Daily Rules, Proposed Rules, and Notices of the Federal Government
The Exchange is filing with the Securities and Exchange Commission ("Commission") a proposal to implement twenty-five new rules in the 1000D Series of rules so that the Exchange may list options on Treasury securities
The text of the proposed rule change is available on the Exchange's Web site at
In its filing with the Commission, the Exchange 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 Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.
The purpose of this filing is to implement Exchange Rules 1000D through 1025D (the "1000D Series"), which would, in conjunction with current applicable Exchange rules and procedures, allow the Exchange to list options on Treasury securities ("Treasury securities options"). The Exchange could then allow trading on Treasury securities options.
Treasury securities are direct debt obligations issued by the U.S. government that are used by the government to raise capital and/or make payments on outstanding debt and by traders and investors, both in the underlying form and as derivatives proposed by this filing, as trading, investing, and hedging vehicles. Since Treasury securities are backed by the full faith and credit of the U.S. government, they are generally considered to have low risk and typically carry lower yields than other debt securities. Marketable Treasury securities are initially sold in a scheduled auction process and thereafter trade in a secondary market that is recognized as among the most liquid and extensively reported in the world.
The Exchange believes that the prices of Treasury securities are widely disseminated, active, and visible to traders and investors. In addition, the Exchange intends to get real-time Treasury prices (data) from a market data provider so that it can use this data in support of the Exchange's market, regulatory and surveillance operations. The Exchange intends to use this data for the purpose of opening and determining settlement values for Treasury options. Thirty days prior to the start of trading the Exchange would make an announcement, via an Options Trader Alert ("OTA"), to its member organizations regarding the details of the proposed real-time Treasury price offering.
The secondary market for Treasury securities is an over-the counter ("OTC") market in which participants trade with one another on a bilateral basis rather than on an organized exchange (Treasury securities can trade at the New York Stock Exchange, but trading in that market is negligible). Trading activity takes place between primary dealers; non-primary dealers; and customers of these dealers, including financial institutions, nonfinancial institutions, and individuals. There are a variety of databases providing bond information, including information regarding the listing and/or trading location of a bond, such as, for example, Govpx, Standard
This filing would allow the Exchange, as permissible by rule on other options exchanges,
The Exchange specifically limits its proposal to listing options on on-the-run Treasury securities.
The secondary Treasury securities market that would underlie the proposed Treasury options is clearly one of the biggest, most liquid securities markets in the world. This is indisputable and supported by the huge trading volumes of Treasury securities, as discussed below. In their 2012 study, Pasquariello, Roush, and Vega, state regarding their study of the secondary market for U.S. Treasury notes and bonds: "The secondary market for these securities is among the largest, most liquid financial markets * * * [a]verage trading volumes are high and quoted bid-ask spreads are small * * *" We note the highly liquid nature of the Treasury securities market is similar to the highly liquid nature of the foreign exchange market, where the Commission recently approved the listing of options on foreign exchange ("forex") currencies ("PHLX FOREX options").
The Exchange believes that the ability to trade standardized options overlying Treasury securities as proposed in this filing would serve an important economic function. In particular, such options could be used by a wide range of investors and traders that may be sensitive to, among other things, the potential price risk of alternative underlying securities and interest rate changes. Through the use of various option purchasing, writing (selling), and combination strategies, investors and
The Exchange contends that trading Treasury securities options on the Exchange, as proposed, offers several distinct benefits.
The Exchange establishes the controlling principle that its existing rules and procedures are applicable to options on Treasury securities and the proposed rules would supplement existing Exchange rules. Proposed Rule 1000D states that unless otherwise specified, the rules in the 1000D Series are applicable only to options on Treasury securities. The rule states further that except to the extent that specific rules in the 1000D Series govern, or unless the context otherwise requires, the provisions of the Option Rules applicable to equity options
Treasury securities options will generally trade on the Exchange's electronic options platform, Phlx XL
Treasury securities options will be physically settled, European-style options that may be exercised only on the day that they expire.
Definitions applicable to Treasury securities and options on them are found in proposed Rule 1001D. Regarding products underlying options to be traded on the Exchange subsection (a)(1) states that "Treasury securities" represent a bond or note, or other evidence of indebtedness that is a direct obligation of, or an obligation guaranteed as to principal or interest by, the United States or a corporation in which the United States has a direct or indirect interest.
The Exchange establishes two exercise price definitions in proposed Rule 1001D: exercise price and aggregate exercise price.
