[Federal Register Volume 85, Number 172 (Thursday, September 3, 2020)]
[Notices]
[Pages 55040-55050]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-19453]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-89707; File No. SR-CBOE-2020-074]
Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of
Filing of a Proposed Rule Change Relating To Adopt Compression Orders
August 28, 2020.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on August 19, 2020, Cboe Exchange, Inc. (the ``Exchange'' or
``Cboe Options'') filed with the Securities and Exchange Commission
(the ``Commission'') the proposed rule change as described in Items I,
II, and III 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
Cboe Exchange, Inc. (the ``Exchange'' or ``Cboe Options'') proposes
to adopt Compression orders. The text of the proposed rule change is
provided in Exhibit 5.
The text of the proposed rule change is also available on the
Exchange's website (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the
Secretary, and at the Commission's Public Reference Room.
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 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.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to adopt Compression or Position Compression
Cross (``PCC'') orders. Currently, the Exchange facilitates compression
forums on the trading floor at the end of each calendar week, month,
and quarter in which Trading Permit Holders (``TPHs'') may reduce open
positions in series of S&P 500 Index (``SPX'') options in order to
mitigate the effects of capital constraints on market participants. SEC
Rule 15c3-1 (Net Capital Requirements for Brokers or Dealers) (``Net
Capital Rules'') requires that every registered broker-dealer maintain
certain specified minimum levels of capital.\3\ The Net Capital Rules
are designed to protect securities customers, counterparties, and
creditors by requiring that broker-dealers have sufficient liquid
resources on hand, at all times, to meet their financial obligations.
Notably, hedged positions, including offsetting futures and options
contract positions, result in certain net capital requirement
reductions under the Net Capital Rules.\4\
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\3\ 17 CFR 240.15c3-1.
\4\ In addition, the Net Capital Rules permit various offsets
under which a percentage of an option position's gain at any one
valuation point is allowed to offset another position's loss at the
same valuation point (e.g., vertical spreads).
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All Options Clearing Corporation (``OCC'') clearing members are
subject to the Net Capital Rules. However, a subset of clearing members
are subsidiaries of U.S. bank holding companies, which, due to their
affiliations with their parent U.S. bank holding companies, must comply
with additional bank regulatory capital requirements pursuant to
rulemaking required under the Dodd-Frank Wall Street Reform and
Consumer Protection Act.\5\ Pursuant to this mandate, the Board of
Governors of the Federal Reserve System, the Office of the Comptroller
of the Currency, and the Federal Deposit Insurance Corporation approved
a comprehensive regulatory capital framework for subsidiaries of U.S.
bank holding company clearing firms.\6\ Generally, these rules imposed
higher minimum capital requirements, more restrictive capital
eligibility standards, and higher asset risk weights than were
previously mandated for clearing members that are subsidiaries of U.S.
bank holding companies under the Net Capital Rules. Furthermore, these
rules do not permit deductions for hedged securities or offsetting
options positions.\7\ Rather, capital charges under these standards are
based on the aggregate notional value of short positions regardless of
offsets. As a result, Clearing Trading Permit Holders (``CTPHs'')
generally must hold substantially more bank regulatory capital than
would otherwise be required under the Net Capital Rules.\8\ The impact
of these regulatory capital rules is compounded in the SPX options
market due to the large notional value of SPX contracts and the
significant number of open SPX positions.
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\5\ H.R. 4173 (amending section 3(a) of the Securities Exchange
Act of 1934 (the ``Act'') (15 U.S.C. 78c(a))).
\6\ 12 CFR 50; 79 FR 61440 (Liquidity Coverage Ratio: Liquidity
Risk Measurement Standards).
\7\ Many options strategies, including relatively simple
strategies often used by retail customers and more sophisticated
strategies used by market-makers and institutions, are risk-limited
strategies or options spread strategies that employ offsets or
hedges to achieve certain investment outcomes. Such strategies
typically involve the purchase and sale of multiple options (and may
be coupled with purchases or sales of the underlying assets),
executed simultaneously as part of the same strategy. In many cases,
the potential market exposure of these strategies is limited and
defined. Whereas regulatory capital requirements have historically
reflected the risk-limited nature of carrying offsetting positions,
these positions may now be subject to large regulatory capital
requirements. Various factors, including administration costs;
transaction fees; and limited market demand or counterparty
interest, however, discourage market participants from closing these
positions even though many market participants likely would prefer
to close the positions rather than carry them to expiration.
\8\ See Letter from Cboe, New York Stock Exchange, and Nasdaq,
Inc., to the Honorable Randal Quarles, Vice Chair for Supervision of
the Board of Governors of the Federal Reserve System, March 18,
2020.
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The Exchange believes these regulatory capital requirements have
impeded efficient use of capital and undermine the critical liquidity
role that Market-Makers play in the SPX options market by limiting the
amount of capital CTPHs can allocate to clearing member transactions.
Specifically, the Exchange understands these rules have caused, and may
continue to cause, CTPHs to impose stricter position limits on their
clearing members. These stricter position limits may impact the
liquidity Market-Makers might supply in the SPX market,\9\ which impact
may be heightened when markets are volatile, and this impact may be
compounded when a CTPH has multiple Market-
[[Page 55041]]
Maker client accounts, each having largely risk-neutral portfolio
holdings.\10\ The Exchange believes that permitting TPHs to close open
interest in offsetting SPX options positions in open outcry compression
forums has had a beneficial effect on the bank regulatory capital
requirements of CTPHs' parent companies without adversely affecting the
quality of the SPX options market.
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\9\ The Exchange notes Market-Makers participate on over 95% of
SPX option trades on the Exchange.
\10\ Several TPHs have indicated to the Exchange that these
rules could hamper their ability to provide consistent liquidity in
the current SPX market, and have inquired about the ability engage
in compression trading prior to the end of the current quarter.
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In November 2019, bank regulatory agencies approved a rulemaking
requiring banks to replace the Current Exposure Method (``CEM'') with
the Standardized Approach to Counterparty Credit Risk (``SA-CCR'') by
January 1, 2022.\11\ The Exchange believes CEM's primary flaws arise
from the methodology's insensitivity to actual risk. For example, CEM
does not account for the delta (i.e., market sensitivity) of an option
position or fully recognize the offsetting of positions with opposite
economic exposures. The Exchange believes implementation of SA-CCR will
help correct many of CEM's flaws by incorporating risk-sensitive
principles, such as delta weighting options positions and more
beneficial netting of derivative contracts that have economically
meaningful relationships. This means that SA-CCR will be less penal to
CTPHs (and the market participants for which they clear options
positions) than CEM as it relates to options positions. However, the
implementation of SA-CCR will not eliminate the need for market-makers
to manage their positions or be concerned about the accumulation of
cleared positions that ultimately contribute to risk weighted asset
requirements of their clearing firms and thus the capital ratios with
which those firms need to comply.
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\11\ Some TPHs have implemented SA-CCR while others have not.
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The Exchange notes there are very few clearing banks, and even
fewer that clear for options market-makers. Increased clearing of over-
the-counter products, such as swaps, by these same clearing banks means
there is a risk of less available clearing bandwidth for listed
options, even with the adoption of SA-CCR. Additionally, market-makers
will continue to hold positions that are virtually riskless but have a
significant capital impact that could be compressed in order to free up
balance sheets to enable market-makers to continue to provide
meaningful liquidity to the market. Therefore, even when all banks have
implemented SA-CCR, the Exchange believes compression will continue to
be a valuable tool for market participants.\12\
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\12\ The Exchange notes another market offers its members a
compression tool for a competitive product. See Chicago Mercantile
Exchange, Inc. (``CME'') Rule 857.
