Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change and Amendment No. 1 Thereto Relating to Strike Price Intervals for VIX Options, 43251-43254 [E6-12155]

Download as PDF Federal Register / Vol. 71, No. 146 / Monday, July 31, 2006 / Notices exchange 7 and, in particular, the requirements of Section 6(b) of the Act 8 and the rules and regulations thereunder. Specifically, the Commission finds that the proposal is consistent with Section 6(b)(5) of the Act,9 in that it is designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, 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. The Commission believes that providing ROTs with a limited ability to send orders in connection with a bona fide hedge or liquidating position in a formerly assigned options class is a reasonable response by the Exchange to the need for ROTs to reduce the position risk that occurs when an options class is relocated. IV. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,10 that the proposed rule change (SR–Amex–2005– 096), as amended, is approved. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.11 Jill M. Peterson, Assistant Secretary. [FR Doc. E6–12175 Filed 7–28–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54192; File No. SR–CBOE– 2006–27] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change and Amendment No. 1 Thereto Relating to Strike Price Intervals for VIX Options July 21, 2006. sroberts on PROD1PC70 with NOTICES Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on March 15, 2006, the Chicago Board Options Exchange, Incorporated (‘‘CBOE’’ or 7 In approving this proposal, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 8 15 U.S.C. 78f(b). 9 15 U.S.C. 78f(b)(5). 10 15 U.S.C. 78f(b)(2). 11 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. VerDate Aug<31>2005 17:34 Jul 28, 2006 Jkt 208001 ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. On July 19, 2006, the CBOE filed Amendment No. 1 to the proposed rule change.3 The Commission is publishing this notice and order to solicit comments on the proposal from interested persons and to approve the proposed rule change, as amended, on an accelerated basis. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes rules that would permit the Exchange to list and trade VIX options in $1 strike price intervals within certain parameters. The text of the proposed rule change, as amended, is below. Proposed new language is in italics. * * * * * Rule 24.9 Terms of Index Option Contracts No change. * * * Interpretations and Policies: .01 The procedures for adding and deleting strike prices for index options are provided in Rule 5.5 and Interpretations and Policies related thereto, as otherwise generally provided by Rule 24.9, and include the following: (a)–(d) No change. (e)(i) Notwithstanding paragraph (a), the interval between strike prices for options on the CBOE Volatility Index (VIX) will be no less than $2.50; provided, that subject to the following conditions, the interval between strike prices for VIX will be no less than $1.00: (A) The Exchange may open for trading series at $1.00 or greater strike price intervals for each expiration on up to 5 VIX option series above and 5 VIX option series below the current index level; (B) The Exchange may open for trading additional series at $1.00 or greater strike price internals for each expiration as the current index level of VIX moves from the exercise price of those VIX options series that already have been opened for trading on the Exchange so as to maintain at least 5 VIX option series above and 5 VIX option series below the current index level; (C) The Exchange may not open for trading series with $1.00 intervals within $0.50 of an existing $2.50 strike price with the same expiration month; and 3 Amendment No. 1 replaced and superseded the original rule filing in its entirety. PO 00000 Frm 00158 Fmt 4703 Sfmt 4703 43251 (D) The interval between strike prices for VIX LEAPs will be no less than $2.50. (ii) For the purposes of adding strike prices on options on VIX at $1.00 or greater strike price intervals, as well as at $2.50 or greater strike price intervals, the ‘‘current index level’’ shall mean the implied forward level based on VIX futures prices. .02–.14 No change. * * * * * II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of, and basis for, the proposed rule change. The text of these statements may be examined at the places specified in Item III below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the proposed rule change is to permit the Exchange to list and trade options on the CBOE Volatility Index (‘‘VIX’’) in $1 strike price intervals within certain parameters described below.4 VIX is calculated using real-time quotes of outof-the-money and at-the-money nearby and second nearby index puts and calls on the S&P 500 Index (‘‘SPX’’). Generally, VIX provides investors with up-to-the-minute market estimates of expected volatility of the S&P 500 Index. VIX is quoted in absolute numbers that represent the volatility of the S&P 500 Index in percentage points per annum. For example, an index level of 12.66 (the closing value of the VIX on March 7, 2006) represents an annualized volatility of 12.66% in the S&P 500 Index. The VIX level fluctuates quite differently than individual equity securities or indexes of individual equity securities. Specifically, the 4 The Commission has also granted approval for