Self-Regulatory Organizations; C2 Options Exchange, Incorporated; Order Approving Proposed Rule Change to Establish a Pilot Program To List and Trade a p.m.-Settled Cash-Settled S&P 500 Index Option Product, 55969-55976 [2011-23045]
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Federal Register / Vol. 76, No. 175 / Friday, September 9, 2011 / Notices
(B) institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–NYSEArca–2011–63 on the
subject line.
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Paper comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
All submissions should refer to File
Number SR–NYSEArca–2011–63. 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 (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. Copies of such filing
also will be available for inspection and
copying at the principal office of the
Exchange. All comments received will
be posted without change; the
Commission does not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
available publicly. All submissions
should refer to File Number SR–
NYSEArca–2011–63 and should be
submitted on or before September 30,
2011.
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For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.25
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011–23035 Filed 9–8–11; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–65256; File No. SR–C2–
2011–008]
Self-Regulatory Organizations; C2
Options Exchange, Incorporated;
Order Approving Proposed Rule
Change to Establish a Pilot Program
To List and Trade a p.m.-Settled CashSettled S&P 500 Index Option Product
September 2, 2011.
I. Introduction
On February 28, 2011, C2 Options
Exchange, Incorporated (the ‘‘Exchange’’
or ‘‘C2’’) 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 permit the
listing and trading of p.m.-settled, cashsettled options on the Standard & Poor’s
500 Index (‘‘S&P 500’’). The proposed
rule change was published for comment
in the Federal Register on March 8,
2011.3 The Commission received seven
comment letters on the proposal, some
of which urged the Commission to
disapprove the proposal.4 C2 responded
to the comment letters in a response
letter dated April 20, 2011.5 To ensure
that the Commission had sufficient time
to consider and take action on the
Exchange’s proposal in light of, among
other things, the comments received on
the proposal, the Commission extended
the time period in which to either
approve the proposed rule change,
disapprove the proposed rule change, or
institute proceedings to determine
25 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 See Securities Exchange Act Release No. 64011
(March 2, 2011), 76 FR 12775 (‘‘Notice’’).
4 See Letters to Elizabeth M. Murphy, Secretary,
Commission, from Randall Mayne, Blue Capital
Group, dated March 18, 2011 and April 28, 2011
(‘‘Mayne Letter 1’’ and ‘‘Mayne Letter 2’’); Michael
J. Simon, Secretary, International Securities
Exchange, LLC (‘‘ISE’’), dated March 29, 2011 and
May 11, 2011 (‘‘ISE Letter 1’’ and ‘‘ISE Letter 2’’);
Andrew Stevens, Legal Counsel, IMC Financial
Markets, dated March 24, 2011 (‘‘IMC Letter’’); John
Trader, dated April 20, 2011 (‘‘Trader Letter’’); and
JP, dated April 30, 2011 (‘‘JP Letter’’).
5 See Letter to Elizabeth M. Murphy, Secretary,
Commission, from Joanne Moffic-Silver, Secretary,
C2, dated April 20, 2011 (‘‘C2 Response Letter’’).
1 15
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whether to disapprove the proposed
rule change, to June 6, 2011.6
In order to solicit additional input
from interested parties, including
relevant data and analysis, on the issues
presented by C2’s proposed rule change,
on June 3, 2011, the Commission
instituted proceedings to determine
whether to approve or disapprove C2’s
proposal.7 In its order instituting the
proceedings, the Commission
specifically noted its interest in
receiving additional data and analysis
relating to the potential effect that
proposed p.m.-settled index options
could have on the underlying cash
equities markets. In response to the
proceedings, the Commission received
an additional three comment letters on
the proposal as well as a rebuttal letter
from C2.8 This order approves the
proposed rule change on a 14-month
pilot basis.
II. Description of the Proposal
The Exchange’s proposal would
permit it to list and trade cash-settled
S&P 500 index options with thirdFriday-of-the-month (‘‘Expiration
Friday’’) expiration dates for which the
exercise settlement value will be based
on the index value derived from the
closing prices of component securities
(‘‘p.m.-settled’’). The proposed contract
(referred to as ‘‘SPXPM’’) would use a
$100 multiplier, and the minimum
trading increment would be $0.05 for
options trading below $3.00 and $0.10
for all other series. Strike price intervals
would be set no less than 5 points apart.
Consistent with existing rules for index
options, the Exchange would allow up
to twelve near-term expiration months,
as well as LEAPS. Expiration processing
would occur on the Saturday following
Expiration Friday. The product would
have European-style exercise and would
not be subject to position limits, though
there would be enhanced reporting
requirements.
The Exchange proposes that the
SPXPM product be approved on a pilot
basis for an initial period of fourteen
months. As part of the pilot program,
the Exchange committed to submit a
pilot program report to the Commission
at least two months prior to the
6 See Securities Exchange Act Release No. 64266
(April 8, 2011), 76 FR 20757 (April 13, 2011).
7 See Securities Exchange Act Release No. 64599
(June 3, 2011), 76 FR 33798 (June 9, 2011).
8 See Letters to Elizabeth M. Murphy, Secretary,
Commission, from Michael J. Simon, Secretary,
International Securities Exchange, LLC dated July
11, 2011 (‘‘ISE Letter 3’’); William J. Brodsky,
Chairman and Chief Executive Officer, C2, dated
July 11, 2011 (‘‘CBOE Letter 3’’); Thomas Foertsch,
President, Exchange Capital Resources, dated July
11, 2011; and William J. Brodsky, Chairman and
Chief Executive Officer, C2, dated July 25, 2011.
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expiration date of the program (the
‘‘annual report’’). The annual report
would contain an analysis of volume,
open interest, and trading patterns. The
analysis would examine trading in the
proposed option product as well as
trading in the securities that comprise
the S&P 500 index. In addition, for
series that exceed certain minimum
open interest parameters, the annual
report would provide analysis of index
price volatility and share trading
activity. In addition to the annual
report, the Exchange committed to
provide the Commission with periodic
interim reports while the pilot is in
effect that would contain some, but not
all, of the information contained in the
annual report. In its filing, C2 notes that
it would provide the annual and interim
reports to the Commission on a
confidential basis.9
III. Comments Received
In response to the initial notice of
C2’s proposal, the Commission received
seven comment letters, some of which
expressed concern with the proposal.10
One commenter specifically urges the
Commission to disapprove the
proposal.11 Commenters expressing
concern with the proposal raised several
issues, including: The potential for
adverse effects on the underlying cash
markets that could accompany the
reintroduction of p.m. settlement;
concern with the similarity (but lack of
fungibility) between the existing S&P
500 index option traded on the Chicago
Board Options Exchange, Incorporated
(‘‘CBOE’’) and the proposed S&P 500
index option that would be traded on
C2; the lack of proposed position limits
for SPXPM; and issues regarding
exclusive product licensing. Three
commenters expressed support for the
proposal.12
In the proceedings to determine
whether to approve or disapprove the
proposal, the Commission preliminarily
summarized the issues raised by the
commenters, and also set forth a series
of questions and requests for data on the
issue of p.m. settlement. In response to
the proceedings, the Commission
received three letters, including one
from C2, one from ISE that expands on
the concerns it previously raised and
reiterates its recommendation for the
Commission to disapprove the proposal,
and one from a new commenter that
supports the proposal because it will
9 See
Notice, supra note 3, at 12777.
Mayne Letter 1, ISE Letter 1, ISE Letter 2,
and Trader Letter, supra note 4.
11 See ISE Letter 1 and ISE Letter 2, supra note
4.
12 See Mayne Letter 2, IMC Letter, and JP Letter,
supra note 4.
10 See
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offer investors greater flexibility.13 The
Commission also received an additional
letter from C2 responding to the
comments of ISE.14 The comments
received are addressed below.
IV. Discussion and Commission
Findings
After careful consideration of the
proposal and the comments received,
the Commission finds that the proposed
rule change is consistent with the
requirements of the Act and the rules
and regulations thereunder applicable to
a national securities exchange,15 and, in
particular, the requirements of Section 6
of the Act.16 Specifically, the
Commission finds that the proposed
rule change is consistent with Section
6(b)(5) of the Act,17 which requires that
an exchange have rules designed to
remove impediments to and perfect the
mechanism of a free and open market
and to protect investors and the public
interest.
A. Relationship to the National Market
System
One commenter believes that separate
a.m. and p.m.-settled S&P 500 index
options could potentially bifurcate the
market for CBOE’s existing a.m.-settled
SPX contract.18 This commenter notes
that the SPX, which trades only on
CBOE, accounts for 60% of all index
options trading, and argues that the sole
difference in settlement between SPX on
CBOE and the proposed S&P 500 index
options on C2 (i.e., a.m. vs. p.m.
settlement) is a ‘‘sham’’ that is intended
to ‘‘keep them non-fungible,’’ which
would ‘‘make a mockery of Section 11A
of the Act.’’ 19 The commenter states
that the objectives of Section 11A are
reflected in a national market system
plan for options that requires exchanges
to prevent trading through better priced
quotations displayed on other options
exchanges, and that making a p.m.settled S&P 500 index option nonfungible with CBOE’s SPX would allow
the CBOE group to establish two
‘‘monopolies’’ in S&P 500 options, one
floor-based (CBOE) and one electronic
(C2) that would avoid the application of
the limitation on trade throughs.20 The
commenter also contends the proposal
13 See
ECR Letter, supra note 8.
C2 Rebuttal Letter, supra note 8.
15 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).
16 15 U.S.C. 78f.
17 15 U.S.C. 78f(b)(5).
18 See ISE Letter 1, supra note 4, at 4.
19 Id. at 2. See also ISE Letter 2, supra note 4, at
3–4.
20 See ISE Letter 1, supra note 4, at 3.
14 See
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is designed to protect CBOE’s floorbased SPX trading without having to
accommodate the more narrow quotes
that would likely occur on C2 in an
electronically-traded p.m.-settled
product.21
Another commenter asserts that CBOE
and C2 should trade a fungible S&P 500
index option in order to address what
the commenter describes as ‘‘huge
customer-unfriendly spreads’’ in SPX.22
The commenter argues that if the CBOE
believes p.m. settlement is superior to
a.m. settlement, then CBOE should file
to change SPX to p.m. settlement so that
the product traded on C2 would be
fungible with that proposed to be traded
on CBOE.23
In response, C2 argues that the
difference between a.m.-settled and
p.m.-settled S&P 500 index option
would be a material term and that C2’s
proposed S&P 500 index option could
not be fungible with, nor could it be
linked with, CBOE’s SPX option.24
The Commission agrees that the
difference between a.m.-settled SPX and
the proposed p.m.-settled SPXPM
involves a materially different term (i.e.,
settlement time) that makes C2’s
proposed SPXPM index option a
different security than, and thus not
fungible with, CBOE’s SPX option.25
The Commission notes that it has
permitted very similar but different
products to trade on the same exchange
or on different exchanges without those
separate products being fungible. For
example, the Commission previously
approved for CBOE the listing and
trading of a.m.-settled S&P 500 index
options during a time when CBOE also
traded p.m.-settled S&P 500 index
options, and the two separate products
were not fungible.26
21 See
ISE Letter 1, supra note 4, at 2.
Trader Letter, supra note 4, at 1. See also
JP Letter, supra note 4, at 1.
23 See Trader Letter, supra note 4, at 1.
24 See C2 Response Letter, supra note 5, at 3.
25 Consequently, rules applicable to prevent
trading through better priced quotations in the same
security displayed on other options exchanges
would not be applicable for trading between these
two products.
Similarly, in response to a comment that
investors would be confused by the presence of an
a.m.-settled SPX on CBOE and a p.m.-settled S&P
500 index option on C2 (see ISE Letter 1, supra note
4, at 3), the Commission does not believe that SPX
on CBOE and a p.m.-settled S&P 500 index option
on C2 would cause investor confusion. The two
products would trade under different ticker
symbols and any potential for investor confusion
could be mitigated though investor outreach and
education initiatives. Furthermore, as C2 notes in
its response letter, CBOE currently lists two options
on the S&P 100 (American-style OEX and Europeanstyle XEO) and is not aware of any investor
confusion among the products. See C2 Response
Letter, supra note 5, at 3.
26 See infra note 44 (citing to Securities Exchange
Act Release No. 24367). See also Securities
22 See
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One commenter also raises concerns
about the potential effect on
competition of C2 listing and trading an
option product that is subject to an
exclusive license, citing to concerns
they express with respect to the SPX
product traded on CBOE.27
The Commission recognizes the
potential impact on competition
resulting from the inability of other
options exchanges to list and trade
SPXPM. In acting on this proposal,
however, the Commission has balanced
the potentially negative competitive
effects with the countervailing positive
competitive effects of C2’s proposal. The
Commission believes that the
availability of SPXPM on the C2
exchange will enhance competition by
providing investors with an additional
investment vehicle, in a fully-electronic
trading environment, through which
investors can gain and hedge exposure
to the S&P 500 stocks. Further, this
product could offer a competitive
alternative to other existing investment
products that seek to allow investors to
gain broad market exposure. Also, we
note that it is possible for other
exchanges to develop or license the use
of a new or different index to compete
with the S&P 500 index and seek
Commission approval to list and trade
options on such index.
