[Federal Register Volume 79, Number 18 (Tuesday, January 28, 2014)]
[Notices]
[Pages 4512-4515]
[FR Doc No: 2014-01510]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71365; File No. SR-ISE-2013-42]

Self-Regulatory Organizations; International Securities Exchange,
LLC; Order Granting Approval of Proposed Rule Change, as Modified by
Amendment No. 1, To List Options on the Nations VolDex Index

I. Introduction

    On July 17, 2013, the International Securities Exchange, LLC
(``Exchange'' or ``ISE'') 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 to list options on the Nations
VolDex Index (``Index''). The proposed rule change was published for
comment in the Federal Register on August 2, 2013.\3\ The Commission
received one comment letter on the proposed rule change.\4\ On
September 10, 2013, the Commission extended the time period for
Commission action to October 31, 2013.\5\ On October 29, 2013, ISE
submitted a response to the comment letter.\6\ On October 30, 2013, ISE
submitted Amendment No. 1 to the proposed rule change. On October 31,
2013, the Commission instituted proceedings to determine whether to
approve or disapprove the proposed rule change, as modified by
Amendment No. 1.\7\ The Commission subsequently received one additional
comment letter on the proposed rule change.\8\ This order grants
approval of the proposed rule change, as modified by Amendment No. 1.
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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. 70059 (July 29,
2013), 78 FR 47041 (``Notice'').
    \4\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Edward T. Tilly, Chief Executive Officer, Chicago Board Options
Exchange, Incorporated (``CBOE''), dated August 23, 2013 (``CBOE
Letter I'').
    \5\ See Securities Exchange Act Release No. 70362, 78 FR 56955
(September 16, 2013).
    \6\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Michael J. Simon, Secretary and General Counsel, ISE, dated
October 29, 2013 (``ISE Letter'').
    \7\ See Securities Exchange Act Release No. 70787, 78 FR 66798
(November 6, 2013).
    \8\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Edward T. Tilly, Chief Executive Officer, CBOE, dated November
27, 2013 (``CBOE Letter II'').
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II. Description of the Proposed Rule Change

    The Exchange proposes to list and trade cash-settled, European-
style options on the Index, which measures changes in implied
volatility of the SPDR S&P 500 Exchange-Traded Fund (``SPY'').\9\
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    \9\ According to the Exchange, SPY is historically the largest
and most actively-traded exchange-traded fund in the United States
as measured by its assets under management and the value of shares
traded. See Notice, supra note 3, at 47042.
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    The Index is calculated using a methodology developed by
NationsShares, which uses published real-time bid/ask quotes of SPY
options.\10\ The Index will be calculated and maintained by a
calculation agent acting on behalf of NationsShares. The Index will be
updated on a real-time basis on each trading day beginning at 9:30 a.m.
and ending at 4:15 p.m. (New York time).\11\ Values of the Index also
will be disseminated every 15 seconds during the Exchange's regular
trading hours to market information vendors such as Bloomberg and
Thomson Reuters. In the event the Index ceases to be maintained or
calculated, or its values are not disseminated every 15 seconds by a
widely available source, the Exchange will not list any additional
series for trading and will limit all transactions in such options to
closing transactions only for the purpose of maintaining a fair and
orderly market and protecting investors.
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    \10\ See id. (describing in more detail the calculation
methodology for the Index).
    \11\ If the current published value of a component is not
available, the last published value will be used in the calculation.
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    The Exchange proposes that the standard trading hours for index
options (9:30 a.m. to 4:15 p.m., New York time) will apply to options
on the Index. Options on the Index will expire on the Wednesday that is
thirty days prior to the third Friday of the calendar month immediately
following the expiration month. Trading in expiring options on the
Index will normally cease at 4:15 p.m. (New York time) on the Tuesday
preceding an expiration Wednesday. The exercise and settlement value
will be calculated on Wednesday at 9:30 a.m. (New York time) using the
mid-point of the NBBO for the SPY options used in the calculation of
the Index at that time. The exercise-settlement amount is equal to the
difference between the settlement value and the exercise price of the
option, multiplied by $100. Exercise will result in the delivery of
cash on the business day following expiration.
