
[Federal Register Volume 82, Number 1 (Tuesday, January 3, 2017)]
[Notices]
[Pages 167-173]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-31766]



[[Page 167]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79697; File No. SR-CBOE-2016-088]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Related to the 
Nullification and Adjustment of Options Transactions

December 27, 2016.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that, on December 14, 2016, Chicago Board Options Exchange, 
Incorporated (the ``Exchange'' or ``CBOE'') filed with the Securities 
and Exchange Commission (the ``Commission'') the proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange seeks to amend Rule 6.25. The text of the proposed 
rule change is available on the Exchange's Web site (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's 
Office of the Secretary, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Last year, the Exchange and other options exchanges adopted a new, 
harmonized rule related to the adjustment and nullification of 
erroneous options transactions, including a specific provision related 
to coordination in connection with large-scale events involving 
erroneous options transactions.\3\ The Exchange believes that the 
changes the options exchanges implemented with the new, harmonized rule 
have led to increased transparency and finality with respect to the 
adjustment and nullification of erroneous options transactions. 
However, as part of the initial initiative, the Exchange and other 
options exchanges deferred a few specific matters for further 
discussion.
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    \3\ See Securities Exchange Act Release No. 74898 (May 7, 2015), 
80 FR 27354 (May 13, 2015) (SR-CBOE-2015-039) (the ``Initial 
Filing'').
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    Specifically, the options exchanges have been working together to 
identify ways to improve the process related to the adjustment and 
nullification of erroneous options transactions as it relates to 
complex orders \4\ and stock-option orders. The goal of the process 
that the options exchanges have undertaken is to further harmonize 
rules related to the adjustment and nullification of erroneous options 
transactions. As described below, the Exchange believes that the 
changes the options exchanges and the Exchange have agreed to propose 
will provide transparency and finality with respect to the adjustment 
and nullification of erroneous complex order and stock-option order 
transactions. Particularly, the proposed changes seek to achieve 
consistent results for participants across U.S. options exchanges while 
maintaining a fair and orderly market, protecting investors and 
protecting the public interest.
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    \4\ See Rule 6.53C(a) (defining complex orders and stock-option 
orders).
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    The Proposed Rule is the culmination of this coordinated effort and 
reflects discussions by the options exchanges whereby the exchanges 
that offer complex orders and/or stock-option orders will universally 
adopt new provisions that the options exchanges collectively believe 
will improve the handling of erroneous options transactions that result 
from the execution of complex orders and stock-option orders.\5\
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    \5\ An exchange that does not offer complex orders and/or stock-
option orders will not adopt these new provisions until such time as 
the exchange offers complex orders and/or stock-option orders.
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    The Exchange believes that the Proposed Rule supports an approach 
consistent with long-standing principles in the options industry under 
which the general policy is to adjust rather than nullify transactions. 
The Exchange acknowledges that adjustment of transactions is contrary 
to the operation of analogous rules applicable to the equities markets, 
where erroneous transactions are typically nullified rather than 
adjusted and where there is no distinction between the types of market 
participants involved in a transaction. For the reasons set forth 
below, the Exchange believes that the distinctions in market structure 
between equities and options markets continue to support these 
distinctions between the rules for handling obvious errors in the 
equities and options markets.
    Various general structural differences between the options and 
equities markets point toward the need for a different balancing of 
risks for options market participants and are reflected in this 
proposal. Option pricing is formulaic and is tied to the price of the 
underlying stock, the volatility of the underlying security and other 
factors. Because options market participants can generally create new 
open interest in response to trading demand, as new open interest is 
created, correlated trades in the underlying or related series are 
generally also executed to hedge a market participant's risk. This 
pairing of open interest with hedging interest differentiates the 
options market specifically (and the derivatives markets broadly) from 
the cash equities markets. In turn, the Exchange believes that the 
hedging transactions engaged in by market participants necessitates 
protection of transactions through adjustments rather than 
nullifications when possible and otherwise appropriate.
    The options markets are also quote driven markets dependent on 
liquidity providers to an even greater extent than equities markets. In 
contrast to the approximately 7,000 different securities traded in the 
U.S. equities markets each day, there are more than 500,000 unique, 
regularly quoted option series. Given this breadth in options series 
the options markets are more dependent on liquidity providers than 
equities markets; such liquidity is provided most commonly by 
registered market makers but also by other professional traders. With 
the number of instruments in which registered market makers must quote 
and the risk attendant with quoting so many products simultaneously, 
the Exchange believes that those liquidity providers should be afforded 
a greater level of protection. In particular, the Exchange believes 
that liquidity providers should be allowed protection of their trades 
given the fact that they typically engage in hedging activity to 
protect them from significant financial risk to encourage continued

