
[Federal Register Volume 77, Number 71 (Thursday, April 12, 2012)]
[Notices]
[Pages 22022-22027]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-8784]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66760; File No. SR-C2-2012-004]


Self-Regulatory Organizations; C2 Options Exchange, Incorporated; 
Order Approving a Proposed Rule Change Relating To Stock-Option Orders

April 6, 2012.

I. Introduction

    On February 7, 2012, the C2 Options Exchange, Incorporated 
(``Exchange'' or ``C2'') 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 C2 Rule 6.13, ``Complex 
Order Execution,'' to, among other things, revise C2'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\ Securities Exchange Act Release No. 66393 (February 14, 
2012), 77 FR 10020 (``Notice'').
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II. Description of the Proposal

    C2 proposes to amend C2 Rule 6.13 to adopt definitions of complex 
order and stock-option order, and to provide procedures for 
electronically executing stock-option orders.

A. Definitions of Complex Order and Stock-Option Order

    C2 proposes to amend C2 Rule 6.13(a) to include definitions of 
complex order \4\ and stock-option order.\5\ C2 notes that its new 
definitions of complex order and stock-option order are consistent with 
those of another options exchange,\6\ and with the definitions used in 
C2 Chapter VI, Section E, ``Intermarket Linkage,'' which incorporates 
by reference Chicago Board Options Exchange, Inc. (``CBOE'') CBOE Rule 
6.80(4).
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    \4\ C2 proposes to define a complex order as any order 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 
or 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 C2 Rule 
6.13(a)(1).
    \5\ C2 proposes to define a ``stock-option order'' as an order 
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 C2 Rule 
6.13(a)(2).
    \6\ See ISE Rule 722(a)(1) and (2).
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    C2 Rule 6.13(b)(2) currently permits only complex orders with no 
more than four legs to be placed in the Complex Order Book (``COB''). 
C2 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 C2 on a class-by-class basis, will be 
eligible for processing.\7\
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    \7\ See C2 Rule 6.13(a)(1) and (2).
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B. Execution of Stock-Option Orders

1. Legging
    C2 proposes to add Interpretation and Policy .06 to Rule 6.13 to 
provide that stock-option orders will execute against other stock-
option orders through COB and the Complex Order RFR Auction (``COA''). 
Stock-option orders will not be legged against the individual component 
legs, except in one limited circumstance, as described below.\8\ C2 
believes that the proposal 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

[[Page 22023]]

