

[Federal Register: July 20, 2006 (Volume 71, Number 139)]
[Notices]               
[Page 41287-41289]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20jy06-94]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54135; File No. SR-CBOE-2005-65]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change and Amendment Nos. 1 
and 2 Relating to the Processing of Complex Orders in the Hybrid 
Trading System

July 12, 2006.

I. Introduction

    On August 24, 2005, the Chicago Board Options Exchange, 
Incorporated (``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'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to, among other things, establish 
an automated Request for Responses (``RFR'') auction process for 
eligible complex orders (a ``COA'' process) traded on the CBOE's Hybrid 
Trading System (``Hybrid System'') and to revise certain CBOE rules 
governing complex orders. The proposed rule change, as amended by 
Amendment Nos. 1 and 2, was published for comment in the Federal 
Register on June 7, 2006.\3\ The Commission received no comments 
regarding the proposal, as amended. This order approves the proposal, 
as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 53909 (May 31, 
2006), 71 FR 33011 (``Notice'').
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II. Description of the Proposal

A. COA Process for Complex Orders

    CBOE Rule 6.53C, ``Complex Orders on the Hybrid System,'' sets 
forth the procedures for trading complex orders on the CBOE's Hybrid 
System. Among other things, CBOE Rule 6.53C addresses whether a complex 
order will be routed to a PAR workstation, for manual handling, or to 
the complex order book (``COB''), for automated handling, and, once in 
the COB, the manner in which a complex order will execute against 
orders or quotes in the EBook, orders resting in the COB, and orders 
submitted to trade against interest in the COB. The CBOE proposes to 
introduce the COA,\4\ a new functionality designed to give eligible 
complex orders an opportunity for price improvement before being booked 
in the COB or once on PAR. The CBOE believes that the COA process will 
facilitate more automated handling of complex orders.
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    \4\ See CBOE Rule 6.53C(d).
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    Under the COA process, when a COA is initiated for a COA-eligible 
order,\5\ the CBOE will send an RFR message to all members who have 
elected to receive RFR messages.\6\ Market Makers with an appointment 
in the relevant options class and members acting as agent for orders 
resting at the top of the COB in the relevant options series may submit

[[Page 41288]]