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From March 16 to June 12, 2020, the Exchange's trading floor was
closed due to the coronavirus pandemic. During that time, the Exchange
operated in an all-electronic configuration, which would have prevented
market participants from reducing open SPX interest in open outcry
compression forums. As a result, the Exchange adopted current Rule
5.24(e)(1)(E) to permit TPHs to reduce open interest in SPX options in
electronic compression forums while the trading floor was closed.\13\
When the trading floor reopened on June 15, 2020, electronic
compression forums were no longer available. However, the Exchange
received feedback from customers while the floor was closed and since
the floor has reopened regarding the benefits of the electronic
compression forums, including the efficiency it provided with respect
to the execution of the orders via an unexposed cross and the
flexibility to effect these executions at more times than currently
available in open outcry. In addition to verbal feedback the Exchange
received, in early May, the Exchange received a letter signed by seven
TPHs noting the increased efficiency in execution of compression trades
the electronic compression forums provided and requesting permanent
approval of daily electronic compression. The firms noted the
significance of the functionality for evaluation of their risks and
capital needs. Additionally, the firms noted daily compression using
the electronic functionality then-available permitted them to respond
to intra-month reviews of regulatory capital necessary for their
positions by clearing firms, to which firms are unable to respond in
real-time using the current open outcry compression forums. Therefore,
the Exchange proposes to adopt Compression orders that can be executed
electronically or in open outcry on a permanent basis via unexposed
crosses.
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\13\ Pursuant to current Rule 5.24(e)(1), electronic compression
forums would be available until August 31, 2020 when the trading
floor is inoperable. Because the proposed rule change proposes to
adopt Compression Orders on a permanent basis, the proposed rule
change deletes the temporary electronic compression forum rule in
Rule 5.24(e)(1)(E). Additionally, because the proposed definition of
Compression Orders and the proposed provisions regarding the
execution of Compression Orders include the same information as set
forth in current Rule 5.88 regarding compression forums, the
proposed rule change deletes Rule 5.88.
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The proposed rule change defines ``Compression'' or ``PCC'' order
in Rule 5.6(c) as an order in SPX option contracts that may execute
without exposure pursuant to Rules 5.32, 5.33, or 5.88 against another
Compression order(s) totaling an equal number of option contracts.\14\
A Trading Permit Holder may use Compression orders only to reduce the
capital associated with its open SPX positions. Current Rule 5.88
specifies when compression forums may occur.\15\ As proposed, as was
the case for electronic compression forums while the trading floor was
closed, the Exchange will announce the times at which TPHs may submit
compression-list positions and at which the Exchange will make
compression-list positions files available to TPHs.\16\ The Exchange
will provide TPHs with reasonable, sufficient notice of the timing at
which lists must be submitted (as described in Rule 1.5), as well as
when the Exchange will provide the lists of offsetting positions (as
further discussed below). As further discussed below, a TPH may not
include a closing SPX position in a Compression order unless it
previously includes that position on a compression list provided to the
Exchange in accordance with the required timeframe.\17\
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\14\ This is substantially similar the definition in Rule
5.24(e)(1).
\15\ See Rule 5.88(a)(6) (compression forums occur on the last
business day of each calendar week, each of the last three business
days of each calendar month, and each of the last five business days
of each calendar quarter). Pursuant to Rule 1.5, the Exchange will
announce the times when the execution of Compression orders may
occur.
\16\ See current Rule 5.24(e)(1)(E)(i).
\17\ For example, if the Exchange indicates it will accept
compression lists and provide individualized lists on a daily basis,
if a TPH identifies a position it would like to compress intraday
but did not submit it on a compression list the prior day (as
required by the Exchange), the TPH could not submit that position in
a Compression order that day. Instead, it could submit a compression
list that day and then include it in a Compression order the
following trading day.
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While the Exchange intends to accept compression-list positions and
make individual position files available at the end of each calendar
week, month, and quarter, as it currently does, the Exchange believes
it will be beneficial to offer TPHs the ability to compress their open
positions more frequently. For example, while the trading floor was
closed, the Exchange engaged in this process daily due to the
volatility present at the time, which resulted in market participants,
particularly market-makers, taking on positions in a larger range of
strikes than they would during normal market conditions due to the
[[Page 55042]]
sharp swings in the value of the S&P 500 Index.\18\ As noted above,
TPHs believed the ability to compress more frequently enabled them to
more adequately and efficiently respond to intra-month reviews by their
clearing firms of regulatory capital necessary for their open
positions. The proposed flexibility will permit the Exchange to react
to market conditions and facilitate TPHs' reduction of SPX open
interest in response to volatility as necessary, such as during times
of extreme market volatility when the ability to close open interest to
alleviate bank regulatory capital requirements is particularly
important.
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\18\ See Cboe Options Exchange Notice C2020033103, issued May
31, 2020.
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As is the case with current open outcry compression forums, all
TPHs (or their CTPHs on their behalf) \19\ may submit lists of open
positions (``compression-list positions'') to the Exchange that they
wish to close against opposing (long/short) positions of other TPHs
using Compression orders.\20\ The proposed rule change streamlines the
process of how the Exchange will make information regarding offsetting
positions and multi-leg positions available. The Exchange will continue
to determine the size of offsetting compression list positions,
including combinations of offsetting multi-leg positions, and send
individual positions files to each TPH that submitted compression-list
positions to the Exchange.\21\ Currently, pursuant to Rule 5.88(a)(2),
the Exchange makes available to all TPHs (on the Exchange website) a
list including the size of the offsetting compression-list positions
(including multi-leg positions) in each series (and multi-leg position)
for which both long and short compression-list positions were submitted
to the Exchange (``compression-list positions file''). The Exchange has
identified no added value from the public posting of this list, as it
has observed the TPHs that participate in the open outcry compression
forums are those that submit the compression-list positions. All TPHs
will continue to be able to submit compression-list positions and thus
have access to the compression-list positions file if they submit
compression-list positions, so the Exchange no longer believes it is
necessary to post the list on its website. Additionally, the Exchange
will no longer send the compression-list positions file to each TPH
that submitted compression-list positions to the Exchange. The Exchange
understands from TPHs that the individual position file, which shows
offsetting size for their single and multi-leg positions, provides them
with the information they seek by participating in the compression
forums. Therefore, the Exchange believes it is no longer necessary to
create and disseminate this separate list.
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\19\ The Exchange understands the CTPHs coordinate with market
participants for which they clear positions regarding the positions
CTPHs may wish to close on those market participants' behalf in
accordance with their clearing relationship. The Exchange notes the
current rule permits OCC to also submit lists on behalf of TPHs.
However, the Exchange understands that occurs only upon the
direction of TPHs, rather than upon any initiative taken by OCC. In
other words, OCC may provide a list to the Exchange in an
administrative capacity at the directive of a TPH. Therefore, the
proposed rule change deletes from the rule the ability of OCC to
submit a list to the Exchange on behalf of a Trading Permit Holder,
because OCC does not make any substantive determinations regarding
what positions should be compressed.
\20\ See proposed Rule 5.6(c), subparagraph (1)(A) of definition
of Compression order; see also current Rule 5.88(a)(1).
\21\ See proposed Rule 5.6(c), subparagraph (1)(B) of definition
of Compression order; see also current Rule 5.88(a)(4).
