83 FR 22550 - Self-Regulatory Organizations; Cboe Exchange, Inc.; Order Approving a Proposed Rule Change Relating to Flexibly Structured Options

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 83, Issue 94 (May 15, 2018)

[Federal Register Volume 83, Number 94 (Tuesday, May 15, 2018)]
[Notices]
[Pages 22550-22552]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2018-10272]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83205; File No. SR-CBOE-2018-008]


Self-Regulatory Organizations; Cboe Exchange, Inc.; Order 
Approving a Proposed Rule Change Relating to Flexibly Structured 
Options

May 9, 2018.

I. Introduction

    On January 18, 2018, Cboe Exchange, Inc. (``Exchange'' or ``Cboe 
Options'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change amending Cboe Options's rules relating to the 
fungibility of Flexible Exchange Options (``FLEX Options''). The 
proposed rule change was published for comment in the Federal Register 
on February 8, 2018.\3\ On March 23, 2018, the Commission designated a 
longer period within which to approve the proposed rule change, 
disapprove the proposed rule change, or institute proceedings to 
determine whether the proposed rule change should be disapproved.\4\ 
The Commission received no comment letters on the proposed rule change. 
This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 82622 (Feb. 2, 
2018), 83 FR 5668 (Feb. 8, 2018) (``Notice'').
    \4\ See Securities Exchange Act Release No. 82936 (Mar. 23, 
2018), 83 FR 13552 (Mar. 29, 2018).
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II. Description of the Proposed Rule Change

    In its filing, the Exchange proposed to amend Interpretation and 
Policy .02 to Rule 24A.4, which sets forth requirements relating to a 
FLEX Option that has the same terms as a Non-FLEX Option.\5\
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    \5\ See Cboe Options Rule 24A.1(q).
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    First, Cboe Options has proposed to amend the rule to make all FLEX 
Options fungible with Non-FLEX Options that have identical terms.\6\ 
Currently, FLEX Options that have quarterly expirations,\7\ short term 
expirations,\8\ weekly expirations,\9\ and End of Month (``EOM'') 
expirations \10\ are not fungible with Non-FLEX Options with identical 
terms.\11\ The OCC

[[Page 22551]]

