
[Federal Register Volume 88, Number 185 (Tuesday, September 26, 2023)]
[Notices]
[Pages 66073-66076]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-20811]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98455; File No. SR-CBOE-2023-019]


Self-Regulatory Organizations; Cboe Exchange, Inc.; Order 
Granting Approval of a Proposed Rule Change To Make Permanent the 
Operation of Its Pilot Program That Allows the Exchange To List P.M.-
Settled Third Friday-of-the-Month Mini-SPX Index (``XSP'') Options and 
Mini-Russell 2000 Index (``MRUT'') Options Series

September 20, 2023.

I. Introduction

    On April 19, 2023, Cboe Exchange, Inc. (``Exchange'' or ``Cboe 
Options'') 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 make permanent the operation of its pilot 
program (``Program'') that permits the Exchange to list p.m.-settled 
third Friday-of-the-month XSP and MRUT options (``p.m.-settled XSP'' 
and ``p.m.-settled MRUT,'' respectively, and collectively, the ``Pilot 
Products''). The proposed rule change was published for comment in the 
Federal Register on April 28, 2023.\3\ On June 9, 2023, pursuant to 
section 19(b)(2) of the Act,\4\ 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 to 
disapprove the proposed rule change.\5\ On July 27, 2023, the 
Commission instituted proceedings to determine whether to approve or 
disapprove the proposed rule change.\6\ The Commission did not receive 
any comment letters and is approving 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. 97366 (April 24, 
2023), 88 FR 26359 (``Notice'').
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 97678, 88 FR 39285 
(June 15, 2023). The Commission designated July 27, 2023, as the 
date by which the Commission shall approve or disapprove, or 
institute proceedings to determine whether to approve or disapprove, 
the proposed rule change.
    \6\ See Securities Exchange Act Release No. 98005, 88 FR 50943 
(August 2, 2023).
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II. Background

    When cash-settled \7\ index options were first introduced in the 
1980s, they

[[Page 66074]]