Treasury securities options will use a convention for describing (designating) options that is uniquely adapted to the nature of such options. Specifically, proposed Rule 1005D states that Treasury options purchased and sold on the Exchange will be designated by reference to the issuer of the underlying Treasury security, principal amount, expiration month (and year for the longest term option series), exercise price, type (put or call), stated rate of interest, and stated date of maturity or nominal term to maturity. For example, a specific cusip call option expiring in March and having an exercise price of 96 of the $10,000 principal amount of a 3
Regarding specific cusip Treasury security options, subsection (a) to proposed Rule 1009D states that at any time after an auction sale of an underlying Treasury security, if the Exchange decides to initially open options for trading the Exchange shall open a minimum of one expiration month and series for each class of options.
Additional series may also be opened when the Exchange deems it necessary to maintain an orderly market, to meet customer demand or to reflect substantial changes in the prices of underlying Treasury securities. These series are opened pursuant to the
The Exchange proposes rules setting forth the initial and continued (maintenance) listing standards for Treasury securities options.
Specifically, subsection (a) of proposed Rule 1006D states that Treasury securities may be initially approved by the Exchange as underlying securities for Exchange transactions in specific cusip options, subject to requirements as to size of original issuance, aggregate principal amount outstanding, and years to maturity.
Additionally, the following factors must be met:
(1) The original public sale of an underlying Treasury security shall be at least $1 billion principal amount.
(2) In order to limit underlying Treasury securities that are approved for specific cusip options listings to the most recently issued and actively traded Treasury securities, Exchange approval of a Treasury security underlying Treasury options will only extend to the settled on-the-run Treasury security ("options listing timeframe"). However, the Exchange shall not approve a subsequent settled on-the-run Treasury security until after the expiration of all the options that are listed pursuant to the preceding options listing timeframe.
Moreover, any additional series of specific cusip Treasury options overlying the settled, on-the-run Treasury security may be opened only within the options listing timeframe.
Proposed Rule 1006D establishes several principals. First, the proposed "options listing timeframe" of a Treasury security on which Treasury options may overlie always coincides with the on-the-run period for the Treasury security, once such option is settled.
As an example, assume that for the 3.00% 30-year Treasury bond that matures on May 15, 2042, the on-the-run period would be the three calendar months of June, July, and August.
Proposed Rule 1007D states in subsection (a) that the Board (or a designee of the Board) may determine, for any reason, to withdraw approval of any Treasury securities that were initially approved for options trading pursuant to Rule 1006D as underlying securities.
Proposed Rule 1013D discusses minimum increment and the unique meaning of bids and offers for options on Treasury securities. Specifically, subsection (a) provides that Treasury securities options shall have a minimum increment of $.01. Subsection (b) similarly provides that bids and offers for Treasury securities options shall be expressed in $.01 increments. The Exchange believes that the proposed $.01 increments are uniform and particularly appropriate for Treasury securities options to allow traders to make the most effective use of the product for trading and hedging purposes. The Exchange believe further that the proposed $.01 increments will not cause any capacity problems.
Penny increments have been used very effectively for more than five years on the Exchange as well as on other options markets. First, the Commission has approved the use of penny increments pursuant to the Penny Pilot, pursuant to which some of the highest-volume options trade in penny increments for series of options less than $3.00.
It is clear that inadequately narrow Treasury securities option intervals negatively impact trading and hedging opportunities.
As an example, if the increments were set at another interval level such as $0.50 instead of the proposed $0.01, and an investor wanted to spend no more than $375 to buy a down-side hedge with a put option on a Treasury bond currently trading 102.00, the investor would have the following strikes available from which to chose: an at-the-money ("ATM") 102 put and an out-of-the-money ("OTM") 101 put. If the bid/ask quote for the ATM 102 put was $350/$400, then the investor may elect not to pay $400 and may subsequently choose the lower OTM 101 put. Even if the resulting 101 put had a bid/ask of $200/$250, thereby allowing the investor to make a purchase for less than $375, the investor would have a different risk/reward scenario because the lower put would not represent an ATM hedge. Accordingly, the investor would have to carry the Treasury bond position with risk of market movement down to the 101 strike before the put becomes an ATM put. If, on the other hand, the proposed $0.01 intervals were effective, and the same investor had a choice of the same strikes from which to choose (an ATM 102 put and an OTM 101 put), at $0.01 intervals the premium cost for a hedge using the ATM 102 put may be about $359 to $360. This would garner the investor as much as a $40 or 10% savings in the cost to put on the desired hedge. The proposed interval range would clearly be very advantageous to investors; and would be costly if not available.