currently prohibits fungibility in quarterly and short-term 
options,\12\ so, as described in more detail below, Cboe Options 
proposes to delay the effectiveness of this proposed rule change to 
allow time for OCC to amend its bylaws.
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    \6\ See proposed Cboe Options Rule 24A.4.02(a) (`[t]his 
Interpretation and Policy shall apply to all FLEX Options'').
    \7\ See Cboe Options Rules 5.5(e), 24.9(a)(2)(B), and 24.9(c).
    \8\ See Cboe Options Rules 5.5(d) and 24.9(a)(2)(A).
    \9\ See Cboe Options Rule 24.9(e). These are currently traded 
pursuant to the Nonstandard Expirations Pilot Program.
    \10\ Id. These are also traded pursuant to the Nonstandard 
Expiration Pilot Program.
    \11\ Cboe Options states in its proposal that FLEX Options with 
these expirations were not originally intended to be fungible. See 
Securities Exchange Release Act Nos. 62658 (August 5, 2010), 75 FR 
49010, 49011 n.8 (August 12, 2010) (SR-CBOE-2009-075) (notice). The 
notice states that FLEX Options do not become fungible with 
subsequently introduced Non-FLEX structured quarterly and short term 
options, and that they will not be with End of Week (``EOW'') and 
EOM expirations because of their similarities to the quarterly and 
short term options. EOW expirations are now called weekly 
expirations as Cboe Options Rule 24.9(e) was amended to include 
Monday and Wednesday expirations. See also Securities Exchange 
Release Act No. 62911 (September 14, 2010), 75 FR 57539 (September 
21, 2010) (SR-CBOE-2009-075) (approval order).
    \12\ See Article I of OCC By-Laws.
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    Second, the Exchange has proposed to clarify that if the expiration 
date is an Exchange holiday, Cboe Options Rule 24A.4.02 shall designate 
the previous business day as the expiration date.\13\ However, for 
weekly expirations that expire on a Monday that is an Exchange 
holiday,\14\ Cboe Options Rule 24A.4.02 shall designate the business 
day that immediately follows the Exchange holiday as the expiration 
date.\15\ According to the Exchange, the proposed rule is designed to 
clarify that when the expiration of a Non-FLEX Option is moved to the 
business day immediately before (or after) the Exchange holiday, the 
FLEX Option that also expires on the day before (or after) will be 
fungible with the Non-FLEX Option.\16\
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    \13\ See Proposed Cboe Options Rule 24A.4.02(a).
    \14\ See Cboe Options Rule 24.9(e)(1).
    \15\ See Proposed Cboe Options Rule 24A.4.02(a).
    \16\ See Notice, supra note 3, at 5669.
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    Third, Cboe Options has proposed to clarify that in the event a 
Non-FLEX American-style series is added intra-day, a FLEX position is 
permitted to be closed using FLEX trading procedures for the balance of 
the trading day on which the Non-FLEX series is added against another 
closing only FLEX position.\17\ The Exchange notes that when it was 
adopted, the Exchange intended to limit this provision to American-
style exercises. According to the Exchange, American-style options face 
assignment risk because when a Non-FLEX Option is listed, the OCC 
cannot net the positions of the Non-FLEX Option and the FLEX Option 
with identical terms until the next business day.\18\
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    \17\ See proposed Cboe Options Rule 24A.4.02(b).
    \18\ See Notice, supra note 3, at 5669 n.7. See also Securities 
Exchange Act Release No. 62870 (September 8, 2010), 75 FR 56147 
(September 15, 2010) (SR-CBOE-2010-078) (stating that there is 
assignment risk for American-style options only). The Commission 
notes that an American-style option may be exercised at any time 
during its life, whereas, a European-style option may only be 
exercised at the end of its life.
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    Fourth, the Exchange has proposed several non-substantive changes 
that are designed to make the text easier to read. The Exchange 
believes that such changes will clarify that the fungibility provisions 
apply to FLEX Options series with terms identical to the terms of a 
Non-FLEX Options series.\19\
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    \19\ See Notice, supra note 3, at 5669.
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    Finally, the proposed rule text provides that the Exchange's 
current rule will remain in effect until the effective date specified 
by the Exchange in a Regulatory Circular.\20\ The Regulatory Circular 
announcing the effective date shall be issued at least 30 days prior to 
the effective date \21\ and such effective date shall be no later than 
July 31, 2018.\22\ As noted in Cboe Options's proposal,\23\ the delayed 
effectiveness is intended to allow OCC time to amend its bylaws to 
eliminate its current restriction on fungibility of certain options.
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    \20\ Id. at 5670.
    \21\ Id.
    \22\ Id.
    \23\ Id.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act \24\ and the 
rules and regulations thereunder applicable to a national securities 
exchange.\25\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\26\ which 
requires that the rules of an exchange be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.
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    \24\ 15 U.S.C. 78f.
    \25\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \26\ 15 U.S.C. 78f(b)(5).
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    The Commission notes that the rules concerning the fungibility of 
certain FLEX Options and Non-FLEX Options were previously approved by 
the Commission.\27\ The proposed rule change extends fungibility to 
quarterly expirations, short term expirations, and, to the nonstandard 
expiration pilot program weekly and EOM expirations. The Commission 
believes that amending Rule 24A.4.02 to allow these additional FLEX 
Options to become fungible with standardized options with identical 
terms could result in some benefits to FLEX Options participants in 
that it may potentially increase the liquidity available to traders of 
FLEX Options. As the Exchange noted in its rule proposal, this is 
because there are more market participants in the Non-FLEX Options and 
thus there is potentially more liquidity available to market 
participants with FLEX Options that will be able to exit their FLEX 
Options positions in the standardized Non-FLEX Option market.\28\
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    \27\ See Securities Exchange Act Release No. 59417 (Feb. 18, 
2009), 74 FR 8591 (Feb. 25, 2009) (SR-CBOE-2009-115).
    \28\ See Notice, supra note 3, at 5670.
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    Because FLEX Options in quarterly, short term, weekly, and EOM 
expirations are not fungible with their Non-FLEX counterparts, parallel 
markets in these expirations exist--one FLEX and one Non-FLEX. The 
Commission previously stated that it is concerned that FLEX Options 
could act as a surrogate for trading in standardized options.\29\ The 
Commission recognizes that the FLEX Options market is designed to 
combine the benefits of an auction market with the features of 
negotiated transactions, and therefore continuous quotes may not always 
be available. Permitting more expirations in FLEX Options to be 
fungible with their Non-FLEX counterparts could help to ensure that 
market participants cannot avoid the protections provided to investors 
in the standardized market for these expirations by trading FLEX 
Options. Specifically, once a Non-FLEX series is open for trading, new 
FLEX Options are not permitted in that series. In addition, once a Non-
FLEX Options series is open, all outstanding FLEX Options in the same 
series become fungible with Non-FLEX Options in the standardized 
market, are traded pursuant to standardized market trading rules, and 
are aggregated for position and exercise limit purposes. Allowing these 
FLEX Options to be fungible with their Non-FLEX counterparts could 
potentially address some of these surrogacy concerns.
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    \29\ See 74 FR at 8593.
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    Nevertheless, the FLEX market was originally intended to allow 
customization of option terms that were not available in the 
standardized options. While this has evolved over time with the current 
fungibility provisions, as the additional classes of options noted 
above are allowed to become fungible with identical term standardized 
options, some of which have much shorter terms to expiration, we expect 
the Exchange to carefully monitor the fungible FLEX Options (and 
standardized options counterparts) to ensure that they are not being 
used in a way to trade ahead and/or gain an advantage over other market 
participants prior to the standardized