[[Page 168]]

liquidity provision and maintenance of the quote-driven options 
markets.
    In addition to the factors described above, there are other 
fundamental differences between options and equities markets which lend 
themselves to different treatment of different classes of participants 
that are reflected in this proposal. For example, there is no trade 
reporting facility in the options markets. Thus, all transactions must 
occur on an options exchange. This leads to significantly greater 
retail customer participation directly on exchanges than in the 
equities markets, where a significant amount of retail customer 
participation never reaches the Exchange but is instead executed in 
off-exchange venues such as alternative trading systems, broker-dealer 
market making desks and internalizers. In turn, because of such direct 
retail customer participation, the exchanges have taken steps to afford 
those retail customers--generally Priority Customers--more favorable 
treatment in some circumstances.
Complex Orders and Stock-Option Orders
    As more fully described below, the Proposed Rule applies much of 
the Current Rule to complex orders and stock-option orders.\6\ The 
Proposed Rule deviates from the Current Rule only to account for the 
unique qualities of complex orders and stock-option orders. The 
Proposed Rule reflects the fact that complex orders can execute against 
other complex orders or can execute against individual simple orders in 
the leg markets. When a complex order executes against the leg markets 
there may be different counterparties on each leg of the complex order, 
and not every leg will necessarily be executed at an erroneous price. 
With regards to stock-option orders, the Proposed Rule reflects the 
fact that stock-option orders contain a stock component that is 
executed on a stock trading venue, and the Exchange may not be able to 
ensure that the stock trading venue will adjust or nullify the stock 
execution in the event of an obvious or catastrophic error. In order to 
apply the Current Rule and account for the unique characteristics of 
complex orders and stock-option orders, proposed Interpretation and 
Policy .07 is split into three parts--paragraphs (a), (b), and (c).
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    \6\ In order for a complex order or stock-option order to 
qualify as an obvious or catastrophic error at least one of the legs 
must itself qualify as an obvious or catastrophic error under the 
Current Rule. See Proposed Rule .07(a)-(c).
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    First, proposed Interpretation and Policy .07(a) governs the review 
of complex orders that are executed against individual legs (as opposed 
to a complex order that executes against another complex order).\7\ 
Proposed Rule 6.25.07(a) provides:
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    \7\ The leg market consists of quotes and/or orders in single 
options series. A complex order may be received by the Exchange 
electronically, and the legs of the complex order may have different 
counterparties. For example, Market-Maker 1 may be quoting in ABC 
calls and Market-Maker 2 may be quoting in ABC puts. A complex order 
to buy the ABC calls and puts may execute against the quotes of 
Market-Maker 1 and Market-Maker 2.

    If a complex order executes against individual legs and at least 
one of the legs qualifies as an Obvious or Catastrophic Error under 
this Rule 6.25, then the leg(s) that is an Obvious or Catastrophic 
Error will be adjusted in accordance with paragraphs (c)(4)(A) or 
(d)(3), respectively, regardless of whether one of the parties is a 
Customer. However, any Customer order subject to this paragraph (a) 
will be nullified if the adjustment would result in an execution 
price higher (for buy transactions) or lower (for sell transactions) 
than the Customer's limit price on the complex order or individual 
leg(s). If any leg of a complex order is nullified, the entire 
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transaction is nullified.

