
[Federal Register Volume 77, Number 198 (Friday, October 12, 2012)]
[Notices]
[Pages 62277-62280]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-25080]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67992; File No. SR-CBOE-2012-095]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Immediate Effectiveness of a 
Proposed Rule Change Relating to Closing Rotation Procedures for S&P 
500 Index Options

October 5, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on September 28, 2012, Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (the ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the Exchange. The Exchange has designated the proposal as a ``non-
controversial'' proposed rule change pursuant to Section 19(b)(3)(A) of 
the Act \3\ and Rule 19b-4(f)(6) thereunder.\4\ The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The filing proposes to adopt Interpretation and Policy .06 under 
CBOE Rule 6.2B relating to closing rotation procedures to determine the 
month-end closing price for each series of S&P 500 Index options based 
on the theoretical fair value of such series. The text of the proposed 
rule change is available on the Exchange's Web site at http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx, at the principal 
office of the Exchange, and at the Commission's Public Reference Room.

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 and 
discussed any comments it received on the proposed rule change. The 
text of these 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 aspects of such 
statements.

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

1. Purpose
    The purpose of the proposed rule change is to codify and formalize 
the process by which, at each month-end, the closing price of each 
series of S&P 500 Index (``SPX'') options are aligned with the closing 
value of (i) the underlying stock index in the cash market, and (ii) 
the related SPX futures contracts traded on the Chicago Mercantile 
Exchange (``CME'').
Background
    Beginning in December 1999, the CME instituted a special settlement 
procedure to determine a fair value settlement price of its domestic 
stock index futures for the December month-end based on the closing 
value of the underlying stock index, rather than the actual closing 
price of the index futures contract.\5\ The fair value of each index 
futures contract is calculated based on the value of the underlying 
stock index as of the cash market close at 3:00 p.m.,\6\ even though 
futures trading continues until 3:15 p.m. For these month-end 
settlement days, this 3:00 p.m. theoretical fair value replaces the 
actual 3:15 p.m. final trading price as the settlement value of the 
stock index futures contract for all purposes--including account value 
reporting and end-of-day variation margin calls.\7\
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    \5\ The CME originally instituted this practice for the December 
31, 1999 year-end, but has adopted the practice for each month-end 
closing date since January 2001.
    \6\ All times referred to herein are Chicago time.
    \7\ See generally CME Group, Month-End Fair Value Procedures, 
available at http://www.cmegroup.com/trading/equity-index/fairvaluefaq.html.
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    The Exchange understands that the CME created this fair value 
settlement price at the request of certain institutional investors. 
These institutional investors require an independent third-party 
valuation of the fair value of their futures positions as of the 3:00 
p.m. close of the underlying cash markets. Many market participants are 
active in both the futures and cash markets and want the values of 
their futures positions to align with the value of their underlying 
cash market positions. If the month-end settlement price in their stock 
index futures positions were based on the 3:15 p.m.

[[Page 62278]]

