
[Federal Register Volume 78, Number 215 (Wednesday, November 6, 2013)]
[Notices]
[Pages 66798-66801]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-26552]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70787; File No. SR-ISE-2013-42]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Instituting Proceedings To Determine Whether To Approve or 
Disapprove a Proposed Rule Change, as Modified by Amendment No. 1, To 
List Options on the Nations VolDex Index

October 31, 2013.

I. Introduction

    On July 17, 2013, the International Securities Exchange, LLC 
(``Exchange'' or ``ISE'') 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 list options on the Nations 
VolDex Index (``Index''). The proposed rule change was published for 
comment in the Federal Register on August 2, 2013.\3\ The Commission 
received one comment letter on the proposed rule change.\4\ On 
September 10, 2013, the Commission extended the time period for 
Commission action to October 31, 2013.\5\ On October 29, 2013, ISE 
submitted a response to the comment letter.\6\ On October 30, 2013, ISE 
submitted Amendment No. 1 to the proposed rule change. This order 
institutes proceedings under Section 19(b)(2)(B) of the Act \7\ to 
determine whether to approve or disapprove the proposed rule change, as 
modified by Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 70059 (July 29, 
2013), 78 FR 47041 (``Notice'').
    \4\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Edward T. Tilly, Chief Executive Officer, Chicago Board Options 
Exchange, Incorporated (``CBOE''), dated August 23, 2013 (``CBOE 
Letter'').
    \5\ See Securities Exchange Act Release No. 70362, 78 FR 56955 
(September 16, 2013).
    \6\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from Michael J. Simon, Secretary and General Counsel, ISE, dated 
October 29, 2013 (``ISE Letter'').
    \7\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange proposes to list and trade cash-settled, European-
style options on the Index, which measures changes in implied 
volatility of the SPDR S&P 500 Exchange-Traded Fund (``SPY'').\8\
---------------------------------------------------------------------------

    \8\ According to the Exchange, SPY is historically the largest 
and most actively-traded exchange-traded fund in the United States 
as measured by its assets under management and the value of shares 
traded. Specifically, the Exchange states that, according to State 
Street Global Advisor, the Trustee of SPY, as of June 20, 2013, the 
net assets under management in SPY was approximately $106.8 billion; 
the weighted average market capitalization of the portfolio 
components was approximately $106 billion; the smallest market 
capitalization was approximately $2.1 billion (Apollo Group Inc., 
ticker: APOL), and the largest was approximately $395.9 billion 
(ExxonMobil, ticker: XOM). Further, according to the Exchange, for 
the three months ending on June 20, 2013, the average daily volume 
in SPY shares was 137 million, and the average value of shares 
traded was $22.1 billion. According to the Exchange, for the same 
period, the average daily volume in SPY options was approximately 
2.8 million contracts and open interest in SPY options was 
approximately 25.2 million contracts. See Notice, supra note 3, at 
47042.
---------------------------------------------------------------------------

    The Index is calculated using a methodology developed by 
NationsShares, which uses published real-time bid/ask quotes of SPY 
options.\9\ The Index will be calculated and maintained by a 
calculation agent acting on behalf of NationsShares. The Index will be 
updated on a real-time basis on each trading day beginning at 9:30 a.m. 
and ending at 4:15 p.m. (New York time).\10\ Values of the Index also 
will be disseminated every 15 seconds during the Exchange's regular 
trading hours to market information vendors such as Bloomberg and 
Thomson Reuters. In the event the Index ceases to be maintained or 
calculated, or its values are not disseminated every 15 seconds by a 
widely available source, the Exchange will not list any additional 
series for trading and will limit all transactions in such options to 
closing transactions only for the purpose of maintaining a fair and 
orderly market and protecting investors.
---------------------------------------------------------------------------

    \9\ See id. (describing in more detail the calculation 
methodology for the Index).
    \10\ If the current published value of a component is not 
available, the last published value will be used in the calculation.
---------------------------------------------------------------------------

