

[Federal Register: February 1, 2007 (Volume 72, Number 21)]
[Notices]               
[Page 4743-4745]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01fe07-97]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55154; File No. SR-CBOE-2006-92]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval to Proposed Rule Change as 
Modified by Amendment No. 1 Thereto, Relating to the Penny Pilot 
Program

January 23, 2007.

I. Introduction

    On November 8, 2006, 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 amend its rules to permit 
certain option classes to be quoted in pennies on a pilot basis. The 
proposed rule change was published for comment in the Federal Register 
on November 29, 2006.\3\ The Commission received one comment letter on 
the proposed rule change.\4\ On January 9, 2007, the Exchange filed 
Amendment No. 1 to the proposed rule change.\5\ The Exchange responded 
to the comment letter on January 10, 2007.\6\ This order approves the 
proposed rule change as modified by Amendment No. 1.
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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. 54805 (November 21, 
2006), 71 FR 69151.
    \4\ See letter to Nancy M. Morris, Secretary, Commission, from 
Christopher Nagy, Chair, Securities Industry and Financial Markets 
Association (``SIFMA'') Options Committee, dated December 20, 2006 
(``SIFMA Letter'').
    \5\ Amendment No. 1 revised the Regulatory Circular CBOE will 
distribute to its members to reflect the replacement of Glamis Gold, 
which was delisted, with Agilent Tech, Inc. in the list of options 
classes permitted to be quoted in pennies. Amendment No. 1 is 
technical in nature, and the Commission is not publishing Amendment 
No. 1 for public comment.
    \6\ See letter to Nancy M. Morris, Secretary, Commission, from 
Patrick Sexton, Associate General Counsel, CBOE, dated January 10, 
2007 (``CBOE Letter'').

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[[Page 4744]]

II. Description of the Proposal

A. Scope of the Penny Pilot Program

    CBOE proposes to amend its rules to permit certain option classes 
to be quoted in pennies during a six-month pilot (``Penny Pilot 
Program''), which would commence on January 26, 2007. Specifically, 
proposed CBOE Rule 6.42 would include a subparagraph stating that 
decimal increments for bids and offers for all series of option classes 
participating in the Penny Pilot Program will be announced by 
Regulatory Circular. The Regulatory Circular would set forth the 
parameters of the Penny Pilot Program.
    Currently, all six options exchanges, including CBOE, quote options 
in nickel and dime increments. The minimum price variation for 
quotations in options series that are quoted at less than $3 per 
contract is $0.05 and the minimum price variation for quotations in 
options series that are quoted at $3 per contract or greater is $0.10. 
Under the Penny Pilot Program, beginning on January 26, 2007, market 
participants would be able to begin quoting in penny increments in 
certain series of option classes.
    The Penny Pilot Program would include the following thirteen 
options: Ishares Russell 2000 (IWM); NASDAQ-100 Index Tracking Stock 
(QQQQ); SemiConductor Holders Trust (SMH); General Electric Company 
(GE); Advanced Micro Devices, Inc. (AMD), (Microsoft Corporation 
(MSFT); Intel Corporation (INTC); Caterpillar, Inc. (CAT); Whole Foods 
Market, Inc. (WFMI); Texas Instruments, Inc. (TXN); Flextronics 
International Ltd. (FLEX); Sun Microsystems, Inc. (SUNW); and Agilent 
Tech, Inc. (A). The Exchange would communicate the list of options to 
be included in the Penny Pilot Program to its membership via Regulatory 
Circular.
    The minimum price variation for all classes included in the Penny 
Pilot Program, except for the QQQQs, would be $0.01 for all quotations 
in option series that are quoted at less than $3 per contract and $0.05 
for all quotations in option series that are quoted at $3 per contract 
or greater. The QQQQs would be quoted in $0.01 increments for all 
options series.
    CBOE commits to deliver a report to the Commission during the 
fourth month of the pilot, which would be composed of data from the 
first three months of trading. The report would analyze the impact of 
penny pricing on market quality and options systems capacity.
    CBOE also proposes to amend CBOE Rule 6.54 relating to 
accommodation liquidations (``cabinet trades'') to state that the rule 
is not applicable to trading in option classes participating in the 
Penny Pilot Program. Currently, CBOE Rule 6.54 sets forth the terms and 
conditions in which cabinet trades can be executed on CBOE. Because 
cabinet trades involve orders priced at $1 per option contract, the 
specific terms and conditions for cabinet trading are not applicable to 
option classes participating in the Penny Pilot Program.

