[Federal Register Volume 87, Number 162 (Tuesday, August 23, 2022)]
[Notices]
[Pages 51723-51726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-18095]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-95520; File No. SR-CBOE-2022-041]


Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of 
Filing of a Proposed Rule Change To Amend Rule 5.34(b) Related to Price 
Protections and Risk Controls for Complex Orders

August 17, 2022.
    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 August 4, 2022, Cboe Exchange, Inc. (``Exchange'' or ``Cboe 
Options'') filed with the Securities and Exchange Commission 
(``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

[[Page 51724]]

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

    Cboe Exchange, Inc. (the ``Exchange'' or ``Cboe Options'') proposes 
to amend Rule 5.34(b) related to price protections and risk controls 
for complex orders. The text of the proposed rule change is provided in 
Exhibit 5.
    The text of the proposed rule change is also available on the 
Exchange's website (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
    The Exchange proposes to amend Rule 5.34(b) related to price 
protections and risk controls for complex orders. Specifically, the 
proposed rule change amends Rule 5.34(b)(4), which provides for a buy 
strategy price check for complex orders, to adopt an additional buy 
strategy price check for certain complex orders and amends Rule 
5.34(b)(1) to provide clarity regarding the definition of a skewed 
butterfly spread.
    First, the proposed rule change amends Rule 5.34(b)(4) to adopt an 
additional buy strategy price check for complex orders.\3\ 
Specifically, the proposed rule change adopts Rule 5.34(b)(4)(B) to 
provide that the System cancels or rejects a vertical or butterfly 
spread \4\ order to buy that has a price of zero and is not designated 
as either IOC or Direct to PAR, and the System does not initiate a COA 
with a vertical or butterfly spread order to buy that has a price of 
zero unless the order is auctioned via PAR. The Exchange may apply this 
check on a class-by-class basis.
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    \3\ Rule 5.34(b)(4) currently provides for one buy strategy 
price check; that the System cancels or rejects a limit complex 
order where all the components of the strategy are to buy and the 
order has (A) a price of zero, (B) a net credit price that exceeds a 
pre-set buffer (which the Exchange determines), or (C) a net debit 
price that is less than the number of individual legs in the 
strategy (or applicable ratio) multiplied by the minimum increment. 
As a result of the proposed additional buy strategy price check, the 
proposed rule change renumbers the current buy strategy price check 
in Rule 5.34(b)(4) as 5.34(b)(4)(A).
    \4\ For the purposes of Rule 5.34(b), the System considers a 
true butterfly and a skewed butterfly to be butterfly spread. The 
proposal explains this definition in further detail below.
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    The proposed buy strategy price check is designed to prevent a 
significant number of resting zero-priced vertical and butterfly buy 
strategies from overwhelming the complex order book (``COB''). The 
Exchange has observed a significant and increasing number of zero-
priced vertical and butterfly buy spread orders in certain classes 
submitted to rest in the COB, and does not believe the vast majority of 
these orders to be legitimately price.[sic] \5\ The Exchange notes 
that, while a zero-priced vertical or butterfly buy spread order may be 
a legitimately priced complex order, these orders infrequently execute 
against an opposing complex order and a majority of such orders remain 
resting in the COB. That is, it is rare that market participants desire 
to sell such strategies at a price of zero. The Exchange has observed 
relatively few fills as compared to the large number of these zero-bid 
strategy orders that remain resting in the COB.\6\ Such strategy orders 
also create a substantial amount of excess market data through which 
market participants must parse. Indeed, the Exchange notes that 
multiple Trading Permit Holders (``TPHs'') have expressed concern to 
the Exchange in connection with the amount of excess data that stems 
from the high number of zero-priced vertical and butterfly buy 
strategies. In particular, the Exchange understands that the high 
number of zero-priced vertical and butterfly buy strategies can impede 
liquidity providers from executing against marketable customer 
interest, as the stream of incoming zero-priced vertical and butterfly 
strategies creates new data messages that liquidity providers must 
process and synthesize into their systems, interfering with liquidity 
providers' time and resources to otherwise process, synthesize and 
react to data messages in connection with marketable customer interest. 
The Exchange notes too that complex orders also generate a COA auction 
message before resting in the COB, and the COA auction message volume 
resulting from the influx of zero-priced vertical and butterfly buy 
spread orders saturates the auction market data and may deter liquidity 
providers from providing auction liquidity, which adversely impacts 
customer orders. Additionally, the Exchange has expended resources to 
implement multiple System enhancements in order to enable the System to 
continue to handle the large number of such strategies.
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    \5\ The Exchange believes that vertical and butterfly spreads 
particularly are being used in this manner given certain 
characteristics: a vertical spread has the fewest number of legs 
(two) that contain the same expiration and different strikes and, 
therefore, is relatively less expensive and has a greater chance of 
legging into the Simple book; and a butterfly spread also has 
comparatively fewer legs (three, as compared to a box spread, which 
has four legs) that contain the same strike and expiration [sic], 
and, given its structure, has a more defined PnL (minimum and 
maximum possible trading price limit) than other strategies, 
providing it with more manageable risk.
    \6\ From its analysis of such orders submitted from January 2022 
through July 2022, the Exchange identified that approximately only 
1.3% of the approximately 177 million zero-priced buy vertical and 
butterfly spread orders submitted to rest in the COB received fills 
(including any in-part fills).
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    To illustrate this issue, the Exchange reviewed the top 25 classes 
in which the most orders were submitted during Q2 2022, and, of this 
sample of classes, the Exchange identified 10 classes that experienced 
(and continue to experience) resting zero-priced vertical and butterfly 
buy strategies overwhelming their respective COBs. On average, 
approximately 6.76% of the orders submitted in these 10 classes were 
zero-priced vertical and butterfly buy strategies, whereas only 
approximately 0.48% of the orders submitted in the other 15 classes 
(classes that the Exchange did not identify as experiencing this issue) 
were zero-priced vertical and butterfly buy strategies. That is, the 10 
classes in the dataset reviewed by the Exchange and identified as 
subject to this particular issue, experienced approximately 1308% more 
zero-priced vertical and butterfly buy spreads resting in their COBs, 
on average, than the other 15 classes. Additionally, from an analysis 
of zero-priced buy vertical and butterfly spread orders submitted from 
January 2022 through July 2022, the Exchange identified that 
approximately only 1.3% of the approximately 177 million zero-priced 
buy vertical and butterfly spread contracts submitted to rest in the 
COB were filled. The Exchange further identified that the majority of 
the zero-priced buy vertical and butterfly spread orders were submitted 
by only a few

