[Federal Register Volume 83, Number 204 (Monday, October 22, 2018)]
[Notices]
[Pages 53337-53339]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-22907]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-84436; File No. SR-CBOE-2018-062]


Self-Regulatory Organizations; Cboe Exchange, Inc.; Order 
Approving a Proposed Rule Change To Amend Rule 6.2, Interpretation and 
Policy .01, Concerning Strategy Orders

October 16, 2018.

I. Introduction

    On August 24, 2018, Cboe Exchange, Inc. (``Exchange'') 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 proposal to amend Exchange Rule 6.2, 
Interpretation and Policy .01, concerning strategy orders. The proposed 
rule change was published for comment in the Federal Register on 
September 12, 2018.\3\ The Commission received no comment letters 
regarding the proposed rule change. This order approves the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 84045 (September 12, 
2018), 83 FR 46230 (``Notice'').
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II. Description of the Proposed Rule Change

    Exchange Rule 6.2, Interpretation and Policy .01 sets forth the 
modified Hybrid Opening System (``HOSS'') procedure for the option 
series used to calculate the exercise or final settlement value for 
expiring volatility index derivatives.\4\ As described in the 
Notice,\5\ the Exchange notes that market participants seeking to 
replicate the exposure of their expiring VIX derivatives generally do 
so with portfolios of constituent SPX options referred to as ``strategy 
orders,'' which they submit for execution in the modified HOSS opening 
procedure on VIX exercise settlement value determination days.\6\ As 
with any

[[Page 53338]]

