Self-Regulatory Organizations; Cboe Exchange, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, To Add Options on the Mini-Russell 2000 Index to Its P.M. Pilot Program

I. Introduction

On December 18, 2020, Cboe Exchange, Inc. (“Cboe” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, a proposed rule change to add Mini-Russell 2000 Index (“Mini-RUT” or “MRUT”) options to the Exchange's pilot program for P.M. settled options with third-Friday-of-the-month expiration dates (“Expiration Friday”). The proposed rule change was published for comment in the Federal Register on December 29, 2020. On January 28, 2021, the Exchange filed Amendment No. 1 to the proposed rule change. The Commission received no comment letters on the proposed rule change. The Commission is approving the proposed rule change.

II. Description of the Proposal, as Modified by Amendment No. 1

The Exchange is proposing to amend its rules to permit it to list and trade, on a pilot basis, cash-settled MRUT options with Expiration Friday expiration dates, for which the exercise settlement value will be based on the index value derived from the closing prices of the component securities (“P.M.-settled”). MRUT options are options on the Mini-RUT Index, the value of which is 1/10th the value of the Russell 2000 (“RUT”) Index.

The Exchange proposes to add P.M.-settled MRUT options to the Exchange's pilot program under Interpretation and Policy .13 to Rule 4.13 that allows the listing of P.M. settled options that expire on Expiration Friday (“P.M. Pilot Program”). The Exchange notes that the existing P.M. Pilot Program, which is set to end on May 3, 2021, includes options on the Mini-SPX Index (“XSP”), the value of which is 1/10th the value of the S&P 500 Index. Cboe has proposed to add P.M.-settled MRUT options to that pilot so that the end of the pilot period for P.M.-settled MRUT options would also be May 3, 2021.

The Exchange notes that trading in P.M.-settled MRUT options would operate in the same manner as provided in the proposal to list and trade Mini-RUT options on the Exchange. That is, P.M.-settled MRUT options would have the same European-style exercise, same number of permissible expirations, same exercise interval prices and limitations, same position and exercise limits, and will trade in the same minimum price increment.

The Exchange proposes to abide by the same reporting requirements for the trading of P.M.-settled MRUT options that it does for the trading of P.M.-settled XSP options. The Exchange proposes to include data regarding P.M.-settled MRUT options as it does for P.M.-settled XSP options in the pilot program report that it submits to the Commission at least two months prior to the expiration date of the P.M. Pilot Program (the “annual report”). Specifically, the Exchange submits annual reports to the Commission that contain an analysis of volume, open interest, and trading patterns in connection with products in the P.M. Pilot Program. The analysis examines trading in products in the P.M. Pilot Program, as well as trading in the securities that comprise the underlying index. Additionally, for series that exceed certain minimum open interest parameters, the annual reports provide analysis of index price volatility and share trading activity.

Going forward, the Exchange would include the same analysis of P.M.-settled MRUT options, as well as trading in securities that comprise the RUT Index (as MRUT options are based on 1/10th the value of the RUT Index), in the annual reports. Also, like it currently does for P.M.-settled XSP options, the Exchange would submit periodic interim reports for P.M.-settled MRUT options that contain some, but not all, of the information contained in the annual reports.

The pilot reports will both contain the following volume and open interest data:

(1) Monthly volume aggregated for all trades;

(2) monthly volume aggregated by expiration date;

(3) monthly volume for each individual series;

(4) month-end open interest aggregated for all series;

(5) month-end open interest for all series aggregated by expiration date; and

(6) month-end open interest for each individual series.

The annual reports will also contain the information noted in Items (1) through (6) above for Expiration Friday, A.M.-settled, RUT index options traded on Cboe, as well as the following analysis of trading patterns in P.M.-settled MRUT options series in the Pilot Program:

(1) A time series analysis of open interest; and

(2) an analysis of the distribution of trade sizes.

Finally, for series that exceed certain minimum parameters, the annual reports will contain the following analysis related to index price changes and underlying share trading volume at the close on Expiration Fridays:

(1) A comparison of index price changes at the close of trading on a given Expiration Friday with comparable price changes from a control sample. The data includes a calculation of percentage price changes for various time intervals and compare that information to the respective control sample. Raw percentage price change data as well as percentage price change data normalized for prevailing market volatility, as measured by the Cboe Volatility Index (VIX), is provided; and

(2) a calculation of share volume for a sample set of the component securities representing an upper limit on share trading that could be attributable to expiring in-the-money series. The data includes a comparison of the calculated share volume for securities in the sample set to the average daily trading volumes of those securities over a sample period.

