Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change and Amendment Nos. 1 and 2 Relating to the Processing of Complex Orders in the Hybrid Trading System, 33011-33017 [E6-8801]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 71, Number 109 (Wednesday, June 7, 2006)]
[Notices]
[Pages 33011-33017]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-8801]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53909; File No. SR-CBOE-2005-65]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change and Amendment 
Nos. 1 and 2 Relating to the Processing of Complex Orders in the Hybrid 
Trading System

May 31, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 24, 2005, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') 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 CBOE. 
The CBOE filed Amendment Nos. 1 and 2 to the proposal on March 13, 
2006, and April 27, 2006, respectively.\3\ The Commission is publishing 
this notice to solicit comments on the proposed rule change, as 
amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 2 replaces and supersedes the original filing 
and Amendment No. 1 in their entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend its procedures applicable to trading complex 
orders on the Hybrid Trading System (``Hybrid System'') to provide for 
an automated Request for Responses (``RFR'') auction process for 
certain eligible complex orders (``COA'' process). CBOE is also 
proposing to make various changes to the existing routing and execution 
processes applicable to the complex order book (``COB'') and various 
changes to its rules pertaining generally to the minimum increments 
applicable to complex orders. The text of the proposed rule change 
appears below. Additions are italicized; deletions are [bracketed].
* * * * *

Chicago Board Options Exchange, Incorporated

Rules

Rule 6.9. Solicited Transactions

    A member or member organization representing an order respecting an 
option traded on the Exchange (an ``original order''), including a 
spread, combination, or straddle order as defined in Rule 6.53, a 
stock-option order as defined in Rule 1.1(ii) [or], a security future-
option order as defined in Rule 1.1(zz), or any other complex order as 
defined in Rule 6.53C, may solicit a member or member organization or a 
non-member customer or broker-dealer (the ``solicited person'') to 
transact in-person or by order (a ``solicited order'') with the 
original order. In addition, whenever a floor broker who is aware of, 
but does not represent, an original order solicits one or more persons 
or orders in response to an original order, the persons solicited and 
any resulting orders are solicited persons or solicited orders subject 
to this Rule. Original orders and solicited orders are subject to the 
following conditions.
    (a)-(f) No change.
    * * * Interpretations & Policies:
    .01-.02 No change.
    .03 In respect of any solicited order that is a spread, straddle or 
combination order as defined in Rule 6.53, or any other complex order 
as defined in Rule

[[Page 33012]]

6.53C, the terms ``bid'' and ``offer'' as used in subparagraphs (a)-(d) 
of this Rule 6.9 mean ``total net debit'' and ``total net credit,'' 
respectively.
    .04-.07 No change.
* * * * *

Rule 6.42. Minimum Increments for Bids and Offers

    (1)-(2) No change.
    (3) Bids and offers on spread, straddle, or combination orders as 
defined in Rule 6.53, or any other complex order as defined in Rule 
6.53C, may be expressed in any increment, and the legs of such an order 
may be executed in one cent increments, regardless of the minimum 
increments otherwise appropriate to the individual legs of the order. 
Notwithstanding the foregoing sentence, bids and offers on spread, 
straddle, [or] combination, or other complex orders as defined in Rule 
6.53C, in options on the S&P 500 Index or on the S&P 100 Index, except 
for box spreads, shall be expressed in decimal increments no smaller 
than $0.05. Spread, straddle, [or] combination, or other complex orders 
as defined in Rule 6.53C expressed in net price increments that are not 
multiples of the minimal increment are not entitled to the same 
priority under Rule 6.45 as such orders expressed in increments that 
are multiples of the minimum increment.
    * * * Interpretations & Policies:
    No change.
* * * * *

Rule 6.45. Priority of Bids and Offers--Allocation of Trades

    (a)-(d) No change.
    (e) Complex Order Priority Exception: A spread, straddle, 
combination, or ratio order (or a stock-option order or security 
future-option order, as defined in Rule 1.1(ii)(b) and Rule 1.1(zz)(b), 
respectively), or any other complex order as defined in Rule 6.53C, may 
be executed at a net debit or credit price (in a multiple of the 
minimum increment) with another member without giving priority to 
equivalent bids (offers) in the trading crowd or in the book provided 
at least one leg of the order betters the corresponding bid (offer) in 
the book. Stock-option orders and security future-option orders, as 
defined in Rule 1.1(ii)(a) and Rule 1.1(zz)(a) respectively, have 
priority over bids (offers) of the trading crowd but not over bids 
(offers) of public customers in the limit order book.
* * * * *

Rule 6.45A.--Priority and Allocation of Equity Option Trades on the 
CBOE Hybrid System

