
[Federal Register Volume 76, Number 250 (Thursday, December 29, 2011)]
[Notices]
[Pages 82017-82022]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-33449]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66035; File No. SR-CBOE-2011-122]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Related to 
FLEX Options

December 22, 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 December 12, 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 below, which Items have been prepared by 
the Exchange. The Commission is 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 certain rules pertaining to the 
electronic trading of Flexible Exchange Options (``FLEX Options'') on 
the Exchange's FLEX Hybrid Trading System platform.\3\

[[Page 82018]]

The Exchange is also proposing an amendment to eliminate certain 
European-Capped style settlement and currency provisions within the 
FLEX rules that pertain to both electronic and open outcry trading. 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.
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    \3\ FLEX Options provide investors with the ability to customize 
basic option features including size, expiration date, exercise 
style, and certain exercise prices. FLEX Options can be FLEX Index 
Options or FLEX Equity Options. In addition, other products are 
permitted to be traded pursuant to the FLEX trading procedures. For 
example, credit options are eligible for trading as FLEX Options 
pursuant to the FLEX rules in Chapters XXIVA and XXIVB. See CBOE 
Rules 24A.1(e) and (f), 24A.4(b)(1) and (c)(1), 24B.1(f) and (g), 
24B.4(b)(1) and (c)(1), and 28.17. The rules governing the trading 
of FLEX Options on the FLEX Request for Quote (``RFQ'') System 
platform are contained in Chapter XXIVA. The rules governing the 
trading of FLEX Options on the FLEX Hybrid Trading System platform 
are contained in Chapter XXIVB.
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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 
Statutory Basis for, Proposed Rule Change

1. Purpose
    The Exchange is in the process of enhancing the FLEX Hybrid Trading 
System platform (referred to herein as the ``FLEX System'' or the 
``System'') in order to further integrate it with the Exchange's 
existing technology platform utilized for non-FLEX trading. In 
conjunction with the enhancement, the Exchange is proposing to make 
some modifications to the existing electronic trading processes 
utilized on the FLEX System platform.\4\ In particular, as discussed in 
more detail below, the Exchange is proposing to (i) revise and enhance 
the process for opening FLEX Option series with existing open interest, 
(ii) eliminate certain Trade Conditions that will no longer be 
supported in the new system and to add a new Trade Condition, (iii) 
eliminate European-Capped exercise style and foreign currency 
provisions that will no longer be supported in the new system, (iv) 
modify and simplify the allocation algorithms applicable to the FLEX 
electronic book and to the FLEX electronic RFQ process, and (v) include 
a description of complex order handling under the electronic RFQ 
process.\5\
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    \4\ The Exchange notes that is [sic] rule change filing is 
primarily seeking to propose changes to the electronic trading 
processes utilized on the FLEX System platform. The Exchange is not 
proposing any changes to the open outcry trading processes for FLEX 
options, except for the proposed changes pertaining to foreign 
currencies.
    \5\ The FLEX System currently utilizes server software (residing 
on CBOE's servers) and client software (installed on Trading Permit 
Holder and Sponsored User workstations) that CBOE has licensed from 
Cinnober Financial Technology AB (``Cinnober''). In conjunction with 
the enhancements to the FLEX System, the Exchange will no longer 
utilize the Cinnober software and, as a result, the Exchange will no 
longer utilize the related Trading Permit Holder/Sponsored User 
software sublicense, which is part of the Sponsored User Agreement 
form that was put in place when the FLEX Hybrid Trading System was 
established. See Securities Exchange Act Release 56792 (November 15, 
2007), 72 FR 65776 (November 23, 2007) (SR-CBOE-2006-99) (the 
``Original FLEX System Approval Order''). The Exchange also notes 
that, in conjunction with the enhancements to the FLEX System, the 
Exchange intends to make available certain risk management 
application tools that CBOE Trading Permit Holders may determine to 
use to assist with mitigating potential risks associated with orders 
that exceed certain pre-trade thresholds.
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Opening Trading in Existing Series

