Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Proposed Rule Change to Adopt Rules in Connection With S&P 500 Option Variance Basket Trades, 71092-71102 [2011-29578]
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71092
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
whether the proposed rule should be
approved or 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 email to rulecomments@sec.gov. Please include File
Number SR–Phlx–2011–147 on the
subject line.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.24
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2011–29510 Filed 11–15–11; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–65725; File No. SR–CBOE–
2011–007]
Self-Regulatory Organizations;
Chicago Board Options Exchange,
Incorporated; Notice of Filing of
Proposed Rule Change to Adopt Rules
in Connection With S&P 500 Option
Variance Basket Trades
mstockstill on DSK4VPTVN1PROD with NOTICES
Paper Comments
November 10, 2011.
• 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–Phlx–2011–147. This file
number should be included on the
subject line if email 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–Phlx–
2011–147 and should be submitted on
or before December 7, 2011.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
notice is hereby given that on October
26, 2011, Chicago Board Options
Exchange, Incorporated (the ‘‘Exchange’’
or ‘‘CBOE’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’) the proposed rule
change as described in Items I and II
below, which Items have been prepared
by the Exchange. The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The filing proposes to adopt rules in
connection with S&P 500 option
variance basket trades. The text of the
proposed rule change is available on the
Exchange’s Web site (https://
www.cboe.org/legal), at the Exchange’s
Office of the Secretary, and at the
Commission.
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
self-regulatory organization 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 those statements may be examined at
the places specified in Item IV below.
The Exchange has prepared summaries,
set forth in sections A, B, and C below,
of the most significant parts of such
statements.
1 15
24 17
CFR 200.30–3(a)(12).
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A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
The Exchange is proposing a new
offering, called S&P 500 variance trades,
which will allow investors to
electronically trade a portfolio of S&P
500 Index options (SPX options) in a
single transaction. An S&P 500 variance
trade (also referred to as the ‘‘basket’’ or
‘‘variance trade basket’’), is intended to
replicate S&P 500 implied variance.3
Demand for volatility products has
increased dramatically in recent years,
and variance baskets will provide
investors with another way to efficiently
trade S&P 500 volatility.4
As an initial matter, S&P 500 variance
trades will only trade electronically on
CBOE (open-outcry S&P 500 variance
trades will not be possible); each day,
one or more new S&P 500 variance trade
baskets will be available for trading, and
transactions in each basket will occur
on that day only; and, no market orders
will be accepted. Each basket will
consist of a portfolio of SPX options
defined by the Exchange the day before
it is available for trading. All of the
constituent options of the basket will
have the same expiration date and will
be centered around an at-the-money
strike price. It is expected that a full
‘‘strip’’ consisting of all series in the
strike range would be offered every
day.5 Each basket will also have a
unique ticker symbol. Market prices for
S&P 500 variance trades will be
expressed and quoted in volatility terms
(e.g. 21.24). Trade quantities will be
expressed in contracts. Each contract
will have a multiplier of $10,000 or
more, as determined and published by
the Exchange (the Exchange would not
3 ‘‘Implied Variance’’ refers to the market’s
expectation of daily price changes of a reference
asset that is implied by the price of an option or
a portfolio of options overlying that reference asset.
Implied variance is related to the more commonlyused term, ‘‘implied volatility,’’ which is the square
root of implied variance. The reference asset for
S&P 500 variance trades is the S&P 500 Index. The
portfolio of options intended to replicate S&P 500
implied variance is comprised of S&P 500 Index
(SPX) options.
4 The Exchange notes that S&P 500 variance
trades do not replicate variance swaps.
5 The Exchange notes that the proposed rule
allows the Exchange to determine the days on
which S&P 500 variance trades will be allowed, and
that the Exchange will make publicly available a
detailed description of the formulas and
methodology used to deconstruct S&P 500 variance
trades into constituent SPX option series. Further,
for each day on which S&P 500 variance trades are
allowed, the Exchange will publish, after the close
of trading on the previous day, the options
comprising the portfolio for the next day.
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Exchange would announce via
Regulatory Circular the applicable
matching algorithm. Second, once a
match occurs, the Exchange will use a
formula to deconstruct the match into
individual trades in the constituent SPX
options that comprise the basket, and
those individual trades will each print
concurrently.
The algorithm used to deconstruct
S&P 500 variance trades into constituent
SPX option legs is a two step process.
The first step assigns the number of
contracts traded for each SPX option
series. The number of SPX contracts is
a function of the S&P 500 variance trade
price and trade quantity, as well as time
to expiration, interest rates and the
strike prices of constituent SPX option
legs. The following formula defines the
trade quantity for each series in the S&P
500 variance trade basket:
of the constituent SPX options by the
same amount and then calculates a set
of simulated option prices using the
Black Model and the adjusted implied
volatilities. The System then (5) uses the
simulated option prices as input values
to the VIX formula; the resulting output
of the VIX formula serves as a new
interim volatility value. The System
then continues to repeat Steps 3 through
5 until the interim volatility value
matches the S&P 500 option variance
basket trade price. Finally, the System
(6) creates a series of matched trades for
all of the constituent SPX option series
using, as trade prices, the simulated
option prices that cause the interim
volatility value to match the S&P 500
option variance basket trade price.
Once trade prices are determined for
each constituent series, the System
executes and reports the constituent
trades. The execution prices are
unrelated to the existing market for the
applicable series, therefore, pursuant to
paragraph (c) of proposed Rule 6.53B,
constituent trades are executed and
reported without regard for existing bids
and offers on the Exchange. This is
appropriate because S&P 500 variance
trades involve the execution of an
investment strategy across numerous
series. Prevailing bids and offers in each
such series cannot satisfy the overall
execution strategy of an S&P 500
variance trade particularly when
considering that the execution prices
reflect pricing that is not based (directly
or indirectly) on the quoted prices at the
time of execution. To highlight to users
that executions of S&P 500 variance
trades are not associated with the
quoted prices in the respective SPX
series at the time of execution, each
constituent execution will be reported
with the ‘‘benchmark’’ indicator. This
indicator was created to facilitate the
execution of benchmark orders as
contemplated by the Options Order
Protection and Locked/Crossed Market
Plan (the ‘‘Linkage Plan’’). A benchmark
order is an order for which the price is
not based, directly or indirectly, on the
quoted price of the option at the time of
the order’s execution and for which the
material terms were not reasonably
determinable at the time a commitment
to trade the order was made.7 While the
benchmark indicator was created for the
reporting of multiply listed option
executions that meet the benchmark
definition, the Exchange believes it will
be useful to append the indicator to the
execution of constituent series of an
S&P 500 variance trade so SPX traders
know that the executions were not
related to the quoted price at the time
of the print. Thus, the use of the
indicator in this context is for
informational purposes and the
fine-tune their investment objectives for short-dated
options and/or low volatility levels.
7 CBOE does not currently offer functionality or
order types that can utilize the benchmark
exception to the Linkage Plan.
The second step assigns trade prices
for each SPX option in the S&P 500
variance trade. The System (1)
calculates a baseline implied volatility
for each constituent SPX option. The
System performs this calculation by
using a Black Model and backing out
implied volatility levels based on the
mid-quote prices of constituent SPX
options prevailing at the time of the
variance basket trade execution. The
System then (2) calculates an initial
‘‘interim volatility’’ value using the midquote SPX option prices as input values
to the VIX formula (the VIX formula is
presented in Example 1 below; a
detailed description of the VIX formula
may be found in the VIX White Paper,
which is available on the CBOE Web
site at https://www.cboe.com/micro/vix/
vixwhite.pdf). Next, the System (3)
compares the variance basket trade price
with the interim volatility value. If the
variance basket trade price is less
(greater) than the interim volatility
value, the System (4) decreases
(increases) the implied volatilities of all
6 The Exchange expects to typically use a higher
multiplier, but seeks to establish a $10,000
minimum to allow investors greater flexibility to
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to the System electronically like orders
in other products. Thus, once an S&P
500 variance trade basket has been
announced and established by the
Exchange (after the close of trading),
users may submit pre-opening orders in
that basket for execution the following
day. The same opening process utilized
for other listed options will be used for
S&P 500 variance trades, and trading in
the S&P 500 variance trade basket will
continue throughout the day just like
other products traded on the Exchange.
S&P 500 variance trade processing
will be different from other listed
options in several respects. First, trading
interest in the disseminated quote for an
S&P 500 variance trade shall be ranked
pursuant to one of the matching
algorithms set forth in Rule 6.45A
which may be different from the
matching algorithm in place for other
option products, including SPX. The
Ni Trade quantity of ith option in portfolio
s Variance basket trade price (expressed in
volatility terms)
T Time to expiration
Ki Strike price of ith option in portfolio
DKi Interval between strike prices
R Risk-free interest rate to expiration
‘‘vega notional’’ Variance basket quantity
times contract multiplier (e.g., $50,000)
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change the multiplier intraday).6 The
multiplier for S&P 500 variance trades
represents the aggregate ‘‘vega’’
exposure of the SPX option series that
comprise the S&P 500 variance trade
portfolio. Vega is a term frequently used
by volatility traders to describe the
change in value of a contract
corresponding to a one-point change in
volatility. For example, assuming a vega
exposure of $50,000, an investor would
expect to pay approximately $50,000
more for a variance basket portfolio with
a trade price of 21.00 than he/she would
if the trade price was 20.00.
The display and trading of S&P 500
variance trades will be handled very
much like the display and trading of
typical listed options. That is, Trading
Permit Holders may submit orders in
S&P 500 variance trades for interaction
with resting S&P 500 variance trade
orders. These orders will be submitted
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Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
constituent executions are not actually
benchmark trades pursuant to the
Linkage Plan.
