Daily Rules, Proposed Rules, and Notices of the Federal Government
The filing proposes to adopt Interpretation and Policy .06 under CBOE Rule 6.2B relating to closing rotation procedures to determine the month-end closing price for each series of S&P 500 Index options based on the theoretical fair value of such series. 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 the proposed rule change is to codify and formalize the process by which, at each month-end, the closing price of each series of S&P 500 Index ("SPX") options are aligned with the closing value of (i) the underlying stock index in the cash market, and (ii) the related SPX futures contracts traded on the Chicago Mercantile Exchange ("CME").
Beginning in December 1999, the CME instituted a special settlement procedure to determine a fair value settlement price of its domestic stock index futures for the December month-end based on the closing value of the underlying stock index, rather than the actual closing price of the index futures contract.
The Exchange understands that the CME created this fair value settlement price at the request of certain institutional investors. These institutional investors require an independent third-party valuation of the fair value of their futures positions as of the 3:00 p.m. close of the underlying cash markets. Many market participants are active in both the futures and cash markets and want the values of their futures positions to align with the value of their underlying cash market positions. If the month-end settlement price in their stock index futures positions were based on the 3:15 p.m.
The market for SPX futures and the market for SPX options are highly interconnected. Many investors in SPX options traded on the Exchange are also active in SPX futures contracts traded on the CME, hedging positions in one with positions in the other. In fact, investors often calculate the value of SPX options with reference to the value of the related SPX futures. Since the CME began its month-end fair value procedure in December 1999, the Exchange determined that it would be disruptive to fair and orderly markets to allow the closing prices of SPX options at month-end (based on the actual 3:15 p.m. Exchange close) to significantly diverge from the settlement value of the related SPX futures (determined based on the fair value at the 3:00 p.m. cash market close). Such a divergence would cause numerous difficulties for investors active in both SPX options and SPX futures, including: (i) Month-end portfolio reports would misrepresent an investor's overall positions because the value of the investor's SPX options and SPX futures positions would reflect different moments in time, falsely indicating tracking error or the level of offsetting hedges, and (ii) an investor that is perfectly hedged between its SPX options and its SPX futures positions could nonetheless (A) be called for additional unnecessary margin, or (B) have necessary margin returned to them, because the futures settlement value (and therefore margin calculation) was based on the 3:00 p.m. fair value, while the SPX options closing prices were based on the actual 3:15 p.m. Exchange close.
One potential approach to prevent this divergence would have been, on the last business day of each month, to end trading in SPX options series at 3:00 p.m. This would cause the closing prices on the Exchange to naturally align with the 3:00 p.m. fair value assigned to SPX futures by the CME. However, the Exchange determined that this would itself be disruptive, as it would result in the market for SPX futures on the CME being open for trading at a time when the market for SPX options on the Exchange was closed. This misalignment would disrupt the trading activities of many market participants, leaving them unable to actively hedge their SPX futures positions in SPX options. The Exchange therefore adopted a practice to align the closing price of SPX options with the settlement value of SPX futures.
Throughout each trading day, the Exchange disseminates bid and offer quotations in each series of SPX options traded on the Exchange. Upon receipt of the final quotations from the Exchange, the Options Clearing Corporation ("OCC") determines the final closing price of each series of SPX options by calculating the midpoint between the final bid and final offer quotations. Generally, the final quotations disseminated by the Exchange on each day reflect the final quotations as of 3:15 p.m. However, pursuant to Exchange Rules 6.2, 6.2A, 6.2B and 24.13, the Exchange determined to deviate from normal rotation policy and procedure in the interest of a fair and orderly markets on those month-end business days when the CME adopted a 3:00 p.m. fair value as the settlement price. On these days, the Exchange holds special non-trading closing rotations to determine the closing price of each SPX options series based on the theoretical fair value at the 3:00 p.m. cash market close.
Thus, unlike other trading days where the SPX options closing prices are based on the final actual quotes as of 3:15 p.m., for these month-end dates, the SPX options closing prices are based on the theoretical 3:00 p.m. fair value. As with the CME, on the days when this procedure is used, although no actual trades occur at these prices, these theoretical fair value closing prices are treated as the closing prices for all purposes, including dissemination through the Options Price Reporting
The Exchange proposes to adopt Interpretation and Policy .06 to Rule 6.2B (the "Interpretation") to codify in its rulebook the Exchange's existing practice with respect to the end-of-month SPX options fair value procedures.