Accordingly, with respect to the
Commission’s consideration of C2’s
proposed rule change at this time, the
Commission finds that it does not
impose any burden on competition not
Exchange Act Release No. 51619 (Apr. 27, 2005), 70
FR 22947 (May 3, 2005) (order approving ISE’s
listing and trading of options on various Russell
Indexes, including options based upon one-tenth
values of the Russell Indexes).
27 See ISE Letter 1, supra note 4, at 6–7 (arguing
in part that ‘‘CBOE’s monopoly in the product
imposes significant harm to investors,’’ including
the fact that ‘‘CBOE charges for trading SPX options
that are much greater than the fees for multiply
listed options’’ and ‘‘the quotes in SPX options are
much wider than they would be if there was
competition from other exchanges,’’ as well as that
‘‘CBOE is able to use the monopolistic revenue
stream from these options to subsidize other
products * * *.’’) and ISE Letter 2, supra note 4,
at 3–4 (arguing in part that ‘‘[t]he Proposal is
harmful to investors because it * * * perpetuates
the unreasonably high monopolistic pricing and
artificially wide spreads that result from the lack of
competition in this product.’’).
The issue of state law intellectual property rights
of index developers in the use of their indexes to
trade derivatives is the subject of litigation between
CBOE and ISE (as well as other parties). See
Chicago Board Options Exchange, Incorporated et
al. v. International Securities Exchange, et al., Case
No. 06 CH 24798 (Cir. Ct. of Cook Cty., Ch. Div. July
8, 2010), appeal docketed, No. 1–10–2228 (Ill. App.
Ct. August 9, 2010). See also Board of Trade of the
City of Chicago v. Dow Jones & Co., Inc., 98 Ill.2d
109 (1983). In issuing this order, the Commission
expresses no view with respect to the matters
underlying this ongoing litigation, including their
validity or the enforceability of the exclusivity
agreement.
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necessary or appropriate in furtherance
of the purposes of the Act.28
B. Position Limits
Under C2’s proposal, position limits
would not apply to SPXPM. One
commenter argues that position limits
should apply to SPXPM.29 This
commenter notes that, since 2001 when
the Commission approved a CBOE rule
filing to remove all position limits for
SPX options,30 the Commission has
generally expected exchanges to apply a
model, such as the Dutt-Harris model, to
determine the appropriate position
limits for all new index options
products.31 Because C2 claims that the
product is new and non-fungible, the
commenter argues that the Commission
should apply the Dutt-Harris model to
require C2 to impose position limits on
SPXPM.32
In its response to comments, C2 notes
that the Dutt-Harris Paper acknowledges
that S&P 500 options have, and should
have, extraordinarily large position
limits and Dutt-Harris observes that
position limits are most useful when
market surveillance is inadequate.33 C2
argues that position limits suggested by
the Dutt-Harris model for an S&P 500
index option would be so large as to be
irrelevant and that positions of such
magnitude would attract scrutiny from
surveillance systems that would, as a
consequence, serve as an effective
substitute for position limits.34 Further,
28 The Commission may in the future determine
it appropriate to consider or address competitive
issues related to exclusive licensing of index option
products on a more comprehensive level.
29 See ISE Letter 1, supra note 4, at 6.
30 See Securities Exchange Act Release No. 44994
(October 26, 2002), 66 FR 55722 (November 2,
2001). In this filing, the Commission relied in part
on CBOE’s ability to provide enhanced surveillance
and reporting safeguards to detect and deter trading
abuses arising from the elimination of position and
exercise limits in options on the S&P 500.
31 See ISE Letter 1, supra note 4, at 6. In a 2005
paper from Hans Dutt and Lawrence Harris, titled
‘‘Position Limits for Cash-Settled Derivative
Contracts’’ (‘‘Dutt-Harris Paper’’) the authors
developed a model to determine appropriate
position limits for cash-settled index derivatives.
The authors concluded that the then-prevailing
position limits were lower than the model
suggested would be appropriate for many derivative
contracts. The authors also concluded, however,
that position limits are not as important for broadbased index derivative contracts that are cash
settled because they are composed of highly liquid
and well-followed securities. As such, the authors
note that it would require very high trading
volumes to manipulate the underlying securities
and, consequently, any attempted manipulation
would be more easily detectable and prosecutable.
32 See ISE Letter 1, supra note 4, at 6.
33 See C2 Response Letter, supra note 5, at 5.
34 See id. Generally, position limits are intended
to prevent the establishment of options positions
that could be used or that might create incentives
to manipulate or disrupt the underlying market to
benefit the holder of the options. See, e.g.,
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in its response letter, C2 summarizes the
circumstances and considerations relied
upon by the Commission when it
approved the elimination of position
limits on CBOE’s S&P 500 index option,
including the enormous capitalization
of the index and enhanced reporting
and surveillance for the product.35
Thus, because of the enhanced reporting
and surveillance for this product,
described below, C2 argues that the
absence of position limits on its
proposed S&P 500 index option would
not be inconsistent with Dutt-Harris.36
The Exchange represents, however,
that it will implement enhanced
reporting requirements pursuant to its
Rule 4.13 (Reports Related to Position
Limits) and Interpretation and Policy
.03 to its Rule 24.4 (Position Limits for
Broad-Based Index Options), which sets
forth the reporting requirements for
certain broad-based indexes that do not
have position limits.37
In 2001, when the Commission
permanently approved a CBOE rule
(which had been in place for a two-year
pilot period) to eliminate position limits
on SPX (as well as options on the Dow
Jones Industrial Average and the S&P
100 index),38 the Commission stated
that because the S&P 500 index is a
broad-based index with a considerable
capitalization, manipulation of the 500
component stocks underlying the index
would require extraordinarily large
positions that would be readily
detectable by enhanced surveillance
procedures. In its approval order, the
Commission relied in part on CBOE’s
enhanced surveillance and reporting
procedures that are intended to allow
CBOE to detect and deter trading abuses
in the absence of position limits. In
particular, CBOE requires its members
to submit a report to CBOE when the
member builds a position of 100,000+
contracts. Among other things, the
report includes a description of the
Securities Exchange Act Release Nos. 39489
(December 24, 1997), 63 FR 276 (January 5, 1998)
(SR–CBOE–97–11) (approving increases to the
position and exercise limits for options on the
Standard & Poor’s 100 Stock Index (‘‘OEX’’), the
OEX firm facilitation exemption, and the OEX
index hedge exemption); Dutt-Harris Paper, supra
note 31 (‘‘Position limits directly limit
manipulation by limiting the size of derivative
positions that would benefit from manipulative
practices.’’).
35 See C2 Response Letter, supra note 5, at 5–6.
C2 represents in its response letter that it would
monitor trading in p.m.-settled S&P 500 index
options in the same manner as CBOE does for other
broad-based index options with no position limits.
See id. at 6.
36 See id.
37 See Notice, supra note 3, at note 4 and
accompanying text.
38 See Securities Exchange Act Release No. 44994
(October 26, 2001), 66 FR 55722 (November 2, 2001)
(SR–CBOE–2001–22).
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option position, whether the position is
hedged (and, if so, a description of the
hedge), and whether collateral was used
(and, if so, a description of the
collateral). This enhanced surveillance
and reporting arrangement allows CBOE
to continually monitor, assess, and
respond to any concerns at an early
stage. To complement its enhanced
surveillance and reporting
requirements, CBOE has the ability to
intervene to impose additional margin
or assess capital charges when
warranted. Thus, together with the
‘‘enormous capitalization’’ 39 of the S&P
500 index and the deep and liquid
markets for the S&P 500 stocks, the
Commission found that CBOE’s
enhanced surveillance procedures
‘‘reduce[] concerns regarding market
manipulation or disruption in the
underlying market.’’ 40
C2 has represented in this filing that
its enhanced surveillance requirements
and procedures for SPXPM would be
identical to the surveillance and
reporting requirements and procedures
used by CBOE with respect to SPX.
Accordingly, the Commission believes
that position limits would not be
necessary for SPXPM options as long as
C2 has in place and enforces effective
enhanced surveillance and reporting
requirements. These enhanced
procedures will allow the Exchange to
see, with considerable advance notice,
the accumulation of large positions,
which it can then monitor more closely
as necessary and take additional action
if appropriate.41
C. Reintroduction of P.M. Settlement
When cash-settled 42 index options
were first introduced in the 1980s, they
generally utilized closing-price
settlement procedures (i.e., p.m.
settlement).43 The Commission became
39 Id.
at 55723.
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40 Id.
41 In addition, the Commission notes that C2
would have access to information through its
membership in the Intermarket Surveillance Group
with respect to the trading of the securities
underlying the S&P 500 index, as well as tools such
as large options positions reports to assist its
surveillance of SPXPM options.
In approving the proposed rule change, the
Commission also has relied upon the Exchange’s
representation that it has the necessary systems
capacity to support new options series that will
result from this proposal. See Notice, supra note 3,
at 12777.
42 The seller of a ‘‘cash settled’’ index option pays
out the cash value of the applicable index on
expiration or exercise. A ‘‘physically settled’’
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/
components/docs/riskstoc.pdf, for a discussion of
settlement.
43 The exercise settlement value for a p.m.-settled
index option is generally determined by reference
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concerned about the impact of p.m.
settlement on cash-settled index options
on the markets for the underlying stocks
at the close on expiration Fridays.44
These concerns were heightened during
the quarterly expirations of the third
Friday of March, June, September and
December when options, index futures,
and options on index futures all expire
simultaneously. P.m.-settlement was
believed to have contributed to aboveaverage volume and added market
volatility on those days, which
sometimes led to sharp price
movements during the last hour of
trading.45 As a consequence, the close of
to the reported level of the index as derived from
the closing prices of the component securities
(generally based on the closing prices as reported
by the primary exchange on which the stock is
listed) on the last business day before expiration
(e.g., the Friday before Saturday expiration). See
Characteristics and Risks of Standardized Options,
available at: https://www.theocc.com/components/
docs/riskstoc.pdf, for a discussion of settlement
value.
44 See, e.g., Securities Exchange Act Release Nos.
45956 (May 17, 2002), 67 FR 36740 (May 24, 2002)
(adopting release concerning cash settlement and
regulatory halt requirements for security futures
products) (‘‘Regulators and self-regulators were
concerned that the liquidity constraints faced by the
securities markets to accommodate expirationrelated buy or sell programs at the market close on
expiration Fridays could exacerbate ongoing market
swings during an expiration and could provide
opportunities for entities to anticipate these
pressures and enter orders as part of manipulative
or abusive trading practices designed to artificially
drive up or down share prices.’’); 24367 (April 17,
1987), 52 FR 13890 (April 27, 1987) (SR–CBOE–87–
11) (order approving a proposal for S&P 500 index
options with an exercise settlement value based on
an index value derived from opening, rather than
closing, prices); and 32868 (September 10, 1993), 58
FR 48687 (September 10, 1993) (notice of filing and
order granting accelerated approval of proposed
rule change by the New York Stock Exchange, Inc.
(‘‘NYSE’’) relating to changes in auxiliary closing
procedures for expiration days) (stating, ‘‘[a]s long
as some index derivative products continue to
expire based on closing stock prices on expiration
Fridays, the Commission agrees with the NYSE that
such procedures are necessary to provide a
mechanism to handle the potential large imbalances
that can be engendered by firms unwinding index
derivative related positions’’). The cash settlement
provisions of stock index futures and options
contracts facilitated the growth of sizeable index
arbitrage activities by firms and professional traders
and made it relatively easy for arbitrageurs to buy
or sell the underlying stocks at or near the market
close on expiration Fridays (i.e., the third Friday of
the expiration month) in order to ‘‘unwind’’
arbitrage-related positions. These types of
unwinding programs at the close on expiration
Fridays often severely strained the liquidity of the
securities markets as the markets, and in particular
the specialists on the NYSE, faced pressure to
attract contra-side interest in the limited time that
was permitted to establish closing prices. See
Securities Exchange Act Release No. 44743 (August
24, 2001), 66 FR 45904 (August 30, 2001) (File No.
S7–15–01) (proposing release concerning cash
settlement and regulatory halt requirements for
security futures products).
45 See, e.g., Securities Exchange Act Release Nos.
24276 (March 27, 1987); 52 FR 10836 (April 3,
1987) (notice of filing and order granting
accelerated approval to a proposed rule change by
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trading on the quarterly expiration
Friday became known as the ‘‘triple
witching hour.’’ Besides contributing to
investor anxiety, heightened volatility
during the expiration periods created
the opportunity for manipulation and
other abusive trading practices in
anticipation of the liquidity
constraints.46
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 (‘‘CFTC’’)
approved a rule change by the Chicago
Mercantile Exchange to provide for a.m.
settlement for index futures, including
futures on the S&P 500 index.47 The
Commission subsequently approved a
rule change by CBOE to list and trade
a.m.-settled S&P 500 index options.48 In
the NYSE relating to opening price settlement of
expiring NYSE Composite and Beta Index options);
37894 (October 30, 1996), 61 FR 56987 (November
5, 1996) (notice of filing and order granting
accelerated approval of proposed rule change by the
NYSE permanently approving the expiration day
auxiliary closing procedures pilot program); and
45956 (May 17, 2002), 67 FR 36740 (May 24, 2002)
(adopting release concerning cash settlement and
regulatory halt requirements for security futures
products) (reaffirming the Commission’s view of the
advantages of a.m. settlement). See also Hans Stoll
and Robert Whaley, Expiration Day Effects of Index
Options & Futures (March 15, 1986) (noting that
share volume on the NYSE was much higher in the
last hour of a quarterly expiration Friday when both
options and futures expire than on non-expiration
Fridays).
