
[Federal Register Volume 79, Number 115 (Monday, June 16, 2014)]
[Notices]
[Pages 34387-34389]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-13934]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72359; File No. SR-ISE-2014-10]


Self-Regulatory Organizations; International Securities Exchange, 
LLC; Order Instituting Proceedings to Determine Whether to Approve or 
Disapprove a Proposed Rule Change Related to Limiting Certain Types of 
Complex Orders From Legging Into the Regular Market

June 10, 2014.

I. Introduction

    On February 25, 2014, the International Securities Exchange, LLC 
(the ``Exchange'' or ``ISE'') filed with the Securities and Exchange 
Commission (the ``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 relating to complex orders. The 
proposed rule change was published for comment in the Federal Register 
on March 14, 2014.\3\ The Commission received no comment letters. On 
April 23, 2014, the Commission extended the time period in which to 
either approve the proposal, disapprove the proposal, or to institute 
proceedings to determine whether to approve or disapprove the proposal, 
to June 12, 2014.\4\ This order institutes proceedings under Section 
19(b)(2)(B) of the Act \5\ to determine whether to approve or 
disapprove the proposal.
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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. 71669 (March 10, 
2014), 79 FR 14563 (``Notice'').
    \4\ See Securities Exchange Act Release No. 72006 (April 23, 
2014), 79 FR 24031 (April 29, 2014).
    \5\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposal

    The Exchange proposes to amend ISE Rule 722 to prohibit certain 
types of complex orders from legging into the regular market (i.e., 
executing against individual quotes for each of the legs of the complex 
order in the regular market).\6\ Specifically, ISE proposes that 
complex orders with two option legs where both legs are buying or both 
legs are selling and both legs are calls or both legs are puts will 
only trade against other complex orders in the complex order book and 
will not be permitted to leg into the regular market.\7\ ISE also 
proposes that complex orders with three option legs where all legs are 
buying or all legs are selling, regardless of whether the options are a 
calls or puts, will only trade against other complex orders in the 
complex order book and will not be permitted to leg into the regular 
market.\8\ ISE describes these types of two and three leg complex order 
strategies as ``atypical'' complex order strategies in that they are 
geared toward an aggressive directional capture of volatility.\9\
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    \6\ See Notice, supra note 3, at 14564. ISE Rule 722(b)(3)(ii) 
rule states that complex orders up to a maximum number of legs 
(determined by the Exchange on a class basis as either two legs or 
three legs) will be automatically executed against bids and offers 
on the Exchange for the individual legs of the complex order 
provided the complex order can be executed while maintaining a 
permissible ratio by such bids and offers.
    \7\ See Notice, supra note 3, at 14564. The Exchange offers some 
examples of such strategies as follows: (i) Buy Call 1, Buy Call 2; 
(ii) Sell Call 1, Sell Call 2; (iii) Buy Put 1, Buy Put 2; (iv) Sell 
Put 1, Sell Put 2. See id.
    \8\ See id. The Exchange offers some examples of such strategies 
as follows: (i) Buy Call 1, Buy Call 2, Buy Put 1; (ii) Buy Put 1, 
Buy Put 2, Buy Put 3; (iii) Buy Call 1, Buy Call 2, Buy Call 3; (iv) 
Buy Put 1, Buy Put 2, Buy Call 3; (v) Sell Put 1, Sell Put 2, Sell 
Call 1. See id.
    \9\ See id. Hereinafter these two and three legged complex order 
strategies that are the subject of this proposal will be referred to 
as ``directional complex orders.'' ISE states that most traditional 
complex order strategies used by retail or professional investors, 
unlike directional complex orders, seek to hedge the potential move 
of the underlying security or to capture a premium from an 
anticipated market event. See id.
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    The Exchange further proposes to amend ISE Rule 722 to prevent 
legging orders\10\ from being generated on behalf of the two-legged 
complex orders where both legs are buying or both legs are selling and 
both legs are calls or both legs are puts.\11\ According to the 
Exchange, preventing the generation of legging orders for these types 
of two-legged complex orders is necessary to effectuate the proposed 
limitation to exclude these types of complex orders from trading in the 
regular market.\12\
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    \10\ ISE Rule 715(k) defines a legging order as a limit order on 
the regular limit order book that represents one side of a complex 
order that is to buy or sell an equal quantity of two options series 
resting on the Exchange's complex order book.
    \11\ See Notice, supra note 3, at 14565. The Exchange notes that 
legging orders cannot be generated for complex orders with three 
options legs, and, therefore, is not proposing to prevent the 
generation of legging orders for complex orders with three option 
legs where all legs are buying or all legs are selling, regardless 
of whether the options are calls or puts. See id.
    \12\ See id.
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    In addition, the Exchange proposes to amend Supplemental Material 
.08 to Rule 716 (Facilitation Mechanism and Solicited Order Mechanism) 
and Supplemental Material .10 to Rule 723 (Price Improvement Mechanism) 
to ensure that directional complex orders do not leg into the regular 
market through an auction.\13\ ISE represents that, under its current 
rules, if an improved net price for a complex order in the Exchange's 
auctions can be achieved from bids and offers for the individual legs 
of the complex order in the regular market, the complex order would 
receive that better net price.\14\ ISE proposes to prevent directional 
complex orders from interacting with the regular market during an 
auction in connection with the Exchange's proposal in order to prevent 
directional complex orders from executing against the regular 
market.\15\ Accordingly, the Exchange proposes to amend Supplemental 
Material .08 to Rule 716 and Supplemental Material .10 to Rule 723 to 
provide that if an improved net price can be achieved from bids and 
offers for the individual legs for directional complex orders during an 
auction, ISE will cancel the auction at the end of the auction's 
exposure period.\16\
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    \13\ See id.
    \14\ See id.
    \15\ See Notice, supra note 3, at 14565.
    \16\ See id.
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    According to the Exchange, the proposed rule amendments are 
designed to prevent directional complex orders from bypassing the 
Exchange's market maker risk parameters for the regular market.\17\ ISE 
states that the market maker risk parameters are designed to 
automatically remove a market maker's quotes in all series of an 
options class when any of four parameter settings established by the 
market maker are triggered.\18\ ISE describes these market maker risk 
parameters as a functionality that allows market makers to provide 
liquidity across many different options series without being at risk of 
executing the full cumulative size of all of their quotes before being 
given adequate opportunity to adjust their quotes.\19\ According to 
ISE, when a complex order legs into the regular market, all of the legs 
of a complex order are considered as a single transaction for purposes 
of the market maker risk parameters, and not as a series of individual 
transactions.\20\ Thus, the trading system performs the market maker 
risk parameter calculations after the entire