generally utilized closing-price settlement procedures (i.e., p.m. 
settlement).\8\ The Commission became concerned with the impact of 
p.m.-settled, cash-settled index options on the underlying cash 
equities markets, and in particular, added market volatility and sharp 
price movements near the close on expiration days.\9\ These concerns 
were heightened during the ``triple-witching'' hour on the third Friday 
of March, June, September, and December when index options, index 
futures, and options on index futures expired concurrently.\10\ 
Academic research at the time provided at least some evidence 
suggesting that futures and options expirations contributed to excess 
volatility and reversals around the close on those days.\11\
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    \7\ The seller of a ``cash-settled'' index option pays out the 
cash value of the applicable index on expiration or exercise. A 
``physical delivery'' option, like equity and ETF options, involves 
the transfer of the underlying asset rather than cash. See 
Characteristics and Risks of Standardized Options, available at: 
https://www.theocc.com/Company-Information/Documents-and-Archives/Options-Disclosure-Document.
    \8\ See Securities Exchange Act Release No. 65256 (September 2, 
2011), 76 FR 55969, at 55972 (September 9, 2011) (SR-C2-2011-008) 
(Order approving proposed rule change to establish a pilot program 
to list and trade p.m.-settled third Friday-of-the-month S&P 500 
stock index (``SPX'') options (``SPXPM'') on the C2 Options 
Exchange, Incorporated (``C2'')) (``C2 SPXPM Approval''). SPXPM was 
traded on a pilot basis on C2 until the introduction of SPXPM 
trading on Cboe Options. See Securities Exchange Act Release No. 
68888 (February 8, 2013), 78 FR 10668, at 10668 (February 14, 2013) 
(SR-CBOE-2012-120) (``SPXPM Approval Order'').
    \9\ See C2 SPXPM Approval, 76 FR at 55972.
    \10\ See id.
    \11\ See Securities and Exchange Commission, Division of 
Economic Risk and Analysis, Memorandum dated February 2, 2021 on 
Cornerstone Analysis of PM Cash-Settled Index Option Pilots 
(September 16, 2020) (``Pilot Memo'') at 5, available at: https://www.sec.gov/files/Analysis_of_PM_Cash_Settled_Index_Option_Pilots.pdf (citing, among 
other papers, Stoll, Hans R., and Robert E. Whaley, ``Expiration day 
effects of index options and futures,'' Monograph Series in Finance 
and Economics, no. 3 (1986)).
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    In light of the concerns with p.m. settlement and to help 
ameliorate the price effects associated with expirations of p.m.-
settled, cash-settled index products, in 1987, the Commodity Futures 
Trading Commission approved a proposed rule change by the Chicago 
Mercantile Exchange (``CME'') to provide for a.m. settlement \12\ for 
index futures, including futures on the S&P 500 Index (``S&P 
500'').\13\ The Commission subsequently approved a proposed rule change 
by Cboe Options to list and trade a.m.-settled options on the S&P 
500.\14\ In 1992, the Commission approved Cboe Options' proposal to 
transition all of its European-style cash-settled options on the S&P 
500 to a.m. settlement.\15\ However, in 1993, the Commission approved a 
proposed rule change allowing Cboe Options to list p.m.-settled options 
on certain broad-based indexes, including the S&P 500, expiring at the 
end of each calendar quarter (since approved as permanent).\16\ 
Starting in 2006, the Commission approved a number of proposals, on a 
pilot basis, permitting Cboe Options to introduce other index options, 
including SPX options, with p.m.-settlement. These include p.m.-settled 
index options expiring weekly (other than the third Friday) and at the 
end of each month,\17\ SPXPM, as well as p.m.-settled XSP and MRUT 
options expiring on the third Friday of the month.\18\
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    \12\ The exercise settlement value for an a.m.-settled index 
option is determined by reference to the reported level of the index 
as derived from the opening prices of the component securities on 
the business day before expiration.
    \13\ See Proposed Amendments Relating to the Standard and Poor's 
500, the Standard and Poor's 100 and the Standard Poor's OTC Stock 
Price Index Futures Contract, 51 FR 47053 (December 30, 1986) 
(notice of proposed rule change from the CME). See also Securities 
Exchange Act Release No. 24367 (April 17, 1987), 52 FR 13890 (April 
27, 1987) (SR-CBOE-87-11) (noting that the CME moved the S&P 500 
futures contract's settlement value to opening prices on the 
delivery date).
    \14\ See Securities Exchange Act Release No. 24367 (April 17, 
1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11).
    \15\ See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09). The Commission 
also approved proposals by other options markets to transfer most of 
their cash-settled index products to a.m. settlement. See, e.g., 
Securities Exchange Act Release No. 25804 (June 15, 1988), 53 FR 
23475 (June 22, 1988) (SR-NYSE-87-11 and 88-04).
    \16\ See Securities Exchange Act Release No. 31800 (February 1, 
1993), 58 FR 7274 (February 5, 1993) (SR-CBOE-92-13). See also 
Securities Exchange Act Release Nos. 54123 (July 11, 2006), 71 FR 
40558 (July 17, 2006) (SR-CBOE-2006-65); and 60164 (June 23, 2009), 
74 FR 31333 (June 30, 2009) (SR-CBOE-2009-029).
    \17\ See Securities Exchange Act Release Nos. 62911 (September 
14, 2010), 75 FR 57539 (September 21, 2010) (SR-CBOE-2009-075); 
76529 (November 30, 2015), 80 FR 75695 (December 3, 2015) (SR-CBOE-
2015-106); and 78531 (August 10, 2016), 81 FR 54643 (August 16, 
2016) (SR-CBOE-2016-046).
    \18\ See Securities Exchange Act Release Nos. 70087 (July 31, 
2013), 78 FR 47809 (August 6, 2013) (SR-CBOE-2013-055) (``XSP 
Approval Order''); and 91067 (February 5, 2021) 86 FR 9108 (February 
11, 2021) (SR-CBOE-2020-116) (``MRUT Approval Order'').
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    In the course of approving the various pilots, the Commission 
reiterated its concern about the potential impact on the market at 
expiration for the underlying component stocks for a p.m.-settled, 
cash-settled index option.\19\ However, the Commission also recognized 
the potential impact was unclear.\20\ The Commission approved the 
Program on a pilot basis to allow the Exchange and the Commission to 
monitor for and assess any potential for adverse market effects.\21\ In 
order to facilitate this assessment, the Exchange committed to provide 
the Commission with data and analysis in connection with the Program 
\22\ and to make such data publicly available.\23\ In addition to the 
Exchange's data and analysis, Cornerstone Research also conducted an 
analysis at the direction of Staff from the Commission's Division of 
Economic and Risk Analysis. The analysis utilizes the level of expiring 
p.m.-settled index options open interest and the measures of volatility 
and price reversals for the corresponding index futures, the underlying 
cash index, and index component securities in the minutes leading up to 
and immediately following the market close to study the effects of 
pilot programs allowing p.m.-settled index options. The Pilot Memo is 
discussed in more detail below.
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    \19\ See, e.g., SPXPM Approval Order, 78 FR at 10669. See also 
Securities Exchange Act Release Nos. 64599 (June 3, 2011), 76 FR 
33798, 33801-02 (June 9, 2011) (order instituting proceedings to 
determine whether to approve or disapprove a proposed rule change to 
allow the listing and trading of SPXPM options on the C2 Options 
Exchange, Incorporated); and C2 SPXPM Approval, 76 FR at 55972-76.
    \20\ See, e.g., SPXPM Approval Order, 78 FR at 10669.
    \21\ See XSP Approval Order, 78 FR at 47811; and MRUT Approval 
Order, 86 FR at 9109.
    \22\ Id.
    \23\ See, e.g., Securities Exchange Act Release No. 97446 (May 
5, 2023), 88 FR 30365, at 30366 (May 11, 2023) (SR-CBOE-2023-024) 
(stating the Exchange is making public on its website data and 
analyses previously submitted to the Commission under the Program 
and committing to make public any data or analyses submitted in the 
future).
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III. Description of the Proposal