    (a) No change.
    (b) Allocation of Orders Represented in Open Outcry: The allocation 
of orders that are represented in open outcry by floor brokers or PAR 
Officials shall be as described below in subparagraphs (b)(i) and 
(b)(ii). With respect to subparagraph (b)(ii), the floor broker or PAR 
Official representing the order shall determine the sequence in which 
bids (offers) are made.
    (i)-(ii) No change.
    (iii) Exception: Complex Order Priority: A spread, straddle, 
combination, or ratio order (or a stock-option order or security 
future-option order, as defined in Rule 1.1(ii)(b) and Rule 1.1(zz)(b), 
respectively), or any other complex order as defined in Rule 6.53C, may 
be executed at a net debit or credit price (in a multiple of the 
minimum increment) with another member without giving priority to 
equivalent bids (offers) in the trading crowd or in the book provided 
at least one leg of the order betters the corresponding bid (offer) in 
the book. Stock-option orders and security future-option orders, as 
defined in Rule 1.1(ii)(a) and Rule 1.1(zz)(a) respectively, have 
priority over bids (offers) of the trading crowd but not over bids 
(offers) of public customers in the limit order book.
    (iv) No change.
    (c)-(e) No change.
    * * * Interpretations and Policies:
    No change.
* * * * *

Rule 6.45B--Priority and Allocation of Trades in Index Options and 
Options on ETFs on the CBOE Hybrid System

    (a) No change.
    (b) Allocation of Orders Represented in Open Outcry: The allocation 
of orders that are represented in the trading crowd by floor brokers or 
PAR Officials shall be as described below in subparagraphs (b)(i) and 
(b)(ii). With respect to subparagraph (b)(ii), the floor broker or PAR 
Official representing the order shall determine the sequence in which 
bids (offers) are made.
    (i)-(ii) No change.
    (iii) Exception: Complex Order Priority: A member holding a spread, 
straddle, or combination order (or a stock-option order or security 
future-option order as defined in Rule 1.1(ii)(b) and Rule 1.1(zz)(b), 
respectively), or any other complex order as defined in Rule 6.53C, and 
bidding (offering) on a net debit or credit basis (in a multiple of the 
minimum increment) may execute the order with another member without 
giving priority to equivalent bids (offers) in the trading crowd or in 
the electronic book provided at least one leg of the order betters the 
corresponding bid (offer) in the book. Stock-option orders and security 
future-option orders, as defined in Rule 1.1(ii)(a) and Rule 
1.1(zz)(a), respectively, have priority over bids (offers) of the 
trading crowd but not over bids (offers) of public customers in the 
limit order book.
    (c)-(d) No change.
    * * * Interpretations and Policies:
    No change.
* * * * *

Rule 6.53C. Complex Orders on the Hybrid System

    RULE 6.53C. (a)-(b) No change.
    (c) Complex Order Book
    (i) No change.
    [(ii) Priority of Complex Orders in the COB: Orders from public 
customers have priority over orders from non-public customers. Multiple 
public customer complex orders at the same price are accorded priority 
based on time.]
    [(iii)] (ii) Execution of Complex Orders in the COB: 
Notwithstanding the provisions of Rule 6.42, the appropriate Exchange 
committee will determine on a class-by-class basis whether complex 
orders that are routed to or resting in the COB may be expressed on a 
net price basis in a multiple of the minimum increment (i.e., $0.05 or 
$0.10, as applicable) or in a one cent increment. All pronouncements 
regarding COB increments will be announced to the membership via 
Regulatory Circular. Complex orders resting in the COB may be executed 
without consideration to prices of the same complex orders that might 
be available on other exchanges, and the legs of a complex order may be 
executed in one cent increments, regardless of the minimum quoting 
increments otherwise appropriate to the individual legs of the order. 
Complex orders resting in the COB may trade in the following way:
    (1) Orders and Quotes in the [Electronic Book (``]EBook['')]: A 
complex order in the COB will automatically execute against individual 
orders or quotes residing in EBook provided the complex order can be 
executed in full (or in a permissible ratio) by the orders and quotes 
in EBook.
    (2) Orders in COB: Complex orders in the COB that are marketable 
against each other will automatically execute. The allocation of a 
complex order within the COB shall be pursuant to the rules of trading 
priority otherwise applicable to incoming electronic orders in the 
individual component legs.
    (3) Market participants, as defined in [CBOE] Rule 6.45A or 6.45B, 
as applicable, may submit orders or quotes to trade against orders in 
the COB. The

[[Page 33013]]