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Because TPHs that participate in compression forums generally
consent to having their identities disclosed to other participating
TPHs, the Exchange also proposes to eliminate the steps of initially
providing the individual position files on an anonymous basis and then
requiring TPHs to consent to having their identities disclosed, as it
is no longer necessary.\22\ Instead, the individual position files the
Exchange distributes will identify the TPHs that hold offsetting
positions. TPHs generally submit compression-list positions with the
goal of identifying other TPHs with offsetting positions that will
enable them to engage in compression transactions. Including the
identities of those TPHs at the outset is therefore consistent with the
goal of compression forums and the proposed Compression orders and more
efficient than the current process.
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\22\ See proposed Rule 5.6(c), subparagraph (1)(B) of proposed
definition of Compression order; see also current Rule 5.88(a)(4)
and (5). Because these lists will no longer be anonymous, the
Exchange no longer believes it is necessary to separate provide a
list of TPHs that submitted compression-list positions, which was
provided only so that TPHs could reach out to those TPHs to see if
they had the offsetting positions. Therefore, it is deleting that
provision. See current Rule 5.88(a)(3).
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Pursuant to proposed subparagraph (1)(B) in the definition of
Compression order, the information the Exchange will include in the
individual position files it sends to each TPH that submitted
compression-list positions to the Exchange the same information the
Exchange provides pursuant to current Rule 5.88(a)(4), as well as two
types of additional information regarding compression positions. First,
the file will also include series positions within a strike range
determined by the Exchange. Currently, the Exchange provides
information (including offsetting positions of other TPHs) for various
multi-leg positions. This additional information is a list of single-
leg positions and offsetting positions of other TPHs. The Exchange
provided this series information in addition to multi-leg information
while the trading floor was closed. The Exchange believes this
additional information will permit TPHs to create larger packages of
positions that may be compressed.\23\ Second, the individual positions
file will also include combos (i.e., purchase (sale) of a call and a
sale (purchase) of a put with the same expiration date and strike
price), in addition to the currently provided multi-leg positions of
vertical call spreads, vertical put spreads, and box spreads.\24\ The
Exchange included combos in the files it provided to TPHs when
electronic compression forums were available.\25\ Because a combo is
essentially a ``synthetic future,'' it is a common multi-leg strategy
among market participants. Market participants often establish market
neutral hedges by purchasing (selling) a number of combos with an
offsetting SPX option position.\26\ As a result, market participants
maintain a significant number of combos in their portfolios.
Additionally, when markets are volatile (as they were earlier in 2020),
market participants often take on positions in a larger range of
strikes, which positions can be put together as combos.
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\23\ See current Rule 5.24(e)(1)(E)(ii).
\24\ See proposed Rule 5.6(c), subparagraph (1)(B) of proposed
definition of Compression order.
\25\ See current Rule 5.24(e)(1)(E)(iv); see also current Rule
5.88, Interpretation and Policy .01, which lists what multi-leg
position strategies are currently made available in the files.
\26\ See, e.g., Rule 5.85(e).
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The Exchange believes closing combo positions will be advantageous
because such positions can be risk neutral, which means the closing of
the entire combo has little or no impact on a TPH's risk profile.
However, the current compression forum framework limits multi-leg
positions to vertical call \27\ and put \28\ spreads and boxes. The
Exchange notes that just as one put spread and one call spread combine
to create a box spread, two combos similarly create a box spread.\29\
For example, a box spread
[[Page 55043]]
would be entered by purchasing 100 DEC 2040 calls and selling 100 DEC
2070 calls (i.e., bull call spread) and selling 100 DEC 2040 puts and
purchasing 100 DEC 2070 puts (i.e., bear put spread). The purchase of
100 DEC 2040 calls and sale of 100 DEC 2040 puts comprises a combo (as
does the sale of 100 DEC 2070 calls and purchase of 100 DEC 2070 puts).
The Exchange believes that providing TPHs with this additional way to
identify multi-leg positions with offsetting interest will enable more
efficient closing of such common strategy positions and is merely
providing information regarding positions TPHs are seeking to close
that is already including in these lists in a different form. Like the
other multi-leg strategies currently covered by Rule 5.88, the Exchange
will compile a list of possible combos.
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\27\ A vertical call spread involves the purchasing and selling
of an equal number of call options with the same expiration date but
different strike prices.
\28\ A vertical put spread involves the purchasing and selling
of an equal number of put options with the same expiration date but
different strike prices.
\29\ A box spread involves purchasing (selling) a bull call
spread and purchasing (selling) a bear put spread. In other words, a
box spread is composed of a long (short) call and short (long) put
position at one strike price and a short (long) call and long
(short) put position at another strike price.
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The lists generated by the Exchange pursuant to the proposed
definition of Compression orders are provided to TPHs for informational
purposes only. Individual TPHs will continue to determine whether to
submit compression-list positions and whether to submit Compression
orders for execution. The Exchange's provision of the list does not
constitute advice, guidance, a commitment to trade, an execution, or a
recommendation to trade, as is the case today for open outcry
compression forums.
Proposed subparagraph (1)(C) of the proposed definition of
Compression order provides that to the extent a Clearing TPH submits
compression-list positions with offsetting to the Exchange on behalf of
a Trading Permit Holder(s), the Exchange will not include those
positions on the individual position files the Exchange makes available
pursuant to proposed subparagraph (1)(B). The Exchange understands from
Clearing TPHs that they have their own ability to identify compressible
positions among the TPHs for which they clear. As discussed above, the
need for compression stems from the regulatory capital requirements
applicable to CTPHs, which as a result may impose stricter position
limits on the firms for which they clear. Therefore, CTPHs are well-
positioned to know which positions of the firms for which they clear
could be compressed in order for those firms to remain in compliance
with the position limits imposed by CTPHs when they conduct their
regulatory reviews. Because CTPHs are in a position to identify
offsetting positions, it is unnecessary for those positions to be
included in the individual lists that are distributed to other TPHs
that submitted compression-list positions, which are intended to assist
those TPHs to identify counterparties with offsetting positions. It may
be counterproductive and potentially confusing for TPHs if the
individual positions lists include positions for which no counterparty
is being sought. While the Exchange initially implemented compression
forums to assist TPHs in finding counterparties with offsetting
positions that were similarly seeking to compress positions, the
Exchange believes expanding the use of Compression orders to CTPHs in
this manner will provide them with more efficient means to comply with
regulatory capital rules and permit the firms for which they clear to
have access to liquidity to provide to the market. The Exchange
believes it is still appropriate for CTPHs to submit compression-list
positions prior to using Compression orders so that the Exchange may
review those positions to determine they are for the purpose of
compression.
Proposed subparagraph (2) of the proposed definition of Compression
order permits Compression orders to be entered in $0.01 increments and
permits the legs of complex Compression orders to be executed in $0.01
increments. This is consistent with the increment currently available
for closing transactions in open outcry compression forums. As
discussed below, complex orders in any ratio are permitted to be
executed in open outcry compression forums, so the proposed rule change
does not expand the complex order strategies that may trade in pennies
for compression purposes. The proposed rule change will permit open
positions in Compression orders to be entered and executed in pennies,
unlike in current open outcry compression forums, which requires any
opening transactions to be executed in the standard increment for SPX.
The Exchange believes this is appropriate given that opening positions
may partly comprise Compression orders as long as the total order is
net position closing or neutral (as discussed below), and legs of
single orders are systematically unable to be input or executed in
different minimum increments. Additionally, the Exchange believes it
may be confusing to have different portions of orders trade in
different increments. The Exchange notes if a TPH opens a position
using a Compression order, it would only be able to close that position
using the standard increment for the class (unless it closes it using a
Compression order, subject to the proposed requirements of that order
type in this proposed rule change).