46 See, e.g., Securities Exchange Act Release No.
45956 (May 17, 2002), 67 FR 36740 (May 24, 2002)
(adopting release concerning cash settlement and
regulatory halt requirements for security futures
products) (explaining that entities could take
advantage of illiquidity resulting from the
unwinding of arbitrage-related positions on
expiration Fridays to manipulate share prices).
47 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 Chicago
Mercantile Exchange). See also Securities Exchange
Act Release No. 24367 (April 17, 1987), 52 FR
13890 (April 27, 1987) (SR–CBOE–87–11) (noting
that the Chicago Mercantile Exchange moved the
S&P 500 futures contract’s settlement value to
opening prices on the delivery date).
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.
48 See Securities Exchange Act Release No. 24367
(April 17, 1987), 52 FR 13890 (April 27, 1987) (SR–
CBOE–87–11) (order approving a proposal for S&P
500 index options with an exercise settlement value
based on an index value derived from opening,
rather than closing, prices). At the time it approved
CBOE’s introduction of a.m. settlement for cashsettled index options, the Commission identified
two benefits to a.m. settlement for cash-settled
index options. See Securities Exchange Act Release
No. 30944 (July 21, 1992), 57 FR 33376 (July 28,
1992) (SR–CBOE–92–09). First, it provides
additional time to test price discovery, as market
participants have the remainder of the regular
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1992, the Commission approved CBOE’s
proposal to transition all of its
European-style cash-settled options on
the S&P 500 index to a.m. settlement.49
Thereafter, the Commission approved
proposals by the options markets to
transfer most of their cash-settled index
products to a.m. settlement.50
The Commission and the CFTC noted
the benefits of a.m. settlement in a 2001
joint release concerning securities
futures, where they observed that ‘‘the
widespread adoption of opening-price
settlement procedures in index futures
and options has served to mitigate the
liquidity strains that had previously
been experienced in the securities
markets on expirations.’’ 51
trading day to adjust to opening session price
movements and determine whether those
movements reflect changes in fundamental values
or short-term supply and demand conditions.
Second, it provides more opportunity to trade out
of positions acquired during the opening auction.
In this respect, attracting contra-side interest to a
single-priced auction to offset an order imbalance
(such as those attributable to index arbitrage) may
more readily be achieved in an opening auction on
Friday morning than a closing auction on Friday
afternoon because the morning session allows
market participants that have provided that
liquidity to have the remainder of the regular
trading day to liquidate their positions. In contrast,
positions acquired in a Friday afternoon closing
auction generally cannot be liquidated as readily
and efficiently until the following Monday. Holding
positions overnight, or over a weekend, may entail
greater risk than holding intraday positions. To
accept such risk (real or perceived), market
participants generally will require a greater
premium, which may translate into greater price
concessions, and thus lead to greater volatility in
the closing auction. In other words, a consequence
of p.m. settlement may be enhanced volatility at the
close. See, e.g., Securities Exchange Act Release No.
44743 (August 24, 2001), 66 FR 45904 at 45908
(August 30, 2001) (‘‘Steep discounts (premiums)
were necessary in part because traders who bought
(sold) stocks to offset unwinding programs had to
maintain their newly acquired long (short) positions
over the weekend—during which time they were
subject to considerable market risk.’’).
49 See Securities Exchange Act Release No. 30944
(July 21, 1992), 57 FR 33376 (July 28, 1992) (SR–
CBOE–92–09) (order approving CBOE’s proposal
relating to position limits for SPX index options
based on the opening price of component
securities).
50 CBOE’s index options on the S&P 100 (OEX),
however, kept their p.m. settlement. See Securities
Exchange Act Release No. 30944 (July 21, 1992), 57
FR 33376 (July 28, 1992) (SR–CBOE–92–09). No
futures or options on futures trade on the S&P 100
index. Other types of options utilize p.m.
settlement, including physically-settled single-stock
options and options on ETFs.
51 See Securities Exchange Act Release No. 44743
(August 24, 2001), 66 FR 45904 at 45908 (August
30, 2001) (proposing release for a joint rule between
the Commission and the CFTC generally
stipulating, among other provisions, that the final
settlement price for each cash-settled security
futures product fairly reflect the opening price of
the underlying security or securities). See also
Securities Exchange Act Release No. 45956 (May
17, 2002), 67 FR 36740 at 36741–42 (May 24, 2002)
(adopting release concerning cash settlement and
regulatory halt requirements for security futures
products in which the Commission reaffirmed the
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Since 1992, the Commission has
approved proposals that provide for
cash-settled index options with p.m.
settlement on a limited basis for options
products that generally are
characterized by lower relative volume
and that generally do not involve
settlement on the third Friday of a
month.52 At the time of each approval,
the Commission stated that limited
approvals on a pilot basis would allow
the exchange and the Commission to
monitor the potential for adverse market
effects and modify or terminate the
pilots, if necessary. Notably, with the
exception of FLEX Index options, these
recently-approved p.m.-settled contracts
do not involve expiration on the third
Friday of the month. These new
contracts, including FLEX, have also
been characterized by limited volume,
and would not be expected to have a
pronounced effect on volatility in the
underlying securities at the close as a
result.
In response to C2’s proposal, two
commenters raise concerns over the
reintroduction of p.m. settlement on a
potentially popular index derivative and
advantages of a.m. settlement) (‘‘[O]pening price
settlement procedures offered several features that
enabled the securities markets to better handle
expiration-related unwinding programs.’’).
52 In particular, in 1993, the Commission
approved CBOE’s proposal to list and trade p.m.settled, cash-settled options on certain broad-based
indexes expiring on the first business day of the
month following the end of each calendar quarter
(‘‘Quarterly Index Expirations’’). See Securities
Exchange Act Release No. 31800 (February 1, 1993),
58 FR 7274 (February 5, 1993) (SR–CBOE–92–13).
In 2006, the Commission approved, on a pilot basis,
CBOE’s listing of p.m.-settled index options
expiring on the last business day of a calendar
quarter (‘‘Quarterly Options Series’’). See Securities
Exchange Act Release No. 54123 (July 11, 2006), 71
FR 40558 (July 17, 2006) (SR–CBOE–2006–65). In
January 2010, the Commission approved CBOE’s
listing of p.m.-settled FLEX options on a pilot
basis.52 See Securities Exchange Act Release No.
61439 (January 28, 2010), 75 FR 5831 (February 4,
2010) (SR–CBOE–2009–087) (order approving rule
change to establish a pilot program to modify FLEX
option exercise settlement values and minimum
value sizes). FLEX options provide investors with
the ability to customize basic option features
including size, expiration date, exercise style, and
certain exercise prices. Prior to 2010, only a.m.
settlement based on opening prices of the
underlying components of an index could be used
to settle a FLEX index option if it expired on, or
within two business days of, a third-Friday-of-themonth expiration (‘‘Blackout Period’’). Last year,
the Commission approved a pilot program to permit
FLEX index options with p.m. settlement that
expire within the Blackout Period. See Securities
Exchange Act Release No. 61439 (January 28, 2010),
75 FR 5831 (February 4, 2010) (SR–CBOE–2009–
087). In September 2010, the Commission approved
CBOE’s listing of p.m.-settled End of Week
expirations (expiring on each Friday, other than the
third Friday) and End of Month expirations
(expiring on the last trading day of the month) for
options on broad-based indexes, also on a pilot
basis. See Securities Exchange Act Release No.
62911 (September 14, 2010), 75 FR 57539
(September 21, 2010) (SR–CBOE–2009–075).
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55973
the possible impact that doing so could
have on the underlying cash equities
markets.53 One commenter urges the
Commission to consider why markets
went to a.m. settlement in the early
1990s and opines that hindsight
supports the conclusion that a.m.
settlement has been good for the
markets.54 While acknowledging that
the answer is not clear, the commenter
asks the Commission to consider
whether it is now safe to return to the
dominance of p.m.-settled index options
and futures.55 However, this commenter
submitted a subsequent letter in which
he agreed with the Exchange that
‘‘conditions today are vastly different’’
from those that drove the transition to
a.m. settlement.56 The commenter
concludes that C2’s proposal should be
approved on a pilot basis, which would
allow the Commission to collect data to
closely analyze the impact of the
proposal.57
A different commenter describes the
history behind the transition to a.m.
settlement and criticizes C2 for
trivializing that history.58 This
commenter argues that a mainstream
return to the ‘‘discredited’’ p.m.
settlement would ‘‘risk undermining the
operation of fair and orderly financial
markets.’’ 59 The commenter notes that
experience with the ‘‘flash crash’’ of
May 6, 2010 demonstrates that the
current market structure struggles to
find price equilibriums, and that
dispersed trading is a ‘‘mirage’’ as
participants often flock to the same
liquidity centers in time of stress.60 In
its July comment letter, the commenter
took a slightly different approach by
arguing that fragmentation is the biggest
change to the markets since 1987 when
markets moved to a.m. settlement.61 The
commenter notes that even with almost
all volume concentrated on one
exchange back in the 1980s, the markets
could not address closing liquidity and
volatility concerns and prevent market
disruptions on ‘‘triple witch’’ settlement
53 See ISE Letter 1, supra note 4, at 4–5; ISE Letter
2, supra note 4, at 2–3; and Mayne Letter 1, supra
note 4, at 1–2.
54 See Mayne Letter 1, supra note 4, at 1 (noting
that concerns with p.m. settlement ‘‘led to the
advent of the far more innocuous, and perhaps
more fair ‘AM–Print’ method of determining the
final value for expiring index options. To judge by
the abatement of the negative press, hindsight
would seem to support that the AM–Print made for
a more level playing field.’’)
55 See id. at 2.
56 See Mayne Letter 2, supra note 4, at 1.
57 See id.
58 See ISE Letter 1, supra note 4, at 4.
59 Id.
60 See id.
61 See ISE Letter 3, supra note 8, at 2.
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dates.62 The commenter believes that
fragmentation makes it almost
impossible for any single market to
concentrate liquidity at the close to
produce an effective clearing price at
times of market volatility.63 In addition,
the commenter argues that exchangespecific closing procedures are only
applicable to trading on one exchange,
which represents a small fraction of the
overall market today, and therefore will
have little ability to dampen market
volatility.64 The commenter believes
that C2’s proposal would exacerbate
liquidity strains by reintroducing an
extraordinary market event—the triple
witching hour—and argues that
allowing S&P 500 index options to be
based on closing settlement prices, even
on a pilot basis, would re-introduce the
potential for extreme market volatility at
expiration.65
In addition, the commenter states that
Commission approval of C2’s proposal
would lead to the reintroduction of
multiple p.m.-settled derivatives and
argues that while the SPXPM pilot
would be troubling, having multiple
pilots operating simultaneously would
undermine the industry-wide move to
a.m. settlement.66 The Commission
generally considers relevant information
available to it at the time it reviews each
filing in evaluating whether the filing is
consistent with the Act.67
Taking the opposite view, two
commenters urge the Commission to
approve the proposal on a pilot basis.68
One commenter asserts its belief that
C2’s proposal will not cause greater
volatility in the underlying securities of
the S&P 500 index.69 This commenter
opines that whether an options contract
is p.m.-settled as opposed to a.m.-settled
is not a contributing factor to volatility,
and the commenter notes that there is
more liquidity in the securities
underlying the S&P 500 index at the
close compared to the opening.70 The
commenter states that exchanges are
well equipped to handle end-of-day
volume and that existing p.m.-settled
products do not contribute to increased
volatility.71 The other commenter states
62 See
id.
id.
64 See id.
65 See ISE Letter 1, supra note 4, at 5. This
commenter also notes that recently-imposed circuit
breakers in the cash equities markets do not apply
in the final 25 minutes of trading. See id.
66 See ISE Letter 3, supra note 8, at 3.
67 See 15 U.S.C. 78s(b) (concerning Commission
consideration of proposed rule changes submitted
by self-regulatory organizations).
68 See IMC Letter, supra note 4, at 1–2 and JP
Letter, supra note 4.
69 See IMC Letter, supra note 4, at 1.
70 See id.
71 See id. at 2.
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63 See
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that the reintroduction of p.m.
settlement is long overdue and would
attract liquidity from dark pools,
crossing mechanisms, and the over-thecounter markets.72
In its initial response to comments, C2
argues that the concerns from 18 years
ago that led to the transition to a.m.
settlement for index derivatives have
been largely mitigated.73 C2 argues that
expiration pressure in the underlying
cash markets at the close has been
greatly reduced with the advent of
multiple primary listing and unlisted
trading privilege markets, and that
trading is now widely dispersed among
many market centers.74 C2 further
argues that opening procedures in the
1990s were deemed acceptable to
mitigate one-sided order flow driven by
index option expiration and that today’s
more sophisticated automated closing
procedures should afford a similar, if
not greater, level of comfort.75
Specifically, C2 notes that many
markets, notably The NASDAQ Stock
Market LLC (‘‘Nasdaq’’) and the NYSE,
now utilize automated closing cross
procedures and have closing order types
that facilitate orderly closings, and that
these closing procedures are wellequipped to mitigate imbalance pressure
at the close.76 In addition, C2 believes
that after-hours trading now provides
market participants with an alternative
to help offset market-on-close
imbalances.77
C2 also notes that for roughly five
years (1987–1992) CBOE listed both
a.m.- and p.m.-settled SPX and did not
observe any related market disruptions
during that period in connection with
the dual a.m./p.m. settlement.78 Finally,
C2 believes that p.m.-settled options
predominate in the over-the-counter
(‘‘OTC’’) market, and C2 is not aware of
any adverse effects in the underlying
cash markets attributable to the
considerable volume of OTC trading.79
C2 asserts that given the changes since
the 1980s, concerns with p.m.
settlement are ‘‘misplaced’’ and have
been ‘‘negated’’ now that closing
procedures on the cash equities markets
have become more automated with realtime data feeds that are distributed to a
wider array of market participants.80
72 See
JP Letter, supra note 4.