[[Page 51725]]

firms, that, on average, received fills on only approximately 0.04% of 
their zero-priced buy vertical and butterfly spread contracts submitted 
to rest in the COB.
    The proposed price check requires zero-priced vertical and 
butterfly buy spread orders to be designated only as IOC \7\ or Direct 
to PAR \8\ to ensure that such orders are either executed against 
marketable orders immediately (in whole or in part) and then cancelled 
without resting in the COB or sent to directly to a PAR workstation for 
manual handling by a Floor Broker--that is, also without resting in the 
COB. Additionally, the proposed rule change allows a zero-priced 
vertical and butterfly buy spread order to initiate a COA, only if such 
order is auctioned via PAR.\9\ By allowing zero-priced vertical and 
butterfly buy spread orders to be submitted only as IOC or for manual 
handling, including manual submission into a COA, the proposed rule 
change continues to provide execution opportunities for orders with 
these strategies that are legitimately priced at zero, while preventing 
a significant number of these orders from overwhelming the COB, many of 
which the Exchange believes do not have legitimate prices. 
Additionally, the proposed rule change provides that the proposed price 
check may be implemented on a class-by-class basis so that the Exchange 
may determine whether allowing zero-prices [sic] vertical and butterfly 
buy spread orders to rest in the COB is appropriate for different 
classes, which may exhibit different trading characteristics and have 
different market models. The Exchange notes that multiple provisions 
governing price checks and risk controls for complex orders permit the 
Exchange to administer such price protections or risk controls on a 
class-by-class basis.\10\
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    \7\ The terms ``Immediate-or-Cancel'' and ``IOC'' mean, for an 
order so designated, a limit order that must execute in whole or in 
part as soon as the System receives it; the System cancels and does 
not post to the Book an IOC order (or unexecuted portion) not 
executed immediately on the Exchange or another options exchange. 
Users may designate bulk messages as IOC. A User may not designate 
an IOC order as Direct to PAR.
    \8\ A ``Direct to PAR'' order is an order a User designates to 
be routed directly to a specified PAR workstation for manual 
handling. A User must designate a Direct to PAR order as RTH Only.
    \9\ To note, orders submitted manually to a COA that do not 
execute at the end of the COA route back to PAR for manual handling. 
See Rule 5.33(d)(5)(B) [sic].
    \10\ See e.g., Rule 5.34(b)(3), (b)(6), (c)(1), and (c)(10).
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    Second, the proposed rule change updates the definition of skewed 
butterfly spread to be consistent with the manner in which the System 
defines a skewed butterfly spread and what the System currently 
considers to be a butterfly spread. Rule 5.34(b)(1)(B) currently 
provides that, for the purposes of Rule 5.34(b) (order and quote price 
protection mechanisms and risk control for complex orders), a butterfly 
spread is a three-legged complex order with two legs to buy (sell) the 
same number of calls (puts) and one leg to sell (buy) twice as many 
calls (puts), all with the same expiration date but different exercise 
prices, and the exercise price of the middle leg is between the 
exercise prices of the other legs. If the exercise price of the middle 
leg is halfway \11\ between the exercise prices of the other legs, it 
is a ``true'' butterfly; otherwise, it is a ``skewed'' butterfly. For 
the purposes of Rule 5.34(b), the System currently defines a skewed 
butterfly more granularly than the current rule text. The System 
considers a butterfly spread to be a skewed butterfly where the 
exercise price of the middle leg is less in-the-money than the average 
of the exercise prices of the other legs. To illustrate, the System 