Unlike in compression forums, where persons can negotiate leg
pricing to accommodate the current rule, such negotiation is not
available in electronic trading. While the proposed rule change may
increase the number of SPX contracts that may trade in pennies, given
that a Compression order that will open any positions must be net
position closing or neutral (as discussed below), the Exchange expects
the majority of contracts that will benefit from this provision will be
ones that close positions, as is the case today. As noted above, the
Exchange believes permitting Compression orders to be partially
comprised of opening positions will increase amount of open SPX
interest TPHs are willing to close, and penny pricing for all contracts
in Compression orders will further encourage closing of these
positions. Because many series the Exchange expects TPHs will attempt
to close will be out-of-the-money, and essentially worthless, TPHs may
not otherwise close positions in these series if a higher minimum
increment causes the price to be too much higher than the option's
value. The Exchange believes it is reasonable to permit these orders to
be entered and executed in penny increments to provide flexibility that
will enable TPHs to maximize the number of open SPX positions they can
close using Compression orders.
The proposed rule change will also permit a complex Compression
order to have any ratio.\30\ Currently, complex orders with any ratio
may execute on the trading floor, including in open outcry compression
forums (and thus they may execute in pennies); however, complex orders
with a ratio of greater than three-to-one (except for Index Combos,
which may have a ratio of up to eight-to-one combo) are not currently
permitted to execute electronically.\31\ Additionally, in open outcry
(including in compression forums), complex orders with a ratio of less
than one-to-three or greater than-three-to-one (except for Index
Combos) do not receive complex order priority benefits and instead must
execute at prices for which each leg betters any priority customer
order on the Book rather than improve one leg.\32\ As noted above,
complex Compression orders may only execute if no leg executes at the
same price as a priority
[[Page 55044]]
customer order in the simple book,\33\ and thus will be subject to the
same priority as larger-ratio complex orders submitted in compression
forums today. Therefore, permitting complex Compression orders with any
ratio to execute electronically or in open outcry is consistent with
current execution opportunities for complex orders in open outcry
compression forums, and merely extends these execution opportunities to
electronic compression trading. This proposed provision will therefore
not result in any additional orders trading ahead of priority customer
orders resting in the book.
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\30\ See proposed Rule 5.6(c), subparagraph (2) of proposed
definition of Compression order.
\31\ See Rule 1.1, definition of complex order.
\32\ See Rule 5.85(b).
\33\ See proposed Rule 5.33(n) and 5.85(j). Note the Exchange
proposes to add Rule 5.33(m) in rule filing SR-CBOE-2020-060.
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One key characteristic of complex compression transactions is that
they are intended to close open interest to alleviate bank regulatory
capital requirements while bearing little, if any, market risk. As a
result, market participants often minimize the net delta of the
compression strategy (i.e., create a package with a delta of zero or
near zero). Delta is the ratio comparing the change in the price of the
underlying asset to the corresponding change in the price of a
derivative. For example, if an index option has a delta value of 0.65,
this means that if the underlying index increases in value by 1, the
price of the option will increase by $0.65, all else equal. Delta
values can be positive or negative depending on the type of option. For
example, the delta for a call option always ranges from 0 to 1, because
as the underlying asset increases in price or value, call options
increase in price. Put option deltas always range from -1 to 0 because
as the underlying asset increases in price or value, the value of put
options decrease. For example, if a put index option has a delta of -
0.33, if the value of the underlying index increases by 1, the price of
the put option will decrease by $0.33. Generally speaking, an at-the-
money option usually has a delta of approximately 0.5 or -0.5.
In order to minimize the delta of a compression strategy, the
Exchange understands that market participants often include combos \34\
to offset any residual delta that the other legs may create. For
example, suppose two market participants seek to execute a transaction
to close their respective offsetting positions in a spread containing
100 contracts of SPX Series A and 100 contracts of SPX Series B, which
has a net delta of 0.02. In order to offset this minimal delta, the
market participants include two contracts of an SPX combo with a
mutually agreed upon expiration and strike price. The addition of these
combos neutralizes the delta market risk of the positions to be
compressed but creates a package with a ratio of 50-1. Orders with this
ratio may currently execute in open outcry but may not execute
electronically. The Exchange believes permitting all complex orders
with any ratio to be submitted as Compression orders will provide TPHs
with additional flexibility to close open interest to eliminate as much
regulatory capital associated with their portfolios as possible while
minimizing any possible associated risk. Additionally, it is consistent
with permissible executions in current open outcry compression forums.
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\34\ As described above, a ``combo'' is a purchase (sale) of a
call and a sale (purchase) of a put with the same expiration date
and strike price, which is essentially a ``synthetic future'' and a
common multi-leg strategy among market participants.
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Proposed subparagraph (3) of the definition of Compression order
provides that a Compression order may be comprised of all closing
positions or a combination of opening and closing positions as long as
it is net position closing or neutral. In other words, the number of
contracts in closing positions must be larger than or equal to the
number of contracts in opening positions.\35\ Any closing position
submitted as part of a Compression order must have been included in a
compression-position list submitted to the Exchange, and Compression
orders may be used solely for the purpose of reducing required capital
associated with TPH's positions. The Exchange believes requiring
closing positions included in compression-list positions to be
submitted to the Exchange on compression position lists will create an
additional control to limit use of Compression orders for legitimate
compression purposes. The proposed rule change is similar to current
open outcry compression forums, which permit opening orders to execute
against closing orders. The goal of compression is for market
participants to close open interest to reduce regulatory capital
attributable to those positions. However, permitting a TPH to include
opening positions in Compression orders may still result in a reduction
of regulatory capital necessary for a TPH's positions, even if it opens
new positions, which will provide TPHs with additional flexibility to
maximize its reduction in required regulatory capital. The files the
Exchange makes available are intended to provide potential offset
opportunities for TPHs looking to compress open SPX positions. However,
TPHs often do not have the same number of offsetting positions to
complete a risk neutral compression transaction. For example, TPH 1
might have an offsetting position with TPH 2 in three out of four
series that comprise a box spread. By trading a box spread, which is
risk neutral, the TPHs can substantially reduce the regulatory capital
attributable to the three series that offset while only needing to open
positions in one series in which they did not have existing position.
As another example, a TPH may determine it is necessary to add a combo
position when attempting to close other positions in order to flatten
the delta risk of a compression trade. To do so, a TPH may need to open
a position in one series of the combo it and another TPH do not have
offsetting positions for that combo. The Exchange believes permitting
TPHs to include opening positions may provide more opportunities to
close open interest to alleviate bank regulatory capital requirements
attributable to their open positions using Compression orders than if
they were restricted to only closing positions.
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\35\ If the contra-side Compression order is comprised of orders
from multiple contra-parties, the positions for each contra-party
must be net position closing or neutral. This is consistent with the
goal of compression, which is to reduce the regulatory capital
attributable to positions of a specific market participant.
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The Exchange believes permitting TPHs to include opening positions
may provide additional opportunities to reduce more regulatory capital
attributable to their portfolios using Compression orders than if they
were restricted to only closing positions. The requirement that
Compression orders be net position closing or neutral is consistent
with the goal of compression, which is to close open interest to
alleviate bank regulatory capital requirements attributable to their
portfolios. If an order is net closing, then more positions will be
closed than opened, ultimately reducing the regulatory capital
associated with the positions of the TPH.