    The Exchange proposes that the standard trading hours for index 
options (9:30 a.m. to 4:15 p.m., New York time) will apply to options 
on the Index. Options on the Index will expire on the Wednesday that is 
thirty days prior to the third Friday of the calendar month immediately 
following the expiration month. Trading in expiring options on the 
Index will normally cease at 4:15 p.m. (New York time) on the Tuesday 
preceding an expiration Wednesday. The exercise and settlement value 
will be calculated on Wednesday at 9:30 a.m. (New York time) using the 
mid-point of the NBBO for the SPY options used in the calculation of 
the Index at that time. The exercise-settlement amount is equal to the 
difference between the settlement value and the exercise price of the 
option, multiplied by $100. Exercise will result in the delivery of 
cash on the business day following expiration.
    In Amendment No. 1, the Exchange expresses its view that 
manipulation of the Index would be very difficult, particularly around 
the time when the settlement value is determined. According to the 
Exchange, the Index options will be settled using a calculation based 
on the mid-point NBBO of the input components, a methodology unlike how 
other index settlement values are determined, as most of those are 
calculated based on transaction prices of the individual index 
components. The Exchange believes that manipulating the Index 
settlement value will be difficult based on the dynamics of a quote-
based calculation methodology as opposed to a single transaction price 
and because the option prices themselves would make such an endeavor 
cost prohibitive. Further, according to the Exchange, the vast 
liquidity of SPY options as well as the underlying SPY shares ensures a 
multitude of market participants at any given time--at least 19 market 
makers actively traded SPY options on ISE during September 2013 on any 
given day, and there are now 12 options exchanges that list SPY 
options. Due to the high level of participation among market makers 
that can enter quotes in SPY options series, the Exchange believes it 
would be very difficult for a single participant to alter the NBBO 
width across multiple series in any significant way without exposing 
the would-be manipulator to regulatory scrutiny and financial costs.
    The Exchange proposes to adopt minimum trading increments for

[[Page 66799]]

options on the Index to be $0.05 for series trading below $3, and $0.10 
for series trading at or above $3. The Exchange also proposes to set 
the minimum strike price interval for options on the Index at $1 or 
greater when the strike price is $200 or less, and $5 or greater when 
the strike price is greater than $200. Currently, when new series of 
index options with a new expiration date are opened for trading, or 
when additional series of index options in an existing expiration date 
are opened for trading as the current value of the underlying index 
moves substantially from the exercise prices of series already opened, 
the exercise prices of such new or additional series must be reasonably 
related to the current value of the underlying index at the time such 
series are first opened for trading.\11\ The Exchange, however, 
proposes to eliminate this range limitation that would otherwise limit 
the number of $1 strikes that may be listed in options on the Index. 
The Exchange's proposal to eliminate this range limitation is identical 
to strike price intervals adopted by CBOE for the CBOE Volatility Index 
(``VIX'').\12\
---------------------------------------------------------------------------

    \11\ See ISE Rule 2009(c)(3). The term ``reasonably related to 
the current index value of the underlying index'' means that the 
exercise price is within thirty percent of the current index value. 
See ISE Rule 2009(c)(4).
    \12\ See Securities Exchange Act Release No. 63155 (October 21, 
2010), 75 FR 66402 (October 28, 2010) (SR-CBOE-2010-096).
---------------------------------------------------------------------------

    The Exchange proposes to list options on the Index in the three 
consecutive near-term expiration months plus up to three successive 
expiration months in the March cycle.\13\ In addition, long-term option 
series having up to sixty months to expiration,\14\ Short Term Option 
Series,\15\ and Quarterly Options Series \16\ may also be traded. 
Options on the Index will be quoted and traded in U.S. dollars.\17\
---------------------------------------------------------------------------

    \13\ See ISE Rule 2009(a)(3).
    \14\ See ISE Rule 2009(b)(1).
    \15\ See ISE Rule 2009, Supplementary Material .01.
    \16\ See ISE Rule 2009, Supplementary Material .02.
    \17\ See ISE Rule 2009(a)(1).
---------------------------------------------------------------------------

    The Exchange believes that the Index is a broad-based index, as 
that term is defined in ISE Rule 2001(k).\18\ The Exchange proposes 
that the Index should be treated as a broad-based index for purposes of 
position limits, exercise limits, and margin requirements. Accordingly, 
the Exchange proposes no position or exercise limits for options on the 
Index \19\ and the Exchange proposes to apply margin requirements that 
are identical to those applied for its other broad-based index options.
---------------------------------------------------------------------------

