
[Federal Register Volume 77, Number 71 (Thursday, April 12, 2012)]
[Notices]
[Pages 22027-22032]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-8783]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66759; File No. SR-CBOE-2012-005]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change Relating to Stock-
Option Orders

 April 6, 2012.

I. Introduction

    On February 7, 2012, 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 6.53C, 
``Complex Orders on the Hybrid System,'' to, among other things, revise 
CBOE's procedures for electronically executing stock-option orders. The 
proposed rule change was published for comment in the Federal Register 
on February 21, 2012.\3\ The Commission received no comment letters 
regarding the proposed rule change. This order approves the proposed 
rule change.
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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. 66394 (February 14, 
2012), 77 FR 10026 (``Notice'').
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II. Description

    CBOE proposes to amend CBOE Rule 6.53C to adopt new definitions of 
complex order and stock-option order, and to make several changes to 
its procedures for electronically executing stock-option orders.

A. Definitions of Complex Order and Stock-Option Order

    CBOE Rule 6.53C(a) currently defines complex orders, including 
stock-option orders, in terms of enumerated strategies. The proposal 
replaces these enumerated strategies with general definitions of 
complex order \4\ and stock-option order.\5\ According to CBOE, the 
investing industry creates new and legitimate investment strategies 
that do not necessarily fit within the current narrow definitions of 
complex order types, and, as a result, bona fide transactions to limit 
risk are not afforded the facility of execution provided to more common 
complex orders.\6\ CBOE believes that more general definitions will 
provide greater flexibility in the design and use of complex 
strategies.\7\ CBOE notes that its new definitions of complex order and 
stock-option order are consistent with those of another options 
exchange \8\ and with CBOE Rule 6.80(4).
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    \4\ CBOE proposes to define a complex order as any order for the 
same account involving the execution of two or more different 
options series in the same underlying security occurring at or near 
the same time in a ratio that is equal to or greater than one-to-
three (.333) and less than equal to three-to-one (3.00) (or such 
lower ratio as may be determined by the Exchange on a class-by-class 
basis) and for the purpose of executing a particular investment 
strategy. See CBOE Rule 6.53C(a)(1).
    \5\ CBOE proposes to define a stock-option order as any order 
for the same account to buy or sell a stated number of units of an 
underlying stock or a security convertible into the underlying stock 
(``convertible security'') coupled with the purchase or sale of 
options contract(s) on the opposite side of the market representing 
either (i) the same number of units of the underlying stock or 
convertible security; or (ii) the number of units of the underlying 
stock necessary to create a delta neutral position, but in no case 
in a ratio greater than eight (8) options contracts per unit of 
trading of the underlying stock or convertible security established 
for that series by The Options Clearing Corporation (or such lower 
ratio as may be determined by the Exchange on a class-by-class 
basis). See CBOE Rule 6.53C(a)(2).
    \6\ See Notice, 77 FR at 10032.
    \7\ See id.
    \8\ See ISE Rule 722(a)(1) and (2).
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    CBOE Rule 6.53C(c)(iii) currently permits only complex orders with 
no more than four legs to be placed in the Complex Order Book 
(``COB''). CBOE proposes to remove this limitation and to provide that 
only complex orders and stock-option orders with no more than the 
applicable number of legs, as determined by CBOE on a class-by-class 
basis, will be eligible for electronic processing.\9\
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    \9\ See CBOE Rule 6.53C(a)(1) and (2).
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B. Execution of Stock-Option Orders

1. Legging of Stock-Option Orders
    Currently, complex orders, including stock-option orders, may trade 
with other complex orders or by ``legging'' with the individual orders 
and quotes in CBOE's and CBSX's electronic books (``EBooks'') for the 
individual component legs, provided that the complex order can be 
executed in full, or in a permissible ratio, by the orders and quotes 
in the EBooks for the individual component legs.\10\ In the case of a 
stock-option order that is legged, the stock component of the order 
would trade with CBSX's EBook and the option

[[Page 22028]]

