). See also supra note 12.
    \22\ See proposed Rule 24.4.05(G).
    \23\ See proposed Rule 24.4.05(E)(2).
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    The Exchange will announce the operative date of the proposed rule 
change in a regulatory circular to be published no later than 60 days 
after Commission approval. The operative date shall be no later than 30 
days after publication of the regulatory circular.
    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder that are applicable to a national securities exchange.\24\ 
In particular, the Commission believes that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\25\ which requires, among 
other things, that CBOE rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to 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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    \24\ In approving this rule, 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).
    \25\ 15 U.S.C. 78f(b)(5).
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    In approving the Equity Exemption, the Commission noted its 
previous statement in support of recognizing options positions hedged 
on a delta neutral basis as properly exempted from position limits.\26\ 
The Commission believes that it is appropriate and consistent with the 
Act to expand the Equity Exemption to allow the use of correlated 
instruments in determining whether an ETF options position is delta 
neutral. The Commission further believes that it is appropriate and 
consistent with the Act to establish a delta based index options hedge 
exemption from position limits. Finally, the Commission believes that 
it is reasonable for CBOE to exempt Exchange Market-Makers and DPMs 
using the OCC Model from the reporting requirements of the Equity 
Exemption, and not to include them as subject to the reporting 
requirements of the Index Exemption, because the Exchange can access 
the information through the Exchange's market surveillance systems.
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    \26\ See Securities Exchange Act Release No. 40594 (October 23, 
1998), 63 FR 59362, 59380 (November 3, 1998) (File No. S7-30-97) 
(adopting rules relating to OTC derivatives dealers), cited in 
Exemption Approval Order, supra note 7.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-CBOE-2010-021), as modified 
by Amendment No. 1, be, and it hereby is, approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-13439 Filed 6-3-10; 8:45 am]
BILLING CODE 8010-01-P