CBOE to list options on the increased-value version of VIX (‘‘Increased-Value VIX’’) (see Securities Exchange Act Release No. 49698 (May 13, 2004), 69 FR 29152 (May 20, 2004) (Notice of Filing and Order Granting Accelerated Approval of a Proposed Rule Change by the Chicago Board Options Exchange, Incorporated Relating to Options on Certain CBOE Volatility Indexes)). This proposed rule change does not apply to options on IncreasedValue VIX. E:\FR\FM\31JYN1.SGM 31JYN1 43252 Federal Register / Vol. 71, No. 146 / Monday, July 31, 2006 / Notices Exchange states that indices such as VIX that track volatility are ‘‘meanreverting,’’ which is a statistical way of saying that there is a strong tendency for the volatility index to move toward its long-term historical average level. In other words, at historically low volatility index levels, there is a higher probability that the next big move will be up rather than down. Conversely, at historically high volatility index levels, the next big move is more likely to be down rather than up. Thus, as exemplified by VIX, the Exchange states volatility indexes tend to move within set ranges, and even when a level moves outside that range, the tendency towards mean-reversion often results in the volatility index returning to a level within the range. In the case of VIX, the historical average of VIX since 1990 is 19.4 and has closed at levels from a low of 9.3 to a high of 45.7. Since January 1, 2004, VIX has fluctuated in a narrow range between a level of 10.2 and a level of 21.6. Furthermore, VIX closed under 25 for 82% of the days on which the level was calculated since 1990 (3,360 days out of a total of 4,078 days) and has closed under 30 for 93% of the days on which the level was calculated since 1990 (3,791 days out of a total of 4,078 days). Under current CBOE rules, the Exchange may only list strikes on VIX options with intervals no less than $2.50. Therefore, the Exchange currently lists strikes on puts and calls on VIX options at 10, 12.50, 15, 17.50, 20, 22.5 and 25. However, because of the generally limited range in which VIX has fluctuated, the Exchange believes that investors will be better served if the Exchange is able to list $1 strike price intervals in VIX option series. To address this, the Exchange is proposing to list series at $1 or greater strike price intervals for each expiration on up to 5 VIX option series above and 5 VIX option series below the current index level. Additional series at $1.00 or greater strike price internals could be listed for each expiration as the current index level of VIX moves from the exercise price of the VIX options series that already have been opened for trading on the Exchange in order to maintain at least 5 VIX option series above and 5 VIX option series below the current index level. For purposes of adding strike prices at $1.00 or greater strike price intervals, as well as at $2.50 or greater strike price intervals, the ‘‘current index level’’ would be defined as the ‘‘implied forward level’’ of VIX for each expiration.5 The Exchange intends to determine implied forward levels of VIX through the use of VIX futures prices. Its reasons for using this approach are explained below. By way of background, the Exchange states that option prices reflect the market’s expectation of the price of the underlying at expiration, which is referred to as the ‘‘forward’’ level. For stock indexes such as the SPX and the Based on SPX options expiring in . . . Spot VIX .......................................................... June 2006 ....................................................... August 2006 .................................................... November 2006 .............................................. February 2007 ................................................. May 2007 ........................................................ May 2008 ........................................................ sroberts on PROD1PC70 with NOTICES VIX expiration month S&P 100 (‘‘OEX’’), the best estimate of the forward level is the current, or ‘‘spot,’’ price adjusted for the ‘‘carry,’’ which is the financing cost of owning the component stocks in the index less the dividends paid by those stocks. For VIX, the Exchange states that a better estimate than the standard ‘‘cash and carry’’ model for calculating the forward levels of VIX at each expiration is reflected in the prices of the options that will be used to calculate VIX on that expiration day. For example, September SPX options will be used to calculate VIX on the August VIX expiration date. Likewise, November VIX options are tied to the implied volatility of December SPX options, and so on. The Exchange states that one important property of implied volatility is that it exhibits a ‘‘term structure.’’ In other words, the VIX volatility of options expiring on different dates can trade at different levels and can move independently. Another property related to the term structure is that implied volatility tends to trend toward the market’s expectation of a long-term ‘‘average’’ value. As a result, the Exchange states that a large spike in one-month implied volatility might not affect implied volatility of longer-dated options very much at all. For example, the following table illustrates the recent behavior of forward VIX levels relative to dramatic change in the current VIX price. VIX forward prices (5/5/06) ......................................................................... July 2006 ........................................................ September 2006 ............................................. December 2006 .............................................. March 2007 .................................................... June 2007 ...................................................... June 2008 ...................................................... 11.62 12.55 13.66 14.59 15.27 15.75 17.13 VIX forward prices (5/19/06) 17.18 14.86 14.67 15.10 15.46 15.93 17.36 Change +5.56 +2.31 +1.01 +0.51 +0.19 +0.18 +0.36 On May 5, 2006, ‘‘spot’’ VIX closed at 11.62. Forward VIX levels at different points along the term structure ranged from 12.55 (June 2006) to 17.13 (May 2008). Two weeks later, spot VIX closed at 17.18—a gain of more than 5.5 points from the May 5th spot VIX. However, June forward VIX levels increased by only 2.31 points, August forward VIX rose by 1.01 points, and November rose by 0.51 point. The increase in forward levels for contracts expiring 9 months and longer was only approximately 0.2 points. The Exchange notes that many traders use VIX futures prices as a proxy for forward VIX levels. The CBOE Futures Exchange, LLC (CFE) lists VIX futures corresponding to each VIX options expiration month. CBOE believes that using these prices is an accurate and transparent method for determining the ‘‘current index level’’ used to center the limited range in which $1 or greater strikes in VIX options will be listed and the broader range in which $2.50 or greater strikes in VIX options will be listed. Thus, the Exchange will use the corresponding VIX futures prices as a method for determining the ‘‘current index level’’ for listing series with both $1 and $2.50 strikes in VIX options. Additionally, the Exchange is proposing that it would not list series with $1 intervals within $0.50 of an existing $2.50 strike price with the same 5 With respect to $2.50 or greater strikes, the $2.50 or greater strike price intervals will be reasonably related to the current index value of VIX at or about the time such series are first opened for trading. The term ‘‘reasonably related to the current index value of the underlying index’’ means that the exercise price is within 30% of the current index value. The Exchange may also open additional $2.50 or greater strike price series that are more than 30% away from the current index value, provided that demonstrated customer interest exists for such series, as expressed by institutional, corporate, or individual customers or their brokers. See Interpretations and Policies .01(d) and .04 of Rule 24.9. VerDate Aug<31>2005 17:34 Jul 28, 2006 Jkt 208001 PO 00000 Frm 00159 Fmt 4703 Sfmt 4703 E:\FR\FM\31JYN1.SGM 31JYN1 Federal Register / Vol. 71, No. 146 / Monday, July 31, 2006 / Notices expiration month (e.g., if there is an existing 12.50 strike, the Exchange would not list a 12 or 13 strike). Finally, the interval between strike prices for VIX long-term option series (‘‘LEAPs ’’) will continue to be no less than $2.50. The Exchange states that the $1 strike price intervals will more closely bracket the level of VIX when it remains locked within a static range, as currently exists and will enable investors to assume more dynamic volatility index option positions that reflect greater possibilities of settling in-the-money. Finally, CBOE has analyzed its capacity and represents that it believes the Exchange and the Options Price Reporting Authority (‘‘OPRA’’) have the necessary systems capacity to handle the additional traffic associated with the listing and trading of $1 strike VIX options as proposed herein. 2. Statutory Basis CBOE believes the proposed rule change is consistent with the Act 6 and the rules and regulations under the Act applicable to a national securities exchange and, in particular, the requirements of Section 6(b) of the Act.7 Specifically, the Exchange believes the proposed rule change is consistent with the Section 6(b)(5) 8 requirements that the rules of an exchange be designed to promote just and equitable principles of trade, and to protect investors and the public interest. B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received from Members, Participants or Others No written comments were solicited or received with respect to the proposed rule change. sroberts on PROD1PC70 with NOTICES III. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Act. Comments may be submitted by any of the following methods: U.S.C. 78a et seq. 7 15 U.S.C. 78(f)(b). 8 15 U.S.C. 78(f)(b)(5). 17:34 Jul 28, 2006 with Section 6(b)(5) of the Act,10 which requires, among other things, that the rules of a national securities exchange be designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, and protect investors and the public interest. Paper Comments The Commission believes that this • Send paper comments in triplicate proposal, as amended, is a reasonable to Nancy M. Morris, Secretary, means of providing investors with Securities and Exchange Commission, greater flexibility to establish 100 F Street, NE., Washington, DC investment positions that can be better 20549–1090. tailored to meet their objectives. All submissions should refer to File Specifically, the Commission believes Number SR–CBOE–2006–27. This file that the implementation of $1 strike number should be included on the price intervals