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June 1, 2011

CBOE's SPX Plans Delayed

By Peter Chapman

The Chicago Board Options Exchange's plan to trade options on the S&P 500 Index on its new C2 platform is stuck in Washington, as the Securities and Exchange Commission has put off any decision to approve the new contract.

The regulator was slated to rule in April, but has postponed the deadline until June 6 to allow more time to consider possible problems. Traders and a rival exchange have raised legal and operational questions regarding the new SPX contract.

CBOE already trades four options based on the S&P 500 Index on its primary market-a weekly, monthly, quarterly and custom contract. It hopes to launch a fifth contract to expire monthly on its new all-electronic C2 exchange. The new product is eagerly awaited by some in the industry-brokers angling for customer flow-and unwelcome in other quarters-SPX market makers.

At issue is the new C2 contract will settle in the afternoon, rather than the morning when the monthly SPX does. That raised concern that the new product could introduce unwanted volatility in the underlying securities of the S&P 500 Index, and that it was designed to thwart inter-exchange rules.

The International Securities Exchange, in a letter to the SEC, questioned the CBOE's motives for an afternoon settlement. Because the C2 SPX settles in the afternoon, it will be a slightly different product than the existing SPX. Therefore, trading in the new SPX will not impinge on trading of the old SPX. In other words, C2 will not have to prevent trade-throughs of orders in the SPX on the CBOE.

The lack of competition between CBOE and C2 in SPX will preserve the monopoly the CBOE has in trading the contract in its pits, ISE charged. CBOE can "continue to trade S&P 500 options on the floor without having to accommodate the more narrow quotes that are likely to exist on C2's electronic market," ISE legal counsel Michael Simon told the SEC. He called the six-and-a-half-hour settlement difference between the two SPX contracts "a sham."

Another options exchange official agrees, telling Traders Magazine, "the afternoon settlement protects the spreads and the crowd" in the SPX pits at the flagship exchange. "CBOE doesn't have to worry about the linkage issues," the executive said.

The CBOE has a legal monopoly in trading the SPX, but preserving that exclusivity with a different settlement time wasn't the rationale for the afternoon settlement, according to one exec there. CBOE executive vice chairman Ed Tilly told Traders Magazine that the SPX's afternoon settlement is intended as a competitive offering for money managers who do similar PM-settled trades in the over-the-counter market.

Another concern is volatility. Both the ISE and Blue Capital Group, an index options market maker, told the SEC that an afternoon settlement might be a step back to the days of the controversial "triple witching hours." In the 1980s, options and futures on stocks and indices all settled on the same four Fridays per year, causing severe disruptions in stock trading, as New York Stock Exchange specialists scrambled to cope with a deluge of orders at the close.

Times have changed, said CBOE. It told the SEC that the conditions that produced the triple witch are gone. Stock trading is now widely dispersed across many exchanges and alternative trading systems, and some use electronic crosses to efficiently close out their days.

A market maker agrees. "It will add some volatility and excitement, but the technology is so efficient today, it's really not an issue at all," said Joe Mazzella, head of institutional block trading at Knight Capital Group. "We'll get things closed in a timely manner."

An options exec agrees. "Technology has changed considerably the way stocks trade," said Slade Winchester, in charge of options market making at Citigroup. "There will likely be some additional volatility, but the market will absorb it. To our knowledge this will be no different from the weekly SPX contracts that expire on the closing print."


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