To summarize, users will submit S&P
500 variance trade orders with limit
prices that will execute when
marketable against other limit orders
resident in the book. Once the execution
occurs, the System will ‘‘deconstruct’’
the match and calculate executions in
the applicable individual SPX series
that comprise the S&P 500 variance
trade basket. The System will then print
each constituent series execution. Only
these constituent executions will be sent
to the Options Clearing Corporation for
clearing. Once the process is completed,
the S&P 500 variance trade transaction
will cease to exist but each party to the
transaction will have traded the
constituent series. In essence, the S&P
500 variance trade process allows
Trading Permit Holders to trade a basket
of SPX options (across different series)
in one transaction (i.e. one basket trade
explodes into numerous SPX
executions). To illustrate the process,
three examples are provided below.
Example 1
On the day before the trade date and
after the close, CBOE publishes, through
its Web site or in some other format, a
set of parameters for an S&P 500
variance trade that will be available for
trading the following business day. This
information identifies the individual
SPX option series comprising the
variance trade portfolio. This example
uses the DEC 2011 variance trade and is
highlighted in the following table:
SPX expiration
Strike range
K0
Min. strike interval
Contract multiplier
($vega/contract)
DEC 2011 ........................................................
500—1500
1125
25
$50,000
In addition, the following values need
to be known as of trade date:
Time to DEC 2011 Expiration (T):
0.34795 years (127 days).
Risk-Free Interest Rate to DEC 2011
(R): 0.02% 8.
Order Entry and Trade Match
• Broker A enters a limit order to sell
2 S&P 500 DEC 2011 variance trade at
33.50.
• Trader B and Trader C each respond
by submitting an order to buy one
contract at 33.00.
• Broker A eventually cancels the
33.50 offer and replaces it with a 33.00
offer.
• The DEC 2011 variance trade
matches at 33.00. Trader B buys 1
contract at 33.00 and Trader C buys 1
contract at 33.00.
• Fill reports for the variance trade
executions are sent to Broker A, Trader
B and Trader C.
Strike price
(K)
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P/C
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P ...............................................................................................................
P (K0) .......................................................................................................
C (K0) .......................................................................................................
C ..............................................................................................................
C ..............................................................................................................
C ..............................................................................................................
C ..............................................................................................................
C ..............................................................................................................
500
525
550
575
600
625
650
675
700
725
750
775
800
825
850
875
900
925
950
975
1000
1025
1050
1075
1100
1125
1125
1150
1175
1200
1225
1250
• The variance trades are then
‘‘deconstructed’’ by the System to create
a series of matched trades in all of the
SPX option series comprising the
variance trade.
Post trade match processing
The following table shows the bid/ask
and mid-quote prices for DEC 2011 SPX
options immediately following the
execution of the variance trade:
Bid
$0.55
0.75
1.10
1.50
2.00
2.35
2.70
3.50
5.00
5.20
6.40
7.80
10.50
11.40
13.30
15.70
18.70
21.60
24.90
29.20
33.40
39.00
44.50
51.40
59.20
67.60
90.10
74.90
61.30
48.40
37.30
27.80
Ask
$1.50
1.55
2.05
2.45
2.95
3.48
4.00
5.00
5.90
7.10
8.30
9.70
11.30
14.20
16.10
18.50
21.60
25.30
28.60
33.10
37.30
42.70
48.40
55.30
63.10
71.50
94.00
78.80
65.20
52.30
41.20
31.70
8 Interest rate on U.S. Treasury Bill maturing
December 15, 2011.
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Mid-quote
$1.03
1.15
1.58
1.98
2.48
2.91
3.35
4.25
5.45
6.15
7.35
8.75
10.90
12.80
14.70
17.10
20.15
23.45
26.75
31.15
35.35
40.85
46.45
53.35
61.15
69.55
92.05
76.85
63.25
50.35
39.25
29.75
DK
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
25
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Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
Strike price
(K)
P/C
C
C
C
C
C
C
C
C
C
C
..............................................................................................................
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..............................................................................................................
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Deconstruction Algorithm
The algorithm used to deconstruct
S&P 500 variance trades into constituent
SPX option series executions is a 2-step
process.
Step 1. The System first determines
the number of contracts (Ni) for each
Bid
1275
1300
1325
1350
1375
1400
1425
1450
1475
1500
SPX option series comprising the
variance trade on a ‘‘per variance trade
contract’’ basis. As shown below, the
number of SPX contracts is a function
of the $vega/contract (e.g., $50,000) and
the trade price for the matched variance
trade (volatility—s), as well as time to
expiration (T), interest rates (R), the
Ask
20.10
13.60
9.20
5.60
3.60
2.00
1.25
0.65
0.45
0.35
Mid-quote
23.60
16.70
11.10
7.50
5.10
3.60
2.20
1.60
1.05
0.70
21.85
15.15
10.15
6.55
4.35
2.80
1.73
1.13
0.75
0.53
DK
25
25
25
25
25
25
25
25
25
25
strike prices of constituent SPX option
legs (Ki) and the strike price interval
(DKi).
The following formula defines the
trade quantity for each series in the
variance trade:
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For example, the trade quantity for
the SPX DEC 2011 500 put (N500 Put) is
given by:
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
Since there are no fractional option
contracts, the value for N500 Put is
rounded to 44. The same calculation is
conducted for each SPX option series
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comprising the variance trade. The
results are shown in the table below. It
should be noted that both puts and calls
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are traded at the K0 (in this case, 1125)
strike.
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71097
(‘‘centering strike’’) are each about 30.
The graph below shows the implied
volatilities of the SPX options
comprising the December 2011 variance
basket. A representation of implied
volatility as a function of strike price is
commonly referred to as a volatility
‘‘smile.’’
s2 Variance (volatility-squared); VIX = s ×
100
T Time to expiration
F Forward SPX level
K0 Variance strip centering strike price
Ki Strike price of ith option
DKi Interval between strike prices
R Risk-free interest rate to expiration
Q(Ki) Price of option with strike Ki.
In this example, the initial interim
volatility value for the SPX options
comprising the DEC 2011 variance trade
is 33.59. Next, the System (3) compares
the variance basket trade price with the
interim volatility value. Since in this
example, the variance basket trade price
of 33.00 is less than the interim
volatility value of 33.59, the System (4)
would decrease the implied volatilities
of all of the constituent SPX options by
the same amount and then calculate a
set of simulated option prices using the
Black Model and the adjusted implied
volatilities. The System then (5) uses the
simulated option prices as input values
to the VIX formula; the resulting output
of the VIX formula serves as a new
interim volatility value. The System
then continues to repeat Steps 3 through
5 until the interim volatility value
matches the S&P 500 option variance
basket trade price. In this example, the
interim volatility value matches the
target trade price of 33.00 when the
baseline implied volatilities are
decreased by 0.46 volatility points.
When the simulated option values
calculated by reducing the baseline
implied volatilities by 0.46 volatility
points are used as input values to the
VIX formula, the result—rounded to the
nearest hundredth—matches the
variance basket trade price.11
At this point, the System (6) creates
a series of matched trades for all of the
constituent SPX option series using, as
trade prices, the simulated option prices
that cause the interim volatility value to
match the S&P 500 option variance
basket trade price.
With trade quantities determined and
SPX option prices assigned, the System
creates the following 42 matched trades
in constituent SPX series—a total of 604
SPX options contracts per S&P 500
variance trade contract, with a total
portfolio value of just over $830,000.
9 Please see ‘‘More than you ever wanted to know
about volatility swaps’’ by Kresimir Demeterfi,
Emanuel Derman, Michael Kamal and Joseph Zou,
Goldman Sachs Quantitative Strategies Research
Notes, March 1999.
10 Please see ‘‘VIX White Paper’’ at
www.cboe.com/vixwhite.pdf
11 As a practical matter, the minimum increment
of change to the baseline volatilities is not limited
to 1/100th of a volatility point. Rather, the System
uses as much precision as it needs in order to
calculate an interim volatility value that, when
rounded to the nearest hundredth, matches the
variance basket trade price.
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the mid-quote SPX option prices as
input values to the VIX formula 9 10
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based on mid-quote prices of
constituent SPX options prevailing at
the time of the variance basket trade
execution. In this example, the baseline
implied volatilities range from a low of
about 20 for the 1500 call to a high of
about 60 for the 500 put. The implied
volatilities of the 1125 put and 1125 call
The System then (2) calculates an
initial ‘‘interim volatility’’ value using
mstockstill on DSK4VPTVN1PROD with NOTICES
Step 2. Next, the System generates
trade prices for each SPX option—
Q(Ki)—in the S&P 500 variance trade.
The System (1) calculates a baseline
implied volatility for each constituent
SPX option. The System performs this
calculation by using a Black Model and
backing out implied volatility levels
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P/C
Strike price
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P ...................................
P (K0) ...........................
C (K0) ...........................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
C ...................................
Mid-quote
option price
500
525
550
575
600
625
650
675
700
725
750
775
800
825
850
875
900
925
950
975
1000
1025
1050
1075
1100
1125
1125
1150
1175
1200
1225
1250
1275
1300
1325
1350
1375
1400
1425
1450
1475
1500
Baseline
implied
volatility
$1.03
1.15
1.58
1.98
2.48
2.91
3.35
4.25
5.45
6.15
7.35
8.75
10.90
12.80
14.70
17.10
20.15
23.45
26.75
31.15
35.35
40.85
46.45
53.35
61.15
69.55
92.05
76.85
63.25
50.35
39.25
29.75
21.85
15.15
10.15
6.55
4.35
2.80
1.73
1.13
0.75
0.53
The S&P 500 variance trade seller
would see 42 sell transactions totaling
1,208 SPX options with an aggregate
value $1.66 million. Each of the two
S&P 500 variance trade buyers would
see 42 buy transactions totaling 604 SPX
Adjusted
implied
volatility
60.00
58.80
57.60
56.40
55.20
54.00
52.80
51.60
50.40
49.20
48.00
46.80
45.60
44.40
43.20
42.00
40.80
39.60
38.40
37.20
36.00
34.80
33.60
32.50
31.30
30.10
30.10
28.90
27.80
26.70
25.60
24.50
23.50
22.50
21.50
20.70
20.30
19.90
19.50
19.20
19.20
19.20
Trade price
(rounded)
59.54
58.34
57.14
55.94
54.74
53.54
52.34
51.14
49.94
48.74
47.54
46.34
45.14
43.94
42.74
41.54
40.34
39.14
37.94
36.74
35.54
34.34
33.14
32.04
30.84
29.64
29.64
28.44
27.34
26.24
25.14
24.04
23.04
22.04
21.04
20.24
19.84
19.44
19.04
18.74
18.74
18.74
options with an aggregate value of
$830,000.