allocation of complex orders among market participants shall be done 
pursuant to CBOE Rule 6.45A(c) or 6.45B(c), as applicable.
    [(iv)] (iii) Complex orders in the COB may be designated as day 
orders or good-til-cancelled orders. Only those complex orders with no 
more than four legs and having a ratio of one-to-three or lower, as 
determined by the appropriate Exchange committee, are eligible for 
placement into the COB.
    (d) Process for Complex Order RFR Auction: Prior to routing to the 
COB or once on PAR, eligible complex orders may be subject to an 
automated request for responses (``RFR'') auction process.
    (i) For purposes of paragraph (d):
    (1) ``COA'' is the automated complex order RFR auction process.
    (2) A ``COA-eligible order'' means a complex order that, as 
determined by the appropriate Exchange committee on a class-by-class 
basis, is eligible for a COA considering the order's marketability 
(defined as a number of ticks away from the current market), size and 
complex order type, as defined in paragraph (a) above. All 
pronouncements regarding COA eligibility will be announced to the 
membership via Regulatory Circular. Complex orders processed through a 
COA may be executed without consideration to prices of the same complex 
orders that might be available on other exchanges.
    (3) The ``Response Time Interval'' means the period of time during 
which responses to the RFR may be entered.
    (ii) Initiation of a COA: On receipt of a COA-eligible order and 
request from the member representing the order that it be COA'd, the 
Exchange will send an RFR message to all members who have elected to 
receive RFR messages. The RFR message will identify the component 
series, the size of the COA-eligible order and any contingencies, if 
applicable, but will not identify the side of the market.
    (iii) Bidding and Offering in Response to RFRs: Each Market-Maker 
with an appointment in the relevant option class, and each member 
acting as agent for orders resting at the top of the COB in the 
relevant options series, may submit responses to the RFR message (``RFR 
Responses'') during the Response Time Interval.
    (1) RFR Response sizes will be limited to the size of the COA-
eligible order for allocation purposes and may be expressed on a net 
price basis in a multiple of the minimum increment (i.e., $0.05 or 
$0.10, as applicable) or in a one cent increment as determined by the 
appropriate Exchange committee on a class-by-class basis. RFR Responses 
will not be visible (other than by the COA system).
    (2) The appropriate Exchange committee will determine the length of 
the Response Time Interval on a class-by-class basis; provided, 
however, that the duration shall not exceed three (3) seconds.
    All pronouncements regarding COA increments and the Response Time 
Interval will be announced to the membership via Regulatory Circular.
    (iv) Processing of COA-Eligible Orders: At the expiration of the 
Response Time Interval, COA-eligible orders will be allocated in 
accordance with subparagraph (v) below or routed in accordance with 
subparagraph (vi) below.
    (v) Execution of COA-Eligible Orders: COA-eligible orders may be 
executed without consideration to prices of the same complex orders 
that might be available on other exchanges, and the legs of a COA-
eligible order may be executed in one cent increments, regardless of 
the minimum quoting increments otherwise appropriate to the individual 
legs of the order. COA-eligible orders will trade first based on the 
best net price(s) and, at the same net price, will be allocated in the 
following way:
    (1) The individual orders and quotes residing in the EBook shall 
have first priority to trade against a COA-eligible order provided the 
COA-eligible order can be executed in full (or in a permissible ratio) 
by the orders and quotes in the EBook. The allocation of a COA-eligible 
order against the EBook shall be consistent with the UMA allocation 
described in Rule 6.45A or 6.45B, as applicable.
    (2) Public customer complex orders resting in the COB before, or 
that are received during, the Response Time Interval and public 
customer RFR Responses shall, collectively have second priority to 
trade against a COA-eligible order. The allocation of a COA-eligible 
order against the public customer complex orders resting in the COB 
shall be according to time priority.
    (3) Non-public customer orders resting in the COB before the 
Response Time Interval shall have third priority to trade against a 
COA-eligible order. The allocation of a COA-eligible order against non-
public customer orders resting in the COB shall be pursuant to the UMA 
allocation described in Rule 6.45A or 6.45B, as applicable.
    (4) Non-public customer orders resting in the COB that are received 
during the Response Time Interval and non-public customer RFR responses 
shall, collectively, have fourth priority. The allocation of a COA-
eligible order against these opposing orders shall be consistent with 
the CUMA allocation described in Rule 6.45A or 6.45B, as applicable.
    (vi) Routing of COA-Eligible Orders: If a COA-eligible order cannot 
be filled in whole or in a permissible ratio, the order (or any 
remaining balance) will route to the COB or back to PAR, as applicable.
    (vii) Firm Quote Requirement for COA-Eligible Orders: RFR Responses 
represent non-firm interest that can be modified or withdrawn at any 
time prior to the end of the Response Time Interval. At the end of the 
Response Time Interval, RFR Responses shall be firm only with respect 
to the COA-eligible order for which it is submitted, provided that RFR 
Responses that exceed the size of a COA-eligible order are also 
eligible to trade with other incoming COA-eligible orders that are 
received during the Response Time Interval. Any RFR Responses not 
accepted in whole or in a permissible ratio will expire at the end of 
the Response Time Interval.
    (viii) Handling of Unrelated Complex Orders: Incoming complex 
orders that are received prior to the expiration of the Response Time 
Interval for a COA-eligible order (the ``original COA'') will impact 
the original COA as follows:
    (1) Incoming complex orders that are received prior to the 
expiration of the Response Time Interval for the original COA that are 
on the opposite side of the market and are marketable against the 
starting price of the original COA-eligible order will cause the 
original COA to end. The processing of the original COA pursuant to 
subparagraphs (d)(iv) through (d)(vi) remains the same. For purposes of 
this Rule, the ``starting price,'' shall mean the better of the 
original COA-eligible order's limit price or the best price, on a net 
debit or credit basis, that existed in the EBook or COB at the 
beginning of the Response Time Interval.
    (2) Incoming COA-eligible orders that are received prior to the 
expiration of the Response Time Interval for the original COA that are 
on the same side of the market, at the same price or worse than the 
original COA-eligible order and better than or equal to the starting 
price will join the original COA. The processing of the original COA 
pursuant to subparagraphs (d)(iv) through (d)(vi) remains the same with 
the addition that the priority of the original COA-eligible order and 
incoming COA-eligible order(s) shall be according to time priority.
    (3) Incoming COA-eligible orders that are received prior to the 
expiration of the Response Time Interval for the