And as yet another example, if an investor were interested in purchasing a complex option spread, narrow option intervals would offer additional cost savings and choice. Using the noted 102 and 101 put example, an investor may choose to purchase (go long) a put spread as a hedge; this would be a complex order where the investor would buy the higher strike and simultaneously sell the lower strike for a debit. If the strike price increments were set at $0.50 and an investor wanted to spend no more than $150 to buy a down-side hedge via a long put spread, and the bid/ask of the 102 put was $350/$400 and the 101 put was $200/$250, the premium cost to the investor would be $200 (simultaneous purchase of the 102 put for $400 and
Proposed Rule 1014D sets forth that current Rule 1014 is applicable to Treasury securities options. Rule 1014 sets for obligations and restrictions applicable to specialists and ROTs and discusses, among other things, market making obligations, quoting obligations and parameters, and priority. Proposed Rule 1014D also sets forth that Rule 1080 is applicable to Treasury securities options. Rule 1080 discusses the operation of Phlx XL and XL II, which are the Exchange's electronic platform in respect of orders, execution and trades. The Exchange specifically notes Rules 1014 and 1080 in proposed Rule 1014D because of the applicability to Treasury securities options trading of fundament trading-related matters in Rules 1014 and 1080 such as, for example, market making and quoting obligations, priority, and electronic trading.
The Exchange likewise proposes Rule 1019D regarding maximum bids and offers that may be maintained by specialists and ROTs in options on Treasury securities. This rule states that without limiting the general obligation to deal for his account as stated in Rule 1014,
(1) No more than $0.25 between the bid and offer for each option contract for which the bid is less than $1;
(2) no more than $0.50 where the bid is $1 or more but less than $5;
(3) no more than $0.80 where the bid is $5 or more but less than $10; and
(4) no more than $1 where the bid is $10 or more.
Subsection (b) of Rule 1019D states that for all longer term series the maximum bid/ask differentials are double those listed in subsection (a). This subsection states further that the differentials apply only to the two nearest term series of each class of Treasury security options. The Exchange notes that the proposed increments and maximum bid/ask variations are designed to allow the Exchange flexibility to list options with strike increments at appropriate levels, while diminishing any potential adverse effect on the Exchange's quote capacity thresholds. The Exchange believes that the operational capacity used to accommodate the trading of Treasury securities options on the Exchange will have a negligible effect on the total capacity used by the Exchange to trade its products on a daily basis.
Proposed Rule 1008D discusses expiration and exercise price in respect of Treasury securities options. Subsection (a) states that a single Treasury security option covers $10,000 principal amount of the underlying security. The expiration month and exercise price of Treasury security options of each series shall be determined by the Exchange at the time each series of options is first opened for trading.
Subsection (b) provides that Treasury security options opened for trading on the Exchange will expire on a monthly basis, none further out than the options listing timeframe and additional series as defined in Rule 1006D.
Proposed Rule 1020D discusses exercise assignment notices in the case of Treasury securities options. Subsection (a) states that the method of allocation of exercise notices established pursuant to Rule 1043 may provide that an exercise notice of block size
Options on Treasury securities will be physically settled and, being European style options, may be exercised only on the expiration date. The settlement process for Treasury securities options will be the same as the settlement process for equity options under current Exchange rules (e.g. Rule 1044).
Subsection (a) to proposed Rule 1021D states, in respect of delivery and payment of options on Treasury securities, that payment of the aggregate exercise price in the case of specific cusip options must be accompanied by payment of accrued interest on the underlying Treasury security. The interest will be from (but not including) the last interest payment date to (and including) the exercise settlement date as specified in the rules of the OCC.
In determining position limit compliance, proposed Rule 1002D establishes initial and maintenance position limits unique to options on Treasury securities.
Regarding initial position limits, subsection (a) of proposed Rule 1002D provides that the options shall be subject to a contract limitation (whether long or short) of the put type and the call type on the same side of the market covering a value no greater than 7.5% of the value of the initial or reopened public issuance, rounded to the next lower $100 million interval. For purposes of this position limit, there will be a combining of long positions in put options with short positions in call options, and short positions in put options with long positions in call options; or such other lower amount of options as fixed from time to time by the Exchange as the position limit for one or more classes or series of options. Subsection (a)(1) provides that in no event shall the position limit exceed a position on either side of the market covering a value in excess of $750,000,000 of the underlying securities. Subsection (a)(2) requires that the Exchange provide reasonable notice of each new position limit fixed by the Exchange, by notifying members thereof via OTA.
