
[Federal Register Volume 77, Number 209 (Monday, October 29, 2012)]
[Notices]
[Pages 65600-65602]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-26470]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68086; File No. SR-CBOE-2012-066]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of a Proposed Rule Change, as 
Modified by Amendment No. 1 Thereto, To Increase Position and Exercise 
Limits for EEM Options

October 23, 2012.

I. Introduction

    On July 9, 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 to increase the position and 
exercise limits for options on the iShares MSCI Emerging Markets Index 
Fund (``EEM'') to 500,000 contracts. The proposed rule change was 
published for comment in the Federal Register on July 26, 2012.\3\ On 
September 6, 2012, the Commission extended the time period for 
Commission action to October 24, 2012.\4\ On October 18, 2012, the 
Exchange filed Amendment No. 1 to the proposed rule change.\5\ The 
Commission received no comment letters on the proposed rule change. 
This order approves the proposed rule change, as modified by Amendment 
No. 1 thereto.
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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. 67478 (July 20, 
2012), 77 FR 43897 (``Notice'').
    \4\ See Securities Exchange Act Release No. 67790 (September 6, 
2012), 77 FR 56243 (September 12, 2012).
    \5\ Amendment No. 1 provides a description of EEM and the MSCI 
Emerging Markets Index, as well as additional justification for the 
proposed rule change. See, e.g., infra notes 6, 12, 14, and 24. 
Amendment No. 1 is not subject to notice and comment because it does 
not materially alter the substance of the proposed rule change or 
raise any novel regulatory issues.
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II. Description of Proposed Rule Change

    Currently, position limits for exchange-traded fund (``ETF'') 
options, such as EEM options,\6\ are determined pursuant to Exchange 
Rule 4.11 and vary according to the number of outstanding shares and 
past six-month trading volume of the underlying security. The current 
position limit for EEM options is 250,000 contracts. The purpose of the 
proposed rule change is to amend Exchange Rule 4.11, Interpretation and 
Policy .07 to increase the position and exercise limits for EEM options 
to 500,000 contracts.\7\ The Exchange states its belief that increasing 
position limits for EEM options will lead to a more liquid and 
competitive market environment for EEM options that will benefit 
customers interested in this product.\8\
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    \6\ In Amendment No. 1, the Exchange states that EEM tracks the 
performance of the MSCI Emerging Markets Index, which has 
approximately 800 components. The Exchange also states that the MSCI 
Emerging Markets Index ``is a free float-adjusted market 
capitalization index that is designed to measure equity market 
performance of emerging markets.'' According to the Exchange, the 
MSCI Emerging Markets Index ``consists of the following 21 emerging 
market country indices: Brazil, Chile, China, Colombia, Czech 
Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, 
Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, 
Thailand, and Turkey.''
    \7\ Pursuant to Exchange Rule 4.12, Interpretation and Policy 
.02, which is not being amended by the proposed rule change, the 
exercise limit for EEM options would be similarly increased.
    \8\ See Notice, supra note 3, at 43898.
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    In its filing, the Exchange states that there is precedent for 
establishing higher position limits for options on actively-traded 
ETFs.\9\ Specifically, options on the DIAMONDS Trust (DIA) have a 
position limit of 300,000 contracts, options on the Standard and Poor's 
Depositary Receipts Trust (SPY) have no position limits,\10\ options on 
the iShares Russell 2000 Index Fund (IWM) have a position limit of 
500,000 contracts, and options on the PowerShares QQQ Trust (QQQQ) have 
a position limit of 900,000 contracts.\11\
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    \9\ See id., at 43897.
    \10\ See Securities Exchange Act Release No. 67937 (September 
27, 2012), 77 FR 60489 (October 3, 2012) (SR-CBOE-2012-091) 
(eliminating position and exercise limits for SPY options on a pilot 
basis).
    \11\ See Exchange Rule 4.11, Interpretation and Policy .07.
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    In addition, in its filing, the Exchange states that the average 
daily volume in 2011 for EEM was 65 million shares,\12\ as compared to 
64.1 million shares for IWM and 213 million shares for SPY.\13\ In 
2011, the average daily volume for options contracts overlying EEM was 
280,000 contracts,\14\ as compared to

[[Page 65601]]

