I. Introduction
On April 21, 2004, the Chicago Board Options Exchange, Inc. (“CBOE” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, a proposed rule change to permanently approve its modified Rapid Opening System (“ROS”) opening procedure, which was approved by the Commission on a pilot basis through November 17, 2004. On April 23, 2004, CBOE filed Amendment No. 1 to the proposed rule change. The proposed rule change, as amended, was published for comment in the Federal Register on April 30, 2004. The Commission received no comment letters on the proposed rule change. On May 13, 2004, CBOE filed Amendment No. 2 to the proposed rule change. This order approves the proposed rule change, as amended.
17 CFR 240.19b-4.
See Securities Exchange Act Release No. 49468 (March 24, 2004), 69 FR 17000 (March 31, 2004) (SR-CBOE-2004-11) (“Modified ROS Opening Procedure Pilot Program Approval Order”).
See letter from David Doherty, Attorney, Legal Division, CBOE, to Terri Evans, Assistant Director, Division of Market Regulation (“Division”), Commission, dated April 23, 2004 (“Amendment No. 1”).
See Securities Exchange Act Release No. 49614 (April 26, 2004), 69 FR 23837 (“Notice”).
See letter from David Doherty, Attorney, Legal Division, CBOE, to Terri Evans, Assistant Director, Division, Commission, dated May 12, 2004 (“Amendment No. 2”). In Amendment No. 2, CBOE amended the proposed rule text to reflect the immediate effectiveness of SR-CBOE-2004-27, which amended the modified ROS opening procedure pilot program to change the cut-off time for the submission of orders to the electronic book from 8:25 am to 8:28 am. See Securities Exchange Act Release No. 49679 (May 11, 2004), 69 FR 27957 (May 17, 2004) (Notice of Filing and Immediate Effectiveness of SR-CBOE-2004-27). The Commission notes that this is a technical, non-substantive amendment and not subject to notice and comment.
II. Description of the Proposal
On March 24, 2004, the Commission approved the implementation of a modified ROS procedure on a pilot basis through November 17, 2004. CBOE now proposes that the modified ROS opening procedure pilot program be approved on a permanent basis. According to CBOE, the modified ROS opening procedure pilot program facilitates the trading of options and futures on volatility indexes (“Volatility Indexes”) by modifying certain of the CBOE rules that govern ROS for index option series whose prices are used to derive the Volatility Indexes on which options and futures are traded.
See Modified ROS Opening Procedure Pilot Program Approval Order, supra note 3.
According to CBOE, in general, Volatility Indexes provide investors with up-to-the-minute market estimates of expected near-term volatility of the prices of a broad-based group of stocks by extracting volatilities from real-time index option bid/ask quotes. Volatility Indexes are calculated using real-time quotes of the nearby and second nearby index puts and calls on established broad-based market indexes, referred to herein as a “Market Index.” The futures and options on a Volatility Index expire on the Wednesday immediately prior to the third Friday of the month that immediately precedes the month in which the options used in the calculation of that index expire (“Settlement Date”). Generally, the modified ROS opening procedure allows, in part, broker-dealer orders, other than contingency orders, to be incorporated into the electronic book for purposes of the ROS opening for any index options series with respect to which a Volatility Index is calculated. The modified ROS opening procedure is used only on the final Settlement Date of the options and futures contracts on the applicable Volatility Index in each expiration month, which is when Volatility Index settlement values are determined.
For a detailed description on how the modified ROS opening procedure operates, see Notice, supra note 5.
III. Discussion
After careful review, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. In particular, the Commission believes that the proposed rule change is consistent with the requirements of Section 6(b)(5) of the Act that the rules of a national securities exchange, in part, promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system and, in general, protect investors and the public interest.
In approving this proposed rule change, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
15 U.S.C. 78f(b)(5).
The Commission notes that futures and options on Volatility Indexes with contract months that expire beyond November 2004 are currently being traded. Therefore, the Commission believes that permanent approval of the modified ROS opening procedure pilot program should provide market participants with greater certainty as to the settlement process for those futures and options. The Commission also continues to believe that the modified ROS opening should ensure that broker-dealer orders are fairly incorporated into the opening, and thereby enable market participants that hedge Volatility Index futures or options contract positions against option positions in the related Market Index to ensure convergence of the value of those two positions at the time of settlement. The ROS modified opening procedure should allow this convergence by allowing market participants to close out their open Market Index option positions and obtain the exact price (i.e., the opening price) for those series that will be used to calculate the Volatility Index settlement value. The Commission notes that the modified ROS opening procedure was used on May 19, 2004 and that CBOE represented that generally no problems or issues arose regarding its use.
Telephone conversation between David Doherty, Attorney, CBOE, and Christopher Solgan, Attorney, Division, Commission, on May 24, 2004.
The Commission notes that it had previously required that CBOE develop a workable plan for the electronic incorporation of non-bookable orders in ROS. This requirement was waived in light of the limited number of non-bookable orders that are present at the open and CBOE's forthcoming ability to record information on non-bookable orders under the Consolidated Options Audit Trail (“COATS”) Plan when Phase V of COATS is implemented. CBOE has represented as part of this filing that it is still unable to incorporate non-bookable orders on a daily basis because of certain technological limitations with respect to index products. Telephone conversation between David Doherty, Attorney, CBOE, and Christopher Solgan, Attorney, Division, Commission, on March 24, 2004. The Commission expects that CBOE will continue to actively monitor the quality of executions received by non-bookable orders that are not incorporated into the modified ROS opening and that CBOE will continue to explore methods to electronically incorporate non-bookable orders in the standard ROS opening in the event that non-bookable orders are more actively represented in the opening.
Telephone conversation between David Doherty, Attorney, CBOE, and Christopher Solgan, Attorney, Division, Commission, on May 28, 2004. CBOE noted that there were two minor issues that arose regarding the May 19, 2004 opening. First, that while 138 market makers were able to log on to ROS for the modified opening, two market makers were unable to participate in the opening because they failed to log onto ROS in a timely manner. Second, CBOE is investigating whether a broker-dealer violated CBOE Rule 6.2A by failing to cancel a broker-dealer order that was not executed during the opening as explicitly required by the rule. CBOE has represented that these problems did not affect the performance of the modified ROS opening. Further, CBOE has represented that it will work with market makers to ensure their timely participation in ROS.
The Commission notes that CBOE has also submitted supplemental surveillance procedures designed to ensure, among other things, that market-makers exercise their discretion to set certain AutoQuote values consistent with their obligation to price options fairly and that identify whether any accounts have engaged in manipulative or violative activity.
CBOE has represented, and the Commission expects, that CBOE will work with the Commission's Office of Compliance Inspections and Examinations (“OCIE”) to finalize any surveillance reports used in connection with the modified ROS opening in a manner acceptable to OCIE. The Commission also expects CBOE to assess its surveillance procedures from time to time to determine whether they are adequate to ensure that market makers do not engage in manipulative or improper trading practices. Further, the Commission expects CBOE to consider whether any additional surveillance procedures are necessary to prevent manipulative or other improper practices. In addition, CBOE stated, and the Commission expects, that it will modify the ROS system software to prevent a market-maker who is logged on to ROS from trading against an order on behalf of the market-maker or the market-maker firm that may be resting in the electronic book. CBOE has also represented and the Commission expects that prior to implementation of this system change, CBOE will file a rule change with the Commission to reflect this system change. See Notice, supra note 5.
IV. Conclusion
For the foregoing reasons, the Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-CBOE-2004-23) and Amendment Nos. 1 and 2 thereto, are approved.
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13088 Filed 6-9-04; 8:45 am]
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