
[Federal Register Volume 77, Number 249 (Friday, December 28, 2012)]
[Notices]
[Pages 76578-76584]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31154]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68504; File No. SR-CBOE-2012-122]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Related to SPX 
Combo Orders

December 20, 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 December 6, 2012, the 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 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend its procedures for trading SPX 
Combo Orders. The text of the rule proposal is available on the 
Exchange's Web site (http://www.cboe.org/legal), at the Exchange's 
Office of the Secretary and at the Commission.

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 self-regulatory organization 
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 those 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 parts of such statements.

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

1. Purpose
    The Exchange proposes to amend CBOE Rule 24.20, SPX Combination 
Orders, to adopt a one-year pilot program containing revised procedures 
that the Exchange believes would make

[[Page 76579]]

the trading of certain combination orders in S&P 500 Index option 
contracts (SPX) more competitive with the trading of combinations in 
S&P 500 Index futures contracts traded on the Chicago Mercantile 
Exchange (``CME''). As discussed further below, the Exchange is also 
proposing to revise the existing SPX Combo Order text to make certain 
clarifying amendments.
Background
    When SPX traders and customers trade SPX options, they hedge their 
underlying risk with either S&P 500 Index futures traded at CME or with 
SPX call and put options traded as combinations at CBOE (for purposes 
of this discussion, a ``combination'' is an order involving a number of 
call option contracts and the same or equivalent number of put option 
contracts in the same underlying security).\3\ In order for SPX traders 
and customers to hedge the risk of their options positions using S&P 
500 futures, they have to execute two separate trades in two separate 
markets.
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    \3\ See CBOE Rule 6.53(e). A combination is a long combination 
when it combines a long call and a short put on the same series, and 
it is a short combination when it combines a short call and a long 
put of the same series. An options position can be hedged by trading 
the number of combinations equivalent to the delta of the particular 
option multiplied by the number of options in the transaction. The 
``delta'' is the number of SPX combinations required to establish a 
market neutral hedge based on the value of the underlying S&P 500 
Index futures contract. See CBOE Rule 24.20(a)(2). For example, a 
customer that purchases 100 SPX calls that have a delta of 30 
(expressed as 30% or .30) may hedge against a downward movement in 
the S&P 500 Index by either selling S&P 500 Index futures on the CME 
or by trading short SPX combinations. If combinations are used to 
hedge, the customer will need to trade 30 short combinations (.30 x 
100). The appropriate ratio of combinations in this example is to 
sell 30 SPX calls and buy 30 SPX puts with the same strike price and 
expiration date. If futures are used to hedge, the customer will 
need to sell 12 S&P 500 Index futures on the CME ((.30 x 100)/2.5 = 
12), where 2.5 is the multiplier used to convert SPX options 
positions to the equivalent S&P 500 Index futures position (one S&P 
500 Index future equals 2.5 SPX combinations).

    Example 1: Assume a trader or customer wants to buy the SPX 
April 1335 puts and hedge with the April futures contract trading at 
1350. First, the SPX April 1335 put option position would be traded 
at CBOE. After the options trade, the trader or customer then has to 
submit an order to CME to trade the appropriate number of S&P 500 
Index April futures contracts to hedge the options trade.
    Example 2: Assume a trader or customer wants to trade a 
conversion involving the purchase of the SPX April 1335 puts and the 
sale of the SPX April 1335 calls with the purchase of the April 
futures contract trading at 1350. First the SPX April 1335 put-call 
option position would be traded on CBOE. After the options trade, 
the trader or customer then has to submit an order to CME to trade 
the appropriate number of S&P 500 Index April futures contracts to 
hedge the options trade.