currently considers, for example, a call butterfly to buy one $40 call, 
sell two $65 calls, and buy one $80 call to be a skewed butterfly as 
the middle leg (selling $65 calls) is less in the money \12\ than a $60 
strike (which is the average of the $40 and $80 strikes) between the 
legs to buy calls). Additionally, for the purposes of Rule 5.34(b), the 
System currently considers a true butterfly and a skewed butterfly to 
be a butterfly spread. That is, if a complex order is not a true 
butterfly or a skewed butterfly, the System does not consider it to be 
a butterfly spread for the purposes of the protection mechanisms and 
risk controls rules. Therefore, to reflect more accurately what the 
System considers to be a skewed butterfly and a butterfly spread 
generally, the proposed rule change adopts language in Rule 5.34(b)(1) 
to provide, in relevant part, that the System considers a true 
butterfly and a skewed butterfly to be a butterfly spread, and that if 
the exercise price of the middle leg is less in-the-money than the 
average \13\ of the exercise prices of the other legs, it is a 
``skewed'' butterfly. The proposed rule change is merely a definitional 
clarification to the rule text and does not alter any current System 
functionality, but instead adds clarity to the Rule by more accurately 
reflecting the manner in which the System currently defines a skewed 
butterfly and a butterfly spread.
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    \11\ See infra.
    \12\ A call option is in the money if the price of the 
underlying is higher than its strike price. Calls increase in 
moneyness as the strike price decreases.
    \13\ The proposed rule change also updates the current 
definition of a true butterfly to refer to ``the average of'' the 
exercise prices of the other legs, instead of ``halfway between'' 
the exercise prices of the other legs. The Exchange notes this 
verbiage does not change the meaning of the rule text and instead 
more specifically reflects the calculation that arrives at the 
halfway point between the other legs and is more consistent with 
proposed updated definition of skewed butterfly.
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Securities Exchange Act of 1934 (the ``Act'') and the rules and 
regulations thereunder applicable to the Exchange and, in particular, 
the requirements of Section 6(b) of the Act.\14\ Specifically, the 
Exchange believes the proposed rule change is consistent with the 
Section 6(b)(5) \15\ requirements that the rules of an exchange be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. Additionally, 
the Exchange believes the proposed rule change is consistent with the 
Section 6(b)(5) \16\ requirement that the rules of an exchange not be 
designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers.
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    \14\ 15 U.S.C. 78f(b).
    \15\ 15 U.S.C. 78f(b)(5).
    \16\ Id.
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    In particular, the Exchange believes that the proposed rule change 
removes impediments to and perfects the mechanism of a free and open 
market and national market system, and, in general, protects investors 
and the public interest as it is designed to prevent significant 
numbers of resting zero-priced vertical and butterfly buy spread orders 
from overwhelming the COB, many of which are likely not legitimately 
priced given their pattern of trading. As described above, the Exchange 
has recently observed a significant and increasing number of zero-
priced vertical and butterfly buy spread orders in certain classes 
submitted to rest in the COB. Because these orders are infrequently 
executed, the majority of such orders remain resting in the COB, 
creating a substantial amount of excess market data, which requires 
market participants and the Exchange to unessentially expend additional 
resources to handle such data and which may impede