To calculate the proposed $750,000,000 position limit proposed in Rule 1002D, the Exchange is using Position Accountability Levels ("Accountability Levels" or "limits") for Treasury futures and options on such futures on CBOT as the starting basis. Unlike the current situation on options markets, where there is no active trading of Treasury derivatives, CBOT has the most active markets in the U.S. for trading listed futures on Treasuries and options on such futures. The current CBOT Accountability levels, which effectively serve as position limits on CBOT Treasury derivatives,
The Exchange believes that its very conservative proposed nominal dollar position limit, in conjunction with the proposed equally conservative 7.5% of the value of the initial or reopened public issuance,
Regarding maintenance of position limits for Treasury securities options, subsection (b) of proposed Rule 1002D provides that in the event that any of the underlying Treasury securities are reported as "separate trading of registered interest and principal of securities" ("strips") in the Monthly Statement of the Public Debt of the United States Government, or such other report or compilation as may be selected from time to time by the Exchange, such stripping shall be taken into account in determining whether the position limit as initially established under paragraph (a) ("the established position limit") can be maintained (the remaining non-stripped underlying securities are hereinafter referred to as "the non-stripped securities").
Subsection (b)(1) states that the established position limit may remain so long as the position limit covers a principal amount of underlying securities not in excess of 7.5% of the non-stripped securities. However, in the event that the established position limit covers a principal amount of securities in excess of 7.5% of the non-stripped securities, the Exchange shall reestablish the position limit to cover a principal amount of underlying securities not in excess of 7.5% of the non-stripped securities.
By virtue of proposed Rule 1003D, exercise limits for options on Treasury securities are equivalent to position limits on these instruments. This is similar to the relationship of position
Moreover, proposed Rule 1004D states that for purposes of Rules 1003 and 1004,
The current procedure for establishing margin on the Exchange is in Rule 721. The rule states that member organizations must elect whether they will follow CBOE or New York Stock Exchange ("NYSE") margin rules, notify the Exchange of the election, and comply with the applicable rules.
Proposed Rule 1022D states that Exchange member organizations shall comply with initial and maintenance margin requirements per Rule 721. By operation of proposed Rule 1022D, member organizations involved in trading Treasury security options will be bound by CBOE or NYSE options margin rules consistent with member organizations' choices of CBOE or NYSE for other margin purposes.
The Exchange believes that this proposed margin procedure is particularly appropriate for Treasury securities options. First, it ensures consistency in that member organizations must consistently follow the margin rules of either CBOE or NYSE according to their written margin rules election per Rule 721; and in particular must follow the short equity margin percentage requirements of CBOE or NYSE. Second, it is operationally and systemically efficient in that member organizations can immediately apply the relevant margin procedures that they use for options margin (e.g. short equity margin percentages) to the proposed new Treasury securities options; and the Exchange can use established margin surveillance processes, thereby reducing the potential for error from all perspectives. And third, the current option margin rules of CBOE are, without a doubt, more up to date and usable in today's fast-paced hybrid and electronic trading environment than the decades-old CBOE Government securities options margin rules.
When trading short Treasury securities options, member organizations must, per proposed Rule 721, apply NYSE or CBOE short equity margin rules. Thus, in terms of CBOE margin rules, CBOE Rule 12.3 (which contains a 20% short margin requirement) would be applicable to equity options margin as well as to Treasury securities margin. As an example, when applying the 20% short margin requirement to one short at-the-money equity option call contract priced at $3.00 on XYZ stock priced at $100.00, the margin would be $2,300. This amount is calculated by adding 100% of options proceeds received (one call option contract priced at $3.00 equals $300) plus 20% of the underlying security value (the underlying security value of 100 shares of XYZ stock priced at $100.00 equals $10,000). And, when applying the 20% short margin requirement to one short at-the-money Treasury securities option call contract priced at $3.00 on an on-the-run 30 year Treasury bond priced at $100.00, the margin would be $2,300. This amount is calculated by adding 100% of options proceeds received (one call option contract priced at $3.00 equals $300) plus 20% of the underlying security value (the underlying principal value of a single option on-the-run 30 year Treasury bond equals $10,000). The Exchange believes that the short Treasury security option margin methodology proposed reflects a proper, and indeed very safe, margin requirement.
Proposed rule 1025D sets up guidelines dealing with customer account approval and supervisory qualification. Subsection (a) states that approval of the accounts of customers shall be conducted in accordance with Rule 747
(1) Evidence of authority for the institution to engage in Treasury securities options transactions (corporate resolutions, trust documents, etc.);
(2) Written designation of individuals within the institution authorized to act for it in connection with Treasury securities options transactions; and
(3) Basic financial information concerning the institution.