[[Page 34388]]

complex order executes against interest in the regular market. 
According to the Exchange, the manner in which complex orders leg into 
the regular market may cause market makers to trade above limits set in 
their market maker risk parameters.\21\ As a result, the Exchange 
believes that market makers may alter their trading behavior to account 
for the additional risk by widening quotes, hurting the Exchange's 
quality of markets and the quality of markets in general.\22\ Further, 
according to ISE, directional complex orders that bypass market makers' 
risk parameters may result in artificially large transactions that 
distort the market for related instruments, including the underlying 
security or related options series.\23\ The Exchange believes that the 
potential risk to market makers of allowing directional complex orders 
to execute against market makers' quotes in the regular market 
outweighs the potential benefit of allowing directional orders to 
execute against interest in the regular market.\24\ By limiting 
directional complex orders from legging into the regular market, the 
Exchange believes that market makers will post tighter and more liquid 
markets for regular orders and traditional complex orders, while 
reducing the frequency and size of related market distortions.\25\
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    \17\ See id. at 14564 and ISE Rule 804(g) (Automated Quotation 
Adjustments). See also Supplemental Material .04 to ISE Rule 722 
(Automated Spread Quotation Adjustments).
    \18\ See Notice, supra note 3, at 14564.
    \19\ See id.
    \20\ See id.
    \21\ See id.
    \22\ See id.
    \23\ See id.
    \24\ See Notice, supra note 3, at 14565. ISE notes that the 
number of directional complex orders is small relative to the total 
number of complex orders executed on the Exchange on a given day. 
See id.
    \25\ See id.
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    Finally, ISE represents that directional complex orders may trade 
against other complex order in the ISE complex order book and may rest 
on the ISE complex order book until they are traded or canceled by the 
member that entered them.\26\
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    \26\ See id.
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III. Proceedings to Determine Whether to Approve or Disapprove SR-ISE-
2014-10 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \27\ to determine whether the proposed rule 
change should be approved or disapproved. Institution of such 
proceedings is appropriate at this time in view of the legal and policy 
issues raised by the proposed rule change, as discussed below. 
Institution of proceedings does not indicate that the Commission has 
reached any conclusions with respect to any of the issues involved. 
Rather, as described in greater detail below, the Commission seeks and 
encourages interested persons to provide additional comment on the 
proposed rule change.
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    \27\ 15 U.S.C. 78s(b)(2)(B).
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    Pursuant to Section 19(b)(2)(B) of the Act,\28\ the Commission is 
providing notice of the grounds for disapproval under consideration. 
The Commission is instituting proceedings to allow for additional 
analysis of, and input from commenters with respect to, the proposed 
rule change's consistency with Section 6(b)(5) of the Act, which 
require that the rules of a national securities exchange be designed, 
among other things, 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; and not be designed to permit unfair discrimination 
between customers, issuers, brokers, or dealers.\29\
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    \28\ Id. Section 19(b)(2)(B) of the Exchange Act also provides 
that proceedings to determine whether to disapprove a proposed rule 
change must be concluded within 180 days of the date of publication 
of notice of the filing of the proposed rule change. See id. The 
time for conclusion of the proceedings may be extended for up to 60 
days if the Commission finds good cause for such extension and 
publishes its reasons for so finding. See id.
    \29\ 15 U.S.C. 78f(b)(5).
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IV. Procedure: Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
concerns identified above, as well as any other concerns they may have 
with the proposed rule change. In particular, the Commission invites 
the written views of interested persons concerning whether the proposal 
is consistent with Section 6(b)(5) \30\ or any other provision of the 
Act, or the rules and regulations thereunder. Although there do not 
appear to be any issues relevant to approval or disapproval which would 
be facilitated by an oral presentation of views, data, and arguments, 
the Commission will consider, pursuant to Rule 19b-4, any request for 
an opportunity to make an oral presentation.\31\
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    \30\ Id.
    \31\ Section 19(b)(2) of the Act, as amended by the Securities 
Acts Amendments of 1975, Public Law 94-29 (June 4, 1975), grants the 
Commission flexibility to determine what type of proceeding--either 
oral or notice and opportunity for written comments--is appropriate 
for consideration of a particular proposal by a self-regulatory 
organization. See Securities Act Amendments of 1975, Senate Comm. on 
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st 
Sess. 30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposed rule change should be approved 
or disapproved by July 7, 2014. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
July 21, 2014. The Commission asks that commenters address the 
sufficiency and merit of the Exchange's statements in support of the 
proposed rule change, in addition to any other comments they may wish 
to submit about the proposed rule change. In particular, the Commission 
seeks comment on the following:
    1. What are commenters' views on ISE's proposal to limit 
directional complex orders from legging into the regular market? Please 
explain.
    a. What are commenters' views on ISE's proposal to prevent legging 
orders from being generated on behalf of directional complex orders? 
Please explain.
    b. What are commenters' views on ISE's proposal to cancel an 
auction at the end of the auction's exposure period if an improved net 
price can be achieved from bids and offers for the individual legs of a 
directional complex during an auction? Please explain.
    2. Do commenters agree with ISE's assertion that complex orders 
with two options legs where both legs are buying or both legs are 
selling and both legs are calls or both legs are puts and complex 
orders with three options legs where all legs are buying or all are 
selling, regardless of whether the options are calls or puts, are not 
traditional complex order strategies used by retail or professional 
investors? Why or why not? Do commenters agree with ISE's assertion 
that such complex orders are primarily geared towards an aggressive 
directional capture of volatility? Why or why not?
    3. According to the Exchange, to account for the additional risk 
presented by the execution of directional complex orders, market makers 
in the regular market may change their trading behavior by widening 
quotes. Do commenters agree with ISE's assertion that market makers in 
the regular market would alter their trading behavior by widening their 
quotes to account for the risk presented by the execution of 
directional complex orders? Why or why not? Are market makers currently 
altering their trading behavior in such a manner? Please explain, and, 
to the extent possible, provide supporting data.