for VIX options is subject line if e-mail is used. To help the designed to better serve investors in that Commission process and review your product in that it will provide more comments more efficiently, please use dynamic strike levels that better reflect only one method. The Commission will movements in the VIX. As explained by post all comments on the Commission’s CBOE, the VIX level fluctuates much Internet Web site (http://www.sec.gov/ differently than individual equity rules/sro.shtml). Copies of the securities or indexes of individual submission, all subsequent equity securities and has generally amendments, all written statements remained in a relatively narrow range with respect to the proposed rule since its inception. Because of these change that are filed with the unique characteristics of the VIX, the Commission, and all written Commission believes that the communications relating to the implementation of $1 strike price proposed rule change between the intervals in the VIX option product, Commission and any person, other than within the parameters detailed in those that may be withheld from the CBOE’s proposal, is appropriate. The public in accordance with the Commission notes that CBOE’s provisions of 5 U.S.C. 552, will be proposed use of VIX futures as a proxy available for inspection and copying in for the ‘‘implied forward level’’ of VIX the Commission’s Public Reference used to calculate the ‘‘current index Room. Copies of such filing also will be value’’ for purposes of adding strike available for inspection and copying at price intervals is a methodology the principal offices of the Exchange. reasonably designed to reflex the unique All comments received will be posted properties of the VIX. The Commission without change; the Commission does further notes that CBOE has represented not edit personal identifying that the Exchange and OPRA have the information from submissions. You necessary systems capacity to absorb the should submit only information that additional options traffic caused by the you wish to make available publicly. All introduction of VIX $1 strikes. submissions should refer to File The Exchange has requested Number SR–CBOE–2006–27 and should accelerated approval of the proposed be submitted on or before August 21, rule change. The Commission finds 2006. good cause, consistent with Section 19(b)(2) of the Act,11 for approving this IV. Commission’s Findings and Order proposed rule change before the Granting Accelerated Approval of the thirtieth day after the publication of Proposed Rule Change notice thereof in the Federal Register. After careful consideration, the The Commission believes that allowing Commission finds that the proposed the Exchange to list and trade options rule change, as amended, is consistent on the VIX in $1 strike price intervals with the requirements of the Act and the immediately will provide investors with rules and regulations thereunder new means of managing their risk applicable to a national securities exposures and carrying out their exchange.9 In particular, the investment objectives, and that any Commission finds that the proposed potential concerns about VIX $1 strikes rule change, as amended, is consistent are mitigated by the parameters detailed in the proposal. 9 In approving this rule change, the Commission notes that it has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 6 15 VerDate Aug<31>2005 Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–CBOE–2006–27 on the subject line. Jkt 208001 43253 PO 00000 Frm 00160 Fmt 4703 Sfmt 4703 10 15 11 15 E:\FR\FM\31JYN1.SGM U.S.C. 78f(b)(5). U.S.C. 78s(b)(2). 31JYN1 43254 Federal Register / Vol. 71, No. 146 / Monday, July 31, 2006 / Notices V. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,12 that the proposed rule change (SR–CBOE–2006– 27), as amended, is approved on an accelerated basis. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.13 Jill M. Peterson, Assistant Secretary. [FR Doc. E6–12155 Filed 7–28–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54191; File No. SR–CHX– 2006–04] Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Order Granting Approval to a Proposed Rule Change and Amendment Nos. 1, 2 and 3 Thereto Relating to the Transfer of Securities Among Co.-Specialists Within a Specialist Firm July 21, 2006. On March 8, 2006, the Chicago Stock Exchange, Inc. (‘‘CHX’’ or ‘‘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 proposed rule change to amend its rules to permit the transfer of securities to different cospecialists within a specialist firm. On May 3, 2006, CHX filed Amendment No. 1 to the proposed rule change.3 On May 22, 2006, CHX filed Amendment No. 2 to the proposed rule change.4 The proposed rule change, as amended, was published for comment in the Federal Register on June 15, 2006.5 On July 3, 2006, CHX filed Amendment No. 3 to 12 Id. 13 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 In Amendment No. 1, the Exchange revised the rule text of the proposed rule change to clarify the application of the proposal to intrafirm transfers and revised the purpose section to discuss the proposed provision requiring the specialist unit to accurately represent its plans in the specialist application regarding designating a particular cospecialist to trade a security. 