
[Federal Register Volume 76, Number 240 (Wednesday, December 14, 2011)]
[Notices]
[Pages 77878-77881]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-32034]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65914; File No. SR-CBOE-2011-114]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Proposed Rule Change Related to Complex Order 
Processing in Hybrid 3.0 Classes

December 8, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on November 29, 2011, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') filed with the Securities and 
Exchange Commission (the ``Commission'') the proposed rule change as 
described in Items I and II, which Items have been prepared by the 
Exchange. The Commission is

[[Page 77879]]

publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend its electronic complex order 
rules. The text of the rule proposal is available on the Exchange's Web 
site (http://www.cboe.org/legal), at the Exchange's Office of the 
Secretary and at the Commission.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of those statements may be examined at 
the places specified in Item IV below. The Exchange has prepared 
summaries, set forth in sections A, B, and C below, of the most 
significant parts of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Currently, complex orders that are submitted to the electronic 
complex order book (``COB'') or the complex order RFR auction process 
(``COA'') automatically execute against individual orders and quotes 
residing in the electronic book (``EBook'') provided the complex order 
can be executed in full or in a permissible ratio, and against other 
complex orders represented in COB or COA (as applicable).
    The Exchange is proposing to revise the operation of COB and COA as 
it relates to options classes trading on the Hybrid 3.0 Platform, which 
currently only includes options on the S&P 500 Index (option symbol 
SPX). The ``Hybrid 3.0 Platform'' is an electronic trading platform on 
the Hybrid Trading System \3\ that allows one or more quoters to submit 
electronic quotes which represent the aggregate Market-Maker quoting 
interest in a series for the trading crowd. The quotes are represented, 
along with other orders, in the EBook. The function of generating the 
aggregate trading crowd quote is currently performed by certain 
designated Lead Market-Makers.
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    \3\ The ``Hybrid Trading System'' refers to the Exchange's 
trading platform that allows Market-Makers to submit electronic 
quotes in their appointed classes. See Rule 1.1(aaa).
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    Under the proposed rule change, for each class trading on the 
Hybrid 3.0 Platform, the Exchange may determine to not allow marketable 
complex orders entered into COB and/or COA to automatically execute 
with the individual quotes residing in the EBook.\4\ In such classes, 
the allocation of such marketable complex orders against orders 
residing in the EBook and other complex orders shall be based on the 
best net price(s), as is currently the case under the existing rule. At 
the same net price, multiple orders will be allocated subject to the 
existing applicable COB or COA allocation algorithm,\5\ subject to the 
following:
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    \4\ Pursuant to Rule 6.53C.01, any determination by the Exchange 
to designate a class for complex order execution in this manner will 
be announced to the membership via Regulatory Circular.
    \5\ For COB, at the same net price, (i) individual orders and 
quotes in the EBook have first priority, provided the complex order 
can be executed in full (or in a permissible ratio), with multiple 
orders and quotes at the same price allocated based on the rules of 
trading priority otherwise applicable to incoming electronic orders 
in the individual component legs; and (ii) complex orders in COB 
have second priority, with multiple complex orders at the same price 
allocated based on the rules of trading priority otherwise 
applicable to incoming electronic orders in the individual series 
legs or such other algorithm as the Exchange may designate. For COA, 
at the same net price, (i) individual orders and quotes residing in 
the EBook have first priority, provided the complex order can be 
executed in full (or in a permissible ratio), with multiple orders 
allocated pursuant to the Ultimate Match Algorithm (``UMA'') 
allocation described in Rule 6.45A or 6.45B, as applicable; (ii) 
public customer complex orders resting in COB before, or that are 
received during the COA auction, and public customer COA responses 
collectively have second priority, with multiple orders/responses 
allocated based on time priority; (iii) non-public customer orders 
resting in COB before the COA auction have third priority, with 
multiple orders allocated pursuant to the UMA allocation described 
in Rule 6.54A or 6.45B, as applicable; and (iv) non-public customer 
orders resting in COB that are received during the COA auction and 
non-public customer COA responses collectively have fourth priority, 
with multiple orders/responses allocated based on the capped UMA 
(``CUMA'') allocation described in Rule 6.45A or 6.45B, as 
applicable. See Rule 6.53C(c)(ii) and (d) and Interpretation and 
Policy .09. The Exchange notes that the aforementioned electronic 
allocation algorithms for COB and COA are consistent with Rule 
6.45A(b)(ii) and 6.45B(b)(ii) (which relate to the allocation of 
orders represented in open outcry and generally allow a Trading 
Permit Holder holding a complex order to trade at the same price as 
the trading crowd and public customer limit order book, provided at 
least one leg of the complex order betters the corresponding bid 
(offer) in the public customer limit order book by at least one 
minimum trading increment (i.e., $0.10, $0.05 or $0.01, as 
applicable) or a $0.01 increment, which increment will be determined 
by the Exchange on a class-by-class basis).
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    First, a complex order submitted to COB or COA, as applicable, that 
is marketable against the individual orders residing in the EBook will 
automatically execute against those individual orders residing in the 
EBook provided the complex order can be executed in full (or in a 
permissible ratio) by the orders in the EBook and provided the orders 
in the EBook are priced equal to or better than the individual quotes 
residing in the EBook.
    Second, complex orders that are marketable against each other will 
automatically execute provided the execution is at a net price that has 
priority over the individual orders and quotes residing in the EBook. 
As noted above, the allocation of a complex order will otherwise be 
consistent with the existing rules of trading priority otherwise 
applicable to COB or COA.\6\
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    \6\ See note 5, supra.
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    Third, to the extent that a marketable complex order cannot 
automatically execute when it is routed to COB or after being subject 
to COA because there are individual quotes residing in the EBook that 
have priority, any part of the order that may be executed will be 
executed automatically and the part of the order that cannot 
automatically execute will be routed on a class-by-class basis to PAR 
or, at the order entry firm's discretion, to the order entry firm's 
booth. If an order is not eligible to route to PAR, then the remaining 
balance will be cancelled.
    Finally, fourth, to the extent that a complex order resting in COB 
becomes marketable and cannot automatically execute in full (or in a 
permissible ratio), the full order will be subject to COA (and the 
process for COA described above). Having the system automatically 
initiate a COA once such a complex order resting in COB becomes 
marketable provides an opportunity for other market participants to 
match or improve the net price and allows for an opportunity for an 
automatic execution before a marketable complex order is routed for 
manual handling to PAR or a booth.\7\ As noted above, after being

