
[Federal Register: February 26, 2008 (Volume 73, Number 38)]
[Notices]               
[Page 10319-10320]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26fe08-102]                         

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57355; File No. SR-CBOE-2007-03]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval of a Proposed Rule Change as 
Modified by Amendment No. 1 Thereto Amending its Obvious Error Rule for 
Options on Indices, ETFs, and HOLDRS

February 20, 2008.

I. Introduction

    On February 21, 2007, 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 CBOE Rule 24.16, which 
is the Exchange's rule applicable to the nullification and adjustment 
of transactions in index options, options on exchange-traded funds 
(``ETFs''), and options on HOLding Company Depository ReceiptS 
(``HOLDRS''), to: (i) Modify the nullification and adjustment 
provisions for erroneous prints and erroneous quotes in the underlying; 
(ii) eliminate the nullification and adjustment provision for trades 
below intrinsic value; and (iii) modify the nullification provision for 
``no bid series.'' On December 20, 2007, the CBOE submitted Amendment 
No. 1 to the proposed rule change. The proposed rule change, as 
amended, was published for comment in the Federal Register on December 
28, 2007.\3\ The Commission received no comment letters on the 
proposal. This order approves the proposed rule change, as amended.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 57012 (December 20, 
2007), 72 FR 73921.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    The Exchange proposes to modify CBOE Rule 24.16 with respect to 
erroneous prints and erroneous quotes in the underlying. Under the 
revised rule, the appropriate Exchange committee would identify 
particular underlying or related instrument(s) that would be used to 
determine an erroneous print or quote and also would identify the 
relevant market(s) trading the underlying or related instrument to 
which the Exchange would look for purposes of applying the obvious 
error analysis. The underlying or related instrument(s) may include the 
underlying or related ETF(s), HOLDRS(s), and/or index value(s),\4\ and/
or related futures product(s).\5\ The relevant underlying market(s) may 
include one or more markets. The underlying or related instrument(s) 
and relevant market(s) would be designated by the appropriate Exchange 
committee and announced to the membership via Regulatory Circular. For 
a particular ETF, HOLDRS, index value, and/or futures product to 
qualify for consideration as a ``related instrument,'' the revised rule 
requires that: (i) The option class and related instrument must be 
derived from or designed to track the same underlying index; or (ii) in 
the case of S&P 100-related options, the options class and related 
instrument must be derived from or designed to track the S&P 100 Index 
or the S&P 500 Index.
---------------------------------------------------------------------------

    \4\ An ``index value'' is the value of an index as calculated 
and reported by the index's reporting authority. Use of an index 
value would be applicable only for purposes of identifying an 
erroneous print in the underlying (and not an erroneous quote). See 
proposed changes to CBOE Rule 24.16(a)(3).
    \5\ This proposed rule change does not seek to designate any of 
the individual underlying stocks (or related options or futures on 
any of the individual underlying stocks) that comprise a particular 
ETF, HOLDR, or index.
---------------------------------------------------------------------------

    In addition, the proposal would eliminate the nullification and 
adjustment provision for trades below intrinsic value. CBOE Rule 
24.16(a)(5) currently states that an obvious pricing error will be 
deemed to have occurred when the transaction price of an option series 
is more than $0.10 below the intrinsic value of the same option. The 
purpose of deleting this provision is to account for circumstances 
under which options are correctly priced $0.10 or more below the 
intrinsic value. For example, this situation might occur in options 
with underlying securities that are hard-to-borrow, extremely volatile 
issues where one market participant seeks to transfer the risk of 
selling or buying a security to other market participants by trading 
options, and options having European-style exercise, thus preventing 
exercise prior to expiration. According to the Exchange, the 
elimination of this provision is consistent with the Exchange's current 
rule for equity options, which does not have an obvious error review 
for trades below intrinsic value.\6\
---------------------------------------------------------------------------

    \6\ See CBOE Rule 6.25.
---------------------------------------------------------------------------

    Finally, the proposal would modify the nullification provision for 
no bid series. Currently, the rule provides that electronic 
transactions in series that are quoted no bid on the Exchange are 
subject to nullification, provided that at least one strike price below 
(for calls) or above (for puts) in the same options class was quoted no 
bid at the time of execution. Under the revised rule, additional 
criteria and clarifying language would be added. Specifically, an 
electronic transaction in a series quoted no bid on the Exchange would 
be subject to nullification provided that: (i) The bid in that series 
immediately preceding the execution was, and for five seconds prior to 
the execution remained, zero; and (ii) at least one strike price below 
(for calls) or above (for puts) in the same options class was quoted no 
bid and offered at the same price or lower as that series at the time 
of execution. The revised no bid provision would provide that, when 
determining the Exchange's quotes in the relevant series, bids and 
offers of the parties to the subject trade that are in any of the 
series in the same options class shall not be considered. The revised 
rule also would provide that when an option series in a class has a 
non-standard deliverable (e.g., 150 contract delivery requirement), it 
will be considered separately for purposes of the no bid provision from 
series in such class that do not have a non-standard deliverable. The 
revised rule would clarify that the no bid provision is intended to 
apply to series quoted no bid on the Exchange (as opposed to series for 
which the national best bid is quoted no bid).

[[Page 10320]]

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange \7\ and, in 
particular, the requirements of Section 6(b) of the Act \8\ and the 
rules and regulations thereunder. Specifically, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\9\ in 
that the proposal promotes just and equitable principles of trade, 
prevents fraudulent and manipulative acts, removes impediments to and 
perfects the mechanism of a free and open market and a national market 
system, and, in general, protects investors and the public interest.
---------------------------------------------------------------------------

    \7\ 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).
    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission considers that in most circumstances trades that are 
executed between parties should be honored. On rare occasions, the 
price of the executed trade indicates an ``obvious error'' may exist, 
suggesting that it is unrealistic to expect that the parties to the 
trade had come to a meeting of the minds regarding the terms of the 
transaction. In the Commission's view, the determination of whether an 
``obvious error'' has occurred should be based on specific and 
objective criteria and subject to specific and objective procedures.
    The provisions of Rule 24.16 that relate to an erroneous print or 
quote in the underlying market would be revised to permit the Exchange 
to designate the underlying or related instruments that can be used as 
a basis for determining whether there is an erroneous print or quote in 
such instrument that indicates an obvious error has occurred. This 
revision recognizes that market participants trading in the index, ETF, 
or HOLDRS options may base their options pricing on trading in various 
markets and instruments. By requiring the underlying related instrument 
to be derived from or track the same underlying index, the Exchange has 
set forth objective criteria that must be met before it can designate 
such underlying or related instrument for use in the obvious error 
analysis. The elimination of the provision for trades below intrinsic 
value would align Rule 24.16 with the Exchange's obvious error rule for 
equity options, which does not contain a similar provision. The 
revisions to the ``no bid series'' provision incorporate additional 
objective factors to be used by CBOE in determining whether an obvious 
error exists.
    In the Commission's view, the proposed changes to Rule 24.16 are 
appropriate and are consistent with the Act. These revisions provide 
reasonable and objective measures to assist the Exchange in 
ascertaining whether an obvious error has occurred in the 
aforementioned circumstances.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\10\ that the proposed rule change (SR-CBOE-2007-03), as amended, 
is hereby approved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
---------------------------------------------------------------------------

    \10\ 15 U.S.C. 78s(b)(2).
    \11\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-3553 Filed 2-25-08; 8:45 am]

BILLING CODE 8011-01-P