4 In Amendment No. 2, the Exchange revised the rule text of the proposed rule change to clarify the impact of an intrafirm transfer on the deregistration and registration of individual co-specialists within a specialist firm and made non-substantive changes to the proposed rule text. The proposed rule text set forth in Amendment No. 2 superceded and replaced the rule text set forth in the initial filing and Amendment No. 1 in its entirety. 5 See Securities Exchange Act Release No. 53949 (June 6, 2006), 71 FR 34648. sroberts on PROD1PC70 with NOTICES 1 15 VerDate Aug<31>2005 17:34 Jul 28, 2006 Jkt 208001 the proposed rule change.6 The Commission received no comments regarding the proposal, as amended. This order approves the proposed rule change, as amended. Under the Exchange’s current rules relating to the assignment of securities to specialist firms, the Committee on Specialist Assignment and Evaluation (‘‘CSAE’’) assigns each security to a specialist firm and this firm is responsible both financially and as a regulatory matter for the trading of the security.7 At the same time, however, when a specialist firm applies to trade a security, it must identify the cospecialist that will trade the security and the CSAE will review the cospecialist’s trading performance in making its assignment decision.8 As an overall matter, the specialist firm and the individual co-specialist are jointly responsible for each assigned security and the decision by either the firm or the individual trader to deregister in a security could result in the posting of the security for re-assignment.9 The current Exchange rules generally require that a co-specialist to whom a security was assigned in competition to keep the assigned security for a period of two years.10 Alternatively, if the specialist unit agrees to have the security posted, a period of at least one year must have elapsed from the date of the original assignment.11 Further, securities assigned without competition may be transferred without a waiting period. However, in all situations, the transfers must be approved by the CSAE.12 The Exchange proposes to delete the waiting period requirement prior to approving a request for deregistration and to permit the transfer of securities among co-specialists within a firm, without seeking prior CSAE approval, as long as: (1) The specialist unit immediately notifies the Exchange of such transfer; and (2) when such a transfer is made within six months of an initial assignment of the security to the specialist unit, the specialist unit provides written notification to the 6 In Amendment No. 3, the Exchange makes minor, non-substantive changes to the rule text of the proposed rule change. This is a technical amendment and is not subject to notice and comment. 7 See Article XXX, Rule 1, Interpretation and Policy .01, Section II, Introductory paragraphs; and Section I.4. 8 See Article XXX, Rule 1, Interpretation and Policy .01, Sections II and III. 9 See Article XXX, Rule 1, Interpretation and Policy .01, Section I.4. 10 See Article XXX, Rule 1, Interpretation and Policy .01, Section I.2. 11 Id. 12 Id. PO 00000 Frm 00161 Fmt 4703 Sfmt 4703 Exchange of the transfer decision and of its reasons for making the change. Accordingly, each intrafirm transfer by the specialist unit effectively would deregister a co-specialist in the securities that the co-specialist no longer trades and register another cospecialist in any newly-assigned securities. In addition, under the Exchange’s existing rules, when the CSAE makes a decision to assign a particular security, the CSAE considers the qualifications of the specialist unit and the co-specialist’s demonstrated ability and experience. Because the CSAE bases its decision, in part, on a co-specialist’s qualifications, the Exchange proposes to make explicit in its rules that it is important that a specialist firm accurately represent plans for having a particular cospecialist trade a security. Under the proposal, a specialist unit must not designate a co-specialist with relatively strong demonstrated ability and experience when applying for a security and then immediately transfer the security to a co-specialist with less demonstrated ability and experience without good cause for making the change. The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.13 In particular, the Commission believes that the proposal, as amended, is consistent with Section 6(b)(5) of the Act, which requires that the rules of an exchange be designed to promote just and equitable principles of trade, remove impediments to, and perfect the mechanism of, a free and open market and a national market system, and, in general, protect investors and the public interest. The Commission believes that the proposed rule change, as amended, is designed to provide specialist firms with greater flexibility to respond to various market conditions that may require prompt transfer of securities among cospecialists within the same firm. With respect to the Exchange’s proposal to require that a specialist unit not designate a co-specialist with relatively strong demonstrated ability and experience when applying for a security and then immediately transfer the security to a co-specialist with less demonstrated ability and experience without good cause for making the change, the Commission believes that 13 In approving this proposed rule change, as amended, the Commission notes that it has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). E:\FR\FM\31JYN1.SGM 31JYN1