    The first purpose of this proposed rule change is to revise and 
enhance the process for opening electronic trading in FLEX Option 
series with existing open interest. Under the current FLEX trading 
procedures, there are no trading rotations conducted at the opening of 
trading.\6\ Instead, to begin trading on a given day, a FLEX RFQ 
process is required to initiate a transaction when there are no FLEX 
Orders \7\ currently resting in the electronic book in the particular 
series to be traded.\8\ Resting FLEX Orders may only be entered in the 
electronic book as ``day orders'' and are cancelled at the close of 
each trade day if unexecuted. Therefore, there would be no orders 
resting in the book from the prior day.\9\ As a result, under the 
current process, an initial RFQ is needed to open a particular series 
for trading each day. Once an RFQ is completed, the series is 
established in the FLEX System for the day and FLEX Orders may be 
entered directly into the FLEX electronic book throughout the day.
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    \6\ See Rule 24B.3.
    \7\ A ``FLEX Order'' refers to (i) FLEX bids and offers entered 
by FLEX Market-Makers and (ii) orders to purchase and orders to sell 
FLEX Options entered by FLEX Traders, in each case into the 
electronic book. A ``FLEX Market-Maker'' means a FLEX Trader that is 
appointed as a FLEX Appointed Market-Maker or a FLEX Qualified 
Market-Maker, each as described in Rule 24B.9. A ``FLEX Trader'' 
means a FLEX-participating Trading Permit Holder who has been 
approved by the Exchange to trade on the System. See Rule 24B.1(h), 
(j) and (l).
    \8\ The Exchange may determine in a class-by-class basis to make 
an electronic book available in the FLEX System. See Rule 24B.5(b).
    \9\ In the future, the Exchange may determine to enable ``good-
til-cancelled'' functionality for FLEX Options. The introduction of 
such functionality would be the subject of a separate rule filing.
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    To make the process more efficient and useful for FLEX users, the 
Exchange is proposing to revise the procedure to provide that FLEX 
Option series with existing open interest will be automatically opened 
by the Exchange at a randomly selected time within a number of seconds 
after 8:30 a.m. (all times noted herein are Central Time), at which 
point in time FLEX Orders may be entered directly into the electronic 
book (if available) and/or FLEX RFQ auctions may be initiated pursuant 
to Rule 24B.5 As revised, it will no longer be necessary for there to 
be an initial RFQ each day before entering a FLEX Order in the 
electronic book in series with existing open interest. New FLEX Option 
series will continue to be subject to the existing requirement that 
there be an initial RFQ to initiate trading in the FLEX series on a 
given trading day.

Trade Conditions

    The second purpose of this proposed rule change is to eliminate 
certain Trade Conditions that will no longer be supported for 
electronic trading in the new system and to add a new Trade Condition. 
Currently, under Rule 24B.1, a ``Trade Condition'' means a contingency 
that has been placed on an RFQ, RFQ Order \10\ or FLEX Order. The 
following Trade Conditions are available in the System for a FLEX 
Trader to choose from: (i) Fill-or-Kill, which is a condition to 
execute an RFQ Order or FLEX Order in its entirety as soon as it is 
represented or canceled it; (ii) All-or-None, which is a condition to 
execute an RFQ Order or FLEX Order in its entirety or not at all; (iii) 
Minimum Fill, which is a condition to execute an RFQ Order or a FLEX 
Order in a minimum quantity or not at all; (iv) Lots Of, which is a 
condition to execute an RFQ Order or a FLEX Order in minimum lot sizes 
or not at all; (v) Intent to Cross, which is an RFQ condition 
indicating that the Submitting Trading Permit Holder intends to cross 
or act as principal and receive a crossing participation entitlement; 
and (vi)

[[Page 82019]]