Hedging SPX options by using S&P futures in this manner is not 
preferred by traders and customers because of the execution risk that 
is involved in having to trade in two separate markets. In other words, 
the trader or customer is exposed to the risk of the S&P 500 Index 
moving significantly before the hedging futures transaction can be 
executed (e.g., assume the trader or customer in Example 1 above 
completes the purchase of the SPX April 1335 puts but the S&P 500 Index 
declines sharply before the futures can be traded. Given the market 
decline, the trader or customer must sell the futures at a much lower 
price to complete the hedge.) As a result, SPX traders and customers 
prefer trading SPX combinations against their SPX options positions in 
order to hedge the risk associated with those positions.
    Example 3: Assume the S&P 500 Index April futures contract is 
trading at 1350 and a customer wants to trade the 30 delta SPX April 
1335 puts tied to the April 1350 calls and April 1350 puts (instead 
of the April futures contract). Under this scenario, all three legs 
of the strategy would be traded on CBOE.
    Example 4: Assume a trader or customer wants to trade a 
conversion involving the purchase of the SPX April 1335 puts and the 
sale of the SPX April 1335 calls tied to the April 1350 calls and 
April 1350 puts (instead of the April futures contract). Under this 
scenario, all four legs of the strategy would be traded on CBOE.
    One reason that the use of combinations by SPX traders and 
customers is preferred is obviously that all the required transactions 
can be effected as a package in one market, CBOE. Hedging options with 
combinations avoids the execution risk and the increased costs involved 
in trading in the futures market. Another reason that the use of 
combinations is preferred is that an options order can be ``tied'' to a 
particular level of the S&P 500 Index in order to establish the hedge 
price.\4\ When SPX options are tied to SPX combinations, the underlying 
hedge level of the S&P 500 Index is established and traders and 
customers can determine the exact implied volatilities of their options 
trades.\5\ Hedging options with combinations acts as an incentive for 
market-makers to reduce the price width of their markets because they 
know that their hedge price has been established and they will not have 
to trade in another market. Thus, customers who trade options tied to 
combinations enjoy tighter and more liquid markets.
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    \4\ Using the example in note 3, supra, the customer will 
request a market for the calls that the customer wishes to purchase 
based on a specified level of the S&P 500 Index. The customer 
specifies an underlying level of the S&P 500 Index to allow market 
participants to determine the delta (in this case 30) and a 
theoretical value of the calls. A market participant will then give 
his or her market for the 30 delta calls and for the component call 
and put options that will make up the combination. The combination 
portion of the order is equivalent to an order to trade futures at 
the underlying value of the S&P 500 Index that has been specified by 
the parties. The prices quoted for the call and put components of 
the combination establish the hedge price for the transaction. When 
the foregoing occurs, SPX traders and customers say that the calls 
have been ``tied'' to the combination or ``tied to the combo.''
    \5\ Implied volatility is defined as the volatility percentage 
that justifies an option's price. When the customer and the market-
maker establish the underlying hedge level of the S&P 500 Index and 
a market price for the calls, the market-maker and the customer are 
able to use option pricing models to determine the implied 
volatility of the calls. Knowing the implied volatility that is 
being quoted in the market is useful to customers and traders in 
that customers and traders frequently take positions in the market 
based on the implied volatility level.
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    Occasionally, certain market activity occurs that makes it 
difficult to effect these types of trades. If an order for options tied 
to a combination receives an initial quote but does not trade 
immediately, it remains a live order until the party that submitted the 
order cancels it. The order may not trade immediately for any reason, 
but some of the more common reasons are that the customer submitting 
the order may want to show the order to other market participants in 
order to improve the initial quote received, or a Trading Permit Holder 
(``TPH'') may need time to locate a customer that it believes might 
like to participate in the trade. Specific market activity can occur 
hours after an order for options tied to a combination is submitted and 
initially quoted that would make the trade desirable to both the 
customer and the market-maker to consummate. However, in a volatile 
market, the underlying index can move substantially in one direction 
such that the originally quoted prices for the options and the 
combinations are no longer within the current market quotes. In such 
market conditions, the parties would be unable to consummate the trade 
because CBOE Rules preclude trading the legs of the options and a 
combination strategy outside of the currently prevailing market quotes 
in the individual component series legs.\6\ Certain relief currently 
applies in the case of an SPX Combo Order executed pursuant to CBOE 
Rule 24.20 (the term ``SPX Combo Order'' is defined and discussed in 
more detail below). However, this relief is limited and not near [sic] 
as accommodating as the rules for trading spreads and combinations on 
the futures

