[Federal Register Volume 82, Number 213 (Monday, November 6, 2017)]
[Notices]
[Pages 51461-51467]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-24051]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81992; File No. SR-BatsEDGX-2017-43]


Self-Regulatory Organizations; Cboe EDGX Exchange, Inc.; Notice 
of Filing and Immediate Effectiveness of a Proposed Rule Change To 
Amend Rule 20.6, Nullification and Adjustment of Options Transactions 
Including Obvious Errors

October 31, 2017.
    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 October 25, 2017, Cboe EDGX Exchange, Inc. (``EDGX'' or the 
``Exchange'') (formerly known as Bats EDGX Exchange, Inc.) filed with 
the Securities and Exchange Commission (``Commission'') the proposed 
rule change as described in Items I and II below, which Items have been 
prepared by the Exchange. The Exchange has designated this proposal as 
a ``non-controversial'' proposed rule change pursuant to Section 
19(b)(3)(A) of the Act \3\ and Rule 19b-4(f)(6) thereunder,\4\ which 
renders it effective upon filing with the Commission. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange filed a proposal to amend Rule 20.6, entitled 
``Nullification and Adjustment of Options Transactions including 
Obvious Errors.'' Rule 20.6 relates to the adjustment and nullification 
of transactions that occur on the Exchange's equity options platform 
(``EDGX Options'').
    The text of the proposed rule change is available at the Exchange's 
Web site at www.bats.com, at the principal office of the Exchange, 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 parts of such 
statements.

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

1. Purpose
Background
    The Exchange proposes to amend Exchange Rule 20.6 to add 
Interpretation and Policy .04 (the ``Proposed Rule''). This filing is 
based on a proposal recently submitted by Cboe Exchange, Inc. (``Cboe 
Options'') and approved by the Securities and Exchange Commission (the 
``Commission'').\5\
---------------------------------------------------------------------------

    \5\ See Securities Exchange Act Release 80040 (February 14, 
2017), 82 FR 11248 (February 21, 2017) (Order Approving SR-CBOE-
2016-088).
---------------------------------------------------------------------------

    In 2015, the U.S. 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.\6\ The Exchange launched an options exchange later that 
year, with the newly harmonized rule as part of the original rule 
set.\7\ The Exchange believes that the changes the options exchanges 
implemented with the new, harmonized rule have led to increased 
transparency and finality with

[[Page 51462]]

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.
---------------------------------------------------------------------------

    \6\ See Securities Exchange Act Release Nos. 74556 (March 20, 
2015), 80 FR 16031 (March 26, 2015) (SR-BATS-2014-067); see also 
Securities Exchange Act Release No. 73884 (December 18, 2014), 79 FR 
77557 (December 24, 2014) (the ``Initial Filing''); 81084 (July 6, 
2017), 82 FR 32216 (July 12, 2017) (SR-BatsBZX-2017-35) (adopting 
subsequent harmonized provisions relating to the calculation of 
Theoretical Price).
    \7\ See Securities Exchange Act Release No. 75650 (August 7, 
2015), 80 FR 48600 (August 13, 2015) (SR-EDGX-2015-18).
---------------------------------------------------------------------------

    Specifically, the options exchanges continued 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 \8\ and stock-option orders. The goal of the process 
undertaken by the options exchanges was 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 proposed, and the Exchange now proposes, 
will provide transparency and finality with respect to the adjustment 
and nullification of erroneous complex order.\9\ 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.
---------------------------------------------------------------------------

    \8\ See Rule 21.20(a)(5) (defining complex orders).
    \9\ The Exchange is not proposing to adopt changes to the 
obvious error rule related to stock-option orders at this time 
because it does not currently accept stock-option orders.
---------------------------------------------------------------------------

    The Proposed Rule is based on this coordinated effort and reflects 
discussions by the options exchanges whereby the exchanges that offer 
complex orders and/or stock-option orders agreed to 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. 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. Although the Exchange was 
involved in the discussions by options exchanges to propose a uniform 
rule, the Exchange has not historically offered complex orders or 
stock-option orders, and thus, has not previously adopted rules 
applicable to such orders. The Exchange is filing this proposal at this 
time in anticipation of launching a complex order book that will accept 
complex orders in the near future.\10\ The Exchange is not proposing to 
adopt changes to the obvious error rule related to stock-option orders 
at this time, as the Exchange does not currently accept stock-option 
orders and does not have a near term expectation to accept such orders.
---------------------------------------------------------------------------

    \10\ See Securities Exchange Act Release No. 81891 (October 17, 
2017) (SR-BatsEDGX-2017-29) (order approving rules for EDGX complex 
order book).
---------------------------------------------------------------------------