    In Amendment No. 1, the Exchange expresses its view that
manipulation of the Index would be very difficult, particularly around
the time when the settlement value is determined. According to the
Exchange, the settlement value calculation for the Index, which is
based on the mid-point NBBO of the input components, is a methodology
unlike how other index settlement values are determined, as most are
calculated based on transaction prices of the individual index
components. The Exchange believes that manipulating the Index
settlement value will be difficult based on the dynamics of a quote-
based calculation methodology as opposed to a single transaction price
and because the option prices themselves would make such an endeavor
cost prohibitive. Further, according to the Exchange, the vast
liquidity of SPY options as well as the underlying SPY shares ensures a
multitude of market participants at any given time. For example, ISE
notes that at least 19 market makers actively traded SPY options on ISE
during September 2013 on any given day, and there are now 12 options
exchanges that list SPY options. Due to the high level of participation
among market makers that can enter quotes in SPY options series, the
Exchange believes it would be very difficult for a single participant
to alter the NBBO width across multiple series in any significant way
without exposing the would-be manipulator to regulatory scrutiny and
financial costs.
    The Exchange proposes to adopt minimum trading increments for
options on the Index to be $0.05 for series trading below $3, and $0.10
for series trading at or above $3. The Exchange also proposes to set
the minimum strike price interval for options on the Index at $1 or
greater when the strike price is $200 or less, and $5 or greater when
the strike price is greater than $200. Currently, when new series of
index options with a new expiration date are opened for trading, or
when additional series of index options in an existing expiration date
are opened for trading as the current value of the underlying index
moves substantially from the exercise prices of series already opened,
the exercise prices of such new or additional series must be reasonably
related to the current value of the underlying index at the time such
series are first opened for trading.\12\ The Exchange, however,
proposes to eliminate this range limitation that would otherwise limit
the number of $1 strikes that may be listed in options on the Index.
The Exchange's proposal to eliminate this range limitation is identical
to strike

price intervals adopted by CBOE for the CBOE Volatility Index
(``VIX'').\13\
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    \12\ See ISE Rule 2009(c)(3). The term ``reasonably related to
the current index value of the underlying index'' means that the
exercise price is within thirty percent of the current index value.
See ISE Rule 2009(c)(4).
    \13\ See Securities Exchange Act Release No. 63155 (October 21,
2010), 75 FR 66402 (October 28, 2010) (SR-CBOE-2010-096).
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    The Exchange proposes to list options on the Index in the three
consecutive near-term expiration months plus up to three successive
expiration months in the March cycle.\14\ In addition, long-term option
series having up to sixty months to expiration,\15\ Short Term Option
Series,\16\ and Quarterly Options Series \17\ may also be traded.
Options on the Index will be quoted and traded in U.S. dollars.\18\
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    \14\ See ISE Rule 2009(a)(3).
    \15\ See ISE Rule 2009(b)(1).
    \16\ See ISE Rule 2009, Supplementary Material .01.
    \17\ See ISE Rule 2009, Supplementary Material .02.
    \18\ See ISE Rule 2009(a)(1).
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    The Exchange believes that the Index is a broad-based index, as
that term is defined in ISE Rule 2001(k).\19\ The Exchange proposes
that the Index should be treated as a broad-based index for purposes of
position limits, exercise limits, and margin requirements.\20\
Accordingly, the Exchange proposes no position or exercise limits for
options on the Index \21\ and the Exchange proposes to apply margin
requirements that are identical to those applied for its other broad-
based index options.
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    \19\ ISE Rule 2001(k) defines the terms ``market index'' and
``broad-based index'' to mean an index designed to be representative
of a stock market as a whole or of a range of companies in unrelated
industries.