[[Page 77880]]

subject to COA, any part of the order that may be executed will be 
executed automatically and the part of the order that cannot 
automatically execute will be routed on a class-by-class basis to PAR 
or, at the order entry firm's discretion, to the order entry firm's 
booth. If an order is not eligible to route to PAR, then the remaining 
balance will be cancelled.
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    \7\ The Exchange notes that, in these circumstances when a 
resting complex order becomes marketable, COA will automatically 
initiate regardless of whether a Trading Permit Holder has requested 
that the complex order be COA'd pursuant to Rule 6.53C.04. In this 
regard, the Exchange notes that, currently, all of its Trading 
Permit Holders have elected to have their COA-eligible orders COA'd. 
In addition, the Exchange notes that other markets have programs in 
place that provide for the automatic auctioning of complex orders. 
See, e.g., NASDAQ OMX PHLX LLC (``Phlx'') Rule 1080(e)(i)(A) which, 
among other things, provides that a complex order live auction 
(``COLA'') will initiate if the Phlx system receives a complex order 
that improves the Phlx complex order best debit or credit price 
respecting the specific complex order strategy that is the subject 
of the complex order. During a COLA, Phlx market participants may 
bid and offer against the COLA-eligible order pursuant to the Phlx 
Rule.
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    The following examples illustrate the operation of the proposed 
system functionality:

    Example 1: Assume an incoming market complex order for 75 units 
is submitted to COA, where the strategy involves the purchase of SPX 
Dec 1250 calls and sale of SPX Dec 1255 calls. At the conclusion of 
COA, assume the best offer in the individual SPX Dec 1250 call 
series is $27.90 for a size of 50 contracts made up only of orders 
resting in the EBook, and the next best offer is $28.20 for 100 
contracts made up only of Lead Market-Maker quotes. Also assume the 
best bid in the individual SPX Dec 1255 call series is $22.90 with a 
size of 50 contracts made up only of orders resting in the EBook, 
and the next best bid is $22.50 made up only of Lead Market-Maker 
quotes. The best derived net leg market price would therefore be 
$5.00 ($27.90-$22.90). Also assume that there is a COA response for 
10 units at a net price of $4.90. The incoming market order to 
purchase 75 units of the call/put strategy would receive a partial 
execution of 60 units: 10 units would execute at a net debit price 
of $4.90 against the COA response (which has priority over the 
individual orders net priced at $5.00), and 50 units at a net debit 
price of $5.00 against the orders resting in each of the individual 
series legs (the execution is in a permissible ratio and the orders 
in the EBook are priced equal to or better than the individual 
quotes residing in the EBook). Because the remaining 15 units are 
only marketable against the quotes in the individual series legs at 
a net price of $5.70 ($28.20-$22.50), the 15 units would be routed 
to PAR or, at the order entry firm's discretion, to the order entry 
firm's booth, for manual handling. If the order would otherwise 
route to PAR but is not eligible to route to PAR, then the remaining 
15 units will be cancelled.

    Example 2: Assume a complex order for 75 units with a net debit 
price of $5.00 is resting in COB, where the strategy involves the 
purchase of SPX Dec 1250 calls and sale of SPX Dec 1255 calls. By 
virtue of the fact that it is resting the COB, the complex order is 
not marketable--meaning there are no orders or quotes within the 
derived net leg market price or other complex orders within COB 
against which the resting complex order may trade. Assume there are 
no other complex orders representing in the COB for the strategy and 
also assume the best offer in the individual SPX Dec 1250 call 
series is $27.90, with a size of 100 contracts (50 contracts are 
orders and 50 contracts represent the Lead Market-Maker quote) and 
the best bid in the individual SPX Dec 1255 call series is $22.75, 
with a size of 100 contracts (50 contracts are orders and 50 
contracts represent the Lead Market-Maker quote). The best derived 
net leg market price would therefore be $5.15 ($27.90-$22.75). If 
the Lead Market-Maker bid in the SPX Dec 1255 call series is 
thereafter updated to $22.90 (with a size of 100 contracts), the 
derived net leg market price would become $5.00 ($27.90-$22.90) and 
the full size of the resting complex order will become marketable 
but cannot automatically execute. As a result, the full size (75 
units) of the resting complex order would be subject to COA. At the 
conclusion of COA, any part of the complex order that may be 
executed against orders in the EBook and other complex orders will 
be automatically executed. Any part of the order that is marketable 
and cannot automatically execute (because of Lead Market-Maker 
quotes in an individual series leg(s)) will be routed on a class-by-
class basis to PAR or, at the order entry firm's discretion, to the 
order entry firm's booth. If an order is not eligible to route to 
PAR, then the remaining balance will be cancelled. To the extent any 
part of the complex order is not marketable, it will continue 
resting in COB.