[[Page 33014]]

original COA that are on the same side of the market and at a better 
price than the original COA-eligible order will join the original COA, 
cause the original COA to end, and a new COA to begin for any remaining 
balance on the incoming COA-eligible order. The processing of the 
original COA pursuant to subparagraphs (d)(iv) through (d)(vi) remains 
the same with the addition that the priority of the original COA-
eligible order and incoming COA-eligible order shall be a according to 
time priority.
    * * * Interpretations and Policies:
    .01-.02 No change.
    .03 With respect to the initiation of a COA (as described in Rule 
6.53C(d)(ii)), members routing complex orders directly to the COB may 
request that the complex orders be COA'd on a class-by-class basis and 
members with resting complex orders on PAR may request that complex 
orders be COA'd on an order-by-order basis.
    .04 A pattern or practice of submitting orders that cause a COA to 
conclude early will be deemed conduct inconsistent with just and 
equitable principles of trade and a violation of Rule 4.1.
    .05 Disseminating information regarding COA-eligible orders to 
third parties will be deemed conduct inconsistent with just and 
equitable principles of trade and a violation of Rule 4.1 and other 
Exchange Rules.
* * * * *

Rule 6.74. Crossing Orders

    (a)-(f) No change.
    * * * Interpretations & Policies:
    .01-.02 No change.
    .03 Spread, straddle, stock-option (as defined in Rule 1.1(ii)), 
inter-regulatory spread as defined in Rule 1.1(ll) (including security 
future-option orders as defined in Rule 1.1(zz) [or], combination 
orders, or any other complex orders as defined in Rule 6.53C on 
opposite sides of the market may be crossed, provided that the Floor 
Broker holding such orders proceeds in the manner described in 
paragraphs (a) or (b) above as appropriate. Members may not prevent a 
spread, straddle, stock-option, inter-regulatory spread (including a 
security future-option order), [or] combination, or any other complex 
order cross from being completed by giving a competing bid or offer for 
one component of such order.
    .04-.08 No change.
* * * * *

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 CBOE 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 CBOE 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 Commission recently approved Exchange Rule 6.53C, ``Complex 
Orders on the Hybrid System,'' which sets forth the procedures for 
trading complex orders on CBOE's Hybrid System.\4\ As an enhancement to 
the current COB system, CBOE intends to develop a COA process, which 
the Exchange believes will, in turn, facilitate more automated handling 
of complex orders. The purpose of this proposed rule change is to adopt 
corresponding revisions to Exchange Rule 6.53C. In addition, CBOE is 
proposing to make certain changes to the existing COB provisions 
contained in Exchange Rule 6.53C to better describe the allocation 
methodology for executing orders in the COB. Lastly, CBOE is proposing 
to make certain modifications and clarifications to its rules generally 
pertaining to complex order minimum increments.
a. Automated RFR Auction Process for Complex Orders
    Exchange Rule 6.53C sets forth the process for trading complex 
orders in the Hybrid System, including whether complex orders will be 
routed to a PAR workstation (for manual handling) or the complex order 
book (for automated handling) and, once in the COB, the manner in which 
complex orders execute against the electronic book (``the EBook''), 
orders resting in the COB, and market participants' orders submitted to 
trade against the COB. The proposed COA-related amendments will 
introduce new functionality that will give certain eligible complex 
orders an opportunity for price improvement before being booked in the 
COB or once on PAR.\5\ Proposed paragraph (d) of Exchange Rule 6.53C 
will describe the COA process. The proposed rule change will give the 
appropriate Exchange committee the authority to determine on a class-
by-class basis what incoming complex orders are eligible for a COA 
based on marketability (defined as a number of ticks away from the 
current market), size and the complex order type (``COA-eligible 
orders'').\6\
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    \4\ See Securities Exchange Act Release No. 51271 (February 28, 
2005), 70 FR 10712 (March 4, 2005) (order approving File No. SR-
CBOE-2004-45).
    \5\ Currently, stock-option orders, security futures-option 
orders, and conversions and reversals are not eligible for routing 
to COB and, similarly, will not be eligible for routing to COA.
    \6\ For example, the appropriate Exchange committee could 
determine that spread orders are eligible for a COA to the extent 
they are less than two ticks away from the ``top of the book,'' 
which would be the best price considering the net prices available 
in the complex order book and the individual component legs quoted 
in the CBOE market. All pronouncements, including changes thereto, 
regarding COA eligibility and Response Time Intervals will be 
announced to the membership via Regulatory Circular.
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    Upon receiving a COA-eligible order and a request by the member 
representing the order that it be COA'd,\7\ the Exchange will send an 
RFR message to CBOE members with an interface connection to CBOE that 
have elected to receive such RFR messages. This RFR message will 
identify the component series, the size of the COA-eligible order and 
any contingencies, if applicable. However, the RFR message will not 
identify the side of the market (i.e., whether the COA-eligible order 
is to buy or to sell).
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    \7\ Systemically, members will be able to make this request for 
incoming orders routing directly to COB on a class-by-class basis 
and for resting PAR orders on an order-by-order basis. If an 
incoming order is not COA-eligible or not designated for a COA, it 
will be routed to either PAR or the COB in accordance with Exchange 
Rule 6.53C(c)(i).
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    Market-Makers with an appointment in the relevant options class, 
and members acting as agent for orders resting at the top of the COB in 
the relevant options series, may electronically submit responses (``RFR 
Responses''), and modify or withdraw them, at any time during the 
request response time interval (the ``Response Time Interval''). RFR 
Responses must be in a permissible ratio, and may be expressed on a net 
price basis in a multiple of the minimum increment (i.e., $0.05 or 
$0.10, as applicable) or in a one-cent increment as determined by the 
appropriate Exchange committee on a class-by-class basis. In addition, 
RFR Response sizes will be limited to the size of the COA-eligible 
order for allocation purposes. RFR Responses will not be visible (other 
than by the COA system). The applicable Response Time Interval will be 
determined by the appropriate Exchange committee on a