C2 Response Letter, supra note 5, at 4.
74 See id.
75 See C2 Response Letter, supra note 5, at 4.
76 See id.
77 See id. at 2.
78 See Notice, supra note 3, at 12776.
79 See id.
80 See C2 Response Letter, supra note 5, at 2 and
4. In its comment letter, ISE notes that C2’s claim
that electronic trading can smooth out the pricesetting process is ‘‘disingenuous’’ as recent history
73 See
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The Commission agrees with C2 that
the closing cross mechanisms on the
primary listing stock markets have
matured considerably since the late
1980s. Closing procedures used by the
primary equity markets now offer a
more transparent and automated process
for attracting contra-side interest and
determining closing prices in a manner
that is comparable to the process used
to determine opening prices.81 The
Commission recognizes, however, that
the ability of such procedures to
counter-balance any potential negative
effects that could stem from p.m.
settlement is dependent on their ability
to attract liquidity in a fragmented
market to the primary listing exchanges
during a very concentrated window of
time at the close of trading on expiration
Fridays. Consequently, the potential
effect that p.m.-settlement of cashsettled index options could have on the
underlying cash equities markets at
expiration remains unclear and the
Commission remains concerned about
suggests that the opposite may be true in some cases
(such as the market events of May 6, 2010). See ISE
Letter 1, supra note 4, at 5.
81 Nasdaq (see Nasdaq Rule 4754), NYSE (see
NYSE Rule 123C), and NYSE Amex LLC (‘‘NYSE
Amex’’) (see NYSE Amex Rule 123C) all have
automated closing cross procedures for their
equities markets, which are designed to attract
liquidity, to determine a price for a security that
minimizes any imbalance, and to match orders at
the 4:00 p.m. close. Participants of these exchanges
generally receive frequently-disseminated market
data reports reflecting any imbalance, which is
intended to attract offsetting interest to minimize or
eliminate an imbalance heading into the close.
NYSE Arca, Inc. has closing procedures (NYSE Arca
Rule 7.35), but it only conducts a closing cross for
securities in which it is the primary listing market
as well as for all exchange-listed derivatives.
Additionally, to minimize the potential for price
swings at the close, Nasdaq provides that the
closing price must be within an acceptable range of
10% of the midpoint of the NBBO, while the NYSE
permits the Designated Market Maker in a stock to
request that the exchange extend its trading day to
not longer than 4:30 p.m. to allow for the
solicitation and entry of orders that are specifically
solicited to offset an imbalance existing as of 4 p.m.
To further minimize selling pressure at the NYSE,
market-on-close and limit-on-close orders may be
entered after 3:45 p.m. only if they offset an
imbalance. The NYSE also provides for closing-only
orders that only execute if they offset an imbalance.
The Commission views these closing cross
procedures as a significant change in how orders
are handled at the close of trading that could
potentially help reduce volatility at the close
caused by p.m. settlement.
C2 also notes that SPXPM expiration dates would
be predetermined and known in advance and, as a
consequence, this awareness could facilitate the
generation of contra-side trading interest. See C2
Response Letter, supra note 5, at 3. The potential
for reoccurring heightened volatility during these
expiration periods may, however, increase the
opportunity for manipulation and other abusive
trading practices in anticipation of the liquidity
constraints. To the extent such volatility was
possible, active surveillance and robust
enforcement activity by C2 and other self-regulatory
organizations around expiration dates would help
to address the potential for abusive trading.
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the possible effect on volatility at the
close of a return to p.m. settlement for
cash-settled index options.82
C2 cites to the Commission’s recent
approval of a series of proposals that
authorized the expansion of a limited
subset of options products to p.m.
settlement along with data collected in
connection with those products as
revealing no evidence that p.m.
settlement is likely to have a disruptive
effect on volatility at the close.83 We do
not believe that such an inference
necessarily can be drawn. These prior
approvals involved sub-categories of
options that are generally characterized
by relatively low volume and thus
would not be expected to have a
pronounced effect on volatility in the
underlying securities at the close on
expiration.84 Further, many of these
products are not authorized for listing
with expiration on the third Friday of a
month when other cash-settled index
derivatives expire. For example, C2
mentions CBOE’s experience with Endof-Week p.m.-settled options (which it
notes is the most heavily traded of
CBOE’s new special-dated expiration
products), and concludes that they fail
to show any evidence of disruptive
volatility on the settlement days for
these contracts.85 Despite the fact that
End-of-Week p.m.-settled options
constitute over 7% of CBOE’s S&P 500
index option volume, their volume does
not compare to that of CBOE’s SPX
product, which accounts for 60% of all
index options trading. For this reason, it
is difficult to draw any conclusions
about the potential impact of p.m.settled S&P 500 index options on the
market for the underlying component
stocks based on the existing p.m.-settled
cash-settled options. Further, past
experience suggests that the potential
82 The Commission’s concern with the potential
effect that p.m.-settlement of cash-settled index
options could have on the underlying cash equities
markets at expiration takes into consideration, as C2
notes, that the use of closing prices by retail and
institutions investors is widespread. See C2 Letter
3, supra note 8, at 6. For example, mutual funds use
closing prices to calculate their net asset values.
Therefore, any event or product that potentially
introduces additional volatility into the process of
determining closing prices has the potential to harm
investors and the public interest.
83 See C2 Letter 3, supra note 8, at 4–5.
84 We note that historical experience with respect
to more heavily traded index options and index
futures indicates that p.m. settlement carries
additional risks for enhanced volatility on
settlement days. See, e.g., Hans Stoll and Robert
Whaley, Expiration Day Effects of Index Options &
Futures (March 15, 1986) (concluding that price
effects ‘‘are observable on quarterly futures
expirations * * * [and] [t]he volatility of prices is
significantly higher on such expiration days, and
the stock market indices tend to fall on such
expiration days.’’).
85 See id. at 5.
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impact would be more significant if
both index options and index futures
(and options on index futures) were
offered with p.m. settlement.
While the enhanced closing processes
on the primary listing markets may
serve to mitigate some of the risk that
imbalances on the underlying cash
markets prior to the close could lead to
excess volatility, the extent of that
mitigation is unclear. A pilot program
would provide an opportunity to
observe and analyze the actual effects
on the underlying cash markets of
SPXPM. Further, to the extent that
trading interest is redirected to the
primary markets during times of stress,
as one commenter noted, it could be
conducive to addressing an imbalance
to concentrate liquidity on the primary
markets during the close. In particular,
those markets conduct automated
closing cross procedures, described
above,86 that are designed to more
efficiently disseminate information
broadly and attract and offset
imbalances. We note, however, that
despite C2’s emphasis on the higher
volumes in today’s markets compared
with the 1980s and the dispersion of
trading to more venues,87 volume
statistics are not necessarily indicative
or predictive of the level of available
liquidity.88
Finally, C2 estimates that 95% of OTC
options based on the S&P 500 index are
p.m.-settled,89 and states that SPXPM
will attract some of that trading interest.
C2 notes that doing so would be
consistent with the objectives of the
Dodd–Frank Wall Street Reform and
Consumer Protection Act and could
help mitigate counterparty risks faced
by OTC market participants.90 The
Commission agrees that the proposal
could benefit investors to the extent it
attracts trading in p.m.-settled S&P 500
index options from the opaque OTC
market to the more transparent
exchange-listed markets.
Further, C2’s proposal will offer
investors another investment option
through which they could obtain and
hedge exposure to the S&P 500 stocks.
In addition, C2’s proposal will provide
investors with the ability to trade an
option on the S&P 500 index in an all86 See
supra note 81.
id.
88 See, e.g., Findings Regarding the Market Events
of May 6, 2010, Report of the Staffs of the CFTC
and SEC to the Joint Advisory Committee on
Emerging Regulatory Issues, available at https://
www.sec.gov/news/studies/2010/marketeventsreport.pdf, at page 6 (‘‘As the events of May 6
demonstrate, especially in times of significant
volatility, high trading volume is not necessarily a
reliable indicator of market liquidity.’’).
89 See C2 Letter 3, supra note 8, at 13.
90 See id.
87 See
PO 00000
Frm 00109
Fmt 4703
Sfmt 4703
55975
electronic market, which may better
meet the needs of investors who may
prefer to trade electronically.91
Accordingly, C2’s proposal will provide
investors with added flexibility through
an additional product that may be better
tailored to meet their particular
investment, hedging, and trading needs.
To assist the Commission in assessing
any potential impact of a p.m.-settled
S&P 500 index option on the options
markets as well as the underlying cash
equities markets, as discussed above,92
C2 has proposed to submit data to the
Commission on a confidential basis in
connection with the pilot. The
Commission believes that C2’s proposed
fourteen-month pilot, together with the
data and analysis that C2 will provide
to the Commission, will allow C2 and
the Commission to monitor for and
assess the potential for adverse market
effects. Specifically, the data and
analysis will assist the Commission in
evaluating the effect of allowing p.m.
settlement for S&P 500 index options on
the underlying component stocks.
In light of the fact that approval of
C2’s proposal would be a change from
a.m. settlement for cash-settled index
options, the Commission instituted
proceedings to determine whether to
approve or disapprove the proposal. In
particular, through specific requests for
comment and data, the Commission
solicited input from market participants
on the potential impact on the markets,
particularly the underlying cash equities
markets.
As discussed above, the Commission
remains concerned about the potential
impact on the market at expiration for
the underlying component stocks for a
p.m.-settled, cash-settled index option
such as SPXPM. The potential impact
today remains unclear, given the
significant changes in the closing
procedures of the primary markets over
the past two decades. The Commission
is mindful of the historical experience
with the impact of p.m. settlement of
cash-settled index derivatives on the
underlying cash markets, discussed at
length above, but recognizes, however,
that these risks may be mitigated today
by the enhanced closing procedures that
are now in use at the primary equity
markets.
Finally, approval of C2’s proposal on
a pilot basis will enable the Commission
to collect current data to assess and
monitor for any potential for impact on
markets, including the underlying cash
91 See, e.g., Exchange Capital Resources Letter,
supra note 8, at 3 (stating in part that ‘‘* * * the
addition of the SPXPM product will offer the
investor greater flexibility and opportunity to
participate in S&P 500 option product line.’’)
92 See Section II (Description of the Proposal).
E:\FR\FM\09SEN1.SGM
09SEN1
55976
Federal Register / Vol. 76, No. 175 / Friday, September 9, 2011 / Notices
equities markets. In particular, the data
collected from C2’s pilot program will
help inform the Commission’s
consideration of whether the SPXPM
pilot should be modified, discontinued,
extended, or permanently approved. It
also could benefit investors and the
public interest to the extent it attracts
trading in p.m.-settled S&P 500 index
options from the opaque OTC market to
the more transparent exchange-listed
markets, where trading in the product
will be subject to exchange trading rules
and exchange surveillance.
Thus, based on the discussion above,
the Commission finds that C2’s current
proposal is consistent with the Act,
including Section 6(b)(5) thereof in that
it is designed to remove impediments to
and perfect the mechanism of a free and
open market, and, in general, to protect
investors and the public interest. In
light of the enhanced closing procedures
and the potential benefits to investors
discussed above, the Commission finds
that it is appropriate and consistent
with the Act to approve C2’s proposal
on a pilot basis. The collection of data
during the pilot and C2’s active
monitoring of any effects of SPXPM on
the markets will help the Commission
assess the impact of p.m. settlement in
today’s market.
V. Conclusion
It Is Therefore Ordered, pursuant to
Section 19(b)(2) of the Act,93 that the
proposed rule change (SR–C2–2011–
008) be, and hereby is, approved on a
14-month pilot basis only.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011–23045 Filed 9–8–11; 8:45 am]
mstockstill on DSK4VPTVN1PROD with NOTICES
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[RELEASE NO. 34–65255; File No. SR–
MSRB–2011–12]
Self-Regulatory Organizations;
Municipal Securities Rulemaking
Board; Notice of Filing of Proposed
New Rule G–42, on Political
Contributions and Prohibitions on
Municipal Advisory Activities;
Proposed Amendments to Rules G–8,
on Books and Records, G–9, on
Preservation of Records, and G–37, on
Political Contributions and
Prohibitions on Municipal Securities
Business; Proposed Form G–37/G–42
and Form G–37x/G–42x; and a
Proposed Restatement of a Rule G–37
Interpretive Notice
September 2, 2011.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (‘‘the
Exchange Act’’) 1 and Rule 19b–4
thereunder,2 notice is hereby given that
on August 19, 2011, the Municipal
Securities Rulemaking Board (‘‘Board’’
or ‘‘MSRB’’) filed with the Securities
and Exchange Commission (‘‘SEC’’ or
‘‘Commission’’) the proposed rule
change as described in Items I, II, and
III below, which Items have been
prepared by the MSRB. The
Commission is publishing this notice to
solicit comments on the proposed rule
change from interested persons.