series leg(s) would trade with CBOE's EBook.\11\
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    \10\ See, e.g., CBOE Rule 6.53C, Interpretation and Policy 
.06(c) and (d).
    \11\ See Notice, 77 FR at footnote 10.
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    The proposal revises CBOE Rule 6.53C, Interpretation and Policy .06 
to provide that stock-option orders will execute against other stock-
option orders through COB and the Complex Order RFR Auction (``COA''), 
rather than by legging against individual orders and quotes.\12\ CBOE 
believes that this change will provide for more efficient execution and 
processing of stock-option orders and will help to mitigate the 
potential risks associated with legging stock-option orders, including 
the risk of an unhedged position if one leg of the order cannot be 
executed.\13\
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    \12\ CBOE will retain legging functionality in one limited 
circumstance, as described below. See CBOE Rule 6.53C, 
Interpretation and Policy .06(d).
    \13\ See Notice, 77 FR at 10028.
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    The proposal retains the legging functionality for an eligible 
market stock-option order that cannot be executed in full or in a 
permissible ratio at the conclusion of a COA.\14\ At the conclusion of 
a COA, any remaining balance of the option leg(s) of an eligible market 
stock-option order will continue to route to the Hybrid System for 
processing as a simple market order(s), and CBOE will electronically 
transmit any remaining balance of the stock leg to a designated broker-
dealer (as described below) for processing as a market order.\15\ The 
designated broker-dealer will represent the stock leg on behalf of the 
party that submitted the stock-option order.
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    \14\ See CBOE Rule 6.53C, Interpretation and Policy .06(d). For 
purposes of the legging functionality, an eligible market order is a 
stock-option order that is within the designated size and order type 
parameters, as determined by CBOE on a class-by-class basis, and for 
which the NBBO is within designated size and price parameters, as 
determined by CBOE for the individual leg. See CBOE Rule 6.53C, 
Interpretation and Policy .06(d).
    \15\ See CBOE Rule 6.53C, Interpretation and Policy .06.
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    CBOE believes that the order eligibility parameters for eligible 
market stock-option orders help to mitigate the potential risks 
associated with legging stock-option orders, including the risk of an 
order drilling through multiple price points on another exchange 
(thereby resulting in executions at prices that are far from the NBBO 
and potentially erroneous), and the risk that one leg of the stock-
option order will go unexecuted (resulting in an incomplete execution 
and a partial position that is unhedged).\16\
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    \16\ See Notice, 77 FR at 10028.
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2. Eligible Market Orders
    For purposes of the legging functionality, an eligible market order 
is a stock-option order that is within certain parameters determined by 
CBOE, and for which the NBBO is within designated size and price 
parameters, as determined by CBOE for the individual leg.\17\ 
Currently, CBOE may determine the NBBO price parameters based on a 
minimum bid price for sell orders and a maximum sell price for buy 
orders.\18\ The proposal eliminates the provision permitting CBOE to 
specify a designated NBBO price parameter based on a maximum offer 
price for buy orders because CBOE does not intend to utilize this 
parameter.\19\
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    \17\ See CBOE Rule 6.53C, Interpretation and Policy .06(d).
    \18\ See CBOE Rule 6.53C, Interpretation and Policy .06(d).
    \19\ See Notice, 77 FR at footnote 16.
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3. Communication of Stock Leg to a Designated Broker-Dealer(s)
    Under the proposal, CBOE will electronically communicate the stock 
leg of a stock-option order to a designated broker-dealer(s) for 
execution on behalf of a Trading Permit Holder, rather than routing the 
stock leg to CBSX.\20\ CBOE believes that this procedure will provide a 
more efficient means for processing stock-option orders.\21\ To 
participate in stock-option order automated processing, a Trading 
Permit Holder must enter into a brokerage agreement with one or more 
designated broker-dealers that are not affiliated with CBOE.\22\ 
However, CBOE notes that this process is not exclusive, and that 
Trading Permit Holders will be able to continue using open outcry 
procedures to execute stock-option orders if they choose to do so.\23\
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    \20\ See CBOE Rule 6.53C, Interpretation and Policy .06(a). As 
described above, CBOE may continue to route to CBSX the stock leg of 
an eligible market stock-option order that cannot be executed in 
full or in a permissible ratio at the conclusion of a COA. See CBOE 
Rule 6.53C, Interpretation and Policy .06(d).
    \21\ See Notice, 77 FR at 10027.
    \22\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
    \23\ CBOE notes that stock-option orders may be represented in 
open outcry by floor brokers or by CBOE PAR officials. See Notice, 
77 FR at footnote 9. See also CBOE Rules 6.45A(b) and 6.45B(b).
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    CBOE will transmit the stock component of a stock-option order to a 
designated broker-dealer as two paired orders with a designated limit 
price (except in the limited circumstance described above for eligible 
market stock-option orders) after the Exchange's trading system has 
determined that a stock-option order trade is possible and at what net 
prices.\24\ The designated broker-dealer will act as agent for the 
stock leg of a stock-option order and will be responsible for the 
proper execution, trade reporting, and submission to clearing of the 
stock trade.\25\ After CBOE communicates the stock orders to the 
designated broker-dealer for execution, the broker-dealer will be 
responsible for determining whether the orders may be executed in 
accordance will all of the rules applicable to the execution of equity 
orders, including compliance with the applicable short sale, trade-
through, and reporting rules.\26\
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    \24\ See Notice, 77 FR at 10026.
    \25\ See Notice, 77 FR at 10026-10027.
    \26\ See Notice, 77 FR at 10027.
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    A Trading Permit Holder may submit a stock-option order only if the 
order complies with the qualified contingent trade exemption (``QCT 
Exemption'') from Rule 611(a) of Regulation NMS,\27\ and a Trading 
Permit Holder submitting a stock-option order represents that the order 
complies with the QCT Exemption.\28\ In addition, as described more 
fully in the Notice, CBOE's Hybrid System will validate compliance with 
the QCT Exemption with respect to each matched order communicated to 
the designated broker-dealer.\29\
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    \27\ 17 CFR 242.611(a). See Securities Exchange Act Release No. 
57620 (April 4, 2008), 73 FR 19271 (April 9, 2008) (order modifying 
the QCT Exemption). See also Securities Exchange Act Release No. 
54389 (August 31, 2006), 71 FR 52829 (September 7, 2006) (order 
establishing the QCT Exemption).
    \28\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
    \29\ See Notice, 77 FR at 10027.
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    CBOE intends to file a separate proposal to establish fees related 
to the routing of the stock portion of a stock-option order.\30\
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    \30\ See Notice, 77 FR at 10026-10027.
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C. Allocation Algorithms and Priority