    The Pilot Products are cash-settled options with third Friday-of-
the-month expiration dates (``Expiration Friday'') whose exercise 
settlement value is derived from closing prices on the last trading day 
prior to expiration.
    The Exchange has filed to extend the operation of the pilot on 
multiple occasions \24\ and it is currently set to expire on the 
earlier of November 6, 2023, or the date on which the Program is 
approved on a permanent basis.\25\ Now, the Exchange proposes to make 
the Program permanent.
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    \24\ See, e.g., Securities Exchange Act Release Nos. 71424 
(January 28, 2014), 79 FR 6249 (February 3, 2014) (SR-CBOE-2014-004) 
and 96222 (November 3, 2022), 87 FR 67736 (November 9, 2022) (SR-
CBOE-2022-054).
    \25\ See Securities Exchange Act Release No. 97446 (May 5, 
2023), 88 FR 30365 (May 11, 2023).
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    Since the Program's inception in 2013 for p.m.-settled XSP and 2021 
for p.m.-settled MRUT, the Exchange has submitted reports to the 
Commission regarding the Program that detail the Exchange's experience 
with the Program, pursuant to the XSP and

[[Page 66075]]

MRUT Approval Orders.\26\ The Exchange states that, during the course 
of the Program, it also provided the Commission with any additional 
data or analyses the Commission requested if the Commission deemed such 
data or analyses necessary to determine whether the Program was 
consistent with the Act.\27\
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    \26\ See supra note 18. The Exchange has made public on its 
website data and analyses previously submitted to the Commission 
under the Program. See https://www.cboe.com/aboutcboe/legal-regulatory/national-market-system-plans/pm-settlement-spxpm-data.
    \27\ See Notice, 88 FR at 26361-26362.
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IV. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities exchange.\28\ In 
particular, the Commission finds that the proposed rule change is 
consistent with section 6(b)(5) of the Act,\29\ which requires, among 
other things, that the Exchange's rules be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. In its 
proposal to make the Program permanent, the Exchange addressed whether 
the Program negatively impacts markets or impacted the quality of the 
XSP and MRUT options market. Each of these elements is discussed in 
greater detail below. As stated above, no comments were received on the 
proposed rule change.
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    \28\ 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).
    \29\ 15 U.S.C. 78f(b)(5).
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Market Impact Considerations