close of futures trading, while the month-end closing price of their 
cash market positions in the stock index were based on the 3:00 p.m. 
cash market close, tracking error would likely occur as 3:15 p.m. 
futures prices reflect information that became available after the 3:00 
p.m. cash market close.\8\ This tracking error due to the difference in 
closing time would cause these institutional investors' financial 
reporting to misrepresent their actual overall portfolio performance.
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    \8\ The CME has explained the reason for maintaining its 3:00 
p.m. fair value procedure as follows:
     Stock index products on the [CME] normally close and settle 
fifteen minutes after the daily close of trading in cash equities. 
The cash/futures basis may be affected to the extent that futures 
may fluctuate--sometimes sharply--during those final fifteen 
minutes. As such, this may become a difficulty for institutional 
traders practicing coordinated cash/futures strategies. Still, the 
opportunity to lay off equity market exposure during those fifteen 
minutes subsequent to the cash close has proven quite beneficial. 
The use of [fair value] settlement procedures is intended to address 
this so-called ``tracking error'' while still permitting trade to 
continue for fifteen minutes past the 3:00 p.m. cash close. 
Conceptually, the fair value settlement is determined when the cash 
market closes at 3:00 p.m., since any new information following 3:00 
p.m. will not affect the closing price of the stocks and the 
indexes. However, information or events subsequent to the cash close 
may still impact futures prices. Market participants should be aware 
of the possibility that futures may trade at prices apart from fair 
value settlement prices between 3:00 p.m. and the close of the 
market at 3:15 p.m. on days on which [fair value] settlement 
procedures are applied.
     See id.
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    The market for SPX futures and the market for SPX options are 
highly interconnected. Many investors in SPX options traded on the 
Exchange are also active in SPX futures contracts traded on the CME, 
hedging positions in one with positions in the other. In fact, 
investors often calculate the value of SPX options with reference to 
the value of the related SPX futures. Since the CME began its month-end 
fair value procedure in December 1999, the Exchange determined that it 
would be disruptive to fair and orderly markets to allow the closing 
prices of SPX options at month-end (based on the actual 3:15 p.m. 
Exchange close) to significantly diverge from the settlement value of 
the related SPX futures (determined based on the fair value at the 3:00 
p.m. cash market close). Such a divergence would cause numerous 
difficulties for investors active in both SPX options and SPX futures, 
including: (i) Month-end portfolio reports would misrepresent an 
investor's overall positions because the value of the investor's SPX 
options and SPX futures positions would reflect different moments in 
time, falsely indicating tracking error or the level of offsetting 
hedges, and (ii) an investor that is perfectly hedged between its SPX 
options and its SPX futures positions could nonetheless (A) be called 
for additional unnecessary margin, or (B) have necessary margin 
returned to them, because the futures settlement value (and therefore 
margin calculation) was based on the 3:00 p.m. fair value, while the 
SPX options closing prices were based on the actual 3:15 p.m. Exchange 
close.
    One potential approach to prevent this divergence would have been, 
on the last business day of each month, to end trading in SPX options 
series at 3:00 p.m. This would cause the closing prices on the Exchange 
to naturally align with the 3:00 p.m. fair value assigned to SPX 
futures by the CME. However, the Exchange determined that this would 
itself be disruptive, as it would result in the market for SPX futures 
on the CME being open for trading at a time when the market for SPX 
options on the Exchange was closed. This misalignment would disrupt the 
trading activities of many market participants, leaving them unable to 
actively hedge their SPX futures positions in SPX options. The Exchange 
therefore adopted a practice to align the closing price of SPX options 
with the settlement value of SPX futures.
Current Procedures
    Throughout each trading day, the Exchange disseminates bid and 
offer quotations in each series of SPX options traded on the Exchange. 