The minimum open interest parameters, control sample, time intervals, method for randomly selecting the component securities, and sample periods are determined by the Exchange and the Commission. Additionally, the Exchange would provide the Commission with any additional data or analyses the Commission requests because it deems such data or analyses necessary to determine whether the P.M. Pilot Program, including P.M.-settled MRUT options as proposed, is consistent with the Exchange Act. As it does for current P.M. Pilot products, the Exchange would make public any data and analyses in connection with P.M.-settled MRUT options it submits to the Commission under the Pilot Program.

Further, the Exchange proposes to amend Rule 5.1, which governs trading days and hours, in conjunction with the proposed addition of MRUT options to the P.M. Pilot Program. Cboe Rule 5.1(b)(2)(C) currently provides that on their last trading day, Regular Trading Hours for P.M.-settled XSP options are between 9:30 a.m. and 4:00 p.m. Eastern Time (as opposed to the 9:30 a.m. to 4:15 p.m. Regular Trading Hours for options with those expirations that are non-expiring). The proposed rule change amends Rule 5.1(b)(2)(C) to apply these time frames to the trading of P.M.-settled MRUT options on their last trading day.

With regard to the impact of this proposal on system capacity, the Exchange has analyzed its capacity and represents that it and the Options Price Reporting Authority have the necessary systems capacity to handle any potential additional traffic associated with trading of P.M.-settled MRUT options. The Exchange believes that its Trading Permit Holders will not experience a capacity issue as a result of this proposal. Cboe represents that it will monitor the trading volume associated with any possible additional options series listed as a result of this proposal and the effect (if any) of these additional series on market fragmentation and on the capacity of the Exchange's automated systems.

III. Discussion and Commission Findings

After careful consideration of the proposal, the Commission finds that the proposed rule is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, the requirements of Section 6 of the Act. Specifically, the Commission finds that the proposed rule change to allow the Exchange to add P.M.-settled MRUT options to the P.M. Pilot Program is consistent with Section 6(b)(5) of the Act, which requires that an exchange have rules designed to remove impediments to and perfect the mechanism of a free and open market and to protect investors and the public interest.

As the Commission noted in its orders approving the listing and trading of P.M.-settled options on the S&P 500 Index (“SPXPM”), the Commission has had concerns about the potential adverse effects and impact of P.M. settlement upon market volatility and the operation of fair and orderly markets on the underlying cash markets at or near the close of trading, including for cash-settled derivatives contracts based on a broad-based index. The potential impact today remains unclear, given the significant changes in the closing procedures of the primary markets in recent decades. The Commission is mindful of the historical experience with the impact of P.M. settlement of cash-settled index derivatives on the underlying cash markets, but recognizes that these risks may be mitigated today by the enhanced closing procedures that are now in use at the primary equity markets.

For the reasons described below, the Commission believes that the Exchange's proposal to add P.M.-settled MRUT options to the P.M. Pilot Program is designed to mitigate concerns regarding P.M. settlement and will provide additional trading opportunities for investors while providing the Commission with data to monitor the effects of MRUT options and the impact of P.M. settlement on the markets. To assist the Commission in assessing any potential impact of a P.M.-settled Mini-RUT index option on the options market as well as the underlying cash equities markets, Cboe will be required to submit data to the Commission in connection with the P.M. Pilot Program. The Commission believes that Cboe's P.M. Pilot Program, together with the data and analysis that the Exchange will provide to the Commission, will allow Cboe and the Commission to monitor for and assess any potential for adverse market effects of allowing P.M. settlement for Mini-RUT index options, including on the underlying component stocks. In particular, the data collected from Cboe's P.M. Pilot Program will help inform the Commission's consideration of whether the P.M. Pilot Program should be modified, discontinued, extended, or permanently approved. Furthermore, the Exchange's ongoing analysis of the P.M. Pilot Program should help it monitor any potential risks from large P.M.-settled positions and take appropriate action on a timely basis if warranted.

The Exchange represents that it has adequate surveillance procedures to monitor trading in these options thereby helping to ensure the maintenance of a fair and orderly market and has represented that it has sufficient capacity to handle additional traffic associated with this new listing.

For the reasons discussed above, the Commission finds that Cboe's proposal is consistent with the Act, including Section 6(b)(5) thereof, in that it is designed to remove impediments to and perfect the mechanism of a free and open market, and, in general, to protect investors and the public interest. In light of the enhanced closing procedures at the underlying markets and the potential benefits to investors discussed by the Exchange in the Notice, the Commission finds that it is appropriate and consistent with the Act to approve Cboe's proposal on a pilot basis. The collection of data during the P.M. Pilot Program and Cboe's active monitoring of any effects of P.M.-settled MRUT options on the markets will help Cboe and the Commission assess any impact of P.M. settlement in today's market.

IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-CBOE-2020-116), as modified by Amendment No. 1, be, and hereby is, approved, subject to a pilot period set to expire on May 3, 2021.