[[Page 76580]]

markets. Thus, when it comes to the existence of rule constraints that 
may prevent complex, multi-part strategy trades from occurring out-of-
range from the prevailing market quotes in the individual component 
series legs, another significant consideration for SPX traders and 
market participants is the ease with which an execution can take place 
on other markets such as the CME, which offers a comparable alternative 
to SPX but is not subject to the same constraints as a national 
securities exchange like CBOE.
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    \6\ See, e.g., CBOE Rules 6.45B(b)(ii) and 6.53C.
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    In that regard, CBOE Rule 24.20 was adopted in 2002 to enable the 
Exchange to better compete with futures exchanges such as the CME.\7\ 
The purpose of the rule is to permit the trading of out-of-range ``SPX 
Combo Orders'' under certain, limited circumstances. In essence, the 
rule sets forth a procedure that allows for an SPX Combo Order to be 
executed and reported up to 2 hours after the order is originally 
quoted, at the prices originally quoted. Specifically, for purposes of 
the rule, an ``SPX Combo Order'' is narrowly defined to be an order to 
purchase or sell SPX options and the offsetting number of SPX 
combinations defined by the delta. An ``SPX combination'' is defined 
[sic] a long SPX call and a short SPX put having the same expiration 
date and strike price (contrast this to the general definition of a 
``combination'' noted above). A ``delta'' is defined as the positive 
(negative) number of SPX combinations that must be sold (bought) to 
establish a market neutral hedge with an SPX option position. Under the 
rule, when a TPH holding an SPX Combo Order and bidding or offer [sic] 
in a multiple of the minimum increment on the basis of a total debit or 
credit for the order has determined that the order may not be executed 
by a combination of transactions with the bids and offers displayed in 
the SPX limit order book or by the displayed quotes of the crowd, then 
the SPX Combo Order may be executed at the best net debit or credit so 
long as (i) no leg of the SPX Combo Order would trade at a price 
outside the currently displayed bids or offers in the trading crowd or 
bids and offers in the SPX limit order book; and (ii) at least one leg 
of the SPX Combo Order would trade at a price better than the 
corresponding bid or offer in the SPX limit order book (which consists 
of public customer orders).\8\ If the SPX Combo Order is not executed 
immediately, the rule provides that, not withstanding any other rules 
of the Exchange, the SPX Combo Order may be executed and printed 
outside the current market quotes and at the prices originally quoted 
for each component series within 2 hours after the time of the original 
quotes (the Exchange refers to this as the ``2-hour window'' 
procedure).
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    \7\ Originally, the Exchange had considered modeling a CBOE rule 
after CME Rule 542 (discussed in more detail below). However, the 
Exchange ultimately settled on a proposal that would have allowed a 
CBOE TPH (referred to as a ``member'' at the time) to execute an SPX 
Combo Order immediately or at any time thereafter during the trading 
day at the prices originally quoted for each of the component option 
series. Thus, the originally quoted prices would have had to have 
been within the current market at the time of the original quote, 
but a trade could be executed and reported at any time thereafter 
during the trading day. This proposal was noticed for comment in 
October 2000. Although there were no comments on the proposal, the 
Exchange submitted several amendments to the rule filing in order 
to, among other things, add a definition of an ``SPX Combo Order,'' 
provide that if the execution does not occur at the current market 
prices originally quoted it may only be executed up to 2 hours after 
the time of the original quote, clarify that each component leg of 
an SPX Combo Order would be reported using an indicator, and to 
include additional information concerning the need for the proposal. 
The proposal, as modified, was ultimately approved in February 2002. 
See Securities Exchange Act Release Nos. 43452 (October 17, 2000), 
65 FR 63658 (October 24, 2000) (SR-CBOE-00-40) and 45389 (February 
4, 2002), 67 FR 6291 (February 11, 2002) (SR-CBOE-00-40).
    \8\ Stated another way, this provision provides that, if there 
are resting public customer orders on all of the legs of the 
individual series of the strategy, at least one leg of the order 
must trade at a price that is better than the corresponding bid or 
offer.

    Example 5: Assume the S&P 500 Index April futures contract is 
trading at 1350 and a customer wants to trade the 30 delta SPX April 
1335 puts tied to the April 1350 calls and April 1350 puts. The TPH 
holding the customer's SPX Combo Order receives an original quoted 
market at 9:35 a.m. (all times are Chicago time). The TPH can 
execute that SPX Combo Order any time up to 11:35 a.m. at the prices 
originally quoted (even if the prices are out-of-range from the 
current display market at the time the trade is later executed and 
reported).\9\
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    \9\ For purposes of the example, assume the 30 delta SPX April 
1335 put is bid $6.00 and offered $6.20, and the SPX April 1350 call 
and April1350 put are each bid $12.00 and offered $12.30. The TPH 
agrees to buy 100 of the 1335 puts at $6.20 and, to hedge these, 
agrees to buy 30 April 1350 calls at $12.00 and to sell 30 April 
1350 puts at $12.00 (30 ``long'' combinations). Before the orders 
can be executed, assume that the market rallies to a new futures 
level of 1355. The April 1350 call is now trading at $15, the April 
1350 put at $10 and the April 1335 put at $ 4.75. Normally the TPH 
would not be able to execute the strategy because the component legs 
would trade out-of-range of the current displayed market. However, 
existing CBOE Rule 24.20 permits an execution at the prices 
originally quoted ($6.20 and $12 in the respective series) because 
the options would not have traded outside the displayed bids or 
offers originally quoted in the crowd and book ($6 bid, $6.20 
offered; $12 bid, $12.30 offered).

