

[Federal Register: June 13, 2007 (Volume 72, Number 113)]
[Notices]               
[Page 32688-32690]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13jn07-119]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55874; File No. SR-CBOE-2006-101]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change as Modified by 
Amendment Nos. 1 and 2 Thereto To Amend CBOE's Rules To Reflect the 
Migration of Its TPF Technology Platform Over to the Existing 
CBOEdirect Technology Platform

June 7, 2007.

I. Introduction

    On November 30, 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 introduce a third trading 
platform into its existing CBOEdirect system, ``Hybrid 3.0.'' The 
Exchange submitted Amendment No. 1 to the proposed rule change on 
February 15, 2007. The Exchange submitted Amendment No. 2

[[Page 32689]]

to the proposed rule change on April 13, 2007.\3\ The proposed rule 
change, as modified by Amendment Nos. 1 and 2, was published for 
comment in the Federal Register on May 3, 2007.\4\ The Commission did 
not receive any comments regarding the proposal. This order approves 
the proposed rule change as modified by Amendment Nos. 1 and 2.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2 \ 17 CFR 240.19b-4.
    \3 \ Amendment No. 2 replaced and superseded Amendment No. 1 and 
the original filing in their entireties.
    \4\ Securities Exchange Act Release No. 55674 (April 26, 2007), 
72 FR 24639 (May 3, 2007).
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II. Description of the Proposal

    In 2003, CBOE introduced the Hybrid Trading System (``Hybrid'' or 
``Hybrid System''), an electronic trading platform integrated with 
CBOE's floor-based open-outcry auction market.\5\ Under CBOE's existing 
rules, the Hybrid System currently supports two trading platforms: (i) 
The original Hybrid Trading System, which is a trading platform that 
allows individual Market-Makers to submit electronic quotes in their 
appointed classes; and (ii) Hybrid 2.0, which is an enhanced trading 
platform that allows remote quoting by authorized categories of 
Exchange members. These two platforms operate on a technology system 
that is referred to as the CBOEdirect trade engine. In addition to 
these two platforms, prior to 2003 and through the present, CBOE has 
also utilized its TPF mainframe system to support trading in its ``non-
Hybrid'' classes.\6\ Therefore, options classes currently may be 
authorized by the Exchange to trade on the non-Hybrid, original Hybrid 
Trading System or Hybrid 2.0 platforms.
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    \5\ See Securities Exchange Act Release No. 47959 (May 30, 
2003), 68 FR 34441 (June 9, 2003).
    \6\ The three current non-Hybrid classes are options: on the S&P 
100 Index--OEX; options on the S&P 500 Index--SPX; and options on 
the Morgan Stanley Retail Index--MVR.
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    CBOE has determined to migrate the trading programs operating on 
its TPF mainframe system to the CBOEdirect trade engine. To accommodate 
this changeover, CBOE has proposed to amend its Hybrid rules to 
introduce a third trading platform into its existing CBOEdirect system, 
called ``Hybrid 3.0,'' which incorporates certain aspects of both the 
Hybrid Trading System and non-Hybrid platforms. The more significant 
aspects of the proposal are outlined below.\7\
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    \7\ To incorporate Hybrid 3.0 into CBOE's existing Hybrid rules, 
CBOE has proposed to define all references to ``Hybrid,'' ``Hybrid 
System,'' and ``Hybrid Trading System'' in CBOE's rules to mean all 
CBOE hybrid platforms, including Hybrid 3.0, unless otherwise 
provided by a specific CBOE rule.
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A. Quoting

    As proposed, the Hybrid 3.0 platform will allow a single electronic 
quote, which will represent the aggregate Market Maker quoting interest 
in each option series for the trading crowd (``Hybrid 3.0 crowd 
quote''). This single quote will be generated from either an appointed 
Designated Primary Market Maker (``DPM'') or Lead Market Maker 
(``LMM''). In this way, Hybrid 3.0 will operate in a manner similar to 
the existing non-Hybrid platform where an appointed DPM or LMM may 
generate an automated quote for the trading crowd.\8\
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    \8\ Currently, the non-Hybrid platform allows for the use of an 
Exchange-sponsored autoquote system. However, according to CBOE, 
this functionality will not be available for Hybrid 3.0.
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    In Hybrid 3.0, members of the trading crowd will be able to submit 
manual quotes. Specifically, members of the trading crowd will be able 
to verbalize manual quotes to be input into Exchange systems by quote 
reporters for dissemination to the Options Price Reporting Authority 
(``OPRA'').\9\ The manual quote disseminated in Hybrid 3.0 classes will 
be separate and additional to the Hybrid 3.0 crowd quote. If market 
participants (which include in-crowd market makers) are eligible to 
submit orders for entry into the electronic book, then the appropriate 
Procedure Committee may determine to disable manual quotes.\10\
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    \9\ Similar to the existing functionality for manual quotes in 
non-Hybrid classes, in Hybrid 3.0 the Exchange's disseminated OPRA 
quote will not distinguish between electronic and manual quotes but 
members of the trading crowd will be able to distinguish between 
electronic and manual quotes.
    \10\ A market participant is defined as a ``Market-Maker, a 
Remote Market-Maker, an in-crowd DPM or LMM, an e-DPM with an 
appointment in the subject class, and a floor broker or PAR Official 
representing orders in the trading crowd.'' See CBOE Rule 6.45B.
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B. Order Eligibility for Entry into Electronic Book