    \20\ In its response letter, ISE states that ISE members are
bound by the initial and maintenance margin requirements of either
CBOE or the New York Stock Exchange. See ISE Letter, supra note 6,
at 3. ISE clarifies that although CBOE has margin rules designed for
individual stock- or ETF-based volatility index options, its
proposal intends to require compliance with CBOE's margin rules
applicable to broad-based index options rather than its specialized
rules adopted for specified individual stock- or ETF-based
volatility index options. See id.
    \21\ The Exchange believes that because the Index will settle
using published quotes of SPY options and there are currently no
position limits for SPY options, it is appropriate not to impose
position or exercise limits for options on the Index. The Exchange
notes that because the size of the market underlying SPY options is
so large, it should dispel concerns regarding market manipulation.
The Exchange believes that the same reasoning applies to options on
the Index since the value of options on the Index is derived from
the volatility of SPY, as implied by SPY options. The Exchange also
notes that VIX options are not subject to any position or exercise
limits. See Notice, supra note 3, at 47043.
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    In addition, the Exchange proposes that the trading of options on
the Index will be subject to the same rules that currently govern the
trading of Exchange index options, including sales practice rules and
trading rules. Trading of options on the Index will also be subject to
the trading halt procedures applicable to other index options traded on
the Exchange.\22\ Further, Chapter 6 of the Exchange's rules, which is
designed to protect public customer trading, will apply to trading in
options on the Index. A trading license issued by the Exchange will
also be required for all market makers to effect transactions as market
makers in the Index options in accordance with ISE Rule 2013.
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    \22\ See ISE Rule 2008(c).
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    The Exchange represents that it has an adequate surveillance
program in place for options on the Index and intends to apply those
same program procedures that it applies to the Exchange's other options
products. Further, in Amendment No. 1, the Exchange notes that it will
monitor for any potential manipulation of the Index settlement value
both according to its current procedures and additional enhanced
surveillance measures.\23\ Additionally, the Exchange notes that it is
a member of the Intermarket Surveillance Group, through which it can
coordinate surveillance and investigative information sharing in the
stock and options markets with all of the U.S. registered stock and
options markets. The Exchange also represents that it has the necessary
system capacity to support additional quotations and messages that will
result from the listing and trading of options on the Index.
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    \23\ Specifically, the Exchange represents that it will review
the opening ISE BBO (``IBBO'') for the input options components to
determine if the IBBO had an effect on the NBBO for these options
series. If it did, the Exchange can determine which member entered
the IBBO quote and review the member's position and quoting activity
to determine if the quote may have been entered to impact the NBBO.
The Exchange also represents that it will compare the Index
settlement value to the subsequent disseminated value. If the
difference between these two values is significant, the Exchange
will review the opening quotes used in the calculation of the Index
across all marketplaces to determine which exchange(s) contributed
to opening NBBO quote(s) and contact the exchange(s) that entered
the quote(s). See Amendment No. 1.
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III. Discussion and Commission Findings

    The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange.\24\
Specifically, the Commission finds that the proposed rule change is
consistent with Section 6(b)(5) of the Act,\25\ which requires, among
other things, that the rules of a national securities exchange be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, 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. Specifically, the Commission believes that the proposed Index
options provide investors with an additional trading and hedging
mechanism.
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    \24\ 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).
    \25\ 15 U.S.C. 78f(b)(5).