    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 
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
    As more fully described below, the Proposed Rule applies much of 
current Rule 20.6 (the ``Current Rule'') to complex orders.\11\ The 
Proposed Rule deviates from the Current Rule only to account for the 
unique qualities of complex 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. In order to apply the 
Current Rule and account for the unique characteristics of complex 
orders, proposed Interpretation and Policy .04 is split into two 
parts--paragraphs (a) and (b).
---------------------------------------------------------------------------

    \11\ In order for a complex 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 .04(a)-(b).
---------------------------------------------------------------------------

    First, proposed Interpretation and Policy .04(a) governs the review 
of complex orders that are executed

[[Page 51463]]

against individual legs (as opposed to a complex order that executes 
against another complex order).\12\ Proposed Interpretation and Policy 
.04(a) provides:
---------------------------------------------------------------------------

    \12\ 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 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 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 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.\13\ If no leg 
qualifies as an obvious or catastrophic error, the transaction stands--
no adjustment and no nullification.
---------------------------------------------------------------------------

    \13\ 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, proposed Interpretation 
and Policy .04(a) will govern.
---------------------------------------------------------------------------

    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.\14\
---------------------------------------------------------------------------

    \14\ Only the execution price on the leg (or legs) that 
qualifies as an obvious or catastrophic error pursuant to any 
portion of Proposed Interpretation and Policy .04 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.
---------------------------------------------------------------------------

    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 \15\ 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.\16\ 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 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).
---------------------------------------------------------------------------

    \15\ See Rule 20.6(b) (defining the manner in which Theoretical 
Price is determined).
    \16\ See Rule 20.6(a)(1) (defining Customer for purposes of Rule 
20.6 as not including a broker-dealer or Professional).
---------------------------------------------------------------------------

    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 
.04 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).\17\ 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.
---------------------------------------------------------------------------

    \17\ See Rule 20.6(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)).
---------------------------------------------------------------------------

    Furthermore, as with the Current Rule, Proposed Interpretation and 
Policy .04(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

[[Page 51464]]

$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).\18\ 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.
---------------------------------------------------------------------------

    \18\ See Rule 20.6(b)(3).
---------------------------------------------------------------------------

     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.\19\
---------------------------------------------------------------------------

    \19\ See Rule 20.6(c)(1).
---------------------------------------------------------------------------

     According to Proposed Interpretation and Policy .04(a) 
Customers will also be adjusted in accordance with Rule 20.6(c)(4)(A), 
which for a buy transaction under $3.00 calls for the Theoretical Price 
to by adjusted by adding $0.15 \20\ to the Theoretical Price of $1.00. 
Thus, adjust execution price for leg 1 would be $1.15.
---------------------------------------------------------------------------

    \20\ See Rule 20.6(c)(4)(A).
---------------------------------------------------------------------------

     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 \21\ because the limit price of a Customer's sell order would 
be violated by the adjustment.\22\
---------------------------------------------------------------------------

    \21\ If any leg of a complex order is nullified, the entire 
transaction is nullified. See Proposed Interpretation and Policy 
.04(a).
    \22\ The simple order in this example is not an erroneous sell 
transaction because the execution price was not erroneously low. See 
Rule 20.6(a)(2).
---------------------------------------------------------------------------

    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 20.6 
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.\23\ 
If the adjustment of a complex order would violate the complex order 
Customer's limit price, the transaction will be nullified.
---------------------------------------------------------------------------

    \23\ See Interpretation and Policy .02 to Rule 20.6.
---------------------------------------------------------------------------

    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 Interpretation and Policy .04(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.
    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.
    Second, proposed Interpretation and Policy .04(b) governs the 
review of complex orders that are executed against other complex 
orders. Proposed Interpretation and Policy .04(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 20.6, the National Spread Market for a complex 
order strategy is determined by the National Best Bid/Offer of the 
individual legs of the strategy (i.e., the SNBBO under Rule 21.20).

As described above in relation to Proposed Interpretation and Policy 
.04(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 Interpretation and Policy .04(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.\24\ Complex orders are exempt from the order protection 
rules of the options exchanges.\25\ 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

[[Page 51465]]

complex order to buy ABC calls and sell ABC puts.
---------------------------------------------------------------------------

    \24\ The NSM is the derived net market for a complex order 
package and is equivalent to the term SNBBO in Exchange Rule 
21.20(a)(12). 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. The Exchange has proposed to 
retain the term NSM to retain consistency with other options 
exchanges that have already adopted uniform rules related to complex 
orders.
    \25\ See Rule 27.2(a)(8). All options exchanges have the same 
order protection rule.
---------------------------------------------------------------------------

     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.\26\
---------------------------------------------------------------------------

    \26\ 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.
---------------------------------------------------------------------------

     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 proposed Interpretation and 
Policy .04(a). The Exchange permits a given leg of a complex order to 
trade through the NBBO provided the complex order trades no more than a 
configurable amount outside of the NBBO.\27\
---------------------------------------------------------------------------