662,500 contracts for options overlying IWM and 2,892,000 contracts for 
options overlying SPY.\15\ The total shares outstanding for EEM was 
922.9 million, as compared to 192.6 million shares for IWM and 716.1 
million shares for SPY.\16\ Further, the fund market cap for EEM was 
$41.1 billion, as compared to $15.5 billion for IWM and $98.3 billion 
for SPY.\17\
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    \12\ In Amendment No. 1, the Exchange states that, through 
October 17, 2012, the year-to-date average daily trading volume for 
EEM across all exchanges was 49.3 million shares.
    \13\ See Notice, supra note 3, at 43898.
    \14\ In Amendment No. 1, the Exchange states that, through 
October 17, 2012, the year-to-date average daily trading volume for 
EEM options across all exchanges was 250,304 contracts.
    \15\ See Notice, supra note 3, at 43898.
    \16\ See id.
    \17\ See id.
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    The Exchange notes that the options reporting requirements of 
Exchange Rule 4.13 would continue to be applicable to EEM options.\18\ 
As set forth in Exchange Rule 4.13(a), each Trading Permit Holder 
(``TPH'') must report to the Exchange certain information in relation 
to any customer who, acting alone, or in concert with others, on the 
previous business day maintained aggregate long or short positions on 
the same side of the market of 200 or more contracts in any single 
class of option contracts dealt in on the Exchange.\19\ Further, 
Exchange Rule 4.13(b) requires each TPH (other than an Exchange market-
maker or Designated Primary Market-Maker) \20\ that maintains a 
position in excess of 10,000 non-FLEX equity option contracts on the 
same side of the market, on behalf of its own account or for the 
account of a customer, to report to the Exchange information as to 
whether such positions are hedged, and provide documentation as to how 
such contracts are hedged.\21\
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    \18\ See id.
    \19\ The report must include, for each such class of options, 
the number of option contracts comprising each such position and, in 
the case of short positions, whether covered or uncovered. See 
Exchange Rule 4.13(a).
    \20\ According to the Exchange, market-makers (including 
Designated Primary Market-Makers) are exempt from the referenced 
reporting requirement because market-maker information can be 
accessed through the Exchange's market surveillance systems. See 
Notice, supra note 3, at 43898.
    \21\ According to the Exchange, this information would include, 
but would not be limited to, the option position, whether such 
position is hedged and, if so, a description of the hedge, and the 
collateral used to carry the position, if applicable. See id.
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    The Exchange believes that the existing surveillance procedures and 
reporting requirements at CBOE, other options exchanges, and at the 
several clearing firms are capable of properly identifying unusual and/
or illegal trading activity.\22\ According to the Exchange, its 
surveillance procedures utilize daily monitoring of market movements 
via automated surveillance techniques to identify unusual activity in 
both options and underlying stocks.\23\ In addition, the Exchange 
states that its surveillance procedures have been effective for the 
surveillance of trading in EEM options, and will continue to be 
employed.\24\
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    \22\ See id.
    \23\ See id.
    \24\ See id., at n. 5. In Amendment No. 1, the Exchange 
represents that more than 50% of the weight of the securities held 
by EEM are now subject to a comprehensive surveillance agreement 
(``CSA''). Additionally, the Exchange states that the component 
securities of the MSCI Emerging Markets Index on which EEM is based 
for which the primary market is in any one country that is not 
subject to a CSA do not represent 20% or more of the weight of the 
MSCI Emerging Markets Index. Further, the Exchange states that the 
component securities of the MSCI Emerging Markets Index on which EEM 
is based for which the primary market is in any two countries that 
are not subject to CSAs do not represent 33% of more of the weight 
of the MSCI Emerging Markets Index.
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    The Exchange further states its belief that the current financial 
requirements imposed by the Exchange and by the Commission adequately 
address concerns that a TPH or its customer may try to maintain an 
inordinately large unhedged position in an option, particularly on 
EEM.\25\ Current margin and risk-based haircut methodologies, the 
Exchange states, serve to limit the size of positions maintained by any 
one account by increasing the margin and/or capital that a TPH must 
maintain for a large position held by itself or by its customer.\26\ In 
addition, the Exchange notes that the Commission's net capital rule, 
Rule 15c3-1 under the Act,\27\ imposes a capital charge on TPHs to the 
extent of any margin deficiency resulting from the higher margin 
requirement.\28\
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    \25\ See Notice, supra note 3, at 43898.
    \26\ See id.
    \27\ 17 CFR 240.15c3-1.
    \28\ See Notice, supra note 3, at 43898.
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III. Discussion and Commission Findings