unhedged position if one leg of the order cannot be executed.\9\
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    \8\ See C2 Rule 6.13, Interpretation and Policy .06(d).
    \9\ See Notice, 77 FR at 10021-22.
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    C2 proposes to permit legging for an eligible market stock-option 
order that cannot be executed in full, or in a permissible ratio, at 
the conclusion of a COA.\10\ At the conclusion of a COA, any remaining 
balance of the option leg(s) of an eligible market stock-option order 
will route to C2's system for processing as a simple market order(s), 
and C2 will electronically transmit any remaining balance of the stock 
leg to a designated broker-dealer (as described below) for processing 
as a market order.\11\ The designated broker-dealer will represent the 
stock leg on behalf of the party that submitted the stock-option order.
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    \10\ See C2 Rule 6.13, 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 C2 on a class-by-class basis, and for 
which the national best bid or offer (``NBBO'') is within designated 
size and price parameters, as determined by C2 for the individual 
leg. See C2 Rule 6.13, Interpretation and Policy .06(d).
    \11\ See C2 Rule 6.13, Interpretation and Policy .06(d).
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    For purposes of this legging functionality, an eligible market 
order is a stock-option order that is within certain parameters 
determined by C2 and for which the NBBO is within designated size and 
price parameters, as determined by C2 for the individual leg.\12\ The 
designated NBBO price parameters will be determined based on a minimum 
bid price for sell orders.\13\ The Exchange may also determine on a 
class-by-class basis to limit the trading times within regular trading 
hours that the legging functionality will be available.\14\
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    \12\ See id.
    \13\ See id.
    \14\ See id.
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    C2 believes that the order eligibility parameters for eligible 
market stock-option orders will 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).\15\
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    \15\ See Notice, 77 FR at 10022.
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2. Communication of Stock Leg to a Designated Broker-Dealer(s)
    Under the proposal, C2 will electronically communicate the stock 
leg of a stock-option order to a designated broker-dealer(s) for 
execution on behalf of a Permit Holder.\16\ C2 believes that this 
procedure will provide a more efficient means for processing stock-
option orders.\17\ To participate in stock-option order automated 
processing, a Permit Holder must enter into a brokerage agreement with 
one or more designated broker-dealers that are not affiliated with 
C2.\18\
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    \16\ See C2 Rule 6.13, Interpretation and Policy .06(a).
    \17\ See Notice, 77 FR at 10021.
    \18\ See C2 Rule 6.13, Interpretation and Policy .06(a).
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    C2 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 
determines that a stock-option order trade is possible and at what net 
prices.\19\ 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.\20\ After C2 communicates the stock orders to the 
designated broker-dealer for execution, the designated broker-dealer 
will be responsible for determining whether the orders may be executed 
in accordance with all of the rules applicable to execution of equity 
orders, including compliance with applicable short sale, trade-through, 
and trade reporting rules.\21\ If the designated broker-dealer cannot 
execute the stock leg at the designated price, the stock-option order 
will not be executed on the Exchange.\22\
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    \19\ See Notice, 77 FR at 10020.
    \20\ See id. at 10020-21.
    \21\ See id. at 10021.
    \22\ See id. at 10021 and C2 Rule 6.13, Interpretation and 
Policy .06.
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    A 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,\23\ and a Permit 
Holder submitting a stock-option order represents that the order 
complies with the QCT Exemption.\24\ In addition, as described more 
fully in the Notice, C2's system will validate compliance with the QCT 
Exemption with respect to each matched order communicated to the 
designated broker-dealer.\25\
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    \23\ See 17 CFR 242.611(a). See also Securities Exchange Act 
Release No. 57620 (April 4, 2008), 73 FR 19271 (April 9, 2008) 
(order modifying the QCT Exemption) and Securities Exchange Act 
Release No. 53489 (August 31, 2006), 71 FR 52829 (September 7, 2006) 
(order establishing the QCT Exemption).
    \24\ See C2 Rule 6.13, Interpretation and Policy .06(a).
    \25\ See Notice, 77 FR at 10021.
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    C2 intends to file a separate proposal to establish fees related to 
the routing of the stock portion of a stock-option order.\26\
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    \26\ See id. at 10021.
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C. Allocation Algorithms and Priority

1. COB and COA Allocation Algorithms
    Stock-option orders in COB and COA will execute according to an 
electronic allocation algorithm. Specifically, stock-option orders in 
COB that are marketable against each other will execute 
automatically.\27\ 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,\28\ or pursuant to another allocation algorithm designated by C2 
under C2 Rule 6.13, Interpretation and Policy .05.\29\
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    \27\ See C2 Rule 6.13, Interpretation and Policy .06(c).
    \28\ See id. C2 notes that the allocation algorithms for the 
individual series legs include price-time, pro-rata, and price-time 
with primary public customer and secondary trade participation right 
priority and an optional priority overlay pertaining to market 
turner priority. See Notice, 77 FR at footnote 15. See also C2 Rule 
6.12.
    \29\ See C2 Rule 6.13, Interpretation and Policy .06(c). C2 Rule 
6.13, Interpretation and Policy .05 allows C2 to determine, on a 
class-by-class basis, which electronic matching algorithm from Rule 
6.12 will apply to executions in COB in lieu of the algorithm 
specified in C2 Rule 6.13(b)(1)(B).
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    Stock-option orders executed against other stock-option orders 
through a COA will trade first at the best net price(s) and, at the 
same price, in the sequence set forth in C2 Rule 6.13(c)(5)(B)-(D).\30\
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    \30\ See C2 Rule 6.13, Interpretation and Policy .06(d). Under 
Interpretation and Policy .06(d), a stock-option order that was 
subject to a COA would execute against other stock-option orders 
first at the same net price(s) and, at the same price, in the 
following sequence: (i) Against public customer stock-option orders 
resting in COB before, or that are received during, the COA Response 
Time Interval, and public customer RFR responses, with multiple 
orders ranked by time priority; (ii) against non-public customer 
stock-option orders resting in the COB before the COA Response Time 
Interval, with multiple orders subject to the rules of trading 
priority otherwise applicable to incoming orders in the individual 
component legs; and (iii) against non-public customer stock-option 
orders resting in the COB that are received during the COA Response 
Time Interval and non-public customer responses, with multiple 
orders subject to the rules of trading priority otherwise applicable 
to incoming orders in the individual component legs.
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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