[[Page 33015]]

class-by-class basis and, in any event, will not exceed three 
seconds.\8\
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    \8\ For example, the appropriate Exchange committee could 
determine to set the timer for a particular class to a random time 
interval determined by the Exchange system between two and three 
seconds.
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    When the Response Time Interval expires, the COA-eligible order 
will be executed and allocated to the extent it is marketable, or 
routed to the COB or back to PAR to the extent it is not marketable.\9\ 
If executed, the rules of trading priority will provide that the COA-
eligible order be executed based first on net price and, at the same 
net price: (i) The individual component orders and quotes in the EBook 
shall have first priority to trade against the COA-eligible order; (ii) 
public customer complex orders resting in the COB before, or that are 
received during, the Response Time Interval and public customer RFR 
Responses shall, collectively, have second priority; (iii) non-public 
customer complex orders resting in the COB before the Response Time 
Interval shall have third priority; and (iv) non-public customer 
complex orders resting in the COB that are received during the Response 
Time Interval and non-public customer RFR Responses shall, 
collectively, have fourth priority.\10\ Allocations within the first 
category above (orders residing in the EBook) shall be based upon the 
Hybrid System ultimate matching algorithm (``UMA'') pertaining to 
equity options or index/exchange-traded fund options in Exchange Rules 
6.45A and 6.45B, respectively, as applicable.\11\ Allocations within 
the second category above (public customer complex orders resting in 
the COB and public customer RFR Responses) shall be based on time when 
multiple public customer complex orders or RFR Responses exist at the 
same price. Allocations within the third category above (non-public 
customer orders resting in the COB before the Response Time Interval) 
shall be based on the applicable UMA algorithm. Allocations within the 
fourth category above (non-public customer orders received during the 
Response Time Interval in the COB and non-public customer RFR 
Responses) shall be based on the Hybrid System ultimate matching 
algorithm in Exchange Rule 6.45A or 6.45B, as applicable, which caps 
the maximum quote size to be no greater than the underlying order for 
allocation purposes (``CUMA'').
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    \9\ For example, if no RFR Responses are received in the 
Response Time Interval and the COA-eligible order is not marketable 
against the individual orders and quotes in the EBook, the COA-
eligible order would be routed to the COB or, as applicable, back to 
PAR at the expiration of the Response Time Interval. If routed to 
COB, the order would then be subject to execution in accordance with 
the provisions of Exchange Rule 6.53C(c)(iii) (proposed to be 
renumbered as Exchange Rule 6.53C(c)(ii)). If routed back to PAR, 
the member holding the order would have the ability to represent the 
order in open outcry, trade the order against the COB in accordance 
with Exchange Rule 6.53C(c)(iii)(3) (proposed to be renumbered as 
Exchange Rule 6.53C(c)(ii)(3)), or route the order to COB in 
accordance with Exchange Rule 6.53C(c)(i).
    \10\ RFR Responses that exceed the size of the COA-eligible 
order are also eligible to trade with other marketable COA-eligible 
orders that may be received during the Response Time Interval. See 
proposed Exchange Rule 6.53C(d)(vii) and (viii).
    \11\ Exchange Rule 6.45A pertains to the priority and allocation 
of trades in equity options on the Hybrid System. Exchange Rule 
6.45B pertains to the priority and allocation of trades in index 
options and options on exchange-traded funds on the Hybrid System.
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    The following is an example of a COA: assume the CBOE's derived 
spread market, considering the individual series prices in the EBook, 
is offered at $1.15 for 20 contracts. In addition, assume a public 
customer order resting in the COB is offered at $1.15 for five 
contracts and two non-public customer orders resting in the COB are 
offered at $1.15 for five contracts each (for a total of 10 contracts). 
A COA-eligible order is then received to buy 100 spreads at $1.15. COA 
will auction the order. An RFR message is sent to members indicating 
the complex order series and 100 contracts (but not the side of the 
market). The Response Time Interval for submitting RFR Responses will 
be for no more than three seconds. Before the conclusion of the 
