FR 2021-03336

The document under review is a notice from the Securities and Exchange Commission (SEC) regarding a new rule change proposed by Cboe Exchange, Inc. The rule imposes a maximum size limit of ten contracts for agency orders in S&P 500 Index Options (SPX) during Regular Trading Hours (RTH) on its Automated Price Improvement Mechanisms, known as AIM and C-AIM.

Summary of the Document

The SEC approved the implementation of this rule change following two amendments. The goal of the change is to enhance execution opportunities and price improvements for smaller orders in the SPX options market. This was backed by data provided by the Cboe, which indicated that orders of a smaller size, specifically those ranging from one to ten contracts, experienced substantial benefits under the auction mechanisms during periods of the floor's inoperability.

Significant Issues and Concerns

However, the approval was not without its criticisms. Some market participants questioned the necessity of the maximum size limit, suggesting that larger orders might also benefit if permitted within the AIM and C-AIM auctions. While the Cboe presented data to justify the limit, some commenters were concerned that this data sample might be inadequate as it did not directly compare floor-based and electronic trades during simultaneous operation periods.

Furthermore, there was concern that the imposition of a fixed maximum size rule might not adequately reflect the dynamics of trading in all market conditions, and it might disadvantage certain larger market participants. Critics suggested that the analysis was not sufficiently robust, and additional data might lead to alternative conclusions.

Impact on the Public

For the general public, particularly retail investors, the primary impact of this rule is expected to be positive. By prioritizing smaller orders, it hopes to engage more individual investors in SPX options, potentially offering them better pricing and execution conditions. The rule is designed to provide more retail customers with the opportunity to benefit from price improvement, which aligns with the broader market goals of fairness and accessibility.

Implications for Stakeholders

Stakeholders among retail investors might find the rule creates a more favorable trading environment through potential price enhancements and increased execution opportunities. Conversely, institutional traders and firms dealing with larger contracts might feel constrained by this limitation, potentially leading to a shift of larger order activity to the trading floor or other venues.

The document's language, while comprehensive and legalistic, may present barriers for those without a financial or legal background. The complexity of the data analysis and regulatory references might limit accessibility, highlighting a need for further clarification and communication from the SEC to ensure all affected parties fully understand the implications of this rule change.

By striking an initial balance that favors smaller order participants, Cboe and the SEC may need to continually monitor the effects, considering further adjustments to optimize market efficiency and fairness. Stakeholders should continue to engage with the SEC process, providing feedback based on their experiences with the new regulations.

The document outlines proposed changes by the Cboe Exchange, Inc. regarding the Automated Price Improvement Mechanism (AIM) and its counterpart for complex orders (C-AIM) in the context of S&P 500® Index Options (SPX). A central financial aspect of the proposal is the maximum size limit on orders to facilitate price improvements for smaller quantities.

Price Improvements for Different Contract Sizes

The document highlights the average price improvement associated with SPX orders of varying sizes. Specifically, orders composed of 1 to 10 contracts received an average price improvement of approximately $0.34 per contract. In contrast, larger orders, such as those containing 11 to 50 contracts, received only a $0.22 average price improvement. This trend of smaller price improvement continued with orders of 51 to 250 contracts, averaging $0.08, and orders of 251 to 500 contracts yielding approximately $0.15. There is a clear financial implication that smaller orders benefit more in terms of price enhancement, thus justifying the proposed maximum order size.

Justification for Financial Limits

These financial details directly relate to the issues brought up in the commentary sections. The decision to set a maximum order size of 10 contracts appears financially sound, given the significantly higher price improvement for smaller orders. Thus, the financial reasoning supports encouraging electronic auctions for these smaller orders.

Investment Comparisons

The document provides a specific example comparing the potential investments needed for SPX versus SPY options. On a given date, an SPX option was valued at $31.00, leading to an investment of $31,000 for purchasing 10 contracts. In comparison, 10 SPY contracts required only a $3,120 investment. This highlights the greater financial commitment entailed in trading SPX options, which could impact retail investor participation and interest in smaller orders.

Relation to Identified Issues

Commenters have raised concerns regarding the fairness of imposing a maximum size limit, asserting that it might restrict price improvement opportunities for larger orders. However, the presented financial data underscores that smaller orders historically receive better price improvements. This supports the Exchange's strategy to prioritize these smaller transactions under the AIM and C-AIM systems.

The commentary also acknowledges the need for more robust analysis of data to ensure stated financial advantages are valid across different trading conditions. Some stakeholders question whether the maximum size cap is sufficiently justified or necessary, hinting that a more detailed comparison of floor and electronic transactions, concerning financial gains, is required.

Accessibility of Financial Information

The use of complex financial metrics and legal jargon could limit comprehension for non-experts, underscoring the importance of simplifying explanations of financial benefits to encourage broader understanding and engagement from the public.

In conclusion, the document uses financial data to argue for a regulatory change intended to benefit smaller SPX orders by outlining the price improvements typically realized under the proposed changes. This financial emphasis aligns with the broader goal of promoting efficiency and fairness in the options market.