[[Page 22552]]

options becoming available to all market participants.
    Furthermore, the Commission expects the Cboe Options to report any 
undue effects that may occur as a result of these fungibility rule 
changes, including taking prompt action should any unanticipated 
consequences occur. The Commission also expects, prior to the effective 
date of the new rule, the Exchange to address whether additional 
position limit aggregation rules should be adopted prior to the rule's 
delayed implementation date. We note that currently the FLEX rules 
require that certain FLEX Options positions be aggregated with the 
position limits in the standardized market.\30\
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    \30\ See Cboe Options Rule 24A.7, concerning FLEX position 
limits and reporting requirements.
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    The Commission believes that the remaining proposed changes will 
help protect investors and the public interest by providing clarity and 
transparency to the rules. The proposed rule text regarding Exchange 
holidays will clarify the fungibility of FLEX Options with expiration 
dates on Exchange holidays and are consistent with the expiration of 
the same standardized options on Exchange holidays. Amending the intra-
day add provision to state that it applies solely to American-style 
expirations will codify in the rule text the Exchange's original intent 
with respect to this provision. Further, the other non-substantive, 
clarifying changes will make the rule easier to read and understand.
    Finally, as noted above the Exchange cannot actually implement this 
rule change immediately because OCC bylaws currently restrict 
fungibility of quarterly and short term options. The Commission 
believes that the delayed implementation date of July 31, 2018 should 
provide OCC with time to consider fungibility in quarterly and short-
term options and determine whether to amend the OCC By-laws to 
accommodate the changes being adopted by the Exchange. The Exchange has 
also committed to announce the implementation of the change at least 30 
days prior to the effective date pursuant to a Regulatory Circular, 
which should provide adequate advance notice to market participants. To 
the extent OCC is not able to implement a bylaw change at or prior to 
the July 31, 2018, we would expect the Exchange to amend its rules or 
extend the implementation date.
    For the reasons above, the Commission finds that the proposed rule 
change is consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change (SR-CBOE-2018-008) be, and 
hereby is, approved.
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    \31\ 15 U.S.C. 78s(b)(2).
    \32\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-10272 Filed 5-14-18; 8:45 am]
 BILLING CODE 8011-01-P