    As noted above, this procedure allowing for a 2-hour window for 
trade execution and reporting was adopted in order to allow the 
Exchange to try to compete on a more level field with the CME, where 
the trading of S&P 500 Index futures contracts is conducted under much 
more liberal trading rules designated to facilitate complex, multi-part 
order executions. By comparison, CME rules provide that a spread or 
combination can trade without regard to the current market prices so 
long as each of the respective legs of the spread or combination 
transaction is priced within the daily price limits for those contracts 
that have price limits. In the case of the S&P 500 Index futures 
contract, the daily limit is a 5 percent upside and downside price 
limit based on the prior day's settlement price.\10\ In essence, CME 
has a market for complex, multi-part order strategies that is entirely 
separate from its market for simple order strategies and is bound only 
by the daily limit.
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    \10\ See, e.g., CME Rule 542, Simultaneous Spread and 
Combination Transactions; see also CME Rule 35102.I, Price Limits, 
Trading Halts, and/or Trading Hours [sic] (which contains 
information on the daily price limits for S&P 500 Index futures 
contracts).

    Example 6: A CME trader wants to execute an S&P 500 Index 
futures contract combination order strategy at 9:35 a.m. (or 9:36 
a.m., or 11:35 a.m., or any other time throughout the regular trade 
day session). The trader can execute the order at any net price so 
long as each respective leg price does not exceed 5 percent of the 
upside/downside price limit based on the prior day's settlement 
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price.

    From CBOE's perspective, the SPX Combo Order rule for options does 
not come close to leveling the field with the CME rule for spread and 
combination trading. CBOE's rule still requires an SPX Combo Order to 
be executed at the prices originally quoted, it just gives a two-hour 
window to find liquidity and complete the execution. By comparison, the 
CME rule allows spread and combination executions to take place without 
regard to market prices and only be bound by the daily limit. Under 
these competing frameworks, it can be more difficult for a CBOE market 
participant attempting to achieve an execution of a complex SPX option 
trading strategy compared to a CME market participant attempting to 
achieve an execution of substantially the same strategy using S&P 500 
Index futures contracts. While this distinction is particularly 
exacerbated during times of market volatility, it can also be an issue 
at other times as well. In addition, the Exchange believes market 
participants who are looking to frequently trade spreads or 
combinations, in general, or as a strategy for hedging risk, in 
particular, would tend to utilize a

[[Page 76581]]

market venue where they can more consistently depend on achieving a net 
price execution at all times--regardless of the level of market 
volatility--which can put CBOE at a competitive disadvantage. The 
additional burden placed on CBOE market participants can have the 
effect of discouraging trading on CBOE in favor of trading on the CME. 
The Exchange believes this competitive disadvantage is not consistent 
with just and equitable principles, serves as an impediment to a free 
and open market, and may ultimately not serve investors or the public 
interest. In order to compete and more effectively achieve certain 
strategy executions, as well as manage risk, the Exchange believes that 
market participants need more comparable procedures within the CBOE 
Rules.
Proposal
    The Exchange is now seeking to amend its SPX Combo Order procedures 
on a pilot basis in an attempt to further level the field of 
competition between market participants trading on CBOE and CME. In 
particular, the Exchange is now proposing to replace the existing 2-
hour window procedure (which allows a trade within 2 hours after the 
original quotes) with a new 2-hour window procedure (which would allow 
a trade to take place so long as it is would have been in the 
permissible net price trading range within the preceding 2 hours) on a 
one-year pilot basis.
    The new 2-hour window procedure would be reflected in proposed new 
Interpretation and Policy .01 to Rule 24.20, which would replace the 
existing 2-hour window procedure reflected in existing Rule 
24.20(b)(2), for a pilot period ending one-year after this rule change 
filing is approved. The new Interpretation and Policy would provide 
that, notwithstanding any other rules of the Exchange, an SPX Combo 
Order may be transacted in open outcry in the following manner: A TPH 
holding an SPX Combo Order may execute the order at the best net debit 
or credit price, which may be outside the current derived net market so 
long as (i) the best net debit or credit price would have been at or 
within the derived net market over the preceding 2 hours of trading 
that day, (ii) no leg of the order would trade at a price outside the 
displayed bids or offers in the trading crowd or in the SPX limit order 
book (which contains public customer orders) for that series at a point 
in time over the preceding 2 hour period, and (iii) at least one leg of 
the order would trade at a price that is better than the corresponding 
bid or offer in the SPX limit order book (which contains public 
customer orders) at the same point in time over the preceding 2 hour 
period.\11\ The ``derived net market'' will be defined as the 
Exchange's best bids and offers displayed in the individual option 
series legs for the strategy at any one point in time.
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    \11\ Stated another way, this provision provides that, if there 
are resting public customer orders on all of the legs of the 
individual series of the strategy at the same point in time, at 
least one leg of the order must trade at a price that is better than 
the corresponding bid or offer.