Upon receipt of the final quotations from the Exchange, the Options 
Clearing Corporation (``OCC'') determines the final closing price of 
each series of SPX options by calculating the midpoint between the 
final bid and final offer quotations. Generally, the final quotations 
disseminated by the Exchange on each day reflect the final quotations 
as of 3:15 p.m. However, pursuant to Exchange Rules 6.2, 6.2A, 6.2B and 
24.13, the Exchange determined to deviate from normal rotation policy 
and procedure in the interest of a fair and orderly markets on those 
month-end business days when the CME adopted a 3:00 p.m. fair value as 
the settlement price. On these days, the Exchange holds special non-
trading closing rotations to determine the closing price of each SPX 
options series based on the theoretical fair value at the 3:00 p.m. 
cash market close.\9\ After the 3:15 p.m. Exchange close, the Exchange, 
based on quotes provided by the Lead Market-Maker (``LMM''), conducts a 
non-trading closing rotation solely to determine the ``fair value'' 
closing prices of its SPX options based on all relevant inputs, 
including the settlement value for the related SPX futures contract 
announced by the CME and the views of any other market participants. 
Shortly after 3:15 p.m., the Exchange then disseminates non-tradable 
final bid and offer quotations, and their midpoint equals the fair 
value price. Upon receipt of these post-3:15 p.m. final quotations, the 
OCC calculates the closing price based on the midpoint, which equals to 
the 3:00 p.m. fair value.
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    \9\ The Exchange has kept the market informed of this procedure 
through frequent Regulatory Circulars. See CBOE Regulatory Circular 
RG99-233 (Dec. 21, 1999), available at https://www.cboe.org/publish/regcir/rg99-233.pdf; CBOE Regulatory Circular RG00-049 (Mar. 29, 
2000), available at https://www.cboe.org/publish/regcir/rg00-049.pdf; CBOE Regulatory Circular RG01-014 (Jan. 25, 2001), 
available at http://www.cboe.com/publish/RegCir/RG01-014.pdf; CBOE 
Regulatory Circular RG01-040 (Mar. 29, 2001), available at https://www.cboe.org/publish/regcir/rg01-040.pdf; CBOE Regulatory Circular 
RG01-058 (Apr. 27, 2001), available at https://www.cboe.org/publish/regcir/rg01-058.pdf; CBOE Regulatory Circular RG02-019 (Apr. 4, 
2002), available at http://www.cboe.com/publish/RegCir/RG02-019.pdf; 
CBOE Regulatory Circular RG02-039 (June 12, 2002), available at 
http://www.cboe.com/publish/RegCir/RG02-039.pdf; CBOE Regulatory 
Circular RG02-073 (Sept. 17, 2002), available at http://www.cboe.com/publish/RegCir/RG02-073.pdf; CBOE Regulatory Circular 
RG02-118 (Dec. 19, 2002), available at http://www.cboe.org/publish/regcir/rg02-118.pdf; CBOE Regulatory Circular RG03-016 (Mar. 19, 
2003), available at http://www.cboe.com/publish/RegCir/RG03-016.pdf; 
CBOE Regulatory Circular RG03-039 (June 11, 2003), available at 
http://www.cboe.com/publish/RegCir/RG03-039.pdf; CBOE Regulatory 
Circular RG03-075 (Sept. 10, 2003), available at http://www.cboe.com/publish/RegCir/RG03-075.pdf; CBOE Regulatory Circular 
RG03-082 (Sept. 22, 2003), available at http://www.cboe.com/publish/RegCir/RG03-082.pdf; CBOE Regulatory Circular RG03-110 (Dec. 17, 
2003), available at http://www.cboe.com/publish/RegCir/RG03-110.pdf; 
CBOE Regulatory Circular RG04-132 (Dec. 30, 2004), available at 
http://www.cboe.com/publish/RegCir/RG04-132.pdf; CBOE Regulatory 
Circular RG05-130 (Dec. 29, 2005), available at http://www.cboe.com/publish/RegCir/RG05-130.pdf; CBOE Regulatory Circular RG06-130 (Dec. 
19, 2006), available at http://www.cboe.org/publish/regcir/rg06-130.pdf; CBOE Regulatory Circular RG08-004 (Jan. 8, 2008), available 
at http://www.cboe.com/publish/RegCir/RG08-004.pdf; CBOE Regulatory 
Circular RG09-151 (Dec. 30, 2009), available at http://www.cboe.org/publish/regcir/rg09-151.pdf; and CBOE Regulatory Circular RG12-023 
(Jan. 30, 2012), available at http://www.cboe.org/publish/regcir/rg12-023.pdf.
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    Thus, unlike other trading days where the SPX options closing 
prices are based on the final actual quotes as of 3:15 p.m., for these 
month-end dates, the SPX options closing prices are based on the 
theoretical 3:00 p.m. fair value. As with the CME, on the days when 
this procedure is used, although no actual trades occur at these 
prices, these theoretical fair value closing prices are treated as the 
closing prices for all purposes, including dissemination through the 
Options Price Reporting

