Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Order Granting Accelerated Approval to Proposed Rule Change, as Modified by Amendment Nos. 1 and 2, Relating to the Regulation NMS Plan To Address Extraordinary Market Volatility, 21642-21648 [2013-08473]
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Federal Register / Vol. 78, No. 70 / Thursday, April 11, 2013 / Notices
modified by Amendment Nos. 1 and 2,
on an accelerated basis.
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–69328; File No. SR–CBOE–
2013–030]
Self-Regulatory Organizations;
Chicago Board Options Exchange,
Incorporated; Order Granting
Accelerated Approval to Proposed
Rule Change, as Modified by
Amendment Nos. 1 and 2, Relating to
the Regulation NMS Plan To Address
Extraordinary Market Volatility
April 5, 2013.
I. Introduction
On March 7, 2013, Chicago Board
Options Exchange, Incorporated
(‘‘CBOE’’ or ‘‘Exchange’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’) 1 and Rule 19b–4
thereunder,2 a proposed rule change to
modify its rules to address certain
option order types, order handling
procedures, obvious error and marketmaker quoting obligations on the
Exchange after the implementation of
the National Market System Plan to
Address Extraordinary Market Volatility
(‘‘Limit up-Limit Down Plan’’). The
proposed rule change was published for
comment in the Federal Register on
March 14, 2013.3 On March 26, 2013,
CBOE filed Amendment No. 1 to the
proposed rule change.4 On April 4,
CBOE filed Amendment No. 2 to the
proposed rule change.5 The Commission
received one comment letter on the
proposed rule change.6 This order
approves the proposed rule change, as
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 69082
(March 8, 2013), 78 FR 16351 (‘‘Notice’’).
4 See Amendment No. 1 dated March 26, 2013
(‘‘Amendment No. 1’’). Amendment No. 1 expanded
upon the Exchange’s rationale for its proposed
changes regarding the nullification and adjustment
of options transactions and agreed to provide the
Commission with relevant data to assess the impact
of the proposal. Additionally, the Exchange
provided rationale for terminating the HAL auction
early and cancelling of the market orders, discussed
infra. Because Amendment No. 1 is technical in
nature, it is not subject to notice and comment.
5 See Amendment No. 2 dated April 4, 2013
(‘‘Amendment No. 2’’). Amendment No. 2 expanded
upon the Exchange’s rationale for its proposal to
accept certain types of market orders during a limit
up-limit down state, its proposal to cancel and
replace limit orders with market orders during a
limit up-limit down state, and its proposed
treatment of stock-option orders in a limit up-limit
down state. Because Amendment No. 2 is technical
in nature, it is not subject to notice and comment.
6 See Letter to Elizabeth M. Murphy, Secretary,
Commission, from Angelo Evangelou, Associate
General Counsel, CBOE, dated April 4, 2013
(‘‘CBOE Letter’’).
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II. Background
On May 6, 2010, the U.S. equity
markets experienced a severe disruption
that, among other things, resulted in the
prices of a large number of individual
securities suddenly declining by
significant amounts in a very short time
period before suddenly reversing to
prices consistent with their pre-decline
levels.7 This severe price volatility led
to a large number of trades being
executed at temporarily depressed
prices, including many that were more
than 60% away from pre-decline prices.
One response to the events of May 6,
2010, was the development of the
single-stock circuit breaker pilot
program, which was implemented
through a series of rule filings by the
equity exchanges and by FINRA.8 The
single-stock circuit breaker was
designed to reduce extraordinary market
volatility in NMS stocks by imposing a
five-minute trading pause when a trade
was executed at a price outside of a
specified percentage threshold.9
To replace the single-stock circuit
breaker pilot program, the equity
exchanges filed a National Market
System Plan 10 pursuant to Section 11A
7 The events of May 6 are described more fully
in a joint report by the staffs of the Commodity
Futures Trading Commission (‘‘CFTC’’) and the
Commission. See Report of the Staffs of the CFTC
and SEC to the Joint Advisory Committee on
Emerging Regulatory Issues, ‘‘Findings Regarding
the Market Events of May 6, 2010,’’ dated
September 30, 2010, available at https://
www.sec.gov/news/studies/2010/marketeventsreport.pdf.
8 For further discussion on the development of
the single-stock circuit breaker pilot program, see
Securities Exchange Act Release No. 67091 (May
31, 2012), 77 FR 33498 (June 6, 2012) (‘‘Limit UpLimit Down Plan’’ or ‘‘Plan’’).
9 See Securities Exchange Act Release Nos. 62884
(September 10, 2010), 75 FR 56618 (September 16,
2010) and Securities Exchange Act Release No.
62883 (September 10, 2010), 75 FR 56608
(September 16, 2010) (SR–FINRA–2010–033)
(describing the ‘‘second stage’’ of the single-stock
circuit breaker pilot) and Securities Exchange Act
Release No. 64735 (June 23, 2011), 76 FR 38243
(June 29, 2011) (describing the ‘‘third stage’’ of the
single-stock circuit breaker pilot).
10 NYSE Euronext filed on behalf of New York
Stock Exchange LLC (‘‘NYSE’’), NYSE Amex LLC
(‘‘NYSE Amex’’), and NYSE Arca, Inc. (‘‘NYSE
Arca’’), and the parties to the proposed National
Market System Plan, BATS Exchange, Inc., BATS YExchange, Inc., Chicago Board Options Exchange,
Incorporated (‘‘CBOE’’), Chicago Stock Exchange,
Inc., EDGA Exchange, Inc., EDGX Exchange, Inc.,
Financial Industry Regulatory Authority, Inc.,
NASDAQ OMX BX, Inc., NASDAQ OMX PHLX
LLC, the Nasdaq Stock Market LLC, and National
Stock Exchange, Inc. (collectively with NYSE,
NYSE MKT, and NYSE Arca, the ‘‘Participants’’).
On May 14, 2012, NYSE Amex filed a proposed rule
change on an immediately effective basis to change
its name to NYSE MKT LLC (‘‘NYSE MKT’’). See
Securities Exchange Act Release No. 67037 (May
21, 2012) (SR–NYSEAmex–2012–32).
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of the Act,11 and Rule 608 thereunder,12
which featured a ‘‘limit up-limit down’’
mechanism.
The Plan sets forth requirements that
are designed to prevent trades in
individual NMS stocks from occurring
outside of the specified price bands. The
price bands consist of a lower price
band and an upper price band for each
NMS stock. When one side of the
market for an individual security is
outside the applicable price band, i.e.,
the National Best Bid is below the
Lower Price Band, or the National Best
Offer is above the Upper Price band, the
Processors 13 are required to disseminate
such National Best Bid or National Best
Offer 14 with a flag identifying that quote
as non-executable. When the other side
of the market reaches the applicable
price band, i.e., the National Best Offer
reaches the lower price band, or the
National Best Bid reaches the upper
price band, the market for an individual
security enters a 15-second Limit State,
and the Processors are required
disseminate such National Best Offer or
National Best Bid with an appropriate
flag identifying it as a Limit State
Quotation. Trading in that stock would
exit the Limit State if, within 15 seconds
of entering the Limit State, all Limit
State Quotations were executed or
canceled in their entirety. If the market
does not exit a Limit State within 15
seconds, then the Primary Listing
Exchange will declare a five-minute
trading pause, which is applicable to all
markets trading the security.
The Primary Listing Exchange may
also declare a trading pause when the
stock is in a Straddle State, i.e., the
National Best Bid (Offer) is below
(above) the Lower (Upper) Price Band
and the NMS Stock is not in a Limit
State. In order to declare a trading pause
in this scenario, the Primary Listing
Exchange must determine that trading
in that stock deviates from normal
trading characteristics such that
declaring a trading pause would support
the Plan’s goal to address extraordinary
market volatility.15
11 15
U.S.C. 78k–1.
CFR 242.608.
13 As used in the Plan, the Processor refers to the
single plan processor responsible for the
consolidation of information for an NMS Stock
pursuant to Rule 603(b) of Regulation NMS under
the Exchange Act. See id.
14 ‘‘National Best Bid’’ and ‘‘National Best Offer’’
has the meaning provided in Rule 600(b)(42) of
Regulation NMS under the Exchange Act. See id.
15 As set forth in more detail in the Plan, all
trading centers would be required to establish,
maintain, and enforce written policies and
procedures reasonably designed to prevent the
display of offers below the Lower Price Band and
bids above the Upper Price Band for an NMS Stock.
The Processors would be able to disseminate an
offer below the Lower Price Band or bid above the
12 17
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Federal Register / Vol. 78, No. 70 / Thursday, April 11, 2013 / Notices
On May 31, 2012, the Commission
approved the Plan as a one-year pilot,
which shall be implemented in two
phases.16 The first phase of the Plan
shall be implemented beginning April 8,
2013.17
III. Description of the Proposed Rule
Change, as Modified by Amendment
Nos. 1 and 2
In light of and in connection with the
Plan, the Exchange proposes to amend
its rules to address certain option order
types, order handling procedures,
obvious error and market-maker quoting
obligations.18 The Exchange believes
these modifications will protect
investors because when an underlying
security is in a limit or straddle state
(collectively referred to as a ‘‘limit uplimit down state’’), there will not be a
reliable price for the security to serve as
a benchmark for the price of the option.
In addition, the Exchange believes these
changes are warranted because the
width of the options markets might be
compromised during the limit up-limit
down states and, thus, the quality of
execution may be adversely impacted.
A. Exchange Rule 6.3A and the Plan
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The Exchange proposes to add to
Exchange Rule 6.3A to codify the
changes occurring throughout its
rulebook in connection with the Plan.
Upper Price Band that nevertheless may be
inadvertently submitted despite such reasonable
policies and procedures, but with an appropriate
flag identifying it as non-executable; such bid or
offer would not be included in National Best Bid
or National Best Offer calculations. In addition, all
trading centers would be required to develop,
maintain, and enforce policies and procedures
reasonably designed to prevent trades at prices
outside the price bands, with the exception of
single-priced opening, reopening, and closing
transactions on the Primary Listing Exchange.
16 See ‘‘Limit Up-Limit Down Plan,’’ supra note
8. See also Securities Exchange Act Release No.
68953 (February 20, 2013), 78 FR 13113 (February
26, 2013) (Second Amendment to Limit Up-Limit
Down Plan by BATS Exchange, Inc., BATS
Y- Exchange, Inc., Chicago Board Options
Exchange, Inc., et al.) and Securities Exchange Act
Release No. 69062 (March 7, 2013), 78 FR 15757
(March 12, 2013) (Third Amendment to Limit UpLimit Down Plan by BATS Exchange, Inc., BATS
Y- Exchange, Inc., Chicago Board Options
Exchange, Inc., et al.)
17 See ‘‘Second Amendment to Limit Up-Limit
Down Plan,’’ supra note 16.