While regulatory capital reduction may be achieved with the closing
of positions, it may also be achieved by ``swapping'' open positions
with new positions with which there is lower regulatory capital
associated. The Exchange understands TPHs may do this for risk
management purposes. Specifically, TPHs retain certain options
positions in their portfolios for hedging and risk exposure purposes.
However, the calculation of regulatory capital associated with options
positions involves a complex formula, but it ultimately is calculating
an amount based on the quantity of a position times the strike price
(which is why the large notional value of SPX options has
[[Page 55045]]
created issues for TPHs). Therefore, an option position with a lower
strike price will likely have lower regulatory capital associated with
that position than regulatory capital associated with a higher strike
price. A market participant may identify options with lower strikes
that provide it with substantially similar risk exposure as some of its
open positions while maintaining a hedge within its portfolio. Merely
closing such higher-strike positions may reduce the required capital
associated with the market participant's portfolio, but such closure
may leave portions of that portfolio unhedged and thus subject to
higher risk. By ``swapping'' its current open positions in options with
higher strikes with positions in options with lower strikes (often
using boxes and combos), a market participant may maintain the same
risk exposure in its portfolio while replacing higher-strike positions
with lower-strike positions in order to swap related exposures. For
example, suppose a TPH has 100 contracts in an SPX box spread with
October expiration and strike prices of 3500 and 3600. Suppose another
TPH has 100 contracts for the offsetting box spread, but also want to
buy 100 contracts in an SPX box spread with October expiration and
strike prices of 1500 and 1600. Each TPH in this close would be opening
positions in 400 contracts as well as closing positions in 400
contracts, making each side net position neutral. While each TPH would
have the same number of open positions after this transaction, the
regulatory capital associated with each TPH's positions would be
significantly reduced given the newly opened positions have strike
prices 2000 lower than the closed positions. Execution of this
transaction would be riskless and would provide meaningful regulatory
capital relief to the TPHs. Ultimately, transactions like this are
essentially riskless exchanges that carry no profit or loss for market
participants, but rather are intended to provide a seamless method for
market participants to reduce margin and capital requirements while
maintaining the same risk exposure within their portfolios.\36\
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\36\ The Exchange notes TPHs similarly swap exposures in order
to reduce capital and margin requirements by exchanging positions in
options with positions in future. See SR-CBOE-2020-060 (the
Exchange's recent proposal to adopt related futures cross (``RFC'')
orders (which were recently adopted by another options exchange),
which would provide market participants with an additional mechanism
to reduce required capital associated with their positions while
maintaining risk exposure within their portfolios).
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Currently, TPHs may only execute compression transactions in open
outcry compression forums in accordance with open outcry trading rules,
except that opening transactions in SPX option could not execute
against opening transactions through a compression forum, and only
closing transactions could be executed in $0.01 increments.\37\ In
accordance with standard open outcry trading rules, a floor broker
would represent a cross of orders representing this interest to the
trading crowd. While other in-crowd market participants have the
opportunity to respond and participate in the transaction, generally
the orders represented in the cross execute cleanly against each other.
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\37\ See current Rule 5.88(b).
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The proposed rule change will permit Compression orders to be
executed electronically and in open outcry as unexposed clean
crosses.\38\ While orders in open outcry compression forums are
currently required to be exposed, they generally execute as clean
crosses. Therefore, permitting Compression orders to execute as clean
crosses replicates how SPX orders generally execute in open outcry
compression forums. As proposed, a Compression order with one leg
submitted for electronic execution will execute automatically on entry
without exposure if the execution price: (a) Is not at the same price
as a Priority Customer order resting in the Book; and (b) is at or
between the national best bid or offer (``NBBO'').\39\ This provision
provides that Compression orders with single legs submitted for
electronic execution must execute in accordance with the same priority
principles that apply to all other simple orders on the Exchange, which
protects Priority Customer orders in the simple book and prohibits
trades through prices available in the book. A Compression order with
multiple legs submitted for electronic execution will execute
automatically on entry without exposure if: (1) Each option leg
executes at a price that complies with Rule 5.33(f)(2),\40\ provided
that no option leg executes at the same price as a Priority Customer
Order in the Simple Book; (2) each option leg executes at a price at or
between the NBBO for the applicable series; and (3) the execution price
is better than the price of any complex order resting in the COB,
unless the submitted complex order is a Priority Customer Order and the
resting complex order is a non-Priority Customer Order, in which case
the execution price may be the same as or better than the price of the
resting complex order.\41\ This provision provides that Compression
orders with multiple legs submitted for electronic execution may only
execute if they provide additional protection to Priority Customer
orders on the Simple Book compared to other ``standard'' complex order
executions, as Compression orders may only execute if no leg trades at
the same price as a customer order on the book rather than just
improving one leg (which priority principles require for other
electronic complex order executions). The System cancels a Compression
order if it cannot execute.\42\ Therefore, if an order cannot execute
in accordance with the execution price and priority requirements
described above, it will be cancelled.
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\38\ See proposed Rules 5.30(a)(2) and (b)(2), 5.33(c),
5.70(a)(2), and 5.83(a)(2) and (b)(2). Unlike current compression
forums, which are restricted to Regular Trading Hours, electronic
Compression orders may be executed during Regular or Global Trading
Hours, as the Exchange makes electronic trading of SPX options
available during Global Trading Hours. This will provide TPHs with
additional flexibility regarding when they may execute Compression
orders and related capital that may be put back into the market.
FLEX SPX options may currently be executed in open outcry
compression forums, and the proposed rule change clarifies the
availability of Compression orders for FLEX SPX options, which will
execute in the same manner as Compression orders for non-FLEX SPX
options. See Rule 5.72(a), which provides that trading of FLEX
Options is subject to all other Rules applicable to the trading of
options on the Exchange, unless otherwise provided in Chapter 5,
Section F of the Rules. Since Compression orders will not be
exposed, as proposed, FLEX Compression orders would execute in the
same manner as opposed to in a FLEX Auction pursuant to Rule 5.72.
\39\ See proposed Rule 5.32(g).
\40\ Rule 5.33(f)(2) requires complex orders to execute only if
the execution price: At a net price: (1) That would cause any
component of the complex strategy to be executed at a price of zero;
(2) worse than the synthetic best bid or offer (``SBBO'') or equal
to the SBBO when there is a Priority Customer Order at the SBBO,
except all-or-none complex orders may only execute at prices better
than the SBBO; (3) that would cause any component of the complex
strategy to be executed at a price worse than the individual
component prices on the Simple Book; (4) worse than the price that
would be available if the complex order Legged into the Simple Book;
or (5) that would cause any component of the complex strategy to be
executed at a price ahead of a Priority Customer Order on the Simple
Book without improving the BBO of at least one component of the
complex strategy.
\41\ See proposed Rule 5.33(n).
\42\ See proposed Rules 5.32(g)(1) and 5.33(n)(1).