The Exchange continues to believe that it is integral to fair and orderly markets in SPX options that the closing price of each series of SPX options traded on the Exchange be based on the value as of the same time as the closing price of the related SPX futures traded on the CME. Because the CME has made a practice of determining the closing price of SPX futures on the last business day of each month based on the 3:00 p.m. fair value, the Exchange believes the closing price of each related SPX options series should similarly be based on the 3:00 p.m. price. Investors active in both the options and futures markets would face numerous difficulties if the closing values of SPX options and SPX futures were allowed to significantly diverge. For example, as noted above, if the closing price of a series of SPX options was to be based on the 3:15 close of trading, while the related SPX futures settlement price was based on the 3:00 p.m. fair value, an investor that was perfectly hedged between the options and futures could nonetheless be subject to potentially significant margin calls due to market movements between 3:00 p.m. and 3:15 p.m.--even though such market movement would not actually impact the level of risk of the perfectly hedged portfolio.
As discussed above, on those days when the CME has instituted its 3:00 p.m. fair value settlement procedure, the Exchange determined to deviate from normal rotation policies and procedures in the interest of fair and orderly markets and conduct fair value closing rotations. The Exchange has done so on a regular basis in response to changes in CME procedures, in order to prevent any disruption to fair and orderly markets that would occur from the closing price of SPX options being determined as of the 3:15 p.m. close and the settlement value of SPX futures being determined as of 3:00 p.m. fair value. However, the CME appears to have adopted its 3:00 p.m. fair value procedure on a permanent basis for each month-end trading date.
The Interpretation codifies the Exchange's current procedures without material change. Specifically, on the last business day of each calendar month, following the 3:15 p.m. close of trading in SPX options, the Exchange will conduct special non-trading closing rotations for each series of SPX options in order to determine their theoretical fair value as of the 3:00 p.m. close of the cash market. The LMM for each series of SPX options will be responsible for calculating the fair value of that series.
The "fair value" of a series of SPX options represents the price at which the series should theoretically trade in relation to cash values in the absence of transaction costs. It is typically calculated as a function of the underlying index value plus the financing cost of owning the underlying stock portfolio, less dividends paid up to the expiration of the option.
To reach this fair value, each LMM will consider various inputs, including the prevailing interest rates, expected dividends, and input from market participants. Additionally, because the fair value of the related futures contract reflects a similar calculation, the Exchange expects that particular weight will be given to the as-of 3:00 p.m. fair value of the related SPX futures contract disseminated by the CME. Upon determination of the fair value, the LMMs will calculate bid and offer quotations, the midpoint of which will equal the calculated fair value, and provide these non-tradable quotations to the Exchange.
The Exchange will disseminate these non-tradable fair value quotations via OPRA after the 3:15 close, within approximately three to five minutes of closing. The OCC will then determine the final closing price of each series of SPX options by calculating the midpoint between these final fair value bid and final fair value offer quotations, which will equal fair value. This fair value closing price will be used as the closing price for all purposes, including the OCC's calculation of variation margin requirements.
The Exchange recognizes that LMMs may have an interest in the outcome of the month-end value determination based on the composition of their own proprietary positions. For example, an LMM may have an incentive to lean their fair value determination in a direction that would minimize the potential variation margin the LMM would be called for by the OCC with respect to their proprietary holdings. However, the Exchange believes that this risk is limited because, as a mathematical formula, fair value can be generally approximated by third parties, allowing for independent checks on the LMMs' calculations. In addition, the Exchange does and will conduct robust surveillance and oversight of LMMs' fair value quotations activities to monitor for potential attempts at manipulation.
Finally, as described above, the need to disseminate after 3:15 p.m. the fair value closing quotations for SPX options based on the 3:00 p.m. fair value on the last business day of each month is due to the current CME procedures in place for SPX futures. However, the Exchange cannot predict whether the CME may determine to forego its special month-end fair value procedure at any time in the future. The proposed interpretation therefore provides the Exchange with discretion not to disseminate the 3:00 p.m. fair value quotations as determined by the LMMs after the 3:15 p.m. close, if not doing so would be in the interest of fair and orderly markets. The Exchange anticipates that it would only not do so in the event that the CME determines not to apply its special month-end fair value settlement procedure for SPX futures, either on a particular month-end trading date or otherwise. In such an event, the Exchange anticipates allowing the actual 3:15 p.m. closing quotations to act as the final quotations, as occurs on other trading days, so that both the closing quotations of SPX options at such a month-end and the settlement value of the related SPX futures would each reflect the same end of trading time.
The Exchange believes that the proposed rule change is consistent with the Securities Exchange Act of 1934 (the "Act")
CBOE does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.
The Exchange neither solicited nor received comments on the proposed rule change.
Because the foregoing proposed rule change does not:
A. Significantly affect the protection of investors or the public interest;
B. Impose any significant burden on competition; and
C. Become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate,
At any time within 60 days of the filing of this proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.
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.
All submissions should refer to File Number SR-CBOE-2012-095. 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 (