Hedge, which is a RFQ or FLEX Order condition contingent on trade 
execution in Non-FLEX Options or other Non-FLEX components (e.g., 
stock, futures, or other related instruments or interests). Trade 
Conditions, other than Intent to Cross or Hedge, are inputted but not 
disclosed on the System. FLEX Orders, other than those designated as 
Fill-or-Kill, are designated as day orders and, if unexecuted, are 
automatically cancelled at the close of each trade day.\11\
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    \10\ An ``RFQ Order'' is an order to purchase or order to sell 
FLEX Options entered by the Submitting Trading Permit Holder during 
the RFQ Reaction Period. The ``RFQ Reaction Period'' means the 
period of time during which a Submitting Trading Permit Holder 
determined whether to accept or reject the RFQ Market. A 
``Submitting Trading Permit Holder'' means the FLEX Trader that (i) 
initiates FLEX bidding and offering by submitting an RFQ or (ii) 
enters a FLEX Order into the electronic book. An ``RFQ Market'' 
means the bids or offers, or both, as applicable, entered in 
response to an electronic RFQ and FLEX Orders resting in the 
electronic book. See Rule 24B.1(s), (t), (v) and (x), and Rule 
24B.5(a)(1)(iii).
    \11\ See Rule 24B.1(y).
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    The Exchange is now proposing to eliminate the Fill-or-Kill, 
Minimum Fill, Lots Of, and Intent to Cross Trade Conditions, as these 
functions will not be supported under the FLEX System enhancements. The 
Fill-or-Kill, Minimum Fill, Lots Of \12\ and Intent to Cross \13\ Trade 
Conditions have generally not been actively used by FLEX Traders. Given 
the lack of use, the Exchange no longer plans to support these Trade 
Conditions under the new FLEX System enhancements.
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    \12\ See proposed changes to Rule 24B.1(y). The Fill-or-Kill, 
Minimum Fill and Lots Of Trade Conditions were originally designed, 
in part, as an additional tool to assist FLEX Traders that are 
electronically trading in meeting certain minimum value size 
requirements applicable to the trading of FLEX Options; however, the 
minimum size requirements have been eliminated on a pilot basis 
(which the Exchange believes is one of the reasons why the Trade 
Conditions are largely not used). See, e.g., Rule 24B.4(a)(5) and 
.01(b). The minimum value size pilot is currently set to expire on 
March 30, 2012, unless otherwise extended or made permanent. It is 
the Exchange's intention to submit a separate rule change filing 
proposing to make the pilot permanent. In addition, if for some 
reason the minimum value size pilot is not extended or otherwise 
made permanent, FLEX Traders have other means to satisfy the minimum 
value size requirements (e.g., utilizing the All-or-None Trade 
Condition, or entering RFQ Orders or FLEX Orders that would trade 
against the electronic book with value sizes that would result in 
transaction sizes sufficient to meet the minimum value size 
requirement).
    \13\ See proposed changes to Rules 24B.1(y) and 
24B.5(a)(1)(iii)(D) and (d)(1)(i). The Exchange notes that the 
Intent to Cross Trade Condition is an optional feature that the 
Exchange may determine to make available electronically on a class-
by-class basis in accordance with Rule 24B.5(d). The Intent to Cross 
Trade Condition was originally designed to allow for an electronic 
crossing participation entitlement for executions resulting from the 
electronic RFQ process. (To use the feature, the Submitting Trading 
Permit Holder must mark its RFQ with an ``intent to cross'' flag at 
the time the RFQ is originally submitted to be automatically 
allocated the applicable crossing participation entitlement for 
facilitation and solicitation transactions. If the RFQ is not 
flagged in this manner, the Submitting Member will not be 
automatically allocated the entitlement.) The Exchange notes that 
this crossing participation entitlement functionality has generally 
not been actively used by FLEX Traders. (The Exchange also notes 
that, apart from the Intent to Cross feature, a Submitting Trading 
Permit Holder also has (and will continue to have) the ability to 
enter an agency or proprietary FLEX Quote in response to the 
Submitting Member's own electronic RFQ in accordance with the 
provisions contained in Rule 24B.5(a)(1)(ii) and/or to cross FLEX 
Orders in accordance with the provisions contained in Rule 
24B.5(b)(3). However, no crossing participation entitlement applies 
when these procedures are used.) In order to make a more efficient 
and effective trading platform offering available for FLEX Traders 
that includes a crossing participation entitlement feature, the 
Exchange has submitted a separate rule change filing proposing to 
make modified versions of the Automated Improvement Mechanism 
(``AIM'') and Solicitation Auction Mechanism (``SAM'')--which are 
currently available for non-FLEX Options under Rule 6.74A and 6.74B, 
respectively--available for FLEX Options. See SR-CBOE-2011-123.
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    The Exchange is also proposing to adopt an Immediate-or-Cancel 
Trade Condition. ``Immediate-or-Cancel'' will be defined as a condition 
to execute an RFQ Order or FLEX Order in its entirety or in part as 
soon as it is represented or cancel it. Thus, as proposed to be 
revised, there will be three Trade Conditions: Immediate-or-Cancel, 
All-or-None, and Hedge. Trade Conditions, other than Hedge, will be 
inputted but not disclosed on the System. In addition, FLEX Orders, 
other than those designated as Immediate-or-Cancel, will be designated 
as day orders and, if unexecuted, will be automatically cancelled at 
the close of each trade day.\14\
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    \14\ See note 9, supra.
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Foreign Currency Provisions

