[Federal Register Volume 85, Number 217 (Monday, November 9, 2020)]
[Notices]
[Pages 71361-71364]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24784]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90319; File No. SR-CBOE-2020-014]


Self-Regulatory Organizations; Cboe Exchange, Inc; Order 
Approving a Proposed Rule Change, as Modified by Amendment No. 1, To 
Adopt the Delta-Adjusted at Close Order Instruction

November 3, 2020.

I. Introduction

    On February 18, 2020, 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 (``Exchange 
Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
introduce the Delta-Adjusted at Close (``DAC'') Order Instruction on 
the Exchange. The proposed rule change was published for comment in the 
Federal Register on March 9, 2020.\3\ On April 13, 2020, the Commission 
designated a longer period within which to approve the proposed rule 
change, disapprove the proposed rule change, or institute proceedings 
to determine whether the proposed rule change should be disapproved.\4\ 
On May 12, 2020, the Exchange submitted Amendment No. 1 to the proposed 
rule change.\5\ On June 3, 2020, the Commission instituted proceedings 
to determine whether to approve or disapprove the proposed rule change, 
as modified by Amendment No. 1.\6\ On September 3, 2020, the Commission 
designated a longer period for Commission action on proceedings to 
determine whether to approve or disapprove the proposed rule change, as 
modified by Amendment No. 1.\7\ The Commission has received one comment 
on the proposed rule change.\8\ This order approves the proposed rule 
change, as modified by Amendment No. 1.
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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. 88312 (March 3, 
2020), 85 FR 13686 (``Notice'').
    \4\ See Securities Exchange Act Release No. 88622, 85 FR 21490 
(April 17, 2020).
    \5\ See https://www.sec.gov/comments/sr-cboe-2020-014/srcboe2020014-7180918-216787.pdf.
    \6\ See Securities Exchange Act Release No. 88997, 85 FR 35351 
(June 9, 2020) (``Order Instituting Proceedings'').
    \7\ See Securities Exchange Act Release No. 89765, 85 FR 55905 
(September 10, 2020).
    \8\ See Letter from Kurt Eckert, Partner, Wolverine Execution 
Services, LLC, to Vanessa Countryman, Secretary, Commission, dated 
June 24, 2020 (``WEX Letter''), available at https://www.sec.gov/comments/sr-cboe-2020-014/srcboe2020014-7343517-218670.pdf.
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II. Summary of the Proposed Rule Change, as Modified by Amendment No. 1

A. Proposed DAC Order Instruction--Generally

    As modified by Amendment No. 1, the Exchange proposes to implement 
a DAC order instruction that a User \9\ may only apply to an order upon 
System \10\ entry (including each leg of a complex order) for an option 
on an Exchange Traded Product (``ETP'') or index for execution in a 
FLEX electronic or open outcry auction.\11\ A DAC order could execute 
throughout the trading day. After the close of trading and upon receipt 
of the official closing price or value for the underlying ETP or index 
from the primary listing exchange or index provider, as applicable, the 
System would adjust the original execution price of the order based on 
a pre-determined delta value applied to the change in the underlying 
reference price between the time of execution and the market close.
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    \9\ The term ``User'' means any TPH or Sponsored User who is 
authorized to obtain access to the System pursuant to Rule 5.5. See 
Rule 1.1.
    \10\ The term ``System'' means the Exchange's hybrid trading 
platform that integrates electronic and open outcry trading of 
option contracts on the Exchange, and includes any connectivity to 
the foregoing trading platform that is administered by or on behalf 
of the Exchange, such as a communications hub. See Rule 1.1.
    \11\ For a more detailed description of the proposed rule 
change, as modified by Amendment No. 1, see Order Instituting 
Proceedings, supra note 6. See also supra note 5.
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    The Exchange states that there can be substantial activity in an 
underlying near the market close that may create wider spreads and 
increased price volatility in the underlying, which may attract 
additional trading activity from market participants seeking arbitrage 
opportunities and further increase volatility. This activity near 
market close makes it difficult to execute FLEX option orders based on 
the exact closing price or value of the underlying (``execution 
risk'').\12\ The Exchange states that the DAC order is designed to 
allow Users to incorporate into the pricing of their FLEX options the 
closing price or value of the underlying ETP or index on the 
transaction date based on how much the price or value changed during 
the trading day. The Exchange also represents that DAC orders will have 
unique message characteristics such that contra-side interest will be 
aware of, and may choose whether to interact with, the DAC order. 
Finally, the Exchange believes that the DAC order would be particularly 
useful for investors that participate in defined outcome strategies, 
including defined-outcome exchange-traded funds (``ETFs''), other 
managed funds, unit investment trusts (``UITs''), index funds, 
structured annuities, and other such funds or instruments that are 
indexed.
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    \12\ See Order Instituting Proceedings, supra note 6, at 35352.
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B. DAC Orders and FLEX Options