[[Page 34389]]

    4. Do commenters agree with ISE's assertion that market makers in 
the regular market would reduce the size of their quotations across 
multiple options series in the regular market because they are at risk 
of executing the cumulative size of their quotations without an 
opportunity to adjust their quotes? Please explain, and, to the extent 
possible, provide supporting data.
    5. Do commenters agree with ISE's assertion that the execution of 
directional complex orders could result in artificially large 
transactions that distort the market for other related instruments, 
including the underlying security or related options series? Why or why 
not? Please explain, and, to the extent possible, provide supporting 
data.
    6. According to the Exchange, the proposed rule change is designed 
to limit a market maker's risk against executions of directional 
complex orders. Please provide data, if available, showing how the 
execution of such complex orders against market maker quotes in the 
regular market affects a market maker's risk exposure.
    7. Do commenters agree with ISE's assertion that the number of 
directional complex orders is small relative to the total number of 
complex orders executed on ISE on a given day? Why or why not? Please 
explain, and, to the extent possible, provide supporting data.
    8. Do commenters agree with ISE's assertion that the potential risk 
to market makers in the regular market of allowing directional complex 
orders to leg into the regular market outweighs the potential benefits 
of continuing to allow directional complex orders to interact with the 
regular market? Why or why not? Please explain, and, to the extent 
possible, provide supporting data.
    9. Do commenters agree with ISE's assertion that the proposed rule 
change would encourage market makers to provide tighter and more liquid 
markets on the Exchange? Why or why not? Please explain, and, to the 
extent possible, provide supporting data.
    10. Do commenters believe that any potential benefits to investors 
resulting from ISE's proposal would exceed any benefits of continuing 
to allow directional complex orders to interact with the regular 
market? Why or why not? Please explain, and, to the extent possible, 
provide supporting data.
    Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-ISE-2014-10 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-ISE-2014-10. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the accommodation proposal that are 
filed with the Commission, and all written communications relating to 
the accommodation proposal between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filings also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-ISE-2014-10 and should be 
submitted on or before July 7, 2014. Rebuttal comments should be 
submitted by July 21, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(57).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-13934 Filed 6-13-14; 8:45 am]
BILLING CODE 8011-01-P