As previously noted, at least one of the legs of the complex order must 
qualify as an obvious or catastrophic error under the Current Rule in 
order for the complex order to receive obvious or catastrophic error 
relief. Thus, when the Exchange is notified (within the timeframes set 
forth in paragraph (c)(2) or (d)(2)) of a complex order that is a 
possible obvious error or catastrophic error, the Exchange will first 
review the individual legs of the complex order to determine if one or 
more legs qualify as an obvious or catastrophic error.\8\ If no leg 
qualifies as an obvious or catastrophic error, the transaction stands--
no adjustment and no nullification.
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    \8\ Because a complex order can execute against the leg market, 
the Exchange may also be notified of a possible obvious or 
catastrophic error by a counterparty that received an execution in 
an individual options series. If upon review of a potential obvious 
error the Exchange determines an individual options series was 
executed against the leg of a complex order or stock-option order, 
proposed Rule 6.25.07 will govern.
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    Reviewing the legs to determine whether one or more legs qualify as 
an obvious or catastrophic error requires the Exchange to follow the 
Current Rule. In accordance with paragraphs (c)(1) and (d)(1) of the 
Current Rule, the Exchange compares the execution price of each 
individual leg to the Theoretical Price of each leg (as determined by 
paragraph (b) of the Current Rule). If the execution price of an 
individual leg is higher or lower than the Theoretical Price for the 
series by an amount equal to at least the amount shown in the obvious 
error table in paragraph (c)(1) of the Current rule or the catastrophic 
error table in paragraph (d)(1) of the Current Rule, the individual leg 
qualifies as an obvious or catastrophic error, and the Exchange will 
take steps to adjust or nullify the transaction.\9\
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    \9\ Only the execution price on the leg (or legs) that qualifies 
as an obvious or catastrophic error pursuant to any portion of 
Proposed Rule 6.25.07 will be adjusted. The execution price of a leg 
(or legs) that does not qualify as an obvious or catastrophic error 
will not be adjusted.
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    To illustrate, consider a Customer submits a complex order to the 
Exchange consisting of leg 1 and leg 2--Leg 1 is to buy 100 ABC calls 
and leg 2 is to sell 100 ABC puts. Also, consider that Market-Maker 1 
is quoting the ABC calls $1.00-1.20 and Market-Maker 2 is quoting the 
ABC puts $2.00-2.20. If the complex order executes against the quotes 
of Market-Makers 1 and 2, the Customer buys the ABC calls for $1.20 and 
sells the ABC puts for $2.00. As with the obvious/catastrophic error 
reviews for simple orders, the execution price of leg 1 is compared to 
the Theoretical Price \10\ of Leg 1 in order to determine if Leg 1 is 
an obvious error under paragraph (c)(1) of the Current Rule or a 
catastrophic error under paragraph (d)(1) of the Current Rule. The same 
goes for Leg 2. The execution price of Leg 2 is compared to the 
Theoretical Price of Leg 2. If it is determined that one or both of the 
legs are an obvious or catastrophic error, then the leg (or legs) that 
is an obvious or catastrophic error will be adjusted in accordance with 
paragraphs (c)(4)(A) or (d)(3) of the Current Rule, regardless of 
whether one of the parties is a Customer.\11\ Although a single-legged 
execution that is deemed to be an obvious error under the Current Rule 
is nullified whenever a Customer is involved in the transaction, the 
Exchange believes adjusting execution prices is generally better for 
the marketplace than nullifying executions because liquidity providers 
often execute hedging transactions to offset options positions. When an 
options transaction is nullified the hedging position can adversely 
affect the liquidity provider. With regards to complex orders that 
execute against individual legs, the additional rationale for adjusting 
erroneous execution prices when possible is the fact that the 
counterparty on a leg that is not executed at an obvious or 
catastrophic error price cannot look at the execution price to 
determine whether the

[[Page 169]]