18 Specifically, the Exchange proposes to make
changes to Exchange Rules Rule 6.2B, ‘‘Hybrid
Opening System, Rule 6.14A, ‘‘Hybrid Agency
Liaison’’, Rule 6.25, ‘‘Nullification and Adjustment
of Options Transactions,’’ Rule 6.53, ‘‘Certain Types
of Orders Defined,’’ Rule 6.53C, ‘‘Complex Orders
on the Hybrid System,’’ Rule 8.7, ‘‘Obligations of
Market-Makers, Rule 8.13, ‘‘Preferred Market-Maker
Program,’’ Rule 8.15A, ‘‘Lead Market-Maker in
Hybrid Classes,’’ Rule 8.15B, ‘‘Participation
Entitlements of LLMs’’, Rule 8.85, ‘‘DPM
Obligations,’’ Rule 8.87, ‘‘Participation Entitlement
of DPMs and e-DPMs,’’ and Rule 8.93, ‘‘e-DPM
Obligations.’’ See Notice and Amendment No. 1.
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The Exchange proposes to re-name Rule
6.3A, which is currently titled ‘‘Equity
Market Trading Halt’’, as ‘‘Equity
Market Plan to Address Extraordinary
Market Volatility’’. The Exchange also
plans to add new rule text that will
define the Plan as it applies to the
Exchange, and will describe the location
of the other rule changes associated
with the Plan. The proposed changes to
Rule 6.3A will essentially serve as a
roadmap for the Exchange’s universal
changes due to the implementation of
the Plan.
B. Order Handling During the Limit UpLimit Down State
The Exchange proposes to modify
Exchange Rules 6.2B, 6.14A, 6.3A, 6.53
and 6.53C to address how certain
Exchange order types will be handled
when the underlying security of such
orders is in a limit up-limit down state.
The proposed rule change will address
how market orders,19 market-on-close,20
stop orders,21 and stock option orders,22
will function on the Exchange upon the
implementation of the Plan. The
Exchange is proposing to add language
to clarify that: (a) Any market order will
be returned during limit up-limit down
states unless it qualifies for certain
exceptions; 23 (b) market-on-close orders
19 See Exchange Rule 6.53(a) which defines a
market order as ‘‘an order to buy or sell a stated
number of options contracts at the best price
obtainable when the order reaches the post.’’
20 See Exchange Rule 6.53(c)(ii) which defines a
market-on-close order designation as an order ‘‘to
be executed as close as possible to the closing bell,
or during the closing rotation, and should be near
to or at the closing price for the particular series of
option contracts.’’
21 See Exchange Rule 6.53(c)(iii), which defines a
stop order as a market order ‘‘to buy or sell when
the market for a particular option contract reaches
a specified price on the CBOE floor.’’ In contrast,
a stop-limit order, as defined in Exchange Rule
6.53(c)(iv), becomes a limit order when the market
for the option contract reaches a specified price.
CBOE does not propose to make any modifications
to the treatment of stop-limit orders.
22 See Exchange Rule 6.53C(a)(2) which defines a
stock-option order as ‘‘an order to buy or sell a
stated number of units of an underlying stock or a
security convertible into the underlying stock * * *
coupled with the purchase or sale of options
contract(s) on the opposite side of the market.’’
23 Specifically, a market order submitted to
initiate an Automated Improvement Mechanism
will be accepted. Market orders will also not be
returned if the TPH elected to route that order for
manual handling. With respect to market orders
submitted to initiate an Automated Improvement
Mechanism, the Exchange represented that such
orders are entered with a contra order. Because
these market orders are entered as a pair, they are
effectively stopped because they must execute at a
price at or better than the contra order. See
Amendment No. 2. With respect to market orders
routed for manual handling, the Exchange
represented that those orders are physically
handled by a broker on the Exchange floor who
must affirmatively agree to an execution price, and
that such orders are thus not subject to the same
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21643
will not be elected if the underlying
security is in a limit up-limit down
state; 24 (c) stop orders will not be
triggered if the underlying security is in
a limit up-limit down state, but will
until the end of that state, at which time
they will become eligible to be triggered;
(d) stock-option orders will only execute
if the calculated stock price is within
the permissible bands.25 In addition, if
a message is sent to replace a limit order
with a market order while the
underlying is in a limit up-limit down
state, the resting limit order will be
cancelled and the replaced market order
will also be cancelled. The Exchange
represented that cancelling a market
order in this scenario is consistent with
its treatment of market orders that are
received during a limit up-limit down
state, and cancelling the original limit
order would be consistent with the
Exchange’s current cancel and replace
functionality.26
The Exchange stated that, although it
has determined to continue options
trading when a stock is in a limit uplimit down state, there will not be a
reliable price for the underlying security
to serve as a benchmark for the price of
the option. Without a reliable
underlying stock price, the Exchange
stated that there is an enhanced risk of
errors and improper executions. The
Exchange also stated that adding a level
of certainty for TPHs by specifying the
treatment of such orders will encourage
participation on the Exchange while the
underlying security is in limit up-limit
down states. Accordingly, the Exchange
believes these order handling changes
will best protect market participants
after the implementation of the Plan by
not allowing execution at unreasonable
prices due to the shift in the stock
prices.
The Exchange also proposes to modify
its opening procedures under Exchange
Rule 6.2B, ‘‘Hybrid Opening System’’
(‘‘HOSS’’). The Exchange proposes to
risks a market order may have if such order were
to execute against unfiltered electronic prices. Id.
24 During closing rotation, the Exchange will
continue to re-evaluate the state of underlying
securities for which the overlying securities have
not yet been closed. If upon re-evaluation the
underlying security should exit a limit up-limit
down state, a market-on-close order may be
executed.
25 If the calculated price of a stock-option order
is not within the permissible Price Bands, the stockoption order will be routed for manual handling.
This provision would help ensure that a stock order
would not be electronically routed to a stock venue
for an execution outside of the price bands. In
addition, by routing stock-option orders for manual
handling, these orders will be physically handled
by a broker on the Exchange floor who must
affirmatively agree to an execution price. See
Amendment No. 2.
26 See Amendment No. 2.
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add an Interpretation and Policy .07 to
clarify that if the underlying security for
a class of options enters into a limit uplimit down state when the class moves
to opening rotation, any market orders
entered that trading day will be
cancelled. The Exchange stated that, by
cancelling the market orders, it will
comply with the Plan by not allowing
orders outside of the Price Bands to
execute. As an exception, market orders
that are considered limit orders
pursuant to Rule 6.13(b)(iv) and entered
the previous trading day will remain in
the book. The Exchange is proposing to
allow such market orders to remain in
the Book because these essentially act as
limit orders at the minimum increment.
Next, the Exchange proposes to
modify Exchange Rule 6.14A, ‘‘Hybrid
Agency Liaison (‘‘HAL’’). This
functionality provides automated order
handling in designated classes trading
on the Hybrid System for qualifying
electronic orders that are not
automatically executed by the Hybrid
System.27 When the Exchange receives
a qualifying order that is marketable
against the National Best Bid or Offer
(‘‘NBBO’’) and/or the Exchange’s best
bid or offer (‘‘BBO’’),28 HAL
electronically exposes the order 29 at the
NBBO price to allow Market-Makers
appointed in that class, as well as all
Trading Permit Holders (‘‘TPHs’’) acting
as agent for orders, at the top of the
Exchange’s book in the relevant series
(or all TPHs if allowed by the Exchange)
to step up to the NBBO price.
The Exchange proposes to amend
Rule 6.14A to modify the functioning of
HAL with respect to market orders
when the underlying security of the
option is in a limit up-limit down state.
Under the proposal, if an underlying
security enters a limit up-limit down
state while a market order is being
exposed through HAL, the auction will
end early, i.e., upon the entering of the
limit up-limit down state. Additionally,
any unexecuted portion of the market
order would be cancelled. The Exchange
stated that because there is an
uncertainty of market prices during a
limit up-limit down state, terminating
27 Currently, the Exchange determines the eligible
order size, eligible order types, eligible origin code
(i.e., public customer orders, non-Market-Maker
broker-dealer orders and Market-Maker brokerdealer orders), and classes in which HAL is
activated. See Exchange Rule 6.14A(a).
28 HAL will not electronically expose the order if
the Exchange’s quotation contains resting orders
and does not contain sufficient Market-Maker
quotation interest to satisfy the entire order.
29 The duration of the exposure period may not
exceed one second. See Exchange Rule 6.14A(c)
(describing the manner in which an exposed order
is allocated under HAL); see also Exchange Rule
6.14A(d) (listing the circumstances in which an
exposure period would terminate early).
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the HAL auction early and cancelling
the market order will ensure that market
orders do not receive an unanticipated
price.30 As such, the proposed rule
changes would protect market
participants by ensuring that they do
not receive an executed order with an
unanticipated price due to the change in
the underlying security.
The Exchange also proposes to modify
the treatment of complex orders on the
Hybrid System and the Complex Order
Auction (‘‘COA’’) process. Generally, on
a class-by-class basis, the Exchange may
activate COA, which is a process by
which eligible complex orders 31 are
given an opportunity for price
improvement before being booked in the
electronic complex order book (‘‘COB’’)
or on a PAR workstation. Upon receipt
of a COA-eligible order and a request
from a TPH representing the order that
such order be subjected to a COA, the
Exchange will send a request for
responses (‘‘RFR’’) message to all TPHs
who have elected to receive RFR
messages.32 Each Market-Maker with an
appointment in the relevant option class
and each TPH acting as agent for orders
resting at the top of the COB in the
relevant options series may then submit
responses to the RFR message during
the Response Time Interval.33
The Exchange proposes to add to the
COA rule that if, during COA of a
market order, the underlying security of
an option enters a limit up-limit down
state, the COA will end upon the
entering of that state and the remaining
portion of the order, if a market order,
will cancel. The Exchange believes this
change will best protect investors
because, once the underlying enters a
limit up-limit down state, pricing in the
options markets may change, resulting
in executions at unexpected prices.
30 See
Amendment No. 1.
31 An eligible complex order, referred to in Rule
6.53C as a ‘‘COA-eligible order,’’ means a complex
order that, as determined by the Exchange 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,
complex order type and complex order origin type
(i.e., non-broker-dealer public customer, brokerdealers that are not Market-Makers or specialists on
an options exchange, and/or Market-Makers or
specialists on an options exchange). All
determinations by the Exchange on COA-eligible
order parameters are announced to Trading Permit
Holders by Regulatory Circular. See Rule
6.53C(d)(i)(2) and Interpretation and Policy .01 to
Rule 6.53C.
32 See Exchange Rule 6.53C(d)(ii). The RFR
message will identify the component series, the size
of the COA-eligible order and any contingencies,
but will not identify the side of the market.
33 See Exchange Rule 6.53C(d)(iii). A ‘‘Response
Time Interval’’ means the period of time during
which responses to the RFR may be entered, the
length of which is determined by the Exchange on
a class-by-class basis but may not exceed three
seconds. See Rule 6.53C(d)(iii)(2).
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C. Market Maker Obligations and
Participation Entitlements
The Exchange proposes to eliminate
all market maker obligations for options
in which the underlying security is in
a limit up-limit down state. Currently,
Exchange Rules 8.7, 8.13, 8.15A, 8.85,
and 8.93 impose certain obligations on
Market-Makers,34 PMMs,35 LMMs,36
DPMs,37 and e-DPMs,38 respectively,
including obligations to provide
continuous electronic quotes.