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Similarly, proposed Rule 5.85(j) \43\ describes how Compression
orders submitted for open outcry execution will execute. A Compression
order with a single leg will execute without representation on the
trading floor if it executes at a price that is not at the same price
as a Priority Customer order resting on the Book and is at or between
the NBBO. These are the same proposed execution price requirements for
electronic Compression orders with a single leg and are also the same
as the
[[Page 55046]]
priority principles that apply to all other simple orders executed on
the trading floor, which protects Priority Customer orders in the
simple book and prohibits trades through prices available in the
book.\44\ A Compression order with multiple legs will execute without
representation on the trading floor if: (1) Each option leg executes at
a price that complies with Rule 5.85(b),\45\ provided that no option
leg executes at the same price as a Priority Customer Order in the
Simple Book; (2) each option leg executes at a price at or between the
NBBO for the applicable series; and (3) the execution price is better
than the price of a complex order resting in the COB, unless the
Compression order is a Priority Customer Order and the resting complex
order is a non-Priority Customer Order, in which case the execution
price may be the same as or better than the price of the resting
complex order. Like the execution and priority requirements described
above for electronic complex Compression orders, this proposed
provision provides that complex Compression orders with multiple legs
submitted for open outcry execution must execute in accordance with the
same priority principles that apply to all other complex orders
executed on the trading floor on the Exchange, except that additional
protection will be provided for Priority Customer Orders in the Simple
Book (the proposed priority principle is the same as the priority
applicable to larger-ratio complex orders executed in open outcry). As
a result, this proposed provision protects Priority Customer orders in
the simple book and COB and prohibits trades through prices available
in the book. A Compression order may not be executed in open outcry
unless these criteria are satisfied. While open outcry Compression
orders do not need to be represented on the trading floor, executions
of such orders will be systematically recorded and reported by TPHs in
the same manner they currently record and report open outcry
transactions.
---------------------------------------------------------------------------
\43\ The Exchange proposes to add Rule 5.85(i) in rule filing
SR-CBOE-2020-060.
\44\ See Rule 5.85(a).
\45\ Pursuant to Rule 5.85(b), a complex order (1) with any
ratio equal to or greater than one-to-three (.333) and less than or
equal to three-to-one (3.00) or (2) that is an Index Combo order may
be executed at a net debit or credit price without giving priority
to equivalent bids (offers) in the individual series legs that are
represented in the trading crowd or in the Book if the price of at
least one leg of the order improves the corresponding bid (offer) of
a Priority Customer order(s) in the Book by at least one minimum
trading increment as set forth in Rule 5.4(b). A complex order with
any ratio less than one-to-three (.333) and greater than three-to-
one (3.00) (except for an Index Combo order) may be executed in open
outcry on the trading floor at a net debit or credit price without
giving priority to equivalent bids (offers) in the individual series
legs that are represented in the trading crowd or in the Book if
each leg of the order betters the corresponding bid (offer) of a
Priority Customer order(s) in the Book on each leg by at least one
minimum trading increment as set forth in Rule 5.4(b).
---------------------------------------------------------------------------
Generally, in SPX options (and other classes), the Exchange lists
series with narrower strike intervals that are closer to the at-the-
money value, and with wider strike intervals that are further from the
at-the-money value. The Exchange's internal listing procedures are
intended to balance the need to list sufficient strikes to provide
market participants with flexibility to manage their risk with Market-
Makers' quoting obligations. The Exchange recently reviewed and
modified these procedures for SPX options in an effort to reduce the
number of listed strikes in a manner intended to permit Market-Makers
to further reduce regulatory capital attributable to their SPX open
interest (and thus free up capital to continue to provide
liquidity).\46\
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\46\ While SPX options are listed for trading exclusively on
Cboe Options, it competes with other listed options, such as options
on the SPDR S&P 500 exchange-traded fund.
---------------------------------------------------------------------------
The proposed rule change moves the provision regarding solicitation
in current Rule 5.88(c) to subparagraph (4) of the proposed definition
of Compression order in Rule 5.6(c) with no substantive changes, and
thus that provision will apply to Compression orders in the same manner
it applies to compression forums, as the process for providing
compression position lists and files will generally be the same.
Proposed subparagraph (5) of the proposed definition of Compression
order in Rule 5.6(c) also provides that Rule 5.9 (related to exposure
of orders on the Exchange) will not apply to executions of Compression
orders, as they will be able to execute without exposure, as discussed
above.\47\
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\47\ See current Rule 5.24(e)(1)(E)(iii)(b).
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Pursuant to the proposed rule change, Compression orders will be
identified as such when submitted into the System for execution. As a
result, the Exchange's Regulatory Division intends to put in place a
regulatory review plan that will permit it to ensure any Compression
orders are submitted and executed in accordance with the proposed rule.
The Exchange understands from customers, and SPX Market-Makers in
particular, that there continues to be significant need to reduce
regulatory capital attributable to their open interest based on then-
current market conditions. These market participants regularly avail
themselves of open outcry compression forums when available, in which
they use the information provided in the Exchange-provided position
lists to identify potential counterparties that similarly need to close
SPX open interest. Providing TPHs, and Market-Makers in particular,
with the ability to more efficiently close or exchange SPX open
interest using this Exchange-provided information, either
electronically or in open outcry, will provide them with additional
flexibility to obtain needed relief from the effect of bank regulatory
capital requirements on the options market at more times than are
currently available and either electronically or in open outcry. As
noted above, because some CTPHs carrying these are bank-owned broker/
dealers, those CTPHs are subject to further bank regulatory capital
requirements, which result in these additional punitive capital
requirements being passed on to their market-maker clients.\48\ Such
flexibility is particularly true during times of extreme volatility,
such as the recent the historic levels of market volatility, which can
make providing liquidity in SPX options immensely more challenging. The
Exchange believes use of Compression orders to close or exchange open
SPX interest in order to alleviate bank regulatory capital requirements
may be more efficient and effective than current open outcry
compression forums, given that orders generally execute in compression
forums as clean crosses.
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\48\ See Letter from Cboe, New York Stock Exchange, and Nasdaq,
Inc., to the Honorable Randal Quarles, Vice Chair for Supervision of
the Board of Governors of the Federal Reserve System, March 18,
2020.
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The Exchange believes the proposed rule change to expand and
enhance functionality currently only available on the trading floor
will allow liquidity providers to execute trades to reduce regulatory
capital attributable to SPX open interest in a substantially similar
manner as they are currently able to in open outcry compression forums.
The Exchange believes Compression orders will assist TPHs to more
efficiently and effectively reduce any potential negative impact on the
market-making community that may result from bank regulatory capital
requirements, which could reduce liquidity available in an extremely
volatile market when the market needs this liquidity the most. The
Exchange believes the proposed rule change will eliminate certain
existing inefficiencies that exist in current open outcry compression
forums, which the Exchange expects will free up liquidity providers'
much needed capital, which will benefit the entire market and all
investors.
[[Page 55047]]
2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Securities Exchange Act of 1934 (the ``Act'') and the rules and
regulations thereunder applicable to the Exchange and, in particular,
the requirements of Section 6(b) of the Act.\49\ Specifically, the
Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \50\ requirements 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. Additionally,
the Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \51\ requirement that the rules of an exchange not be
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers.
---------------------------------------------------------------------------
\49\ 15 U.S.C. 78f(b).
\50\ 15 U.S.C. 78f(b)(5).
\51\ Id.
---------------------------------------------------------------------------
In particular, the Exchange believes the proposed rule change will
remove impediments to and perfect the mechanism of a free and open
market and a national market system, and, in general, protect investors
and the public interest because it seeks to further mitigate the
potentially negative effects of the bank capital requirements on
liquidity in the SPX markets. As described above, current regulatory
capital requirements could potentially impede efficient use of capital
and undermine the critical liquidity role that Market-Makers and other
liquidity providers play in the SPX options market by limiting the
amount of capital CTPHs allocate to clearing member transactions.
Specifically, the rules may cause CTPHs to impose stricter position
limits on their clearing members. In turn, this could force Market-
Makers to reduce the size of their quotes and result in reduced
liquidity in the market. The Exchange believes that permitting TPHs to
close SPX options positions to reduce regulatory capital attributable
to their portfolios will permit to contribute to the availability of
liquidity in the SPX options market and help ensure that these markets
retain their competitive balance. The Exchange believes that the
proposed rule would serve to protect investors by helping to ensure
consistent continued depth of liquidity, particularly given current
market conditions when liquidity is needed the most by investors.