    The Exchange states it has not identified any evidence from the 
pilot data indicating that the trading of the Pilot Products has any 
adverse impact on fair and orderly markets on Expiration Fridays for 
the Mini-SPX Index, the Mini-RUT Index or the underlying securities 
comprising the underlying indexes, nor have there been any observations 
of abnormal market movements attributable to the Pilot Products from 
any market participants that have come to the attention of the 
Exchange.\30\ In order to support its overall assessment of the 
Program, the Exchange included a review and analysis of pilot data.\31\ 
Among other things, the Exchange's analysis includes end of day 
volatility as well as a comparison of the impact of quarterly index 
rebalancing versus p.m.-settled expirations.\32\
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    \30\ See Notice, 88 FR at 26362.
    \31\ See id. at 26361-65. The Exchange states that although its 
analysis specifically evaluated SPX options, the Exchange believes 
it is appropriate to extrapolate the data to apply the Pilot 
Products. See Notice, 88 FR at 26365. The Commission agrees it is 
appropriate to extrapolate the data to the Pilot Products, as the 
Exchange's analysis examines liquidity and volatility dynamics 
around the market close, which may be associated with typical 
hedging activities tied to expiring p.m.-settled index options.
    \32\ See id. at 26364.
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    In addition to reviewing the data and analysis provided by the 
Exchange, the Commission reviewed the analysis in the Pilot Memo, which 
evaluates whether higher levels of expiring open interest in p.m.-
settled index options results in increased volatility and price 
reversals around the close. The Pilot Memo shows that the market share 
for p.m.-settled options on the S&P 500 has grown substantially since 
2007.\33\ The Exchange's review of pilot data also showed this trend 
continuing from 2019 through 2021.\34\
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    \33\ See Pilot Memo at 2.
    \34\ See Notice, 88 FR at 26362. Specifically, since 2007, p.m.-
settled SPX options grew from 0.1% of open interest to 30% of open 
interest in 2021. Id.
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    The Pilot Memo examines whether and to what extent expiring open 
interest in p.m.-settled index options is empirically related with the 
tendency of the corresponding index futures, the underlying index, or 
index components to experience increased transitory volatility and 
price reversals around the time of market close on expiration dates. 
The Pilot Memo concludes that, although expiring p.m.-settled index 
option open interest may have a statistically significant relationship 
with volatility and price reversals of the underlying index, index 
futures, and index component securities around the market close, the 
magnitude of the effect is economically very small.\35\ For example, 
the largest settlement event that occurred during the time period 
studied in the Pilot Memo (a settlement of $100.4 billion of notional 
on December 29, 2017) had an estimated impact on the futures price of 
only approximately 0.02% (a predicted impact of $0.54 relative to a 
closing futures price of $2,677).\36\
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    \35\ See Pilot Memo at 3. The Pilot Memo also examined options 
on the Russell 2000 Index and the Nasdaq-100 Index. However, during 
the time period covered by the study (2007-2018), the markets for 
both a.m.- and p.m.-settled options on these indexes were very small 
compared to the size of that for S&P 500 Index options. See id. at 
4.
    \36\ See id. at 3.
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    The Exchange further reviewed a sample of pilot data from 2019 
through 2021, and measured the volatility of the S&P 500 over the final 
fifteen minutes of each trading day and compared expiration days to 
non-expiration days.\37\ Generally volatility was slightly higher on 
expiration days, but in cases where overall market volatility 
increased, the normalized impact on expiration days versus non-
expiration days remained consistent.\38\ The Exchange further analyzed 
volatility on days when the S&P 500 was rebalanced, and states its 
results suggest more closing volatility on rebalance dates compared to 
non-rebalance expiration dates, indicating that rebalancing of the S&P 
500 may have a greater impact on S&P 500 volatility than p.m.-settled 
option expirations.\39\
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    \37\ See Notice, 88 FR at 26363.
    \38\ See id.
    \39\ See id.
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    The Exchange also reviewed a sample of post-2018 pilot data for 
potential correlation between excess market volatility and price 
reversals and the hedging activity of liquidity providers.\40\ To 
determine whether there is a correlation, the Exchange calculated an 
estimate of the amount of market-on-close (``MOC'') volume in the S&P 
500 component markets attributable to expected hedging activity as a 
result of expiring in-the-money options.\41\ The Exchange states its 
results indicate that other sources of MOC share volume generally 
exceed the volume resulting from hedging activity for p.m.-settled SPX 
options.\42\ Further, the Exchange also compared hedging futures 
positions that would correspond to expiring in-the-money p.m.-settled 
SPX options and concludes the data indicate negligible capacity for 
hedging activity to increase volatility in the underlying markets.\43\
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    \40\ See id.
    \41\ See id.
    \42\ See id. at 26364.
    \43\ See id.
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    Finally, the Exchange states that the significant changes in the 
closing procedures of the primary markets in recent decades, including 
considerable advances in trading systems and technology, have 
significantly minimized risks of any potential impact of p.m.-, cash-
settled XSP or MRUT options on the underlying cash markets.\44\
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    \44\ See id.
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Market Quality Considerations