The Exchange proposes to eliminate
all market maker quoting obligations 39
in series of options when the underlying
security is currently in a limit up-limit
down state. According to the Exchange,
eliminating all Market Maker
obligations in connection with the
implementation of the Plan is the most
effective way to ensure the options
markets will not be compromised when
the underlying security enters a limit
up-limit down state. Specifically, there
may not be reliable prices for an
underlying security during a limit uplimit down state. Additionally, it may
be difficult or not possible for a market
participant to hedge the purchase or sale
of an option if the bid or offer of an
underlying security may not be
executable due to a limit up-limit down
state. Given the possible effects of the
limit up-limit down state, the Exchange
anticipates that Exchange MarketMakers may be forced to change
behaviors during these periods. In an
effort to protect the investors in the
options market while the underlying
security is in a limit up-limit down
state, the Exchange believes that
eliminating quoting obligations is the
more effective way for this protection.
Although the Exchange is proposing
to relieve market makers of their quoting
34 See Exchange Rule 8.1, which defines a
‘‘Market-Maker’’ as ‘‘an individual Trading Permit
Holder or a TPH organization that is registered with
the Exchange for the purpose of making
transactions as a dealer specialist on the Exchange
* * *.’’
35 See Exchange Rule 8.13, which defines a
‘‘Preferred Market-Maker’’ as a specific MarketMaker designated by a Trading Permit Holder to
receive that Trading Permit Holder’s orders in a
specific class.
36 See Exchange Rule 8.15A, which defines a
‘‘Lead Market-Maker’’ as a Market-Maker in good
standing appointed by the Exchange ‘‘in an option
class for which a DPM has not been appointed
* * *.’’
37 See Exchange Rule 8.80, which defines a
‘‘Designated Primary Market-Maker’’ as a ‘‘TPH
organization that is approved by the Exchange to
function in allocated securities as a Market-Maker
* * * and is subject to the obligations under Rule
8.85 * * *.’’
38 See Exchange Rule 8.92, which defines an
‘‘Electronic DPM’’ as a ‘‘TPH Organization that is
approved by the Exchange to remotely function in
allocated option classes as a DPM and to fulfill
certain obligations required of DPMs * * *.’’
39 See Notice, supra note 3.
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obligations when the underlying is in a
limit up-limit down state, the Exchange
is proposing that PMMs, LMMs, DPMs
and e-DPMs may still receive
participation entitlements pursuant to
the proposed rules in all series in their
assigned classes in which they are
quoting, even in series in which they are
not required to provide continuous
electronic quotes under the Exchange
Rules. The Exchange stated that market
makers already receive participation
entitlements in series in which they are
not required to quote; thus, under the
proposed rule change, the market would
continue to function as it does now with
respect to how entitlements are
allocated to Market-Makers. The
Exchange believes this benefit is
appropriate, as it incentivizes MarketMakers to quote in as many series as
possible in their appointed classes, even
those series in which the underlying
security has entered into a limit up-limit
down state. The Exchange stated that it
is attempting to better encourage
Market-Makers to quote even though
they will not have the obligation. If
market makers do choose to quote, the
Exchange believes they should be
entitled to receive the entitlement for
such quoting as appropriate.
D. Nullification and Adjustment of
Options Transactions
In connection with the
implementation of the Plan, the
Exchange proposes to adopt
Interpretation and Policies .06 to Rule
6.25 to exclude transactions in options
that overlay a security during a Limit
State or Straddle State from the obvious
error pricing provision in Rule 6.25(a)(1)
for a one year pilot basis from the date
of adoption of the proposed rule change.
Additionally, the Exchange proposes to
specify that electronic transactions in
options that overlay an NMS stock that
occur during a Limit State or Straddle
State may be reviewed on an Exchange
motion pursuant to Rule 6.25(b)(3). The
Exchange also proposes to provide the
Commission with data and analysis
during the duration of the pilot as
requested.
Under Rule 6.25, an Obvious Price
Error occurs when the execution price
of an electronic transaction is above or
below the theoretical price for the series
by a specified amount. Pursuant to Rule
6.25(a)(1)(i), the theoretical price of an
option series is currently defined, for
series traded on at least one other
options exchange, as the last national
best bid price with respect to an
erroneous sell transaction, and the last
national best offer price with respect to
an erroneous buy transaction, just prior
to the trade. In certain circumstances,
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Trading Officials have the discretion to
determine the theoretical price pursuant
to Rule 6.25(a)(1)(iv).40
The Exchange believes that neither
method is appropriate during a Limit
State or Straddle State. In Amendment
No. 1, the Exchange noted that during
a Limit State or Straddle State, options
prices may deviate substantially from
those available prior to or following the
state. The Exchange believes this
provision would give rise to much
uncertainty for market participants as
there is no bright line definition of what
the theoretical value should be for an
option when the underlying NMS stock
has an unexecutable bid or offer or both.
The Exchange noted that determining
theoretical value in such a situation
would be often times be very subjective
rather than an objective determination
and would give rise to additional
uncertainty and confusion for investors.
Similarly, the Exchange believes the
application of the current rule would be
impracticable given the lack of a reliable
national best bid or offer in the options
market during Limit States and Straddle
States, and would produce undesirable
effects.
Ultimately, the Exchange believes that
adding certainty to the execution of
limit orders in these situations should
encourage market participants to
continue to provide liquidity to the
Exchange, thus promoting a fair and
orderly market. On balance, the
Exchange believes that removing the
potential inequity of nullifying or
adjusting executions occurring during
Limit States or Straddle States
outweighs any potential benefits from
applying these provisions during such
unusual market conditions.
Therefore, the Exchange proposes to
adopt Interpretation and Policy .06 to
Rule 6.25 to provide that transactions
executed during a Limit State or
Straddle State are not subject to the
obvious pricing error provision in Rule
6.25(a)(1). In addition, amended Rule
6.25 will include a qualification that
nothing in the proposed rule change
will prevent transactions in options that
overlay a security in a Limit State or
Straddle State from being reviewed on
an Exchange motion pursuant to Rule
6.25(b)(3). According to the Exchange,
this safeguard will provide the
flexibility to act when necessary and
appropriate, while also providing
market participants with certainty that
40 Rule 6.25(a)(1)(iv) provides there are no quotes
for comparison, or if the bid/ask differential of the
national best bid and offer for the affected series
just prior to the erroneous transaction was at least
two times the permitted bid/ask differential
determined by the Exchange, designated Trading
Officials will determine the theoretical price.
PO 00000
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21645
trades they effect with quotes and/or
orders having limit prices will stand
irrespective of subsequent moves in the
underlying security. The right to review
on Exchange motion electronic
transactions that occur during a Limit
State or Straddle State under this
provision, according to the Exchange,
would enable the Exchange to account
for unforeseen circumstances that result
in obvious or catastrophic errors for
which a nullification or adjustment may
be necessary in order to preserve the
interest of maintaining a fair and orderly
market and for the protection of
investors. The Exchange also proposes
to provide the Commission with data
and analysis during the duration of the
pilot as requested.
IV. Discussion and Commission’s
Findings
After careful review, the Commission
finds that the proposed rule change is
consistent with the requirements of the
Act and rules and regulations
thereunder applicable to a national
securities exchange.41 In particular, the
Commission finds that the proposed
rule change is consistent with Section
6(b)(5) of the Act,42 which, among other
things, requires a national securities
exchange to be so organized and have
the capacity to be able to carry out the
purposes of the Act and to enforce
compliance by its members and persons
associated with its members with the
provisions of the Act, the rules and
regulations thereunder, and the rules of
the exchange, and is 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 regulation, 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.
A. Exchange Rule 6.3A and the Plan
Exchange Rule 6.3A lists changes to
Exchange order types, order handling,
obvious error, and market-maker
quoting obligations that the Exchange is
making in connection with the
implementation of the Plan. The
Exchange believes that the proposed
changes to Rule 6.3A will describe to
TPHs and other market participants
where to find the changes associated
41 In approving the proposed rule changes, the
Commission has considered their impact on
efficiency, competition, and capital formation. See
15 U.S.C. 78c(f).
42 15 U.S.C. 78f(b).
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with the Plan’s implementation.
Accordingly, the Commission finds that
this change promotes clarity in
connection with CBOE’s proposed
changes in response to the Limit upLimit Down Plan and is therefore
consistent with the Act.
B. Order Handling During the Limit UpLimit Down State
As detailed above, the Exchange
proposes to add language to clarify that:
(a) market orders, with certain
exceptions, will be returned during
limit up-limit down states, (b) marketon-close orders will not be elected if the
underlying security is in a limit up-limit
down state, (c) stop orders will not be
triggered while the underlying security
is in a limit up-limit down state, and (d)
stock-option orders will only execute if
the calculated stock price is within the
permissible bands, unless such order is
routed for manual handling. In addition,
during a limit up-limit down state, if a
message is sent to replace a limit order
with a market order, the resting limit
order will be cancelled and the replaced
market order will also be cancelled.
The Commission finds that the
Exchange’s proposed method of
handling such orders is consistent with
Section 6(b)(5) of the Act. When the
underlying stock enters a limit up-limit
down state, the lack of a reliable price
in that market could affect the options
markets in various ways, including
wider spreads and less liquidity. This
could potentially mean that market
orders, which contain no restrictions on
the price at which they may execute,
could receive executions at unintended
prices if executed during the limit uplimit down state. As such, the proposed
changes to reject market orders and
market-on-close orders if the underlying
is in a limit up-limit down state, to not
trigger stop orders if the underlying is
in a limit up-limit down state, and to
cancel market orders that replace limit
orders when the underlying is in a limit
up-limit down state, are reasonably
designed to prevent such orders from
being executed at potentially
unexpected prices.
At the same time, the proposed
exceptions to the treatment of these
orders—accepting market orders that are
submitted to initiate an Automated
Price Improvement Mechanism, or
which are routed for manual handling—
are designed to take into account that
market orders submitted in these ways
may not be at the same risk as other
market orders for executions at
unexpected prices. Specifically, market
orders submitted through the
Automated Price Improvement
Mechanism are submitted as pairs, and
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are effectively stopped because they
must execute at a price at or better than
the contra order. With respect to market
orders routed for manual handling, such
orders are physically handled by a
broker on the Exchange floor who must
affirmatively agree to an execution
price, as opposed to simply executing
that order against electronic prices.
Similarly, the Exchange’s proposal to
route a stock-option order for manual
handling when the underlying is in a
limit up-limit down state allows such
orders to be physically handled by a
broker on the Exchange floor who must
affirmatively agree to an execution
price.
The Exchange proposes to add an
Interpretation and Policy .07 to Rule
6.2B which states that if the underlying
security for a class of options enters into
a limit up-limit down state when the
class moves to opening rotation, any
market orders entered that trading day
will be cancelled. However, market
orders that are considered limit orders
pursuant to Rule 6.13(b)(iv) and entered
the previous trading day will remain in
the Book and can essentially act as limit
orders at the minimum increment.