    \18\ ISE Rule 2001(k) defines the terms ``market index'' and 
``broad-based index'' to mean an index designed to be representative 
of a stock market as a whole or of a range of companies in unrelated 
industries.
    \19\ The Exchange believes that because the Index will settle 
using published quotes of SPY options and there are currently no 
position limits for SPY options, it is appropriate not to impose 
position or exercise limits for options on the Index. The Exchange 
notes that because the size of the market underlying SPY options is 
so large, it should dispel concerns regarding market manipulation. 
The Exchange believes that the same reasoning applies to options on 
the Index since the value of options on the Index is derived from 
the volatility of SPY, as implied by SPY options. The Exchange also 
notes that VIX options are not subject to any position or exercise 
limits. See Notice, supra note 3, at 47043.
---------------------------------------------------------------------------

    In addition, the Exchange proposes that the trading of options on 
the Index will be subject to the same rules that currently govern the 
trading of Exchange index options, including sales practice rules and 
trading rules. Trading of options on the Index will also be subject to 
the trading halt procedures applicable to other index options traded on 
the Exchange.\20\ Further, Chapter 6 of the Exchange's rules, which is 
designed to protect public customer trading, will apply to trading in 
options on the Index.\21\ A trading license issued by the Exchange will 
also be required for all market makers to effect transactions as market 
makers in the Index options in accordance with ISE Rule 2013.
---------------------------------------------------------------------------

    \20\ See ISE Rule 2008(c).
    \21\ The Exchange notes that ISE Rules 608(a) and (b) prohibit 
Members from accepting a customer order to purchase or write an 
option, including options on the Index, unless such customer's 
account has been approved in writing by a designated Options 
Principal of the Member. In addition, ISE's Rule 610, regarding 
suitability, is designed to ensure that options, including options 
on the Index, are only sold to customers capable of evaluating and 
bearing the risks associated with trading in this instrument. 
Further, ISE Rule 611 permits members to exercise discretionary 
power with respect to trading options, including options on the 
Index, in a customer's account only if the Member has received prior 
written authorization from the customer and the account had been 
accepted in writing by a designated Options Principal. According to 
the Exchange, ISE Rule 611 also requires designated Options 
Principals or Representatives of a Member to approve and initial 
each discretionary order, including discretionary orders for options 
on the Index, on the day the discretionary order is entered. 
Finally, ISE Rule 609, Supervision of Accounts, Rule 612, 
Confirmation to Customers, and Rule 616, Delivery of Current Options 
Disclosure Documents and Prospectus, will also apply to trading in 
options on the Index. See Notice, supra note 3, at 47043-44.
---------------------------------------------------------------------------

    The Exchange represents that it has an adequate surveillance 
program in place for options on the Index and intends to apply those 
same program procedures that it applies to the Exchange's other options 
products. Further, in Amendment No. 1, the Exchange states that it will 
monitor for any potential manipulation of the Index settlement value 
both according to its current procedures and additional surveillance 
measures.\22\ Additionally, the Exchange notes that it is a member of 
the Intermarket Surveillance Group, through which it can coordinate 
surveillance and investigative information sharing in the stock and 
options markets with all of the U.S. registered stock and options 
markets. The Exchange also represents that it has the necessary system 
capacity to support additional quotations and messages that will result 
from the listing and trading of options on the Index.
---------------------------------------------------------------------------

    \22\ The Exchange represents that it will review the opening ISE 
BBO (``IBBO'') for the input options components to determine if the 
IBBO had an effect on the NBBO for these options series. If it did, 
the Exchange can determine which member entered the IBBO quote and 
review the member's position and quoting activity to determine if 
the quote may have been entered to impact the NBBO. The Exchange 
also represents that it will compare the Index settlement value to 
the subsequent disseminated value. If the difference between these 
two values is significant, the Exchange will review the opening 
quotes used in the calculation of the Index across all marketplaces 
to determine which exchange(s) contributed to opening NBBO quote(s) 
and contact the exchange(s) that entered the quote(s).
---------------------------------------------------------------------------

III. Comment Letters

    As noted above, the Commission received one comment letter 
regarding the proposed rule change.\23\ In its comment letter, CBOE 
argues that the Index should not be treated as a broad-based security 
index for regulatory purposes.\24\ Specifically, CBOE notes that the 
spot calculation of the Index would be comprised of a total of four 
component SPY put options and that the settlement value for the Index 
option would be calculated using the opening NBBO quotations of those 
component options.\25\ CBOE states that the component weights of the 
four put options used to calculate the Index can become highly 
concentrated in just one or two component options, depending on the 
time to expiration and the relationship of the forward SPY price to the 
strike prices of the component options.\26\ In this regard, CBOE 
questions the Exchange's proposal not to impose position limits for 
options on the Index.\27\ In particular, CBOE asserts that, although 
the Commission has permitted some broad-based security index options to 
have no position limits, the same rationale should not apply to the 
proposed Index options because they are not options on a broad-based 
security index.\28\ CBOE argues that the more analogous comparison for 
position limit treatment is the Alpha Index

