JAN-84-1996 21:21

Ms. Jean A. Webb
October 6, 2005
Page 4 of 4

Sincerely,

as a
Cf C4 &
John W. Labuszewski, Managing Director
Research & Product Development

P.@5/85

TOTAL P.@5


JAN-G4-1996 21:26 P.@2/85.

cme @

Chicago Mercantile Exchange

October 6, 2005

Ms. Jean A. Webb

Office of the Secretariat

Commodity Futures Trading Commission
Three Lafayette Centre

1155 21" Street, NW

Washington, DC 20581

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RE: Price Banding on GLOBEX for Options Contracts

Submitted per Sec. 5c(c)(1) of the CEA and Regulation Sec. 40.6(a).
CME Submission # 05.28% 9 9

Dear Ms. Webb:

Chicago Mercantile Exchange (“CME” or “Exchange”) hereby certifies with the
Commission the following modification to the price banding practice for GLOBEX order entry.
The Exchange certifies that this amendment complies with the Act and rules thereunder.

The practice of “price banding” on the GLOBEX electronic trading system was originally
introduced! on April 22, 2001. The intent of price banding is to mitigate the impact of erroneous
order entrics. An overly aggressive crroneous order, i.e. limit bids at prices well above the
market or limit offers at prices well below the market, can trigger a sequence of market-moving
trades that requires subsequent cancellations. To lessen such possibilities of market destabilizing
events, price bands are established to prevent the entry of overly aggressive orders. For example,
for the E-mini S&P 500 futures, a limit bid at a price of more than 12.00 points above the last
price” cannot be entered into the GLOBEX system and will be rejected. Likewise, a limit offer
at a price of more than 12.00 points below the last price will be rejected.

The foregoing practice has proven to be effective for futures markets. While similar
price banding practice has been applied to options markets on GLOBEX, it appears that certain
adjustments are necessary. While a series of options on a particular futures contract may trade
frequently, any one option with a specific strike price may not trade or even have “quote traffic”
frequently. Thus, the last price on a specific option is a poor anchor for the price bands. The
price of the underlying futures contract may have changed substantially since the “last price” of a

“CME Submission #01-28, dated April 5, 2001.
? The last price is usually the price at which the last trade was executed. [1 may also be a better bid or offer.

20 South Wacker Drive, Chicago IL 60606-7499, Tel. 312-930-1000


JAN-@4-1996 21:28 P.@3/85

Ms. Jean A. Webb
October 6, 2005
Page 2 of 4

particular option was updated, thereby causing the market value of a formerly out-of-money
option to increase substantially while the price band is locked in place by the “last price,” for

example.

Further, it is also not desirable to establish price bands with the same “width” for options
with different strikes. The price bands for “out-of-money” options> should be narrower than
those for “in-the-money” options, reflecting the differences in the extent to which bids and offers
depart from their fair market value may be considered erroneous.

Based on the foregoing considerations, a dynamic price banding scheme will be deployed
on selected options and options combinations trading on GLOBEX. There are a number of
possible options:

© The price bands shall be established based on cither (a) the “last price” of the option
instrument (or combination of instruments), or (b) the Theoretical Options Price (TOP)
based on well established options pricing algorithms, or (c) if practical, the more recent
of the “last price” and TOP.

The TOP for each option contract is updated frequently, based on the prevailing price of
the underlying futures contracts and other relevant information. The Exchange may elect
to deploy any one of the preceding options based upon current market conditions and
practicality considerations.

e The width of the price bands shall be established pursuant to any of the following
options:

(a) fixed width, e.g. 6 index points, for the entire option series, regardless of the
strike price in relation to the current futures price, or other characteristics of
the options. This is the current price banding practice;

(b) a fixed width based on the delta‘ of the option. The delta of the option shall
be estimated by the TOP calculation. Based the range of values the estimated
delta falls under, the width of the price band shall be established. E.g. for
options with estimated delta between 0 and .10, the band shall be 2 index
points; for options with estimated delta betwcen .10 and .25, the width of the
price band shall be 4 index points; for options with estimated delta of .25 and
higher, the width of the price band shall be 6 index points. As the price of the
underlying futures contract changes, the delta of a specific option may fall in

> Gencrally speaking, low delta options or options combinations require tighter bands than high delta options or options
co mbinations.

Delta of an option is the “first order” sensitivity of the price of the options to a unilury change in the price of its underlying
futures. For example, the value of a 20 delta option will increase or decreasc by 0.20 with a }-point move in the funures contract,
ceteris paribus.


JAN-84-1995 21:28

Ms. Jean A. Webb
October 6, 2005
Page 3 of 4

P.04/@5

different ranges. The applicable width of the price band becomes dynamic in

nature;

(c) a band based on a certain percentage of the TOP, with the percentage assigned
according to the estimated delta of the option. E.g. if the estimated delta of
the option falls between .10 and .25, a 20% band is assigned. Thus, the width
of the band shall be 20% x TOP of the option instrument. Please note that the
percentage band for an option series may vary, depending on the delta of the

specific instrument; or

(d) a combination of (b) and (c), i.e. the larger of the price band based on a fixed,
delta-based, schedule and a percentage band. E.g. for a specific option, the
fixed schedule call for a 4 index point band while the percentage banding calls
for a 5 index point band. The larger of the two bands applies.

To the extent that the prevailing market condition dictates a wider price band, e.g. in a
(temporarily) volatile market in which prices fluctuate quickly, the Exchange may elect

to temporarily relax or suspend the price banding restriction.

The Exchange shall continue to disclose information regarding its price banding practice.
Specifically, the width of the band, either fixed for the whole option series, or in accordance with
delta ranges, and, if applicable, the percentage bands will be available on the Exchange website
at the following URL: http://www.cme.comyclcaring/clr/tp/tradeprac/priceband 1472. html,

The modified price banding shall be implemented on the trade date of October 10, 2005.
Initially, this practice will be applicd to the options on E-mini S&P 500, E-mini NASDAQ-100,
E-mini Russell 2000 futures as well as the European-style options on EuroFX and Japanese Yen
futures. The bands shall be anchored by the Theoretical Options Prices. The width of the bands

shall be as follows. As

‘Yen Contracts

0-0.10 2 index points 6 ticks
0.10 - 0.25 4 index points 12 ticks
0.25 -- 1.00 6 index points 20 ticks

Please do not hesitate to contact Mr. Richard Co at 312-930-3227 or rco@cme.com if any
questions arise during the processing of this submission. Please reference our CME Submission

#05-099 on all future correspondence for this submission.