The Commission finds that these
changes are consistent with the Act in
that they are reasonably designed to
counter potential price dislocations that
may occur if the underlying enters a
limit up-limit down state during the
opening by preventing market orders,
which contain no restrictions on the
price at which they may execute, from
being executed at potentially
unintended prices. At the same time,
this proposal allows market orders that
are essentially limit orders to continue
to participate in the opening process
without a similar risk of an execution at
an unintended price.
The Exchange also proposes that, if an
underlying security enters a limit uplimit down state while a market order is
being exposed through HAL, the auction
will end early, and any unexecuted
portion of the market order would be
cancelled. The Commission believes
that this provision will provide
certainty to options market participants
on how market orders submitted to HAL
will be handled during limit up-limit
down states. In addition, the
Commission finds that this provision is
consistent with the Act in that it is
reasonably designed to counter potential
price dislocations that may occur if the
underlying enters a limit up-limit down
state while the HAL functionality is
underway by preventing market orders,
which contain no restrictions on the
price at which they may execute, from
being executed at potentially
unintended prices.
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The Exchange proposes to amend the
COA rule so that, if during a COA of a
market order, the underlying security of
an option enters a limit up-limit down
state, the COA will end and the
remaining portion of the order, if a
market order, will cancel. As with the
proposed change to HAL, the
Commission believes that this provision
is consistent with the Act in that it will
provide certainty to options market
participants on how market orders
submitted to COA will be handled
during limit up-limit down states. In
addition, the Commission finds that this
provision is reasonably designed to
counter potential price dislocations that
may occur if the underlying enters a
limit up-limit down state while a COA
is underway by preventing market
orders, which contain no restrictions on
the price at which they may execute,
from being executed at potentially
unintended prices.
C. Market Maker Obligations
The Commission finds that the
proposal to suspend a market maker’s
obligations when the underlying
security is in a limit up-limit down state
is consistent with the Act. During a
limit up-limit down state, there may not
be a reliable price for the underlying
security to serve as a benchmark for
market makers to price options. In
addition, the absence of an executable
bid or offer for the underlying security
will make it more difficult for market
makers to hedge the purchase or sale of
an option. Given these significant
changes to the normal operating
conditions of market makers, the
Commission finds that the Exchange’s
decision to suspend a market maker’s
obligations in these limited
circumstances is consistent with the
Act. The Commission notes, however,
that the Plan was approved on a pilot
basis and its Participants will monitor
how it is functioning in the equity
markets during the pilot period. To this
end, the Commission expects that, upon
implementation of the Plan, the
Exchange will continue monitoring the
quoting requirements that are being
amended in this proposed rule change
and determine if any necessary
adjustments are required to ensure that
they remain consistent with the Act.
The Commission also finds that the
proposal to maintain participation
entitlements for market makers in all
series in their assigned classes in which
they are quoting, including in series for
which the underlying security is in a
limit up-limit down state and for which
they are not required to provide
continuous electronic quotes under the
Exchange Rules, is consistent with the
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Act. To the extent that market makers
are only eligible for participation
entitlements if they are quoting at the
best price on the Exchange, this
proposal is reasonably designed to
incentivize Market-Makers to quote
more aggressively when the underlying
security has entered into a limit up-limit
down state than they might otherwise
quote, potentially providing additional
liquidity and price discovery. To the
extent that, under this proposal, market
makers would receive participation
entitlements in series in which they are
not required to quote, the Commission
notes that this aspect of the proposal is
consistent with the current application
of participation entitlements.
D. Nullification and Adjustment of
Options Transactions
The Commission finds that the
Exchange’s proposal to suspend certain
aspects of Rule 6.25 during a Limit State
or Straddle State is consistent with the
requirements of the Act and the rules
and regulations thereunder applicable to
a national securities exchange.
Specifically, the Commission finds that
the proposal is consistent with Section
6(b)(5) of the Act,43 in that it is designed
to prevent fraudulent and manipulative
acts and practices, promote just and
equitable principles of trade, foster
cooperation and coordination with
persons engaged in regulating, clearing,
settling, processing information with
respect to, and facilitating transactions
in securities, 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.
In Amendment No. 1, the Exchange
notes its belief that suspending certain
aspects of Rule 6.25 during a Limit State
or Straddle State will ensure that limit
orders that are filled during a Limit or
Straddle State will have certainty of
execution in a manner that promotes
just and equitable principles of trade
and removes impediments to, and
perfects the mechanism of, a free and
open market and a national market
system. The Exchange believes the
application of the current rule would be
impracticable given what it perceives
will be the lack of a reliable NBBO in
the options market during Limit States
and Straddle States, and that the
resulting actions (i.e., nullified trades or
adjusted prices) may not be appropriate
given market conditions. In addition,
given the Exchange’s view that options
prices during Limit States or Straddle
States may deviate substantially from
those available shortly following the
43 15
U.S.C. 78f(b)(5).
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Limit State or Straddle State, the
Exchange believes that providing market
participants time to re-evaluate a
transaction executed during a Limit
State or Straddle State will create an
unreasonable adverse selection
opportunity that will discourage
participants from providing liquidity
during Limit States or Straddle States.
Ultimately, the Exchange believes that
adding certainty to the execution of
orders in these situations should
encourage market participants to
continue to provide liquidity to the
Exchange during Limit States and
Straddle States, thus promoting fair and
orderly markets.
The Exchange, however, has proposed
this rule change based on its
expectations about the quality of the
options market during Limit States and
Straddle States. The Exchange states, for
example, that it believes that
application of the obvious and
catastrophic error rules would be
impracticable given the potential for
lack of a reliable NBBO in the options
market during Limit States and Straddle
States. Given the Exchange’s recognition
of the potential for unreliable NBBOs in
the options markets during Limit States
and Straddle States, the Commission is
concerned about the extent to which
investors may rely to their detriment on
the quality of quotations and price
discovery in the options markets during
these periods. This concern is
heightened by the Exchange’s proposal
to exclude electronic trades that occur
during a Limit State or Straddle State
from the obvious pricing error
provisions of Rule 6.25(a)(1) and the
nullification or adjustment provisions of
Rule 6.25. The Commission urges
investors and market professionals to
exercise caution when considering
trading options under these
circumstances. Broker-dealers also
should be mindful of their obligations to
customers that may or may not be aware
of specific options market conditions or
the underlying stock market conditions
when placing their orders.
While the Commission remains
concerned about the quality of the
options market during the Limit States
and Straddle States, and the potential
impact on investors of executing in this
market without the protections of the
obvious or catastrophic error rules that
are being suspended during the Limit
and Straddle States, it believes that
certain aspects of the proposal could
help mitigate those concerns.
First, despite the removal of obvious
and catastrophic error protection during
Limit States and Straddle States, the
Exchange states that there are additional
measures in place designed to protect
PO 00000
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21647
investors. For example, the Exchange
states in Amendment No. 1 that by
rejecting market orders and not electing
stop orders, only those orders with a
limit price will be executed during a
Limit State or Straddle State.
Additionally, the Exchange notes the
existence of SEC Rule 15c3–5 requiring
broker-dealers to have controls and
procedures in place that are reasonably
designed to prevent the entry of
erroneous orders. Therefore, on balance,
the Exchange believes that removing the
potential inequity of nullifying or
adjusting executions occurring during
Limit States or Straddle States
outweighs any potential benefits from
applying certain provisions during such
unusual market conditions.
The Exchange also believes that the
aspect of the proposed rule change that
will continue to allow the Exchange to
review on its own motion electronic
trades that occur during a Limit State or
a Straddle State is consistent with the
Act because it would provide flexibility
for the Exchange to act when necessary
and appropriate to nullify or adjust a
transaction and will enable the
Exchange to account for unforeseen
circumstances that result in obvious
errors for which a nullification or
adjustment may be necessary in order to
preserve the interest of maintaining a
fair and orderly market and for the
protection of investors. The Exchange
represents that it will administer this
provision in a manner that is consistent
with the principles of the Act. In
addition, the Exchange has represented
that it will create and maintain records
relating to the use of the authority to act
on its own motion during a Limit State
or Straddle State.
Finally, the Exchange has proposed
that the changes be implemented on a
one year pilot basis. The Commission
believes that it is important to
implement the proposal as a pilot. The
one year pilot period will allow the
Exchange time to assess the impact of
the Plan on the options marketplace and
allow the Commission to further
evaluate the effect of the proposal prior
to any proposal or determination to
make the changes permanent. To this
end, the Exchange has committed to: (1)
Evaluate the options market quality
during Limit States and Straddle States;
(2) assess the character of incoming
order flow and transactions during
Limit States and Straddle States; and (3)
review any complaints from members
and their customers concerning
executions during Limit States and
Straddle States. Additionally, the
Exchange has agreed to provide the
Commission with data requested to
evaluate the impact of the elimination of
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the obvious error rule, including data
relevant to assessing the various
analyses noted above. On April 4, 2013,
the Exchange submitted a letter stating
that it would provide specific data to
the Commission and the public and
certain analysis to the Commission to
evaluate the impact of Limit States and
Straddle States on liquidity and market
quality in the options markets.44 This
will allow the Commission, the
Exchange, and other interested parties
to evaluate the quality of the options
markets during Limit States and
Straddle States and to assess whether
the additional protections noted by the
Exchange are sufficient safeguards
against the submission of erroneous
trades, and whether the Exchange’s
proposal appropriately balances the
protection afforded to an erroneous
order sender against the potential
hazards associated with providing
market participants additional time to
review trades submitted during a Limit
State or Straddle State.
44 In particular, the Exchange represented that, at
least two months prior to the end of the one year
pilot period of proposed Interpretation and Policy
.06 to Rule 6.25, it would provide to the
Commission an evaluation of (i) the statistical and
economic impact of Straddle States on liquidity and
market quality in the options market and (ii)
whether the lack of obvious error rules in effect
during the Limit States and Straddle States are
problematic. In addition, the Exchange represented
that each month following the adoption of the
proposed rule change it would provide to the
Commission and the public a dataset containing
certain data elements for each Limit State and
Straddle State in optionable stocks. The Exchange
stated that the options included in the dataset will
be those that meet the following conditions: (i) the
options are more than 20% in the money (strike
price remains greater than 80% of the last stock
trade price for calls and strike price remains greater
than 120% of the last stock trade price for puts
when the Limit State or Straddle State is reached);
(ii) the option has at least two trades during the
Limit State or Straddle State; and (iii) the top ten
options (as ranked by overall contract volume on
that day) meeting the conditions listed above. For
each of those options affected, each dataset will
include, among other information: stock symbol,
option symbol, time at the start of the Limit State
or Straddle State and an indicator for whether it is
a Limit State or Straddle State. For activity on the
exchange in the relevant options, the Exchange has
agreed to provide executed volume, time-weighted
quoted bid-ask spread, time-weighted average
quoted depth at the bid, time-weighted average
quoted depth at the offer, high execution price, low
execution price, number of trades for which a
request for review for error was received during
Straddle States and Limit States, an indicator
variable for whether those options outlined above
have a price change exceeding 30% during the
underlying stock’s Limit State or Straddle State
compared to the last available option price as
reported by OPRA before the start of the Limit or
Straddle state (1 if observe 30% and 0 otherwise),
and another indicator variable for whether the
option price within five minutes of the underlying
stock leaving the Limit State or Straddle State (or
halt if applicable) is 30% away from the price
before the start of the Limit State or Straddle state.