1. COB and COA Allocation Algorithms
    Currently, stock-option orders in COB may execute against other 
stock-option orders or against individual orders and quotes in the 
EBook.\31\ Because CBOE will no longer permit the legging of stock-
option orders in COB against individual orders and quotes in the 
component legs, the proposal amends the COB algorithm to provide that 
stock-option orders that are marketable against each other will execute 
automatically.\32\ Multiple stock-option orders at the same price will 
be allocated pursuant to the rules of trading priority otherwise 
applicable to incoming electronic orders in the individual component 
legs,\33\ or

[[Page 22029]]

pursuant to another allocation algorithm designated by CBOE under CBOE 
Rule 6.53C, Interpretation and Policy .09.\34\
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    \31\ See CBOE Rule 6.53C, Interpretation and Policy .06(b), (c), 
and (f).
    \32\ See CBOE Rule 6.53C, Interpretation and Policy .06(c).
    \33\ See id. CBOE notes that the allocation algorithms for the 
individual series legs include price-time, pro-rata, and the 
ultimate matching algorithm (``UMA'') base priorities, and a 
combination of various optional priority overlays pertaining to 
public customer priority, Market Maker participation entitlement, 
small order preference, and market turner. See Notice, 77 FR at 
footnote 17. See also CBOE Rules 6.45A and 6.45B.
    \34\ CBOE Rule 6.53C, Interpretation and Policy .09 allows CBOE 
to determine, on a class-by-class basis, which electronic matching 
algorithm from CBOE Rule 6.45A or 6.45B, as applicable, will apply 
to executions in COB in lieu of the algorithm specified in CBOE Rule 
6.53C(c)(ii)(2) and (3).
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    Stock-option orders in COA, like stock-option orders in COB, 
currently may execute against other stock-option orders or against 
individual orders and quotes in the EBook.\35\ Because CBOE will no 
longer permit the legging of stock-option orders in COA against 
individual orders and quotes in the component legs, except in the 
limited circumstance noted above, the proposal amends the COA algorithm 
to provide that stock-option orders executed against other stock-option 
orders through COA will trade first at the best net price(s) and, at 
the same price, in the sequence set forth in CBOE Rule 6.53C(d)(2)-
(4).\36\
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    \35\ See CBOE Rule 6.53C, Interpretation and Policy .06(b), (d), 
and (f).
    \36\ See CBOE Rule 6.53C, Interpretation and Policy .06(d). 
Under Interpretation and Policy .06(d), as amended, a stock-option 
order that was subject to a COA would execute against other stock-
option orders first, at the best net price(s) and, at the same 
price, in the following sequence: (i) Against public customer stock-
option orders resting in COB before, or received during, the COA 
Response Time Interval, and public customer RFR Responses, with 
multiple public customer orders ranked by time priority; (ii) 
against non-public customer orders resting in COB before the COA 
Response Time Interval, with multiple orders subject to the UMA 
allocation in CBOE Rule 6.45A or 6.45B, as applicable; and (iii) 
against non-public customer orders resting in COB that are received 
during the COA Response Time Interval, and non-public customer RFR 
Responses, with multiple orders subject to the CUMA allocation in 
CBOE Rule 6.45A or 6.45B, as applicable.
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2. Priority
    For a stock-option order to execute against another stock-option 
order in COB or COA, the execution must occur at a price where the 
option leg(s) of the stock-option order have priority over the 
individual orders and quotes in CBOE's EBook.\37\ To satisfy this 
condition, the individual options legs of the stock-option order: (1) 
Must not trade at a price that is inferior to CBOE's best bid (offer) 
in the individual component series; and (2) must not trade at CBOE's 
best bid (offer) in the individual component series if one or more 
public customer orders are resting at the best bid (offer) in each of 
the component series and the stock-option order could otherwise be 
executed in full or in a permissible ratio.\38\
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    \37\ See Notice, 77 FR at 10028.
    \38\ See CBOE Rule 6.53C, Interpretation and Policy .06(a) and 
(d). See also Notice, 77 FR at 10028 and 10029.
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D. Provisions Applicable to Marketable Stock-Option Orders