Example 2
Following is a hypothetical historical
example of a MAR 2011 S&P 500
variance trade on December 29, 2010.
Trade quantity
$0.79
1.05
1.36
1.74
2.20
2.75
3.39
4.15
5.04
6.08
7.27
8.65
10.24
12.06
14.14
16.52
19.23
22.31
25.83
29.82
34.35
39.51
45.35
52.23
59.76
68.28
91.08
75.70
61.82
49.27
38.16
28.54
20.68
14.31
9.36
5.95
3.90
2.45
1.48
0.89
0.58
0.37
Trade value
44
39
36
33
30
28
26
24
22
21
19
18
17
16
15
14
13
13
12
11
11
10
10
9
9
5
4
8
8
8
7
7
7
6
6
6
6
6
5
5
5
5
$3,476
4,095
4,896
5,742
6,600
7,700
8,814
9,960
11,088
12,768
13,813
15,570
17,408
19,296
21,210
23,128
24,999
29,003
30,996
32,802
37,785
39,510
45,350
47,007
53,784
34,140
36,432
60,560
49,456
39,416
26,712
19,978
14,476
8,586
5,616
3,570
2,340
1,470
740
445
290
185
After the close on December 28, 2010
CBOE publishes the following
parameters for the S&P 500 variance
trade effective for the next trade date—
December 29. The information defining
the SPX options effective for MAR 2011
basket is highlighted below:
SPX expiration
Strike range
K0
Min. strike
interval
Contract
multiplier
($vega/contract)
MAR 2011 ........................................................
600–1600
1250
25
$50,000
mstockstill on DSK4VPTVN1PROD with NOTICES
Order Entry and Trade Match
• Broker A receives an order to buy
2 SPX MAR 2011 S&P 500 variance
trade basket contracts at 20.50.
• Trader B posts an offer to sell 2
contracts at 20.75.
• Broker A eventually cancels the
20.50 bid and replaces it with a 20.75
bid.
VerDate Mar<15>2010
17:45 Nov 15, 2011
Jkt 226001
• The variance basket trade matches
at 20.75.
• The System begins to deconstruct
the S&P 500 variance trade basket into
a series of matched trades in all of the
SPX option series comprising the S&P
500 variance trade basket.
PO 00000
Frm 00145
Fmt 4703
Sfmt 4703
Deconstruction
As previously described, the
algorithm used to deconstruct S&P 500
variance trades into constituent SPX
option trades is a 2-step process; the
first step assigns the number of
contracts traded for each SPX option
series comprising the S&P 500 variance
trade basket, and the second step
E:\FR\FM\16NON1.SGM
16NON1
71099
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
assigns trade prices to those SPX option
series. The following table shows the
SPX option mid-quote prices prevailing
at the time of the S&P 500 variance trade
execution, as well as the trade quantities
and trade prices assigned by the
deconstruction algorithm. In this
example, the S&P 500 variance trade
was deconstructed into 42 separate
matched trades, totaling over 2,400 SPX
P/C
Strike price
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P (K0) ...................................................................................
C (K0) ...................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
Example 3
Following is a hypothetical historical
example of a JUN 2012 S&P 500
variance trade on April 29, 2011.
Mid-quote
option price
600
625
650
675
700
725
750
775
800
825
850
875
900
925
950
975
1000
1025
1050
1075
1100
1125
1150
1175
1200
1225
1250
1250
1275
1300
1325
1350
1375
1400
1425
1450
1475
1500
1525
1550
1575
1600
option contracts (1,206 SPX contracts
per variance trade basket) and over
$1 million in option premium ($521,000
per variance trade basket).
Trade price
(rounded)
$0.10
0.08
0.10
0.13
0.25
0.50
0.33
0.45
0.53
0.83
0.75
1.23
1.23
1.80
2.20
2.60
3.10
4.05
5.20
6.95
8.40
10.40
13.35
17.20
22.15
28.75
37.45
44.00
29.70
19.05
11.20
5.90
3.10
1.43
0.78
0.45
0.48
0.18
0.50
0.20
0.15
0.15
After the close on April 28, 2011
CBOE publishes the following
parameters for the S&P 500 variance
trade effective for the next trade date—
Trade quantity
$0.09
0.12
0.15
0.20
0.26
0.34
0.43
0.55
0.69
0.86
1.07
1.33
1.65
2.03
2.50
3.07
3.77
4.65
5.73
7.09
8.80
10.97
13.97
17.84
22.94
29.73
38.51
45.06
30.77
19.98
12.03
6.53
3.48
1.70
0.90
0.49
0.40
0.33
0.29
0.26
0.23
0.22
155
143
132
122
114
106
99
93
87
82
77
73
69
65
62
59
56
53
51
48
46
44
42
40
39
37
17
19
34
33
32
31
29
28
27
26
26
25
24
23
22
22
Trade value
$1,395
1,716
1,980
2,440
2,964
3,604
4,257
5,115
6,003
7,052
8,239
9,709
11,385
13,195
15,500
18,113
21,112
24,645
29,223
34,032
40,480
48,268
58,674
71,360
89,466
110,001
65,467
85,614
104,618
65,934
38,496
20,243
10,092
4,760
2,430
1,274
1,040
825
696
598
506
484
April 29, 2011. The information
defining the SPX options effective for
JUN 2012 basket is highlighted below:
Strike range
K0
Min. strike
interval
Contract multiplier
($vega/contract)
JUN 2012 .........................................................
mstockstill on DSK4VPTVN1PROD with NOTICES
SPX expiration
400–1800
1325
25
$50,000
Order Entry and Trade Match
• Broker A receives an order to buy
2 SPX JUN 2012 baskets at 22.50.
• Trader B responds with an offer to
sell 2 contracts at 22.75.
• Broker A eventually cancels the
22.50 bid and replaces it with a 22.75
bid.
VerDate Mar<15>2010
17:45 Nov 15, 2011
Jkt 226001
• The S&P 500 variance trade
matches at 22.75.
• The System begins to deconstruct
the trade into a series of matched trades
in all of the SPX option series
comprising the S&P 500 variance trade.
PO 00000
Frm 00146
Fmt 4703
Sfmt 4703
Deconstruction
As previously described, the
algorithm used to deconstruct variance
trades into constituent SPX option
trades is a 2-step process; the first step
assigns the number of contracts traded
for each SPX option series comprising
the S&P 500 variance trade and the
E:\FR\FM\16NON1.SGM
16NON1
71100
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
second step assigns trade prices to those
SPX option series. The following table
shows the SPX option mid-quote prices
prevailing at the time of the S&P 500
variance trade execution, as well as the
trade quantities and trade prices
assigned by the deconstruction
algorithm. In this example, the S&P 500
variance trade was deconstructed into
46 separate matched trades, totaling
P/C
Strike price
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P (K0) ...................................................................................
C (K0) ...................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
Example 4
Following is a hypothetical historical
example of an October 2011 S&P 500
variance trade on August 11, 2011.
Mid-quote
option price
400
450
500
550
600
650
700
725
750
775
800
825
850
875
900
925
950
975
1000
1025
1050
1075
1100
1125
1150
1175
1200
1225
1250
1275
1300
1325
1325
1350
1375
1400
1425
1450
1475
1500
1550
1600
1625
1650
1700
1800
$0.73
1.08
1.65
2.45
3.35
4.55
6.15
7.05
8.15
9.30
10.45
11.90
13.45
15.25
17.15
19.25
21.55
24.10
27.05
30.10
33.45
37.20
41.20
45.65
50.50
55.85
61.70
68.20
75.25
83.05
91.50
100.85
115.00
100.35
86.65
73.90
62.35
51.80
42.45
34.25
21.20
12.30
9.10
6.70
3.45
0.90
After the close on August 10, 2011
CBOE publishes the following
parameters for the S&P 500 variance
trade effective for the next trade date—
over 800 SPX option contracts (412 SPX
contracts per variance trade basket) and
over 1.1 million in option premium
(567,000 per variance trade basket).
Trade price
(rounded)
Trade quantity
$0.40
0.75
1.29
2.07
3.15
4.57
6.46
7.41
8.45
9.59
10.83
12.26
13.84
15.65
17.64
19.82
22.20
24.81
27.65
30.76
34.15
38.03
42.07
46.68
51.51
56.86
62.74
69.27
76.38
84.25
92.71
102.09
116.35
101.73
87.99
75.17
63.60
53.04
43.52
35.28
22.05
13.02
9.80
7.21
3.92
1.07
Trade value
122
96
78
64
54
46
30
19
17
16
15
14
13
13
12
11
11
10
10
9
9
8
8
8
7
7
7
6
6
6
6
3
3
5
5
5
5
5
4
6
8
6
4
5
10
12
$4,880
7,200
10,062
13,248
17,010
21,022
19,380
14,079
14,365
15,344
16,245
17,164
17,992
20,345
21,168
21,802
24,420
24,810
27,650
27,684
30,735
30,424
33,656
37,344
36,057
39,802
43,918
41,562
45,828
50,550
55,626
30,627
34,905
50,865
43,995
37,585
31,800
26,520
17,408
21,168
17,640
7,812
3,920
3,605
3,920
1,284
August 11, 2011. The information
defining the SPX options effective for
JUN 2012 basket is highlighted below:
mstockstill on DSK4VPTVN1PROD with NOTICES
SPX expiration
Strike range
K0
Min. strike interval
Contract multiplier
($vega/contract)
OCT 2012 ........................................................