See CBOE Letter, supra note 6.
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In addition, the Commission finds
good cause, pursuant to Section 19(b)(2)
of the Act 45 for approving the proposed
rule change on an accelerated basis.
This proposal is related to the Plan,
which will become operative on April 8,
2013, and aspects of the proposal, such
as rejecting market orders and not
electing Stop Orders during a limit uplimit down state, are designed to
prevent such orders from receiving poor
executions during those times. In
granting accelerated approval, the
proposed rule change, and its
corresponding protections, will take
effect upon the Plan’s implementation
date. Accordingly, the Commission
finds that good cause exists for
approving the proposed rule change on
an accelerated basis.
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,46 that the
proposed rule change (SR–CBOE–2013–
030), as modified by Amendments Nos.
1 and 2, be, and it hereby is, approved
on an accelerated basis.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.47
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2013–08473 Filed 4–10–13; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–69318; File No. SR–CTA/
CQ–2013–02]
Consolidated Tape Association; Notice
of Filing and Immediate Effectiveness
of the Seventeenth Charges
Amendment to the Second
Restatement of the CTA Plan and Ninth
Charges Amendment to the Restated
CQ Plan
April 5, 2013.
Pursuant to Section 11A of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 608 thereunder,2
notice is hereby given that on March 27,
2013, the Consolidated Tape
Association (‘‘CTA’’) Plan and
Consolidated Quotation (‘‘CQ’’) Plan
participants (‘‘Participants’’) 3 filed with
45 15
U.S.C. 78s(b)(2)
U.S.C. 78s(b)(2).
47 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78k–1.
2 17 CFR 242.608.
3 The Participants are: BATS Exchange, Inc.,
BATS-Y Exchange, Inc., Chicago Board Options
Exchange, Incorporated, Chicago Stock Exchange,
Inc., EDGA Exchange, Inc. (‘‘EDGA’’), EDGX
Exchange, Inc. (‘‘EDGX’’), Financial Industry
46 15
PO 00000
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the Securities and Exchange
Commission (‘‘Commission’’) a proposal
to amend the Second Restatement of the
CTA Plan and Restated CQ Plan
(collectively, the ‘‘Plans’’).4 The
proposal represents the seventeenth
charges amendment to the CTA Plan
and the ninth charges amendment to the
CQ Plan (‘‘Amendments’’) and delays
the effective date for the change to the
Network B interrogation device fee
payable in respect of professional
subscribers.5
Pursuant to Rule 608(b)(3)(ii) under
the Act,6 the Participants designated the
Amendments as concerned solely with
the administration of the Plans. As a
result, the Amendments are effective
upon filing with the Commission. At
any time within 60 days of the filing of
the Amendments, the Commission may
summarily abrogate the Amendments
and require that the Amendments be
refiled in accordance with paragraph
(a)(1) of Rule 608 and reviewed in
accordance with paragraph (b)(2) of
Rule 608, if it appears to the
Commission that such action is
necessary or appropriate in the public
interest, for the protection of investors,
or the maintenance of fair and orderly
markets, to remove impediments to, and
perfect the mechanisms of, a national
market system or otherwise in
furtherance of the purposes of the Act.
The Commission is publishing this
notice to solicit comments from
interested persons on the proposed
Amendments.
Regulatory Authority, Inc. (‘‘FINRA’’), International
Securities Exchange, LLC, NASDAQ OMX BX, Inc.
(‘‘Nasdaq BX’’), NASDAQ OMX PHLX, Inc.
(‘‘Nasdaq PSX’’), Nasdaq Stock Market LLC,
National Stock Exchange, New York Stock
Exchange LLC (‘‘NYSE’’), NYSE MKT LLC (formerly
NYSE Amex, Inc.), and NYSE Arca, Inc. (‘‘NYSE
Arca’’). Because the proposal constitutes a
Ministerial Amendment under both clause (1) of
Section IV(b) of the CTA Plan and clause (1) of
Section IV(c) of the CQ Plan, the Chairman of CTA
and the CQ Plan’s Operating Committee may submit
the proposal on behalf of the Participants.
4 See Securities Exchange Act Release Nos. 10787
(May 10, 1974), 39 FR 17799 (May 20, 1974)
(declaring the CTA Plan effective); 15009 (July 28,
1978), 43 FR 34851 (August 7, 1978) (temporarily
authorizing the CQ Plan); and 16518 (January 22,
1980), 45 FR 6521 (January 28, 1980) (permanently
authorizing the CQ Plan). The most recent
restatement of both Plans was in 1995. The CTA
Plan, pursuant to which markets collect and
disseminate last sale price information for nonNASDAQ listed securities, is a ‘‘transaction
reporting plan’’ under Rule 601 under the Act, 17
CFR 242.601, and a ‘‘national market system plan’’
under Rule 608 under the Act, 17 CFR 242.608. The
CQ Plan, pursuant to which markets collect and
disseminate bid/ask quotation information for listed
securities, is a ‘‘national market system plan’’ under
Rule 608 under the Act, 17 CFR 242.608.
5 See Securities Exchange Act Release No. 69157
(March 18, 2013), 78 FR 17946 (March 25, 2013).
6 17 CFR 242.608(b)(3)(ii).
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]]>Agencies
[Federal Register Volume 78, Number 70 (Thursday, April 11, 2013)]
[Notices]
[Pages 21642-21648]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-08473]
[[Page 21642]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69328; File No. SR-CBOE-2013-030]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Granting Accelerated Approval to Proposed Rule
Change, as Modified by Amendment Nos. 1 and 2, Relating to the
Regulation NMS Plan To Address Extraordinary Market Volatility
April 5, 2013.
I. Introduction
On March 7, 2013, Chicago Board Options Exchange, Incorporated
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to modify its rules to address
certain option order types, order handling procedures, obvious error
and market-maker quoting obligations on the Exchange after the
implementation of the National Market System Plan to Address
Extraordinary Market Volatility (``Limit up-Limit Down Plan''). The
proposed rule change was published for comment in the Federal Register
on March 14, 2013.\3\ On March 26, 2013, CBOE filed Amendment No. 1 to
the proposed rule change.\4\ On April 4, CBOE filed Amendment No. 2 to
the proposed rule change.\5\ The Commission received one comment letter
on the proposed rule change.\6\ This order approves the proposed rule
change, as modified by Amendment Nos. 1 and 2, on an accelerated basis.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 69082 (March 8,
2013), 78 FR 16351 (``Notice'').
\4\ See Amendment No. 1 dated March 26, 2013 (``Amendment No.
1''). Amendment No. 1 expanded upon the Exchange's rationale for its
proposed changes regarding the nullification and adjustment of
options transactions and agreed to provide the Commission with
relevant data to assess the impact of the proposal. Additionally,
the Exchange provided rationale for terminating the HAL auction
early and cancelling of the market orders, discussed infra. Because
Amendment No. 1 is technical in nature, it is not subject to notice
and comment.
\5\ See Amendment No. 2 dated April 4, 2013 (``Amendment No.
2''). Amendment No. 2 expanded upon the Exchange's rationale for its
proposal to accept certain types of market orders during a limit up-
limit down state, its proposal to cancel and replace limit orders
with market orders during a limit up-limit down state, and its
proposed treatment of stock-option orders in a limit up-limit down
state. Because Amendment No. 2 is technical in nature, it is not
subject to notice and comment.
\6\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Angelo Evangelou, Associate General Counsel, CBOE, dated April
4, 2013 (``CBOE Letter'').
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II. Background
On May 6, 2010, the U.S. equity markets experienced a severe
disruption that, among other things, resulted in the prices of a large
number of individual securities suddenly declining by significant
amounts in a very short time period before suddenly reversing to prices
consistent with their pre-decline levels.\7\ This severe price
volatility led to a large number of trades being executed at
temporarily depressed prices, including many that were more than 60%
away from pre-decline prices. One response to the events of May 6,
2010, was the development of the single-stock circuit breaker pilot
program, which was implemented through a series of rule filings by the
equity exchanges and by FINRA.\8\ The single-stock circuit breaker was
designed to reduce extraordinary market volatility in NMS stocks by
imposing a five-minute trading pause when a trade was executed at a
price outside of a specified percentage threshold.\9\
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\7\ The events of May 6 are described more fully in a joint
report by the staffs of the Commodity Futures Trading Commission
(``CFTC'') and the Commission. See Report of the Staffs of the CFTC
and SEC to the Joint Advisory Committee on Emerging Regulatory
Issues, ``Findings Regarding the Market Events of May 6, 2010,''
dated September 30, 2010, available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf.
\8\ For further discussion on the development of the single-
stock circuit breaker pilot program, see Securities Exchange Act
Release No. 67091 (May 31, 2012), 77 FR 33498 (June 6, 2012)
(``Limit Up-Limit Down Plan'' or ``Plan'').
\9\ See Securities Exchange Act Release Nos. 62884 (September
10, 2010), 75 FR 56618 (September 16, 2010) and Securities Exchange
Act Release No. 62883 (September 10, 2010), 75 FR 56608 (September
16, 2010) (SR-FINRA-2010-033) (describing the ``second stage'' of
the single-stock circuit breaker pilot) and Securities Exchange Act
Release No. 64735 (June 23, 2011), 76 FR 38243 (June 29, 2011)
(describing the ``third stage'' of the single-stock circuit breaker
pilot).
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To replace the single-stock circuit breaker pilot program, the
equity exchanges filed a National Market System Plan \10\ pursuant to
Section 11A of the Act,\11\ and Rule 608 thereunder,\12\ which featured
a ``limit up-limit down'' mechanism.
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\10\ NYSE Euronext filed on behalf of New York Stock Exchange
LLC (``NYSE''), NYSE Amex LLC (``NYSE Amex''), and NYSE Arca, Inc.
(``NYSE Arca''), and the parties to the proposed National Market
System Plan, BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago
Board Options Exchange, Incorporated (``CBOE''), Chicago Stock
Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., Financial
Industry Regulatory Authority, Inc., NASDAQ OMX BX, Inc., NASDAQ OMX
PHLX LLC, the Nasdaq Stock Market LLC, and National Stock Exchange,
Inc. (collectively with NYSE, NYSE MKT, and NYSE Arca, the
``Participants''). On May 14, 2012, NYSE Amex filed a proposed rule
change on an immediately effective basis to change its name to NYSE
MKT LLC (``NYSE MKT''). See Securities Exchange Act Release No.
67037 (May 21, 2012) (SR-NYSEAmex-2012-32).
\11\ 15 U.S.C. 78k-1.
\12\ 17 CFR 242.608.
