
[Federal Register Volume 77, Number 30 (Tuesday, February 14, 2012)]
[Notices]
[Pages 8304-8307]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-3328]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66348; File No. SR-CBOE-2011-122]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change, as Modified by 
Amendment No. 1, Related to Trading of FLEX Options

February 7, 2012.

I. Introduction

    On December 12, 2011, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') 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 rules pertaining to the 
electronic trading of Flexible Exchange Options (``FLEX Options'') and 
to eliminate certain European-Capped style settlement and currency 
provisions with the FLEX rules that pertain to both electronic and open 
outcry trading. The proposed rule change was published for comment in 
the Federal Register on December 29, 2011.\3\ On February 7, 2012, the 
Exchange filed an Amendment No. 1 to the proposed rule change.\4\ The 
Commission received one comment letter regarding the proposal.\5\ This 
order approves the proposed rule change, as modified by Amendment No. 
1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 66035 (December 22, 
2011), 76 FR 82017 (``Notice'').
    \4\ Amendment No. 1 amended the proposed rule change to provide 
an implementation plan of the proposed rule changes. The Exchange 
intends to begin implementation by no later than March 30, 2012, 
with the specific implementation schedule to be announced via 
Regulatory Circular. Since Amendment No. 1 does not alter the 
substance of the proposal, it is not subject to notice and comment.
    \5\ See letter from Todd Weingart, Spot On Brokerage Services, 
Division of Trading Block, William O'Keefe, Spot On Brokerage 
Services, Division of Trading Block, and Steve Stepanek, The SJS 
Group, Inc., to Elizabeth M. Murphy, Secretary, Commission, dated 
January 20, 2012.

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[[Page 8305]]

II. Description of the Proposal

    The Exchange is in the process of enhancing the FLEX Hybrid Trading 
System platform (``FLEX System'') to further integrate it with the 
Exchange's existing technology platform for non-FLEX trading. 
Accordingly, the Exchange proposes to make certain modifications to the 
existing electronic trading processes utilized on the FLEX System 
platform. The Exchange does not propose any changes to the open outcry 
trading processes for FLEX Options, except for proposed changes 
pertaining to foreign currencies as described below.

A. Opening Trading in Existing Series

    The Exchange proposes to revise the procedure for opening FLEX 
Option series with existing open interest. Currently there are no 
trading rotations conducted at the opening of trading.\6\ Instead, an 
initial FLEX Request for Quote (``RFQ'') process is required 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 
\7\ may be entered directly into the FLEX electronic book throughout 
the day.\8\
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    \6\ See Rule 24B.3.
    \7\ See Rule 24B.1(j).
    \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.
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    Under the proposal, 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. (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. 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.

B. Trade Conditions

    Under Rule 24B.1, a ``Trade Condition'' means a contingency that 
has been placed on an RFQ, RFQ Order \9\ or FLEX Order. There are 
currently six Trade Conditions available in the FLEX System.\10\ The 
Exchange proposes to eliminate the Fill-or-Kill, Minimum Fill, Lots Of, 
and Intent to Cross Trade Conditions, as their functions will not be 
supported under the FLEX System enhancements. In addition, the Exchange 
represents that these Trade Conditions have generally not been actively 
used by FLEX Traders. The Exchange also proposes to adopt a new 
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, 
under the proposal, there will only be three Trade Conditions: 
Immediate-or-Cancel, All-or-None, and Hedge.
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    \9\ See Rule 24B.1(t).
    \10\ See Rule 24B.1(y)(1)-(6).
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C. Foreign Currency Provisions

    The Exchange also proposes to eliminate the 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. In addition, related index multiplier 
provisions for foreign currencies will also be eliminated. The changes 
will apply to all FLEX trading on the Exchange, whether electronic or 
open outcry. According to the Exchange, these European-Capped style and 
foreign currency provisions have generally not been actively utilized, 
and the Exchange no longer plans to support foreign currency 
settlements in the enhanced FLEX System.