825–1325
1125
25
$10,000
Order Entry and Trade Match
• Broker A receives an order to buy
2 SPX OCT 2011 baskets at 14.75.
VerDate Mar<15>2010
17:45 Nov 15, 2011
Jkt 226001
• Trader B responds with an offer to
sell 2 contracts at 15.00.
PO 00000
Frm 00147
Fmt 4703
Sfmt 4703
• Broker A eventually cancels the
14.75 bid and replaces it with a 15.00
bid.
E:\FR\FM\16NON1.SGM
16NON1
71101
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
• The S&P 500 variance trade
matches at 15.00.
• The System begins to deconstruct
the trade into a series of matched trades
in all of the SPX option series
comprising the S&P 500 variance trade.
Deconstruction
As previously described, the
algorithm used to deconstruct variance
trades into constituent SPX option
trades is a 2-step process; the first step
assigns the number of contracts traded
for each SPX option series comprising
the S&P 500 variance trade and the
second step assigns trade prices to those
SPX option series. The following table
shows the SPX option mid-quote prices
prevailing at the time of the S&P 500
variance trade execution, as well as the
P/C
Strike price
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P ...........................................................................................
P (K0) ...................................................................................
C (K0) ...................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
C ...........................................................................................
mstockstill on DSK4VPTVN1PROD with NOTICES
Additional Considerations
Because of the electronic nature of the
deconstruction process, option variance
baskets will not trade in open outcry on
the Exchange trading floor. Only
electronically submitted trading interest
will be handled by the Exchange. Also,
as there are no position limits for SPX
options, there will be no limits for
executions associated with S&P 500
variance trades. Because SPX options
are what actually change hands at the
conclusion of an S&P 500 variance
trade, reporting limits applicable to SPX
options will continue to apply pursuant
to CBOE Rule 24.4, Interpretation and
Policy .03. Similarly, the minimum
increment for bids and offers in S&P 500
variance trades as well as trading hours
will be the same as the minimum
increment applicable to SPX.
The Exchange expects S&P 500
variance trades to appeal to institutional
users and not to retail customers.
Because of the complex nature of S&P
500 variance trades, the Exchange will
only allow orders from Trading Permit
Holders who have affirmatively
communicated to the Exchange a desire
to submit orders in S&P 500 variance
trades. Thus, orders from retail
brokerage firms (or any firms) that have
VerDate Mar<15>2010
17:45 Nov 15, 2011
Jkt 226001
Mid-quote
option price
825
850
875
900
925
950
975
1000
1025
1050
1075
1100
1125
1125
1150
1175
1200
1225
1250
1275
1300
1325
trade quantities and trade prices
assigned by the deconstruction
algorithm. In this example, the S&P 500
variance trade was deconstructed into
22 separate matched trades, totaling 330
SPX option contracts (165 SPX contracts
per variance trade basket) and about
$160,000 in option premium ($80,000
per variance trade basket).
Trade price
(rounded)
$0.01
0.02
0.05
0.10
0.20
0.39
0.76
1.42
2.58
4.54
7.78
12.73
20.05
42.85
28.12
16.85
8.98
4.13
1.58
0.49
0.12
0.02
not opted to submit orders in S&P 500
variance trades, will not be allowed to
send orders into the Exchanges
matching engine. Any such orders
would be rejected by the System.
The Exchange represents that
appropriate surveillance will be in place
in connection with the trading of
variance baskets. Indeed, because S&P
500 variance trades result in the
execution of standard SPX options,
unique surveillance methods are not
necessary. Executions that are
associated with an S&P 500 variance
trade will be surveilled to the same
extent as all other SPX executions.
Lastly, CBOE has analyzed its
capacity and represents that it believes
the Exchange and the Options Price
Reporting Authority have the necessary
systems capacity to handle the
additional traffic associated with S&P
500 option variance basket trades.
2. Statutory Basis
The Exchange believes the proposed
rule change is consistent with the
Securities Exchange Act of 1934 (the
‘‘Act’’) 12 and the rules and regulations
thereunder and, in particular, the
requirements of Section 6(b) of the
$0.01
0.02
0.05
0.10
0.20
0.39
0.76
1.43
2.59
4.55
7.80
12.75
20.07
42.87
28.14
16.87
8.99
4.14
1.59
0.50
0.12
0.02
PO 00000
U.S.C. 78s(b)(1) [sic].
Frm 00148
Fmt 4703
Sfmt 4703
26
24
22
22
20
18
18
18
16
16
14
14
8
6
12
12
12
12
10
10
10
10
Trade value
$26
48
110
220
400
702
1,368
2,574
4,144
7,280
10,920
17,850
16,056
25,722
33,768
20,244
10,788
4,968
1,590
500
120
20
Act.13 Specifically, the Exchange
believes the proposed rule change is
consistent with the Section 6(b)(5) 14
requirements that the rules of an
exchange be designed to remove
impediments to and to perfect the
mechanism for a free and open market
in that the introduction of S&P 500
variance trades will allow market
participants to more efficiently trade an
entire option portfolio replicating S&P
500 implied variance. In addition, the
Exchange understands that market
participants may seek to effect
comparable investment strategies in the
other-the-counter marketplace and
believes that the introduction of S&P
500 variance trades will attract order
flow to the Exchange, increase the
variety of exchange-sponsored
investment vehicles available to
investors, and provide a valuable
trading tool to institutional investors.
Thus, the proposed rule change will
permit market participants to trade S&P
500 variance trades in an environment
subject to exchange-based rules that
provides price transparency and
eliminates contra-party risk through the
role of the OCC as issuer, thereby
13 15
12 15
Trade quantity
14 15
E:\FR\FM\16NON1.SGM
U.S.C. 78f(b).
U.S.C. 78f(b)(5).
16NON1
71102
Federal Register / Vol. 76, No. 221 / Wednesday, November 16, 2011 / Notices
removing impediments to a free and
open market consistent with the Act.
Further, S&P 500 variance trades will be
subject to CBOE’s rules, regulations and
oversight, which serve to protect
investors and the public interest and
provide enhanced investor protection
and market surveillance.
Allowing constituent trades to be
executed and reported without regard
for existing bids and offers on the
Exchange is consistent with the
benchmark order exception in the
Linkage Plan 15 as well as with the
benchmark exception of the SEC’s Order
Protection Rule under Regulation NMS
(Rule 611(b)(7)).16 Appending the
benchmark designator to these
executions would alert users that the
executions are not related to the
prevailing bids and offers, and will
therefore help remove impediments to
and to perfect the mechanism for a free
and open market.
Requiring permit holders to
affirmatively indicate a desire to
transmit S&P 500 variance trades to the
Exchange before the Exchange would
process such orders will help ensure
that retail customers and other users
that may not intend to transact in
variance trades will not do so
inadvertently which also helps to
protect investors and the public interest.
Lastly, the Exchange believes S&P 500
variance trades will be useful to
investors because they will facilitate the
use of highly liquid SPX options to
hedge and trade the growing number of
volatility-related products currently
available in both the listed and over-thecounter markets which serves to help
remove impediments to and to perfect
the mechanism for a free and open
market.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
mstockstill on DSK4VPTVN1PROD with NOTICES
CBOE does not believe that the
proposed rule change will impose any
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Act.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants or Others
No written comments were solicited
or received with respect to the proposed
rule change.
15 Section
5(b)(xi) of the Linkage Plan.
16 17 CFR 242.611(b)(7).
VerDate Mar<15>2010
17:45 Nov 15, 2011
Jkt 226001
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period (i)
as the Commission may designate up to
90 days of such date if it finds such
longer period to be appropriate and
publishes its reasons for so finding or
(ii) as to which the self-regulatory
organization consents, the Commission
will:
(A) By order approve or disapprove
the proposed rule change, or
(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. In
particular, the Commission seeks
comment on the following:
1. The Exchange’s proposal would
allow the constituent SPX option trades
of a variance trade basket to be executed
and reported without regard to existing
bids and offers on the Exchange in SPX
at the time of the transaction. The
Commission requests comment on this
aspect of the Exchange’s proposal,
including commenters’ opinions on
whether this would be consistent with
the Exchange Act and what, if any,
potential impact this proposal might
have on market participants.
2. The Commission notes that the
proposal seeks to use the ‘‘benchmark’’
indicator for informational purposes
when reporting the constituent legs of a
variance trade transaction, though such
trades would not be benchmark trades
pursuant to Section 5(b)(xi) of the
Linkage Plan, which by its terms applies
only to inter-market order protection.
The Commission requests comment the
use of the benchmark trade reporting
indicator as proposed.
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 email to rulecomments@sec.gov. Please include File
No. SR–CBOE–2011–007 on the subject
line.
Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
PO 00000
Frm 00149
Fmt 4703
Sfmt 4703
Station Place, 100 F Street NE.,
Washington, DC 20549–1090.
All submissions should refer to File
Number SR–CBOE–2011–007. This file
number should be included on the
subject line if email 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–CBOE–
2011–007 and should be submitted on
or before December 7, 2011.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.17
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011–29578 Filed 11–15–11; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–65719; File No. SR–Phlx–
2011–148]
Self-Regulatory Organizations;
NASDAQ OMX PHLX LLC; Notice of
Filing and Immediate Effectiveness of
Proposed Rule Change Relating to
Qualified Contingent Cross Orders
November 9, 2011.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b–4 thereunder,2
17 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
E:\FR\FM\16NON1.SGM
16NON1
]]>Agencies
[Federal Register Volume 76, Number 221 (Wednesday, November 16, 2011)]
[Notices]
[Pages 71092-71102]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-29578]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-65725; File No. SR-CBOE-2011-007]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Notice of Filing of Proposed Rule Change to Adopt Rules
in Connection With S&P 500 Option Variance Basket Trades
November 10, 2011.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on October 26, 2011, Chicago Board Options Exchange, Incorporated (the
``Exchange'' or ``CBOE'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I and II below, which Items have been prepared by the Exchange.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The filing proposes to adopt rules in connection with S&P 500
option variance basket trades. The text of the proposed rule change is
available on the Exchange's Web site (https://www.cboe.org/legal), at
the Exchange's Office of the Secretary, and at the Commission.
