
[Federal Register Volume 77, Number 157 (Tuesday, August 14, 2012)]
[Notices]
[Pages 48580-48582]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-19862]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67624; File No. SR-CBOE-2012-040]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of Proposed Rule Change Related 
to Permanent Approval of Its Pilot on FLEX Minimum Value Sizes

August 8, 2012.

I. Introduction

    On April 25, 2012, 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 relating to permanent approval of 
its pilot program eliminating Flexible Exchange Option (``FLEX 
Option'') minimum value sizes. The proposed rule change was published 
for comment in the Federal Register on May 11, 2012.\3\ The Commission 
received no comments on the proposal. The Exchange consented to an 
extension of the time period for the Commission to approve the proposed 
rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether the proposed rule change should be 
disapproved, to August 9, 2012. CBOE filed Amendment No. 1 to the 
proposed rule change, in order to transmit a pilot report, on August 6, 
2012.\4\ 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. 66934 (May 7, 2012), 
77 FR 27822 (May 11, 2012) (``Notice'').
    \4\ In Amendment No. 1, CBOE submitted as Exhibit 3 to its 
proposal an annual report summarizing pilot data collected for the 
year 2011, the most recent complete year of the pilot program 
(``Pilot Report''). Specifically, the Pilot Report summarizes the 
open interest and trading volume in FLEX Option transactions opened 
during the year 2011 with a size below the minimum value thresholds 
in force before the pilot, as well as the types of customers 
initiating such transactions.
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II. Description of the Proposal

    FLEX Options, unlike traditional standardized options, allow 
investors to customize basic option terms, including size, expiration 
date, exercise style, and certain exercise style prices within certain 
parameters as set forth in CBOE's rules.\5\ CBOE currently has in place 
a pilot program under which there is no minimum value size requirement 
for FLEX Option transactions (``Pilot Program'') which, practically, 
allows FLEX Option trades to be initiated at levels as low as one 
contract.\6\ CBOE is proposing to make the Pilot Program permanent.
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    \5\ See Notice, supra note 3; see also CBOE Rules 24A.1(d) and 
24B.1(d).
    \6\ See CBOE Rules 24A.4.01(b), 24B.4.01(b); Securities Exchange 
Act Release Nos. 61439 (January 28, 2010), 75 FR 5831 (February 4, 
2010) (SR-CBOE-2009-087) (approving establishment of pilot program); 
61676 (March 9, 2010), 75 FR 13191 (March 18, 2010) (SR-CBOE-2010-
026) (technical rule change to include original pilots' conclusion 
date of March 28, 2011 in the rule text); 64110 (March 24, 2011), 76 
FR 17463 (March 29, 2011) (SR-CBOE-2011-024) (extending the pilots 
through March 30, 2012); and 66701 (March 30, 2012), 77 FR 20673 
(April 5, 2012) (SR-CBOE-2012-027) (extending the pilots through the 
earlier of November 2, 2012 or the date on which the respective 
pilot program is approved on a permanent basis). There is also a 
CBOE pilot program currently in place that eliminates certain 
restrictions on the exercise settlement values for FLEX index 
options. Although that exercise settlement value pilot was 
originally approved along with the Pilot Program, it is not part of 
this proposal.
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    Prior to the Pilot Program, the minimum value size for an opening 
transaction in any FLEX series without open interest was: (1) For FLEX 
Equity Options,\7\ the lesser of 250 contracts or the number of 
contracts overlying $1 million in the underlying securities; \8\ and 
(2) for FLEX Index Options,\9\ $10 million Underlying Equivalent 
Value.\10\ Additionally, the minimum value size for a transaction in 
any currently-opened FLEX series was: (1) For FLEX Equity Options, the 
lesser of 100 contracts or the number of contracts overlying $1 million 
in the underlying securities, and 25 contracts in the case of closing 
transactions; (2) for FLEX Index Options, $1 million Underlying 
Equivalent Value in the case of both opening and closing transactions; 
or (3) in either case, the remaining underlying size or Underlying 
Equivalent Value on a closing transaction, whichever is less.\11\ There 
were also, prior to the Pilot Program, minimum value size requirements 
applicable to FLEX Quotes \12\ responsive to a Request for Quotes,\13\ 
including certain minimum