[[Page 62279]]

Authority (``OPRA'') and OCC margin calculations.
Proposed Interpretation
    The Exchange proposes to adopt Interpretation and Policy .06 to 
Rule 6.2B (the ``Interpretation'') to codify in its rulebook the 
Exchange's existing practice with respect to the end-of-month SPX 
options fair value procedures.
    The Exchange continues to believe that it is integral to fair and 
orderly markets in SPX options that the closing price of each series of 
SPX options traded on the Exchange be based on the value as of the same 
time as the closing price of the related SPX futures traded on the CME. 
Because the CME has made a practice of determining the closing price of 
SPX futures on the last business day of each month based on the 3:00 
p.m. fair value, the Exchange believes the closing price of each 
related SPX options series should similarly be based on the 3:00 p.m. 
price. Investors active in both the options and futures markets would 
face numerous difficulties if the closing values of SPX options and SPX 
futures were allowed to significantly diverge. For example, as noted 
above, if the closing price of a series of SPX options was to be based 
on the 3:15 close of trading, while the related SPX futures settlement 
price was based on the 3:00 p.m. fair value, an investor that was 
perfectly hedged between the options and futures could nonetheless be 
subject to potentially significant margin calls due to market movements 
between 3:00 p.m. and 3:15 p.m.--even though such market movement would 
not actually impact the level of risk of the perfectly hedged 
portfolio.
    As discussed above, on those days when the CME has instituted its 
3:00 p.m. fair value settlement procedure, the Exchange determined to 
deviate from normal rotation policies and procedures in the interest of 
fair and orderly markets and conduct fair value closing rotations. The 
Exchange has done so on a regular basis in response to changes in CME 
procedures, in order to prevent any disruption to fair and orderly 
markets that would occur from the closing price of SPX options being 
determined as of the 3:15 p.m. close and the settlement value of SPX 
futures being determined as of 3:00 p.m. fair value. However, the CME 
appears to have adopted its 3:00 p.m. fair value procedure on a 
permanent basis for each month-end trading date.\10\ Therefore, rather 
than continuing to rely on its authority to deviate from normal 
rotation policies and procedures, the Exchange has determined to adopt 
the Interpretation to codify the Exchange's existing practice in its 
rulebook.
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    \10\ The Exchange notes, however, that the CME does not appear 
to maintain a specific rule in connection with its fair value 
procedure, and therefore may change its practice at any time.
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    The Interpretation codifies the Exchange's current procedures 
without material change. Specifically, on the last business day of each 
calendar month, following the 3:15 p.m. close of trading in SPX 
options, the Exchange will conduct special non-trading closing 
rotations for each series of SPX options in order to determine their 
theoretical fair value as of the 3:00 p.m. close of the cash market. 
The LMM for each series of SPX options will be responsible for 
calculating the fair value of that series.
    The ``fair value'' of a series of SPX options represents the price 
at which the series should theoretically trade in relation to cash 
values in the absence of transaction costs. It is typically calculated 
as a function of the underlying index value plus the financing cost of 
owning the underlying stock portfolio, less dividends paid up to the 
expiration of the option.
    To reach this fair value, each LMM will consider various inputs, 
including the prevailing interest rates, expected dividends, and input 
from market participants. Additionally, because the fair value of the 
related futures contract reflects a similar calculation, the Exchange 
expects that particular weight will be given to the as-of 3:00 p.m. 
fair value of the related SPX futures contract disseminated by the CME. 
Upon determination of the fair value, the LMMs will calculate bid and 
offer quotations, the midpoint of which will equal the calculated fair 
value, and provide these non-tradable quotations to the Exchange.
    The Exchange will disseminate these non-tradable fair value 
quotations via OPRA after the 3:15 close, within approximately three to 
five minutes of closing. The OCC will then determine the final closing 
price of each series of SPX options by calculating the midpoint between 
these final fair value bid and final fair value offer quotations, which 
will equal fair value. This fair value closing price will be used as 
the closing price for all purposes, including the OCC's calculation of 
variation margin requirements.
    The Exchange recognizes that LMMs may have an interest in the 
outcome of the month-end value determination based on the composition 
of their own proprietary positions. For example, an LMM may have an 
incentive to lean their fair value determination in a direction that 
would minimize the potential variation margin the LMM would be called 
for by the OCC with respect to their proprietary holdings. However, the 
Exchange believes that this risk is limited because, as a mathematical 
formula, fair value can be generally approximated by third parties, 
allowing for independent checks on the LMMs' calculations. In addition, 
the Exchange does and will conduct robust surveillance and oversight of 
LMMs' fair value quotations activities to monitor for potential 
attempts at manipulation.
    Finally, as described above, the need to disseminate after 3:15 
p.m. the fair value closing quotations for SPX options based on the 
3:00 p.m. fair value on the last business day of each month is due to 
the current CME procedures in place for SPX futures. However, the 
Exchange cannot predict whether the CME may determine to forego its 
special month-end fair value procedure at any time in the future. The 
proposed interpretation therefore provides the Exchange with discretion 
not to disseminate the 3:00 p.m. fair value quotations as determined by 
the LMMs after the 3:15 p.m. close, if not doing so would be in the 
interest of fair and orderly markets. The Exchange anticipates that it 
would only not do so in the event that the CME determines not to apply 
its special month-end fair value settlement procedure for SPX futures, 
either on a particular month-end trading date or otherwise. In such an 
event, the Exchange anticipates allowing the actual 3:15 p.m. closing 
quotations to act as the final quotations, as occurs on other trading 
days, so that both the closing quotations of SPX options at such a 
month-end and the settlement value of the related SPX futures would 
each reflect the same end of trading time.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with the Securities Exchange Act of 1934 (the ``Act'') \11\ and the 
rules and regulations thereunder and, in particular the requirement of 
Section 6(b) of the Act.\12\ Specifically, the Exchange believes the 
proposed rule change furthers the objectives of Section 6(b)(5) \13\ in 
that it is 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 facilitating 
transactions in securities, and to remove impediments to and perfect 
the mechanism of a free and open market and a national market