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 self-regulatory organization
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 those statements may be examined at
the places specified in Item IV below. The Exchange has prepared
summaries, set forth in sections A, B, and C below, of the most
significant parts of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange is proposing a new offering, called S&P 500 variance
trades, which will allow investors to electronically trade a portfolio
of S&P 500 Index options (SPX options) in a single transaction. An S&P
500 variance trade (also referred to as the ``basket'' or ``variance
trade basket''), is intended to replicate S&P 500 implied variance.\3\
Demand for volatility products has increased dramatically in recent
years, and variance baskets will provide investors with another way to
efficiently trade S&P 500 volatility.\4\
---------------------------------------------------------------------------
\3\ ``Implied Variance'' refers to the market's expectation of
daily price changes of a reference asset that is implied by the
price of an option or a portfolio of options overlying that
reference asset. Implied variance is related to the more commonly-
used term, ``implied volatility,'' which is the square root of
implied variance. The reference asset for S&P 500 variance trades is
the S&P 500 Index. The portfolio of options intended to replicate
S&P 500 implied variance is comprised of S&P 500 Index (SPX)
options.
\4\ The Exchange notes that S&P 500 variance trades do not
replicate variance swaps.
---------------------------------------------------------------------------
As an initial matter, S&P 500 variance trades will only trade
electronically on CBOE (open-outcry S&P 500 variance trades will not be
possible); each day, one or more new S&P 500 variance trade baskets
will be available for trading, and transactions in each basket will
occur on that day only; and, no market orders will be accepted. Each
basket will consist of a portfolio of SPX options defined by the
Exchange the day before it is available for trading. All of the
constituent options of the basket will have the same expiration date
and will be centered around an at-the-money strike price. It is
expected that a full ``strip'' consisting of all series in the strike
range would be offered every day.\5\ Each basket will also have a
unique ticker symbol. Market prices for S&P 500 variance trades will be
expressed and quoted in volatility terms (e.g. 21.24). Trade quantities
will be expressed in contracts. Each contract will have a multiplier of
$10,000 or more, as determined and published by the Exchange (the
Exchange would not
[[Page 71093]]
change the multiplier intraday).\6\ The multiplier for S&P 500 variance
trades represents the aggregate ``vega'' exposure of the SPX option
series that comprise the S&P 500 variance trade portfolio. Vega is a
term frequently used by volatility traders to describe the change in
value of a contract corresponding to a one-point change in volatility.
For example, assuming a vega exposure of $50,000, an investor would
expect to pay approximately $50,000 more for a variance basket
portfolio with a trade price of 21.00 than he/she would if the trade
price was 20.00.
---------------------------------------------------------------------------
\5\ The Exchange notes that the proposed rule allows the
Exchange to determine the days on which S&P 500 variance trades will
be allowed, and that the Exchange will make publicly available a
detailed description of the formulas and methodology used to
deconstruct S&P 500 variance trades into constituent SPX option
series. Further, for each day on which S&P 500 variance trades are
allowed, the Exchange will publish, after the close of trading on
the previous day, the options comprising the portfolio for the next
day.
\6\ The Exchange expects to typically use a higher multiplier,
but seeks to establish a $10,000 minimum to allow investors greater
flexibility to fine-tune their investment objectives for short-dated
options and/or low volatility levels.
---------------------------------------------------------------------------
The display and trading of S&P 500 variance trades will be handled
very much like the display and trading of typical listed options. That
is, Trading Permit Holders may submit orders in S&P 500 variance trades
for interaction with resting S&P 500 variance trade orders. These
orders will be submitted to the System electronically like orders in
other products. Thus, once an S&P 500 variance trade basket has been
announced and established by the Exchange (after the close of trading),
users may submit pre-opening orders in that basket for execution the
following day. The same opening process utilized for other listed
options will be used for S&P 500 variance trades, and trading in the
S&P 500 variance trade basket will continue throughout the day just
like other products traded on the Exchange.
S&P 500 variance trade processing will be different from other
listed options in several respects. First, trading interest in the
disseminated quote for an S&P 500 variance trade shall be ranked
pursuant to one of the matching algorithms set forth in Rule 6.45A
which may be different from the matching algorithm in place for other
option products, including SPX. The Exchange would announce via
Regulatory Circular the applicable matching algorithm. Second, once a
match occurs, the Exchange will use a formula to deconstruct the match
into individual trades in the constituent SPX options that comprise the
basket, and those individual trades will each print concurrently.
The algorithm used to deconstruct S&P 500 variance trades into
constituent SPX option legs is a two step process. The first step
assigns the number of contracts traded for each SPX option series. The
number of SPX contracts is a function of the S&P 500 variance trade
price and trade quantity, as well as time to expiration, interest rates
and the strike prices of constituent SPX option legs. The following
formula defines the trade quantity for each series in the S&P 500
variance trade basket:
[GRAPHIC] [TIFF OMITTED] TN16NO11.066
Ni Trade quantity of ith option in portfolio
[sigma] Variance basket trade price (expressed in volatility terms)
T Time to expiration
Ki Strike price of ith option in portfolio
[Delta]Ki Interval between strike prices
R Risk-free interest rate to expiration
``vega notional'' Variance basket quantity times contract multiplier
(e.g., $50,000)
The second step assigns trade prices for each SPX option in the S&P
500 variance trade. The System (1) calculates a baseline implied
volatility for each constituent SPX option. The System performs this
calculation by using a Black Model and backing out implied volatility
levels based on the mid-quote prices of constituent SPX options
prevailing at the time of the variance basket trade execution. The
System then (2) calculates an initial ``interim volatility'' value
using the mid-quote SPX option prices as input values to the VIX
formula (the VIX formula is presented in Example 1 below; a detailed
description of the VIX formula may be found in the VIX White Paper,
which is available on the CBOE Web site at https://www.cboe.com/micro/vix/vixwhite.pdf). Next, the System (3) compares the variance basket
trade price with the interim volatility value. If the variance basket
trade price is less (greater) than the interim volatility value, the
System (4) decreases (increases) the implied volatilities of all of the
constituent SPX options by the same amount and then calculates a set of
simulated option prices using the Black Model and the adjusted implied
volatilities. The System then (5) uses the simulated option prices as
input values to the VIX formula; the resulting output of the VIX
formula serves as a new interim volatility value. The System then
continues to repeat Steps 3 through 5 until the interim volatility
value matches the S&P 500 option variance basket trade price. Finally,
the System (6) creates a series of matched trades for all of the
constituent SPX option series using, as trade prices, the simulated
option prices that cause the interim volatility value to match the S&P
500 option variance basket trade price.
Once trade prices are determined for each constituent series, the
System executes and reports the constituent trades. The execution
prices are unrelated to the existing market for the applicable series,
therefore, pursuant to paragraph (c) of proposed Rule 6.53B,
constituent trades are executed and reported without regard for
existing bids and offers on the Exchange. This is appropriate because
S&P 500 variance trades involve the execution of an investment strategy
across numerous series. Prevailing bids and offers in each such series
cannot satisfy the overall execution strategy of an S&P 500 variance
trade particularly when considering that the execution prices reflect
pricing that is not based (directly or indirectly) on the quoted prices
at the time of execution. To highlight to users that executions of S&P
500 variance trades are not associated with the quoted prices in the
respective SPX series at the time of execution, each constituent
execution will be reported with the ``benchmark'' indicator. This
indicator was created to facilitate the execution of benchmark orders
as contemplated by the Options Order Protection and Locked/Crossed
Market Plan (the ``Linkage Plan''). A benchmark order is an order for
which the price is not based, directly or indirectly, on the quoted
price of the option at the time of the order's execution and for which
the material terms were not reasonably determinable at the time a
commitment to trade the order was made.\7\ While the benchmark
indicator was created for the reporting of multiply listed option
executions that meet the benchmark definition, the Exchange believes it
will be useful to append the indicator to the execution of constituent
series of an S&P 500 variance trade so SPX traders know that the
executions were not related to the quoted price at the time of the
print. Thus, the use of the indicator in this context is for
informational purposes and the
[[Page 71094]]
constituent executions are not actually benchmark trades pursuant to
the Linkage Plan.
---------------------------------------------------------------------------
\7\ CBOE does not currently offer functionality or order types
that can utilize the benchmark exception to the Linkage Plan.
---------------------------------------------------------------------------
To summarize, users will submit S&P 500 variance trade orders with
limit prices that will execute when marketable against other limit
orders resident in the book. Once the execution occurs, the System will
``deconstruct'' the match and calculate executions in the applicable
individual SPX series that comprise the S&P 500 variance trade basket.
The System will then print each constituent series execution. Only
these constituent executions will be sent to the Options Clearing
Corporation for clearing. Once the process is completed, the S&P 500
variance trade transaction will cease to exist but each party to the
transaction will have traded the constituent series. In essence, the
S&P 500 variance trade process allows Trading Permit Holders to trade a
basket of SPX options (across different series) in one transaction
(i.e. one basket trade explodes into numerous SPX executions). To
illustrate the process, three examples are provided below.
Example 1
On the day before the trade date and after the close, CBOE
publishes, through its Web site or in some other format, a set of
parameters for an S&P 500 variance trade that will be available for
trading the following business day. This information identifies the
individual SPX option series comprising the variance trade portfolio.