B. Quote Mitigation Strategies

    To mitigate quote message traffic, CBOE has represented to the 
Commission that it has already implemented or intends to implement the 
following quote mitigation strategies.
     Limitation on Messages. Pursuant to CBOE Rule 6.23A, CBOE 
currently limits the number of messages sent by members accessing CBOE 
electronically in order to protect the integrity of the Hybrid Trading 
System. Limiting the number of messages sent by members accessing CBOE 
electronically reduces the number of quotations sent by CBOE to the 
Options Price Reporting Authority (``OPRA'').
     Amendment to Market-Maker Obligations. CBOE proposes to 
amend CBOE Rule 8.7 to modify the continuous electronic quoting 
obligation of Market-Makers and Remote Market-Makers (``RMMs''). 
Currently, as set forth in CBOE Rule 8.7(d)(ii) and (e), Market-Makers 
and RMMs, respectively, are obligated to provide continuous electronic 
quotes in 60% of the series of his/her appointed option class. CBOE 
proposes to amend these obligations to provide that Market-Makers and 
RMMs shall provide continuous electronic quotes in 60% of the series of 
his/her appointed class that have a time to expiration of less than 
nine months. CBOE believes that excluding series that are nine months 
or more to expiration, i.e., LEAPS, from Market-Makers' and RMMs' 
continuous quoting obligations should reduce the number of quotes CBOE 
disseminates to OPRA, while continuing to impose upon Market-Makers and 
RMMs significant quoting obligations. CBOE also notes that this 
proposed change is consistent with CBOE Rule 5.8 which provides that 
the continuity rules do not apply to option series until the time to 
expiration is less than nine months.\7\
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    \7\ The Commission recently approved a similar proposal from the 
Philadelphia Stock Exchange. See Securities Exchange Act Release No. 
54648 (October 24, 2006), 71 FR 63375 (October 30, 2006) (SR-Phlx-
2006-52).
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     Delisting Policy. CBOE is adopting the following delisting 
policy: equity option classes with national average daily volume 
(``ADV'') of less than 20 contracts will be delisted.
     Oversight of Member Quoting. CBOE continuously monitors 
the quotation activity of its members submitting electronic quotations 
to CBOE, and regularly notifies any member that appears to be 
disseminating significantly more quotations than other members. CBOE 
also regularly communicates with independent vendors who provide 
quotation services to members to encourage the vendors to modify their 
systems to provide efficient quotation systems and to alert them 
whenever it appears that users of their system appear to be submitting 
significantly more quotations than other members.\8\
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    \8\ In addition to the quote mitigation strategies discussed 
above, to encourage more efficient quoting by its members, the 
Exchange filed a proposed rule change on November 20, 2006, that 
assesses an additional monthly fee, commencing on February 1, 2007, 
on all Market Makers who submit electronic quotes to the Exchange of 
$.03 per 1,000 quotes in excess of 1,000,000 quotes. The proposed 
rule change was immediately effective under Section 19(b)(3)(A) of 
the Act. See Securities Exchange Act Release No. 54804 (November 21, 
2006), 71 FR 69150 (November 29, 2006) (File No. SR-CBOE-2006-98).
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III. Discussion

    After careful review of the proposal and consideration of SIFMA's 
comment letter and the Exchange's response thereto, the Commission 
finds that the proposed rule change, as modified by Amendment No. 1, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange.\9\ 
In particular, the Commission finds that the proposal is consistent 
with Section 6(b)(5) of the Act,\10\ which requires, among other 
things, that the rules of an exchange be designed 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.
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    \9\ 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).
    \10\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the implementation of a limited six-
month Penny Pilot Program by CBOE and the five other options exchanges 
will provide valuable information to the exchanges, the Commission and 
others about the impact of penny quoting in the options market. In 
particular, the Penny Pilot Program will allow analysis of the impact 
of penny quoting on: (1)

[[Page 4745]]

Spreads; (2) transaction costs; (3) payment for order flow; and (4) 
quote message traffic.
    The Commission believes that the thirteen options classes to be 
included in the penny pilot program represent a diverse group of 
options classes with varied trading characteristics. This diversity 
should facilitate analyses by the Commission, the options exchanges and 
others. The Commission also believes that the Penny Pilot Program is 
sufficiently limited that it is unlikely to increase quote message 
traffic beyond the capacity of market participants' systems and disrupt 
the timely receipt of quote information.
    Nevertheless, because the Commission expects that the Penny Pilot 
Program will increase quote message traffic, the Commission is also 
approving the Exchange's proposals to reduce the number of quotations 
it disseminates.
    SIFMA commented on the CBOE's quote mitigation proposal.\11\ SIFMA 
recommends that all six of the option exchanges adopt a comprehensive 
and uniform quote mitigation strategy. In particular, SIFMA strongly 
supports the adoption of the ``holdback timer'' mitigation proposal as 
the most efficient means of reducing quotation traffic. SIFMA, however, 
expressed concern that the lack of uniformity among the quote 
mitigation proposals adopted by the exchanges will impose a burden on 
member firms and cause confusion for market participants, especially 
retail investors.
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    \11\ See SIFMA Letter, supra note 4.
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    Although SIFMA urges the adoption of a uniform and comprehensive 
approach to quote mitigation, it does not oppose CBOE's quote 
mitigation proposals. In fact, SIFMA acknowledges that certain of 
CBOE's proposals, such as notifying members whose quote activity 
suggests systems malfunctions or wrong settings and delisting inactive 
series can contribute to quote mitigation. SIFMA, however, expressed 
its belief that these proposals do not go far enough to resolve the 
industry's concerns regarding systems capacity.
    Although the Commission supports efforts to implement a uniform, 
industry-wide quote mitigation plan, it does not believe such efforts 
preclude individual exchanges from initiating their own quote 
mitigation strategies. The Commission agrees with CBOE that its 
proposed quote mitigation strategies will not lead to confusion among 
market participants.\12\
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    \12\ See CBOE Letter, supra note 6.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-2006-92), as modified 
by Amendment No. 1, be, and hereby is, approved on a six month pilot 
basis, which will commence on January 26, 2007.
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    \13\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-1586 Filed 1-31-07; 8:45 am]

BILLING CODE 8011-01-P