[[Page 22024]]

individual orders and quotes in C2's Book.\31\ To satisfy this 
condition, the individual option leg(s) of the stock-option order: (i) 
Must not trade at a price that is inferior to C2's best bid (offer) in 
the individual component series; and (ii) must not trade at C2's best 
bid (offer) in the individual component series if one or more public 
customer orders are resting at the best bid (offer) price in each of 
the component option series and the stock-option order could otherwise 
be executed in full or in a permissible ratio.\32\ The option leg(s) of 
a stock-option order may be executed in a one-cent increment regardless 
of the minimum quoting increment applicable to that series.\33\
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    \31\ See Notice, 77 FR at 10022.
    \32\ See C2 Rule 6.13, Interpretation and Policy .06(b). See 
also Notice, 77 FR at 10022.
    \33\ See C2 Rule 6.13, Interpretation and Policy .06(b).
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D. Provisions Applicable to Marketable Stock-Option Orders

    Several provisions in the proposal address the handling of a stock-
option order that is or becomes marketable. First, to the extent that a 
marketable stock-option order cannot be executed in full, or in a 
permissible ratio, when it is routed to COB or following a COA, any 
part of the order that can execute will execute and the part that 
cannot automatically execute will be cancelled.\34\
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    \34\ See C2 Rule 6.13, Interpretation and Policy .06(b)(1).
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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.\35\ The derived net market for a strategy will be 
calculated using C2's best bid or offer in the individual option series 
leg(s) and the NBBO in the stock leg.\36\ After being subject to a COA, 
any part of the order that may be executed will be executed 
automatically and the part that cannot execute automatically will be 
canceled.\37\ C2 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.\38\ C2 notes that this system feature will not 
be applicable to a resting stock-option order that becomes marketable 
against another stock-option order(s).\39\
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    \35\ See C2 Rule 6.13, Interpretation and Policy .06(b)(2). The 
order would not execute automatically against the derived net market 
because stock-option orders will not execute against the individual 
legs of the order, except in the limited circumstance described 
above.
    \36\ See id.
    \37\ See C2 Rule 6.13, Interpretation and Policy .06(b)(1). For 
examples of this proposed functionality, see the Notice, 77 FR at 
10023.
    \38\ See Notice, 77 FR at 10022-23.
    \39\ See id. at 10022.
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E. Price Check Parameters