This example uses the DEC 2011 variance trade and is highlighted in the
following table:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Contract multiplier
SPX expiration Strike range K0 Min. strike interval ($vega/contract)
--------------------------------------------------------------------------------------------------------------------------------------------------------
DEC 2011.................................................... 500--1500 1125 25 $50,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
In addition, the following values need to be known as of trade
date:
Time to DEC 2011 Expiration (T): 0.34795 years (127 days).
Risk-Free Interest Rate to DEC 2011 (R): 0.02% \8\.
---------------------------------------------------------------------------
\8\ Interest rate on U.S. Treasury Bill maturing December 15,
2011.
---------------------------------------------------------------------------
Order Entry and Trade Match
Broker A enters a limit order to sell 2 S&P 500 DEC 2011
variance trade at 33.50.
Trader B and Trader C each respond by submitting an order
to buy one contract at 33.00.
Broker A eventually cancels the 33.50 offer and replaces
it with a 33.00 offer.
The DEC 2011 variance trade matches at 33.00. Trader B
buys 1 contract at 33.00 and Trader C buys 1 contract at 33.00.
Fill reports for the variance trade executions are sent to
Broker A, Trader B and Trader C.
The variance trades are then ``deconstructed'' by the
System to create a series of matched trades in all of the SPX option
series comprising the variance trade.
Post trade match processing
The following table shows the bid/ask and mid-quote prices for DEC
2011 SPX options immediately following the execution of the variance
trade:
----------------------------------------------------------------------------------------------------------------
Strike
P/C price (K) Bid Ask Mid-quote [Delta]K
----------------------------------------------------------------------------------------------------------------
P.............................................. 500 $0.55 $1.50 $1.03 25
P.............................................. 525 0.75 1.55 1.15 25
P.............................................. 550 1.10 2.05 1.58 25
P.............................................. 575 1.50 2.45 1.98 25
P.............................................. 600 2.00 2.95 2.48 25
P.............................................. 625 2.35 3.48 2.91 25
P.............................................. 650 2.70 4.00 3.35 25
P.............................................. 675 3.50 5.00 4.25 25
P.............................................. 700 5.00 5.90 5.45 25
P.............................................. 725 5.20 7.10 6.15 25
P.............................................. 750 6.40 8.30 7.35 25
P.............................................. 775 7.80 9.70 8.75 25
P.............................................. 800 10.50 11.30 10.90 25
P.............................................. 825 11.40 14.20 12.80 25
P.............................................. 850 13.30 16.10 14.70 25
P.............................................. 875 15.70 18.50 17.10 25
P.............................................. 900 18.70 21.60 20.15 25
P.............................................. 925 21.60 25.30 23.45 25
P.............................................. 950 24.90 28.60 26.75 25
P.............................................. 975 29.20 33.10 31.15 25
P.............................................. 1000 33.40 37.30 35.35 25
P.............................................. 1025 39.00 42.70 40.85 25
P.............................................. 1050 44.50 48.40 46.45 25
P.............................................. 1075 51.40 55.30 53.35 25
P.............................................. 1100 59.20 63.10 61.15 25
P (K0)......................................... 1125 67.60 71.50 69.55 25
C (K0)......................................... 1125 90.10 94.00 92.05
C.............................................. 1150 74.90 78.80 76.85 25
C.............................................. 1175 61.30 65.20 63.25 25
C.............................................. 1200 48.40 52.30 50.35 25
C.............................................. 1225 37.30 41.20 39.25 25
C.............................................. 1250 27.80 31.70 29.75 25
[[Page 71095]]
C.............................................. 1275 20.10 23.60 21.85 25
C.............................................. 1300 13.60 16.70 15.15 25
C.............................................. 1325 9.20 11.10 10.15 25
C.............................................. 1350 5.60 7.50 6.55 25
C.............................................. 1375 3.60 5.10 4.35 25
C.............................................. 1400 2.00 3.60 2.80 25
C.............................................. 1425 1.25 2.20 1.73 25
C.............................................. 1450 0.65 1.60 1.13 25
C.............................................. 1475 0.45 1.05 0.75 25
C.............................................. 1500 0.35 0.70 0.53 25
----------------------------------------------------------------------------------------------------------------
Deconstruction Algorithm
The algorithm used to deconstruct S&P 500 variance trades into
constituent SPX option series executions is a 2-step process.
Step 1. The System first determines the number of contracts (Ni)
for each SPX option series comprising the variance trade on a ``per
variance trade contract'' basis. As shown below, the number of SPX
contracts is a function of the $vega/contract (e.g., $50,000) and the
trade price for the matched variance trade (volatility--[sigma]), as
well as time to expiration (T), interest rates (R), the strike prices
of constituent SPX option legs (Ki) and the strike price interval
([Delta]Ki).
The following formula defines the trade quantity for each series in
the variance trade:
BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TN16NO11.067
For example, the trade quantity for the SPX DEC 2011 500 put (N500
Put) is given by:
[GRAPHIC] [TIFF OMITTED] TN16NO11.068
[[Page 71096]]
[GRAPHIC] [TIFF OMITTED] TN16NO11.069
Since there are no fractional option contracts, the value for N500
Put is rounded to 44. The same calculation is conducted for each SPX
option series comprising the variance trade. The results are shown in
the table below. It should be noted that both puts and calls are traded
at the K0 (in this case, 1125) strike.
BILLING CODE 8011-01-C
[[Page 71097]]
Step 2. Next, the System generates trade prices for each SPX
option--Q(Ki)--in the S&P 500 variance trade. The System (1) calculates
a baseline implied volatility for each constituent SPX option. The
System performs this calculation by using a Black Model and backing out
implied volatility levels based on mid-quote prices of constituent SPX
options prevailing at the time of the variance basket trade execution.
In this example, the baseline implied volatilities range from a low of
about 20 for the 1500 call to a high of about 60 for the 500 put. The
implied volatilities of the 1125 put and 1125 call (``centering
strike'') are each about 30. The graph below shows the implied
volatilities of the SPX options comprising the December 2011 variance
basket. A representation of implied volatility as a function of strike
price is commonly referred to as a volatility ``smile.''
[GRAPHIC] [TIFF OMITTED] TN16NO11.070
The System then (2) calculates an initial ``interim volatility''
value using the mid-quote SPX option prices as input values to the VIX
formula 9 10
---------------------------------------------------------------------------
\9\ Please see ``More than you ever wanted to know about
volatility swaps'' by Kresimir Demeterfi, Emanuel Derman, Michael
Kamal and Joseph Zou, Goldman Sachs Quantitative Strategies Research
Notes, March 1999.
\10\ Please see ``VIX White Paper'' at www.cboe.com/vixwhite.pdf
[GRAPHIC] [TIFF OMITTED] TN16NO11.071
[sigma]\2\ Variance (volatility-squared); VIX = [sigma] x 100
T Time to expiration
F Forward SPX level
K0 Variance strip centering strike price
K\i\ Strike price of ith option
[Delta]Ki Interval between strike prices
R Risk-free interest rate to expiration
Q(Ki) Price of option with strike Ki.
In this example, the initial interim volatility value for the SPX
options comprising the DEC 2011 variance trade is 33.59. Next, the
System (3) compares the variance basket trade price with the interim
volatility value. Since in this example, the variance basket trade
price of 33.00 is less than the interim volatility value of 33.59, the
System (4) would decrease the implied volatilities of all of the
constituent SPX options by the same amount and then calculate a set of
simulated option prices using the Black Model and the adjusted implied
volatilities. The System then (5) uses the simulated option prices as
input values to the VIX formula; the resulting output of the VIX
formula serves as a new interim volatility value. The System then
continues to repeat Steps 3 through 5 until the interim volatility
value matches the S&P 500 option variance basket trade price. In this
example, the interim volatility value matches the target trade price of
33.00 when the baseline implied volatilities are decreased by 0.46
volatility points. When the simulated option values calculated by
reducing the baseline implied volatilities by 0.46 volatility points
are used as input values to the VIX formula, the result--rounded to the
nearest hundredth--matches the variance basket trade price.\11\
---------------------------------------------------------------------------
\11\ As a practical matter, the minimum increment of change to
the baseline volatilities is not limited to 1/100th of a volatility
point. Rather, the System uses as much precision as it needs in
order to calculate an interim volatility value that, when rounded to
the nearest hundredth, matches the variance basket trade price.
---------------------------------------------------------------------------
At this point, the System (6) creates a series of matched trades
for all of the constituent SPX option series using, as trade prices,
the simulated option prices that cause the interim volatility value to
match the S&P 500 option variance basket trade price.
With trade quantities determined and SPX option prices assigned,
the System creates the following 42 matched trades in constituent SPX
series--a total of 604 SPX options contracts per S&P 500 variance trade
contract, with a total portfolio value of just over $830,000.