    The Exchange also completed an analysis intended to evaluate 
whether the Program impacted the quality of the a.m.-settled options 
market. Specifically, the Exchange compared

[[Page 66076]]

values of key market quality indicators (specifically, the bid-ask 
spread \45\ and effective spread \46\) in p.m.-settled SPX weekly 
(``SPXW'') options both before and after the introduction of Tuesday 
expirations and Thursday expirations for SPXW options on April 18 and 
May 11, 2022, respectively.\47\ The Exchange concludes from this 
analysis that the introduction of SPX options with Tuesday and Thursday 
options had no significant impact on the market quality of SPXW options 
with Monday, Wednesday, and Friday expirations.\48\ For a majority of 
the series analyzed, the Exchange observed no statistically significant 
difference in bid-ask spread or effective spread.\49\ The Exchange 
states that analyzing whether the introduction of new SPXW p.m.-settled 
expirations (i.e., SPXW options with Tuesday and Thursday expirations) 
impacted the market quality of then-existing SPXW p.m.-settled 
expirations (i.e., SPXW options with Monday, Wednesday, and Friday 
expirations) provides a reasonable substitute to evaluate whether the 
introduction of p.m.-settled index options impacted market quality when 
the Program began.\50\ Therefore, the Exchange believes the results of 
its analysis permit the Exchange to extrapolate that it is unlikely the 
introduction of p.m.-settled XSP or p.m.-settled MRUT options 
significantly impacted the market quality of a.m.-settled options, such 
as a.m.-settled SPX or Russell 2000 options, respectively, when the 
Program began.\51\
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    \45\ The Exchange calculated for each of SPXW options (with 
Monday, Wednesday, and Friday expirations) and SPY Weekly options 
(with Monday, Wednesday, and Friday expirations) the daily time-
weighted bid-ask spread on the Exchange during its regular trading 
hours session, adjusted for the difference in size between SPXW 
options and SPY options (SPXW options are approximately ten times 
the value of SPY options).
    \46\ The Exchange calculated the volume-weighted average daily 
effective spread for simple trades for each of SPXW options (with 
Monday, Wednesday, and Friday expirations) and SPY Weekly options 
(with Monday, Wednesday, and Friday expirations) as twice the amount 
of the absolute value of the difference between an order execution 
price and the midpoint of the national best bid and offer at the 
time of execution, adjusted for the difference in size between SPXW 
options and SPY options.
    \47\ For purposes of comparison, the Exchange paired SPXW 
options and SPY options with the same moneyness and same days to 
expiration.
    \48\ See Notice, 88 FR at 26364.
    \49\ See id.
    \50\ See Notice, 88 FR at 26364.
    \51\ See id. at 26365.
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    The Commission believes that the evidence contained in the 
Exchange's filing, the Exchange's pilot data and reports, and the Pilot 
Memo analysis demonstrate that the Program has benefitted investors and 
other market participants by providing more flexible trading and 
hedging opportunities while also having no disruptive impact on the 
market. The market for p.m.-settled options has grown in size over the 
course of the Program, and analysis of the pilot data did not identify 
any significant economic impact on the underlying component securities 
surrounding the close as a result of expiring p.m.-settled options nor 
did it indicate a deterioration in market quality (as measured by bid-
ask and effective spreads) for an existing product when a new p.m.-
settled expiration was introduced. Further, significant changes in 
closing procedures in the decades since index options moved to a.m. 
settlement may also serve to mitigate the potential impact of p.m.-
settled index options on the underlying cash markets.
    Accordingly, the Commission finds that the proposed rule change is 
consistent with section 6(b)(5) of the Act \52\ and the rules and 
regulations thereunder applicable to a national securities exchange.
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    \52\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\53\ that the proposed rule change (SR-CBOE-2023-019) be, and 
hereby is, approved.
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    \53\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\54\
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    \54\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-20811 Filed 9-25-23; 8:45 am]
BILLING CODE 8011-01-P