The proposed rule change will provide liquidity providers and other
market participants with the ability to reduce regulatory capital
attributable to their open interest in SPX options electronically or in
open outcry in a substantially similar manner as they are able to do on
the trading floor. The proposed flexibility with respect to when the
Exchange will accept and make available lists of positions TPHs would
like to compress will permit the Exchange to react to market conditions
and facilitate TPHs' reduction of SPX open interest in response to
volatility as necessary. Permitting Compression orders to be submitted
for execution at any time will also provide TPHs with flexibility to
complete these compression transactions in accordance with their own
needs (as long as they previously submitted the applicable positions to
be closed to the Exchange in advance), as well as to address intra-
month position reviews by their CTPHs. The Exchange believes this
enhanced compression process will allow market participants to reduce
the necessary regulatory capital associated with their options
positions and permit them to provide more liquidity in the market. This
additional liquidity may result in tighter spreads and more execution
opportunities, which benefits all investors, particularly in volatile
markets.
Additionally, the Exchange believes the proposed rule change will
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 by adding information (combos and
individual positions) to the lists the Exchange will make available to
TPHs for informational purposes. The Exchange believes the additional
information that may be provided to TPHs in compression forums may
encourage TPHs to close additional positions via the compression
process. With respect to the addition of combos, that information may
enable TPHs to more efficiently and effectively close positions
comprising a common multi-leg strategy in the SPX market via
Compression orders, which, in general, helps to protect investors and
the public interest because closing positions via the compression
process serves to alleviate the adverse impact of bank capital
requirements. The information regarding individual and combo positions
is currently included in the compression position lists the Exchange
provides to TPHs in different forms--the single leg positions are part
of multi-leg strategies and combos are parts of box spreads. The
proposed rule change merely provides the Exchange with the ability to
list single leg positions and combo positions separately, which will
provide TPHs with additional flexibility when locating counterparties
with which to execute Compression orders. This may create opportunities
for TPHs to compress additional positions, which frees up additional
liquidity and ultimately benefits investors.
The Exchange also believes the proposed rule change is consistent
with the Act, because the proposed compression process is a streamlined
version of the current open outcry compression forums on the trading
floor. It eliminates the provisions of compression-list positions
files, which the Exchange understands were generally unused by TPHs.
Additionally, it eliminates the additional steps the Exchange and TPHs
must take to have TPHs names disclosed with their associated
compression-list positions, as TPHs that currently participate in open
outcry compression forums do not choose to remain anonymous. The
Exchange understands that TPHs generally submit compression-list
positions with the goal of identifying other TPHs with offsetting
positions that will enable them to engage in compression transactions.
Therefore, eliminating the ability to remain anonymous in the
individual position files is consistent with the goal of Compression
orders and more efficient than the current process. Submission of
compression-list positions will constitute TPHs' consent to disclosure
of their names and associated positions on the individual positions
files. The Exchange believes the proposed rule will provide an enhanced
and more efficient open outcry and electronic mechanism for compression
of SPX open positions.
The Exchange believes the proposed rule change to exclude
compression-list positions submitted by a Clearing TPH to the Exchange
on behalf of a Trading Permit Holder(s) from the individual position
files will further remove impediments to and perfect the mechanism of a
free and open market and a national market system. As discussed above,
the need for compression stems from the regulatory capital requirements
applicable to CTPHs, which as a result may impose stricter position
limits on the firms for which they clear. Therefore, CTPHs are well-
positioned to know which positions of the firms for which they clear
could be compressed in order for
[[Page 55048]]
those firms to remain in compliance with the position limits imposed by
CTPHs when they conduct their regulatory reviews. Because CTPHs are in
a position to identify offsetting positions, it is unnecessary for
those positions to be included in the individual position files, which
are intended to assist those TPHs to identify counterparties with
offsetting positions.\52\ It may be counterproductive and potentially
confusing for TPHs if the individual positions lists include positions
for which no counterparty is being sought. While the Exchange initially
implemented compression forums to assist TPHs in finding counterparties
with offsetting positions that were similarly seeking to compress
positions, the Exchange believes expanding the use of Compression
orders to CTPHs in this manner will provide CTPHs with more efficient
means to comply with regulatory capital rules and permit the firms for
which they clear to have access to liquidity to provide to the market,
which ultimately benefits all investors.
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\52\ The Exchange notes CTPHs can continue to submit compression
position lists without a list of offsetting positions, in which case
those positions would be included in the individual position files
and assist those CTPHs with identifying TPHs with offsetting
positions.
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The proposed rule change imposes priority requirements that will
protect Priority Customer orders and orders on top of the book that
comprise the BBO. In fact, the proposed priority requirements for
complex orders will provide customers orders in the book with
additional protection with respect to electronic complex orders and
smaller ratio complex orders in open outcry, as no leg of a Compression
order may execute at the same price as any Priority Customer order on
the Simple Book.
The proposed rule change is consistent with how compression
transactions currently execute on the trading floor. The proposed rule
change is replicating a procedure that is currently available to market
participants only on the trading floor and enhances the current open
outcry procedure. The proposed rule change will protect Priority
Customer orders and orders on top of the book that comprise the BBO, as
well as Priority Customer orders on the top of the COB, and thus will
provide additional protection to customers on the book compared to
other executions of orders on the Exchange. While orders are currently
required to be exposed on the trading floor, the Exchange has observed
that market participants generally defer their allocations to permit a
clean cross, as that is necessary for these transactions to achieve
their intended effect and not leave market participants with unhedged
positions (and thus more risk). As a result, the lack of exposure of
Compression orders will be practically consistent with how orders are
currently executed in compression forums--it just eliminates the need
to represent the orders on the floor, which representation during
compression forums has been demonstrated to be unnecessary.
While orders in compression forums are currently required to be
exposed to the trading crowd, the Exchange has observed that market
participants generally deferred their allocations to permit a clean
cross. Because orders that are executed in compression forums on the
trading floor are generally not broken, and because the purpose of
these trades is unrelated to profits and losses (making the price at
which the transaction is executed relatively unimportant like
competitive trades), the Exchange believes it is appropriate to not
require exposure of these orders in an electronic or open outcry
setting. As noted above, during the time the Exchange's trading floor
was closed, the Exchange made Compression orders available to TPHs for
immediate (and thus unexposed) electronic execution. The Exchange
received feedback from several TPHs regarding the increased efficiency
provided by electronic Compression orders, which feedback included
requests to make Compression orders available when the trading floor
reopened. The Exchange believes it is unlikely that TPHs on the trading
floor would seek to break up the execution of Compression orders in the
future, as several TPHs engage in compression to reduce capital
attributable to the positions in their portfolio and would similarly
expect to be able to execute their Compression orders without other
TPHs breaking them up. The Exchange understands this type of mutual
understanding among TPHs contributes to smoother operations on the
trading floor. The Exchange also believes that TPHs understand the
benefits that compression may bring to liquidity on the trading floor.