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
MSRB included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. The Board has
prepared summaries, set forth in
Sections A, B, and C below, of the most
significant aspects of such statements.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
The MSRB is filing with the SEC a
proposed rule change consisting of (i)
Proposed MSRB Rule G–42 (on political
contributions and prohibitions on
municipal advisory activities); (ii)
proposed amendments that would make
conforming changes to MSRB Rules G–
8 (on books and records), G–9 (on
preservation of records), and G–37 (on
political contributions and prohibitions
on municipal securities business); (iii)
proposed Form G–37/G–42 and Form
G–37x/G–42x; and (iv) a proposed
restatement of a Rule G–37 interpretive
notice issued by the MSRB in 1997
(‘‘Rule G–37 Interpretive Notice’’).3
The MSRB requests that, if approved
by the Commission, the proposed rule
change be made effective six months
after the date on which the Commission
first approves rules defining the term
‘‘municipal advisor’’ under the
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 Interpretation of Prohibition on Municipal
Securities Business Pursuant to Rule G–37
(February 21, 1997), reprinted in MSRB Rule Book.
2 17
93 15
U.S.C. 78s(b)(2).
VerDate Mar<15>2010
16:58 Sep 08, 2011
Jkt 223001
Exchange Act or such later date as the
Commission approves the proposed rule
change; provided, however, that the
MSRB requests that no contribution
made prior to the effective date of
proposed Rule G–42 would result in a
ban pursuant to proposed Rule G–
42(b)(i); 4 and, provided that any ban on
municipal securities business under
Rule G–37(b)(i) in existence prior to the
effective date of proposed Rule G–42
would continue until it otherwise
would have terminated under Rule G–
37(b)(i), as in effect prior to the effective
date of proposed Rule G–42.
The text of the proposed rule change
is available on the MSRB’s Web site at
https://www.msrb.org/Rules-andInterpretations/SEC–Filings/2011Filings.aspx, at the MSRB’s principal
office, and at the Commission’s Public
Reference Room.
PO 00000
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Fmt 4703
Sfmt 4703
1. Purpose
The Dodd-Frank Wall Street Reform
and Consumer Protection Act (‘‘DoddFrank Act’’) 5 authorized the MSRB to
establish a comprehensive body of
regulation for municipal advisors and
provided that municipal advisors to
municipal entities have a Federal
fiduciary duty.6 The Dodd-Frank Act
required the MSRB to adopt rules for
municipal advisors that, in addition to
implementing the Federal fiduciary
duty, are designed to prevent fraudulent
and manipulative acts and practices and
to promote just and equitable principles
of trade.7 It also expanded the mission
4 As described in more detail below, under
proposed Rule G–42(b)(i) certain contributions
could result in a ban on municipal advisory
business for compensation, a ban on solicitations of
third-party business for compensation, and a ban on
the receipt of compensation for the solicitation of
third-party business.
5 Public Law No. 111–203, 124 Stat. 1376 (2010).
6 See 15B(c)(1) of the Exchange Act.
7 See Section 15B(b)(2)(C) of the Exchange Act.
E:\FR\FM\09SEN1.SGM
09SEN1
]]>Agencies
[Federal Register Volume 76, Number 175 (Friday, September 9, 2011)]
[Notices]
[Pages 55969-55976]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-23045]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-65256; File No. SR-C2-2011-008]
Self-Regulatory Organizations; C2 Options Exchange, Incorporated;
Order Approving Proposed Rule Change to Establish a Pilot Program To
List and Trade a p.m.-Settled Cash-Settled S&P 500 Index Option Product
September 2, 2011.
I. Introduction
On February 28, 2011, C2 Options Exchange, Incorporated (the
``Exchange'' or ``C2'') 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 permit the listing and trading
of p.m.-settled, cash-settled options on the Standard & Poor's 500
Index (``S&P 500''). The proposed rule change was published for comment
in the Federal Register on March 8, 2011.\3\ The Commission received
seven comment letters on the proposal, some of which urged the
Commission to disapprove the proposal.\4\ C2 responded to the comment
letters in a response letter dated April 20, 2011.\5\ To ensure that
the Commission had sufficient time to consider and take action on the
Exchange's proposal in light of, among other things, the comments
received on the proposal, the Commission extended the time period in
which to either approve the proposed rule change, disapprove the
proposed rule change, or institute proceedings to determine whether to
disapprove the proposed rule change, to June 6, 2011.\6\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 64011 (March 2,
2011), 76 FR 12775 (``Notice'').
\4\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Randall Mayne, Blue Capital Group, dated March 18, 2011 and
April 28, 2011 (``Mayne Letter 1'' and ``Mayne Letter 2''); Michael
J. Simon, Secretary, International Securities Exchange, LLC
(``ISE''), dated March 29, 2011 and May 11, 2011 (``ISE Letter 1''
and ``ISE Letter 2''); Andrew Stevens, Legal Counsel, IMC Financial
Markets, dated March 24, 2011 (``IMC Letter''); John Trader, dated
April 20, 2011 (``Trader Letter''); and JP, dated April 30, 2011
(``JP Letter'').
\5\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Joanne Moffic-Silver, Secretary, C2, dated April 20, 2011 (``C2
Response Letter'').
\6\ See Securities Exchange Act Release No. 64266 (April 8,
2011), 76 FR 20757 (April 13, 2011).
---------------------------------------------------------------------------
In order to solicit additional input from interested parties,
including relevant data and analysis, on the issues presented by C2's
proposed rule change, on June 3, 2011, the Commission instituted
proceedings to determine whether to approve or disapprove C2's
proposal.\7\ In its order instituting the proceedings, the Commission
specifically noted its interest in receiving additional data and
analysis relating to the potential effect that proposed p.m.-settled
index options could have on the underlying cash equities markets. In
response to the proceedings, the Commission received an additional
three comment letters on the proposal as well as a rebuttal letter from
C2.\8\ This order approves the proposed rule change on a 14-month pilot
basis.
---------------------------------------------------------------------------
\7\ See Securities Exchange Act Release No. 64599 (June 3,
2011), 76 FR 33798 (June 9, 2011).
\8\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Michael J. Simon, Secretary, International Securities Exchange,
LLC dated July 11, 2011 (``ISE Letter 3''); William J. Brodsky,
Chairman and Chief Executive Officer, C2, dated July 11, 2011
(``CBOE Letter 3''); Thomas Foertsch, President, Exchange Capital
Resources, dated July 11, 2011; and William J. Brodsky, Chairman and
Chief Executive Officer, C2, dated July 25, 2011.
---------------------------------------------------------------------------
II. Description of the Proposal
The Exchange's proposal would permit it to list and trade cash-
settled S&P 500 index options with third-Friday-of-the-month
(``Expiration Friday'') expiration dates for which the exercise
settlement value will be based on the index value derived from the
closing prices of component securities (``p.m.-settled''). The proposed
contract (referred to as ``SPXPM'') would use a $100 multiplier, and
the minimum trading increment would be $0.05 for options trading below
$3.00 and $0.10 for all other series. Strike price intervals would be
set no less than 5 points apart. Consistent with existing rules for
index options, the Exchange would allow up to twelve near-term
expiration months, as well as LEAPS. Expiration processing would occur
on the Saturday following Expiration Friday. The product would have
European-style exercise and would not be subject to position limits,
though there would be enhanced reporting requirements.
The Exchange proposes that the SPXPM product be approved on a pilot
basis for an initial period of fourteen months. As part of the pilot
program, the Exchange committed to submit a pilot program report to the
Commission at least two months prior to the
[[Page 55970]]
expiration date of the program (the ``annual report''). The annual
report would contain an analysis of volume, open interest, and trading
patterns. The analysis would examine trading in the proposed option
product as well as trading in the securities that comprise the S&P 500
index. In addition, for series that exceed certain minimum open
interest parameters, the annual report would provide analysis of index
price volatility and share trading activity. In addition to the annual
report, the Exchange committed to provide the Commission with periodic
interim reports while the pilot is in effect that would contain some,
but not all, of the information contained in the annual report. In its
filing, C2 notes that it would provide the annual and interim reports
to the Commission on a confidential basis.\9\
---------------------------------------------------------------------------
\9\ See Notice, supra note 3, at 12777.
---------------------------------------------------------------------------
III. Comments Received
In response to the initial notice of C2's proposal, the Commission
received seven comment letters, some of which expressed concern with
the proposal.\10\ One commenter specifically urges the Commission to
disapprove the proposal.\11\ Commenters expressing concern with the
proposal raised several issues, including: The potential for adverse
effects on the underlying cash markets that could accompany the
reintroduction of p.m. settlement; concern with the similarity (but
lack of fungibility) between the existing S&P 500 index option traded
on the Chicago Board Options Exchange, Incorporated (``CBOE'') and the
proposed S&P 500 index option that would be traded on C2; the lack of
proposed position limits for SPXPM; and issues regarding exclusive
product licensing. Three commenters expressed support for the
proposal.\12\
---------------------------------------------------------------------------
\10\ See Mayne Letter 1, ISE Letter 1, ISE Letter 2, and Trader
Letter, supra note 4.
\11\ See ISE Letter 1 and ISE Letter 2, supra note 4.
\12\ See Mayne Letter 2, IMC Letter, and JP Letter, supra note
4.
---------------------------------------------------------------------------
In the proceedings to determine whether to approve or disapprove
the proposal, the Commission preliminarily summarized the issues raised
by the commenters, and also set forth a series of questions and
requests for data on the issue of p.m. settlement. In response to the
proceedings, the Commission received three letters, including one from
C2, one from ISE that expands on the concerns it previously raised and
reiterates its recommendation for the Commission to disapprove the
proposal, and one from a new commenter that supports the proposal
because it will offer investors greater flexibility.\13\ The Commission
also received an additional letter from C2 responding to the comments
of ISE.\14\ The comments received are addressed below.
---------------------------------------------------------------------------
\13\ See ECR Letter, supra note 8.
\14\ See C2 Rebuttal Letter, supra note 8.
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
After careful consideration of the proposal and the comments
received, the Commission finds that the proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
exchange,\15\ and, in particular, the requirements of Section 6 of the
Act.\16\ Specifically, the Commission finds that the proposed rule
change is consistent with Section 6(b)(5) of the Act,\17\ which
requires that an exchange have rules designed to remove impediments to
and perfect the mechanism of a free and open market and to protect
investors and the public interest.
---------------------------------------------------------------------------
\15\ 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).
\16\ 15 U.S.C. 78f.
\17\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
A. Relationship to the National Market System
One commenter believes that separate a.m. and p.m.-settled S&P 500
index options could potentially bifurcate the market for CBOE's
existing a.m.-settled SPX contract.\18\ This commenter notes that the
SPX, which trades only on CBOE, accounts for 60% of all index options
trading, and argues that the sole difference in settlement between SPX
on CBOE and the proposed S&P 500 index options on C2 (i.e., a.m. vs.
p.m. settlement) is a ``sham'' that is intended to ``keep them non-
fungible,'' which would ``make a mockery of Section 11A of the Act.''
\19\ The commenter states that the objectives of Section 11A are
reflected in a national market system plan for options that requires
exchanges to prevent trading through better priced quotations displayed
on other options exchanges, and that making a p.m.-settled S&P 500
index option non-fungible with CBOE's SPX would allow the CBOE group to
establish two ``monopolies'' in S&P 500 options, one floor-based (CBOE)
and one electronic (C2) that would avoid the application of the
limitation on trade throughs.\20\ The commenter also contends the
proposal is designed to protect CBOE's floor-based SPX trading without
having to accommodate the more narrow quotes that would likely occur on
C2 in an electronically-traded p.m.-settled product.\21\
---------------------------------------------------------------------------
\18\ See ISE Letter 1, supra note 4, at 4.
\19\ Id. at 2. See also ISE Letter 2, supra note 4, at 3-4.
\20\ See ISE Letter 1, supra note 4, at 3.
\21\ See ISE Letter 1, supra note 4, at 2.
---------------------------------------------------------------------------
Another commenter asserts that CBOE and C2 should trade a fungible
S&P 500 index option in order to address what the commenter describes
as ``huge customer-unfriendly spreads'' in SPX.\22\ The commenter
argues that if the CBOE believes p.m. settlement is superior to a.m.
settlement, then CBOE should file to change SPX to p.m. settlement so
that the product traded on C2 would be fungible with that proposed to
be traded on CBOE.\23\
---------------------------------------------------------------------------
\22\ See Trader Letter, supra note 4, at 1. See also JP Letter,
supra note 4, at 1.
\23\ See Trader Letter, supra note 4, at 1.
---------------------------------------------------------------------------
In response, C2 argues that the difference between a.m.-settled and
p.m.-settled S&P 500 index option would be a material term and that
C2's proposed S&P 500 index option could not be fungible with, nor
could it be linked with, CBOE's SPX option.\24\
---------------------------------------------------------------------------
\24\ See C2 Response Letter, supra note 5, at 3.