[[Page 62280]]

system. In particular, the proposed rule change furthers the interest 
of fair and orderly markets by avoiding the artificial tracking error 
that could result if the underlying value of the closing price of SPX 
options were allowed to significantly diverge at month-end from the 
closing value of the underlying stock index and the settlement value of 
the related SPX futures contract. Additionally, the proposed rule 
change is designed to improve the Exchange's ability to prevent 
fraudulent and manipulative practices by adopting a surveillance 
program to monitor the LMMs' month-end fair value quoting activities.
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    \11\ 15 U.S.C. 78a.
    \12\ 15 U.S.C. 78f(b).
    \13\ 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 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

    The Exchange neither solicited nor received comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not:
    A. Significantly affect the protection of investors or the public 
interest;
    B. Impose any significant burden on competition; and
    C. Become operative for 30 days from the date on which it was 
filed, or such shorter time as the Commission may designate,

it has become effective pursuant to Section 19(b)(3)(A) \14\ of the Act 
and Rule 19b-4(f)(6) \15\ thereunder.\16\
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    \14\ 15 U.S.C. 78s(b)(3)(A).
    \15\ 17 CFR 240.19b-4(f)(6).
    \16\ In addition, Rule 19b-4(f)(6)(iii) requires a self-
regulatory organization to provide the Commission with written 
notice of its intent to file the proposed rule change, along with a 
brief description and text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission. The 
Exchange has satisfied this requirement.
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    At any time within 60 days of the filing of this proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.

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 email to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2012-095 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-2012-095. This 
file number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such 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-2012-095 and should be 
submitted on or before November 2, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-25080 Filed 10-11-12; 8:45 am]
BILLING CODE 8011-01-P