[[Page 71098]]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline Adjusted
P/C Strike price Mid-quote implied implied Trade price Trade quantity Trade value
option price volatility volatility (rounded)
--------------------------------------------------------------------------------------------------------------------------------------------------------
P....................................... 500 $1.03 60.00 59.54 $0.79 44 $3,476
P....................................... 525 1.15 58.80 58.34 1.05 39 4,095
P....................................... 550 1.58 57.60 57.14 1.36 36 4,896
P....................................... 575 1.98 56.40 55.94 1.74 33 5,742
P....................................... 600 2.48 55.20 54.74 2.20 30 6,600
P....................................... 625 2.91 54.00 53.54 2.75 28 7,700
P....................................... 650 3.35 52.80 52.34 3.39 26 8,814
P....................................... 675 4.25 51.60 51.14 4.15 24 9,960
P....................................... 700 5.45 50.40 49.94 5.04 22 11,088
P....................................... 725 6.15 49.20 48.74 6.08 21 12,768
P....................................... 750 7.35 48.00 47.54 7.27 19 13,813
P....................................... 775 8.75 46.80 46.34 8.65 18 15,570
P....................................... 800 10.90 45.60 45.14 10.24 17 17,408
P....................................... 825 12.80 44.40 43.94 12.06 16 19,296
P....................................... 850 14.70 43.20 42.74 14.14 15 21,210
P....................................... 875 17.10 42.00 41.54 16.52 14 23,128
P....................................... 900 20.15 40.80 40.34 19.23 13 24,999
P....................................... 925 23.45 39.60 39.14 22.31 13 29,003
P....................................... 950 26.75 38.40 37.94 25.83 12 30,996
P....................................... 975 31.15 37.20 36.74 29.82 11 32,802
P....................................... 1000 35.35 36.00 35.54 34.35 11 37,785
P....................................... 1025 40.85 34.80 34.34 39.51 10 39,510
P....................................... 1050 46.45 33.60 33.14 45.35 10 45,350
P....................................... 1075 53.35 32.50 32.04 52.23 9 47,007
P....................................... 1100 61.15 31.30 30.84 59.76 9 53,784
P (K0).................................. 1125 69.55 30.10 29.64 68.28 5 34,140
C (K0).................................. 1125 92.05 30.10 29.64 91.08 4 36,432
C....................................... 1150 76.85 28.90 28.44 75.70 8 60,560
C....................................... 1175 63.25 27.80 27.34 61.82 8 49,456
C....................................... 1200 50.35 26.70 26.24 49.27 8 39,416
C....................................... 1225 39.25 25.60 25.14 38.16 7 26,712
C....................................... 1250 29.75 24.50 24.04 28.54 7 19,978
C....................................... 1275 21.85 23.50 23.04 20.68 7 14,476
C....................................... 1300 15.15 22.50 22.04 14.31 6 8,586
C....................................... 1325 10.15 21.50 21.04 9.36 6 5,616
C....................................... 1350 6.55 20.70 20.24 5.95 6 3,570
C....................................... 1375 4.35 20.30 19.84 3.90 6 2,340
C....................................... 1400 2.80 19.90 19.44 2.45 6 1,470
C....................................... 1425 1.73 19.50 19.04 1.48 5 740
C....................................... 1450 1.13 19.20 18.74 0.89 5 445
C....................................... 1475 0.75 19.20 18.74 0.58 5 290
C....................................... 1500 0.53 19.20 18.74 0.37 5 185
--------------------------------------------------------------------------------------------------------------------------------------------------------
The S&P 500 variance trade seller would see 42 sell transactions
totaling 1,208 SPX options with an aggregate value $1.66 million. Each
of the two S&P 500 variance trade buyers would see 42 buy transactions
totaling 604 SPX options with an aggregate value of $830,000.
Example 2
Following is a hypothetical historical example of a MAR 2011 S&P
500 variance trade on December 29, 2010. After the close on December
28, 2010 CBOE publishes the following parameters for the S&P 500
variance trade effective for the next trade date--December 29. The
information defining the SPX options effective for MAR 2011 basket is
highlighted below:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Contract multiplier
SPX expiration Strike range K0 Min. strike interval ($vega/contract)
--------------------------------------------------------------------------------------------------------------------------------------------------------
MAR 2011.................................................... 600-1600 1250 25 $50,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Order Entry and Trade Match
Broker A receives an order to buy 2 SPX MAR 2011 S&P 500
variance trade basket contracts at 20.50.
Trader B posts an offer to sell 2 contracts at 20.75.
Broker A eventually cancels the 20.50 bid and replaces it
with a 20.75 bid.
The variance basket trade matches at 20.75.
The System begins to deconstruct the S&P 500 variance
trade basket into a series of matched trades in all of the SPX option
series comprising the S&P 500 variance trade basket.
Deconstruction
As previously described, the algorithm used to deconstruct S&P 500
variance trades into constituent SPX option trades is a 2-step process;
the first step assigns the number of contracts traded for each SPX
option series comprising the S&P 500 variance trade basket, and the
second step
[[Page 71099]]
assigns trade prices to those SPX option series. The following table
shows the SPX option mid-quote prices prevailing at the time of the S&P
500 variance trade execution, as well as the trade quantities and trade
prices assigned by the deconstruction algorithm. In this example, the
S&P 500 variance trade was deconstructed into 42 separate matched
trades, totaling over 2,400 SPX option contracts (1,206 SPX contracts
per variance trade basket) and over $1 million in option premium
($521,000 per variance trade basket).
----------------------------------------------------------------------------------------------------------------
Mid-quote Trade price
P/C Strike price option price (rounded) Trade quantity Trade value
----------------------------------------------------------------------------------------------------------------
P............................... 600 $0.10 $0.09 155 $1,395
P............................... 625 0.08 0.12 143 1,716
P............................... 650 0.10 0.15 132 1,980
P............................... 675 0.13 0.20 122 2,440
P............................... 700 0.25 0.26 114 2,964
P............................... 725 0.50 0.34 106 3,604
P............................... 750 0.33 0.43 99 4,257
P............................... 775 0.45 0.55 93 5,115
P............................... 800 0.53 0.69 87 6,003
P............................... 825 0.83 0.86 82 7,052
P............................... 850 0.75 1.07 77 8,239
P............................... 875 1.23 1.33 73 9,709
P............................... 900 1.23 1.65 69 11,385
P............................... 925 1.80 2.03 65 13,195
P............................... 950 2.20 2.50 62 15,500
P............................... 975 2.60 3.07 59 18,113
P............................... 1000 3.10 3.77 56 21,112
P............................... 1025 4.05 4.65 53 24,645
P............................... 1050 5.20 5.73 51 29,223
P............................... 1075 6.95 7.09 48 34,032
P............................... 1100 8.40 8.80 46 40,480
P............................... 1125 10.40 10.97 44 48,268
P............................... 1150 13.35 13.97 42 58,674
P............................... 1175 17.20 17.84 40 71,360
P............................... 1200 22.15 22.94 39 89,466
P............................... 1225 28.75 29.73 37 110,001
P (K0).......................... 1250 37.45 38.51 17 65,467
C (K0).......................... 1250 44.00 45.06 19 85,614
C............................... 1275 29.70 30.77 34 104,618
C............................... 1300 19.05 19.98 33 65,934
C............................... 1325 11.20 12.03 32 38,496
C............................... 1350 5.90 6.53 31 20,243
C............................... 1375 3.10 3.48 29 10,092
C............................... 1400 1.43 1.70 28 4,760
C............................... 1425 0.78 0.90 27 2,430
C............................... 1450 0.45 0.49 26 1,274
C............................... 1475 0.48 0.40 26 1,040
C............................... 1500 0.18 0.33 25 825
C............................... 1525 0.50 0.29 24 696
C............................... 1550 0.20 0.26 23 598
C............................... 1575 0.15 0.23 22 506
C............................... 1600 0.15 0.22 22 484
----------------------------------------------------------------------------------------------------------------
Example 3
Following is a hypothetical historical example of a JUN 2012 S&P
500 variance trade on April 29, 2011.
After the close on April 28, 2011 CBOE publishes the following
parameters for the S&P 500 variance trade effective for the next trade
date--April 29, 2011. The information defining the SPX options
effective for JUN 2012 basket is highlighted below:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Contract multiplier
SPX expiration Strike range K0 Min. strike interval ($vega/contract)
--------------------------------------------------------------------------------------------------------------------------------------------------------
JUN 2012.................................................... 400-1800 1325 25 $50,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Order Entry and Trade Match
Broker A receives an order to buy 2 SPX JUN 2012 baskets
at 22.50.
Trader B responds with an offer to sell 2 contracts at
22.75.
Broker A eventually cancels the 22.50 bid and replaces it
with a 22.75 bid.
The S&P 500 variance trade matches at 22.75.
The System begins to deconstruct the trade into a series
of matched trades in all of the SPX option series comprising the S&P
500 variance trade.
Deconstruction
As previously described, the algorithm used to deconstruct variance
trades into constituent SPX option trades is a 2-step process; the
first step assigns the number of contracts traded for each SPX option
series comprising the S&P 500 variance trade and the
[[Page 71100]]
second step assigns trade prices to those SPX option series. The
following table shows the SPX option mid-quote prices prevailing at the
time of the S&P 500 variance trade execution, as well as the trade
quantities and trade prices assigned by the deconstruction algorithm.
In this example, the S&P 500 variance trade was deconstructed into 46
separate matched trades, totaling over 800 SPX option contracts (412
SPX contracts per variance trade basket) and over 1.1 million in option
premium (567,000 per variance trade basket).