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    As noted above, the Commission received two comment letters
regarding the proposed rule change.\26\ In its comment letters, CBOE
argues that the Index should not be treated as a broad-based security
index for regulatory purposes.\27\ Specifically, CBOE notes that the
spot calculation of the Index would be comprised of a total of four
component SPY put options and that the settlement value for the Index
option would be calculated using the opening NBBO quotations of those
component options.\28\ CBOE states that the component weights of the
four put options used to calculate the Index can become highly
concentrated in just one or two component options, depending on the
time to expiration and the relationship of the forward SPY price to the
strike prices of the component options.\29\ In this regard, CBOE
questions the Exchange's proposal not to impose position limits for
options on the Index.\30\ In particular, CBOE asserts that, although
the Commission has permitted some broad-based security index options to
have no position limits, the same rationale should not apply to the
proposed Index options because they are not options on a broad-based
security index.\31\ CBOE argues that the more analogous comparison for
position limit treatment is the Alpha Index options that trade on
NASDAQ OMX PHLX LLC (``Phlx'').\32\ According to CBOE, Alpha Index
options are cash-settled index options that measure the relative
performance of two securities (a target component and a benchmark
component), and all approved Alpha Index pairs include SPY as the
benchmark component.\33\ CBOE notes that Alpha Index options where the
target component is an exchange-traded

fund have a position limit of 15,000 contracts, and Alpha Index options
where the target component is a single stock have a position limit of
60,000 contracts.\34\
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    \26\ See CBOE Letter I, supra note 4 and CBOE Letter II, supra
note 8.
    \27\ See CBOE Letter I, supra note 4 at 1-2.
    \28\ See CBOE Letter I, supra note 4 at 1 and CBOE Letter II,
supra note 8 at 1.
    \29\ See CBOE Letter I, supra note 4 at 1 and CBOE Letter II,
supra note 8 at 1.
    \30\ See CBOE Letter I, supra note 4 at 2-3 and CBOE Letter II,
supra note 8 at 1.
    \31\ See CBOE Letter I, supra note 4 at 2.
    \32\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II,
supra note 8 at 1-2.
    \33\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II,
supra note 8 at 2.
    \34\ See CBOE Letter I, supra note 4 at 2 and CBOE Letter II,
supra note 8 at 2.
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    In its response letter, ISE draws an analogy between the Index and
the VIX.\35\ ISE argues that, as with the VIX, designating the Index as
a broad-based index should not be based only on the number of
components that the index contains, but rather, on the economic
exposure that the underlying reference seeks to provide.\36\ ISE states
that, according to CBOE, the VIX is a key measure of the market
expectations of near-term volatility conveyed by options on the S&P 500
Index.\37\ ISE asserts that the Index provides a similar economic
exposure as exposure to the VIX because it measures changes in implied
volatility of SPY, which is a broad-based exchange-traded fund based on
the price and yield of the stocks held in the SPY portfolio.\38\ ISE
therefore concludes that the Index should similarly be treated as
broad-based by looking through to the exposure provided by the
underlying reference.\39\
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    \35\ ISE notes that CBOE sought to designate the VIX as a broad-
based index. See ISE Letter, supra note 6, at 1.
    \36\ See id., at 2.
    \37\ See id.
    \38\ See id.
    \39\ See id.
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    ISE also argues that the proposed Index options are not analogous
to Alpha Index options.\40\ In particular, ISE points out that Phlx's
Alpha Index options involve the pairing of a single equity security or
an exchange-traded fund that has a position limit against the SPY that
has no position limit.\41\ ISE believes that, because the pairing
includes one security that has position limits, it does not follow that
the combined new index should have no position limits.\42\ In contrast,
ISE believes that its proposal to apply no position limits to the Index
options is appropriate.\43\
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    \40\ See id.
    \41\ See id.
    \42\ See id.
    \43\ See id., at 2-3. See also supra note 21 and accompanying
text.
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    Further, as discussed above, in Amendment No. 1, ISE asserts that
there is a low potential for manipulation of the settlement value of
the Index due to the quote-based calculation methodology used, high
cost that would result from any attempted manipulation, and the vast
liquidity and high level of participation among market participants
making manipulation very difficult.\44\ In addition, while ISE notes
that manipulation of the Index settlement value is unlikely, it
represents that in addition to its current surveillance procedures, it
will undertake certain additional surveillance measures with respect to
the Index options.\45\
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    \44\ See Amendment No. 1.
    \45\ See supra note 23 and accompanying text.