[[Page 66800]]

options that trade on NASDAQ OMX PHLX LLC (``Phlx'').\29\ According to 
CBOE, Alpha Index options are cash-settled index options that measure 
the relative performance of two securities (a target component and a 
benchmark component), and all approved Alpha Index pairs include SPY as 
the benchmark component.\30\ CBOE notes that Alpha Index options where 
the target component is an exchange-traded fund have a position limit 
of 15,000 contracts, and Alpha Index options where the target component 
is a single stock have a position limit of 60,000 contracts.\31\
---------------------------------------------------------------------------

    \23\ See CBOE Letter, supra note 4.
    \24\ See id., at 1-2.
    \25\ See id., at 1.
    \26\ See id.
    \27\ See id., at 2-3.
    \28\ See id., at 2.
    \29\ See id.
    \30\ See id.
    \31\ See id.
---------------------------------------------------------------------------

    In its response letter, ISE draws an analogy between the Index and 
the VIX.\32\ ISE argues that, as with the VIX, designating the Index as 
a broad-based index should not be based only on the number of 
components that the index contains, but rather, on the economic 
exposure that the underlying reference seeks to provide.\33\ ISE states 
that, according to CBOE, the VIX is a key measure of the market 
expectations of near-term volatility conveyed by options on the S&P 500 
Index.\34\ ISE asserts that the Index provides a similar economic 
exposure as exposure to the VIX because it measures changes in implied 
volatility of SPY, which is a broad-based exchange-traded fund based on 
the price and yield of the stocks held in the SPY portfolio.\35\ ISE 
therefore concludes that the Index should similarly be treated as 
broad-based by looking through to the exposure provided by the 
underlying reference.\36\
---------------------------------------------------------------------------

    \32\ ISE notes that CBOE sought to designate the VIX as a broad-
based index. See ISE Letter, supra note 6, at 1.
    \33\ See id., at 2.
    \34\ See id.
    \35\ See id.
    \36\ See id.
---------------------------------------------------------------------------

    In its response letter, ISE also argues that the proposed Index 
options are not analogous to Alpha Index options.\37\ In particular, 
ISE points out that Phlx's Alpha Index options involve the pairing of a 
single equity security or an exchange-traded fund that has a position 
limit against the SPY that has no position limit.\38\ ISE believes 
that, because the pairing includes one security that has position 
limits, it does not follow that the combined new index should have no 
position limits.\39\ In contrast, ISE believes that its proposal to 
apply no position limits to the Index options is appropriate.\40\ 
Further, as discussed above, in Amendment No. 1, the Exchange provides 
additional information regarding the potential for manipulation of the 
settlement value of the Index and the additional surveillance measures 
that the Exchange will undertake with respect to the Index options.
---------------------------------------------------------------------------

    \37\ See id.
    \38\ See id.
    \39\ See id.
    \40\ See id., at 2-3. See also supra note 19. In its response 
letter, ISE also states that ISE members are bound by the initial 
and maintenance margin requirements of either CBOE or the New York 
Stock Exchange. See ISE Letter, supra note 6, at 3. ISE clarifies 
that although CBOE has margin rules designed for individual stock- 
or ETF-based volatility index options, its proposal intends to 
require compliance with CBOE's margin rules applicable to broad-
based index options rather than its specialized rules adopted for 
specified individual stock- or ETF-based volatility index options. 
See id. See also text accompanying supra note 19.
---------------------------------------------------------------------------

IV. Proceedings To Determine Whether To Approve or Disapprove SR-ISE-
2013-42 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) \41\ of the Act to determine whether the proposed rule 
change should be approved or disapproved. Institution of such 
proceedings is appropriate at this time in view of the legal and policy 
issues raised by the proposed rule change. Institution of proceedings 
does not indicate that the Commission has reached any conclusions with 
respect to any of the issues involved. Rather, as described in greater 
detail below, the Commission seeks and encourages interested persons to 
provide additional comment on the proposed rule change to inform the 
Commission's analysis of whether to approve or disapprove the proposed 
rule change.
---------------------------------------------------------------------------