execution may later be nullified (as opposed to the counterparty on 
single-legged order that is executed at an obvious error or 
catastrophic error price).
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    \10\ See Rule 6.25(b) (defining the manner in which Theoretical 
Price is determined).
    \11\ See Rule 6.25(a)(1) (defining Customer for purposes of Rule 
6.25 as not including a broker-dealer, Professional Customer, or 
Voluntary Professional Customer).
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    Paragraph (c)(4)(A) of the Current Rule mandates that if it is 
determined that an obvious error has occurred, the execution price of 
the transaction will be adjusted pursuant to the table set forth in 
(c)(4)(A). Although for simple orders paragraph (c)(4)(A) is only 
applicable when no party to the transaction is a Customer, for the 
purposes of complex orders paragraph (a) of Interpretation and Policy 
.07 will supersede that limitation; therefore, if it is determined that 
a leg (or legs) of a complex order is an obvious error, the leg (or 
legs) will be adjusted pursuant to (c)(4)(A), regardless of whether a 
party to the transaction is a Customer. The Size Adjustment Modifier 
defined in subparagraph (a)(4) will similarly apply (regardless of 
whether a Customer is on the transaction) by virtue of the application 
of paragraph (c)(4)(A).\12\ The Exchange notes that adjusting all 
market participants is not unique or novel. When the Exchange 
determines that a simple order execution is a Catastrophic Error 
pursuant to the Current Rule, paragraph (d)(3) already provides for 
adjusting the execution price for all market participants, including 
Customers.
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    \12\ See Rule 6.25(c)(4)(A) (stating that any non-Customer 
Obvious Error exceeding 50 contracts will be subject to the Size 
Adjustment Modifier defined in sub-paragraph (a)(4)). The Size 
Adjustment Modifier may also apply to the option leg of a stock-
option order that is adjusted pursuant to Proposed Rule 6.25.07(c).
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    Furthermore, as with the Current Rule, Proposed Rule 6.25.07(a) 
provides protection for Customer orders, stating that where at least 
one party to a complex order transaction is a Customer, the transaction 
will be nullified if adjustment would result in an execution price 
higher (for buy transactions) or lower (for sell transactions) than the 
Customer's limit price on the complex order or individual leg(s). For 
example, assume Customer enters a complex order to buy leg 1 and leg 2.
     Assume the NBBO for leg 1 is $0.20-1.00 and the NBBO for 
leg 2 is $0.50-1.00 and that these have been the NBBOs since the market 
opened.
     A split-second prior to the execution of the complex order 
a Customer enters a simple order to sell the leg 1 options series at 
$1.30, and the simple order enters the Exchange's book so that the BBO 
is $.20-$1.30. The limit price on the simple order is $1.30.
     The complex order executes leg 1 against the Exchange's 
best offer of $1.30 and leg 2 at $1.00 for a net execution price of 
$2.30.
     However, leg 1 executed on a wide quote (the NBBO for leg 
1 was $0.20-1.00 at the time of execution, which is wider than 
$0.75).\13\ Leg 2 was not executed on a wide quote (the market for leg 
2 was $0.50-1.00); thus, leg 2 execution price stands.
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    \13\ See Rule 6.25(b)(3).
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     The Exchange determines that the Theoretical Price for leg 
1 is $1.00, which was the best offer prior to the execution. Leg 1 
qualifies as an obvious error because the difference between the 
Theoretical Price ($1.00) and the execution price ($1.30) is larger 
than $0.25.\14\
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    \14\ See Rule (c)(1).
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     According to Proposed Rule 6.25.07(a) Customers will also 
be adjusted in accordance with Rule 6.25(c)(4)(A), which for a buy 
transaction under $3.00 calls for the Theoretical Price to by adjusted 
by adding $0.15 \15\ to the Theoretical Price of $1.00. Thus, adjust 
execution price for leg 1 would be $1.15.
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    \15\ See Rule 6.25(c)(4)(A).
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     However, adjusting the execution price of leg 1 to $1.15 
violates the limit price of the Customer's sell order on the simple 
order book for leg 1, which was $1.30.
     Thus, the entire complex order transaction will be 
nullified \16\ because the limit price of a Customer's sell order would 
be violated by the adjustment.\17\
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    \16\ If any leg of a complex order is nullified, the entire 
transaction is nullified. See Proposed Rule 6.25.07(a).
    \17\ The simple order in this example is not an erroneous sell 
transaction because the execution price was not erroneously low. See 
Rule 6.25(a)(2).
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    As the above example demonstrates, incoming complex orders may 
execute against resting simple orders in the leg market. If a complex 
order leg is deemed to be an obvious error, adjusting the execution 
price of the leg may violate the limit price of the resting order, 
which will result in nullification if the resting order is for a 
Customer. In contrast, Interpretation and Policy .02 to Rule 6.25 
provides that if an adjustment would result in an execution price that 
is higher than an erroneous buy transaction or lower than an erroneous 
sell transaction the execution will not be adjusted or nullified.\18\ 
If the adjustment of a complex order would violate the complex order 
Customer's limit price, the transaction will be nullified.
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    \18\ See Rule 6.25.02.
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    As previously noted, paragraph (d)(3) of the Current Rule already 
mandates that if it is determined that a catastrophic error has 
occurred, the execution price of the transaction will be adjusted 
pursuant to the table set forth in (d)(3). For purposes of complex 
orders under Proposed Rule .07(a), if one of the legs of a complex 
orders is determined to be a Catastrophic Error under paragraph (d)(3), 
all market participants will be adjusted in accordance with the table 
set forth in (d)(3). Again, however, where at least one party to a 
complex order transaction is a Customer, the transaction will be 
nullified if adjustment would result in an execution price higher (for 
buy transactions) or lower (for sell transactions) than the Customer's 
limit price on the complex order or individual leg(s). Again, if any 
leg of a complex order is nullified, the entire transaction is 
nullified. Additionally, as is the case today, if an Official 
determines that a Catastrophic Error has not occurred, the Trading 
Permit Holder will be subject to a charge of $5,000.\19\
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    \19\ See Rule 6.25(d)(3).
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    Other than honoring the limit prices established for Customer 
orders, the Exchange has proposed to treat Customers and non-Customers 
the same in the context of the complex orders that trade against the 
leg market. When complex orders trade against the leg market, it is 
possible that at least some of the legs will execute at prices that 
would not be deemed obvious or catastrophic errors, which gives the 
counterparty in such situations no indication that the execution will 
later by adjusted or nullified. The Exchange believes that treating 
Customers and non-Customers the same in this context will provide 
additional certainty to non-Customers (especially Market-Makers) with 
respect to their potential exposure and hedging activities, including 
comfort that even if a transaction is later adjusted, such transaction 
will not be fully nullified. However, as noted above, under the 
Proposed Rule where at least one party to the transaction is a 
Customer, the trade will be nullified if the adjustment would result in 
an execution price higher (for buy transactions) or lower (for sell 
transactions) than the Customer's limit price on the complex order or 
individual leg(s). The Exchange has retained the protection of a 
Customer's limit price in order to avoid a situation where the 
adjustment could be to a price that a Customer would not have expected, 
and market professionals such as non-Customers would be better prepared 
to recover in such situations. Therefore, adjustment for non-Customers 
is more appropriate.