    As stated above, the use of the DAC order instruction is limited to 
the trading of an option on an ETP or index for execution in a FLEX 
electronic or open outcry auction, and would be handled and executed in 
the same manner as any other FLEX option order pursuant to the 
applicable FLEX auction rules, including pricing, priority, and 
allocation rules.\13\ Specifically, pursuant to Rules 5.72, 5.73, and 
5.74, FLEX Orders (including proposed DAC orders) may only execute in a 
FLEX electronic or open outcry auction which would include the FLEX 
Automated Improvement Auction,\14\ the FLEX Solicitation Auction 
Mechanism or,\15\ a FLEX order submitted for manual handling in an open 
outcry auction on the Exchange's trading floor.\16\ Pursuant to 
proposed Rule 5.33(b)(5), a DAC order instruction may be used in 
conjunction with complex orders that are submitted for execution in a 
FLEX complex electronic or open outcry auctions pursuant to proposed 
Rule 5.72.
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    \13\ See Rules 5.72(b), (c), and (d).
    \14\ See Rule 5.73.
    \15\ See Rule 5.74.
    \16\ See Rule 5.72(d).
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    The DAC order instruction may not be used with all FLEX orders. 
Specifically, proposed Rule 5.70(a)(2) sets forth that a User may not 
apply the DAC order instruction to a FLEX order for a FLEX option 
series with an exercise price formatted as a percentage of the closing 
value of the underlying on the trade date. In other words, the exercise 
price of a DAC order must be expressed as a fixed price in dollars and 
decimals because otherwise, according to the Exchange, the formatting 
would not be compatible with the DAC order instruction. Proposed Rule 
5.70(a)(2) also prohibits the use of the DAC order instruction with 
FLEX Option series that are Asian or Cliquet-settled because DAC orders 
would be based on the movement of the underlying on the transaction 
date but the prices for Asian or Cliquet-settled options are determined 
by averaging a pre-set number of closing index values or summing the 
monthly returns,

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respectively, on specified monthly observation dates.\17\
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    \17\ See Rule 4.21(b)(5)(B).
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C. Delta and Reference Prices