Agencies

[Federal Register Volume 71, Number 146 (Monday, July 31, 2006)]
[Notices]
[Pages 43251-43254]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-12155]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54192; File No. SR-CBOE-2006-27]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Order Granting Accelerated Approval 
of Proposed Rule Change and Amendment No. 1 Thereto Relating to Strike 
Price Intervals for VIX Options

July 21, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 15, 2006, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by the Exchange. 
On July 19, 2006, the CBOE filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice and order to 
solicit comments on the proposal from interested persons and to approve 
the proposed rule change, as amended, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced and superseded the original rule 
filing in its entirety.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes rules that would permit the Exchange to list 
and trade VIX options in $1 strike price intervals within certain 
parameters. The text of the proposed rule change, as amended, is below. 
Proposed new language is in italics.
* * * * *
Rule 24.9 Terms of Index Option Contracts
    No change.
    * * * Interpretations and Policies:
    .01 The procedures for adding and deleting strike prices for index 
options are provided in Rule 5.5 and Interpretations and Policies 
related thereto, as otherwise generally provided by Rule 24.9, and 
include the following:
    (a)-(d) No change.
    (e)(i) Notwithstanding paragraph (a), the interval between strike 
prices for options on the CBOE Volatility Index (VIX) will be no less 
than $2.50; provided, that subject to the following conditions, the 
interval between strike prices for VIX will be no less than $1.00:
    (A) The Exchange may open for trading series at $1.00 or greater 
strike price intervals for each expiration on up to 5 VIX option series 
above and 5 VIX option series below the current index level;
    (B) The Exchange may open for trading additional series at $1.00 or 
greater strike price internals for each expiration as the current index 
level of VIX moves from the exercise price of those VIX options series 
that already have been opened for trading on the Exchange so as to 
maintain at least 5 VIX option series above and 5 VIX option series 
below the current index level;
    (C) The Exchange may not open for trading series with $1.00 
intervals within $0.50 of an existing $2.50 strike price with the same 
expiration month; and
    (D) The interval between strike prices for VIX LEAPs will be no 
less than $2.50.
    (ii) For the purposes of adding strike prices on options on VIX at 
$1.00 or greater strike price intervals, as well as at $2.50 or greater 
strike price intervals, the ``current index level'' shall mean the 
implied forward level based on VIX futures prices.
    .02-.14 No change.
* * * * *

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
    The purpose of the proposed rule change is to permit the Exchange 
to list and trade options on the CBOE Volatility Index (``VIX'') in $1 
strike price intervals within certain parameters described below.\4\ 
VIX is calculated using real-time quotes of out-of-the-money and at-
the-money nearby and second nearby index puts and calls on the S&P 500 
Index (``SPX''). Generally, VIX provides investors with up-to-the-
minute market estimates of expected volatility of the S&P 500 Index.
---------------------------------------------------------------------------

    \4\ The Commission has also granted approval for CBOE to list 
options on the increased-value version of VIX (``Increased-Value 
VIX'') (see Securities Exchange Act Release No. 49698 (May 13, 
2004), 69 FR 29152 (May 20, 2004) (Notice of Filing and Order 
Granting Accelerated Approval of a Proposed Rule Change by the 
Chicago Board Options Exchange, Incorporated Relating to Options on 
Certain CBOE Volatility Indexes)). This proposed rule change does 
not apply to options on Increased-Value VIX.
---------------------------------------------------------------------------

    VIX is quoted in absolute numbers that represent the volatility of 
the S&P 500 Index in percentage points per annum. For example, an index 
level of 12.66 (the closing value of the VIX on March 7, 2006) 
represents an annualized volatility of 12.66% in the S&P 500 Index. The 
VIX level fluctuates quite differently than individual equity 
securities or indexes of individual equity securities. Specifically, 
the

[[Page 43252]]