D. Electronic Allocation Algorithms

    Further, the Exchange proposes to modify and simplify the 
allocation algorithms applicable to the FLEX electronic book and to the 
FLEX electronic RFQ process. Generally, the algorithms will be based on 
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. The specific 
allocation algorithms for the FLEX electronic book and the FLEX 
electronic RFQ process are described below.
1. 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.\11\ If a 
FLEX Appointed Market-Maker participation entitlement has been 
established, priority 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, based on time 
priority; (ii) any FLEX Orders that are subject to the FLEX Appointed 
Market-Maker participation entitlement, based on a participation 
entitlement formula specified in Rule 24B.5(d)(2)(ii); then (iii) all 
other FLEX Orders, based on time priority.
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    \11\ 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. See Rule 24B.5(d)(2)(ii).
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    As proposed, priority for the FLEX electronic book with multiple 
bids (offers) at the same price would be: (i) Public customer and non-
TPH broker-dealers will participate in the execution based on time 
priority; (ii) any FLEX Orders that are subject to the FLEX Appointed 
Market-Maker participation entitlement, based on a participation 
entitlement formula specified in Rule 24B.5(d)(2)(ii); then (iii) all 
other FLEX Orders will participate in the execution, based on time 
priority.
2. FLEX Electronic RFQs
    Pursuant to the current 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 \12\ and FLEX Orders whose price 
is better than the BBO clearing price, then to FLEX Quotes and FLEX 
Orders at the BBO clearing price. Priority 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; (ii) FLEX Orders resting in the electronic 
book, based on the current book priority algorithm; (iii) FLEX Quotes 
for the account of public customers and non-TPH broker-dealers, based 
on time priority; and then (iv) all other FLEX Quotes, based on time 
priority.
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    \12\ See Rule 24B.1(k).
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    The Exchange proposes to eliminate the concept of a ``BBO clearing 
price'' except in the limited scenario where the RFQ Market is locked 
or crossed. Thus, an incoming FLEX electronic 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). In 
general, priority among multiple FLEX Quotes and FLEX Orders at the 
same price would be: (i) FLEX Quotes and FLEX Orders for the account of 
public customers and non-TPH broker-dealers, based on time priority; 
(ii) any FLEX Quotes and FLEX Orders subject to a

[[Page 8306]]

FLEX Appointed Market-Maker participation entitlement; and then (iii) 
all other FLEX Quotes and FLEX Orders, based on time priority.
a. Lock/Crossed Markets
    Currently, in the event the RFQ Market \13\ is locked or crossed 
(e.g., $1.25-$1.20), priority 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, based on the current book priority 
algorithm; (ii) if applicable, an RFQ Order for the account of a public 
customer or non-TPH broker-dealer, then any FLEX Quotes subject to a 
FLEX Appointed Market-Maker participation entitlement; (iii) FLEX 
Quotes for the account of public customers and non-TPH broker-dealers, 
based on time priority; (iv) if applicable, an RFQ Order for the 
account of a Trading Permit Holder, then any FLEX Quotes that are 
subject to a FLEX Appointed Market-Maker participation entitlement; and 
then (v) all other FLEX Quotes, based on time priority.
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    \13\ 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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    As noted above, the Exchange proposes to eliminate the concept of a 
``BBO clearing price'' except in the limited scenario where the RFQ 
Market is locked or crossed. Under the proposal, in the event the RFQ 
Market is locked or crossed, FLEX Quotes and FLEX Orders would be 
eligible to trade at a single BBO clearing price pursuant to the 
existing BBO clearing price process. The priority 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 will be: (i) FLEX Quotes and 
FLEX Orders for the account of public customers and non-TPH broker-
dealers, based on time priority; (ii) an RFQ Order, then any FLEX 
Quotes and FLEX Orders that are subject to a FLEX Appointed Market-
Maker participation entitlement; and then (iii) all other FLEX Quotes 
and FLEX Orders, based on time priority.
b. Intent to Cross Trade Condition
    Currently, in the event the Submitting Trading Permit Holder has 
indicated an Intention to Cross in its RFQ request, the Submitting 
Trading Permit Holder may obtain a crossing participation entitlement 
if certain conditions are met. The incoming RFQ Order will then be 
eligible to trade with the FLEX Quotes and FLEX Orders at the BBO 
clearing price. Priority 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 based on the current book 
priority algorithm; (ii) FLEX Quotes for the account of public 
customers and non-TPH broker-dealers, based on time priority; (iii) the 
crossing participation entitlement; (iv) any FLEX Quotes subject to a 
FLEX Appointed Market-Maker participation entitlement; and then (v) all 
other FLEX Quotes, based on time priority.
    Under the proposal, 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.\14\
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    \14\ See proposed changes to Rule 24B.5(a)(1)(iii)(D) and 
(d)(2)(i).
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E. Electronic RFQ Processing of Complex Orders

    Finally, the Exchange proposes to adopt a new Interpretation and 
Policy under Rule 24B.5 to more fully describe the electronic 
processing of complex orders. Specifically, complex orders will only be 
eligible to electronically trade with other complex orders through the 
electronic RFQ process described in Rule 24B.5(a)(1). 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 automatically 
cancelled if not traded at the conclusion of the electronic RFQ 
process.