[[Page 51726]]

liquidity providers from submitting liquidity in response to otherwise 
marketable interest, including resting customer orders, and auctions. 
The Exchange again notes that multiple TPHs have expressed concern to 
the Exchange in connection with the amount of excess data that stems 
from the high number of zero-priced vertical and butterfly buy 
strategies. By allowing zero-priced vertical and butterfly buy spread 
orders to be submitted only as IOC or for manual handling, including 
manual submission to COA, the proposed rule change continues to provide 
execution opportunities for these strategy orders, while preventing an 
influx of such orders from inundating the COB. Also, the Exchange 
believes that the proposed rule change to permit the Exchange to apply 
the proposed price check on a class basis protects investors as the 
proposed price check, like other price protections and risk controls 
permitted under the Rules on a class basis,\17\ may be appropriate for 
different classes as different classes may exhibit different trading 
characteristics and have different market models.
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    \17\ See supra note 10.
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    Further, the Exchange believes that the proposed rule change to 
clarify the definition of a skewed butterfly and butterfly spread 
removes impediments to and perfects the mechanism of a free and open 
market and national market system by amending Rule 5.34(b)(1)(B) to be 
more consistent with the manner in which the System currently defines a 
skewed butterfly and a butterfly spread for the purposes of the 
protection mechanisms and risk controls rules. The proposed rule change 
is merely a definitional clarification intended to more accurately 
reflect how the System currently works, thereby increasing transparency 
in the Rule and ultimately benefitting investors. The proposed 
clarifications do not alter any current functionality, but instead 
provides clarity to the Rule by more precisely defining a skewed 
butterfly and a butterfly spread.

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. The Exchange does not 
believe the proposed price check for zero-priced vertical and butterfly 
buy spread orders will impose any burden on intramarket competition 
because the proposed priced check will apply to all such orders in the 
same manner. The proposed price protection will benefit investors and 
the marketplace generally by preventing significant numbers of resting 
zero-priced vertical and butterfly buy spread orders from overwhelming 
the COB, many of which are likely not legitimately priced, while 
continuing to provide execution opportunities for such orders that are 
legitimately priced at zero via the IOC instruction or manual handling. 
The Exchange does not believe the proposed price check will impose any 
burden on intermarket competition because it is designed solely to 
mitigate the adverse impacts of an increasingly significant number of 
certain, infrequently executed complex orders resting in the COB. 
Further, the proposed rule change to clarify the definition of skewed 
butterfly and butterfly spread in Rule 5.34(b)(1)(B) is not competitive 
in nature but are merely a definitional clarification in the Rule, 
consistent with existing System functionality and intended to provide 
clarity to the Rule by more accurately reflecting the System's current 
definition of a skewed butterfly and a butterfly spread for the 
purposes of the purposes of the protection mechanisms and risk controls 
rules. As stated, the proposed clarification does not alter any current 
functionality.

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 [email protected]. Please include 
File Number SR-CBOE-2022-041 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-CBOE-2022-041. 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 website (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 website 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 the 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-CBOE-2022-041, and should be submitted 
on or before September 13, 2022.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2022-18095 Filed 8-22-22; 8:45 am]
BILLING CODE 8011-01-P