    In Hybrid 3.0, public customer orders are automatically eligible 
for electronic book entry.\11\ Moreover, in Hybrid 3.0, the appropriate 
Procedure Committee can determine, on a class by class basis, to allow 
certain other types of orders into the electronic book, including 
orders of market participants and broker-dealers.\12\ These eligibility 
rules are the same as the existing rules for other Hybrid classes 
except that, with respect to other Hybrid classes, market participants 
are eligible to submit orders for entry into the electronic book 
without the appropriate Procedure Committee's approval. The proposed 
electronic book eligibility rules for Hybrid 3.0 are consistent with 
current practices in CBOE's non-Hybrid classes.\13\
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    \11\ See CBOE Rule 7.4(a)(1).
    \12\ Id.
    \13\ See CBOE Rule 6.8.01.
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C. Automatic Execution of Incoming Orders

    Hybrid 3.0 proposes to permit automatic execution of non-broker-
dealer public customer orders. In addition, the appropriate Procedure 
Committee may determine, on a class by class basis, to allow orders of 
broker-dealers that are not market-makers or specialists on an exchange 
who are exempt from the provisions of Regulation T of the Federal 
Reserve Board pursuant to Section 7(c)(2) of the Act (``non-Market-
Maker or non-Specialist broker-dealers'') to be eligible for automatic 
execution.\14\
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    \14\ See proposed changes to CBOE Rule 6.13(b)(i)(C)(i). This 
process is consistent with the appropriate Procedure Committee's 
ability to permit broker-dealer orders to be automatically executed 
through the Exchange's Retail Automatic Execution System (``RAES'') 
in CBOE's non-Hybrid Classes. See CBOE Rule 6.8.01.
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    For Hybrid 3.0 classes, incoming orders that are eligible to 
receive automatic execution will execute against public customer orders 
in the electronic book. The remaining balance of the incoming order, if 
any, may be (i) Represented in the electronic book provided such order 
is eligible for book entry \15\ or (ii) if the order is not eligible 
for book entry, it will route to PAR, BART, or to the order entry 
firm's booth printer.
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    \15\ Even if an order is eligible for book entry, the order 
entry firm will have the discretion to have the remaining balance of 
the eligible order route to PAR, BART, or to the order entry firm's 
booth printer.
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    On the Hybrid 3.0 platform, automatic execution against quotes 
(whether electronic or manual) will not be allowed.\16\ However, if the 
electronic book price matches a manual quote, then automatic execution 
will be permissible against public customer orders in the electronic 
book.\17\ CBOE represented that, consistent with existing practices in 
CBOE's non-Hybrid

[[Page 32690]]

Classes, the Exchange will apply similar firm quote surveillance 
procedures in Hybrid 3.0 to monitor for compliance with members' firm 
quote obligations.
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    \16\ See CBOE Rule 6.13. By comparison, currently in CBOE's non-
Hybrid Classes, orders may be eligible for automatic execution 
against market maker quotes on RAES. See CBOE Rules 6.8 and 24.17. 
The Exchange represents that the number of trades that occur on RAES 
is minimal (approximately 1/10th of 1% of all volume occurs on 
RAES).
    \17\ See proposed changes to CBOE Rule 6.43(b). For example, if 
the electronic book is a $1.20 bid and the manual quote is at a 
$1.20 bid, then the system will allow for automatic execution 
against the $1.20 electronic book bid but not the $1.20 quote. In 
addition, if the Hybrid 3.0 crowd quote matches the electronic book 
price, automatic execution against public customer orders in the 
book is permissible.
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D. Application of CBOE Rule 6.45B