    As stated above, the original execution price of a DAC order that 
executes during the trading day would be delta-adjusted at the market 
close upon receipt of the official closing price or value for the 
underlying ETP or index from the primary listing exchange or index 
provider, as applicable.\18\ Delta is the measure of the change in the 
option price as it relates to a change in the price of the underlying 
security or value of the underlying index, as applicable. For example, 
an option with a 50 delta (which is generally represented as 0.50) 
would result in the option moving $0.50 per $1.00 move in the 
underlying (i.e., price move in the underlying x delta value = 
anticipated price move in the option). The delta changes as a result 
from the passage of time and changes to the price or value of the 
underlying stock or index changes, and provide Users with an estimate 
of how an option reacts to movement, in either direction, of the 
underlying. For example, call option deltas are positive (ranging from 
0 to 1), because as the underlying increases in price so does a call 
option. Conversely, put option deltas are negative (ranging from -1 to 
0), because as the underlying increases in price the put option 
decreases in price. Specifically, the delta-adjusted execution price 
would equal the original execution price plus the delta value times the 
difference between the official closing price or value of the 
underlying on the transaction date and the reference price or index 
value of the underlying (``reference price'').
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    \18\ According to the Exchange, like the execution price of any 
option, a delta-adjusted price may never be zero or negative and the 
System would instead set the delta-adjusted price to the minimum 
permissible increment if such a calculation were to occur. See Order 
Instituting Proceedings, supra note 6, at 35353.
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    A User entering a DAC order for a FLEX electronic auction must 
designate a delta value and may designate a reference price.\19\ If no 
reference price is designated, the System would include the price or 
value, as applicable, of the underlying at the time of order entry as 
the reference price.\20\ A User entering a DAC order for a FLEX open 
outcry auction may, but is not required to, designate a delta value 
and/or a reference price.\21\ During the FLEX open outcry auction, the 
User designated delta value or reference price may differ from the 
final terms of the order because in-crowd market participants \22\ can 
negotiate the final delta value and/or reference price.\23\ A User 
entering a complex order with a DAC order instruction into a FLEX 
electronic auction is required to designate a delta value for each leg 
of the complex order pursuant to proposed Rule 5.33(b)(5)).\24\
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    \19\ See proposed Rules 5.6(c) and 5.33(b)(5).
    \20\ See id.
    \21\ See proposed Rules 5.6(c) and 5.33(b)(5).
    \22\ The Exchange states that in-crowd participants currently 
have delta values built into their own analytics and pricing tools 
and that there is generally only a slight difference of values 
across participants. See Order Instituting Proceedings, supra note 
6, at 35353, n. 25.
    \23\ See id.
    \24\ See proposed Rule 5.72(b)(2)(A).
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    User-designated reference prices will be subject to a reasonability 
check to determine if the DAC order would be cancelled or rejected by 
the System for being more than an Exchange-determined amount away from 
the underlying price or value at the time of submission.\25\ In 
addition, if a DAC order is submitted without a reference price, the 
System would automatically input a reference price equal to the price 
or value of the underlying at the time of order entry.\26\ The ultimate 
delta value and reference price would be reflected in the final terms 
of the execution.\27\
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    \25\ The System will use the most recent last sale (or 
disseminated index value) as the reference price. See proposed Rule 
5.34(c)(12).
    \26\ See proposed Rules 5.6(c) and 5.33(b)(5).
    \27\ See id. The Exchange provided examples to demonstrate how 
the System would apply the delta adjustment formula to DAC orders a 
t the market close. See Order Instituting Proceedings, supra note 6, 
at 35353-54.
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    The Exchange represents that its electronic and open outcry FLEX 
auctions currently last between three seconds to five minutes as 
designated by the Submitting/Initiating FLEX Trader.\28\ Accordingly, 
to the extent a DAC order executes in a FLEX auction, it would do so 
within the three second to five minute timeframe which should limit the 
impact of time on the delta and reference price and help investors meet 
their goal of limiting downside risk while still being able to 
participate in any upward movement in the market.
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    \28\ See Rules 5.72(c), 5.73(c)(3) and 5.74(c)(3).
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D. Time-in-Force

    Proposed Rule 5.6(c) sets forth that a DAC order submitted for 
execution in open outcry may only have a Time-in-Force of Day.\29\ If 
not executed, an order with a Time-in-force of Day would expire at 
Regular Trading Hours (``RTH'') market close. Proposed Rule 5.6(c) also 
provides that a User may not designate a DAC order as All Sessions 
(i.e., eligible for RTH and Global Trading Hours),\30\ as the 
adjustment calculation for DAC orders is linked to the RTH market close 
for the underlying securities and indexes.\31\ The Exchange explained 
that the proposed Time-in-Force of Day requirement for DAC orders 
submitted for execution in open outcry correlates with the need for any 
execution to occur within a limited timeframe after the order's entry 
in order to achieve the result desired by the broker's customer.\32\
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    \29\ The Exchange notes that electronically submitted DAC orders 
will be submitted through the electronic auctions, and either 
executed or cancelled upon the conclusion of an auction, making an 
instruction regarding the time the System will hold an order 
unnecessary. Therefore, the Exchange believes that a requirement to 
apply a Time-in-Force of Day is not necessary for electronic DAC 
orders.
    \30\ See Rule 1.1.
    \31\ See proposed Rules 5.6(c) and 5.33(b)(5).
    \32\ See Order Instituting Proceedings, supra note 6, at 35354-
55.
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E. Trade Reporting