Even if TPHs decided to attempt to break up these orders in the
future, the Exchange believes the benefits of permitting Compression
orders to execute as clean crosses greatly outweigh any benefits that
may result from exposing these orders for potential break up. The
Exchange notes that the benefits of requiring a broker to expose an
order on the trading floor generally flow to that order, which include
the potential of price improvement for the order and to locate
liquidity against which to execute the order. In the case of a
Compression order, the representing broker has already located the
necessary liquidity to execute the order, as that is necessary given
the nature of these transactions. If TPHs believed it was reasonably
possible that other TPHs in the trading crowd would break up
Compression orders, those TPHs would not attempt to execute those
orders on the trading floor (and thus there would be no orders for
other TPHs to break up). If an electronic Compression order that
immediately executes without exposure were available (as it was when
the trading floor was closed), then TPHs would merely submit
Compression orders for electronic execution. Permitting open outcry
Compression orders will permit TPHs to cross these orders using the
same tools they use to currently execute those orders.
It is critical that TPHs are able to efficiently manage capital and
margin requirements so that they continuously have sufficient capital
available to provide to the markets, which benefits all market
participants, including those that may seek to break up Compression
orders. Many TPHs clear through CTPHs that have been impacted by bank
regulatory capital requirements, and therefore the Exchange believes
all TPHs on the trading floor understand and respect the need of other
TPHs to reduce capital attributable to their positions in accordance
with capital reviews performed by CTPHs as efficiently as possible,
including through the use of compression.
While the proposed rule change eliminates certain steps with
respect to the compression files the Exchange provides, as discussed
above, the Exchange believes these steps provide no current value to
the process. As a result, the Exchange believes the proposed process is
practically consistent with the current process. Because the changes
create a process that is practically consistent with the current
process, the Exchange does not believe they will have any negative
impact on the ability of TPHs to effect compression transactions. The
proposed rule change streamlines the process by eliminating steps that
add no demonstrable value to the compression process and will enable
TPHs to engage in compression transactions more efficiently.
The Exchange believes the proposed rule change to permit
Compression orders to have any ratio will 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
[[Page 55049]]
public interest, as it will provide TPHs with the ability to maximize
positions they may close while minimizing market risk. Currently in
open outcry compression forums, complex orders may be executed in any
ratio (and in pennies if closing positions). Because the proposed
priority requirements are consistent with the open outcry complex order
priority for larger ratio orders, the Exchange believes the proposed
rule change will not disadvantage the simple order market, as no leg of
a Compression order may execute at the same price as a resting Priority
Customer order in the simple book.
The proposed rule change to permit the opening portions of
Compression orders to be entered and executed in pennies will benefit
investors, as it will eliminate potential confusion about different
portions of different trades executing at different increments. The
Exchange believes this is appropriate given that opening positions may
partly comprise Compression orders as long as the total order is net
position closing or neutral and legs of single orders are
systematically unable to be input or executed in different minimum
increments. The Exchange believes restricting use of Compression orders
to positions intended to reduce required capital associated with a
TPH's positions will limit the use of Compression orders, including the
inclusion of opening positions in those orders, to the intended purpose
of these orders. Additionally, the Exchange believes it may reduce
potential investor confusion that may result from requiring different
portions of orders to trade in different increments, if that were
systematically possible. Unlike in compression forums on the trading
floor, where persons can negotiate leg pricing to accommodate the
current rule, such negotiation is not available in electronic trading.
While the proposed rule change may increase the number of SPX contracts
that may trade in pennies, given that a Compression order that will
open any positions must be net position closing or neutral, the
Exchange expects the majority of contracts that execute as part of
Compression orders will be ones that close positions, as is the case
today.
As noted above, the Exchange believes permitting Compression orders
to be partially comprised of opening positions will increase amount of
open SPX interest TPHs are willing to close, and penny pricing for all
contracts in Compression orders will further encourage closing of these
positions. Because many series the Exchange expects TPHs will attempt
to close will be out-of-the-money, and essentially worthless, TPHs may
not otherwise close positions in these series if a higher minimum
increment causes the price to be too much higher than the option's
value. The Exchange believes it is reasonable to permit these orders to
be entered and executed in penny increments to provide flexibility that
will enable TPHs to maximize the number of open SPX positions they can
close using Compression orders. While the Exchange understands there
may be a concern that market participants may attempt to use
Compression orders to execute orders in pennies that would otherwise be
required to execute in a larger increment, the Exchange believes this
minimal risk is outweigh by the benefits the proposed rule change may
provide to the market and all investors. Additionally, the Exchange
believes the requirements that Compression orders be net closing or
neutral and include closing positions previously submitted to the
Exchange on compression position lists, and be for the purpose of
reducing required capital associated with open positions will create
additional controls to limit use of Compression orders for legitimate
compression purposes that further minimizes this potential risk.
It is critical to the ongoing stability of the options markets that
TPHs are able to efficiently manage capital and margin requirements so
that they continuously have sufficient capital available to provide to
the markets, which benefits all market participants, including those
that may seek to break up Compression orders. As all TPHs are subject
to capital and margin requirements, the Exchange believes all TPHs on
the trading floor understand and respect the need of other TPHs to
manage these requirements as efficiently as possible. The Exchange
believes the proposed rule change, which is limited to one class the
Exchange believes is being significantly impacted by bank regulatory
capital requirements and the one class in which open outcry compression
forums may currently occur, as well as limiting the use of Compression
orders for reducing the required capital associated with a TPH's open
SPX positions, is narrowly tailored for the specific purpose of
facilitating the ability of liquidity providers to alleviate the
negative effects of current bank regulatory capital requirements. The
Exchange believes the proposed rule change will protect investors by
providing a more seamless execution of compression transactions and
thus facilitate a more efficient way for liquidity providers to meeting
their capital requirements, which will protect investors by contributed
to the continued depth of liquidity in the SPX options market.
Based on activity in open outcry compression forums and the number
of orders executed in electronic compression forums when the trading
floor was closed, the Exchange believes it has sufficient system
capacity to handle any additional traffic that may result from the
proposed rule change. The Exchange's Regulatory Division intends to
incorporate Compression orders into its surveillances.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange 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 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 does not believe the proposed rule
change will impose any burden on intramarket competition, as
Compression orders will be available to all market participants with
SPX open interest. As discussed above, while the proposed rule change
is directed at market-makers, all market participants may submit
Compression orders in the same manner as long as all criteria of the
proposed rule are satisfied. While compression-list positions submitted
by CTPHs on behalf of TPHs for which they clear will no longer be
included in individual position files, the Exchange believes this is
appropriate given that bank regulatory capital requirements apply to
CTPHs, who are therefore positioned to identify offsetting positions
among TPHs for which they clear that will enable them to more
efficiently comply with those requirements. Ultimately, this still
benefits TPHs on whose behalf CTPHs submit compression-list positions,
as the resulting compression transactions will result in the ability of
those TPHs to provide additional liquidity to the market.
The Exchange does not believe the proposed rule change will impose
any burden on intermarket competition, as it will apply only to SPX
options, which are currently listed for trading only on the Exchange.
Additionally, open outcry compression forums are currently limited to
SPX options. In addition, the proposed rule change is intended create a
more efficient effective mechanism for market participants to close SPX
option interest to reduce regulatory capital attributable to their
portfolios.
[[Page 55050]]
Compression orders are not seeking price improvement but rather looking
to free up capital that will permit those parties to continue to
provide liquidity to the market, and thus is not intended to have a
competitive impact.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received from Members, Participants, or Others
The Exchange neither solicited nor received comments on 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 up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission will:
A. By order approve or disapprove such 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. 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 Number SR-CBOE-2020-074 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-CBOE-2020-074. 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 website (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 website 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 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of the Exchange. All comments
received will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-CBOE-2020-074 and should be submitted on
or before September 18, 2020.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\53\
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\53\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-19453 Filed 9-2-20; 8:45 am]
BILLING CODE 8011-01-P