    CBOE Rule 6.45B, which relates to the priority and allocation of 
trades, will apply to trading in Hybrid 3.0 classes in the same way it 
is applied to CBOE's existing Hybrid Trading System. For example, 
multiple customer orders in the electronic book at the same price will 
be ranked based on time priority pursuant to the priority methods set 
forth in Rule 6.45B.\18\ Further, unlike CBOE's non-Hybrid classes, 
Hybrid 3.0 will allow (i) Each Market-Maker in the trading crowd and 
(ii) all floor brokers in the trading crowd (collectively referred to 
as ``in-crowd market participants'' or ``ICMPs'') to trade against the 
electronic book pursuant to CBOE Rule 6.45B(c).\19\
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    \18\ See CBOE Rule 6.45B(a)(ii)(A)(1).
    \19\ This process is the same as for existing Hybrid classes.
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    CBOE Rule 6.45B(d) currently governs the interaction of quotes when 
they are locked (e.g., $1.00 bid--1.00 offer). Specifically, CBOE Rule 
6.45B(d) provides that when the quotes of two Market-Makers interact 
(i.e., ``quote lock''), either party has one second during which it may 
move its quote without obligation to trade with the other party. If, 
however, the quotes remain locked at the conclusion of one-second, the 
quotes trade in full against each other. For quote locks in Hybrid 3.0 
classes, the appropriate Procedure Committee will set the length of the 
counting period, provided that the period shall not exceed ten 
seconds.\20\ According to the Exchange, the proposed ten second 
threshold is intended to provide additional flexibility for Market-
Makers to become acclimated with Hybrid 3.0.\21\
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    \20\ See proposed changes to CBOE Rule 6.45B(d).
    \21\ By comparison, the current quote lock timer for Hybrid and 
Hybrid 2.0 classes may not exceed one second. See CBOE Rule 
6.45B(d)(i)(C).
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    Regarding the time periods required for order exposure in 
Interpretation .01 of Rule 6.45B (``Principal Transactions'') and 
Interpretation .02 of Rule 6.45B (``Solicitation Orders''), CBOE has 
proposed a minimum exposure time for Hybrid 3.0 classes, on a class by 
class basis, to be at least three seconds but not to exceed thirty 
seconds.\22\ According to CBOE, this extended time frame for exposure 
will provide additional flexibility as ICMPs become more acclimated 
with Hybrid 3.0.\23\
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    \22\ See proposed changes to CBOE Rule 6.45B.01 and 6.45B.02.
    \23\ By comparison, the current exposure period for Hybrid and 
Hybrid 2.0 classes is at least three seconds. See CBOE Rule 6.45B.01 
and 6.45B.02.
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E. Opening Procedures

    Only the DPM or LMM responsible for generating the Hybrid 3.0 crowd 
quote will be required to enter quotes as part of the opening rotations 
in Hybrid 3.0 option classes. The DPM or LMM must enter opening quotes 
in opening rotations that comply with the legal quote width 
requirements of Rule 8.7(b)(iv), and if there is not a quote present in 
a series that complies with the legal quote width requirements of Rule 
8.7(b)(iv), then that series will not open.\24\ Additionally, Hybrid 
3.0 will allow public customer, broker-dealer, Exchange Market-Maker, 
away Marker-Maker and Specialist participation in the opening. Since 
Hybrid 3.0 is a single quoter environment, these participants will not 
be permitted to enter opening quotes in opening rotations but will be 
permitted to directly enter opening orders in opening rotations in 
Hybrid 3.0 classes.\25\ Further, similar to the rules for CBOE's non-
Hybrid classes, Hybrid 3.0 also proposes to allow special ``modified'' 
opening procedures for settlement in options on the Volatility 
Indexes.\26\
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    \24\ This is consistent with the opening quote requirements in 
CBOE's existing Hybrid classes that utilize CBOE's Hybrid Opening 
System (``HOSS''). See CBOE Rule 6.2B.
    \25\ See proposed Interpretation .01 to CBOE Rule 6.2B. By 
comparison, currently in non-Hybrid option classes (such as SPX and 
OEX), public customers, Market-Makers and broker-dealers are not 
able to directly participate in the opening rotations (for series 
that utilize the Exhange's Rapid Opening System). For example, 
Market-Makers who wish to participate on ROS in the opening rotation 
in non-Hybrid option classes must submit orders through the LMM at 
least ten minutes prior to the opening of trading pursuant to CBOE 
Rules 6.2A and 24.13.
    \26\ See the ``Modified HOSS Opening Procedures'' in proposed 
Interpretation .01 to CBOE Rule 6.2B. By comparison, non-Hybrid 
option classes that utilize RAES and ROS have special procedures for 
purposes of settlement in the volatility indexes called ``Modified 
ROS Opening Procedures'' pursuant to Interpretation .03 to CBOE Rule 
6.2A.
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III. Discussion

    The Commission has reviewed carefully the proposed rule change, as 
amended, and finds that it is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to a national 
securities exchange.\27\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\28\ 
which requires that an exchange have rules designed, among other 
things, 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. The proposed rules for Hybrid 3.0 are similar to 
existing rules applicable to trading in Hybrid and/or non-Hybrid 
classes. The Commission believes that the proposed rules for the Hybrid 
3.0 platform, including those pertaining to quoting, order eligibility 
in the electronic book, automatic execution, order priority and 
allocation, are consistent with the Act.
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    \27\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \28\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\29\ that the proposed rule change as modified by Amendment Nos. 1 
and 2 thereto (File No. SR-CBOE-2006-101) be, and hereby is, approved.
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    \29\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant delegated authority.\30\
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    \30\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-11366 Filed 6-12-07; 8:45 am]

BILLING CODE 8010-01-P