    The third purpose of the proposed rule change is to eliminate 
certain provisions in the FLEX Rules that permit (i) FLEX Options to be 
designated with a European-Capped style exercise and (ii) FLEX Index 
Options to be designated for settlement in foreign currencies (and 
related index multiplier provisions for such currencies).\15\ These 
European-Capped style and foreign currency provisions have generally 
not been actively utilized.\16\ The Exchange no longer plans to support 
foreign currency settlements in the new FLEX System, so the Exchange is 
proposing to eliminate the provision within the rules and limit the 
[sic] currently for FLEX Index Options to U.S. dollars. These changes 
will apply to all FLEX trading on the Exchange, whether electronic or 
open outcry.\17\
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    \15\ See proposed changes to Rules 24A.1(c) and (i), 
24A.4(a)(2)(iii) and (b)(4), 24A.5(f), 24B.1(c) and (m), 
24B.4(a)(2)(iii) and (b)(4), and 24B.5(e).
    \16\ The Exchange notes that there is currently no open interest 
in any FLEX Option series with a European-Capped style exercise and 
currently no open interest [sic] any FLEX Index Option series that 
is designated for settlement in a foreign currency.
    \17\ In the future, the Exchange may determine to re-enable the 
capability for settlement of FLEX Index Options in a foreign 
currency, such foreign currency settlement provisions would be the 
subject of a separate rule filing.
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Electronic Allocation Algorithms

    The fourth purpose of the proposed rule change is to modify and 
simplify the allocation algorithms applicable to the FLEX electronic 
book and to the FLEX electronic RFQ process. Generally, and as 
discussed in more detail below, the algorithms are proposed to be 
simplified to be price-time priority, subject to public customer and 
non-Trading Permit Holder broker-dealer (``non-TPH broker-dealer'') 
priority and, if applicable, any applicable entitlement priority. In 
particular, the existing algorithms and proposed modifications are as 
follows:
    FLEX Electronic Book: Currently, for the FLEX electronic book, all 
FLEX Orders are ranked and matched based on price-time priority, unless 
a FLEX Appointed Market-Maker is quoting at the best bid (offer) and a 
FLEX Appointed Market-Maker participation entitlement has been 
established.\18\ If a FLEX Appointed Market-Maker participation 
entitlement has been established, allocation among multiple bids 
(offers) at the same price is as follows: (i) All FLEX Orders for the 
account of a public customer ranked ahead of the FLEX Appointed Market-
Maker will participate in the execution based on time priority; (ii) 
any FLEX Orders that are subject to the FLEX Appointed Market-Maker 
participation entitlement will participate in the execution based on a 
participation entitlement formula specified in Rule 24B.5(d)(2)(ii); 
then (iii) all other FLEX Orders will participate based on time 
priority.
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    \18\ The Exchange may establish from time to time a 
participation entitlement formula that is applicable to FLEX 
Appointed Market Makers on a class-by-class basis with respect to 
open outcry RFQs, electronic RFQs and/or electronic book 
transactions. Any such FLEX Appointed Market-Maker participation 
entitlement shall: (i) Be divided equally by the number of FLEX 
Appointed Market-Makers quoting at the BBO or BBO clearing price, as 
applicable; (ii) collectively be no more than: 50% of the amount 
remaining in the order when there is one other FLEX Market-Maker 
also quoting at the same price, 40% when there are two other FLEX 
Market-Makers also quoting at the same price; and 30% when there are 
three or more FLEX Market-Makers also quoting at the same price; and 
(iii) when combined with any crossing participation entitlement, 
shall not exceed 40% of the original order. See Rule 
24B.5(d)(2)(ii).
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    As proposed to be revised and simplified, allocation among multiple 
bids (offers) at the same price in the FLEX electronic book would be as 
follows: (i) Public customer and non-TPH broker-dealers will 
participate in the execution based on time priority; (ii) if 
applicable, any FLEX Orders that are subject to the FLEX Appointed 
Market-Maker participation entitlement will participate in the 
execution based on a

