Document ID: SEC-2011-1763-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Chicago Board Options Exchange, Inc.
Posted Date: 2011-11-16T05:00Z

[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]

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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.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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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 (http://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.
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    \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 http://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 (http://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 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 (http://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.
---------------------------------------------------------------------------

    \17\ 17 CFR 200.30-3(a)(12).

    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