Response Time Interval, the following RFR Responses on the offer side 
are received: Public customer RFR Responses to sell five at a price of 
$1.14 and five at a price of $1.15; and non-public customer RFR 
Responses to sell 15 at a price of $1.13, 35 at a price of $1.14, and 
100 at a price of $1.15. The execution of the COA-eligible order will 
proceed as follows:
     15 contracts get filled at $1.13 (against non-public 
customer RFR Responses);
     40 contracts get filled at $1.14 (five contracts against 
public customer RFR Responses, then 35 contracts against non-public 
customer RFR Responses); and
     45 contracts get filled at $1.15 (20 contracts against the 
individual series legs in the EBook allocated by UMA, then 10 contracts 
against the public customer orders in COB and public customer RFR 
Responses allocated by time priority, then 10 contracts against the 
non-public customer orders resting in the COB before the COA began 
allocated by UMA, then five contracts against the non-public customer 
RFR Responses allocated via CUMA).
    The proposed rule change also describes the handling of unrelated 
incoming complex orders that may be received prior to the expiration of 
a COA.\12\ Specifically, the proposed rule change provides the 
following:
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    \12\  See proposed Exchange Rule 6.53C(d)(viii). The COA system 
cannot be used to trade a COA-eligible order against a facilitated 
or solicited order. Instead, facilitations and solicitations of 
complex orders are subject to Interpretations and Policies .01 and 
.02 of Exchange Rule 6.45A (with respect to equity options) and 
Interpretations and Policies .01 and .02 of Exchange Rule 6.45B 
(with respect to index options and options on exchange-traded 
funds). These rules also apply to complex orders that are COA'd. 
Interpretation and Policy .01 of both Exchange Rules 6.45A and 6.45B 
pertains to principal transactions and prohibit an order entry firm 
from executing as principal against an order it represents as agent 
unless: (1) The agency order is first exposed on the Hybrid System 
for at least three seconds; (2) the order entry firm has been 
bidding or offering for at least three seconds prior to receiving an 
agency order that is executable against such bid or offer; or (3) 
the order entry firm proceeds in accordance with the crossing rules 
in Exchange Rule 6.74. Interpretation and Policy .02 of both 
Exchange Rules 6.45A and 6.45B pertains to solicitation orders and 
requires an order entry firm to expose for at least three seconds an 
order it represents as agent before the order may be executed 
electronically via the electronic execution mechanism of the Hybrid 
System, in whole or in part, against orders solicited from members 
and non-member broker-dealers to transact with the order.
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     An incoming complex order received prior to the expiration 
of the Response Time Interval for a pending COA (the ``original COA'') 
that is on the opposite side of the original COA-eligible order and is 
marketable against the starting price \13\ of the original COA-eligible 
order will cause the original COA to end. The processing of the 
original COA pursuant to proposed subparagraphs (d)(iv) through (d)(vi) 
of Exchange Rule 6.53C is the same. Specifically, the COA-eligible 
order will be allocated in accordance with proposed subparagraph (d)(v) 
of Exchange Rule 6.53C or, if the COA-eligible order cannot be filled 
in whole or in a permissible ratio, the order (or any remaining 
balance) will route to the COB or back to PAR, as applicable, in 
accordance with proposed subparagraph (d)(vi) of Exchange Rule 
6.53C.\14\
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    \13\ The ``starting price,'' which is not visible (other than by 
the COA system), is the better of the original COA-eligible order's 
limit price or the best price, on a net debit or credit basis, that 
existed in the EBook or COB at the beginning of the Response Time 
Interval. See proposed Exchange Rule 6.53C(d)(viii)(1).
    \14\ For example, assume that a COA-eligible order to buy with a 
net price of $1.20 is received when the starting price is a net 
price of $1.10. A COA will be initiated at a net price of $1.10. An 
incoming order to sell at a price less than or equal to $1.10 will 
cause the COA to end. To the extent possible, the original COA-
eligible order will be filled and any remaining balance would route 
to COB or back to PAR.
---------------------------------------------------------------------------

     Incoming COA-eligible orders that are received prior to 
the expiration of the Response Time Interval for the original COA that 
are on the same side