----------------------------------------------------------------------------------------------------------------
Mid-quote Trade price
P/C Strike price option price (rounded) Trade quantity Trade value
----------------------------------------------------------------------------------------------------------------
P............................... 400 $0.73 $0.40 122 $4,880
P............................... 450 1.08 0.75 96 7,200
P............................... 500 1.65 1.29 78 10,062
P............................... 550 2.45 2.07 64 13,248
P............................... 600 3.35 3.15 54 17,010
P............................... 650 4.55 4.57 46 21,022
P............................... 700 6.15 6.46 30 19,380
P............................... 725 7.05 7.41 19 14,079
P............................... 750 8.15 8.45 17 14,365
P............................... 775 9.30 9.59 16 15,344
P............................... 800 10.45 10.83 15 16,245
P............................... 825 11.90 12.26 14 17,164
P............................... 850 13.45 13.84 13 17,992
P............................... 875 15.25 15.65 13 20,345
P............................... 900 17.15 17.64 12 21,168
P............................... 925 19.25 19.82 11 21,802
P............................... 950 21.55 22.20 11 24,420
P............................... 975 24.10 24.81 10 24,810
P............................... 1000 27.05 27.65 10 27,650
P............................... 1025 30.10 30.76 9 27,684
P............................... 1050 33.45 34.15 9 30,735
P............................... 1075 37.20 38.03 8 30,424
P............................... 1100 41.20 42.07 8 33,656
P............................... 1125 45.65 46.68 8 37,344
P............................... 1150 50.50 51.51 7 36,057
P............................... 1175 55.85 56.86 7 39,802
P............................... 1200 61.70 62.74 7 43,918
P............................... 1225 68.20 69.27 6 41,562
P............................... 1250 75.25 76.38 6 45,828
P............................... 1275 83.05 84.25 6 50,550
P............................... 1300 91.50 92.71 6 55,626
P (K0).......................... 1325 100.85 102.09 3 30,627
C (K0).......................... 1325 115.00 116.35 3 34,905
C............................... 1350 100.35 101.73 5 50,865
C............................... 1375 86.65 87.99 5 43,995
C............................... 1400 73.90 75.17 5 37,585
C............................... 1425 62.35 63.60 5 31,800
C............................... 1450 51.80 53.04 5 26,520
C............................... 1475 42.45 43.52 4 17,408
C............................... 1500 34.25 35.28 6 21,168
C............................... 1550 21.20 22.05 8 17,640
C............................... 1600 12.30 13.02 6 7,812
C............................... 1625 9.10 9.80 4 3,920
C............................... 1650 6.70 7.21 5 3,605
C............................... 1700 3.45 3.92 10 3,920
C............................... 1800 0.90 1.07 12 1,284
----------------------------------------------------------------------------------------------------------------
Example 4
Following is a hypothetical historical example of an October 2011
S&P 500 variance trade on August 11, 2011.
After the close on August 10, 2011 CBOE publishes the following
parameters for the S&P 500 variance trade effective for the next trade
date--August 11, 2011. The information defining the SPX options
effective for JUN 2012 basket is highlighted below:
--------------------------------------------------------------------------------------------------------------------------------------------------------
Contract multiplier
SPX expiration Strike range K0 Min. strike interval ($vega/contract)
--------------------------------------------------------------------------------------------------------------------------------------------------------
OCT 2012.................................................... 825-1325 1125 25 $10,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Order Entry and Trade Match
Broker A receives an order to buy 2 SPX OCT 2011 baskets
at 14.75.
Trader B responds with an offer to sell 2 contracts at
15.00.
Broker A eventually cancels the 14.75 bid and replaces it
with a 15.00 bid.
[[Page 71101]]
The S&P 500 variance trade matches at 15.00.
The System begins to deconstruct the trade into a series
of matched trades in all of the SPX option series comprising the S&P
500 variance trade.
Deconstruction
As previously described, the algorithm used to deconstruct variance
trades into constituent SPX option trades is a 2-step process; the
first step assigns the number of contracts traded for each SPX option
series comprising the S&P 500 variance trade and the second step
assigns trade prices to those SPX option series. The following table
shows the SPX option mid-quote prices prevailing at the time of the S&P
500 variance trade execution, as well as the trade quantities and trade
prices assigned by the deconstruction algorithm. In this example, the
S&P 500 variance trade was deconstructed into 22 separate matched
trades, totaling 330 SPX option contracts (165 SPX contracts per
variance trade basket) and about $160,000 in option premium ($80,000
per variance trade basket).
----------------------------------------------------------------------------------------------------------------
Mid-quote Trade price
P/C Strike price option price (rounded) Trade quantity Trade value
----------------------------------------------------------------------------------------------------------------
P............................... 825 $0.01 $0.01 26 $26
P............................... 850 0.02 0.02 24 48
P............................... 875 0.05 0.05 22 110
P............................... 900 0.10 0.10 22 220
P............................... 925 0.20 0.20 20 400
P............................... 950 0.39 0.39 18 702
P............................... 975 0.76 0.76 18 1,368
P............................... 1000 1.42 1.43 18 2,574
P............................... 1025 2.58 2.59 16 4,144
P............................... 1050 4.54 4.55 16 7,280
P............................... 1075 7.78 7.80 14 10,920
P............................... 1100 12.73 12.75 14 17,850
P (K0).......................... 1125 20.05 20.07 8 16,056
C (K0).......................... 1125 42.85 42.87 6 25,722
C............................... 1150 28.12 28.14 12 33,768
C............................... 1175 16.85 16.87 12 20,244
C............................... 1200 8.98 8.99 12 10,788
C............................... 1225 4.13 4.14 12 4,968
C............................... 1250 1.58 1.59 10 1,590
C............................... 1275 0.49 0.50 10 500
C............................... 1300 0.12 0.12 10 120
C............................... 1325 0.02 0.02 10 20
----------------------------------------------------------------------------------------------------------------
Additional Considerations
Because of the electronic nature of the deconstruction process,
option variance baskets will not trade in open outcry on the Exchange
trading floor. Only electronically submitted trading interest will be
handled by the Exchange. Also, as there are no position limits for SPX
options, there will be no limits for executions associated with S&P 500
variance trades. Because SPX options are what actually change hands at
the conclusion of an S&P 500 variance trade, reporting limits
applicable to SPX options will continue to apply pursuant to CBOE Rule
24.4, Interpretation and Policy .03. Similarly, the minimum increment
for bids and offers in S&P 500 variance trades as well as trading hours
will be the same as the minimum increment applicable to SPX.
The Exchange expects S&P 500 variance trades to appeal to
institutional users and not to retail customers. Because of the complex
nature of S&P 500 variance trades, the Exchange will only allow orders
from Trading Permit Holders who have affirmatively communicated to the
Exchange a desire to submit orders in S&P 500 variance trades. Thus,
orders from retail brokerage firms (or any firms) that have not opted
to submit orders in S&P 500 variance trades, will not be allowed to
send orders into the Exchanges matching engine. Any such orders would
be rejected by the System.
The Exchange represents that appropriate surveillance will be in
place in connection with the trading of variance baskets. Indeed,
because S&P 500 variance trades result in the execution of standard SPX
options, unique surveillance methods are not necessary. Executions that
are associated with an S&P 500 variance trade will be surveilled to the
same extent as all other SPX executions.
Lastly, CBOE has analyzed its capacity and represents that it
believes the Exchange and the Options Price Reporting Authority have
the necessary systems capacity to handle the additional traffic
associated with S&P 500 option variance basket trades.
2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Securities Exchange Act of 1934 (the ``Act'') \12\ and the rules
and regulations thereunder and, in particular, the requirements of
Section 6(b) of the Act.\13\ Specifically, the Exchange believes the
proposed rule change is consistent with the Section 6(b)(5) \14\
requirements that the rules of an exchange be designed to remove
impediments to and to perfect the mechanism for a free and open market
in that the introduction of S&P 500 variance trades will allow market
participants to more efficiently trade an entire option portfolio
replicating S&P 500 implied variance. In addition, the Exchange
understands that market participants may seek to effect comparable
investment strategies in the other-the-counter marketplace and believes
that the introduction of S&P 500 variance trades will attract order
flow to the Exchange, increase the variety of exchange-sponsored
investment vehicles available to investors, and provide a valuable
trading tool to institutional investors. Thus, the proposed rule change
will permit market participants to trade S&P 500 variance trades in an
environment subject to exchange-based rules that provides price
transparency and eliminates contra-party risk through the role of the
OCC as issuer, thereby
[[Page 71102]]
removing impediments to a free and open market consistent with the Act.
Further, S&P 500 variance trades will be subject to CBOE's rules,
regulations and oversight, which serve to protect investors and the
public interest and provide enhanced investor protection and market
surveillance.
---------------------------------------------------------------------------
\12\ 15 U.S.C. 78s(b)(1) [sic].
\13\ 15 U.S.C. 78f(b).
\14\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
Allowing constituent trades to be executed and reported without
regard for existing bids and offers on the Exchange is consistent with
the benchmark order exception in the Linkage Plan \15\ as well as with
the benchmark exception of the SEC's Order Protection Rule under
Regulation NMS (Rule 611(b)(7)).\16\ Appending the benchmark designator
to these executions would alert users that the executions are not
related to the prevailing bids and offers, and will therefore help
remove impediments to and to perfect the mechanism for a free and open
market.
---------------------------------------------------------------------------
\15\ Section 5(b)(xi) of the Linkage Plan.
\16\ 17 CFR 242.611(b)(7).
---------------------------------------------------------------------------
Requiring permit holders to affirmatively indicate a desire to
transmit S&P 500 variance trades to the Exchange before the Exchange
would process such orders will help ensure that retail customers and
other users that may not intend to transact in variance trades will not
do so inadvertently which also helps to protect investors and the
public interest.
Lastly, the Exchange believes S&P 500 variance trades will be
useful to investors because they will facilitate the use of highly
liquid SPX options to hedge and trade the growing number of volatility-
related products currently available in both the listed and over-the-
counter markets which serves to help remove impediments to and to
perfect the mechanism for a free and open market.
B. Self-Regulatory Organization's Statement on Burden on Competition
CBOE does not believe that the proposed rule change will impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove the proposed rule change, or
(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. In particular, the Commission seeks
comment on the following:
1. The Exchange's proposal would allow the constituent SPX option
trades of a variance trade basket to be executed and reported without
regard to existing bids and offers on the Exchange in SPX at the time
of the transaction. The Commission requests comment on this aspect of
the Exchange's proposal, including commenters' opinions on whether this
would be consistent with the Exchange Act and what, if any, potential
impact this proposal might have on market participants.
2. The Commission notes that the proposal seeks to use the
``benchmark'' indicator for informational purposes when reporting the
constituent legs of a variance trade transaction, though such trades
would not be benchmark trades pursuant to Section 5(b)(xi) of the
Linkage Plan, which by its terms applies only to inter-market order
protection. The Commission requests comment the use of the benchmark
trade reporting indicator as proposed.
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 email to rule-comments@sec.gov. Please include
File No. SR-CBOE-2011-007 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, Station Place, 100 F
Street NE., Washington, DC