    Over time, the Exchange has introduced various enhancements to the 
operation of COB and COA, which enhancements the Exchange believes are 
generally designed to make the processes operate more efficiently and 
effectively, as well as to avoid executions at extreme and potentially 
erroneous prices. The Exchange believes the instant proposed rule 
change is another example of such an enhancement. The Exchange believes 
the proposed system functionality will permit more efficient and 
effective execution of complex orders in our electronic trading 
environment. In addition, the Exchange believes the change will assist 
in preventing complex orders from automatically executing against the 
individual quotes residing in the individual series legs at potentially 
erroneous prices, particularly when there are momentary or inadvertent 
discrepancies that occur between the pricing of an individual series 
leg that is a component of a complex order strategy. The Exchange 
recognizes that Market-Makers could encounter difficulties maintaining 
quotations in the individual series legs if the quotes are allowed to 
execute against complex orders in COB or COA. In particular, Market-
Maker pricing systems automatically update the price of a Market-
Maker's quotations when there is a move in the price of the underlying 
stock, index, component securities or related futures. When such a 
change occurs, a Market-Maker will need to send updates for its quotes 
all [sic] the individual series legs it is quoting in each of the 
Market-Maker's appointed classes. In the SPX options class alone this 
can include thousands of series, and when considering all series across 
a Market-Makers [sic] various appointed classes, this can include 
millions of series. Accordingly, it is possible that the Market-Maker 
could unintentionally trade with another Market-Maker or market 
participant via COB or COA before a quote update(s) in the individual 
series leg is processed.\8\ The result is executions at price(s) that 
were not intended and, at times, that may also be at extreme or 
potentially erroneous prices.
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    \8\ Indeed, the Exchange has long recognized the need to 
ameliorate small timing differences in processing Market-Maker 
quotations updates by delaying Market-Maker quotations from 
executing against each other for up to one second. See, e.g., 
Exchange Rule 6.45B(d).
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    The proposed rule change is designed to protect the Lead Market-
Maker that generate [sic] quotes in SPX, as well as other Market-Makers 
and other market participants that may trade against these quotes with 
complex orders at extreme or potentially erroneous prices. The Exchange 
believes the proposed system functionality is fair and reasonable with 
respect to classes trading on the Hybrid 3.0 Platform in particular, 
where the quotes represent the aggregate Market-Maker quoting interest 
in a series for the trading crowd but the responsibility for generating 
the quotes and satisfying trades against those quotes in relation to 
executions occurring through COB or COA rests with the designated Lead 
Market-Maker(s) that generates the quote. The functionality will 
mitigate the risk borne only by the Lead Market-Makers that a complex 
order may execute against a quote in an individual series leg at an 
extreme or potentially erroneous price. The Exchange believes that the 
proposed system functionality is a reasonable limitation on Hybrid 3.0 
Market-Maker quotations that will appropriately address an operational 
issue that would discourage Market-Makers, particularly Lead Market-
Makers, from offering additional liquidity in the individual series 
legs. It also will prevent other Market-Makers and other market 
participants from receiving executions at extreme or potentially 
erroneous prices.\9\
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    \9\ The Exchange has determined to limit the application of this 
proposed rule change to Hybrid 3.0 classes. In the future, the 
Exchange may determine to expand the alternate process of not 
permitting complex orders to trade against Market-Maker quotes to 
other option classes. Any such expansion would be the subject of a 
separate rule change filing.
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2. Statutory Basis
    The proposed rule change is consistent with Section 6(b) of the Act 
\10\ in general and furthers the objectives of

[[Page 77881]]

Section 6(b)(5) of the Act \11\ in particular in that it should promote 
just and equitable principles of trade, serve to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system, and protect investors and the public interest. The 
Exchange believes that the proposed rule change will facilitate the 
orderly execution of complex orders in our Hybrid 3.0 electronic 
trading environment.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange neither solicited nor received comments on the 
proposal.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days of such 
date (i) as the Commission may designate if it finds such longer period 
to be appropriate and publishes its reasons for so finding or (ii) as 
to which the self-regulatory organization consents, the Commission 
will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2011-114 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2011-114. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of CBOE. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-CBOE-2011-114 and should be 
submitted on or before January 4, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-32034 Filed 12-13-11; 8:45 am]
BILLING CODE 8011-01-P