---------------------------------------------------------------------------
The Commission agrees that the difference between a.m.-settled SPX
and the proposed p.m.-settled SPXPM involves a materially different
term (i.e., settlement time) that makes C2's proposed SPXPM index
option a different security than, and thus not fungible with, CBOE's
SPX option.\25\ The Commission notes that it has permitted very similar
but different products to trade on the same exchange or on different
exchanges without those separate products being fungible. For example,
the Commission previously approved for CBOE the listing and trading of
a.m.-settled S&P 500 index options during a time when CBOE also traded
p.m.-settled S&P 500 index options, and the two separate products were
not fungible.\26\
---------------------------------------------------------------------------
\25\ Consequently, rules applicable to prevent trading through
better priced quotations in the same security displayed on other
options exchanges would not be applicable for trading between these
two products.
Similarly, in response to a comment that investors would be
confused by the presence of an a.m.-settled SPX on CBOE and a p.m.-
settled S&P 500 index option on C2 (see ISE Letter 1, supra note 4,
at 3), the Commission does not believe that SPX on CBOE and a p.m.-
settled S&P 500 index option on C2 would cause investor confusion.
The two products would trade under different ticker symbols and any
potential for investor confusion could be mitigated though investor
outreach and education initiatives. Furthermore, as C2 notes in its
response letter, CBOE currently lists two options on the S&P 100
(American-style OEX and European-style XEO) and is not aware of any
investor confusion among the products. See C2 Response Letter, supra
note 5, at 3.
\26\ See infra note 44 (citing to Securities Exchange Act
Release No. 24367). See also Securities Exchange Act Release No.
51619 (Apr. 27, 2005), 70 FR 22947 (May 3, 2005) (order approving
ISE's listing and trading of options on various Russell Indexes,
including options based upon one-tenth values of the Russell
Indexes).
---------------------------------------------------------------------------
[[Page 55971]]
One commenter also raises concerns about the potential effect on
competition of C2 listing and trading an option product that is subject
to an exclusive license, citing to concerns they express with respect
to the SPX product traded on CBOE.\27\
---------------------------------------------------------------------------
\27\ See ISE Letter 1, supra note 4, at 6-7 (arguing in part
that ``CBOE's monopoly in the product imposes significant harm to
investors,'' including the fact that ``CBOE charges for trading SPX
options that are much greater than the fees for multiply listed
options'' and ``the quotes in SPX options are much wider than they
would be if there was competition from other exchanges,'' as well as
that ``CBOE is able to use the monopolistic revenue stream from
these options to subsidize other products * * *.'') and ISE Letter
2, supra note 4, at 3-4 (arguing in part that ``[t]he Proposal is
harmful to investors because it * * * perpetuates the unreasonably
high monopolistic pricing and artificially wide spreads that result
from the lack of competition in this product.'').
The issue of state law intellectual property rights of index
developers in the use of their indexes to trade derivatives is the
subject of litigation between CBOE and ISE (as well as other
parties). See Chicago Board Options Exchange, Incorporated et al. v.
International Securities Exchange, et al., Case No. 06 CH 24798
(Cir. Ct. of Cook Cty., Ch. Div. July 8, 2010), appeal docketed, No.
1-10-2228 (Ill. App. Ct. August 9, 2010). See also Board of Trade of
the City of Chicago v. Dow Jones & Co., Inc., 98 Ill.2d 109 (1983).
In issuing this order, the Commission expresses no view with respect
to the matters underlying this ongoing litigation, including their
validity or the enforceability of the exclusivity agreement.
---------------------------------------------------------------------------
The Commission recognizes the potential impact on competition
resulting from the inability of other options exchanges to list and
trade SPXPM. In acting on this proposal, however, the Commission has
balanced the potentially negative competitive effects with the
countervailing positive competitive effects of C2's proposal. The
Commission believes that the availability of SPXPM on the C2 exchange
will enhance competition by providing investors with an additional
investment vehicle, in a fully-electronic trading environment, through
which investors can gain and hedge exposure to the S&P 500 stocks.
Further, this product could offer a competitive alternative to other
existing investment products that seek to allow investors to gain broad
market exposure. Also, we note that it is possible for other exchanges
to develop or license the use of a new or different index to compete
with the S&P 500 index and seek Commission approval to list and trade
options on such index.
Accordingly, with respect to the Commission's consideration of C2's
proposed rule change at this time, the Commission finds that it does
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act.\28\
---------------------------------------------------------------------------
\28\ The Commission may in the future determine it appropriate
to consider or address competitive issues related to exclusive
licensing of index option products on a more comprehensive level.
---------------------------------------------------------------------------
B. Position Limits
Under C2's proposal, position limits would not apply to SPXPM. One
commenter argues that position limits should apply to SPXPM.\29\ This
commenter notes that, since 2001 when the Commission approved a CBOE
rule filing to remove all position limits for SPX options,\30\ the
Commission has generally expected exchanges to apply a model, such as
the Dutt-Harris model, to determine the appropriate position limits for
all new index options products.\31\ Because C2 claims that the product
is new and non-fungible, the commenter argues that the Commission
should apply the Dutt-Harris model to require C2 to impose position
limits on SPXPM.\32\
---------------------------------------------------------------------------
\29\ See ISE Letter 1, supra note 4, at 6.
\30\ See Securities Exchange Act Release No. 44994 (October 26,
2002), 66 FR 55722 (November 2, 2001). In this filing, the
Commission relied in part on CBOE's ability to provide enhanced
surveillance and reporting safeguards to detect and deter trading
abuses arising from the elimination of position and exercise limits
in options on the S&P 500.
\31\ See ISE Letter 1, supra note 4, at 6. In a 2005 paper from
Hans Dutt and Lawrence Harris, titled ``Position Limits for Cash-
Settled Derivative Contracts'' (``Dutt-Harris Paper'') the authors
developed a model to determine appropriate position limits for cash-
settled index derivatives. The authors concluded that the then-
prevailing position limits were lower than the model suggested would
be appropriate for many derivative contracts. The authors also
concluded, however, that position limits are not as important for
broad-based index derivative contracts that are cash settled because
they are composed of highly liquid and well-followed securities. As
such, the authors note that it would require very high trading
volumes to manipulate the underlying securities and, consequently,
any attempted manipulation would be more easily detectable and
prosecutable.
\32\ See ISE Letter 1, supra note 4, at 6.
---------------------------------------------------------------------------
In its response to comments, C2 notes that the Dutt-Harris Paper
acknowledges that S&P 500 options have, and should have,
extraordinarily large position limits and Dutt-Harris observes that
position limits are most useful when market surveillance is
inadequate.\33\ C2 argues that position limits suggested by the Dutt-
Harris model for an S&P 500 index option would be so large as to be
irrelevant and that positions of such magnitude would attract scrutiny
from surveillance systems that would, as a consequence, serve as an
effective substitute for position limits.\34\ Further, in its response
letter, C2 summarizes the circumstances and considerations relied upon
by the Commission when it approved the elimination of position limits
on CBOE's S&P 500 index option, including the enormous capitalization
of the index and enhanced reporting and surveillance for the
product.\35\ Thus, because of the enhanced reporting and surveillance
for this product, described below, C2 argues that the absence of
position limits on its proposed S&P 500 index option would not be
inconsistent with Dutt-Harris.\36\
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\33\ See C2 Response Letter, supra note 5, at 5.
\34\ See id. Generally, position limits are intended to prevent
the establishment of options positions that could be used or that
might create incentives to manipulate or disrupt the underlying
market to benefit the holder of the options. See, e.g., Securities
Exchange Act Release Nos. 39489 (December 24, 1997), 63 FR 276
(January 5, 1998) (SR-CBOE-97-11) (approving increases to the
position and exercise limits for options on the Standard & Poor's
100 Stock Index (``OEX''), the OEX firm facilitation exemption, and
the OEX index hedge exemption); Dutt-Harris Paper, supra note 31
(``Position limits directly limit manipulation by limiting the size
of derivative positions that would benefit from manipulative
practices.'').
\35\ See C2 Response Letter, supra note 5, at 5-6. C2 represents
in its response letter that it would monitor trading in p.m.-settled
S&P 500 index options in the same manner as CBOE does for other
broad-based index options with no position limits. See id. at 6.
\36\ See id.
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The Exchange represents, however, that it will implement enhanced
reporting requirements pursuant to its Rule 4.13 (Reports Related to
Position Limits) and Interpretation and Policy .03 to its Rule 24.4
(Position Limits for Broad-Based Index Options), which sets forth the
reporting requirements for certain broad-based indexes that do not have
position limits.\37\
---------------------------------------------------------------------------
\37\ See Notice, supra note 3, at note 4 and accompanying text.
---------------------------------------------------------------------------
In 2001, when the Commission permanently approved a CBOE rule
(which had been in place for a two-year pilot period) to eliminate
position limits on SPX (as well as options on the Dow Jones Industrial
Average and the S&P 100 index),\38\ the Commission stated that because
the S&P 500 index is a broad-based index with a considerable
capitalization, manipulation of the 500 component stocks underlying the
index would require extraordinarily large positions that would be
readily detectable by enhanced surveillance procedures. In its approval
order, the Commission relied in part on CBOE's enhanced surveillance
and reporting procedures that are intended to allow CBOE to detect and
deter trading abuses in the absence of position limits. In particular,
CBOE requires its members to submit a report to CBOE when the member
builds a position of 100,000+ contracts. Among other things, the report
includes a description of the
[[Page 55972]]
option position, whether the position is hedged (and, if so, a
description of the hedge), and whether collateral was used (and, if so,
a description of the collateral). This enhanced surveillance and
reporting arrangement allows CBOE to continually monitor, assess, and
respond to any concerns at an early stage. To complement its enhanced
surveillance and reporting requirements, CBOE has the ability to
intervene to impose additional margin or assess capital charges when
warranted. Thus, together with the ``enormous capitalization'' \39\ of
the S&P 500 index and the deep and liquid markets for the S&P 500
stocks, the Commission found that CBOE's enhanced surveillance
procedures ``reduce[] concerns regarding market manipulation or
disruption in the underlying market.'' \40\
---------------------------------------------------------------------------
\38\ See Securities Exchange Act Release No. 44994 (October 26,
2001), 66 FR 55722 (November 2, 2001) (SR-CBOE-2001-22).
\39\ Id. at 55723.
\40\ Id.
---------------------------------------------------------------------------
C2 has represented in this filing that its enhanced surveillance
requirements and procedures for SPXPM would be identical to the
surveillance and reporting requirements and procedures used by CBOE
with respect to SPX. Accordingly, the Commission believes that position
limits would not be necessary for SPXPM options as long as C2 has in
place and enforces effective enhanced surveillance and reporting
requirements. These enhanced procedures will allow the Exchange to see,
with considerable advance notice, the accumulation of large positions,
which it can then monitor more closely as necessary and take additional
action if appropriate.\41\
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\41\ In addition, the Commission notes that C2 would have access
to information through its membership in the Intermarket
Surveillance Group with respect to the trading of the securities
underlying the S&P 500 index, as well as tools such as large options
positions reports to assist its surveillance of SPXPM options.
In approving the proposed rule change, the Commission also has
relied upon the Exchange's representation that it has the necessary
systems capacity to support new options series that will result from
this proposal. See Notice, supra note 3, at 12777.
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C. Reintroduction of P.M. Settlement
When cash-settled \42\ index options were first introduced in the
1980s, they generally utilized closing-price settlement procedures
(i.e., p.m. settlement).\43\ The Commission became concerned about the
impact of p.m. settlement on cash-settled index options on the markets
for the underlying stocks at the close on expiration Fridays.\44\ These
concerns were heightened during the quarterly expirations of the third
Friday of March, June, September and December when options, index
futures, and options on index futures all expire simultaneously. P.m.-
settlement was believed to have contributed to above-average volume and
added market volatility on those days, which sometimes led to sharp
price movements during the last hour of trading.\45\ As a consequence,
the close of trading on the quarterly expiration Friday became known as
the ``triple witching hour.'' Besides contributing to investor anxiety,
heightened volatility during the expiration periods created the
opportunity for manipulation and other abusive trading practices in
anticipation of the liquidity constraints.\46\
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\42\ The seller of a ``cash settled'' index option pays out the
cash value of the applicable index on expiration or exercise. A
``physically settled'' 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/components/docs/riskstoc.pdf, for a discussion
of settlement.
\43\ The exercise settlement value for a p.m.-settled index
option is generally determined by reference to the reported level of
the index as derived from the closing prices of the component
securities (generally based on the closing prices as reported by the
primary exchange on which the stock is listed) on the last business
day before expiration (e.g., the Friday before Saturday expiration).
See Characteristics and Risks of Standardized Options, available at:
https://www.theocc.com/components/docs/riskstoc.pdf, for a discussion
of settlement value.