[[Page 170]]

    Second, proposed Interpretation and Policy .07(b) governs the 
review of complex orders that are executed against other complex 
orders. Proposed Rule 6.25.07(b) provides:

    If a complex order executes against another complex order and at 
least one of the legs qualifies as an Obvious Error under paragraph 
(c)(1) or a Catastrophic Error under paragraph (d)(1), then the 
leg(s) that is an Obvious or Catastrophic Error will be adjusted or 
busted in accordance with paragraph (c)(4) or (d)(3), respectively, 
so long as either: (i) the width of the National Spread Market for 
the complex order strategy just prior to the erroneous transaction 
was equal to or greater than the amount set forth in the wide quote 
table of paragraph (b)(3) or (ii) the net execution price of the 
complex order is higher (lower) than the offer (bid) of the National 
Spread Market for the complex order strategy just prior to the 
erroneous transaction by an amount equal to at least the amount 
shown in the table in paragraph (c)(1). If any leg of a complex 
order is nullified, the entire transaction is nullified. For 
purposes of Rule 6.25, the National Spread Market for a complex 
order strategy is determined by the National Best Bid/Offer of the 
individual legs of the strategy.

As described above in relation to Proposed Rule 6.25.07(a), the first 
step is for the Exchange to review (upon receipt of a timely 
notification in accordance with paragraphs (c)(2) or (d)(2) of the 
Current Rule) the individual legs to determine whether a leg or legs 
qualifies as an obvious or catastrophic error. If no leg qualifies as 
an obvious or catastrophic error, the transaction stands--no adjustment 
and no nullification.
    Unlike Proposed Rule 6.25.07(a), the Exchange is also proposing to 
compare the net execution price of the entire complex order package to 
the National Spread Market (``NSM'') for the complex order 
strategy.\20\ Complex orders are exempt from the order protection rules 
of the options exchanges.\21\ Thus, depending on the manner in which 
the systems of an options exchange are calibrated, a complex order can 
execute without regard to the prices offered in the complex order books 
or the leg markets of other options exchanges. In certain situations, 
reviewing the execution prices of the legs in a vacuum would make the 
leg appear to be an obvious or catastrophic error, even though the net 
execution price on the complex order is not an erroneous price. For 
example, assume the Exchange receives a complex order to buy ABC calls 
and sell ABC puts.
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    \20\ NSM is the derived net market for a complex order package. 
See e.g., Rule 6.53C.04 (utilizing the term derived net market in 
the context of complex order strategies). For example, if the NBBO 
of Leg 1 is $1.00-2.00 and the NBBO of Leg 2 is $5.00-7.00, then the 
NSM for a complex order to buy Leg 1 and buy Leg 2 is $6.00-9.00.
    \21\ See Rule 6.81(b)(7). All options exchanges have the same 
order protection rule.
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     If the BBO for the ABC calls is $5.50-7.50 and the BBO for 
ABC puts is $3.00-4.50, then the Exchange's spread market is $1.00-
4.50.\22\
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    \22\ The complex order is to buy ABC calls and sell ABC puts. 
The Exchange's best offer for ABC puts is $7.50 and Exchange's best 
bid for is $3.00. If the Customer were to buy the complex order 
strategy, the Customer would receive a debit of $4.50 (buy ABC calls 
for $7.50 minus selling ABC puts for $3.00). If the Customer were to 
sell the complex order strategy the Customer would receive a credit 
of $1.00 (selling the ABC calls for $5.50 minus buying the ABC puts 
for $4.50). Thus, the Exchange's spread market is $1.00-4.50.
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     If the NBBO for the ABC calls is $6.00-6.50 and the NBBO 
for the ABC puts is $3.50-4.00, then the NSM is $2.00-3.00.
     If the Customer buys the calls at $7.50 and sells the puts 
at $4.00, the complex order Customer receives a net execution price of 
$3.00 (debit), which is the expected net execution price as indicated 
by the NSM offer of $3.00.
    If the exchange were to solely focus on the $7.50 execution price 
of the ABC calls or the $4.00 execution price of the ABC puts, the 
execution would qualify as an obvious or catastrophic error because the 
execution price on the legs was outside the NBBO, even though the net 
execution price is accurate. Thus, the additional review of the NSM to 
determine if the complex order was executed at a truly erroneous price 
is necessary. The same concern is not present when a complex order 
executes against the leg market under Rule 6.25.07(a) because the 
Exchange is modifying its system in order to ensure the leg will 
execute at or within the NBBO of the leg markets.\23\
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    \23\ The proposed rule change to modify Exchange systems to 
ensure the legs of a complex order will execute against legs in the 
simple order market within the NBBO of the simple order market will 
be in a separate filing.
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    In order to incorporate NSM, Rule 6.25.07(b) provides that if the 
Exchange determines that a leg or legs does qualify as on obvious or 
catastrophic error, the leg or legs will be adjusted or busted in 
accordance with paragraph (c)(4) or (d)(3) of the Current Rule, so long 
as either: (i) the width of the NSM for the complex order strategy just 
prior to the erroneous transaction was equal to or greater than the 
amount set forth in the wide quote table of paragraph (b)(3) of the 
Current Rule or (ii) the net execution price of the complex order is 
higher (lower) than the offer (bid) of the NSM for the complex order 
strategy just prior to the erroneous transaction by an amount equal to 
at least the amount shown in the table in paragraph (c)(1) of the 
Current Rule.
    For example, assume an individual leg or legs qualifies as an 
obvious or catastrophic error and the width of the NSM of the complex 
order strategy just prior to the erroneous transaction is $6.00-9.00. 
The complex order will qualify to be adjusted or busted in accordance 
with paragraph (c)(4) of the Current Rule because the wide quote table 
of paragraph (b)(3) of the Current Rule indicates that the minimum 
amount is $1.50 for a bid price between $5.00 to $10.00. If the NSM 
were instead $6.00-7.00 the complex order strategy would not qualify to 
be adjusted or busted pursuant to .07(b)(i) because the width of the 
NSM is $1.00, which is less than the required $1.50. However, the 
execution may still qualify to be adjusted or busted in accordance with 
paragraph (c)(4) or (d)(3) of the Current Rule pursuant to .07(b)(ii). 
Focusing on the NSM in this manner will ensure that the obvious/
catastrophic error review process focuses on the net execution price 
instead of the execution prices of the individual legs, which may have 
execution prices outside of the NBBO of the leg markets.
    Again, assume an individual leg or legs qualifies as an obvious or 
catastrophic error as described above. If the NSM is $6.00-7.00 (not a 
wide quote pursuant to the wide quote table in paragraph (b)(3) of the 
Current Rule) but the execution price of the entire complex order 
package (i.e., the net execution price) is higher (lower) than the 
offer (bid) of the NSM for the complex order strategy just prior to the 
erroneous transaction by an amount equal to at least the amount in the 
table in paragraph (c)(1) of the Current Rule, then the complex order 
qualifies to be adjusted or busted in accordance with paragraph (c)(4) 
or (d)(3) of the Current Rule. For example, if the NSM for the complex 
order strategy just prior to the erroneous transaction is $6.00-7.00 
and the net execution price of the complex order transaction is $7.75, 
the complex order qualifies to be adjusted or busted in accordance with 
paragraph (c)(4) of the Current Rule because the execution price of 
$7.75 is more than $0.50 (i.e., the minimum amount according to the 
table in paragraph (c)(1) when the price is above $5.00 but less than 
$10.01) from the NSM offer of $7.00. Focusing on the NSM in this manner 
will ensure that the obvious/catastrophic error review process focuses 
on the net execution price instead of the execution prices of the 
individual legs, which may have execution prices outside of the NBBO of 
the leg markets.
    Although the Exchange believes adjusting execution prices is 
generally better for the marketplace than