    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.\29\ In 
particular, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\30\ 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 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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    \29\ 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).
    \30\ 15 U.S.C. 78f(b)(5).
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    Position and exercise limits serve as a regulatory tool designed to 
address manipulative schemes and adverse market impact surrounding the 
use of options. Since the inception of standardized options trading, 
the options exchanges have had rules limiting the aggregate number of 
options contracts that a member or customer may hold or exercise.\31\ 
These position and exercise limits are intended to prevent the 
establishment of options positions that can be used or might create 
incentives to manipulate the underlying market so as to benefit the 
options positions.\32\ In particular, position and exercise limits are 
designed to minimize the potential for mini-manipulations and for 
corners or squeezes of the underlying market.\33\ In addition, such 
limits serve to reduce the possibility for disruption of the options 
market itself, especially in illiquid classes.\34\
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    \31\ See, e.g., Securities Exchange Act Release No. 45236 
(January 4, 2002), 67 FR 1378 (January 10, 2002) (SR-Amex-2001-42).
    \32\ See, e.g., Securities Exchange Act Release No. 47346 
(February 11, 2003), 68 FR 8316 (February 20, 2003) (SR-CBOE-2002-
26).
    \33\ See id.
    \34\ See id.
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    Over the years, the Commission has taken a gradual, evolutionary 
approach toward expansion of position and exercise limits for option 
products overlying certain ETFs where there is considerable liquidity 
in both the underlying cash markets and the options markets, and, in 
the case of certain broad-based index options, toward elimination of 
such limits altogether.\35\ The Commission has been careful to balance 
two competing concerns when considering proposals by self-regulatory 
organizations to change position and exercise limits. The Commission 
has recognized that the limits can be useful to prevent investors from 
disrupting the market in securities underlying the options.\36\ At the 
same time, the Commission has determined that limits should not be 
established in

[[Page 65602]]

a manner that will unnecessarily discourage participation in the 
options market by institutions and other investors with substantial 
hedging needs or to prevent specialists and market makers from 
adequately meeting their obligations to maintain a fair and orderly 
market.\37\
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    \35\ The Commission's incremental approach to approving changes 
in position and exercise limits for option products overlying 
certain ETFs is well-established. See, e.g., Securities Exchange Act 
Release No. 67672 (August 15, 2012), 77 FR 50750, n. 42 and 
accompanying text (August 22, 2012) (SR-NYSEAmex-2012-29) (approving 
proposed rule change to eliminate position limits for SPY options on 
a pilot basis); Securities Exchange Act Release No. 64695 (June 17, 
2011), 76 FR 36942, n. 19 and accompanying text (June 23, 2011) (SR-
Phlx-2011-58) (approving increase of SPY options position limit to 
900,000 contracts).
    \36\ See Securities Exchange Act Release No. 39489 (December 24, 
1997), 63 FR 276 (January 5, 1998) (SR-CBOE-97-11).
    \37\ See id.
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    The Commission believes that it is reasonable for the Exchange to 
increase the position and exercise limits for options on EEM to 500,000 
contracts. As noted above, the markets for standardized options on EEM 
and for EEM itself have substantial trading volume and liquidity. The 
Commission believes that this liquidity would lessen the opportunity 
for manipulation of this product and disruption in the underlying 
market that a lower position limit may protect against. Specifically, 
the Exchange notes that, in 2011, the average daily trading volumes for 
EEM and options on EEM were 65 million shares and 280,000 contracts, 
respectively.\38\ In Amendment No. 1, the Exchange notes that, through 
October 17, 2012, the year-to-date average daily trading volume for EEM 
across all exchanges was 49.3 million shares, and the year-to-date 
average daily trading volume for EEM options across all exchanges was 
250,304 contracts.\39\ The Exchange also notes that there were 922.9 
million shares of EEM outstanding, with a market cap of $41.1 
billion.\40\
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    \38\ See Notice, supra note 3, at 43898.
    \39\ See supra notes 12 and 14 and accompanying text.
    \40\ See Notice, supra note 3, at 43898.
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    As noted above, the Exchange also believes that current margin and 
net capital requirements serve to limit the size of positions 
maintained by any one account.\41\ The Commission agrees that these 
financial requirements should help to address concerns that a member or 
its customer may try to maintain an inordinately large unhedged 
position in EEM options and will help to reduce risks if such a 
position is established.
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    \41\ See supra notes 25-28 and accompanying text.
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    The Commission further agrees with the Exchange that the reporting 
requirements imposed by Exchange Rule 4.13,\42\ as well as the 
Exchange's surveillance procedures, together with those of other 
exchanges and clearing firms,\43\ should help protect against potential 
manipulation. The Commission expects that the Exchange will continue to 
monitor trading in the EEM options for the purpose of discovering and 
sanctioning manipulative acts and practices, and to reassess the 
position and exercise limits, if and when appropriate, in light of its 
findings.
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    \42\ See supra notes 18-21 and accompanying text.
    \43\ See supra notes 22-24 and accompanying text.
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    In sum, given the measure of liquidity for EEM and options on EEM, 
the broad range of component securities that make up the MSCI Emerging 
Markets Index, the margin and capital requirements cited above, the 
Exchange's options reporting requirements, and the Exchange's 
surveillance procedures and agreements with other markets, the 
Commission believes that increasing the position and exercise limits 
for the EEM options to 500,000 contracts is consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\44\ that the proposed rule change (SR-CBOE-2012-066), as modified 
by Amendment No. 1 thereto, be, and hereby is, approved.
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    \44\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\45\
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    \45\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-26470 Filed 10-26-12; 8:45 am]
BILLING CODE 8011-01-P