responses to the RFR message (``RFR Responses'') during the Response 
Time Interval.\7\ RFR Responses, which will not be displayed to the 
market, may be expressed on a net price basis in a multiple of the 
minimum increment or in one-cent increments, as determined by the 
appropriate CBOE committee on a class-by-class basis.\8\ The legs of a 
COA-eligible order may be executed in one-cent increments, regardless 
of the minimum quoting increments that otherwise would apply to the 
individual legs of the order.\9\
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    \5\ The appropriate CBOE committee will determine, on a class-
by-class basis, the complex orders that are eligible for a COA based 
on the order's marketability (defined as a number of ticks away from 
the current market), size, and complex order type. See CBOE Rule 
6.53C(d)(i)(2).
    \6\ The RFR message will identify the component series, the size 
of the COA-eligible order and any contingencies, if applicable, but 
will not identify the side of the market. See CBOE Rule 
6.53C(d)(ii).
    \7\ The Response Time Interval is the period of time during 
which responses to the RFR may be entered. The appropriate CBOE 
committee will determine the Response Time Interval, which will not 
exceed three seconds, on a class-by-class basis. See CBOE Rule 
6.53C(d)(iii)(2).
    \8\ See CBOE Rule 6.53C(d)(iii)(1).
    \9\ See CBOE Rule 6.53C(d)(v).
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    At the conclusion of the Response Time Interval, a COA-eligible 
order will trade first based on the best net price(s) available.\10\ At 
the same net price, the COA-eligible order will trade, first, against 
individual orders and quotes in the EBook, provided the COA-eligible 
order can be executed in full or in a permissible ratio by orders and 
quotes in the EBook; second, against public customer complex orders 
resting in the COB before, or that are received during, the Response 
Time Interval, and public customer RFR Responses; third, against non-
public customer orders resting in the COB before the Response Time 
Interval; and fourth, against non-public customer orders resting in the 
COB that are received during the Response Time Interval and non-public 
customer RFR Responses.\11\ A COA-eligible order that cannot be filled 
in whole or in a permissible ratio will route to the COB or back to 
PAR, as applicable.\12\
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    \10\ See CBOE Rule 6.53C(d)(v).
    \11\ See CBOE Rule 6.53C(d)(v)(1)-(4).
    \12\ See CBOE Rule 6.53C(d)(vi).
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    The COA provisions also address the handling of unrelated complex 
orders that the CBOE receives prior to the expiration of the Response 
Time Interval.\13\ A pattern or practice of submitting orders that 
cause a COA to conclude early will be deemed conduct inconsistent with 
just and equitable principles of trade and a violation of CBOE Rule 
4.1, ``Just and Equitable Principles of Trade.'' \14\ Similarly, the 
dissemination of information regarding COA-eligible orders to third 
parties will be deemed conduct inconsistent with just and equitable 
principles of trade and a violation of CBOE Rule 4.1 and other CBOE 
Rules.\15\
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    \13\ An incoming COA-eligible order on the opposite side of the 
market that is marketable against the starting price of the original 
COA-eligible order will end the original COA; an incoming COA-
eligible order on the same side of the market, at the same price or 
worse than the original COA-eligible order and better than or equal 
to the starting price, will join the original COA; and an incoming 
COA-eligible order on the same side of the market at a better price 
than the original COA-eligible order will join the original COA, 
cause the original COA to end, and cause a new COA to begin for any 
remaining balance on the incoming COA-eligible order. See CBOE Rule 
6.53C(d)(viii). CBOE Rule 6.53C(d)(viii) also describes the 
processing of orders when an unrelated complex order arrives prior 
to the expiration of the Response Time Interval.
    \14\ See CBOE Rule 6.53C, Interpretation and Policy .04.
    \15\ See CBOE Rule 6.53C, Interpretation and Policy .05.
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    The CBOE states that the COA process may not be used to trade a 
COA-eligible order against a facilitated or solicited order.\16\ In 
this regard, the CBOE notes that facilitations and solicitations of 
complex orders, including COA-eligible orders, will continue to be 
subject to the limitations on facilitations and solicitations provided 
in Interpretations and Policies .01 and .02 to CBOE Rule 6.45A, 
``Priority and Allocation of Equity Option Trades on the CBOE Hybrid 
System,'' and in Interpretations and Policies .01 and .02 to CBOE Rule 
6.45B, ``Priority and Allocation of Trades in Index Options and Options 
on ETFs on the CBOE Hybrid System.'' \17\
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    \16\ See Notice supra note 3, at 33015 n.12.
    \17\ Regarding principal transactions, Interpretation and Policy 
.01 of CBOE Rules 6.45A and 6.45B prohibit an order entry firm from 
executing as principal against an order it represents as agent 
unless: (1) The agency order is first exposed on the Hybrid System 
for at least three seconds; (2) the order entry firm has been 
bidding or offering for at least three seconds prior to receiving an 
agency order that is executable against such bid or offer; or (3) 
the order entry firm proceeds in accordance with the crossing rules 
in CBOE Rule 6.74. Regarding solicitation orders, Interpretation and 
Policy .02 of CBOE Rules 6.45A and 6.45B require an order entry firm 
to expose for at least three seconds an order it represents as agent 
before the order may be executed electronically via the electronic 
execution mechanism of the Hybrid System, in whole or in part, 
against orders solicited from members and non-member broker-dealers 
to transact with the order.
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B. Revisions to the COB