[[Page 82020]]

participation entitlement formula specified in Rule 
24B.5(d)(2)(ii);\19\ then (iii) all other FLEX Orders will participate 
in the execution based on time priority.
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    \19\ Id.
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    FLEX Electronic RFQs: Currently, for the electronic RFQ process, 
executions of RFQ Orders occur at a single price that will leave bids 
and offers which cannot trade with each other (referred to as the ``BBO 
clearing price''). In determining the priority of bids and offers, the 
FLEX System gives priority to FLEX Quotes \20\ and FLEX Orders whose 
price is better than the BBO clearing price, then to FLEX Quotes and 
FLEX Orders at the BBO clearing price. Currently, the allocation among 
multiple FLEX Quotes and FLEX Orders priced at the BBO clearing price 
is as follows:
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    \20\ A ``FLEX Quote'' refers to (i) FLEX bids and offers entered 
by FLEX Market-Makers and (ii) orders to purchase and orders to sell 
FLEX Options entered by FLEX Traders, in each case in response to an 
RFQ. See Rule 24B.1(k).
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     General: The allocation among multiple FLEX Quotes and 
FLEX Orders priced at the BBO clearing price is generally as follows: 
(i) Any FLEX Quotes subject to a FLEX Appointed Market-Maker 
participation entitlement will participate in the execution based on a 
participation entitlement formula (as described above); (ii) FLEX 
Orders resting in the electronic book will participate in the execution 
pursuant to the current book priority algorithm (discussed above); 
(iii) FLEX Quotes for the account of public customers and non-TPH 
broker-dealers will participate in the execution based on time 
priority; then (iv) all other FLEX Quotes will participate in the 
execution based on time priority.
     Lock/Crossed Markets: In the event the RFQ Market \21\ is 
locked or crossed (e.g., $1.25-$1.20), allocation among multiple FLEX 
Quotes and FLEX Orders that are priced at the BBO clearing price and 
are on the same side of the market as the RFQ Order is as follows: (i) 
FLEX Orders resting in the electronic book will participate in the 
execution pursuant to the current book priority algorithm (discussed 
above); (ii) if applicable, an RFQ Order for the account of a public 
customer or non-TPH broker-dealer will participate in the execution, 
then any FLEX Quotes subject to a FLEX Appointed Market-Maker 
participation entitlement will participate in the execution based on a 
participation entitlement formula (discussed above); (iii) FLEX Quotes 
for the account of public customers and non-TPH broker-dealers will 
participate in the execution based on time priority; (iv) if 
applicable, an RFQ Order for the account of a Trading Permit Holder 
will participate in the execution, then any FLEX Quotes that are 
subject to a FLEX Appointed Market-Maker participation entitlement will 
participate in the execution based on a participation entitlement 
formula (discussed above); then (v) all other FLEX Quotes will 
participate in the execution based on time priority.
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    \21\ The ``RFQ Market'' means the bids or offers, or both, as 
applicable, entered in response to an electronic Request for Quotes 
and FLEX Orders resting in the electronic book. See Rule 24B.1(s).
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     Intent to Cross Trade Condition/Crossing Participation 
Entitlement: In the event the Submitting Trading Permit Holder has 
indicated an intention to cross with respect to any part of the FLEX 
trade, the Submitting Trading Permit Holder may obtain a crossing 
participation entitlement if a crossing participation entitlement has 
been established by the Exchange pursuant to Rule 24B.5(d), the 
Submitting Trading Permit Holder has indicated an intention to cross as 
part of the RFQ, and the RFQ Order submitted during the RFQ Reaction 
Period matches or improves the BBO clearing price. In such an event, 
the incoming RFQ Order will be eligible to trade with the FLEX Quotes 
and FLEX Orders at the BBO clearing price as discussed above. The 
allocation among multiple FLEX Quotes and FLEX Orders that are priced 
at the BBO clearing price and on the same side of the market as the 
crossing participation entitlement is as follows: (i) FLEX Orders 
resting in the electronic book will participate in the execution 
pursuant to the current book priority algorithm (discussed above); (ii) 
FLEX Quotes for the account of public customers and non-TPH broker-
dealers will participate in the execution based on time priority; (iii) 
the crossing participation entitlement will participate in the 
execution pursuant to the crossing participation entitlement formula 
discussed in Rule 24B.5(d)(2)(i); (iv) any FLEX Quotes subject to a 
FLEX Appointed Market-Maker participation entitlement will participate 
in the execution pursuant to the participation entitlement formula 
(discussed above); then (v) all other FLEX Quotes will participate in 
the execution based on time priority.
    As proposed to be revised and simplified, first, as discussed 
above, the Exchange would eliminate the ``Intent to Cross'' Trade 
Condition. As a result, the Intent to Cross/Crossing Participation 
Entitlement scenario under the electronic RFQ process described above 
would no longer be applicable.\22\ Second, the Exchange would eliminate 
the concept of a ``BBO clearing price'' (except in the limited scenario 
noted below where the RFQ Market is locked or crossed). Thus, an 
incoming RFQ Order would be eligible to trade with FLEX Quotes and FLEX 
Orders at the best price(s) (i.e., an incoming RFQ Order could trade at 
multiple price points). Third, at a given price point, allocation among 
multiple FLEX Quotes and FLEX Orders at the same price would be as 
follows:
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    \22\ See proposed changes to Rule 24B.5(a)(1)(iii)(D) and 
(d)(2)(i).
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     General: The allocation among multiple FLEX Quotes and 
FLEX Orders priced at the same price would be as follows: (i) FLEX 
Quotes and FLEX Orders for the account of public customers and non-TPH 
broker-dealers will participate in the execution based on time 
priority; (ii) any FLEX Quotes and FLEX Orders subject to a FLEX 
Appointed Market-Maker participation entitlement will participate in 
the execution (as described above); then (iii) all other FLEX Quotes 
and FLEX Orders will participate in the execution based on time 
priority.
     Lock/Crossed Markets: In the event the RFQ Market is 
locked or crossed (e.g., $1.25-$1.20), FLEX Quotes and FLEX Orders 
would be eligible to trade at a single BBO clearing price pursuant to 
the existing BBO clearing price process (i.e., (i) the BBO clearing 
price will leave bids and offers which cannot trade with each other; 
and (ii) in determining priority of FLEX Quotes and FLEX Orders to be 
traded, the System gives priority to FLEX Quotes and FLEX Orders whose 
price is better than the BBO clearing price, then to FLEX Quotes and 
FLEX Orders at the BBO clearing price based on the general allocation 
algorithm noted above). The allocation among multiple FLEX Quotes and 
FLEX Orders that are priced at the same price and are on the same side 
of the market as the RFQ Order would be as follows: (i) FLEX Quotes and 
FLEX Orders for the account of public customers and non-TPH broker-
dealers will participate in the execution based on time priority; (ii) 
an RFQ Order will participate in the execution, then any FLEX Quotes 
and FLEX Orders that are subject to a FLEX Appointed Market-Maker 
participation entitlement will participate in the execution (as 
described above); then (iii) all other FLEX Quotes and FLEX Orders will 
participate in the execution based on time priority.
    All other provisions of Rule 24B.5 will apply unchanged. As noted 
above,