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The Plan sets forth requirements that are designed to prevent
trades in individual NMS stocks from occurring outside of the specified
price bands. The price bands consist of a lower price band and an upper
price band for each NMS stock. When one side of the market for an
individual security is outside the applicable price band, i.e., the
National Best Bid is below the Lower Price Band, or the National Best
Offer is above the Upper Price band, the Processors \13\ are required
to disseminate such National Best Bid or National Best Offer \14\ with
a flag identifying that quote as non-executable. When the other side of
the market reaches the applicable price band, i.e., the National Best
Offer reaches the lower price band, or the National Best Bid reaches
the upper price band, the market for an individual security enters a
15-second Limit State, and the Processors are required disseminate such
National Best Offer or National Best Bid with an appropriate flag
identifying it as a Limit State Quotation. Trading in that stock would
exit the Limit State if, within 15 seconds of entering the Limit State,
all Limit State Quotations were executed or canceled in their entirety.
If the market does not exit a Limit State within 15 seconds, then the
Primary Listing Exchange will declare a five-minute trading pause,
which is applicable to all markets trading the security.
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\13\ As used in the Plan, the Processor refers to the single
plan processor responsible for the consolidation of information for
an NMS Stock pursuant to Rule 603(b) of Regulation NMS under the
Exchange Act. See id.
\14\ ``National Best Bid'' and ``National Best Offer'' has the
meaning provided in Rule 600(b)(42) of Regulation NMS under the
Exchange Act. See id.
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The Primary Listing Exchange may also declare a trading pause when
the stock is in a Straddle State, i.e., the National Best Bid (Offer)
is below (above) the Lower (Upper) Price Band and the NMS Stock is not
in a Limit State. In order to declare a trading pause in this scenario,
the Primary Listing Exchange must determine that trading in that stock
deviates from normal trading characteristics such that declaring a
trading pause would support the Plan's goal to address extraordinary
market volatility.\15\
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\15\ As set forth in more detail in the Plan, all trading
centers would be required to establish, maintain, and enforce
written policies and procedures reasonably designed to prevent the
display of offers below the Lower Price Band and bids above the
Upper Price Band for an NMS Stock. The Processors would be able to
disseminate an offer below the Lower Price Band or bid above the
Upper Price Band that nevertheless may be inadvertently submitted
despite such reasonable policies and procedures, but with an
appropriate flag identifying it as non-executable; such bid or offer
would not be included in National Best Bid or National Best Offer
calculations. In addition, all trading centers would be required to
develop, maintain, and enforce policies and procedures reasonably
designed to prevent trades at prices outside the price bands, with
the exception of single-priced opening, reopening, and closing
transactions on the Primary Listing Exchange.
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[[Page 21643]]
On May 31, 2012, the Commission approved the Plan as a one-year
pilot, which shall be implemented in two phases.\16\ The first phase of
the Plan shall be implemented beginning April 8, 2013.\17\
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\16\ See ``Limit Up-Limit Down Plan,'' supra note 8. See also
Securities Exchange Act Release No. 68953 (February 20, 2013), 78 FR
13113 (February 26, 2013) (Second Amendment to Limit Up-Limit Down
Plan by BATS Exchange, Inc., BATS Y- Exchange, Inc., Chicago Board
Options Exchange, Inc., et al.) and Securities Exchange Act Release
No. 69062 (March 7, 2013), 78 FR 15757 (March 12, 2013) (Third
Amendment to Limit Up-Limit Down Plan by BATS Exchange, Inc., BATS
Y- Exchange, Inc., Chicago Board Options Exchange, Inc., et al.)
\17\ See ``Second Amendment to Limit Up-Limit Down Plan,'' supra
note 16.
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III. Description of the Proposed Rule Change, as Modified by Amendment
Nos. 1 and 2
In light of and in connection with the Plan, the Exchange proposes
to amend its rules to address certain option order types, order
handling procedures, obvious error and market-maker quoting
obligations.\18\ The Exchange believes these modifications will protect
investors because when an underlying security is in a limit or straddle
state (collectively referred to as a ``limit up-limit down state''),
there will not be a reliable price for the security to serve as a
benchmark for the price of the option. In addition, the Exchange
believes these changes are warranted because the width of the options
markets might be compromised during the limit up-limit down states and,
thus, the quality of execution may be adversely impacted.
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\18\ Specifically, the Exchange proposes to make changes to
Exchange Rules Rule 6.2B, ``Hybrid Opening System, Rule 6.14A,
``Hybrid Agency Liaison'', Rule 6.25, ``Nullification and Adjustment
of Options Transactions,'' Rule 6.53, ``Certain Types of Orders
Defined,'' Rule 6.53C, ``Complex Orders on the Hybrid System,'' Rule
8.7, ``Obligations of Market-Makers, Rule 8.13, ``Preferred Market-
Maker Program,'' Rule 8.15A, ``Lead Market-Maker in Hybrid
Classes,'' Rule 8.15B, ``Participation Entitlements of LLMs'', Rule
8.85, ``DPM Obligations,'' Rule 8.87, ``Participation Entitlement of
DPMs and e-DPMs,'' and Rule 8.93, ``e-DPM Obligations.'' See Notice
and Amendment No. 1.
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A. Exchange Rule 6.3A and the Plan
The Exchange proposes to add to Exchange Rule 6.3A to codify the
changes occurring throughout its rulebook in connection with the Plan.
The Exchange proposes to re-name Rule 6.3A, which is currently titled
``Equity Market Trading Halt'', as ``Equity Market Plan to Address
Extraordinary Market Volatility''. The Exchange also plans to add new
rule text that will define the Plan as it applies to the Exchange, and
will describe the location of the other rule changes associated with
the Plan. The proposed changes to Rule 6.3A will essentially serve as a
roadmap for the Exchange's universal changes due to the implementation
of the Plan.
B. Order Handling During the Limit Up-Limit Down State
The Exchange proposes to modify Exchange Rules 6.2B, 6.14A, 6.3A,
6.53 and 6.53C to address how certain Exchange order types will be
handled when the underlying security of such orders is in a limit up-
limit down state. The proposed rule change will address how market
orders,\19\ market-on-close,\20\ stop orders,\21\ and stock option
orders,\22\ will function on the Exchange upon the implementation of
the Plan. The Exchange is proposing to add language to clarify that:
(a) Any market order will be returned during limit up-limit down states
unless it qualifies for certain exceptions; \23\ (b) market-on-close
orders will not be elected if the underlying security is in a limit up-
limit down state; \24\ (c) stop orders will not be triggered if the
underlying security is in a limit up-limit down state, but will until
the end of that state, at which time they will become eligible to be
triggered; (d) stock-option orders will only execute if the calculated
stock price is within the permissible bands.\25\ In addition, if a
message is sent to replace a limit order with a market order while the
underlying is in a limit up-limit down state, the resting limit order
will be cancelled and the replaced market order will also be cancelled.
The Exchange represented that cancelling a market order in this
scenario is consistent with its treatment of market orders that are
received during a limit up-limit down state, and cancelling the
original limit order would be consistent with the Exchange's current
cancel and replace functionality.\26\
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\19\ See Exchange Rule 6.53(a) which defines a market order as
``an order to buy or sell a stated number of options contracts at
the best price obtainable when the order reaches the post.''
\20\ See Exchange Rule 6.53(c)(ii) which defines a market-on-
close order designation as an order ``to be executed as close as
possible to the closing bell, or during the closing rotation, and
should be near to or at the closing price for the particular series
of option contracts.''
\21\ See Exchange Rule 6.53(c)(iii), which defines a stop order
as a market order ``to buy or sell when the market for a particular
option contract reaches a specified price on the CBOE floor.'' In
contrast, a stop-limit order, as defined in Exchange Rule
6.53(c)(iv), becomes a limit order when the market for the option
contract reaches a specified price. CBOE does not propose to make
any modifications to the treatment of stop-limit orders.
\22\ See Exchange Rule 6.53C(a)(2) which defines a stock-option
order as ``an order to buy or sell a stated number of units of an
underlying stock or a security convertible into the underlying stock
* * * coupled with the purchase or sale of options contract(s) on
the opposite side of the market.''
\23\ Specifically, a market order submitted to initiate an
Automated Improvement Mechanism will be accepted. Market orders will
also not be returned if the TPH elected to route that order for
manual handling. With respect to market orders submitted to initiate
an Automated Improvement Mechanism, the Exchange represented that
such orders are entered with a contra order. Because these market
orders are entered as a pair, they are effectively stopped because
they must execute at a price at or better than the contra order. See
Amendment No. 2. With respect to market orders routed for manual
handling, the Exchange represented that those orders are physically
handled by a broker on the Exchange floor who must affirmatively
agree to an execution price, and that such orders are thus not
subject to the same risks a market order may have if such order were
to execute against unfiltered electronic prices. Id.
\24\ During closing rotation, the Exchange will continue to re-
evaluate the state of underlying securities for which the overlying
securities have not yet been closed. If upon re-evaluation the
underlying security should exit a limit up-limit down state, a
market-on-close order may be executed.
\25\ If the calculated price of a stock-option order is not
within the permissible Price Bands, the stock-option order will be
routed for manual handling. This provision would help ensure that a
stock order would not be electronically routed to a stock venue for
an execution outside of the price bands. In addition, by routing
stock-option orders for manual handling, these orders will be
physically handled by a broker on the Exchange floor who must
affirmatively agree to an execution price. See Amendment No. 2.
\26\ See Amendment No. 2.
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The Exchange stated that, although it has determined to continue
options trading when a stock is in a limit up-limit down state, there
will not be a reliable price for the underlying security to serve as a
benchmark for the price of the option. Without a reliable underlying
stock price, the Exchange stated that there is an enhanced risk of
errors and improper executions. The Exchange also stated that adding a
level of certainty for TPHs by specifying the treatment of such orders
will encourage participation on the Exchange while the underlying
security is in limit up-limit down states. Accordingly, the Exchange
believes these order handling changes will best protect market
participants after the implementation of the Plan by not allowing
execution at unreasonable prices due to the shift in the stock prices.
The Exchange also proposes to modify its opening procedures under
Exchange Rule 6.2B, ``Hybrid Opening System'' (``HOSS''). The Exchange
proposes to
[[Page 21644]]
add an Interpretation and Policy .07 to clarify that if the underlying
security for a class of options enters into a limit up-limit down state
when the class moves to opening rotation, any market orders entered
that trading day will be cancelled. The Exchange stated that, by
cancelling the market orders, it will comply with the Plan by not
allowing orders outside of the Price Bands to execute. As an exception,
market orders that are considered limit orders pursuant to Rule
6.13(b)(iv) and entered the previous trading day will remain in the
book. The Exchange is proposing to allow such market orders to remain
in the Book because these essentially act as limit orders at the
minimum increment.
Next, the Exchange proposes to modify Exchange Rule 6.14A, ``Hybrid
Agency Liaison (``HAL''). This functionality provides automated order
handling in designated classes trading on the Hybrid System for
qualifying electronic orders that are not automatically executed by the
Hybrid System.\27\ When the Exchange receives a qualifying order that
is marketable against the National Best Bid or Offer (``NBBO'') and/or
the Exchange's best bid or offer (``BBO''),\28\ HAL electronically
exposes the order \29\ at the NBBO price to allow Market-Makers
appointed in that class, as well as all Trading Permit Holders
(``TPHs'') acting as agent for orders, at the top of the Exchange's
book in the relevant series (or all TPHs if allowed by the Exchange) to
step up to the NBBO price.