Subsection (b) states that as a general matter, supervisory qualifications of a Registered Options Principal may be demonstrated only by successful completion of an examination prescribed by the Exchange (e.g. Series 4) for the purpose of demonstrating an adequate knowledge of Treasury securities options and the underlying Treasury securities.
The Exchange proposes additional trading-related rules for Treasury securities options that are similar to certain rules that are applicable to equity and other options. Proposed Rule 1018D states that a limit order book will be available for Treasury securities options. Proposed Rule 1015D states that accommodation trading under the applicable terms and conditions of Rule 1059 will be available in each series of Treasury securities option contracts open for trading on the Exchange. However, bids or offers for opening transactions at a price of $1 per option contract may be executed only with closing transactions that cannot at that time in open outcry be executed with another closing transaction. Proposed Rule 1016D states that all members, member firms, and clearing members shall resolve unmatched trades in Treasury security options from the previous day's trading no later than 9:00 a.m. (Eastern Time) of the following business day. And proposed Rule 1024D permits members to establish and maintain communication links with other members for the purpose of obtaining timely information on price movements in Treasury securities on which options are dealt in on the Exchange.
Proposed Rule 1023D sets forth procedures regarding furnishing of books, records, and other information to the Exchange. Subsection (a) provides that no specialists or ROTs in Treasury securities options shall fail to make available to the Exchange books, records or other information
Proposed Rules 1011D and 1012D state that Rules 1047 and 1092 are applicable to Treasury securities options. Rule 1047 governs trading halts, rotations and suspensions, and Rule 1092 governs obvious errors and catastrophic errors for equity (and other) options traded on the Exchange. Proposed Rule 1012D(a) states that in addition to the factors set forth in Rule 1047, a factor that may be considered by Options Exchange Officials in connection with the institution of trading halts is that current quotations for the underlying Treasury securities are unavailable or have become unreliable; or that there is a need to prevent an unfair and disorderly market.
Proposed Rule 1012D(b) states that Rule 1092 error procedures shall be applicable to Treasury securities options. The Exchange proposes to amend Rule 1092(a) to state, for purposes of conformity, that Treasury security options will have the same obvious error thresholds as equity and index options.
The Exchange will implement surveillance systems that are being used for equity, ETF, currency, and index options to monitor trading in Treasury securities options. This will include, but not be limited to, monitoring for insider trading, manipulation, front-running, and capping and pegging. The Exchange will also monitor public media for rating downgrades and other relevant actions to ensure that the Exchange's maintenance standards are fulfilled, and will monitor for any material actions that may influence the pricing of Treasury securities and options thereon.
The Exchange believes that its proposal is consistent with Section 6(b) of the Act
The Exchange believes that the proposed rules for listing and trading Treasury securities options, including options on Treasury notes and bonds, are reasonable and consistent with the Act. The Exchange believes that its proposal would enhance competition and provide access to an additional trading and investing vehicle so that traders and large, institutional, retail, and public investors could more effectively and closely tailor their investing and hedging decisions.
The Exchange has proposed rules that are specifically tailored for trading Treasury security options. Pursuant to these proposed rules, the underlying Treasury securities may be approved as appropriate for listing options subject to requirements as to size of original issuance, aggregate principal amount outstanding, or years to maturity. The proposed position limits, exercise limits, margin rules, and other rules, in conjunction with the current Exchange rules, are particularly tailored for Treasury securities options, reasonable, and consistent with the Act. In particular, the proposed position and exercise limits reasonably balance the promotion of a free and open market for these securities with minimization of incentives for market manipulation and insider trading; and the proposed margin rules are reasonably designed to deter a member or its customer from assuming an imprudent position in Treasury securities options.
For these and previously-noted reasons, the Exchange believes that the proposal to allow the Exchange to list and permit trading of Treasury securities options would enhance competition and provide access to valuable additional trading and investing vehicles. These would allow traders and investors--including large and institutional investors and retail and public investors--to more effectively tailor their investing and hedging decisions in the current challenging economic climate.
Phlx 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. To the contrary, the Exchange believes that its proposal is pro-competitive. The proposal will allow a new and innovative options product to be listed and traded on the Exchange. This will give market participants the ability to significantly expand their trading and hedging capabilities.
No written comments were either solicited or received.
Within 45 days of the date of publication of this notice in the
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:
* Use the Commission's Internet comment form (
* Send an email to
* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
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 (