    Several provisions in the proposal address the handling of stock-
option orders that become marketable. First, to the extent that a 
marketable stock-option order cannot be executed in full, or in a 
permissible ratio, after it is routed to COB or following a COA, any 
part of the order that can execute will execute and the remaining 
balance 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.\39\ If 
the order is not eligible to route to PAR, the remaining balance will 
be cancelled.\40\
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    \39\ See CBOE Rule 6.53C, Interpretation and Policy .06(b)(1). 
The Commission notes that CBOE intends to file a separate proposed 
rule change to revise CBOE Rule 6.53C, Interpretation and Policy .06 
and .08 to further describe booth routing parameters and related 
order management terminal operations. See email message from 
Jennifer Lamie, Assistant General Counsel, Legal Division, CBOE, to 
Yvonne Fraticelli, Special Counsel, and Brian Baltz, Attorney, 
Division of Trading and Markets, Commission, dated March 27, 2012.
    \40\ See id.
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    Second, to the extent that a stock-option order resting in COB 
becomes marketable against the derived net market, the full order will 
be subject to a COA.\41\ The derived net market will be calculated 
using CBOE's best bid or offer for the individual option series leg(s) 
and the NBBO for the stock leg.\42\ CBOE believes that automatically 
initiating a COA after a resting stock-option order becomes marketable 
against the derived net market will provide an opportunity for market 
participants to match or improve the net price and provide an 
opportunity for automatic execution of the order.\43\ CBOE notes that 
this system feature will not be applicable to a resting stock-option 
order that becomes marketable against another stock-option 
order(s).\44\
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    \41\ See CBOE Rule 6.53C, Interpretation and Policy .06(a)(2). 
The order would not execute automatically against the derived net 
market because stock-option orders will no longer execute against 
the individual legs of the order, except in the limited circumstance 
described above.
    \42\ See id.
    \43\ See Notice, 77 FR at 10029.
    \44\ See id.
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E. Price Check Parameters

    CBOE proposes to adopt a new price check parameter applicable to 
the electronic processing of stock-option orders.\45\ This price check 
parameter would allow CBOE to determine, on a class-by-class basis, and 
announce to Trading Permit Holders via Regulatory Circular, not to 
automatically execute a marketable stock-option order if, following a 
COA, the execution would not be within the acceptable derived net 
market for the strategy that existed at the start of the COA.\46\ Such 
an order would route on a class-by-class basis to PAR or, at the order 
entry firm's discretion, to the order entry firm's booth.\47\ If the 
order is not eligible to route to PAR, the remaining balance would be 
cancelled.\48\
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    \45\ See CBOE Rule 6.53C, Interpretation and Policy .08(f).
    \46\ See CBOE Rule 6.53, Interpretation and Policy .08(f)(1).
    \47\ See CBOE Rule 6.53C, Interpretation and Policy .08(f)(2). 
See also note 39, supra.
    \48\ See id.
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    The ``acceptable derived net market'' for a strategy will be 
calculated using CBOE's best bid or offer in the individual option 
series leg(s) and the NBBO in the stock leg plus/minus an acceptable 
tick distance.\49\ CBOE will determine the ``acceptable tick distance'' 
on a class-by-class and premium basis.\50\ CBOE believes that it is 
reasonable and appropriate to use the Exchange's best bid and offer for 
the individual series to calculate the acceptable derived net market 
for the option series leg(s) because the option component leg(s) of a 
stock-option order are not permitted to trade at a price that is 
inferior to CBOE's best bid and offer.\51\ CBOE believes that it is 
reasonable and appropriate to use the NBBO plus/minus an acceptable 
tick distance to calculate the acceptable derived net market for the 
stock component because CBOE believes that the NBBO should serve as a 
reasonable proxy for what may be considered a reasonable price for the 
automatic execution of the stock component leg.\52\ CBOE believes, 
further, that it also may be appropriate to consider some range outside 
the NBBO in determining the acceptable tick distance because the stock 
leg of a stock-option order that qualifies for the QCT Exemption \53\ 
may be executed outside the NBBO for the stock.\54\ Accordingly, in 
establishing the acceptable tick distance for the stock leg of the 
order, CBOE would have the flexibility to use the NBBO (which would 
equate to an acceptable tick