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    The Commission believes that the Exchange's proposal to impose no
position limits on the Index options is appropriate and consistent with
the Act.\46\ As noted above, the Index is calculated using published
real-time bid/ask quotes of SPY options and measures changes in the
implied volatility of the SPY. The Commission notes that SPY options
are the most actively-traded options in terms of average daily volume.
The Commission believes that because the options composing the Index
are extremely liquid, the potential manipulation and potential market
disruption concerns that position limits are designed to address are
mitigated in the case of this product.\47\ Moreover, the Commission
believes that having no position limits for the proposed Index options
may benefit investors by bringing additional depth and liquidity to
these Index options without raising significant concerns about
potential manipulation or potential market disruption.
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    \46\ In approving this proposed rule change to list and trade
options on the Index, the Commission is not determining whether the
Index is a ``narrow-based'' security index as that term is defined
in the Act. See 15 U.S.C. 78c(a)(55)(B).
    \47\ See also Amendment No. 1.
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    The Commission also believes that permitting $1.00 strike price
intervals if the strike price is equal to or less than $200 will
provide investors with added flexibility in the trading of these
options and will further the public interest by allowing investors to
establish positions that are better tailored to meet their investment
objectives. As noted above, the Exchange proposes to provide an
exception for the proposed Index options from the existing requirement
that exercise prices of new or additional series must be reasonably
related to the current value of the Index at the time such series are
first opened for trading.\48\ The Commission believes that this change
is consistent with the Act because it should provide investors added
flexibility to meet their investment objectives.\49\ The Commission
also notes that the Exchange has represented that it has the necessary
systems capacity to handle the additional traffic associated with the
listing and trading of this new product and it expects that the
Exchange considered this expansion of the permissible range of strike
prices in making such a representation.\50\
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    \48\ See supra notes 12-13 and accompanying text.
    \49\ The Commission notes that CBOE recently eliminated the band
that limited the number of $1 strikes that could be listed on VIX
options. See Securities Exchange Act Release No. 63155 (October 21,
2010), 75 FR 66402 (October 28, 2010) (SR-CBOE-2010-096).
    \50\ See Notice, supra note 3, at 47044.
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    The Commission also believes that it is consistent with the Act to
apply margin requirements to the proposed Index options that are
otherwise applicable to options on broad-based indexes.\51\ The
Commission further believes that the Exchange's proposed minimum
trading increment, series openings, and other aspects of the proposed
rule change are appropriate and consistent with the Act.
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    \51\ See supra note 20.
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    As a national securities exchange, the Exchange is required, under
Section 6(b)(1) of the Act,\52\ to enforce compliance by its members
and persons associated with its members with the provisions of the Act,
Commission rules and regulations thereunder, and its own rules. In this
regard, the Commission notes that trading of options on the Index will
be subject to the same rules that currently govern the trading of other
index options on the Exchange.\53\ In addition, as noted above, the
Exchange has asserted that manipulation of the Index settlement value
will be difficult.\54\ Moreover, the Exchange has represented that it
has an adequate surveillance program in place for options traded on the
Index, and will monitor for any potential manipulation of the Index
settlement value according to its current surveillance procedures and
additional surveillance measures.\55\ In approving the proposed listing
and trading of the Index options, the Commission has also relied on
ISE's representation that it has the necessary systems capacity to
support the new options series that will result from this proposal.\56\
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    \52\ 15 U.S.C. 78f(b)(1).
    \53\ See supra note 22 and accompanying text.
    \54\ See Amendment No. 1.
    \55\ See Notice, supra note 3, at 47044 and Amendment No. 1.
    \56\ See Notice, supra note 3, at 47044.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\57\ that the proposed rule change (SR-ISE-2013-42), as modified by
Amendment No. 1, be, and hereby is, approved.
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    \57\ 15 U.S.C. 78s(b)(2).

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    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\58\
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    \58\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-01510 Filed 1-27-14; 8:45 am]
BILLING CODE 8011-01-P