    When a DAC order is executed, the time of the execution, original 
execution price, the reference price and delta value will be provided 
to all transaction parties on all fill reports (i.e., an ``unadjusted 
DAC trade'').\33\ Unadjusted DAC trade information will also be sent to 
the Options Clearing Corporation (``OCC'') and disseminated to Options 
Price Reporting Agency (``OPRA'').\34\ Like all FLEX Orders, DAC order 
trade information will be reported via a text message to OPRA \35\ 
reflecting the (1) execution of a DAC order, (2) delta, and (3) 
reference price.\36\ Like all complex orders, the individual legs of 
DAC complex orders would be reported with an identifier to indicate 
that they are part of a complex order.\37\ At the market close, when 
the execution price is delta-adjusted, all transactions parties will be 
sent fill restatements. Matched trades with the delta-adjusted price 
will also be sent to the OCC and OPRA once the restatement process is 
complete. The prior unadjusted DAC trade report that was sent to the 
OCC and disseminated to OPRA will be cancelled and replaced with a 
trade report reflecting the delta-adjusted execution price. The 
remaining information (i.e., time of the execution, delta, and 
reference price) would be unchanged.\38\ A new DAC order text message 
would be disseminated to OPRA with the same information included in the 
original text plus the closing price. The Exchange states that

[[Page 71363]]

OCC and OPRA are aware of, and deem acceptable, this proposed 
restatement process.\39\
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    \33\ See id.
    \34\ See id.
    \35\ See id.
    \36\ See id.
    \37\ See id.
    \38\ The Exchange notes that this restatement process is the 
same for an order that has been adjusted or nullified and 
subsequently restated pursuant to the Exchange's obvious error 
rules. See Rule 6.5.
    \39\ See Order Instituting Proceedings, supra note 6, at 35355.
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F. System Capacity and Surveillance