    \27\ See Rule 20.20 [sic], Interpretation and Policy .04(f), 
which states: ``The Drill-Through Price Protection feature is a 
price protection mechanism applicable to all complex orders under 
which a buy (sell) order will not be executed at a price that is 
higher (lower) than the SNBBO or the SNBBO at the time of order 
entry plus (minus) a buffer amount (the ``Drill-Through Price''). 
The Exchange will adopt a default buffer amount for the Drill-
Through Price Protection and will publish this amount in publicly 
available specifications and/or a Regulatory Circular. A Member may 
modify the buffer amount applicable to Drill-Through Price 
Protections to either a larger or smaller amount than the Exchange 
default . . . .''
---------------------------------------------------------------------------

    In order to incorporate NSM, proposed Interpretation and Policy 
.04(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 proposed Interpretation and Policy 
.04(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 proposed Interpretation and Policy .04(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 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 Interpretation and Policy .04(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 proposed 
Interpretation and Policy .04(a)) and catastrophic errors in accordance 
with (d)(3).
    Therefore, for purposes of complex orders under Proposed 
Interpretation and Policy .04(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 Member submits 200 or more Customer 
transactions for review in accordance with (c)(4)(C) of the Current 
Rule.\28\ For purposes of complex orders under Interpretation and 
Policy .04(b), if one of the legs is determined to be a catastrophic 
error under paragraph (d)(3) and all of the other requirements of 
Interpretation and Policy .04(b) are met, all market participants will 
be adjusted in accordance with the table set forth in (d)(3) of the 
Current Rule. 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

[[Page 51466]]

complex order is nullified, the entire transaction is nullified.
---------------------------------------------------------------------------

    \28\ Rule 20.6(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.
---------------------------------------------------------------------------

Implementation Date
    The Exchange anticipates launching its complex order book on 
October 23, 2017. Accordingly, the Exchange proposes to implement this 
rule immediately.
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.\29\ Specifically, the 
proposal is consistent with Section 6(b)(5) of the Act \30\ 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.
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78f(b).
    \30\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    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 \31\ in that the Proposed Rule will foster cooperation and 
coordination with persons engaged in regulating and facilitating 
transactions.
---------------------------------------------------------------------------

    \31\ 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 
Members, 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-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.

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

    The Exchange 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 have 
adopted rules 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 has neither solicited nor received written comments on 
the proposed rule change.

[[Page 51467]]

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

    Because the proposed rule change does not (i) significantly affect 
the protection of investors or the public interest; (ii) impose any 
significant burden on competition; and (iii) become operative for 30 
days from the date on which it was filed, or such shorter time as the 
Commission may designate, it has become effective pursuant to Section 
19(b)(3)(A) of the Act \32\ and Rule 19b-4(f)(6) thereunder.\33\
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78s(b)(3)(A).
    \33\ 17 CFR 240.19b-4(f)(6). As required under Rule 19b-
4(f)(6)(iii), the Exchange provided the Commission with written 
notice of its intent to file the proposed rule change, along with a 
brief description and the text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission.
---------------------------------------------------------------------------

    A proposed rule change filed pursuant to Rule 19b-4(f)(6) under the 
Act \34\ normally does not become operative for 30 days after the date 
of its filing. However, Rule 19b-4(f)(6)(iii) \35\ permits the 
Commission to designate a shorter time if such action is consistent 
with the protection of investors and the public interest. The Exchange 
has asked the Commission to waive the 30-day operative delay so that 
the Exchange may, as soon as possible, implement the changes proposed 
by this filing. The Exchange notes that the proposal will promote 
consistency between the Exchange and other options exchanges that 
accept complex orders. For this reason, the Commission believes the 
waiver of the operative delay is consistent with the protection of 
investors and the public interest. Accordingly, the Commission hereby 
waives the operative delay and designates the proposed rule change 
operative upon filing.\36\
---------------------------------------------------------------------------

    \34\ 17 CFR 240.19b-4(f)(6).
    \35\ 17 CFR 240.19b-4(f)(6)(iii).
    \36\ For purposes only of waiving the 30-day operative delay, 
the Commission has also considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
---------------------------------------------------------------------------

    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act. If the Commission 
takes such action, the Commission shall institute proceedings to 
determine whether the proposed rule should be approved or 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 [email protected]. Please include 
File Number SR-BatsEDGX-2017-43 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-BatsEDGX-2017-43. 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 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. Persons submitting 
comments are cautioned that we do not redact or edit personal 
identifying information from comment submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-BatsEDGX-2017-43, and should 
be submitted on or before November 27, 2017.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\37\
---------------------------------------------------------------------------

    \37\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-24051 Filed 11-3-17; 8:45 am]
 BILLING CODE 8011-01-P