[[Page 171]]

nullifying executions because liquidity providers often execute hedging 
transactions to offset options positions, the Exchange recognizes that 
complex orders executing against other complex orders is similar to 
simple orders executing against other simple orders because both 
parties are able to review the execution price to determine whether the 
transaction may have been executed at an erroneous price. Thus, for 
purposes of complex orders that meet the requirements of Rule 
6.25.07(b), the Exchange proposes to apply the Current Rule and adjust 
or bust obvious errors in accordance with paragraph (c)(4) (as opposed 
to applying paragraph (c)(4)(A) as is the case under .07(a)) and 
catastrophic errors in accordance with (d)(3).
    Therefore, for purposes of complex orders under Proposed Rule 
6.25.07(b), if one of the legs is determined to be an obvious error 
under paragraph (c)(1), all Customer transactions will be nullified, 
unless a Trading Permit Holder (``TPH'') submits 200 or more Customer 
transactions for review in accordance with (c)(4)(C).\24\ For purposes 
of complex orders under Proposed Rule 6.25.07(b), if one of the legs is 
determined to be a catastrophic error under paragraph (d)(3) and all of 
the other requirements of Rule 6.25.07(b) are met, all market 
participants will be adjusted in accordance with the table set forth in 
(d)(3). Again, however, pursuant to paragraph (d)(3) where at least one 
party to a complex order transaction is a Customer, the transaction 
will be nullified if adjustment would result in an execution price 
higher (for buy transactions) or lower (for sell transactions) than the 
Customer's limit price on the complex order or individual leg(s). Also, 
if any leg of a complex order is nullified, the entire transaction is 
nullified.
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    \24\ Rule 6.25(c)(4)(C) also requires the orders resulting in 
200 or more Customer transactions to have been submitted during the 
course of 2 minutes or less.
---------------------------------------------------------------------------