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\27\ Currently, the Exchange determines the eligible order size,
eligible order types, eligible origin code (i.e., public customer
orders, non-Market-Maker broker-dealer orders and Market-Maker
broker-dealer orders), and classes in which HAL is activated. See
Exchange Rule 6.14A(a).
\28\ HAL will not electronically expose the order if the
Exchange's quotation contains resting orders and does not contain
sufficient Market-Maker quotation interest to satisfy the entire
order.
\29\ The duration of the exposure period may not exceed one
second. See Exchange Rule 6.14A(c) (describing the manner in which
an exposed order is allocated under HAL); see also Exchange Rule
6.14A(d) (listing the circumstances in which an exposure period
would terminate early).
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The Exchange proposes to amend Rule 6.14A to modify the functioning
of HAL with respect to market orders when the underlying security of
the option is in a limit up-limit down state. Under the proposal, if an
underlying security enters a limit up-limit down state while a market
order is being exposed through HAL, the auction will end early, i.e.,
upon the entering of the limit up-limit down state. Additionally, any
unexecuted portion of the market order would be cancelled. The Exchange
stated that because there is an uncertainty of market prices during a
limit up-limit down state, terminating the HAL auction early and
cancelling the market order will ensure that market orders do not
receive an unanticipated price.\30\ As such, the proposed rule changes
would protect market participants by ensuring that they do not receive
an executed order with an unanticipated price due to the change in the
underlying security.
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\30\ See Amendment No. 1.
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The Exchange also proposes to modify the treatment of complex
orders on the Hybrid System and the Complex Order Auction (``COA'')
process. Generally, on a class-by-class basis, the Exchange may
activate COA, which is a process by which eligible complex orders \31\
are given an opportunity for price improvement before being booked in
the electronic complex order book (``COB'') or on a PAR workstation.
Upon receipt of a COA-eligible order and a request from a TPH
representing the order that such order be subjected to a COA, the
Exchange will send a request for responses (``RFR'') message to all
TPHs who have elected to receive RFR messages.\32\ Each Market-Maker
with an appointment in the relevant option class and each TPH acting as
agent for orders resting at the top of the COB in the relevant options
series may then submit responses to the RFR message during the Response
Time Interval.\33\
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\31\ An eligible complex order, referred to in Rule 6.53C as a
``COA-eligible order,'' means a complex order that, as determined by
the Exchange 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, complex order type and complex
order origin type (i.e., non-broker-dealer public customer, broker-
dealers that are not Market-Makers or specialists on an options
exchange, and/or Market-Makers or specialists on an options
exchange). All determinations by the Exchange on COA-eligible order
parameters are announced to Trading Permit Holders by Regulatory
Circular. See Rule 6.53C(d)(i)(2) and Interpretation and Policy .01
to Rule 6.53C.
\32\ See Exchange Rule 6.53C(d)(ii). The RFR message will
identify the component series, the size of the COA-eligible order
and any contingencies, but will not identify the side of the market.
\33\ See Exchange Rule 6.53C(d)(iii). A ``Response Time
Interval'' means the period of time during which responses to the
RFR may be entered, the length of which is determined by the
Exchange on a class-by-class basis but may not exceed three seconds.
See Rule 6.53C(d)(iii)(2).
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The Exchange proposes to add to the COA rule that if, during COA of
a market order, the underlying security of an option enters a limit up-
limit down state, the COA will end upon the entering of that state and
the remaining portion of the order, if a market order, will cancel. The
Exchange believes this change will best protect investors because, once
the underlying enters a limit up-limit down state, pricing in the
options markets may change, resulting in executions at unexpected
prices.
C. Market Maker Obligations and Participation Entitlements
The Exchange proposes to eliminate all market maker obligations for
options in which the underlying security is in a limit up-limit down
state. Currently, Exchange Rules 8.7, 8.13, 8.15A, 8.85, and 8.93
impose certain obligations on Market-Makers,\34\ PMMs,\35\ LMMs,\36\
DPMs,\37\ and e-DPMs,\38\ respectively, including obligations to
provide continuous electronic quotes.
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\34\ See Exchange Rule 8.1, which defines a ``Market-Maker'' as
``an individual Trading Permit Holder or a TPH organization that is
registered with the Exchange for the purpose of making transactions
as a dealer specialist on the Exchange * * *.''
\35\ See Exchange Rule 8.13, which defines a ``Preferred Market-
Maker'' as a specific Market-Maker designated by a Trading Permit
Holder to receive that Trading Permit Holder's orders in a specific
class.
\36\ See Exchange Rule 8.15A, which defines a ``Lead Market-
Maker'' as a Market-Maker in good standing appointed by the Exchange
``in an option class for which a DPM has not been appointed * * *.''
\37\ See Exchange Rule 8.80, which defines a ``Designated
Primary Market-Maker'' as a ``TPH organization that is approved by
the Exchange to function in allocated securities as a Market-Maker *
* * and is subject to the obligations under Rule 8.85 * * *.''
\38\ See Exchange Rule 8.92, which defines an ``Electronic DPM''
as a ``TPH Organization that is approved by the Exchange to remotely
function in allocated option classes as a DPM and to fulfill certain
obligations required of DPMs * * *.''
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The Exchange proposes to eliminate all market maker quoting
obligations \39\ in series of options when the underlying security is
currently in a limit up-limit down state. According to the Exchange,
eliminating all Market Maker obligations in connection with the
implementation of the Plan is the most effective way to ensure the
options markets will not be compromised when the underlying security
enters a limit up-limit down state. Specifically, there may not be
reliable prices for an underlying security during a limit up-limit down
state. Additionally, it may be difficult or not possible for a market
participant to hedge the purchase or sale of an option if the bid or
offer of an underlying security may not be executable due to a limit
up-limit down state. Given the possible effects of the limit up-limit
down state, the Exchange anticipates that Exchange Market-Makers may be
forced to change behaviors during these periods. In an effort to
protect the investors in the options market while the underlying
security is in a limit up-limit down state, the Exchange believes that
eliminating quoting obligations is the more effective way for this
protection.
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\39\ See Notice, supra note 3.
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Although the Exchange is proposing to relieve market makers of
their quoting
[[Page 21645]]
obligations when the underlying is in a limit up-limit down state, the
Exchange is proposing that PMMs, LMMs, DPMs and e-DPMs may still
receive participation entitlements pursuant to the proposed rules in
all series in their assigned classes in which they are quoting, even in
series in which they are not required to provide continuous electronic
quotes under the Exchange Rules. The Exchange stated that market makers
already receive participation entitlements in series in which they are
not required to quote; thus, under the proposed rule change, the market
would continue to function as it does now with respect to how
entitlements are allocated to Market-Makers. The Exchange believes this
benefit is appropriate, as it incentivizes Market-Makers to quote in as
many series as possible in their appointed classes, even those series
in which the underlying security has entered into a limit up-limit down
state. The Exchange stated that it is attempting to better encourage
Market-Makers to quote even though they will not have the obligation.
If market makers do choose to quote, the Exchange believes they should
be entitled to receive the entitlement for such quoting as appropriate.
D. Nullification and Adjustment of Options Transactions
In connection with the implementation of the Plan, the Exchange
proposes to adopt Interpretation and Policies .06 to Rule 6.25 to
exclude transactions in options that overlay a security during a Limit
State or Straddle State from the obvious error pricing provision in
Rule 6.25(a)(1) for a one year pilot basis from the date of adoption of
the proposed rule change. Additionally, the Exchange proposes to
specify that electronic transactions in options that overlay an NMS
stock that occur during a Limit State or Straddle State may be reviewed
on an Exchange motion pursuant to Rule 6.25(b)(3). The Exchange also
proposes to provide the Commission with data and analysis during the
duration of the pilot as requested.
Under Rule 6.25, an Obvious Price Error occurs when the execution
price of an electronic transaction is above or below the theoretical
price for the series by a specified amount. Pursuant to Rule
6.25(a)(1)(i), the theoretical price of an option series is currently
defined, for series traded on at least one other options exchange, as
the last national best bid price with respect to an erroneous sell
transaction, and the last national best offer price with respect to an
erroneous buy transaction, just prior to the trade. In certain
circumstances, Trading Officials have the discretion to determine the
theoretical price pursuant to Rule 6.25(a)(1)(iv).\40\
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\40\ Rule 6.25(a)(1)(iv) provides there are no quotes for
comparison, or if the bid/ask differential of the national best bid
and offer for the affected series just prior to the erroneous
transaction was at least two times the permitted bid/ask
differential determined by the Exchange, designated Trading
Officials will determine the theoretical price.
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The Exchange believes that neither method is appropriate during a
Limit State or Straddle State. In Amendment No. 1, the Exchange noted
that during a Limit State or Straddle State, options prices may deviate
substantially from those available prior to or following the state. The
Exchange believes this provision would give rise to much uncertainty
for market participants as there is no bright line definition of what
the theoretical value should be for an option when the underlying NMS
stock has an unexecutable bid or offer or both. The Exchange noted that
determining theoretical value in such a situation would be often times
be very subjective rather than an objective determination and would
give rise to additional uncertainty and confusion for investors.
Similarly, the Exchange believes the application of the current rule
would be impracticable given the lack of a reliable national best bid
or offer in the options market during Limit States and Straddle States,
and would produce undesirable effects.
Ultimately, the Exchange believes that adding certainty to the
execution of limit orders in these situations should encourage market
participants to continue to provide liquidity to the Exchange, thus
promoting a fair and orderly market. On balance, the Exchange believes
that removing the potential inequity of nullifying or adjusting
executions occurring during Limit States or Straddle States outweighs
any potential benefits from applying these provisions during such
unusual market conditions.
Therefore, the Exchange proposes to adopt Interpretation and Policy
.06 to Rule 6.25 to provide that transactions executed during a Limit
State or Straddle State are not subject to the obvious pricing error
provision in Rule 6.25(a)(1). In addition, amended Rule 6.25 will
include a qualification that nothing in the proposed rule change will
prevent transactions in options that overlay a security in a Limit
State or Straddle State from being reviewed on an Exchange motion
pursuant to Rule 6.25(b)(3). According to the Exchange, this safeguard
will provide the flexibility to act when necessary and appropriate,
while also providing market participants with certainty that trades
they effect with quotes and/or orders having limit prices will stand
irrespective of subsequent moves in the underlying security. The right
to review on Exchange motion electronic transactions that occur during
a Limit State or Straddle State under this provision, according to the
Exchange, would enable the Exchange to account for unforeseen
circumstances that result in obvious or catastrophic errors for which a
nullification or adjustment may be necessary in order to preserve the
interest of maintaining a fair and orderly market and for the
protection of investors. The Exchange also proposes to provide the
Commission with data and analysis during the duration of the pilot as
requested.
IV. Discussion and Commission's Findings
After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and rules and
regulations thereunder applicable to a national securities
exchange.\41\ In particular, the Commission finds that the proposed
rule change is consistent with Section 6(b)(5) of the Act,\42\ which,
among other things, requires a national securities exchange to be so
organized and have the capacity to be able to carry out the purposes of
the Act and to enforce compliance by its members and persons associated
with its members with the provisions of the Act, the rules and
regulations thereunder, and the rules of the exchange, and is 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 regulation, 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.