[[Page 33016]]

of the market, at the same price or worse than the original COA-
eligible order and that are better than or equal to the starting price, 
will join the original COA. The processing of the original COA pursuant 
to proposed subparagraphs (d)(iv) through (d)(vi) of Exchange Rule 
6.53C is the same (as described above) with the addition that the 
priority of the original COA-eligible order and incoming COA-eligible 
order(s) shall be according to time priority.\15\
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    \15\ For example, assume that a COA-eligible order to buy with a 
net price of $1.20 is received when the starting price is a net 
price of $1.10. A COA will be initiated at a net price of $1.10. 
Incoming orders to buy at net prices ranging from $1.10 to $1.20 
will join the COA. To the extent possible, the original COA-eligible 
order will be filled and then the incoming COA-eligible order will 
be filled. Any remaining balance on either the original COA-eligible 
order or the incoming COA-eligible order will route to COB or back 
to PAR.
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     An incoming COA-eligible order that is received prior to 
the expiration of the Response Time Interval for the original COA that 
is on the same side of the market and at a better price than the 
original COA-eligible order will join the COA, cause the original COA 
to end, and a new COA to begin for any remaining balance on the 
incoming COA-eligible order. The processing of the original COA 
pursuant to proposed subparagraphs (d)(iv) through (d)(vi) of Exchange 
Rule 6.53C is the same (as described above), with the addition that the 
priority of the original COA-eligible order and incoming COA-eligible 
order shall be according to time priority.\16\
    A pattern or practice of submitting unrelated orders that cause a 
COA to conclude early will be deemed conduct inconsistent with just and 
equitable principles of trade and a violation of Exchange Rule 4.1, 
``Just and Equitable Principles of Trade.'' Dissemination of 
information related to COA-eligible orders to third parties will also 
be deemed conduct inconsistent with just and equitable principles of 
trade and a violation of Exchange Rule 4.1 and other Exchange rules.
    In addition, the CBOE notes that COA-eligible orders may be 
executed without consideration of prices of the same complex orders 
that might be available on other exchanges.\17\
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    \16\ For example, assume that a COA-eligible order to buy with a 
net price of $1.20 is received when the starting price is a net 
price of $1.10. A COA will be initiated at a net price of $1.10. An 
incoming order to buy at a net price higher than $1.20 will join the 
COA, cause the COA to end, and a new COA to begin for any remaining 
balance of the incoming order. To the extent possible, the original 
COA-eligible order will be filled, and then the incoming COA-
eligible order will be filled. Any remaining balance on the original 
COA-eligible order will route to COB or back to PAR. Any remaining 
balance on the incoming COA-eligible order will be subject to a new 
COA.
    \17\ This principle also applies currently to complex orders 
that are executed through the COB. See Exchange Rule 6.53C(c)(iii).
---------------------------------------------------------------------------

    Finally, CBOE is proposing that RFR Responses be firm only to the 
extent they may exist at the end of the Response Time Interval and only 
with respect to COA-eligible orders. As such, RFR Responses that 
collectively exceed the size of a COA-eligible order would be eligible 
to trade with other incoming COA-eligible orders that are received 
prior to the expiration of the Response Time Interval. Any RFR Response 
not accepted to trade against COA-eligible orders either in whole or in 
a permissible ratio would expire at the end of the Response Time 
Interval and would not be eligible to trade with the EBook or the COB.
b. Revisions to the Complex Order Book
    CBOE is also proposing to make certain revisions to the existing 
complex order execution procedures to better describe the allocation 
algorithm applicable to the trading of complex orders that are entered 
into the COB. With respect to complex orders that trade against the 
EBook, the filing will clarify in renumbered paragraph (c)(ii)(1) of 
Exchange Rule 6.53C that the ``EBook'' consists of electronic orders 
and quotes residing in the Hybrid System, which would include public 
and non-public orders and market participants' quotes. With respect to 
complex orders that trade with other orders in the COB, renumbered 
paragraph (c)(ii)(2) of Exchange Rule 6.53C will provide that such 
trades will be allocated based on the rules of trading priority 
otherwise applicable to the individual component leg series in the 
EBook. With respect to the allocation of complex orders among market 
participants' orders submitted to trade against the COB, renumbered 
paragraph (c)(ii)(3) of Exchange Rule 6.53C will provide that market 
participants may enter both orders and quotes and that resulting trades 
will be allocated based on the rules of trading otherwise applicable to 
the interaction of quotes and/or orders with orders in the EBook in the 
individual component leg series contained in Exchange Rules 6.45A(c) or 
6.45B(c), as applicable. Currently the rule text makes specific 
reference to only Exchange Rule 6.45A(c). The Exchange believes that 
these revisions will help to clarify and simplify the COB rules such 
that similar priority and allocation algorithms apply whether trading 
an individual series or a complex order.
    The Exchange is also proposing to make some clarifications with 
respect to the minimum increments applicable to the pricing and trading 
of complex orders in the COB. Exchange Rule 6.42(3), ``Minimum 
Increments for Bids and Offers,'' currently provides that complex 
orders may be entered in any increment. This provision also applies to 
orders entered into the COB. However, CBOE is proposing to include a 
clarification in Exchange Rule 6.53C to provide that complex orders 
that are routed to, or resting in, the COB may be expressed on a net 
price basis only in a multiple of the minimum increment (i.e., $0.05 or 
$0.10, as applicable) or in a one-cent increment as determined by the 
appropriate Exchange committee. As discussed further below, the 
Exchange is also proposing to clarify that the individual legs of a 
complex order entered into COB may be executed in one-cent increments.
c. Revisions Related to Complex Order Minimum Increments
    The Exchange is proposing to revise and clarify the minimum 
increments that are permissible for bids and offers on complex orders. 
CBOE believes these changes will facilitate the orderly execution of 
complex orders in open outcry and via the COB and COA systems. With 
respect to minimum increments, Exchange Rule 6.42(3) currently provides 
that complex orders may generally be expressed in any increment, 
regardless of the minimum increment otherwise appropriate to the 
individual legs of the order. Thus, for example, a complex order could 
be entered at a net debit or credit price of $1.03 even though the 
standard minimum increment for the individual series is generally $0.05 
or $0.10. As an exception to this provision, Exchange Rule 6.42(3) also 
provides that complex orders in options on the S&P 500 Index (``SPX'') 
that are not box spreads \18\ are to be expressed in decimal increments 
no smaller than $0.05. The Exchange is proposing to amend this 
provision of Exchange Rule 6.42(3) to provide that complex orders in 
options on the S&P 100 Index (``OEX'') that are not box