\44\ See, e.g., Securities Exchange Act Release Nos. 45956 (May
17, 2002), 67 FR 36740 (May 24, 2002) (adopting release concerning
cash settlement and regulatory halt requirements for security
futures products) (``Regulators and self-regulators were concerned
that the liquidity constraints faced by the securities markets to
accommodate expiration-related buy or sell programs at the market
close on expiration Fridays could exacerbate ongoing market swings
during an expiration and could provide opportunities for entities to
anticipate these pressures and enter orders as part of manipulative
or abusive trading practices designed to artificially drive up or
down share prices.''); 24367 (April 17, 1987), 52 FR 13890 (April
27, 1987) (SR-CBOE-87-11) (order approving a proposal for S&P 500
index options with an exercise settlement value based on an index
value derived from opening, rather than closing, prices); and 32868
(September 10, 1993), 58 FR 48687 (September 10, 1993) (notice of
filing and order granting accelerated approval of proposed rule
change by the New York Stock Exchange, Inc. (``NYSE'') relating to
changes in auxiliary closing procedures for expiration days)
(stating, ``[a]s long as some index derivative products continue to
expire based on closing stock prices on expiration Fridays, the
Commission agrees with the NYSE that such procedures are necessary
to provide a mechanism to handle the potential large imbalances that
can be engendered by firms unwinding index derivative related
positions''). The cash settlement provisions of stock index futures
and options contracts facilitated the growth of sizeable index
arbitrage activities by firms and professional traders and made it
relatively easy for arbitrageurs to buy or sell the underlying
stocks at or near the market close on expiration Fridays (i.e., the
third Friday of the expiration month) in order to ``unwind''
arbitrage-related positions. These types of unwinding programs at
the close on expiration Fridays often severely strained the
liquidity of the securities markets as the markets, and in
particular the specialists on the NYSE, faced pressure to attract
contra-side interest in the limited time that was permitted to
establish closing prices. See Securities Exchange Act Release No.
44743 (August 24, 2001), 66 FR 45904 (August 30, 2001) (File No. S7-
15-01) (proposing release concerning cash settlement and regulatory
halt requirements for security futures products).
\45\ See, e.g., Securities Exchange Act Release Nos. 24276
(March 27, 1987); 52 FR 10836 (April 3, 1987) (notice of filing and
order granting accelerated approval to a proposed rule change by the
NYSE relating to opening price settlement of expiring NYSE Composite
and Beta Index options); 37894 (October 30, 1996), 61 FR 56987
(November 5, 1996) (notice of filing and order granting accelerated
approval of proposed rule change by the NYSE permanently approving
the expiration day auxiliary closing procedures pilot program); and
45956 (May 17, 2002), 67 FR 36740 (May 24, 2002) (adopting release
concerning cash settlement and regulatory halt requirements for
security futures products) (reaffirming the Commission's view of the
advantages of a.m. settlement). See also Hans Stoll and Robert
Whaley, Expiration Day Effects of Index Options & Futures (March 15,
1986) (noting that share volume on the NYSE was much higher in the
last hour of a quarterly expiration Friday when both options and
futures expire than on non-expiration Fridays).
\46\ See, e.g., Securities Exchange Act Release No. 45956 (May
17, 2002), 67 FR 36740 (May 24, 2002) (adopting release concerning
cash settlement and regulatory halt requirements for security
futures products) (explaining that entities could take advantage of
illiquidity resulting from the unwinding of arbitrage-related
positions on expiration Fridays to manipulate share prices).
---------------------------------------------------------------------------
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 (``CFTC'') approved a rule change by the Chicago
Mercantile Exchange to provide for a.m. settlement for index futures,
including futures on the S&P 500 index.\47\ The Commission subsequently
approved a rule change by CBOE to list and trade a.m.-settled S&P 500
index options.\48\ In
[[Page 55973]]
1992, the Commission approved CBOE's proposal to transition all of its
European-style cash-settled options on the S&P 500 index to a.m.
settlement.\49\ Thereafter, the Commission approved proposals by the
options markets to transfer most of their cash-settled index products
to a.m. settlement.\50\
---------------------------------------------------------------------------
\47\ 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 Chicago Mercantile
Exchange). See also Securities Exchange Act Release No. 24367 (April
17, 1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11) (noting that
the Chicago Mercantile Exchange moved the S&P 500 futures contract's
settlement value to opening prices on the delivery date).
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.
\48\ See Securities Exchange Act Release No. 24367 (April 17,
1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11) (order approving
a proposal for S&P 500 index options with an exercise settlement
value based on an index value derived from opening, rather than
closing, prices). At the time it approved CBOE's introduction of
a.m. settlement for cash-settled index options, the Commission
identified two benefits to a.m. settlement for cash-settled index
options. See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09). First, it
provides additional time to test price discovery, as market
participants have the remainder of the regular trading day to adjust
to opening session price movements and determine whether those
movements reflect changes in fundamental values or short-term supply
and demand conditions. Second, it provides more opportunity to trade
out of positions acquired during the opening auction. In this
respect, attracting contra-side interest to a single-priced auction
to offset an order imbalance (such as those attributable to index
arbitrage) may more readily be achieved in an opening auction on
Friday morning than a closing auction on Friday afternoon because
the morning session allows market participants that have provided
that liquidity to have the remainder of the regular trading day to
liquidate their positions. In contrast, positions acquired in a
Friday afternoon closing auction generally cannot be liquidated as
readily and efficiently until the following Monday. Holding
positions overnight, or over a weekend, may entail greater risk than
holding intraday positions. To accept such risk (real or perceived),
market participants generally will require a greater premium, which
may translate into greater price concessions, and thus lead to
greater volatility in the closing auction. In other words, a
consequence of p.m. settlement may be enhanced volatility at the
close. See, e.g., Securities Exchange Act Release No. 44743 (August
24, 2001), 66 FR 45904 at 45908 (August 30, 2001) (``Steep discounts
(premiums) were necessary in part because traders who bought (sold)
stocks to offset unwinding programs had to maintain their newly
acquired long (short) positions over the weekend--during which time
they were subject to considerable market risk.'').
\49\ See Securities Exchange Act Release No. 30944 (July 21,
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09) (order approving
CBOE's proposal relating to position limits for SPX index options
based on the opening price of component securities).
\50\ CBOE's index options on the S&P 100 (OEX), however, kept
their p.m. settlement. See Securities Exchange Act Release No. 30944
(July 21, 1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09). No
futures or options on futures trade on the S&P 100 index. Other
types of options utilize p.m. settlement, including physically-
settled single-stock options and options on ETFs.
---------------------------------------------------------------------------
The Commission and the CFTC noted the benefits of a.m. settlement
in a 2001 joint release concerning securities futures, where they
observed that ``the widespread adoption of opening-price settlement
procedures in index futures and options has served to mitigate the
liquidity strains that had previously been experienced in the
securities markets on expirations.'' \51\
---------------------------------------------------------------------------
\51\ See Securities Exchange Act Release No. 44743 (August 24,
2001), 66 FR 45904 at 45908 (August 30, 2001) (proposing release for
a joint rule between the Commission and the CFTC generally
stipulating, among other provisions, that the final settlement price
for each cash-settled security futures product fairly reflect the
opening price of the underlying security or securities). See also
Securities Exchange Act Release No. 45956 (May 17, 2002), 67 FR
36740 at 36741-42 (May 24, 2002) (adopting release concerning cash
settlement and regulatory halt requirements for security futures
products in which the Commission reaffirmed the advantages of a.m.
settlement) (``[O]pening price settlement procedures offered several
features that enabled the securities markets to better handle
expiration-related unwinding programs.'').
---------------------------------------------------------------------------
Since 1992, the Commission has approved proposals that provide for
cash-settled index options with p.m. settlement on a limited basis for
options products that generally are characterized by lower relative
volume and that generally do not involve settlement on the third Friday
of a month.\52\ At the time of each approval, the Commission stated
that limited approvals on a pilot basis would allow the exchange and
the Commission to monitor the potential for adverse market effects and
modify or terminate the pilots, if necessary. Notably, with the
exception of FLEX Index options, these recently-approved p.m.-settled
contracts do not involve expiration on the third Friday of the month.
These new contracts, including FLEX, have also been characterized by
limited volume, and would not be expected to have a pronounced effect
on volatility in the underlying securities at the close as a result.
---------------------------------------------------------------------------
\52\ In particular, in 1993, the Commission approved CBOE's
proposal to list and trade p.m.-settled, cash-settled options on
certain broad-based indexes expiring on the first business day of
the month following the end of each calendar quarter (``Quarterly
Index Expirations''). See Securities Exchange Act Release No. 31800
(February 1, 1993), 58 FR 7274 (February 5, 1993) (SR-CBOE-92-13).
In 2006, the Commission approved, on a pilot basis, CBOE's listing
of p.m.-settled index options expiring on the last business day of a
calendar quarter (``Quarterly Options Series''). See Securities
Exchange Act Release No. 54123 (July 11, 2006), 71 FR 40558 (July
17, 2006) (SR-CBOE-2006-65). In January 2010, the Commission
approved CBOE's listing of p.m.-settled FLEX options on a pilot
basis.\52\ See Securities Exchange Act Release No. 61439 (January
28, 2010), 75 FR 5831 (February 4, 2010) (SR-CBOE-2009-087) (order
approving rule change to establish a pilot program to modify FLEX
option exercise settlement values and minimum value sizes). FLEX
options provide investors with the ability to customize basic option
features including size, expiration date, exercise style, and
certain exercise prices. Prior to 2010, only a.m. settlement based
on opening prices of the underlying components of an index could be
used to settle a FLEX index option if it expired on, or within two
business days of, a third-Friday-of-the-month expiration (``Blackout
Period''). Last year, the Commission approved a pilot program to
permit FLEX index options with p.m. settlement that expire within
the Blackout Period. See Securities Exchange Act Release No. 61439
(January 28, 2010), 75 FR 5831 (February 4, 2010) (SR-CBOE-2009-
087). In September 2010, the Commission approved CBOE's listing of
p.m.-settled End of Week expirations (expiring on each Friday, other
than the third Friday) and End of Month expirations (expiring on the
last trading day of the month) for options on broad-based indexes,
also on a pilot basis. See Securities Exchange Act Release No. 62911
(September 14, 2010), 75 FR 57539 (September 21, 2010) (SR-CBOE-
2009-075).
---------------------------------------------------------------------------
In response to C2's proposal, two commenters raise concerns over
the reintroduction of p.m. settlement on a potentially popular index
derivative and the possible impact that doing so could have on the
underlying cash equities markets.\53\ One commenter urges the
Commission to consider why markets went to a.m. settlement in the early
1990s and opines that hindsight supports the conclusion that a.m.
settlement has been good for the markets.\54\ While acknowledging that
the answer is not clear, the commenter asks the Commission to consider
whether it is now safe to return to the dominance of p.m.-settled index
options and futures.\55\ However, this commenter submitted a subsequent
letter in which he agreed with the Exchange that ``conditions today are
vastly different'' from those that drove the transition to a.m.
settlement.\56\ The commenter concludes that C2's proposal should be
approved on a pilot basis, which would allow the Commission to collect
data to closely analyze the impact of the proposal.\57\
---------------------------------------------------------------------------
\53\ See ISE Letter 1, supra note 4, at 4-5; ISE Letter 2, supra
note 4, at 2-3; and Mayne Letter 1, supra note 4, at 1-2.
\54\ See Mayne Letter 1, supra note 4, at 1 (noting that
concerns with p.m. settlement ``led to the advent of the far more
innocuous, and perhaps more fair `AM-Print' method of determining
the final value for expiring index options. To judge by the
abatement of the negative press, hindsight would seem to support
that the AM-Print made for a more level playing field.'')
\55\ See id. at 2.
\56\ See Mayne Letter 2, supra note 4, at 1.
\57\ See id.
---------------------------------------------------------------------------
A different commenter describes the history behind the transition
to a.m. settlement and criticizes C2 for trivializing that history.\58\
This commenter argues that a mainstream return to the ``discredited''
p.m. settlement would ``risk undermining the operation of fair and
orderly financial markets.'' \59\ The commenter notes that experience
with the ``flash crash'' of May 6, 2010 demonstrates that the current
market structure struggles to find price equilibriums, and that
dispersed trading is a ``mirage'' as participants often flock to the
same liquidity centers in time of stress.\60\ In its July comment
letter, the commenter took a slightly different approach by arguing
that fragmentation is the biggest change to the markets since 1987 when
markets moved to a.m. settlement.\61\ The commenter notes that even
with almost all volume concentrated on one exchange back in the 1980s,
the markets could not address closing liquidity and volatility concerns
and prevent market disruptions on ``triple witch'' settlement
[[Page 55974]]
dates.\62\ The commenter believes that fragmentation makes it almost
impossible for any single market to concentrate liquidity at the close
to produce an effective clearing price at times of market
volatility.\63\ In addition, the commenter argues that exchange-
specific closing procedures are only applicable to trading on one
exchange, which represents a small fraction of the overall market
today, and therefore will have little ability to dampen market
volatility.\64\ The commenter believes that C2's proposal would
exacerbate liquidity strains by reintroducing an extraordinary market
event--the triple witching hour--and argues that allowing S&P 500 index
options to be based on closing settlement prices, even on a pilot
basis, would re-introduce the potential for extreme market volatility
at expiration.\65\
---------------------------------------------------------------------------
\58\ See ISE Letter 1, supra note 4, at 4.
\59\ Id.
\60\ See id.
\61\ See ISE Letter 3, supra note 8, at 2.
\62\ See id.
\63\ See id.
\64\ See id.
\65\ See ISE Letter 1, supra note 4, at 5. This commenter also
notes that recently-imposed circuit breakers in the cash equities
markets do not apply in the final 25 minutes of trading. See id.
---------------------------------------------------------------------------
In addition, the commenter states that Commission approval of C2's
proposal would lead to the reintroduction of multiple p.m.-settled
derivatives and argues that while the SPXPM pilot would be troubling,
having multiple pilots operating simultaneously would undermine the
industry-wide move to a.m. settlement.\66\ The Commission generally
considers relevant information available to it at the time it reviews
each filing in evaluating whether the filing is consistent with the
Act.\67\
---------------------------------------------------------------------------
\66\ See ISE Letter 3, supra note 8, at 3.
