[Federal Register Volume 65, Number 206 (Tuesday, October 24, 2000)]
[Notices]
[Pages 63658-63660]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-27239]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43452; File No. SR-CBOE-00-40]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to SPX 
Combination Orders

October 17, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ is hereby given that on August 17, 2000, the Chicago 
Board Options Exchange, Inc. (``CBOE'' or ``Exchange'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items, I, II, and III below, which 
Items have been prepared by the CBOE. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to adopt CBOE Rule 24.20, ``SPX Combination 
Orders,'' to allow S&P 500 Index option (``SPX'') traders to print and 
execute orders for SPX options and orders for hedging transactions in 
SPX combination orders (``combos'') \2\ outside of the prevailing

[[Page 63659]]

bid or offer (``out-of-range'') at any time during the trading day, at 
the prices originally quoted for each option so long as each option 
when originally quoted would not trade at a price outside the displayed 
bids or offers in the trading crowd or bids or offers in the SPX 
customer limit order book. The member initiating the orders must 
indicate the delta \3\ of the options he wishes to trade and must bid 
and offer for each of the options and each of the legs of the SPX combo 
on the basis of the total debit or credit. The text of the proposed 
rule appears below. Proposed new language is in italics.
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    \2\ A combination order is an order involving a number of call 
option contracts and the same number of put option contracts in the 
same underlying security. See CBOE Rule 6.53(e).
    \3\ For purposes of proposed CBOE Rule 24.20, the ``delta'' is 
the number of SPX combos required to establish a delta neutral hedge 
with an SPX option position, based on the value of the underlying 
S&P 500 futures contract. See CBOE Rule 24.20(a)(2).
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SPX Combination Orders

    Rule 24.20(a) For purposes of this rule, the following terms 
shall have the following meanings:
    (1) An ``SPX combination'' is an order combining a long SPX call 
and a short SPX put of the same series, or an order combining a 
short SPX call and a long SPX put of the same series.
    (2) A ``delta'' is the number of SPX combinations required to 
establish a delta neutral hedge with an SPX option position, based 
on the value of the underlying S&P futures contract.
    (b) Notwithstanding any other rules of the Exchange, orders for 
SPX options executed in conjunction with SPX combination orders may 
be transacted in the following manner:
    (i) A member holding an order(s) to purchase or sell SPX options 
must indicate the delta of the option and must bid or offer for each 
option and each of the legs of a combination order(s) on the basis 
of the total debit or credit. At the time they are originally 
quoted, the prices quoted for the options and each leg of the 
combination order(s) must be such that none would trade at a price 
outside the currently displayed bids or offers in the trading crowd 
or bids or offers in the SPX customer limit order book.
    (ii) The option order(s) and each leg of the combination 
order(s) may be executed immediately or at any time during the 
trading day. If the orders are not executed immediately, the option 
order(s) and each leg of the combination order(s) may be printed at 
their originally quoted prices in order to achieve the total debit 
or credit agreed to for the entire transaction.

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 CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CBOE has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

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

    The purpose of the proposed rule change is to establish a new rule, 
CBOE Rule 24.20, that will facilitate the use of SPX combination orders 
(``SPX combos'') to hedge positions in SPX options. The proposed new 
rule would allow SPX traders to print and execute orders for SPX 
options, and orders for hedging transactions in SPX combos, outside of 
the prevailing bid or offer (``out-of-range'') at any time during the 
trading day, at the prices originally quoted for each option, so long 
as each option when originally quoted would not trade at a price 
outside the displayed bids or offers in the trading crowd or bids or 
offers in the SPX customer limit order book.
    According to the CBOE, SPX traders commonly hedge their positions 
in SPX options with SPX combos, also called ``synthetic futures,'' 
which are created by combining long (short) SPX calls with short (long) 
SPX puts of the same series, in lieu of hedging with the actual S&P 500 
Index futures contract. The individual legs of the SPX combo are priced 
so that a value for the SPX combo is established which is equivalent to 
the value of a future at a level at which the trader wishes to make the 
underlying futures market ``static.'' Then, based on the ``underlying'' 
value established by the SPX combo that has been quoted, the trader 
will request a market for the options that he wishes to trade, and will 
indicate the delta of the option. An SPX trader will execute SPX combos 
in conjunction with transactions in SPX options, taking into account 
the delta of the particular option, so that the combined positions will 
create a ``delta neutral'' hedge, i.e., a position that has no market 
exposure.\4\
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    \4\ For example, the purchase of 100 SPX puts with a 30 delta 
would require the purchase of 30 ``long'' SPX combos (30 long SPX 
calls and 30 short SPX puts of the same series) to be hedged delta 
neutral.
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    According to the CBOE, proposed CBOE Rule 24.20 will alleviate a 
reoccurring problem faced by SPX traders executing SPX combo orders. 
According to the CBOE, current CBOE Rules provide that a combination 
order (and any spread order) may be executed only so long as no leg of 
the order would trade at a price outside the currently displayed bids 
or offers in the trading crowd or bids or offers in the customer limit 
order book.\5\ The prices of the options and the legs of the SPX combo 
can, and frequently do, move away quickly from the market that 
prevailed when the options were originally quoted (and away from the 
level at which the trader sought to reproduce the value of the 
underlying future). If the market moves before the trader is able to 
effect all of the required transactions, the trader cannot complete the 
strategy as originally designed because the options or the legs of the 
SPX combo, if traded at the originally quoted prices, would trade out-
of-range.
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    \5\ CBOE Rule 6.45(e) provides, in part, that when a member 
holding a combination order and bidding or offering in a multiple of 
\1/16\ on the basis of a total credit or debit for the order has 
determined that the order may not be executed by a combination of 
transactions with the bids and offers displayed in the customer 
limit order book or announced by members in the trading crowd, then 
the order may be executed as a combination at the total debit or 
credit with one other member without giving priority to bids or 
offers of members in the trading crowd that are no better than the 
bids or offers comprising such total debit or credit and bids and 
offers in the customer limit order book, provided at least one leg 
of the order would trade at a price that is better than the 
corresponding bid or offer in the book.
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    Proposed CBOE Rule 24.20 would allow an SPX trader who is unable to 
complete the transactions before the market moves the component options 
away from the displayed bids or offers to print and execute the orders 
at any time during the trading day at the originally quoted prices. 
Proposed CBOE Rule 24.20 would permit these orders to be transacted in 
this manner only if two conditions are satisfied: (1) the member 
initiating the orders indicates the delta (as defined in proposed CBOE 
Rule 24.20(a)(2)) of the options he wishes to trade and bids and offers 
for each of the options each of the legs of the SPX combo on the basis 
of the total debit or credit; and (2) at the time they are quoted, the 
options and the leges of the SPX combo are quoted so that none would 
trade at a price outside the currently displayed bids or offers in the 
crowds or bids or offer in the book.
    The CBOE notes that a delta neutral SPX combo trade is designed so 
that market movement will have no impact on the resulting position. The 
delta made known to the participants to the trade is used to establish 
the hedge ratio required to keep the trade market neutral. Therefore, 
whether the component options of a delta neutral SPX combo are traded 
immediately or later, the Exchange beleives the SPX trader should be 
allowed to print the options at the original quotes (which represent 
the level at which the underlying future was ``frozen'') because