[[Page 22030]]

distance of 0) or a range outside the NBBO.\55\
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    \49\ See CBOE Rule 6.53C, Interpretation and Policy .08(f)(1).
    \50\ See id.
    \51\ See Notice, 77 FR at footnote 21.
    \52\ See id.
    \53\ See note 27, supra.
    \54\ See Notice, 77 FR at footnote 21.
    \55\ See id.
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    In classes where this price check parameter is available, it will 
also be available for COA responses under CBOE Rule 6.53C(d), AIM and 
Solicitation Auction Mechanism stock-option orders and responses under 
CBOE Rules 6.74A and 6.74B, and customer-to-customer immediate cross 
stock-option orders under CBOE Rule 6.74A, Interpretation and Policy 
.08 (``CTC'').\56\ Under these provisions, paired stock-option orders 
and responses will not be accepted except that, to the extent that only 
a paired contra-side order subject to an auction under CBOE Rule 6.74A 
or 6.74B exceeds the price check parameter, the contra-side order will 
not be accepted and the paired original Agency Order will not be 
accepted or, at the order entry firm's discretion, the Agency Order 
would continue processing as an unpaired stock option order (e.g., the 
Agency Order would route to COB or COA for processing).\57\ To the 
extent that a contra-side order or response is marketable, its price 
will be capped at the price inside the acceptable derived net 
market.\58\
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    \56\ See CBOE Rule 6.53C, Interpretation and Policy .08(f)(2). 
AIM, SAM and CTC are mechanisms that may be used to cross two paired 
orders. See Notice, 77 FR at footnote 22.
    \57\ See CBOE Rule 6.53C, Interpretation and Policy .08(f)(2) 
and Notice, 77 FR at 10030.
    \58\ See CBOE Rule 6.53C, Interpretation and Policy .08(f)(2).
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    CBOE also proposes to apply the existing individual series leg 
width price check parameter in CBOE Rule 6.53C, Interpretation and 
Policy .08(a)(i) to market and marketable limit stock-option 
orders.\59\ Under this price check parameter, a market or marketable 
limit stock-option order in a class where the price check parameter was 
available would not be executed automatically if the width between 
CBOE's best bid and best offer in any individual series leg was not 
within an acceptable price range.\60\
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    \59\ See CBOE Rule 6.53C, Interpretation and Policy .08(a) and 
Notice, 77 FR at 10030-10031.
    \60\ See id.
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    CBOE believes that the price protection parameters will help to 
mitigate the potential risks associated with stock-option orders 
drilling through multiple price points, thereby resulting in executions 
that are extreme and potentially erroneous.\61\
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    \61\ See Notice, 77 FR at 10031.
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F. Extension of the re-COA Feature to Stock-Option Orders

    CBOE Rule 6.53C, Interpretation and Policy .04(b) provides that, 
for classes in which COA is activated, a non-marketable order resting 
at the top of the COB may be automatically subject to COA if the order 
is within a number of ticks away from current derived net market. The 
proposal extends this ``re-COA'' feature to include stock-option orders 
resting at the top of the COB, and to provide that the derived net 
market for a stock-option order will be calculated using CBOE's best 
bid or offer in the individual option series leg(s) and the NBBO in the 
stock leg.\62\ CBOE notes that this feature would apply only to a 
resting non-marketable stock-option order that moves close to the 
derived net market, but would not apply to a resting stock-option order 
that becomes marketable against another stock-option order(s).\63\ CBOE 
believes that this feature will facilitate the execution of stock-
option orders by providing an automated opportunity for the execution 
of, and price improvement to, a resting stock-option order that is 
priced near the current market, similar to what a Trading Permit Holder 
might do if the Trading Permit Holder were representing the stock-
option order in open outcry or entering the order into COB.\64\
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    \62\ See CBOE Rule 6.53C, Interpretation and Policy .04(b).
    \63\ See Notice, 77 FR at 10031.
    \64\ See id.
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G. Rule Text Reorganizations

    As described more fully in the Notice, CBOE also proposes various 
changes to reorganize and simplify the rules governing stock-option 
orders by, among other things, consolidating certain provisions in CBOE 
Rule 6.53C, Interpretation and Policy .06.\65\
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    \65\ See Notice, 77 FR at 10031-10032.
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III. Discussion and Commission's Findings

    After careful review, 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.\66\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\67\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest.
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    \66\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \67\ 15 U.S.C. 78f(b)(5).
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A. Definitions of Complex Order and Stock-Option Order