    C2 proposes to adopt a new price check parameter applicable to the 
electronic processing of stock-option orders.\40\ This new price check 
parameter will allow C2 to determine, on a class-by-class basis, and 
announce via Regulatory Circular, not to automatically execute a 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.\41\ A stock-option order that is not within the 
acceptable derived net market will be cancelled.\42\
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    \40\ See C2 Rule 6.13, Interpretation and Policy .04(f).
    \41\ See id.
    \42\ See C2 Rule 6.13, Interpretation and Policy .04(f)(2).
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    The ``acceptable derived net market'' for a strategy will be 
calculated using C2'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.\43\ C2 will determine the ``acceptable tick distance'' on a 
class-by-class basis.\44\ C2 believes 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 the Exchange's 
best bid and offer.\45\ C2 believes 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 C2 
believes 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.\46\ C2 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 \47\ may be executed outside the 
NBBO for the stock.\48\ Accordingly, in establishing the acceptable 
tick distance for the stock leg of the order, C2 would have the 
flexibility to use the NBBO (which would equate to an acceptable tick 
distance of 0) or a range outside the NBBO.\49\
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    \43\ See C2 Rule 6.13, Interpretation and Policy .04(f)(1).
    \44\ See id. For an example of how this price check parameter 
would operate, see the Notice, 77 FR at 10023.
    \45\ See Notice, 77 FR at footnote 19.
    \46\ See id.
    \47\ See supra note 23.
    \48\ See Notice, 77 FR at footnote 19.
    \49\ See id.
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    In classes where this price check parameter is available, it will 
also be available for COA responses under C2 Rule 6.13(c); Automated 
Improvement Mechanism (``AIM'') and Solicitation Auction Mechanism 
stock-option orders and responses under C2 Rules 6.51 and 6.52; and AIM 
customer-to-customer immediate cross stock-option orders under C2 Rule 
6.51, Interpretation and Policy .08.\50\ Under these provisions, paired 
stock-option orders and responses will not be accepted, except that, to 
the extent only a paired contra-side order subject to an auction under 
C2 Rule 6.51 or C2 Rule 6.52 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, 
continue processing as an unpaired stock-option order (e.g., the Agency 
Order would route to COB or COA for processing).\51\ 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.\52\
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    \50\ See C2 Rule 6.13, Interpretation and Policy .04(f).
    \51\ See id.
    \52\ See id. For an example of how this price check parameter 
would operate, see the Notice, 77 FR at 10024.
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    C2 also proposes to apply the existing individual series leg width 
price check parameter in C2 Rule 6.13, Interpretation and Policy .04(a) 
to market and marketable limit stock-option orders.\53\ Under this 
price check parameter, a market or marketable limit stock-option order 
in a class where the price check parameter is available will not be 
executed automatically if the width between C2's best bid and best 
offer in any individual series leg is not within an acceptable price 
range.\54\
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    \53\ See C2 Rule 6.13, Interpretation and Policy .04(a)(5) and 
Notice, 77 FR at 10024.
    \54\ See C2 Rule 6.13, Interpretation and Policy .04(a).
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    In addition, C2 proposes to apply the existing buy-buy (sell-sell) 
strategy price check parameter in C2 Rule 6.13, Interpretation and 
Policy .04(d) to stock-option orders.\55\ Under this price check 
parameter, C2's system will not automatically execute a limit order 
where (1) all the components of the

[[Page 22025]]

strategy are to buy and the order is priced at zero, any net credit 
price, or a net debit price that is less than the number of an 
individual option series leg in the strategy (or applicable ratio) 
multiplied by the applicable minimum net price increment for the 
complex order; or (2) all the components of the strategy are to sell 
and the order is priced at zero, any net debit price, or a net credit 
price that is less than the number of individual option series legs in 
the strategy (or applicable ratio) multiplied by the applicable minimum 
net price increment for the complex order.\56\ Instead, such a stock-
option order will not be accepted.\57\
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    \55\ See C2 Rule 6.13, Interpretation and Policy .04(d) and 
Notice, 77 FR at 10024.
    \56\ See C2 Rule 6.13, Interpretation and Policy .04(d). The 
minimum net price increment calculation would only apply to the 
individual option series legs.
    \57\ See id.
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    C2 believes that the price protection parameters will help to 
mitigate the potential risks associated with stock-option orders 
drilling through multiple price points and with stock-option orders 
being entered at net limit prices that are inconsistent with the 
particular ``buy-buy'' or ``sell-sell'' strategy, thereby resulting in 
executions that are extreme and potentially erroneous.\58\
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    \58\ See Notice, 77 FR at 10024.
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F. Extension of the re-COA Feature to Stock-Option Orders