    Example 7: Assume the S&P 500 Index April futures contract is 
trading at 1350 and a TPH wants to trade the 30 delta SPX April 1335 
puts tied to the April 1350 calls and April 1350 puts. Assume the 
TPH wants to buy 100 SPX April 1335 puts at $6.20 tied to a purchase 
of 30 April 1350 calls at $12 and sale of 30 April 1350 puts at $12 
at 9:35 a.m. At the time, assume the current displayed market for 
the April 1335 puts is $6.00-$6.20, for the April 1350 calls is 
$12.10-$12.50, and for the April 1350 puts is $12.10-$12.50. As a 
result, the SPX Combo Order is priced ``out-of-range'' from the 
current derived net market ($12 is outside the $12.10 bid, $12.50 
offered markets for the April 1350 calls and April 1350 puts). The 
TPH can execute the SPX Combo Order at the desired net price so long 
as it is the best net price and the net price would have been in 
range over the preceding 2 hours of trading that day. In particular, 
the net price must be at or within the derived net market price 
range over the preceding 2 hours of trading that day, each component 
series leg must trade at a price at or within the displayed bids or 
offers at a point in time over the preceding 2 hour period, and at 
least one leg must trade at a price that is better than the 
corresponding bid or offer in the SPX limit order book at the same 
point in time. (In this particular example, the derived net market 
range would be based on the markets that existed from 8:30 a.m.-9:35 
a.m., since the market was open for less than 2 hours). Assume, for 
example, if the displayed market at 9:20 a.m. for the April 1335 
puts was $5.90-$6.30, for the April 1350 calls was $12.00-$12.60, 
and for the April 1350 puts was $12.00-$12.60 and there are not 
public customer orders displayed at the best price in all of the 
component series, then the SPX Combo Order could be executed at the 
desired net price because it would have been net priced at or within 
the derived net market over the preceding two hours of trading, the 
individual component leg prices are at or within the displayed 
component series prices, and at least one leg would trade at [sic] 
price that improves corresponding public customer orders in the SPX 
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limit order book.

It should be noted that the derived net market would be calculated 
based on the displayed prices in each of the component series that 
exist at a single point in time over the preceding 2-hour window, not 
separate points in time for each series (e.g., a TPH cannot use the 
prices of the April 1335 puts at 9:20 a.m. and the prices of the April 
1350 calls and puts at 9:30 a.m. to calculate a derived net market). 
The net execution price must have been ``in range'' over the prior 2-
hour window of trading. To be ``in range,'' as noted above, the net 
price must have been at or within the derived net market over the 
preceding 2-hour period, and each leg of the order must ``line up'' and 
trade at a price that would have been at or inside the best bids and 
offers displayed in the individual option series legs at a single point 
in time over the 2-hour window and at least one leg must trade at a 
price that is better that corresponding public customer orders in the 
SPX limit order book at the same point in time.
    This procedure is generally modeled after CME Rule 542 (e.g., an 
SPX Combo Order may be executed out-of-range from the current market 
prices in the individual component option series legs), except that 
under CBOE's proposed pilot the reported net price and related 
component series prices must [sic] in range within the preceding 2 
hours. By comparison, the CME rule only requires the reported price of 
each component futures contract leg to be within the daily limit price 
(a number that is, by definition, generally much wider than the 2-hour 
derived net market range proposed by CBOE).
    As is the case for the existing SPX Combo Order trading procedure 
today, SPX Combo Orders executed under the proposed new pilot procedure 
would continue to be identified with a special indicator on each 
component leg that would be price reported to the trading floor and the 
Options Price Reporting Authority (``OPRA''). This indicator acts as 
notice to the public that the reported prices are part of an SPX Combo 
Order trade. Therefore, the Exchange believes that price discovery 
should not be adversely affected by the operation of CBOE Rule 24.20, 
as proposed to be modified. In addition, as is the case today, the 
proposed procedure under CBOE Rule 24.20 would not lessen the 
obligations of TPHs to obtain best execution of options orders for 
their customers. Therefore, with the approval of the proposed rule 
change, CBOE will issue a regulatory circular to its TPHs explaining 
the operation of CBOE Rule 24.20, as amended. In the regulatory 
circular, CBOE will remind TPHs that CBOE 24.20 does not lessen the 
obligation of TPHs to obtain best execution of options orders for their 
customers.
    If the Exchange were to propose an extension of the proposed pilot 
program, or should the Exchange propose to make the program permanent, 
the Exchange would submit,