[[Page 82021]]

these changes re [sic] intended to simplify the allocation algorithms. 
The Exchange believes these changes will make the applicable 
programming for FLEX allocation algorithms less complicated, which 
should make for efficient and effective processing of complex orders 
(and also make it easier for users to understand) if there is a more 
consistent allocation algorithm applied across the various FLEX 
electronic processes described above (i.e., for FLEX electronic book 
priority and for FLEX RFQ priority generally and in locked or crossed 
and crossing participation entitlement scenarios).
    The Exchange notes that the proposed changes to the existing series 
opening process and allocation algorithms are similar to other existing 
opening processes and allocation algorithms.\23\ As such, the Exchange 
believes that the proposed rule change does not present any new, unique 
or substantive issues.
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    \23\ With respect to the existing series opening process, the 
Exchange notes that various exchanges' rules provide for automatic 
openings of existing series. See, e.g., CBOE Rule 6.2B (which, among 
other things, provides for an opening rotation to automatically 
begin in index options at a randomly selected time within a number 
of seconds after 8:30 a.m. for index options). A distinction with 
FLEX Options is that an existing series will move immediately to an 
opening state (there is no rotation). The Exchange has designed the 
system this way for simplicity and due to the customized nature of 
FLEX Options, which has no or very limited secondary trading and no 
need for daily opening rotations. This aspect of the existing 
opening series process is not new or unique. In fact, CBOE Rule 
24B.3 already provides that there shall be no trading rotations in 
FLEX Options, either at the opening or at the close of trading. With 
respect to the allocation algorithm, the Exchange notes that various 
exchanges' rules provide for executions at best price(s) and the use 
of price-time priority with public customer and participation 
entitlement priority overlays. See, e.g., CBOE Rules 6.45A(a) and 
6.45B(a) (which, among various allocation algorithm alternatives, 
may permit an executions [sic] at best price(s) using price-time 
priority with public customer and participation entitlements 
priority overlays).
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Electronic RFQ Processing of Complex Orders