Exchange states that indices such as VIX that track volatility are 
``mean-reverting,'' which is a statistical way of saying that there is 
a strong tendency for the volatility index to move toward its long-term 
historical average level. In other words, at historically low 
volatility index levels, there is a higher probability that the next 
big move will be up rather than down. Conversely, at historically high 
volatility index levels, the next big move is more likely to be down 
rather than up.
    Thus, as exemplified by VIX, the Exchange states volatility indexes 
tend to move within set ranges, and even when a level moves outside 
that range, the tendency towards mean-reversion often results in the 
volatility index returning to a level within the range. In the case of 
VIX, the historical average of VIX since 1990 is 19.4 and has closed at 
levels from a low of 9.3 to a high of 45.7. Since January 1, 2004, VIX 
has fluctuated in a narrow range between a level of 10.2 and a level of 
21.6. Furthermore, VIX closed under 25 for 82% of the days on which the 
level was calculated since 1990 (3,360 days out of a total of 4,078 
days) and has closed under 30 for 93% of the days on which the level 
was calculated since 1990 (3,791 days out of a total of 4,078 days).
    Under current CBOE rules, the Exchange may only list strikes on VIX 
options with intervals no less than $2.50. Therefore, the Exchange 
currently lists strikes on puts and calls on VIX options at 10, 12.50, 
15, 17.50, 20, 22.5 and 25. However, because of the generally limited 
range in which VIX has fluctuated, the Exchange believes that investors 
will be better served if the Exchange is able to list $1 strike price 
intervals in VIX option series. To address this, the Exchange is 
proposing to list series at $1 or greater strike price intervals for 
each expiration on up to 5 VIX option series above and 5 VIX option 
series below the current index level. Additional series at $1.00 or 
greater strike price internals could be listed for each expiration as 
the current index level of VIX moves from the exercise price of the VIX 
options series that already have been opened for trading on the 
Exchange in order to maintain at least 5 VIX option series above and 5 
VIX option series below the current index level. For purposes of adding 
strike prices at $1.00 or greater strike price intervals, as well as at 
$2.50 or greater strike price intervals, the ``current index level'' 
would be defined as the ``implied forward level'' of VIX for each 
expiration.\5\ The Exchange intends to determine implied forward levels 
of VIX through the use of VIX futures prices. Its reasons for using 
this approach are explained below.
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    \5\ With respect to $2.50 or greater strikes, the $2.50 or 
greater strike price intervals will be reasonably related to the 
current index value of VIX at or about the time such series are 
first opened for trading. The term ``reasonably related to the 
current index value of the underlying index'' means that the 
exercise price is within 30% of the current index value. The 
Exchange may also open additional $2.50 or greater strike price 
series that are more than 30% away from the current index value, 
provided that demonstrated customer interest exists for such series, 
as expressed by institutional, corporate, or individual customers or 
their brokers. See Interpretations and Policies .01(d) and .04 of 
Rule 24.9.
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    By way of background, the Exchange states that option prices 
reflect the market's expectation of the price of the underlying at 
expiration, which is referred to as the ``forward'' level. For stock 
indexes such as the SPX and the S&P 100 (``OEX''), the best estimate of 
the forward level is the current, or ``spot,'' price adjusted for the 
``carry,'' which is the financing cost of owning the component stocks 
in the index less the dividends paid by those stocks. For VIX, the 
Exchange states that a better estimate than the standard ``cash and 
carry'' model for calculating the forward levels of VIX at each 
expiration is reflected in the prices of the options that will be used 
to calculate VIX on that expiration day. For example, September SPX 
options will be used to calculate VIX on the August VIX expiration 
date. Likewise, November VIX options are tied to the implied volatility 
of December SPX options, and so on.
    The Exchange states that one important property of implied 
volatility is that it exhibits a ``term structure.'' In other words, 
the VIX volatility of options expiring on different dates can trade at 
different levels and can move independently. Another property related 
to the term structure is that implied volatility tends to trend toward 
the market's expectation of a long-term ``average'' value. As a result, 
the Exchange states that a large spike in one-month implied volatility 
might not affect implied volatility of longer-dated options very much 
at all. For example, the following table illustrates the recent 
behavior of forward VIX levels relative to dramatic change in the 
current VIX price.

----------------------------------------------------------------------------------------------------------------
                                                                    VIX forward     VIX forward
         VIX expiration month             Based on SPX options     prices (5/5/   prices  (5/19/      Change
                                            expiring in . . .           06)             06)
----------------------------------------------------------------------------------------------------------------
Spot VIX..............................  ........................           11.62           17.18           +5.56
June 2006.............................  July 2006...............           12.55           14.86           +2.31
August 2006...........................  September 2006..........           13.66           14.67           +1.01
November 2006.........................  December 2006...........           14.59           15.10           +0.51
February 2007.........................  March 2007..............           15.27           15.46           +0.19
May 2007..............................  June 2007...............           15.75           15.93           +0.18
May 2008..............................  June 2008...............           17.13           17.36           +0.36
----------------------------------------------------------------------------------------------------------------

    On May 5, 2006, ``spot'' VIX closed at 11.62. Forward VIX levels at 
different points along the term structure ranged from 12.55 (June 2006) 
to 17.13 (May 2008). Two weeks later, spot VIX closed at 17.18--a gain 
of more than 5.5 points from the May 5th spot VIX. However, June 
forward VIX levels increased by only 2.31 points, August forward VIX 
rose by 1.01 points, and November rose by 0.51 point. The increase in 
forward levels for contracts expiring 9 months and longer was only 
approximately 0.2 points.
    The Exchange notes that many traders use VIX futures prices as a 
proxy for forward VIX levels. The CBOE Futures Exchange, LLC (CFE) 
lists VIX futures corresponding to each VIX options expiration month. 
CBOE believes that using these prices is an accurate and transparent 
method for determining the ``current index level'' used to center the 
limited range in which $1 or greater strikes in VIX options will be 
listed and the broader range in which $2.50 or greater strikes in VIX 
options will be listed. Thus, the Exchange will use the corresponding 
VIX futures prices as a method for determining the ``current index 
level'' for listing series with both $1 and $2.50 strikes in VIX 
options.
    Additionally, the Exchange is proposing that it would not list 
series with $1 intervals within $0.50 of an existing $2.50 strike price 
with the same