    The Commission finds that the proposed definitions of complex order 
and stock-option order are consistent with the Act. The Commission 
believes that the new definitions could permit the electronic trading 
on CBOE of complex orders representing investment strategies that do 
not fall within the enumerated strategies in CBOE's current rule, 
including transactions designed to limit risk. The Commission notes 
that the proposed definitions of complex order and stock-option order 
are consistent with definitions included in the rules of another 
options exchange \68\ and in CBOE Rule 6.80(4).\69\ In addition, the 
Commission believes that the rule changes removing the limit on the 
number of legs that may be included in a complex order could provide 
greater flexibility and permit the electronic trading on CBOE of 
additional complex orders.
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    \68\ See ISE Rule 722(a)(1) and (2).
    \69\ CBOE Rule 6.80(4) defines a Complex Trade for purposes of 
CBOE Chapter VI, Section E, ``Order Protection; Locked and Crossed 
Markets.'' CBOE Rule 6.81(b)(7) provides an exception from the 
prohibition on Trade-Throughs for any transaction that was effected 
as a portion of a Complex Trade.
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B. Execution of Stock-Option Orders

1. Legging of Stock-Option Orders
    The Commission believes that the proposal to revise CBOE Rule 
6.53C, Interpretation and Policy .06 to provide for the execution of 
stock-option against other stock-option orders through COB and COA, 
rather than by legging against individual orders and quotes in the CBOE 
and CBSX EBooks, is consistent with the Act because it could facilitate 
the execution of stock-option orders. The Commission notes that another 
options exchange similarly permits stock-option orders traded on its 
electronic trading platform to execute only against other stock-option 
orders.\70\
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    \70\ See Phlx Rule 1080, Commentary .08(a)(i) (stating that 
stock-option orders may only be executed against other stock-option 
orders and cannot be executed by the System against orders for the 
individual components).
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    The Commission also believes that it is consistent with the Act for 
CBOE to retain the legging feature for eligible market stock-option 
orders that cannot be executed, in full or in a permissible ratio, at 
the conclusion of a COA because the legging functionality could provide 
an additional opportunity for these orders to be executed. The 
Commission notes that CBOE believes

[[Page 22031]]

that the eligibility parameters for eligible market stock-option orders 
could help to mitigate the risks that may be associated with legging 
stock-option orders.\71\
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    \71\ See Notice, 77 FR at 10028. Under CBOE Rule 6.53C, 
Interpretation and Policy .06(d), as amended, an ``eligible market 
order'' is a stock-option order that is within the designated size 
and order type parameters determined by CBOE on a class-by-class 
basis, and for which the NBBO is within designated size and price 
parameters, as determined by CBOE for the individual leg. The 
designated NBBO price parameters will be determined based on a 
minimum bid price for sell orders. CBOE may determine on a class-by-
class basis to limit the trading times within regular trading hours 
that the legging functionality will be available.
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2. Eligible Market Orders
    The Commission believes that it is consistent with the Act for CBOE 
to modify the eligible market order parameter in CBOE Rule 6.53C, 
Interpretation and Policy .06(d) by eliminating the provision that 
allows CBOE to establish an NBBO price parameter for such orders based 
on a maximum offer price for buy orders. CBOE states that it does not 
intend to use this parameter.\72\ Accordingly, the Commission believes 
that eliminating this parameter will help to assure that the rule 
accurately reflects the parameters that CBOE may use to identify 
eligible market stock-option orders.
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    \72\ See Notice, 77 FR at footnote 16.
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3. Communication of Stock Leg to a Designated Broker-Dealer(s)
    As described more fully above, CBOE proposes to revise its rules to 
allow the Exchange to electronically communicate the stock leg of a 
stock-option order to a designated broker-dealer for execution on 
behalf of a Trading Permit Holder.\73\ To participate in stock-option 
order automated processing, a Trading Permit Holder must enter into a 
brokerage agreement with one or more designated broker-dealers that are 
not affiliated with CBOE.\74\
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    \73\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
    \74\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
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    The designated broker-dealer will act as agent for the stock leg of 
a stock-option order and will be responsible for the proper execution, 
trade reporting, and submission to clearing of the stock trade.\75\ In 
addition, after CBOE communicates the paired stock orders to the 
designated broker-dealer for execution, the broker-dealer will be 
responsible for determining whether the orders may be executed in 
accordance with all of the rules applicable to the execution of equity 
orders, including compliance with the applicable short sale, trade-
through, and reporting rules.\76\ In addition, a Trading Permit Holder 
may submit a stock-option order only if the order complies with the QCT 
Exemption from Rule 611(a) of Regulation NMS, and a Trading Permit 
Holder submitting a stock-option order represents that the order 
complies with the QCT Exemption.\77\ As described more fully in the 
Notice, CBOE's Hybrid System will validate compliance with the QCT 
Exemption with respect to each matched order communicated to the 
designated broker-dealer.\78\
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    \75\ See Notice, 77 FR at 10026-10027.
    \76\ See Notice, 77 FR at 10027.
    \77\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
    \78\ See Notice, 77 FR at 10027.
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    CBOE states that this automated process for executing stock-option 
orders is not exclusive, and that Trading Permit Holders will continue 
to be able to use open outcry procedures to execute stock-option orders 
if they choose to do so.\79\
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    \79\ Stock-option orders may be represented in open outcry by 
floor brokers or by CBOE PAR officials. See Notice, 77 FR at 
footnote 9 and accompanying text. See also CBOE Rules 6.45A(b) and 
6.45B(b).
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    The Commission notes that CBOE's proposal to electronically 
communicate the stock leg of a stock-option order to a designated 
broker-dealer for execution is similar to rules adopted by other 
options exchanges.\80\ In addition, the Commission notes that Trading 
Permit Holders will continue to have the ability to use open outcry 
procedures to execute stock-option orders if they choose to do so. 
Accordingly, the Commission finds that the proposal to allow CBOE to 
electronically communicate the stock leg of a stock-option order to a 
designated broker-dealer that is not affiliated with CBOE for execution 
on behalf of a Trading Permit Holder is consistent with the Act.
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    \80\ See ISE Rule 722, Supplementary Material .02. See also Phlx 
Rule 1080, Commentary .08.
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C. Allocation Algorithms and Priority