    The fifth purpose of the proposed rule change is to amend the FLEX 
System rules to describe certain complex order handling procedures. 
Under the current FLEX electronic trading procedures, multi-legged RFQs 
and FLEX Orders are permitted. However, there is no provision for an 
electronic complex order book for multi-legged, complex orders to rest. 
The electronic book, to the extent the Exchange determines to make it 
available for a given class, is only available for simple orders.
    To more fully describe the electronic processing of complex orders, 
the Exchange is proposing to adopt Interpretation and Policy .01 under 
Rule 24B.5. This Interpretation and Policy will provide that there is 
no electronic complex order book for multi-legged, complex orders. To 
trade electronically, complex orders will only be eligible to trade 
with other complex orders through the electronic RFQ process described 
in Rule 24B.5(a)(1). The order allocation for such complex orders 
executed through the RFQ process will [sic] the same as is applicable 
to simple orders (which is proposed to be amended as described above 
under the ``FLEX Electronic RFQ [sic] heading). To the extent the 
Exchange determines to make an electronic book available for simple, 
resting FLEX Orders, there will be no ``legging'' of complex orders 
represented in the electronic RFQ process with FLEX Orders that may be 
represented in the individual series legs represented in the electronic 
book. In the event there are bids (offers) in any of the individual 
component series legs represented in the electronic book when an 
electronic RFQ for a complex order strategy is submitted to the System, 
the electronic RFQ will not commence. In the event an unrelated FLEX 
Order in any of the individual series legs is received during the 
duration of an electronic RFQ, such FLEX Order will not be considered 
in the electronic RFQ allocation. Further, to the extent that a complex 
RFQ Order or responsive FLEX Quote is not executed, any remaining 
balance of the complex order or FLEX Quote will be automated [sic] 
cancelled if not traded at the conclusion of the electronic RFQ 
process.

