WHITE PAPER Global Trading Hours Cboe Study on Execution and Market Quality in Extended Trading Hours

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1 WHITE PAPER Global Trading Hours Cboe Study on Execution and Market Quality in Extended Trading Hours

2 Page 2 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours Cboe s Extended Trading Hours 1 (ETH) offers trading in the Exchange s fl agship SPX, SPXW, and VIX option products beginning at 8:00 a.m. London time. Cboe made ETH available in March 2015 and has seen significant growth in Liquidity has continued to improve and has most recently dramatically increased with the entrance of two London-based dealers willing and able to commit capital to trades. August is on pace to be the best month of ETH growth has been strong, but a challenge to increasing volume even further has been a common perception that liquidity is poor. Cboe recently conducted an analysis to test the validity of this perception. The analysis revealed that ETH liquidity is much stronger than expected. Indeed, large institutional trades are frequently executed at levels that are generally commensurate with quality experienced during regular U.S. trading hours (RTH), (2:30 p.m. 9:15 p.m. London time). 1 CBOE has ETH for both options and futures. This study to pertains to ETH options. VIX futures trade virtually 24 hours per day, five days per week, with approximately 10% of the volume coming during non-u.s. hours. Trades executed in ETH are fungible with trades executed during regular U.S. trading hours.

3 Page 3 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours Order Demographics Our study examined 211 large trades executed in ETH during These trades represent 60% of the volume traded in ETH from 3 January August Underlying Total Contracts Orders Studied ORDER DEMOGRAPHICS Order Size Trade Size Expiration Moneyness Order Size Range Average Trade Size Median Trade Size Days to Expiration Range Average Days To Expiration Days to Expiration Median VIX 594, ,000 3,451 2, SPX/SPXW 77, , Out-ofmoney trades At-themoney trades In-themoney trades 2 A trade was deemed large in VIX options if the order was for 500 or more contracts; the threshold was 100 contracts for SPX/SPXW options.

4 Page 4 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours The 211 examined trades included both simple and complex orders in VIX options, SPX options, and SPXW options. Various electronic execution methods were used to complete these orders: Simple orders executed against the screen bid / ask Complex orders executed in the Complex Order Book (COB) or the Complex Order Auction (COA) Facilitated paired orders executed via CBOE s Automated Improvement Mechanism (AIM), for both simple and complex orders (please see AIM description for more details:

5 Page 5 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours Does it Pay to Wait Until the U.S. Markets Open? When considering ETH, a common claim among investors is that better liquidity and / or execution prices can be attained during regular U.S. trading hours. We challenged this notion by examining these 211 large ETH trades, asking what the execution price would have been had the trades been held until the U.S. market open. We categorized the estimated results into three distinct buckets: Trades favourable to ETH execution Trades indifferent to ETH / RTH execution (i.e., same execution price) Trades favourable to RTH execution As predicted by the random walk theory, roughly a third of the trades fell into each category, thereby significantly diminishing the notion that better executions are attained by waiting until the U.S. market open. 3 For estimating execution prices at the U.S. market open, we used the respective option markets at 2:31p.m. London time on the same trade date. For complex orders, we used the derived market from the individual option legs. Instead of assuming full cross of the bid / ask spread, we made accommodations for typical effective spreads that market participants experience during regular U.S. trading hours, without slippage.

6 Page 6 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours However, ETH and RTH are by no means equal. Eliminating the trades where we estimated that there would have been the same execution price, the amount of money represented by the estimated price improvements on favourable RTH executions exceeded the amount of money on the estimated ETH favourable executions. Moreover, execution time is slow during ETH relative to RTH, especially towards the beginning of the ETH session. Lastly, the size displayed on the bid / ask tends to be much smaller during ETH. But the smaller displayed size does not seem to severely impact the amount of business that can be executed liquidity providers are responding to large orders with large size.

7 Page 7 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours While RTH seems to hold some advantages, ETH presents important opportunities. Specifically, ETH offers market participants the opportunity to react to sudden changes in implied volatility sparked by global events during non-u.s. trading hours. A recent example happened on August 29: North Korea fired a missile that travelled over Japan, causing spot VIX to spike 27% in early European trading hours 4. These gains in spot VIX were largely eliminated by the U.S. open at 2:30 p.m. Effective Spreads Effective spreads 5 are generally converging between ETH and RTH, indicating that the execution experience in both sessions are becoming similar 6. 4 August 29, 2017 was the 8th highest ETH option volume session with nearly 40,000 VIX options trading. August 2017 has seen three of the top 10 ETH option sessions. 5 Effective spread is defined as the absolute value of the difference between the mid-point of the option s bid / ask and the execution price. 6 Effective spreads for RTH markets provided are open outcry effective spreads, which are much better than RTH electronic effective spreads. (ETH is a completely electronic market). Effective spreads are volume weighted for SPX/SPXW options and VIX/VIXW options.

8 Page 8 White Paper Cboe Study on Execution and Market Quality in Extended Trading Hours Plans for Continued Improvements to ETH Liquidity CBOE has created a robust price discovery environment within our ETH session, with eight market making firms actively quoting in VIX options and six consistently present in SPX/SPXW options. While a few market makers garner a significant portion of the fl ow, no single market maker is capturing a majority, which indicates that liquidity-providing firms are vigorously competing to win trades. Existing ETH liquidity is strong. Nevertheless, CBOE is working to further improve the ETH trading experience for customers. The Exchange is working to expand the number of London-based dealers that are actively committing capital to ETH trades so that customers can source risk prices from additional counterparties. In addition, CBOE is considering enhancements to market maker incentive programs that could result in tighter bid / ask spreads with greater displayed size. Please visit Cboe.com/ETH for more details. Options involve risk and are not suitable for all investors. The information in this paper is provided for general education and information purposes only. No statement within this paper should be construed as a recommendation to buy or sell a security or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in this paper is available by contacting CBOE at Past performance is not indicative of future results. Back-tested performance information is purely hypothetical and is provided in this presentation solely for informational purposes. Backtested performance does not represent actual performance and should not be interpreted as an indication of actual performance. Performance returns do not refl ect management fees, transactions costs or expenses. Cboe and VIX are registered trademarks of Cboe Options Exchange, Incorporated (Cboe) in the U.S. and throughout the world CBOE. All Rights Reserved.