1. COB and COA Allocation Algorithms
    Because stock-option orders generally will not execute against 
individual leg market interest in the CBOE and CBSX EBooks, CBOE is 
eliminating references in CBOE Rule 6.53C, Interpretation and Policy 
.06 to executions of stock-option orders against individual orders and 
quotes. Instead, stock-option orders in COB that are marketable against 
each other will execute automatically, and multiple stock-option orders 
at the same price will be allocated pursuant to the rules of trading 
priority otherwise applicable to incoming electronic orders in the 
individual component legs.\81\ The Commission notes that this 
allocation provision for stock-option orders in COB is consistent with 
the existing complex order allocation provision in CBOE Rule 
6.53C(c)(ii)(2).\82\ Accordingly, the Commission believes that the 
allocation provision for marketable stock-option orders in COB is 
consistent with the Act.
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    \81\ See CBOE Rule 6.53C, Interpretation and Policy .06(c). CBOE 
also could allocate stock-option orders pursuant to another 
allocation algorithm designated by CBOE under CBOE Rule 6.53C, 
Interpretation and Policy .09.
    \82\ CBOE Rule 6.53C(c) states that the allocation of complex 
orders in COB that are marketable against each other will be 
pursuant to the rules to trading priority otherwise applicable to 
incoming electronic orders in the individual component legs.
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    Because CBOE will no longer permit the legging of stock-option 
orders in COA against individual orders and quotes in the component 
legs (except with respect to an eligible market stock-option order that 
cannot be executed following a COA), CBOE is amending the COA algorithm 
to eliminate the reference to executions against individual orders and 
quotes in the EBook, but retaining the remainder of the current stock-
option order allocation algorithm in CBOE Rule 6.53C, Commentary 
.06(d). Accordingly, stock-option orders executed through COA will 
trade first at the best net price(s) and, at the same price, in the 
sequence set forth in CBOE Rule 6.53C(d)(v)(2)-(4).\83\ The Commission 
believes that it is consistent with the Act for CBOE to continue to 
apply this allocation algorithm to stock-option orders.
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    \83\ See CBOE Rule 6.53C, Interpretation and Policy .06(d).
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2. Priority
    For a stock-option order to execute against another stock-option 
order in COB or COA, the execution must occur at a price where the 
option leg(s) of the stock-option order have priority over the 
individual orders and quotes in CBOE's EBook.\84\ To satisfy this 
condition, the individual options legs of the stock-option order: (1) 
Must not trade at a price that is inferior to CBOE's best bid (offer) 
in the individual component series; and (2) must not trade at CBOE's 
best bid (offer) in the individual component series if one or more 
public customer orders are resting at the best bid (offer) in each of 
the component series and the stock-option order could otherwise be 
executed in full or in a permissible ratio. These provisions are 
consistent with CBOE's existing priority rules,\85\ and with the rules 
of other

[[Page 22032]]

options exchanges.\86\ Accordingly, the Commission finds that the 
priority requirements for stock-option orders in CBOE Rule 6.53C, 
Commentary .06(b) are consistent with the Act.
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    \84\ See Notice, 77 FR at 10028.
    \85\ See, e.g., CBOE Rules 6.45(e); 6.45A(b)(ii); and 
6.45B(b)(ii).
    \86\ See, e.g., ISE Rule 722(b)(2); and NYSE Amex Rule 980NY, 
Commentary .03(d).
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D. Provisions Applicable to Marketable Stock-Option Orders