III. Discussion and Commission Findings

    After careful consideration, 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 \15\ and, in particular, the requirements of Section 6 of the 
Act.\16\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(5) of the Act,\17\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
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 Commission believes that the 
proposal should benefit FLEX Traders and investors by providing a more 
simplified and efficient trading functionality that competes with the 
over-the-counter market in customized options.
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    \15\ In approving the proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \16\ 15 U.S.C. 78f.
    \17\ 15 U.S.C. 78f(b)(5).
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    The Exchange proposes to revise the process for opening electronic 
trading in FLEX Option series with existing open interest. The 
Commission believes that the proposal to automatically open FLEX Option 
series with existing open interest could make the opening process more 
efficient for FLEX users. In addition, the Commission notes that 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.
    In addition, the Exchange proposes to eliminate the Fill-or-Kill, 
Minimum Fill, Lots Of, and Intent to Cross Trade Conditions, and to 
adopt a new Immediate-or-Cancel Trade Condition. Furthermore, the 
Exchange proposes to eliminate European-Capped exercise style and 
foreign currency provisions for FLEX Options. The Commission notes that 
the proposed changes help to clarify the procedures utilized in the 
Exchange's enhanced FLEX System and should help encourage further use 
of FLEX Options. The Commission notes that the eliminated Trade 
Conditions and foreign currency settlement provisions will not be 
supported under the FLEX System enhancements. Also, according to the 
Exchange, the eliminated Trade Conditions, as well as the European-
Capped style and foreign currency provisions have generally not been 
actively used by FLEX Traders.
    The Exchange also proposes to adopt a new Interpretation and Policy 
to Rule 24B.5 to describe the electronic

[[Page 8307]]

processing of complex orders. The Commission believes that such a 
provision will clarify application of Exchange rules and processes for 
CBOE Trading Permit Holders and investors.
    The Exchange further proposes to modify the priority algorithms 
applicable to the FLEX electronic book and to the FLEX electronic RFQ 
process. The Commission believes that the proposed changes will 
simplify the allocation algorithms for FLEX Traders and investors. 
Under the proposal, allocation will be based on price-time priority, 
subject to public customer and non-TPH broker-dealer priority and, if 
applicable, any applicable entitlement priority. The Commission 
believes that the priority and allocation rules are reasonable and 
consistent with the Act and applies a more consistent allocation 
algorithm across these FLEX electronic processes.\18\ Moreover, the 
proposed changes regarding public customer priority/non-TPH broker-
dealer priority and price-time priority have previously been found 
consistent with the Act.\19\
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    \18\ The Commission also believes that the amended priority and 
allocation rules for electronic FLEX trading are consistent with 
Section 11(a) of the Act. 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. The 
Commission believes, however, that neither a Submitting Trading 
Permit Holder 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 Section 
11(a). 17 CFR 240.11a2-2(T). Nevertheless, the Commission believes 
that other exceptions may apply. FLEX Market-Makers qualify for the 
market-maker exception. With respect to non-market-maker members, 
the new System appears 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. See 15 U.S.C. 78k(a)(1)(G) (setting forth all 
requirements for the ``G'' exception).
    \19\ See e.g., Securities Exchange Act Release Nos. 51822 (June 
10, 2005), 70 FR 35321 (June 17, 2005) (SR-CBOE-2004-87) (Adopting 
rules pertaining to priority and allocation of trades for index 
options) and 56792 (November 15, 2007), 72 FR 65776 (November 23, 
2007) (SR-CBOE-2006-99) (Adopting rules providing for the trading of 
FLEX Options on an electronic platform).
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    The Commission received one comment letter regarding the proposed 
rule change.\20\ The comment suggested that there be an additional 
phase, the Decision Phase, in the RFQ process. During this Decision 
Phase, the initiator of an RFQ would have a brief period of time, 
during which no changes of any type to market quotes would be 
permitted, in order to decide to trade or cancel their RFQ.\21\ 
According to the Exchange, it previously proposed an RFQ process with a 
``locked up RFQ Market,'' similar to the one suggested in the comment 
letter, during the Reaction Phase. However the Exchange amended the 
process to allow FLEX Quotes and FLEX Orders to be entered, modified or 
cancelled during the Reaction Phase.\22\ The Exchange stated that the 
amendment was the result of feedback received concerning the risk of 
market movements that might occur during the ``locked up RFQ Market.'' 
\23\ The Commission agrees with the Exchange that the five-minute RFQ 
Reaction Period should be sufficient time for the Submitting Trading 
Permit Holder to determine whether to trade against the RFQ Market 
while at the same time not exposing those who respond to an RFQ to any 
unreasonable risks of market movements that may occur during the RFQ 
Reaction Period.
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    \20\ See supra note 4.
    \21\ Id.
    \22\ See Securities Exchange Act Release No. 56792, supra note 
19.
    \23\ See SR-CBOE-2006-99 Amendment No. 2, http://www.cboe.com/publish/RuleFilingsSEC/SR-CBOE-2006-099.a2.pdf.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (File No. SR-CBOE-2011-122), as 
amended by Amendment No. 1, be, and hereby is, approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-3328 Filed 2-13-12; 8:45 am]
BILLING CODE 8011-01-P