opening auction, the entry of such strategy orders may lead to order 
imbalances in the constituent option series, which is noteworthy 
because such series are used to determine the exercise settlement value 
of the expiring VIX derivatives.\7\ Consequently, the Exchange 
currently imposes a cut-off time by which such strategy orders, or 
changes to such orders, must be received.
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    \4\ See proposed Exchange Rule 6.2, Interpretation and Policy 
.01(a). These volatility indexes include the Cboe Volatility Index 
(``VIX'') and the Russell 2000 Volatility Index. See Notice, supra 
note 3, at 46232, n.3.
    \5\ See note 3, supra.
    \6\ See Notice, supra note 3, at 46232-3. The exercise 
settlement value determination day is a day on which the Exchange 
determines the exercise or final settlement value, as applicable, of 
expiring volatility index derivatives. See proposed Exchange Rule 
6.2, Interpretation and Policy .01(a). The Exchange notes that 
because market participants use strategy orders to convert vega 
(volatility) exposure from one instrument (expiring VIX derivative) 
to another (portfolio of SPX options expiring in 30 days), the 
market participant is likely to be indifferent to the settlement 
price received for the expiring VIX derivatives. See Notice, supra 
note 3, at 46233. The Exchange further explained that ``[s]ince VIX 
derivatives expire 30 days prior to the SPX options used to 
calculate their settlement value, a market participant may have a 
vega risk from its portfolio of index positions that the participant 
wants to continue to hedge after the participant's VIX derivatives 
expire. To continue that vega coverage following expiration of a VIX 
derivative, a market participant may determine to trade the 
portfolio of SPX options used to calculate the exercise settlement 
value of an expiring VIX derivative, since those SPX options still 
have 30 more days to expiration. This trade essentially replaces the 
uncovered vega exposure ``hole'' created by an expiring VIX 
derivative.'').
    \7\ See Notice, supra note 3, at 46233. Generally, if a series 
(1) has a market order imbalance, or (2) is at a price that is 
outside the Exchange prescribed opening width (as described in 
Exchange Rule 6.2(d)), the series will not open for trading. See id.
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    The Exchange believes that, in the past, some market participants 
that have submitted strategy orders prior to the strategy order cut-off 
time \8\ may have refrained from entering orders to offset imbalances 
after the strategy order cut-off time because of the perceived risk 
that their orders may be deemed to be a new strategy order or a change 
to an existing strategy order, which are not permitted under the 
Exchange's rules after the strategy order cut-off time.\9\ As a result, 
the Exchange believes that the possible non-participation in the 
opening auction of firms that have submitted strategy orders could 
impact liquidity at the opening on exercise settlement value 
determination days and increase the risk that some series do not open 
because of an imbalance.\10\ To address these concerns, the proposal 
modifies the definitions of strategy order and non-strategy order to 
provide more guidance to market participants.\11\
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    \8\ The strategy order cut-off time is currently set as 8:20 
a.m. Chicago time. See Notice, supra note 3, at 46236.
    \9\ See id. at 46235.
    \10\ See Notice, supra note 3, at 46235.
    \11\ The proposal retains the existing requirement that market 
participants submit strategy orders prior to the strategy order cut-
off time and continues to prohibit a change to or cancellation of a 
strategy order after the strategy order cut-off time, except as 
provided in proposed Exchange Rule 6.2, Interpretation and Policy 
.01(c)(2). See proposed Exchange Rule 6.2, Interpretation and Policy 
.01(c). The proposal also adds the new defined terms volatility 
index derivatives, exercise settlement value determination day, and 
constituent option series; places all of the defined terms used in 
Exchange Rule 6.2, Interpretation and Policy .01 in paragraph (a) of 
that rule; and makes several non-substantive changes to 
Interpretation and Policy .01.
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    The proposal revises the definition of strategy order to provide 
that individual orders (considered collectively) that a market 
participant submits for participation in the modified opening procedure 
on exercise settlement value determination days generally are 
considered to be a strategy order if they: (1) Relate to the market 
participant's positions in expiring volatility index derivatives; (2) 
are for option series with the expiration that the Exchange will use to 
calculate the exercise or final settlement value, as applicable, of the 
applicable volatility index derivative; (3) are for option series with 
strike prices approximating the range of series that are later 
determined to constitute the constituent option series \12\ for the 
applicable expiration; (4) are for put (call) options with strike 
prices equal to or less (greater) than the ``at-the-money'' strike 
price; and (5) have quantities approximating the weighting formula used 
to determine the exercise or final settlement value, as applicable, in 
accordance with the applicable volatility index methodology.\13\
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    \12\ The constituent option series are all of the options series 
that are used to calculate the exercise or final settlement value, 
as applicable, of expiring volatility index derivatives. See 
proposed Exchange Rule 6.2, Interpretation and Policy .01(a).
    \13\ See proposed Exchange Rule 6.2, Interpretation and Policy 
.01(a).
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    Conversely, the proposal defines a non-strategy order to mean any 
order (including an order in a constituent option series) a market 
participant submits for participation in the modified opening procedure 
on exercise settlement value determination days that is not a strategy 
order (or a change to or cancellation of a strategy order).\14\ In its 
filing, the Exchange provided examples of non-strategy orders, 
including: (1) A buy (sell) order in a constituent options series if an 
expected opening information message (``EOI'') is disseminated no more 
than two minutes prior to the time a market participant submitted the 
order included a sell (buy) imbalance and the size of the order is no 
larger than the size of the imbalance in the EOI, regardless of whether 
the market participant previously submitted a strategy order or has 
positions in expiring volatility index derivatives; or (2) a Market-
Maker bid or offer in a constituent option series, as set forth in 
Exchange Rule 6.2, Interpretation and Policy .01(e).\15\ The Exchange 
stated that its definition of non-strategy order is designed to 
encourage all market participants to enter orders following the 
strategy order cut-off time for the purpose of offsetting disseminated 
imbalances in the constituent option series, regardless of whether the 
market participant previously submitted a strategy order.\16\
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    \14\ See id.
    \15\ See id. The proposal renumbers current Exchange Rule 6.2, 
Interpretation and Policy .01(c) as .01(e).
    \16\ See Notice, supra note 3, at 46235. The Exchange determines 
the non-strategy order cut-off time on a class-by-class basis, which 
may be no earlier than 8:25 a.m. and no later than the opening of 
trading in a series. The Exchange will announce any changes to the 
non-strategy order cut-off time at least one day prior to 
implementation. See proposed Exchange Rule 6.2, Interpretation and 
Policy .01(d). The Exchange has set the non-strategy order cut-off 
time to be the opening of trading. See Notice, supra note 3, at 
46236.
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    The Exchange notes the proposed rule change would not impact a 
Trading Permit Holder's (``TPH'') requirements to abide by Exchange 
Rules 4.1 (Just and Equitable Principles of Trade), 4.7 (Manipulation), 
and 4.18 (Prevention of the Misuse of Material, Nonpublic 
Information).\17\ In addition, the Exchange will continue to conduct 
surveillance to monitor trading in the constituent option series, 
including but not limited to compliance with the strategy order cut-off 
time.\18\
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    \17\ See id.
    \18\ See id.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act,\19\ and the 
rules and regulations thereunder applicable to a national securities 
exchange.\20\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\21\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest, and that the 
rules are not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers.
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    \19\ 15 U.S.C. 78f.
    \20\ 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).
    \21\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that by more clearly identifying what 
constitutes a strategy order, and by defining a non-strategy order to 
include, among other things, orders in a constituent option series that 
offset an imbalance identified in an EOI, as described above, the 
proposed rule

[[Page 53339]]

change could encourage market participants to submit orders that offset 
imbalances in constituent option series, thereby reducing the 
likelihood that a constituent option series will fail to open due to an 
order imbalance. By reducing the likelihood that constituent option 
series will fail to open, the proposal is reasonably designed to 
facilitate an orderly opening for volatility index derivatives. 
Nevertheless, the Commission remains mindful of the potential for 
disruptive or manipulative trading to occur in connection with the 
opening process in constituent options series on exercise settlement 
value determination days for volatility index options. The Commission 
believes that the proposal provides narrowly tailored guidance to 
market participants to promote participation in the modified HOSS 
opening procedure on exercise settlement value determination days in a 
manner that is reasonably designed to support orderly trading in a free 
and open market, which can benefit investors in those constituent 
options series and the volatility index derivatives.
    Further, the Commission notes that TPHs will continue to be subject 
to Exchange Rules 4.1 (Just and Equitable Principles of Trade), 4.7 
(Manipulation), and 4.18 (Prevention of the Misuse of Material, 
Nonpublic Information).\22\ In addition, the Exchange will continue to 
conduct surveillance to monitor trading in the constituent option 
series,\23\ which the Commission believes is essential to protect 
investors and the public interest.
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    \22\ See Notice, supra note 3, at 46236.
    \23\ See id.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-CBOE-2018-062) is approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-22907 Filed 10-19-18; 8:45 am]
BILLING CODE 8011-01-P