[[Page 76582]]

along with any filing proposing such amendments to the program, a pilot 
program report that would provide an analysis of the program covering 
the period during which the program was in effect. This report would 
include information on the number of SPX Combo trades and best bid or 
offer trade through/trade at analysis of such SPX Combo trades. The 
report will also include information on the SPX options class and other 
broad-based index option products, including information on average 
contract value, average daily volume, open interest, average order 
size, percentage of complex orders, percentage of volume from complex 
orders, and average daily notional value traded. The report would be 
submitted to the Commission at least two months prior to the expiration 
date of the pilot program and would be provided on a confidential 
basis.
    The Exchange believes the proposed pilot procedure will facilitate 
the orderly execution of SPX Combo Orders at all times, including 
during volatile markets, in a manner that is more competitive with the 
existing CME process. In addition, the Exchange believes the proposed 
pilot procedure will continue to address customers' desire to show an 
order to other market participants to seek price improvement or 
additional liquidity. The Exchange also believes the proposed pilot 
procedure will continue to create an incentive for market-makers to 
reduce the price width of their markets because they know that their 
hedge price has been established and they will not have to trade in 
another market. Thus, customers who trade options tied to combinations 
will continue to enjoy tighter and more liquid markets
    In proposing to introduce this pilot, CBOE is cognizant of the need 
for market participants to have substantial options transaction 
capacity and flexibility to hedge their trading activity in SPX, on the 
one hand, and priority principles common to securities exchanges, on 
the other. CBOE is also cognizant of the CME market, in which similar 
restrictions do not apply. In light of these considerations, CBOE 
believes the proposed pilot procedure is appropriate and reasonable and 
would provide market participants with additional flexibility in 
achieving desired SPX Combo Order strategies and in determining whether 
to execute their options on CBOE or a comparable product on CME. In 
that regard, the Exchange notes that the proposed new procedure 
outlined above does not go as far as what exists today on CME and 
instead represents what the Exchange believes is only an incremental 
change to an existing trading process that is already very narrowly 
tailored. For the foregoing reasons, CBOE believes that the proposed 
pilot procedure for trading SPX Combo Orders is reasonable and 
appropriate, would promote just and equitable principles of trade, and 
would facilitate transactions in securities while continuing to foster 
the public interest and investor protection.
    The S&P 500 Index is widely regarded as the best single gauge of 
investable U.S. equities. There is over $4.83 trillion benchmarked to 
the index, of which index assets comprise approximately $1.1 trillion. 
The index includes 500 leading companies with an aggregate market 
capitalization of $12.4 trillion, which represents approximately 80% of 
the available market capitalization of all U.S. equities.\12\ Aggregate 
trading activity in S&P 500 component securities averages 2.7 billion 
shares per day, roughly four times the aggregate average daily volume 
of components of the Nasdaq-100, Russell 2000 Indexes and the Dow Jones 
Industrial Average.
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    \12\ See http://us.spindices.com/indices/equity/sp-500. In 
comparison, the aggregate market capitalization [sic] other popular 
broad-based indexes are: Nasdaq-100 Index--$2.9 trillion, Russell 
2000 Index--$1.3 trillion and the Dow Jones Industrial Average--$3.8 
trillion.
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    The S&P 500 serves as the underlying interest for the most liquid 
and actively-traded derivatives contracts globally, in both listed and 
over-the-counter markets. As a result, S&P 500 index derivatives are 
widely recognized, and used, by institutional investors as efficient 
and cost-effective tools to quickly gain or reduce exposure to U.S. 
equities. The average order size in SPX options of 152 contracts, for 
instance, represents an economic exposure of over $20 million. CBOE 
estimates that activity in over-the-counter S&P 500 contracts is 
between 4 to 6 times the size of listed activity, yet competition among 
dealers typically results in narrower spreads than comparable over-the-
counter (``OTC'') instruments overlying other leading U.S. equity 
benchmarks.
    As shown in the following table, trading activity and open interest 
in listed S&P 500 derivative contracts is at least ten times the 
activity and open interest of other leading broad-based index contracts 
in terms of both contracts and notional value.\13\
---------------------------------------------------------------------------