    \41\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------

    Pursuant to Section 19(b)(2)(B),\42\ the Commission is providing 
notice of the grounds for disapproval under consideration. The section 
of the Act applicable to the proposed rule change that provides the 
grounds for the disapproval (or approval) under consideration is 
Section 6(b)(5),\43\ which requires that the rules of an exchange be 
designed, among other things, 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.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78s(b)(2)(B).
    \43\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As discussed above, the proposed rule change would allow ISE to 
list and trade cash-settled, European-style options on the Index, which 
measures changes in implied volatility of the SPY. As proposed, the 
Index options would be treated as broad-based index options for 
purposes of position limits, exercise limits, and margin. Accordingly, 
ISE proposes no position or exercise limits for the Index options. In 
addition, the exercise and settlement value will be calculated on 
expiration Wednesday at 9:30 a.m. using the mid-point of the NBBO for 
the SPY options that compose the Index, a methodology that ISE states 
is unlike how other index settlement values are determined, as most of 
those are calculated based on transaction prices of the individual 
index components.\44\ In Amendment No. 1, ISE asserts that manipulation 
of the Index would be very difficult, particularly around the time when 
the settlement value is determined.\45\ The Exchange believes that 
manipulating the Index settlement value will be difficult based on the 
dynamics of a quote-based calculation methodology as opposed to a 
single transaction price and because the option prices themselves would 
make such an endeavor cost prohibitive. In addition, the Exchange 
contends that its surveillance procedures currently in place, coupled 
with the additional measures proposed in Amendment No. 1, would allow 
for adequate surveillance for any potential manipulation in the trading 
of the Index options.\46\
---------------------------------------------------------------------------

    \44\ See Amendment No. 1.
    \45\ See id.
    \46\ See id.
---------------------------------------------------------------------------

    The Commission believes that questions remain as to whether the 
proposed rule change is consistent with the requirements of Section 
6(b)(5) of the Act, including whether the proposed rules to allow the 
listing and trading of the Index options are designed to protect 
investors and the public interest and to prevent fraudulent and 
manipulative acts and practices. Thus, the Commission believes the 
issues raised by the proposed rule change can benefit from additional 
consideration and evaluation in light of the requirements of Section 
6(b)(5) of the Act.

V. Procedure: Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
issues identified above, as well as any others they may have identified 
with the proposal. In particular, the Commission invites the written 
views of interested

[[Page 66801]]

persons concerning whether the proposed rule change is consistent with 
Section 6(b)(5) or any other provision of the Act, or the rules and 
regulations thereunder. Although there do not appear to be any issues 
relevant to approval or disapproval which would be facilitated by an 
oral presentation of views, data, and arguments, the Commission will 
consider, pursuant to Rule 19b-4, any request for an opportunity to 
make an oral presentation.\47\
---------------------------------------------------------------------------

    \47\ Section 19(b)(2) of the Act, as amended by the Securities 
Acts Amendments of 1975, Public Law 94-29, 89 Stat. 97 (1975), 
grants the Commission flexibility to determine what type of 
proceeding--either oral or notice and opportunity for written 
comments--is appropriate for consideration of a particular proposal 
by a self-regulatory organization. See Securities Acts Amendments of 
1975, Report of the Senate Committee on Banking, Housing and Urban 
Affairs to Accompany S. 249, S. Rep. No. 75, 94th Cong., 1st Sess. 
30 (1975).
---------------------------------------------------------------------------

    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposed rule change should be approved 
or disapproved by November 27, 2013. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
December 11, 2013.
    The Commission is asking that commenters address the merit of ISE's 
statements in support of the proposal. Specifically, the Commission is 
requesting comment on the following:
     What are commenters' views regarding whether the terms of 
the proposal sufficiently mitigate concerns about potential 
manipulation and potential market disruption to support trading this 
product without position limits?
     What are commenters' views regarding the settlement 
methodology for the Index options and the additional information the 
Exchange has provided to support its contention that manipulation of 
the Index would be very difficult, particularly around the time when 
the settlement value is determined?
    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-ISE-2013-42 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-ISE-2013-42. 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 the 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-ISE-2013-42 and should be 
submitted on or before November 27, 2013. Rebuttal comments should be 
submitted by December 11, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\48\
---------------------------------------------------------------------------

    \48\ 17 CFR 200.30-3(a)(57).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-26552 Filed 11-5-13; 8:45 am]
BILLING CODE 8011-01-P