    To the extent that a marketable stock-option order cannot be 
executed in full in, or in a permissible ratio, after it is routed to 
COB or following a COA, any part of the order that can execute will 
execute and the remaining balance 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.\87\ If the order is not eligible to route to PAR, 
the remaining balance will be cancelled.\88\ The Commission believes 
that these provisions are consistent with the Act because they 
establish procedures for handling the remaining balance of a marketable 
stock-option order that cannot be executed in full or in a permissible 
ratio.
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    \87\ See CBOE Rule 6.53C, Interpretation and Policy .06(a)(1). 
As noted above, CBOE plans to file a separate proposal that will 
further describe booth routing parameters and order management 
terminal operations. See note 39, supra.
    \88\ See id.
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    In addition, to the extent that a stock-option order resting in COB 
becomes marketable against the derived net market, the full order will 
be subject to a COA.\89\ The Commission believes that this provision is 
consistent with the Act because it could facilitate the execution of a 
stock-option order that is marketable against the derived net market, 
but that would not execute against the derived net market because 
stock-option orders generally will not execute against leg market 
interest.
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    \89\ See CBOE Rule 6.53C, Interpretation and Policy .06(a)(2). 
This system feature will not be applicable to a resting stock-option 
order that becomes marketable against another stock-option order(s).
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E. Price Check Parameters

    The stock-option derived net market price check parameter in CBOE 
Rule 6.53C, Interpretation and Policy .08(f) will prevent the automatic 
execution of a stock-option order following a COA if the execution 
would not be within the acceptable derived net market that existed at 
the start of the COA. The Commission believes that this price check 
parameter is consistent with the Act because it could help to prevent 
the automatic execution of stock-option orders at extreme or 
potentially erroneous prices. The Commission believes that it is 
reasonable to use CBOE's best bid and offer for the individual series 
legs to calculate the acceptable derived net market for the option 
leg(s) of a stock-option order because the option leg(s) would not be 
permitted to trade at a price that is inferior to CBOE's best bid or 
offer. The Commission believes that using the NBBO for the stock, plus 
or minus an acceptable tick distance, to determine the acceptable 
derived net market for the stock leg of a stock-option order will 
provide CBOE with flexibility in setting this parameter. The Commission 
notes that a stock-option order submitted to the Hybrid System must 
comply with the QCT Exemption.\90\ The stock leg of a stock-option 
order that complies with the QCT Exemption would be permitted to trade 
at a price that is outside the NBBO for the stock.
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    \90\ See CBOE Rule 6.53C, Interpretation and Policy .06(a).
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    CBOE also proposes to extend the existing individual series leg 
width price check parameter in CBOE Rule 6.53C, Interpretation and 
Policy .08(a)(i), which currently applies to complex orders, to the 
individual series legs of market and marketable limit stock-option 
orders.\91\ This price check parameter prevents the automatic execution 
of a marketable complex order when the width between CBOE's best bid 
and offer in any individual series leg is not within an acceptable 
price range. The Commission believes that it is consistent with the Act 
for CBOE to have the ability to apply this price check parameter to 
stock-option orders, in addition to complex orders.
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    \91\ See CBOE Rule 6.53C, Interpretation and Policy .08(a)(5) 
and Notice, 77 FR at 10030--10031.
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F. Extension of the Re-COA Feature to Stock-Option Orders

    CBOE proposes to amend CBOE Rule 6.53C, Interpretation and Policy 
.04(b) to apply its ``re-COA'' feature to stock-option orders resting 
at the top of the COB. For classes in which COA is activated, a non-
marketable stock-option order resting at the top of the COB may be 
automatically subject to COA if the order is within a number of ticks 
away from current derived net market.\92\ The Commission believes that 
applying the ``re-COA'' feature to stock-option orders could facilitate 
the execution of stock-option orders by providing an opportunity for a 
stock-option resting at the top of the COB to be executed 
automatically. Accordingly, the Commission finds that the provision is 
consistent with the Act.
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    \92\ See CBOE Rule 6.53C, Interpretation and Policy .04(b). CBOE 
will calculate the derived net market for a stock-option order using 
CBOE's best bid or offer in the individual option series leg(s) and 
the NBBO in the stock leg.
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G. Rule Text Reorganizations

    The Commission believes that the proposed changes to reorganize, 
consolidate, and simplify CBOE Rule 6.53C, Interpretation and Policy 
.06 are consistent with the Act.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\93\ that the proposed rule change (SR-CBOE-2012-005) is approved.
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    \93\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\94\
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    \94\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-8783 Filed 4-11-12; 8:45 am]
BILLING CODE 8011-01-P