    \13\ ``Notional Value'' is the product of contracts times 
contract multiplier times underlying index value.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                            Avg. daily
                                                            Avg. daily         % ADV      notional value   % Avg. daily    Open interest      % Open
                                                           volume  (ADV)                    ($Millions)   notional value    (10/31/12)       interest
--------------------------------------------------------------------------------------------------------------------------------------------------------
S&P 500 Index...........................................       2,793,369              82        $253,003              84      18,133,151              89
Nasdaq-100 Index........................................         297,295               9          24,457               8         867,724               4
Russell 2000 Index......................................         205,087               6          16,489               5       1,078,110               5
Dow Jones Industrial Average............................         128,435               4           8,140               3         354,232               2
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................       3,424,187  ..............         302,089  ..............      20,433,217  ..............
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Cash-settled SPX options and S&P 500 futures and futures options 
account for 2.8 million contracts per day, or 82% of the average daily 
volume traded in the leading equity index contracts. Additionally, S&P 
500-based derivatives account for over $250 billion average daily 
notional value traded, or 84% of average daily notional in the leading 
index contracts. Open interest in S&P 500 index contracts as of October 
31, 2012 was over 18 million contracts with a notional value of over $2 
trillion, which is ten times greater than the open interest in the 
other leading index contracts combined.
    The transparency and liquidity of S&P 500 index options has given 
rise to substantial activity in volatility trading. CBOE understands 
that equity volatility trading globally is predominantly based on 3 
indexes: S&P 500 Index (U.S.), EuroStoxx 50 Index (Europe) and Nikkei 
225 Index (Japan, Asia); most of that activity is based on the S&P 500 
Index. Futures and options on the CBOE Volatility Index (VIX), based on 
S&P 500 index option prices, are by far the most active listed 
volatility contracts in the world. CBOE understands VIX-related 
activity currently represents the majority of all S&P 500-based 
volatility trading (listed and OTC).

[[Page 76583]]

    CBOE understands that combination orders in SPX, including SPX 
Combo Orders, are also used as a way to trade volatility. By trading an 
SPX position ``delta-neutral'' with an offsetting combination in SPX, 
traders virtually eliminate market risk, leaving implied volatility as 
the predominant risk factor.
    The Exchange is also proposing to revise the existing SPX Combo 
Order text to make certain clarifying amendments. In particular, the 
Exchange is proposing to revise the definition of an ``SPX 
combination.'' As noted above, currently an SPX combination is defined 
as ``a long SPX call and a short SPX put having the same expiration 
date and strike price.'' The Exchange is proposing to revise the 
definition to include a short SPX call and a long SPX put having the 
same expiration date and strike price. By definition, both strategies 
are permissible under the existing rule (otherwise one would never have 
a contra-side with which to trade; also, this clarification is 
consistent with other provisions of the rule that recognize both buy-
side and sell-side interest). In addition, instead of using the terms 
``long'' and ``short,'' the Exchange is proposing to use the terms 
``purchase'' and ``sale'' to be consistent with the language in the 
existing definitions of ``SPX Combo'' and ``delta'' (which are noted 
above). Thus, as revised, an ``SPX combination'' would be defined as 
``a purchase (sale) of an SPX call and a sale (purchase) of an SPX put 
having the same expiration date and strike price.'' The Exchange is 
also proposing to revise the definition of an ``SPX Combo'' to replace 
the phrase ``SPX options'' with ``an SPX option position'' (as revised, 
the definition would be ``an order to purchase or sell an SPX option 
position and the offsetting number of SPX combinations defined by the 
delta''). The use of the phrase ``an SPX option position'' is 
consistent with the language in the existing definition of delta (which 
is defined as ``the positive (negative) number of SPX combinations that 
must be sold (bought) to establish a market neutral hedge with an SPX 
option position'') and also is intended to make it clear that an SPX 
Combo Order is intended to consist of an SPX combination (which has two 
component legs) that hedges an SPX option position (which can consist 
of one or more component legs). Finally, the Exchange is proposing to 
change a reference in the rule from ``SPX combination'' to the word 
``order.'' \14\ This change is intended to clarify the existing 
application of the rule. The use of the word ``order'' (which is 
intended to capture the broader SPX Combo order) is consistent with the 
terminology used elsewhere in the existing rule text \15\ and with the 
Exchange's general priority provisions for any complex order.\16\
---------------------------------------------------------------------------