[[Page 63660]]

the originally quoted prices were tied to the delta of the options.
    The following example illustrates how proposed CBOE Rule 24.20 
would operate: Assume that the S&P 500 Index September futures contract 
is trading at 1495 and an SPX trader requests quotes for the SPX 
September 1495 call and September 1495 put, for the purpose of pricing 
an SPX combo that will reproduce the S&P 500 future at 1495. Assume the 
September 1495 call and September 1495 put are each quoted at 12 bid, 
12\1/8\ asked. Assume that the trader then requests quotes for the 30 
delta SPX September 1480 puts, based on the underlying futures value of 
1495, and receives a quote of 6 bid, 6\1/8\ asked. The trader agrees to 
buy 100 of the 1480 puts at 6\1/8\ and to hedge these agrees to buy 30 
September 1495 calls at 12 and to sell 30 September 1495 puts at 12 (30 
``long'' combos). Now assume that the market rallies five points, to a 
new underlying futures level of 1500, before these orders can be 
executed. The September 1495 call is now trading at 15, the September 
1495 put at 10 and the September 1480 puts at 4\5/8\. Under current 
Exchange rules, the trader could purchase the 1480 puts at 6\1/8\, but 
could not execute the legs of the SPX combo at 12 because they would 
trade out-of-range of the current displayed market. Proposed CBOE Rule 
24.20 would allow the parties to the trade to print and execute the 
orders at the original quotes, 12 and 6\1/8\, because the options would 
not have traded outside the displayed bids or offers in the crowd or in 
the book (12 bid, 12\1/8\ asked: 6 bid, 6\1/8\ asked), and because the 
transaction as agreed to at a futures level of 1495 had market 
neutrality and would not have been affected by the five point market 
rally (the gain on the SPX combo of 5 points  x  30 contracts x 500 
multiplier = $75,000, is offset by the loss on the 1480 puts of 1.5  x  
100 contracts  x  500 = $75,000).
    When an SPX combo transaction is effected out-of-range pursuant to 
proposed CBOE Rule 24.20, that fact will be denoted in the Exchange's 
disseminated quote by an ``indicator.''
    The Exchange believes the proposed CBOE Rule 24.20 will give both 
customers and traders of SPX options an efficient means of hedging 
positions in SPX options, benefiting the marketplace. The Exchange 
believes that as a result of proposed CBOE Rule 24.20, SPX combo 
trading will become more consistent with current pricing practices in 
the futures markets \6\ and the over-the-counter market, enabling the 
Exchange to compete more effectively with these markets and offering 
Exchange members and their customers greater flexibility.
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    \6\ See Chicago Mercantile Exchange Rule 542, which provides 
that spread and combination transactions involving options need not 
satisfy the requirement that at least one leg must be within the 
price range established during the trading session whenever the 
spread or combination involves one or more contract months which 
have an established price range.
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    The CBOE believes that the proposed rule will allow for the 
efficient conduct of SPX combo orders and will be beneficial to both 
customers and traders. Accordingly, the CBOE believes that the proposed 
rule change is consistent with and furthers the objectives of Section 
6(b) of the Act, in general, and Section 6(b)(5), in particular, in 
that is designed to facilitate transactions in securities, to perfect 
the mechanisms of a free and open market and to protect investors and 
the public interest.

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

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

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

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

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 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 by 
order approve such proposed rule change, or 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. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CBOE. All submission should refer to File No. SR-CBOE-00-40 and should 
be submitted by November 14, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-27239 Filed 10-23-00; 8:45 am]
BILLING CODE 8010-01-M