BOX Exchange Seeks OK for 1,000-Share Options on S&P 500 ETF

BOX Options Exchange, owned by the operator of the Toronto stock market and seven brokers, asked regulators for permission to trade so-called jumbo contracts on the most active exchange-traded fund.

The Chicago-based exchange plans to trade contracts based on 1,000 shares of the SPDR S&P 500 ETF Trust, according to its request. Most contracts are based on 100 shares. BOX’s offering would be roughly the same size as Standard & Poor’s 500 Index options, which trade exclusively on the Chicago Board Options Exchange. The jumbo options could be traded on any venue if the Securities and Exchange Commission approves the contract.

The initiative comes as exchanges are preparing to trade mini options on five securities that are more than $100, including the S&P 500 ETF, Google Inc. and Apple Inc., to cater to individual investors more likely to speculate or hedge positions with contracts based on 10 shares. The SEC has recognized that contracts based on a different number of shares make sense for different segments of the trading industry, according to Edward Boyle, senior vice president of strategy for BOX Options.

“It’s a product for which we’ve had demand from institutions,” Boyle said in a phone interview. “Institutions demand a higher notional value per contract than the current SPY offers,” he said, referring to the ticker symbol for the S&P 500 ETF. “It will also be price-competitive since it will be available for multiple listing on all exchanges.”

BOX accounted for 3.6 percent of options volume last year, according to data compiled by Chicago-based OCC, which clears and settles all equity derivatives trades. Industry volume fell 12 percent to 4 billion contracts last year, compared with a record 4.56 billion that changed hands in 2011, OCC said.

Previous Efforts

Efforts to trade options tied to a larger number of shares have fizzled in the past. The American Stock Exchange offered contracts based on 1,000 shares of the SPDR S&P MidCap 400 ETF Trust in the late 1990s, according to Michael Bickford, who was senior vice president for options at Amex before NYSE Euronext bought it in 2008. The so-called grand options weren’t popular and were de-listed around 2000, he said in a phone interview. They traded on what is now known as NYSE Amex Options alongside S&P MidCap 400 ETF contracts based on 100 shares.

Since then the options business has changed. Most options are now listed on multiple exchanges and can be traded on any venue. New rules oversee electronic linkages among markets and dictate how orders must be handled by an exchange.

‘More Demand’

“In 2013 there’s significantly more demand for options than in the late 1990s,” said Bickford, a principal at TYJS Group LLC, a consulting firm in Basking Ridge, New Jersey. “There’s more of an audience for options in general and there’s more institutional demand than there was back then.”

Boyle joined BOX this month after working at Chicago-based Getco LLC. Before joining the automated trading firm in early 2011 he was head of the U.S. options business at NYSE Euronext.

BOX Chief Executive Officer Anthony McCormick said last month the exchange planned to introduce products for institutional investors and would consider starting a second options market. It may also sell stakes to brokers and financial firms, he said. In addition to Toronto-based TMX Group Ltd., BOX Holdings Group LLC’s owners include Interactive Brokers Group Inc., a market maker and brokerage firm.

Institutions often prefer larger-size contracts like S&P 500 Index options that enable them to buy or sell bigger positions without signaling their intentions and moving the market. Options for a larger notional size may have wider bid-ask spreads than similar regular-size contracts.

‘Large Blocks’

Institutional investors such as mutual and pension funds “would benefit from the introduction and availability of jumbo SPY options by making options on large blocks of the SPY ETF more available,” BOX said in its filing.

The strike prices, or levels at which a contract can profitably be converted into shares in the underlying ETF, and the bids and offers will be the same for the jumbo and regular-size contracts to limit investor confusion, BOX said, and the larger product would use the symbol SPYJ.

The Philadelphia Stock Exchange, now owned by Nasdaq OMX Group Inc., asked the SEC for permission to trade jumbo options on the S&P 500 ETF in 2008. The contracts would have been European-style options, which meant they could be exercised only on their date of expiration. Most U.S. options are American-style and can be exercised at any time before they expire. The exchange withdrew the request without citing a reason.

NYSE Amex Options asked the SEC in 2010 if it could trade contracts based on 1,000 shares of four ETFs. In addition to the S&P 500 ETF, it sought to allow jumbo options on the PowerShares QQQ Trust, which tracks the performance of the Nasdaq 100 Index; iShares Russell 2000 Index Fund; and SPDR Dow Jones Industrial Average ETF Trust.

Position Limits

The exchange also asked the SEC to end limits on the size of positions traders could amass in those ETFs. Position limits, introduced to prevent manipulation of the underlying security, were eliminated for the most-active index options that settle for cash, such as those on the S&P 500 and Russell 2000, in the 2000s. The SEC ended position limits for the S&P 500 ETF, which settles into shares in the underlying ETF, in August.

Wolverine Trading LLC, a Chicago-based broker, supported NYSE Amex and asked the SEC to approve the filing in 2010.

CBOE urged the SEC in a letter that year to reject NYSE Amex’s proposal or require “substantial alteration.” Granting the request would have allowed some products to avoid so-called price-protection rules for products on the same ETF with a different number of underlying shares and would produce investor confusion, it said. CBOE also said the SEC had rejected a similar request it had made for a contract based on a different number of shares for an index option it already traded.

Other Plans

Amex withdrew its proposal in 2011. It doesn’t charge firms such as mutual funds classified as customers a trading fee when they buy or sell S&P 500 ETF options, according to an e-mail from Steve Crutchfield, head of US options at NYSE Euronext.

The International Securities Exchange, the industry’s first all-electronic venue, submitted a proposal last March to trade options on what it called the ISE Max SPY Index, designed to be 10 times the value of the underlying benchmark. The request generated several rounds of positive and negative letters, including six from CBOE objecting to the plan. An Illinois court said the contract would violate an injunction against ISE offering a product based on the S&P 500 Index. ISE withdrew the proposal in November.

BOX’s proposed jumbo S&P 500 ETF contract would be a separate product from the regular-size version and therefore price-protection rules would not apply across the related contracts, the exchange told the SEC in its filing. Arbitrage opportunities between the products would keep their respective prices in line with each other, it said. The specifications for the new contracts differ from those Amex suggested in 2010.

Mini Options

While discussion of jumbo options may heat up again, the industry is preparing for mini options on five products including the S&P 500 ETF and SPDR Gold Trust, Apple, Google and Inc. The smaller-size contracts will start trading across exchanges on March 18.

Concerns about a two-tiered market in which the regular-size and larger options have different prices no longer apply since the SEC has approved mini contracts that raise similar issues relative to products overlying 100 shares, Boyle said.

“SPYJ will have a different market on the screen just like minis likely will have a different market than the regular-size options,” Boyle said. “The exact same argument about pricing holds true for minis and the SEC has approved them.”

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