    The CBOE also proposes to revise its rules governing the COB \18\ 
to: (1) Allow the appropriate CBOE committee to determine, on a class-
by-class basis, whether complex orders routed to or resting in the COB 
may be expressed on a net price basis in multiples of the minimum 
increment or in one-cent increments; (2) provide that the legs of a 
complex order may be executed in one-cent increments, regardless of the 
minimum quoting increments otherwise applicable to the individual legs 
of the order; (3) provide that a complex order in the COB may execute 
against quotes, as well as orders, in the EBook, and that market 
participants, as defined in CBOE Rule 6.45A or 6.45B, as applicable, 
may submit quotes, as well as orders, to trade against orders in the 
COB; (4) provide that the allocation of complex orders within the COB 
will be pursuant to the rules of trading priority otherwise applicable 
to incoming orders in the individual component legs; and (5) provide 
that the allocation of complex orders among market participants will be 
made pursuant to CBOE Rule 6.45A(c) or 6.45B(c), as applicable.
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    \18\ See CBOE Rule 6.53C(c).
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C. Changes to the Minimum Trading Increment for Complex Orders

    CBOE Rule 6.42(3) currently provides that bids and offers in 
spread, straddle, and combination orders, as defined in CBOE Rule 6.53, 
may be expressed in any increment, regardless of the minimum increments 
otherwise appropriate to the individual legs of the order. The proposal 
revises CBOE Rule 6.42(3) to include the other complex orders defined 
in CBOE Rule 6.53C in addition to the complex orders currently 
enumerated CBOE Rule 6.42(3).\19\
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    \19\ The complex orders defined in CBOE Rule 6.53C(a) are: 
Spread order; straddle order; strangle order; combination order as 
defined in CBOE Rule 6.53(e); ratio order; butterfly spread order; 
box/roll spread order; collar orders and risk reversals; and 
conversions and reversals.
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    CBOE Rule 6.42(3) also provides that bids and offers for spread, 
straddle, or combination orders in S&P 500 Index options, other than 
box spreads, must be expressed in decimal increments no smaller than 
$.05. The CBOE proposes to apply this provision to S&P 100 Index 
options. The CBOE believes that this change is appropriate in light of 
the complexity of complex orders and the size of the underlying S&P 100 
Index.
    In addition, the proposal revises CBOE Rule 6.42(3) to state that 
the legs of complex orders may be executed in one-cent increments. CBOE 
Rule 6.42(3) will continue to require complex orders to be expressed in 
net price increments that are multiples of the minimum increment to be 
entitled to priority under CBOE Rule 6.45, ``Priority of Bids and 
Offers--Allocation of Trades.''

D. Additional Changes

    The CBOE proposes to revise CBOE Rules 6.45; 6.45A; 6.45B; 
Interpretation and Policy .03 to CBOE Rule 6.74, ``Crossing Orders;'' 
and CBOE Rule 6.9, ``Solicited Transactions,'' to include the complex 
orders defined in CBOE Rule 6.53C in addition to the complex orders 
currently specified in the rules.

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is

[[Page 41289]]

consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange 
and, in particular, with Section 6(b)(5) of the Act,\20\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to, and perfect the mechanism of, a free and open market 
and a national market system and, in general, to protect investors and 
the public interest.\21\
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    \20\ 15 U.S.C. 78f(b)(5).
    \21\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
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    The new COA functionality will provide an electronic auction for 
eligible complex orders. Under the COA auction process, Market Makers 
with an appointment in the relevant options class and members acting as 
agent for orders resting at the top of the COB in the relevant options 
series will be able to submit RFR Responses. At the conclusion of the 
COA auction, the auctioned order will execute against the interest 
available in the EBook, the COB, and/or RFR Responses submitted during 
the COA.\22\ By providing an electronic auction for eligible complex 
orders, the Commission believes that the COA process could facilitate 
the execution of eligible complex orders and provide them with an 
opportunity for price improvement.
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    \22\ See notes 10-12, supra, and accompanying text. The 
Commission notes that, at the same price, public customer orders in 
the COB and public customer RFR Responses will trade against a COA-
eligible order before non-public customer orders in the COB and non-
public customer RFR Responses. See CBOE Rule 6.53C(d)(v)(2)-(4).
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    The Commission notes that the CBOE's rules provide that a pattern 
or practice of submitting orders that cause a COA to conclude early 
will be deemed conduct inconsistent with just and equitable principles 
of trade and a violation of CBOE Rule 4.1,\23\ and that the 
dissemination of information regarding COA-eligible orders to third 
parties will be deemed conduct inconsistent with just and equitable 
principles of trade and a violation of CBOE Rule 4.1 and other CBOE 
rules.\24\ These provisions will require the CBOE to surveil for, and 
should help to deter, potential abuses of the COA process.
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    \23\ See CBOE Rule 6.53C, Interpretation and Policy .04.
    \24\ See CBOE Rule 6.53C, Interpretation and Policy .05.
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    In addition, the Commission notes that the COA system cannot be 
used to trade a COA-eligible order against a facilitated or solicited 
order. COA-eligible orders, like other orders on the Hybrid System, 
will be subject to CBOE Rule 6.45A, Interpretation and Policies .01 and 
.02, and CBOE Rule 6.45B, Interpretation and Policies .01 and .02. 
Accordingly, a CBOE member seeking to trade with its customer's COA-
eligible order would be required to comply with Interpretation and 
Policy .01 of CBOE Rule 6.45A or 6.45B, as applicable, and a CBOE 
member seeking to cross its customer's COA-eligible order with a 
solicited order would be required to comply with Interpretation and 
Policy .02 of CBOE Rule 6.45A or 6.45B, as applicable.
    The Commission believes that the changes to the COB should 
facilitate the execution of complex orders. In this regard, the 
proposal revises CBOE Rule 6.53C(c) to provide that quotes in the 
EBook, as well as orders in the EBook, may execute against a complex 
order in the COB, and that market participants, as defined in CBOE Rule 
6.45A or 6.45B, as applicable, may submit quotes, as well as orders, to 
trade against orders in the COB. In addition, the proposal revises CBOE 
Rule 6.53C(c) to allow complex orders routed to or resting in the COB 
to be expressed and executed in one-cent increments, thereby providing 
additional price points at which complex orders could be executed.\25\ 
The proposal also clarifies the operation of the COB by providing that 
complex orders in the COB will be allocated pursuant to the rules of 
trading priority otherwise applicable to incoming electronic orders in 
the individual component legs,\26\ and that complex orders will be 
allocated among market participants pursuant to CBOE Rule 6.45A or 
6.45B, as applicable.\27\
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    \25\ The appropriate CBOE committee will determine, on a class-
by-class basis, whether complex orders routed to or resting in the 
COB may be expressed in a multiple of the minimum increment or in 
one-cent increments. See CBOE Rule 6.53C(c)(ii).
    \26\ See CBOE Rule 6.53C(c)(ii)(2).
    \27\ See CBOE Rule 6.53C(c)(ii)(3).
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    The CBOE proposes to revise CBOE Rule 6.42(3) to allow the legs of 
a complex order to be executed in one-cent increments, which, according 
to the CBOE, will allow members to execute complex order transactions 
more easily. Accordingly, the Commission believes that this change 
could facilitate the execution of complex orders. The Commission notes 
that CBOE Rule 6.42(3) will continue to require complex orders to be 
expressed in multiplies of the minimum increment to be entitled to 
priority under CBOE Rule 6.45.
    CBOE Rule 6.42(3) currently requires bids and offers in complex 
orders in S&P 500 Index options, other than box spreads, to be 
expressed in increments no smaller than $0.05. The CBOE proposes to 
apply this provision to S&P 100 Index options. The Commission believes 
that this change is consistent with the Act because of the similarities 
between the S&P 500 Index and the S&P 100 Index.
    Finally, the Commission believes that the proposal to revise CBOE 
Rules 6.45, 6.45A, 6.45B, 6.9, and 7.4 to include the complex orders 
defined in CBOE Rule 6.53C is consistent with the Act because it should 
provide consistent treatment for different types of complex orders 
under the CBOE's rules.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-CBOE-2005-65), as amended, 
is approved.
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    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
 [FR Doc. E6-11491 Filed 7-19-06; 8:45 am]

BILLING CODE 8010-01-P