    C2 Rule 6.13, Interpretation and Policy .02(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 a COA if the order 
is within a number of ticks away from the current derived net market. 
C2 proposes to extend 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 C2's best 
bid or offer in the individual option series leg(s) and the NBBO in the 
stock leg.\59\ C2 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).\60\ C2 
believes that this re-COA 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 Permit Holder 
might do if the Permit Holder were representing a stock-option order in 
open outcry on another exchange or entering the order into the COB.\61\
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    \59\ See C2 Rule 6.13, Interpretation and Policy .02(b).
    \60\ See Notice, 77 FR at 10024. For an example of how the re-
COA feature would operate, see id. at 10025.
    \61\ See id. at 10024-25.
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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.\62\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\63\ 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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    \62\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \63\ 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 
notes that the proposed definitions of complex order and stock-option 
order are consistent with definitions included in the rules of another 
options exchange,\64\ and in CBOE Rule 6.80(4), which is incorporated 
by reference in C2's rules.\65\ In addition, the Commission believes 
that the proposed rule change 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 C2 of additional 
complex orders.
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    \64\ See ISE Rule 722(a)(1) and (2).
    \65\ See C2 Chapter VI, Section E, ``Intermarket Linkage'' 
(incorporating the rules in CBOE Chapter VI, Section E). 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 add Interpretation and 
Policy .06 to Rule 6.13 to provide that stock-option orders will 
execute against other stock-option orders through COB and COA 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.\66\
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    \66\ 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 
C2 to permit the legging of eligible market stock-option orders that 
cannot be executed in full or in a permissible ratio at the conclusion 
of COA because the legging functionality could provide an additional 
opportunity for these orders to be executed. The Commission notes that 
C2 believes that the eligibility parameters for eligible stock-option 
orders could help to mitigate the risks that may be associated with 
legging stock-option orders.\67\
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    \67\ See Notice, 77 FR at 10022. Under C2 Rule 6.13, 
Interpretation and Policy .06(d), an eligible market order means a 
stock-option order that is within the designated size and order type 
parameters, determined by the Exchange on a class-by-class basis, 
and for which the NBBO is within designated size and price 
parameters, as determined by the Exchange for the individual leg. 
The designated NBBO price parameters will be determined based on a 
minimum bid price for sell orders. The Exchange may also 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. Communication of Stock Leg to a Designated Broker-Dealer(s)
    As described more fully above, C2 proposes to allow the Exchange to 
electronically communicate the stock leg of a stock-option order to a 
designated broker-dealer(s) for execution on behalf of a Permit 
Holder.\68\ To participate in stock-option order automated processing, 
a Permit Holder must enter into a brokerage agreement with one or more 
designated broker-dealers that are not affiliated with C2.\69\
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    \68\ See C2 Rule 6.13, Interpretation and Policy .06(a).
    \69\ See id.
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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.\70\ In 
addition, after C2 communicates the paired stock orders to the 
designated broker-dealer for execution, the designated broker-dealer 
will be responsible for determining

[[Page 22026]]