Section 11(a)(1) of the Act

    Finally, the Exchange believes the proposed changes to the priority 
and allocation rules for electronic FLEX trading are consistent with 
Section 11(a)(1) of the Act \24\ and the rules promulgated thereunder. 
By way of background, when the FLEX Hybrid Trading System was 
originally approved, the Commission believed that the priority and 
allocation rules for electronic FLEX trading were consistent with 
Section 11(a) of the Act.\25\ The Commission believed, however, that 
neither a Submitting Trading Permit Holder \26\ who trades against an 
electronic RFQ Market nor any other FLEX Trader who itself submits an 
RFQ Quote electronically qualifies for the ``effect-versus-execute'' 
exception to [sic] section 11(a).\27\ Nevertheless, the Commission 
believed that other exceptions may apply. For example, FLEX Market-
Makers qualify for the market-maker exception. The Commission also 
noted that, with respect to non-market-maker Trading Permit Holders, 
the FLEX Hybrid Trading System appeared reasonably designed to cause 
RFQ Quotes constituting the RFQ Market and the RFQ Order that trades 
against the RFQ Market to yield to non-member interest, consistent with 
the ``G'' exception.\28\ The Exchange believes the proposed changes 
[sic] the electronic RFQ process and allocation algorithms are 
consistent with the Original FLEX System Approval Order because the 
System will continue to be designed to cause RFQ Quotes constituting 
the RFQ Market and the RFQ Order that trades against the RFQ Market to 
yield to non-member interest (i.e., public customers and non-TPH 
broker-dealers continue to have priority).
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    \24\ 15 U.S.C. 78k(a). Section 11(a)(1) prohibits a member of a 
national securities exchange from effecting transactions on that 
exchange for its own account, the account of an associated person, 
or an account over which it or its associated person exercises 
discretion unless an exception applies.
    \25\ See Original FLEX System Approval Order, note 5, supra; see 
also Securities Exchange Act Release No. 56311 (August 23, 2007), 72 
FR 50133 (August 30, 2007) (SR-CBOE-2006-99) (notice of filing of 
the proposed FLEX System), which includes a more detailed discussion 
of the priority and allocation rules and section 11(a) and existing 
Rule 24B.5(b)(2)(ii) and (d)(4).
    \26\ The Exchange notes that, under the Original FLEX Approval 
Order, the term ``Submitting Member'' is used instead of 
``Submitting Trading Permit Holder.'' The Exchange subsequently 
revised its rules to replace the term ``Member'' with ``Trading 
Permit Holder.'' See Securities Exchange Act Release No. 62382 (June 
25, 2010), 75 FR 38164 (July 1, 2010) (SR-CBOE-2010-058).
    \27\ 17 CFR 240.11a2-2(T).
    \28\ See 15 U.S.C. 78k(a)(1)(G) (setting forth all requirements 
for the ``G'' exemption).
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    With respect to the electronic book, in the Original FLEX System 
Approval Order the Commission noted that, if the Exchange enables an 
electronic book in a FLEX Option class, any transaction involving a 
booked order must comply with Section 11(a) of the Act. If a FLEX 
Trader cannot avail itself of any other exception, it must rely on the 
``G'' exception, which requires, among other things, that a member 
order yield to a non-member order at the same price, even if the member 
order has time priority. It was noted that the FLEX System has not been 
programmed to cause a member order on the electronic book to yield to a 
later-arriving non-member order at the same price, although Rule 
24B.5(b)(2)(ii) prohibits a member order that is relying on the ``G'' 
exemption from resting on the electronic book. The Commission believed 
that a member may rely on the ``G'' exemption if it sends an order to 
the electronic book and then cancels it immediately if it is not 
executed in full. The Exchange notes that the proposed changes to the 
electronic book

[[Page 82022]]

allocation algorithm are consistent with the Original FLEX System 
Approval Order and Trading Permit Holders and Rule 24B.5(b)(2)(ii), a 
Trading Permit Holder order that is relying on the ``G'' exemption 
continues to be prohibited from resting on the electronic book and such 
a Trading Permit Holder may rely on the ``G'' exemption if it sends an 
order to the electronic book and then cancels it immediately if it is 
not executed in full.
2. Statutory Basis
    The proposed rule change is consistent with Section 6(b) of the Act 
\29\ in general and furthers the objectives of Section 6(b)(5) of the 
Act \30\ 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. In particular, the Exchange 
believes that the use of FLEX Options provide CBOE Trading Permit 
Holders and investors with additional tools to trade customized options 
in an exchange environment \31\ and greater opportunities to manage 
risk. The proposed changes to the existing series opening process and 
the allocation algorithms should serve to further those objectives and 
encourage use of FLEX Options by enhancing and simplifying the existing 
processes, which should make the system more efficient and effective 
and easier for users to understand.
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    \29\ 15 U.S.C. 78f(b).
    \30\ 15 U.S.C. 78f(b)(5).
    \31\ FLEX Options provide Trading Permit Holders and investors 
with an improved but comparable alternative to the over-the-counter 
(``OTC'') market in customized options, which can take on contract 
characteristics similar to FLEX Options but are not subject to the 
same restrictions. The Exchange believes that making these changes 
will make the FLEX Hybrid Trading System an even more attractive 
alternative when market participants consider whether to execute 
their customized options in an exchange environment or in the OTC 
market. CBOE believes market participants benefit from being able to 
trade customized options in an exchange environment in several ways, 
including, but not limited to the following: (1) Enhanced efficiency 
in initiating and closing out positions; (2) increased market 
transparency; and (3) heightened contra-party creditworthiness due 
to the role of The Options Clearing Corporation as issuer and 
guarantor of FLEX Options.
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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 that is 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 (i) as the Commission may 
designate up to 90 days of such date 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-2011-122 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-2011-122. 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 Web site viewing and 
printing 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-2011-122 and should be 
submitted on or before January 19, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-33449 Filed 12-28-11; 8:45 am]
BILLING CODE 8011-01-P