[[Page 48581]]

value size requirements that specifically applied to FLEX Appointed 
Market Makers and FLEX Index Appointed Market Makers.\14\
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    \7\ See CBOE Rules 24A.1(e) and 24B.1(f) (defining ``FLEX Equity 
Option'').
    \8\ Under a different pilot program, superseded by the pilot 
that CBOE now seeks to make permanent, the 250-contract minimum for 
Flex Equity Options was reduced to 150 contracts. See Securities 
Exchange Act Release No. 57429 (March 4, 2008), 73 FR 13058 (March 
11, 2008) (order approving SR-CBOE-2006-36).
    \9\ See CBOE Rules 24A.1(f) and 24B.1(g) (defining ``FLEX Index 
Option'').
    \10\ See CBOE Rules 24A.4(a)(4)(ii) and 24B.4(a)(5)(ii); see 
also CBOE Rules 24A.1(q) and 24B.1(z) (defining ``Underlying 
Equivalent Value'').
    \11\ See CBOE Rules 24A.4(a)(4)(iii) and 24B.4(a)(5)(iii).
    \12\ See CBOE Rules 24A.1(h) and 24B.1(k) (defining ``FLEX 
Quote'').
    \13\ See CBOE Rules 24A.1(n) and 24B.1(r) (defining ``Request 
for Quotes'').
    \14\ See CBOE Rules 24A.4(a)(4)(iv) and 24B.4(a)(5)(iv); see 
also CBOE Rules 24A.9 and 24B.9 (defining and describing FLEX 
Qualified Market Makers and FLEX Appointed Market Makers).
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    CBOE's proposal will make permanent the Pilot Program eliminating 
these minimum value sizes by deleting CBOE Rules 24A.4(a)(4), 
24A.4.01(b), 24B.4(a)(5), and 24B.4.01(b), as well as by deleting 
cross-references in Rules 24A.9(b) and 24B.9(c) that applied the 
minimum value size requirements in Rules 24A.4(a)(4)(iv) and 
24B.4(a)(5)(iv) to FLEX Quotes entered by FLEX Appointed Market Makers 
or FLEX Qualified Market Makers.\15\
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    \15\ As a technical change, CBOE also proposes to relocate 
certain language from the provisions that would be deleted by its 
proposal. Specifically, CBOE proposes to move from Rules 
24A.4(a)(4)(i) and 24B.4(a)(5)(i) to Rules 24A.4(a)(2)(iv) and 
24B.4(a)(2)(iv), respectively, language setting an expiration date 
maximum term of fifteen years for FLEX Requests for Quotes, FLEX 
Orders and FLEX Option contracts. CBOE also proposes to move from 
Rule 24B.4(a)(5)(iv) to Rule 24B.9(c) language regarding the minimum 
percentage of Requests for Quotes in response to which FLEX 
Appointed Market Makers must provide a FLEX Quote.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\16\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\17\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, 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; 
and not be designed to permit unfair discrimination between customers, 
issuers, brokers or dealers.
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    \16\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
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    FLEX Options were originally designed for use by institutional and 
high net worth customers, rather than retail investors.\18\ In 
approving the Pilot Program, while the Commission noted that it had 
received several comment letters stating that the proposal would assist 
institutional customers, it also noted that the elimination of the 
minimum value size requirements raised the possibility that retail 
customers would access the FLEX Options market.\19\ One of the risks to 
retail investors outlined in the ODD\20\ is that, because of the 
customized nature of FLEX Options and lack of continuous quotes, 
trading in FLEX Options is often less deep and liquid than trading in 
standardized options on the same underlying interest.\21\ Additionally, 
the Commission observed, in approving the Pilot Program, that reducing 
the minimum value size for opening FLEX Option transactions increases 
the potential for the FLEX Options market to act as a surrogate for the 
standardized options market, and expressed its concern in this regard 
because the standardized market contains certain protections for 
investors not present in the FLEX Options market.\22\ The Commission 
stated that, in the event the Exchange proposed making the Pilot 
Program permanent, information regarding the types of customers 
initiating opening FLEX Options transactions during the Pilot Program, 
to be compiled and submitted to the Commission by CBOE as part of its 
monitoring of the Pilot Program, would enable the Commission to 
evaluate how market participants have responded to the Pilot Program 
and what types of customers are using the FLEX Options market.\23\
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    \18\ See Securities Exchange Act Release Nos. 31920 (February 
24, 1993), 58 FR 12280 (March 3, 1993) (order approving SR-CBOE-92-
17); 57429 (March 4, 2008), 73 FR 13058 (March 11, 2008) (order 
approving SR-CBOE-2006-36). As noted in the Options Disclosure 
Document (``ODD''), which explains the characteristics and risks of 
exchange-traded options, flexibly structured options may be useful 
to sophisticated investors seeking to manage particular portfolio 
and trading risks. Rule 9b-1 under the Act requires that broker-
dealers furnish the ODD to a customer before accepting an order from 
the customer to purchase or sell an option contract relating to an 
options class that is the subject of the ODD, or approving the 
customer's account for the trading of such option. See 17 CFR 
240.9b-1(d).
    \19\ See Securities Exchange Act Release No. 61439 (January 28, 
2010), 75 FR 5831 (February 4, 2010) (SR-CBOE-2009-087) (``Pilot 
Approval Order'').
    \20\ See supra note 18.
    \21\ In particular, the ODD states that because many of the 
terms of FLEX Options are not standardized, it is less likely that 
there will be an active secondary market in which holders and 
writers of such options will be able to close out their positions by 
offsetting sales and purchases. Also, the ODD states that certain 
margin requirements for positions in flexibly structured options may 
be significantly greater than the margin requirements applicable to 
similar positions in other options on the same underlying interest.
    \22\ See Pilot Approval Order, supra note 19. In particular, the 
Commission noted that continuous quotes may not always be available 
in the FLEX Options market and that FLEX Options do not have trading 
rotations at either the opening or closing of trading. Id.
    \23\ Id. CBOE has submitted the Pilot Report as well as other, 
confidential reports of data collected during the Pilot Program. See 
Notice, supra note 3; see also Amendment No. 1, supra note 4.
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    Based on the Pilot Report that CBOE provided to the Commission, the 
significant majority of FLEX Option transactions with small value sizes 
have been initiated by institutional customers, while, at the same 
time, retail investor participation in such transactions has remained 
extremely low.\24\ For example, the Pilot Report states that of the 551 
FLEX Option transactions for non-broker-dealer customers that were 
initiated below the pre-pilot minimum value size requirement, 550 were 
initiated for the accounts of institutional customers.\25\ Based on 
this usage, CBOE has stated that it believes that there is sufficient 
investor interest and demand to make the Pilot Program permanent.\26\
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    \24\ See Pilot Report, supra note 4.
    \25\ Id.
    \26\ Id.
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    On balance, the Commission believes that it is consistent with the 
Act to make the Pilot Program permanent. Given the current level of 
retail usage, the potential concerns regarding exposing less 
sophisticated investors to the FLEX Options market are minimized. The 
protections noted below, including heightened options suitability 
requirements, should help to address any concerns about the potential 
for increased retail participation in the FLEX Options market. 
Moreover, the Commission is not aware of data or analysis suggesting 
that the trading of FLEX Options has acted as a surrogate for the 
trading of standardized options on CBOE as a result of the Pilot 
Program.
    Existing safeguards--such as position reporting requirements and 
margin requirements--will continue to apply to FLEX Options.\27\ 
Further, as noted above, under Rule 9b-1 under the Act,\28\ all 
customers of a broker-dealer with options accounts approved to trade 
FLEX Options must receive the ODD, which contains specific disclosures 
about the characteristics and special risks of trading FLEX 
Options.\29\ In addition, similar to other options, FLEX Options are 
subject to Trading Permit Holder supervision and suitability