    Third, proposed Interpretation and Policy .07(c) governs stock-
option orders. Proposed Rule 6.25.07(c) provides:

    If the option leg of a stock-option order qualifies as an 
Obvious Error under paragraph (c)(1) or a Catastrophic Error under 
paragraph (d)(1), then the option leg that is an Obvious or 
Catastrophic Error will be adjusted in accordance with paragraph 
(c)(4)(A) or (d)(3), respectively, regardless of whether one of the 
parties is a Customer. However, the option leg of any Customer order 
subject to this paragraph (c) will be nullified if the adjustment 
would result in an execution price higher (for buy transactions) or 
lower (for sell transactions) than the Customer's limit price on the 
stock-option order, and the Exchange will attempt to nullify the 
stock leg. Whenever a stock trading venue nullifies the stock leg of 
a stock-option order or whenever the stock leg cannot be executed, 
the Exchange will nullify the option leg upon request of one of the 
parties to the transaction or in accordance with paragraph (c)(3).

    Similar to proposed Interpretation and Policy .07(a), an options 
leg (or legs) of a stock-option order must qualify as an obvious or 
catastrophic error under the Current Rule in order for the stock-option 
order to qualify as an obvious or catastrophic error. Also similar to 
Proposed Rule 6.25.07(a), if an options leg (or legs) does qualify as 
an obvious or catastrophic error, the option leg (or legs) will be 
adjusted in accordance with paragraph (c)(4)(A) or (d)(3), 
respectively, regardless of whether one of the parties is a Customer. 
Again, as with Proposed Rule 6.25.07(a), where at least one party to a 
complex order transaction is a Customer, the Exchange will nullify the 
option leg and attempt to nullify the stock leg if adjustment would 
result in an execution price higher (for buy transactions) or lower 
(for sell transactions) than the Customer's limit price on the complex 
order or individual leg(s).
    The stock leg of a stock-option order is not executed on the 
Exchange; rather, the stock leg is sent to a stock trading venue for 
execution. The Exchange is unaware of a mechanism by which the Exchange 
can guarantee that the stock leg will be nullified by the stock trading 
venue in the event of an obvious or catastrophic error on the Exchange. 
Thus, in the event of the nullification of the option leg pursuant to 
Proposed Rule 6.25.07(c), the Exchange will attempt to have the stock 
leg nullified by the stock trading venue by either contacting the stock 
trading venue or notifying the parties to the transaction that the 
option leg is being nullified. The party or parties to the transaction 
may ultimately need to contact the stock trading venue to have the 
stock portion nullified.
    Finally, the Exchange proposes to provide guidance that whenever 
the stock trading venue nullifies the stock leg of a stock-option 
order, the option will be nullified upon request of one of the parties 
to the transaction or by an Official acting on their own motion in 
accordance with paragraph (c)(3). There are situations in which buyer 
and seller agree to trade a stock-option order, but the stock leg 
cannot be executed. The Exchange proposes to provide guidance that 
whenever the stock portion of a stock-option order cannot be executed, 
the Exchange will nullify the option leg upon request of one of the 
parties to the transaction or on an Official's own motion.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with the 
requirements of the Act and the rules and regulations thereunder that 
are applicable to a national securities exchange, and, in particular, 
with the requirements of Section 6(b) of the Act.\25\ Specifically, the 
proposal is consistent with Section 6(b)(5) of the Act \26\ because it 
would promote just and equitable principles of trade, remove 
impediments to, and perfect the mechanism of, a free and open market 
and a national market system, and, in general, protect investors and 
the public interest.
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    \25\ 15 U.S.C. 78f(b).
    \26\ 15 U.S.C. 78f(b)(5).
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    As described above, the Exchange and other options exchanges are 
seeking to adopt harmonized rules related to the adjustment and 
nullification of erroneous options transactions. The Exchange believes 
that the Proposed Rule will provide greater transparency and clarity 
with respect to the adjustment and nullification of erroneous options 
transactions. Particularly, the proposed changes seek to achieve 
consistent results for participants across U.S. options exchanges while 
maintaining a fair and orderly market, protecting investors and 
protecting the public interest. Based on the foregoing, the Exchange 
believes that the proposal is consistent with Section 6(b)(5) of the 
Act \27\ in that the Proposed Rule will foster cooperation and 
coordination with persons engaged in regulating and facilitating 
transactions.
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Exchange believes the various provisions allowing or dictating 
adjustment rather than nullification of a trade are necessary given the 
benefits of adjusting a trade price rather than nullifying the trade 
completely. Because options trades are used to hedge, or are hedged by, 
transactions in other markets, including securities and futures, many 
TPHs, and their customers, would rather adjust prices of executions 
rather than nullify the transactions and, thus, lose a hedge 
altogether. As such, the Exchange believes it is in the best interest 
of investors to allow for price adjustments as well as nullifications.
    The Exchange does not believe that the proposal is unfairly 
discriminatory, even though it differentiates in many places between 
Customers and non-