[[Page 33017]]

spreads must be expressed in decimal increments no smaller than $0.05. 
Thus, the minimum increment applicable to OEX options will be the same 
as that which is currently applicable to SPX options. The Exchange 
believes that this change is appropriate given the complexity of these 
orders and the size of the underlying S&P 100 Index. As discussed 
above, the Exchange is also proposing to clarify in Exchange Rule 6.53C 
that complex orders entered into and resting in the COB may be 
expressed on a net price basis in a multiple of the minimum increment 
(i.e., $0.05 or $0.10, as applicable) or in a one-cent increment as 
determined by the appropriate Exchange committee on a class-by-class 
basis.
---------------------------------------------------------------------------

    \18\ A ``box spread'' (also referred to as a ``box/roll 
spread'') means ``an aggregation of positions in a long call option 
and short put option with the same exercise price (`buy side') 
coupled with a long put option and short call option with the same 
exercise price (`sell side' all of which have the same aggregate 
current underlying value, and are structured as either: (A) a `long 
box spread' in which the sell side exercise price exceeds the buy 
side exercise price or (B) a `short box spread' in which the buy 
side exercise price exceeds the sell side exercise price.'' See 
Exchange Rule 6.42, Interpretation and Policy .05, and Exchange Rule 
6.53C(a)(7).
---------------------------------------------------------------------------

    The Exchange is also proposing to make some clarifications with 
respect to the execution of the individual legs of a complex order. By 
way of background, after a complex order has been executed at the total 
net debit or credit price, the contract quantity and price for each 
individual component leg of the trade are reported as executions. 
However, the Exchange's rules are silent as to the minimum increment in 
which these resulting legs may be reported for execution. In the past, 
when a complex order was expressed in increments smaller than $0.05 or 
$0.10 in open outcry, each of the component legs of a resulting trade 
typically would be reported in ``split'' prices in order to reach the 
quoted debit or credit price. However, with the introduction of the 
COB, that system may report the legs of a resulting trade in one-cent 
increments. Because the Exchange rules do not specifically address the 
minimum increment in which the legs of a resulting complex order 
transaction are to be reported, CBOE is proposing to include language 
in Exchange Rules 6.42 and 6.53C to clarify that the legs of a complex 
order may be executed in open outcry, via COB or via a COA in one-cent 
increments, regardless of the minimum quoting increments otherwise 
appropriate to the individual legs of the order. This change applies a 
consistent standard for reporting the legs of a complex order 
transaction whether the transaction takes place in open outcry or via 
electronic trading, and the Exchange believes that it will enable 
members to more efficiently execute transactions with less component 
parts in the transaction.
    Lastly, the Exchange is proposing to update the provisions of its 
rules that refer to the trading of various types of complex orders such 
as spreads, straddles and combinations. These provisions will now 
include a cross reference to the various other types of complex orders 
defined in Exchange Rule 6.53C.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\19\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\20\ in particular, in that it is designed 
to promote just and equitable principles of trade, to remove 
impediments to, and perfect the mechanism of, a free and open market 
and a national market system, and to protect investors and the public 
interest.
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78f(b).
    \20\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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 not necessary or appropriate in furtherance of 
the purposes of the Act.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date 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 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 (https://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2005-65 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2005-65. This file 
number should be included on the subject line if e-mail 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 (https://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 inspection and 
copying in the Commission's Public Reference Room. 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; 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-2005-65 and should be submitted on or before June 28, 2006.
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    \21\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E6-8801 Filed 6-6-06; 8:45 am]
BILLING CODE 8010-01-P