[[Page 43253]]

expiration month (e.g., if there is an existing 12.50 strike, the 
Exchange would not list a 12 or 13 strike). Finally, the interval 
between strike prices for VIX long-term option series 
(``LEAPs[reg] '') will continue to be no less than $2.50.
    The Exchange states that the $1 strike price intervals will more 
closely bracket the level of VIX when it remains locked within a static 
range, as currently exists and will enable investors to assume more 
dynamic volatility index option positions that reflect greater 
possibilities of settling in-the-money.
    Finally, CBOE has analyzed its capacity and represents that it 
believes the Exchange and the Options Price Reporting Authority 
(``OPRA'') have the necessary systems capacity to handle the additional 
traffic associated with the listing and trading of $1 strike VIX 
options as proposed herein.
2. Statutory Basis
    CBOE believes the proposed rule change is consistent with the Act 
\6\ and the rules and regulations under the Act applicable to a 
national securities exchange and, in particular, the requirements of 
Section 6(b) of the Act.\7\ Specifically, the Exchange believes the 
proposed rule change is consistent with the Section 6(b)(5) \8\ 
requirements that the rules of an exchange be designed to promote just 
and equitable principles of trade, and to protect investors and the 
public interest.
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    \6\ 15 U.S.C. 78a et seq.
    \7\ 15 U.S.C. 78(f)(b).
    \8\ 15 U.S.C. 78(f)(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2006-27 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2006-27. This file 
number should be included on the subject line if e-mail 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 inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal offices of the Exchange. All comments received will be posted 
without change; the Commission does not edit personal identifying 
information from submissions. You should submit only information that 
you wish to make available publicly. All submissions should refer to 
File Number SR-CBOE-2006-27 and should be submitted on or before August 
21, 2006.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    After careful consideration, the Commission finds that the proposed 
rule change, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities exchange.\9\ In particular, the Commission finds that the 
proposed rule change, as amended, is consistent with Section 6(b)(5) of 
the Act,\10\ which requires, among other things, that the rules of a 
national securities exchange be designed to promote just and equitable 
principles of trade, remove impediments to and perfect the mechanism of 
a free and open market and a national market system, and protect 
investors and the public interest.
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    \9\ In approving this rule change, the Commission notes that it 
has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that this proposal, as amended, is a 
reasonable means of providing investors with greater flexibility to 
establish investment positions that can be better tailored to meet 
their objectives. Specifically, the Commission believes that the 
implementation of $1 strike price intervals for VIX options is designed 
to better serve investors in that product in that it will provide more 
dynamic strike levels that better reflect movements in the VIX. As 
explained by CBOE, the VIX level fluctuates much differently than 
individual equity securities or indexes of individual equity securities 
and has generally remained in a relatively narrow range since its 
inception. Because of these unique characteristics of the VIX, the 
Commission believes that the implementation of $1 strike price 
intervals in the VIX option product, within the parameters detailed in 
CBOE's proposal, is appropriate. The Commission notes that CBOE's 
proposed use of VIX futures as a proxy for the ``implied forward 
level'' of VIX used to calculate the ``current index value'' for 
purposes of adding strike price intervals is a methodology reasonably 
designed to reflex the unique properties of the VIX. The Commission 
further notes that CBOE has represented that the Exchange and OPRA have 
the necessary systems capacity to absorb the additional options traffic 
caused by the introduction of VIX $1 strikes.
    The Exchange has requested accelerated approval of the proposed 
rule change. The Commission finds good cause, consistent with Section 
19(b)(2) of the Act,\11\ for approving this proposed rule change before 
the thirtieth day after the publication of notice thereof in the 
Federal Register. The Commission believes that allowing the Exchange to 
list and trade options on the VIX in $1 strike price intervals 
immediately will provide investors with new means of managing their 
risk exposures and carrying out their investment objectives, and that 
any potential concerns about VIX $1 strikes are mitigated by the 
parameters detailed in the proposal.
---------------------------------------------------------------------------

    \11\ 15 U.S.C. 78s(b)(2).

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[[Page 43254]]

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-CBOE-2006-27), as amended, 
is approved on an accelerated basis.
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    \12\ Id.
    \13\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-12155 Filed 7-28-06; 8:45 am]
BILLING CODE 8010-01-P