    \14\ The current text of Rule 24.2(b)(1) [sic] provide [sic] in 
relevant part as follows: ``When a Trading Permit Holder holding an 
SPX Combo Order and bidding or offering in a multiple of the minimum 
increment on the basis of a total debit or credit for the order has 
determined that the order may not be executed by a combination of 
transactions with the bids and offers displayed in the SPX limit 
order book or by the displayed quotes of the crowd, then the order 
may be executed at the best net debit or credit so long as (A) no 
leg of the order would trade at a price outside the currently 
displayed bids or offers in the trading crowd or bids or offers in 
the SPX limit order book and (B) at least one leg of the SPX 
combination would trade at a price that is better than the 
corresponding bid or offer in the SPX limit order book.'' (emphasis 
added). As proposed to be revised, the phrase ``SPX combination'' 
would be replaced with the word ``order.''
    \15\ Id.
    \16\ See, e.g., Rules 6.45A(b) and 6.45B(b).
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes that the proposed rule change will allow for 
the orderly execution of SPX Combo Orders and will be beneficial to 
both customers and traders. Accordingly, the Exchange believes the 
proposed rule change is consistent with and furthers the objectives of 
Section 6(b) of the Act,\17\ in general, and Section 6(b)(5) of the 
Act,\18\ in particular, in that it should promote just and equitable 
principles of trade, serve to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and 
protect investors and the public interest.
---------------------------------------------------------------------------

    \17\ 15 U.S.C. 78f(b).
    \18\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As noted above, the Exchange believes the proposed pilot procedure 
will facilitate the orderly execution of SPX Combo Orders at all times, 
including during volatile markets, in a manner that is more competitive 
with the existing CME process. In addition, the Exchange believes the 
proposed pilot procedure will continue to address customers' desire to 
show an order to other market participants to seek price improvement or 
additional liquidity. The Exchange also believes the proposed pilot 
procedure will continue to create an incentive for market-makers to 
reduce the price width of their markets because they know that their 
hedge price has been established and they will not have to trade in 
another market. Thus, customers who trade options tied to combinations 
will continue to enjoy tighter and more liquid markets.
    In proposing the pilot, CBOE is cognizant of the need for market 
participants to have substantial options transaction capacity and 
flexibility to hedge their trading activity in SPX, on the one hand, 
and priority principles common to securities exchanges, on the other. 
CBOE is also cognizant of the CME market, in which similar restrictions 
do not apply. In light of these considerations, CBOE believes the 
proposed pilot procedure is appropriate and reasonable and would 
provide market participants with additional flexibility in achieving 
desired SPX Combo Order strategies and in determining whether to 
execute their options on CBOE or a comparable product on CME. In that 
regard, the Exchange notes that the proposed pilot procedure outlined 
above does not go as far as what exists today on CME and instead 
represents what the Exchange believe [sic] is only an incremental 
change to an existing trading process that is already very narrowly 
tailored. For the foregoing reasons, CBOE believes that the proposed 
new procedure for trading SPX Combo Orders is reasonable and 
appropriate, would promote just and equitable principles of trade, and 
would facilitate transactions in securities while continuing to foster 
the public interest and investor protection. Finally, the Exchange 
believes that the proposed revisions to the existing SPX Combo Order 
text will provide clarity on the existing application of the SPX Combo 
Order provisions.

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 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 
proposal.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or

[[Page 76584]]

    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
argument 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-2012-122 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-2012-122. 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 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 offices 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-2012-122, and should be submitted on or before 
January 18, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-31154 Filed 12-27-12; 8:45 am]
BILLING CODE 8011-01-P