[[Page 172]]

Customers. As with the Current Rule, Customers are treated differently, 
often affording them preferential treatment. This treatment is 
appropriate in light of the fact that Customers are not necessarily 
immersed in the day-to-day trading of the markets, are less likely to 
be watching trading activity in a particular option throughout the day, 
and may have limited funds in their trading accounts. At the same time, 
the Exchange reiterates that in the U.S. options markets generally 
there is significant retail customer participation that occurs directly 
on (and only on) options exchanges such as the Exchange. Accordingly, 
differentiating among market participants with respect to the 
adjustment and nullification of erroneous options transactions is not 
unfairly discriminatory because it is reasonable and fair to provide 
Customers with additional protections as compared to non-Customers.
    The Exchange believes that its proposal to adopt the ability to 
adjust a Customer's execution price when a complex order is deemed to 
be an Obvious or Catastrophic Error is consistent with the Act. A 
complex order that executes against individual leg markets may receive 
an execution price on an individual leg that is not an Obvious or 
Catastrophic error but another leg of the transaction is an Obvious or 
Catastrophic Error. In such situations where the complex order is 
executing against at least one individual or firm that is not aware of 
the fact that they have executed against a complex order or that the 
complex order has been executed at an erroneous price, the Exchange 
believes it is more appropriate to adjust execution prices if possible 
because the derivative transactions are often hedged with other 
securities. Allowing adjustments instead of nullifying transactions in 
these limited situations will help to ensure that market participants 
are not left with a hedge that has no position to hedge against.
    The Exchange also believes its proposal related to stock-option 
orders is consistent with the Act. Stock-option orders consist of an 
option component and a stock component. Due to the fact that the 
Exchange has no control over the venues on which the stock is executed 
the proposal focuses on the option component of the stock-option order 
by adjusting or nullifying the option in accordance with paragraph 
(c)(4)(A) or (d)(3). Also, nullifying the option component if the stock 
component cannot be executed ensures that market participants receive 
the execution for which they bargained. Stock-option orders are 
negotiated and agreed to as a package; thus, if for any reason the 
stock portion of a stock-option order cannot ultimately be executed, 
the parties should not be saddled with an options position sans stock.

B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.
    Importantly, the Exchange believes the proposal will not impose a 
burden on intermarket competition but will rather alleviate any burden 
on competition because it is the result of a collaborative effort by 
all options exchanges to harmonize and improve the process related to 
the adjustment and nullification of erroneous options transactions. The 
Exchange does not believe that the rules applicable to such process is 
an area where options exchanges should compete, but rather, that all 
options exchanges should have consistent rules to the extent possible. 
Particularly where a market participant trades on several different 
exchanges and an erroneous trade may occur on multiple markets nearly 
simultaneously, the Exchange believes that a participant should have a 
consistent experience with respect to the nullification or adjustment 
of transactions. The Exchange understands that all other options 
exchanges that trade complex orders and/or stock-option orders intend 
to file proposals that are substantially similar to this proposal.
    The Exchange does not believe that the proposed rule change imposes 
a burden on intramarket competition because the provisions apply to all 
market participants equally within each participant category (i.e., 
Customers and non-Customers). With respect to competition between 
Customer and non-Customer market participants, the Exchange believes 
that the Proposed Rule acknowledges competing concerns and tries to 
strike the appropriate balance between such concerns. For instance, the 
Exchange believes that protection of Customers is important due to 
their direct participation in the options markets as well as the fact 
that they are not, by definition, market professionals. At the same 
time, the Exchange believes due to the quote-driven nature of the 
options markets, the importance of liquidity provision in such markets 
and the risk that liquidity providers bear when quoting a large breadth 
of products that are derivative of underlying securities, that the 
protection of liquidity providers and the practice of adjusting 
transactions rather than nullifying them is of critical importance. As 
described above, the Exchange will apply specific and objective 
criteria to determine whether an erroneous transaction has occurred 
and, if so, how to adjust or nullify a transaction.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Exchange neither solicited nor received comments on the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    A. by order approve or disapprove such proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2016-088 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2016-088. 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

[[Page 173]]

with respect to the proposed rule change that are filed with the 
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE., Washington, 
DC 20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of such filing 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-CBOE-2016-088, and should be 
submitted on or before January 24, 2017.
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    \28\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2016-31766 Filed 12-30-16; 8:45 am]
 BILLING CODE 8011-01-P