\67\ See 15 U.S.C. 78s(b) (concerning Commission consideration
of proposed rule changes submitted by self-regulatory
organizations).
---------------------------------------------------------------------------
Taking the opposite view, two commenters urge the Commission to
approve the proposal on a pilot basis.\68\ One commenter asserts its
belief that C2's proposal will not cause greater volatility in the
underlying securities of the S&P 500 index.\69\ This commenter opines
that whether an options contract is p.m.-settled as opposed to a.m.-
settled is not a contributing factor to volatility, and the commenter
notes that there is more liquidity in the securities underlying the S&P
500 index at the close compared to the opening.\70\ The commenter
states that exchanges are well equipped to handle end-of-day volume and
that existing p.m.-settled products do not contribute to increased
volatility.\71\ The other commenter states that the reintroduction of
p.m. settlement is long overdue and would attract liquidity from dark
pools, crossing mechanisms, and the over-the-counter markets.\72\
---------------------------------------------------------------------------
\68\ See IMC Letter, supra note 4, at 1-2 and JP Letter, supra
note 4.
\69\ See IMC Letter, supra note 4, at 1.
\70\ See id.
\71\ See id. at 2.
\72\ See JP Letter, supra note 4.
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In its initial response to comments, C2 argues that the concerns
from 18 years ago that led to the transition to a.m. settlement for
index derivatives have been largely mitigated.\73\ C2 argues that
expiration pressure in the underlying cash markets at the close has
been greatly reduced with the advent of multiple primary listing and
unlisted trading privilege markets, and that trading is now widely
dispersed among many market centers.\74\ C2 further argues that opening
procedures in the 1990s were deemed acceptable to mitigate one-sided
order flow driven by index option expiration and that today's more
sophisticated automated closing procedures should afford a similar, if
not greater, level of comfort.\75\ Specifically, C2 notes that many
markets, notably The NASDAQ Stock Market LLC (``Nasdaq'') and the NYSE,
now utilize automated closing cross procedures and have closing order
types that facilitate orderly closings, and that these closing
procedures are well-equipped to mitigate imbalance pressure at the
close.\76\ In addition, C2 believes that after-hours trading now
provides market participants with an alternative to help offset market-
on-close imbalances.\77\
---------------------------------------------------------------------------
\73\ See C2 Response Letter, supra note 5, at 4.
\74\ See id.
\75\ See C2 Response Letter, supra note 5, at 4.
\76\ See id.
\77\ See id. at 2.
---------------------------------------------------------------------------
C2 also notes that for roughly five years (1987-1992) CBOE listed
both a.m.- and p.m.-settled SPX and did not observe any related market
disruptions during that period in connection with the dual a.m./p.m.
settlement.\78\ Finally, C2 believes that p.m.-settled options
predominate in the over-the-counter (``OTC'') market, and C2 is not
aware of any adverse effects in the underlying cash markets
attributable to the considerable volume of OTC trading.\79\ C2 asserts
that given the changes since the 1980s, concerns with p.m. settlement
are ``misplaced'' and have been ``negated'' now that closing procedures
on the cash equities markets have become more automated with real-time
data feeds that are distributed to a wider array of market
participants.\80\
---------------------------------------------------------------------------
\78\ See Notice, supra note 3, at 12776.
\79\ See id.
\80\ See C2 Response Letter, supra note 5, at 2 and 4. In its
comment letter, ISE notes that C2's claim that electronic trading
can smooth out the price-setting process is ``disingenuous'' as
recent history suggests that the opposite may be true in some cases
(such as the market events of May 6, 2010). See ISE Letter 1, supra
note 4, at 5.
---------------------------------------------------------------------------
The Commission agrees with C2 that the closing cross mechanisms on
the primary listing stock markets have matured considerably since the
late 1980s. Closing procedures used by the primary equity markets now
offer a more transparent and automated process for attracting contra-
side interest and determining closing prices in a manner that is
comparable to the process used to determine opening prices.\81\ The
Commission recognizes, however, that the ability of such procedures to
counter-balance any potential negative effects that could stem from
p.m. settlement is dependent on their ability to attract liquidity in a
fragmented market to the primary listing exchanges during a very
concentrated window of time at the close of trading on expiration
Fridays. Consequently, the potential effect that p.m.-settlement of
cash-settled index options could have on the underlying cash equities
markets at expiration remains unclear and the Commission remains
concerned about
[[Page 55975]]
the possible effect on volatility at the close of a return to p.m.
settlement for cash-settled index options.\82\
---------------------------------------------------------------------------
\81\ Nasdaq (see Nasdaq Rule 4754), NYSE (see NYSE Rule 123C),
and NYSE Amex LLC (``NYSE Amex'') (see NYSE Amex Rule 123C) all have
automated closing cross procedures for their equities markets, which
are designed to attract liquidity, to determine a price for a
security that minimizes any imbalance, and to match orders at the
4:00 p.m. close. Participants of these exchanges generally receive
frequently-disseminated market data reports reflecting any
imbalance, which is intended to attract offsetting interest to
minimize or eliminate an imbalance heading into the close. NYSE
Arca, Inc. has closing procedures (NYSE Arca Rule 7.35), but it only
conducts a closing cross for securities in which it is the primary
listing market as well as for all exchange-listed derivatives.
Additionally, to minimize the potential for price swings at the
close, Nasdaq provides that the closing price must be within an
acceptable range of 10% of the midpoint of the NBBO, while the NYSE
permits the Designated Market Maker in a stock to request that the
exchange extend its trading day to not longer than 4:30 p.m. to
allow for the solicitation and entry of orders that are specifically
solicited to offset an imbalance existing as of 4 p.m. To further
minimize selling pressure at the NYSE, market-on-close and limit-on-
close orders may be entered after 3:45 p.m. only if they offset an
imbalance. The NYSE also provides for closing-only orders that only
execute if they offset an imbalance. The Commission views these
closing cross procedures as a significant change in how orders are
handled at the close of trading that could potentially help reduce
volatility at the close caused by p.m. settlement.
C2 also notes that SPXPM expiration dates would be predetermined
and known in advance and, as a consequence, this awareness could
facilitate the generation of contra-side trading interest. See C2
Response Letter, supra note 5, at 3. The potential for reoccurring
heightened volatility during these expiration periods may, however,
increase the opportunity for manipulation and other abusive trading
practices in anticipation of the liquidity constraints. To the
extent such volatility was possible, active surveillance and robust
enforcement activity by C2 and other self-regulatory organizations
around expiration dates would help to address the potential for
abusive trading.
\82\ The Commission's concern with the potential effect that
p.m.-settlement of cash-settled index options could have on the
underlying cash equities markets at expiration takes into
consideration, as C2 notes, that the use of closing prices by retail
and institutions investors is widespread. See C2 Letter 3, supra
note 8, at 6. For example, mutual funds use closing prices to
calculate their net asset values. Therefore, any event or product
that potentially introduces additional volatility into the process
of determining closing prices has the potential to harm investors
and the public interest.
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C2 cites to the Commission's recent approval of a series of
proposals that authorized the expansion of a limited subset of options
products to p.m. settlement along with data collected in connection
with those products as revealing no evidence that p.m. settlement is
likely to have a disruptive effect on volatility at the close.\83\ We
do not believe that such an inference necessarily can be drawn. These
prior approvals involved sub-categories of options that are generally
characterized by relatively low volume and thus would not be expected
to have a pronounced effect on volatility in the underlying securities
at the close on expiration.\84\ Further, many of these products are not
authorized for listing with expiration on the third Friday of a month
when other cash-settled index derivatives expire. For example, C2
mentions CBOE's experience with End-of-Week p.m.-settled options (which
it notes is the most heavily traded of CBOE's new special-dated
expiration products), and concludes that they fail to show any evidence
of disruptive volatility on the settlement days for these
contracts.\85\ Despite the fact that End-of-Week p.m.-settled options
constitute over 7% of CBOE's S&P 500 index option volume, their volume
does not compare to that of CBOE's SPX product, which accounts for 60%
of all index options trading. For this reason, it is difficult to draw
any conclusions about the potential impact of p.m.-settled S&P 500
index options on the market for the underlying component stocks based
on the existing p.m.-settled cash-settled options. Further, past
experience suggests that the potential impact would be more significant
if both index options and index futures (and options on index futures)
were offered with p.m. settlement.
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\83\ See C2 Letter 3, supra note 8, at 4-5.
\84\ We note that historical experience with respect to more
heavily traded index options and index futures indicates that p.m.
settlement carries additional risks for enhanced volatility on
settlement days. See, e.g., Hans Stoll and Robert Whaley, Expiration
Day Effects of Index Options & Futures (March 15, 1986) (concluding
that price effects ``are observable on quarterly futures expirations
* * * [and] [t]he volatility of prices is significantly higher on
such expiration days, and the stock market indices tend to fall on
such expiration days.'').
\85\ See id. at 5.
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While the enhanced closing processes on the primary listing markets
may serve to mitigate some of the risk that imbalances on the
underlying cash markets prior to the close could lead to excess
volatility, the extent of that mitigation is unclear. A pilot program
would provide an opportunity to observe and analyze the actual effects
on the underlying cash markets of SPXPM. Further, to the extent that
trading interest is redirected to the primary markets during times of
stress, as one commenter noted, it could be conducive to addressing an
imbalance to concentrate liquidity on the primary markets during the
close. In particular, those markets conduct automated closing cross
procedures, described above,\86\ that are designed to more efficiently
disseminate information broadly and attract and offset imbalances. We
note, however, that despite C2's emphasis on the higher volumes in
today's markets compared with the 1980s and the dispersion of trading
to more venues,\87\ volume statistics are not necessarily indicative or
predictive of the level of available liquidity.\88\
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\86\ See supra note 81.
\87\ See id.
\88\ See, e.g., Findings Regarding the Market Events of May 6,
2010, Report of the Staffs of the CFTC and SEC to the Joint Advisory
Committee on Emerging Regulatory Issues, available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf, at page 6
(``As the events of May 6 demonstrate, especially in times of
significant volatility, high trading volume is not necessarily a
reliable indicator of market liquidity.'').
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Finally, C2 estimates that 95% of OTC options based on the S&P 500
index are p.m.-settled,\89\ and states that SPXPM will attract some of
that trading interest. C2 notes that doing so would be consistent with
the objectives of the Dodd-Frank Wall Street Reform and Consumer
Protection Act and could help mitigate counterparty risks faced by OTC
market participants.\90\ The Commission agrees that the proposal could
benefit investors to the extent it attracts trading in p.m.-settled S&P
500 index options from the opaque OTC market to the more transparent
exchange-listed markets.
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\89\ See C2 Letter 3, supra note 8, at 13.
\90\ See id.
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Further, C2's proposal will offer investors another investment
option through which they could obtain and hedge exposure to the S&P
500 stocks. In addition, C2's proposal will provide investors with the
ability to trade an option on the S&P 500 index in an all-electronic
market, which may better meet the needs of investors who may prefer to
trade electronically.\91\ Accordingly, C2's proposal will provide
investors with added flexibility through an additional product that may
be better tailored to meet their particular investment, hedging, and
trading needs.
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\91\ See, e.g., Exchange Capital Resources Letter, supra note 8,
at 3 (stating in part that ``* * * the addition of the SPXPM product
will offer the investor greater flexibility and opportunity to
participate in S&P 500 option product line.'')
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To assist the Commission in assessing any potential impact of a
p.m.-settled S&P 500 index option on the options markets as well as the
underlying cash equities markets, as discussed above,\92\ C2 has
proposed to submit data to the Commission on a confidential basis in
connection with the pilot. The Commission believes that C2's proposed
fourteen-month pilot, together with the data and analysis that C2 will
provide to the Commission, will allow C2 and the Commission to monitor
for and assess the potential for adverse market effects. Specifically,
the data and analysis will assist the Commission in evaluating the
effect of allowing p.m. settlement for S&P 500 index options on the
underlying component stocks.
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\92\ See Section II (Description of the Proposal).
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In light of the fact that approval of C2's proposal would be a
change from a.m. settlement for cash-settled index options, the
Commission instituted proceedings to determine whether to approve or
disapprove the proposal. In particular, through specific requests for
comment and data, the Commission solicited input from market
participants on the potential impact on the markets, particularly the
underlying cash equities markets.
As discussed above, the Commission remains concerned about the
potential impact on the market at expiration for the underlying
component stocks for a p.m.-settled, cash-settled index option such as
SPXPM. The potential impact today remains unclear, given the
significant changes in the closing procedures of the primary markets
over the past two decades. The Commission is mindful of the historical
experience with the impact of p.m. settlement of cash-settled index
derivatives on the underlying cash markets, discussed at length above,
but recognizes, however, that these risks may be mitigated today by the
enhanced closing procedures that are now in use at the primary equity
markets.
Finally, approval of C2's proposal on a pilot basis will enable the
Commission to collect current data to assess and monitor for any
potential for impact on markets, including the underlying cash
[[Page 55976]]
equities markets. In particular, the data collected from C2's pilot
program will help inform the Commission's consideration of whether the
SPXPM pilot should be modified, discontinued, extended, or permanently
approved. It also could benefit investors and the public interest to
the extent it attracts trading in p.m.-settled S&P 500 index options
from the opaque OTC market to the more transparent exchange-listed
markets, where trading in the product will b