    The Exchange represents that it believes: (1) The Exchange and OPRA 
have the necessary systems capacity to handle any additional order 
traffic, and the associated restatements, that may result from the use 
of DAC orders, and (2) its surveillance program is adequately robust to 
monitor orders with delta-adjusted pricing, and (3) the DAC order will 
not have any impact on pricing or price discovery at or near the market 
close.\40\
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    \40\ See id.
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III Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\41\ In particular, the 
Commission finds that the proposed rule change, as modified by 
Amendment No. 1, is consistent with Section 6(b)(5) of the Act,\42\ 
which requires, among other things, that the rules of a national 
securities exchange be designed 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, and not be designed to 
permit unfair discrimination between customers, issuers, brokers, or 
dealers.
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    \41\ 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).
    \42\ 15 U.S.C. 78f(b)(5).
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    The Exchange proposes to introduce the DAC order instruction for 
use with both simple and complex orders for FLEX options on ETPs and 
indexes in electronic or open outcry auctions. The DAC order would 
execute during the trading day and the original execution price would 
be adjusted after receipt of the official closing price/value for the 
underlying ETP or index from the primary listing exchange or index 
provider, as applicable, based on a delta value applied to the change 
in the underlying reference price between the time of execution and the 
market close. The Exchange states that the introduction of the DAC 
order instruction will allow market participants to incorporate into 
the pricing of their FLEX options the closing price of the underlying 
ETP or index on the transaction date, based on the amount in which the 
price or value of the underlying ETP or index changes intraday. The 
Exchange also states that the DAC order will be useful to investors 
that engage in defined-outcome strategies and that certain market 
participants, managed funds in particular, already use similar 
strategies at the market close.
    The Commission received one comment letter supporting the 
Exchange's proposal.\43\ The commenter agrees with the Exchange that 
there may be dislocations in the closing price of a FLEX option and its 
execution price,\44\ and that the DAC order would eliminate such 
dislocations while limiting downside risk and allowing users to 
incorporate any upside market moves that may occur following the 
execution of the order up to the market close.\45\ The commenter also 
believes that the DAC order will improve the efficiency of the options 
market.\46\
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    \43\ See WEX Letter, supra note 8.
    \44\ See id. at 1.
    \45\ See id.
    \46\ See id. at 2.
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    The Commission believes that the DAC order instruction is designed 
to remove impediments to and perfect the mechanism of a free and open 
market by allowing market participants to more effectively incorporate 
the closing price of the underlying ETP or index into the execution 
price of the FLEX option, which should facilitate the ability of market 
participants to execute certain investment strategies. Specifically, as 
the Exchange notes, the DAC order instruction would allow FLEX option 
orders to be executed anytime during the trading day, eliminating 
execution risk near the market close and thereby realizing the 
objective of pricing based on the exact underlying closing prices. The 
Commission believes that the proposal is designed to protect investors 
by providing them with a mechanism designed to ensure FLEX option 
pricing certainty based on the closing price of the underlying ETP or 
index and to eliminate execution risk near the market close, which 
should effectively implement their investment strategies. The 
Commission agrees with the Exchange that, at this time, it is 
appropriate to limit the use of the DAC order instruction to FLEX 
options on ETPs and indexes as the stated goal of the DAC order 
instruction is to assist investors that participate in defined-outcome 
investment strategies, including defined-outcome ETFs, other managed 
funds, UITs, index funds, structured annuities, and other such funds or 
instruments that are indexed.
    The Commission believes that DAC orders are designed promote just 
and equitable principles of trade as their operation should be 
transparent to market participants and the implementation of DAC orders 
should not raise any new or novel order entry, allocation, and 
execution processes. For instance, DAC orders will be entered and 
processed pursuant to the existing FLEX rules like any other order that 
is submitted into a FLEX electronic or open outcry auction.\47\ The 
Commission also believes that the proposed delta adjustment of DAC 
orders is designed to promote just and equitable principles of trade 
and to remove impediments to and perfect the mechanism of a free and 
open market because it is consistent with the general manner in which 
deltas function. The Exchange has designed the proposal to limit the 
period between entry and execution of a DAC order. Because the 
Exchange's electronic and open outcry FLEX auctions currently last 
between three seconds to five minutes, DAC orders should generally 
execute within a timeframe that limits the impact of the passage of 
time on the delta and reference price. Taken together, the Commission 
believes that the DAC order is designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market, and to protect investors by providing a 
mechanism to effectively implement certain investment strategies to 
market participants that should have familiarity with the design and 
strategy of the order type.
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    \47\ See Rules 5.72(d).
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    Finally, the Exchange represents that: (1) DAC orders will have 
unique message characteristics that will indicate to contra-side 
interest its status as a DAC order which will allow market participants 
to choose whether to interact with DAC orders, (2) the OCC and OPRA are 
able to accommodate the DAC restatement process, (3) the Exchange and 
OPRA have the necessary systems capacity to handle additional order 
traffic, and the associated restatements, that may result from the use 
of DAC orders, (4) the Exchange's surveillance program will monitor the 
pricing of DAC orders, and (5) DAC orders should not have any impact on 
pricing or price discovery in the underlying products at or near the 
market close.
    Accordingly, for the foregoing reasons, the Commission believes 
that this proposed rule change, as modified

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by Amendment No. 1, is consistent with the Exchange Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\48\ that the proposed rule change (SR-CBOE-2020-014), as modified 
by Amendment No.1, be, and hereby is, approved.
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    \48\ 15 U.S.C. 78s(b)(2).
    \49\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\49\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-24784 Filed 11-6-20; 8:45 am]
BILLING CODE 8011-01-P