whether the orders may be executed in accordance with all of the rules 
applicable to the execution of equity orders, including compliance with 
applicable short sale, trade-through, and trade reporting rules.\71\ A 
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 Permit Holder submitting a stock-option order represents that the 
order complies with the QCT Exemption.\72\ As described more fully in 
the Notice, C2's system will validate compliance with the QCT Exemption 
with respect to each matched order communicated to the designated 
broker-dealer.\73\
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    \70\ See Notice, 77 FR at 10020-21.
    \71\ See id. at 10021.
    \72\ See C2 Rule 6.13, Interpretation and Policy .06(a).
    \73\ See Notice, 77 FR at 10021.
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    C2'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.\74\ Accordingly, 
the Commission finds that the proposal to allow C2 to electronically 
communicate the stock leg of a stock-option order to a designated 
broker-dealer that is not affiliated with C2 for execution on behalf of 
a Permit Holder is consistent with the Act.
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    \74\ 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
    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.\75\ The Commission notes that this allocation provision 
for stock-option orders in COB is consistent with the existing complex 
order allocation provision in C2 Rule 6.13(b)(1)(B).\76\ Accordingly, 
the Commission believes that the allocation provision for marketable 
stock-option orders in COB is consistent with the Act.
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    \75\ See id.
    \76\ C2 Rule 6.13(b)(1)(B) states that the allocation of complex 
orders in COB will be pursuant to the rules to trading priority 
otherwise applicable to incoming electronic orders in the individual 
component legs.
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    Under the proposal, stock-option orders executed against other 
stock-option orders through a COA will trade first at the best net 
price(s) and, at the same price, in the sequence set forth in C2 Rule 
6.13(c)(5)(B)-(D).\77\ The allocation sequence in C2 Rule 
6.13(c)(5)(A)-(D) currently applies to complex orders.\78\ The 
Commission believes that it is consistent with the Act for C2 to apply 
this allocation sequence, as modified to reflect that stock-option 
orders will not execute against individual orders and quotes in the 
Book, to stock-option orders as well as complex orders.
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    \77\ See C2 Rule 6.13, Interpretation and Policy .06(d). Under 
Interpretation and Policy .06(d), a stock-option order that was 
subject to a COA would execute against other stock-option orders 
first at the same net price(s) and, at the same price, in the 
following sequence: (i) Against public customer stock-option orders 
resting in the COB before, or that are received during, the COA 
Response Time Interval and public customer RFR responses, with 
multiple orders ranked by time priority; (ii) against non-public 
customer stock-option orders resting in the COB before the COA 
Response Time Interval, with multiple orders subject to the rules of 
trading priority otherwise applicable to incoming orders in the 
individual component legs; and (iii) against non-public customer 
stock-option orders resting in the COB that are received during the 
COA Response Time Interval and non-public customer responses, with 
multiple orders subject to the rules of trading priority otherwise 
applicable to incoming orders in the individual component legs.
    \78\ Because C2 will not permit the legging of stock-option 
orders, except with respect to eligible market stock-option orders 
at the conclusion of a COA, the allocation algorithm for stock-
option orders will not apply C2 Rule 6.13(c)(5)(A), which provides 
for the execution of a complex order against individual orders and 
quotes in the Book. See C2 Rule 6.13, 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 C2's Book.\79\ To satisfy this 
condition, the individual option leg(s) of the stock-option order: (i) 
Must not trade at a price that is inferior to C2's best bid (offer) in 
the individual component series; and (ii) must not trade at C2's best 
bid (offer) in the individual component series if one or more public 
customer orders are resting at the best bid (offer) price in each of 
the component option series and the stock-option order could otherwise 
be executed in full or in a permissible ratio.\80\ These provisions are 
consistent with the rules of other options exchanges.\81\ Accordingly, 
the Commission believes that the priority requirements for stock-option 
orders in Rule 6.13, Interpretation and Policy .06(b) are consistent 
with the Act.
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    \79\ See Notice, 77 FR at 10022.
    \80\ See C2 Rule 6.13, Interpretation and Policy .06(b). See 
also Notice, 77 FR at 10022.
    \81\ 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 or in a permissible ratio when it is routed to COB or 
following a COA, any part of the order that can execute will execute 
and the part that cannot automatically execute will be cancelled.\82\ 
The Commission believes this provision is consistent with the Act 
because it describes the handling of the remaining balance of a 
marketable stock-option order that cannot be executed in full or in a 
permissible ratio.
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    \82\ See C2 Rule 6.13, Interpretation and Policy .06(b)(1).
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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.\83\ The Commission believes that this provision is 
consistent with the Act.
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    \83\ See C2 Rule 6.13, Interpretation and Policy .06(b)(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 C2 
Rule 6.13, Interpretation and Policy .04(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 C2'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 C2 with flexibility in setting this parameter. The Commission 
notes that a stock-option order submitted to C2's system must comply 
with the QCT Exemption.\84\ 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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    \84\ See C2 Rule 6.13, Interpretation and Policy .06(a).

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[[Page 22027]]

    C2 also proposes to extend the existing individual series leg width 
price check parameter in C2 Rule 6.13, Interpretation and Policy .04(a) 
to the individual series legs of market and marketable limit stock-
option orders.\85\ This price check parameter prevents the automatic 
execution of a marketable complex order when the width between C2's 
best bid and offer in any individual series leg is not within an 
acceptable price range. C2 further proposes to extend the existing buy-
buy (sell-sell) strategy price check parameter in C2 Rule 6.13, 
Interpretation and Policy .04(d) to stock-option orders.\86\ As 
described more fully above, this price check parameter prevents the 
automatic execution of complex order at a net limit price that is 
inconsistent with the order's strategy (e.g., an order where all of the 
components of a strategy are to buy, but the order is priced at 0 or at 
a net credit). The Commission believes it is consistent with the Act 
for C2 to have the ability to apply these price check parameters to 
stock-option orders, in addition to complex orders.
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    \85\ See C2 Rule 6.13, Interpretation and Policy .04(a)(5) and 
Notice, 77 FR at 10024.
    \86\ See C2 Rule 6.13, Interpretation and Policy .04(d) and 
Notice, 77 FR at 10024.
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F. Extension of the re-COA Feature to Stock-Option Orders

    C2 proposes to amend C2 Rule 6.13, Interpretation and Policy .02(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 a COA if the order is within a number of ticks away from the 
current derived net market.\87\ The Commission believes 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 order 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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    \87\ See C2 Rule 6.13, Interpretation and Policy .02(b).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\88\ that the proposed rule change (SR-C2-2012-004) is approved.
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    \88\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\89\
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    \89\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-8784 Filed 4-11-12; 8:45 am]
BILLING CODE 8011-01-P