[[Page 48582]]

requirements, such as in CBOE Rules 9.8 and 9.9.\30\ The Commission 
believes that these safeguards are reasonably designed to help mitigate 
potential risks for retail and other investors of investing in FLEX 
Options.
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    \27\ Certain FLEX Options such as, for example, narrow-based 
index FLEX options, have exercise and position limits, but other 
FLEX Options do not. See CBOE Rules 24A.7, 24A.8, 24B.7 and 24B.8.
    \28\ 17 CFR 240.9b-1.
    \29\ See supra note 18.
    \30\ See Notice, supra note 3.
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    CBOE also believes that permanently removing the minimum value size 
requirements for FLEX Options will give investors a more viable, 
exchange-traded alternative to customized options in the OTC market, 
which are not subject to minimum value size requirements.\31\ 
Furthermore, CBOE has represented that broker-dealers have indicated to 
CBOE that the minimum value size requirements have prevented them from 
bringing transactions on the Exchange that are already taking place in 
the OTC market.\32\ Therefore, it appears possible that permanent 
approval of the Pilot Program could further incent trading interest in 
customized options to move from the OTC market to CBOE. To the extent 
investors choose to trade FLEX Options on CBOE in lieu of the OTC 
market as a result of the permanent removal of the minimum value size 
requirements, such action should benefit investors. As the Commission 
has previously noted, there are certain benefits to trading on an 
exchange, such as enhanced efficiency in initiating and closing out 
positions, increased market transparency, and heightened contra-party 
creditworthiness due to the role of the Options Clearing Corporation as 
issuer and guarantor of FLEX Options.\33\
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    \31\ Id.
    \32\ Id.
    \33\ See Securities Exchange Act Release No. 57429 (March 4, 
2008), 73 FR 13058 (March 11, 2008) (order approving SR-CBOE-2006-
36).
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IV. Conclusion

    In summary, the Commission believes, for the reasons noted above, 
that the proposed rule change to permanently approve the Pilot Program 
is consistent with the Act and Section 6(b)(5) thereunder in 
particular, and should be approved. The Commission expects CBOE to 
continue to monitor the usage of FLEX Options and review whether 
changes need to be made to its rules or the ODD to address any changes 
in retail FLEX Option participation or any other issues that may occur 
as a result of the elimination of the minimum value sizes on a 
permanent basis.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\34\ that the proposed rule change (SR-CBOE-2012-040) be, and it 
hereby is, approved.
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    \34\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-19862 Filed 8-13-12; 8:45 am]
BILLING CODE 8011-01-P