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\41\ In approving the proposed rule changes, the Commission has
considered their impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\42\ 15 U.S.C. 78f(b).
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A. Exchange Rule 6.3A and the Plan
Exchange Rule 6.3A lists changes to Exchange order types, order
handling, obvious error, and market-maker quoting obligations that the
Exchange is making in connection with the implementation of the Plan.
The Exchange believes that the proposed changes to Rule 6.3A will
describe to TPHs and other market participants where to find the
changes associated
[[Page 21646]]
with the Plan's implementation. Accordingly, the Commission finds that
this change promotes clarity in connection with CBOE's proposed changes
in response to the Limit up-Limit Down Plan and is therefore consistent
with the Act.
B. Order Handling During the Limit Up-Limit Down State
As detailed above, the Exchange proposes to add language to clarify
that: (a) market orders, with certain exceptions, will be returned
during limit up-limit down states, (b) market-on-close orders will not
be elected if the underlying security is in a limit up-limit down
state, (c) stop orders will not be triggered while the underlying
security is in a limit up-limit down state, and (d) stock-option orders
will only execute if the calculated stock price is within the
permissible bands, unless such order is routed for manual handling. In
addition, during a limit up-limit down state, if a message is sent to
replace a limit order with a market order, the resting limit order will
be cancelled and the replaced market order will also be cancelled.
The Commission finds that the Exchange's proposed method of
handling such orders is consistent with Section 6(b)(5) of the Act.
When the underlying stock enters a limit up-limit down state, the lack
of a reliable price in that market could affect the options markets in
various ways, including wider spreads and less liquidity. This could
potentially mean that market orders, which contain no restrictions on
the price at which they may execute, could receive executions at
unintended prices if executed during the limit up-limit down state. As
such, the proposed changes to reject market orders and market-on-close
orders if the underlying is in a limit up-limit down state, to not
trigger stop orders if the underlying is in a limit up-limit down
state, and to cancel market orders that replace limit orders when the
underlying is in a limit up-limit down state, are reasonably designed
to prevent such orders from being executed at potentially unexpected
prices.
At the same time, the proposed exceptions to the treatment of these
orders--accepting market orders that are submitted to initiate an
Automated Price Improvement Mechanism, or which are routed for manual
handling--are designed to take into account that market orders
submitted in these ways may not be at the same risk as other market
orders for executions at unexpected prices. Specifically, market orders
submitted through the Automated Price Improvement Mechanism are
submitted as pairs, and are effectively stopped because they must
execute at a price at or better than the contra order. With respect to
market orders routed for manual handling, such orders are physically
handled by a broker on the Exchange floor who must affirmatively agree
to an execution price, as opposed to simply executing that order
against electronic prices. Similarly, the Exchange's proposal to route
a stock-option order for manual handling when the underlying is in a
limit up-limit down state allows such orders to be physically handled
by a broker on the Exchange floor who must affirmatively agree to an
execution price.
The Exchange proposes to add an Interpretation and Policy .07 to
Rule 6.2B which states that if the underlying security for a class of
options enters into a limit up-limit down state when the class moves to
opening rotation, any market orders entered that trading day will be
cancelled. However, market orders that are considered limit orders
pursuant to Rule 6.13(b)(iv) and entered the previous trading day will
remain in the Book and can essentially act as limit orders at the
minimum increment.
The Commission finds that these changes are consistent with the Act
in that they are reasonably designed to counter potential price
dislocations that may occur if the underlying enters a limit up-limit
down state during the opening by preventing market orders, which
contain no restrictions on the price at which they may execute, from
being executed at potentially unintended prices. At the same time, this
proposal allows market orders that are essentially limit orders to
continue to participate in the opening process without a similar risk
of an execution at an unintended price.
The Exchange also proposes that, if an underlying security enters a
limit up-limit down state while a market order is being exposed through
HAL, the auction will end early, and any unexecuted portion of the
market order would be cancelled. The Commission believes that this
provision will provide certainty to options market participants on how
market orders submitted to HAL will be handled during limit up-limit
down states. In addition, the Commission finds that this provision is
consistent with the Act in that it is reasonably designed to counter
potential price dislocations that may occur if the underlying enters a
limit up-limit down state while the HAL functionality is underway by
preventing market orders, which contain no restrictions on the price at
which they may execute, from being executed at potentially unintended
prices.
The Exchange proposes to amend the COA rule so that, if during a
COA of a market order, the underlying security of an option enters a
limit up-limit down state, the COA will end and the remaining portion
of the order, if a market order, will cancel. As with the proposed
change to HAL, the Commission believes that this provision is
consistent with the Act in that it will provide certainty to options
market participants on how market orders submitted to COA will be
handled during limit up-limit down states. In addition, the Commission
finds that this provision is reasonably designed to counter potential
price dislocations that may occur if the underlying enters a limit up-
limit down state while a COA is underway by preventing market orders,
which contain no restrictions on the price at which they may execute,
from being executed at potentially unintended prices.
C. Market Maker Obligations
The Commission finds that the proposal to suspend a market maker's
obligations when the underlying security is in a limit up-limit down
state is consistent with the Act. During a limit up-limit down state,
there may not be a reliable price for the underlying security to serve
as a benchmark for market makers to price options. In addition, the
absence of an executable bid or offer for the underlying security will
make it more difficult for market makers to hedge the purchase or sale
of an option. Given these significant changes to the normal operating
conditions of market makers, the Commission finds that the Exchange's
decision to suspend a market maker's obligations in these limited
circumstances is consistent with the Act. The Commission notes,
however, that the Plan was approved on a pilot basis and its
Participants will monitor how it is functioning in the equity markets
during the pilot period. To this end, the Commission expects that, upon
implementation of the Plan, the Exchange will continue monitoring the
quoting requirements that are being amended in this proposed rule
change and determine if any necessary adjustments are required to
ensure that they remain consistent with the Act.
The Commission also finds that the proposal to maintain
participation entitlements for market makers in all series in their
assigned classes in which they are quoting, including in series for
which the underlying security is in a limit up-limit down state and for
which they are not required to provide continuous electronic quotes
under the Exchange Rules, is consistent with the
[[Page 21647]]
Act. To the extent that market makers are only eligible for
participation entitlements if they are quoting at the best price on the
Exchange, this proposal is reasonably designed to incentivize Market-
Makers to quote more aggressively when the underlying security has
entered into a limit up-limit down state than they might otherwise
quote, potentially providing additional liquidity and price discovery.
To the extent that, under this proposal, market makers would receive
participation entitlements in series in which they are not required to
quote, the Commission notes that this aspect of the proposal is
consistent with the current application of participation entitlements.
D. Nullification and Adjustment of Options Transactions
The Commission finds that the Exchange's proposal to suspend
certain aspects of Rule 6.25 during a Limit State or Straddle State is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities exchange.
Specifically, the Commission finds that the proposal is consistent with
Section 6(b)(5) of the Act,\43\ in that it is designed to prevent
fraudulent and manipulative acts and practices, promote just and
equitable principles of trade, foster cooperation and coordination with
persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, remove impediments to and perfect the mechanism of a free
and open market and a national market system, and, in general, protect
investors and the public interest.
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\43\ 15 U.S.C. 78f(b)(5).
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In Amendment No. 1, the Exchange notes its belief that suspending
certain aspects of Rule 6.25 during a Limit State or Straddle State
will ensure that limit orders that are filled during a Limit or
Straddle State will have certainty of execution in a manner that
promotes just and equitable principles of trade and removes impediments
to, and perfects the mechanism of, a free and open market and a
national market system. The Exchange believes the application of the
current rule would be impracticable given what it perceives will be the
lack of a reliable NBBO in the options market during Limit States and
Straddle States, and that the resulting actions (i.e., nullified trades
or adjusted prices) may not be appropriate given market conditions. In
addition, given the Exchange's view that options prices during Limit
States or Straddle States may deviate substantially from those
available shortly following the Limit State or Straddle State, the
Exchange believes that providing market participants time to re-
evaluate a transaction executed during a Limit State or Straddle State
will create an unreasonable adverse selection opportunity that will
discourage participants from providing liquidity during Limit States or
Straddle States. Ultimately, the Exchange believes that adding
certainty to the execution of orders in these situations should
encourage market participants to continue to provide liquidity to the
Exchange during Limit States and Straddle States, thus promoting fair
and orderly markets.
The Exchange, however, has proposed this rule change based on its
expectations about the quality of the options market during Limit
States and Straddle States. The Exchange states, for example, that it
believes that application of the obvious and catastrophic error rules
would be impracticable given the potential for lack of a reliable NBBO
in the options market during Limit States and Straddle States. Given
the Exchange's recognition of the potential for unreliable NBBOs in the
options markets during Limit States and Straddle States, the Commission
is concerned about the extent to which investors may rely to their
detriment on the quality of quotations and price discovery in the
options markets during these periods. This concern is heightened by the
Exchange's proposal to exclude electronic trades that occur during a
Limit State or Straddle State from the obvious pricing error provisions
of Rule 6.25(a)(1) and the nullification or adjustment provisions of
Rule 6.25. The Commission urges investors and market professionals to
exercise caution when considering trading options under these
circumstances. Broker-dealers also should be mindful of their
obligations to customers that may or may not be aware of specific
options market conditions or the underlying stock market conditions
when placing their orders.
While the Commission remains concerned about the quality of the
options market during the Limit States and Straddle States, and the
potential impact on investors of executing in this market without the
protections of the obvious or catastrophic error rules that are being
suspended during the Limit and Straddle States, it believes that
certain aspects of the proposal could help mitigate those concerns.
First, despite the removal of obvious and catastrophic error
protection during Limit States and Straddle States, the Exchange states
that there are additional measures in place designed to protect
investors. For example, the Exchange states in Amendment No. 1 that by
rejecting market orders and not electing stop orders, only those orders
with a limit price will be executed during a Limit State or Straddle
State. Additionally, the Exchange notes the existence of SEC Rule 15c3-
5 requiring broker-dealers to have controls and procedures in place
that are reasonably designed to prevent the entry of erroneous orders.
Therefore, on balance, the Exchange believes that removing the
potential inequity of nullifying or adjusting executions occurring
during Limit States or Straddle States outweighs any potential benefits
from applying certain provisions during such unusual market conditions.
The Exchange also believes that the aspect of the proposed rule
change that will continue to allow the Exchange to review on its own
motion electronic trades that occur during a Limit State or a Straddle
State is consistent with the Act because it would provide flexibility
for the Exchange to act when necessary and appropriate to nullify or
adjust a transaction and will enable the Exchange to account for
unforeseen circumstances that result in obvious errors for which a
nullification or adjustment may be necessary in order to preserve the
interest of maintaining a fair and orderly market and for the
protection of investors. The Exchange represents that it will
administer this provision in a manner that is consistent with the
principles of the Act. In addition, the Exchange has represented that
it will create and maintain records relating to the use of the
authority to act on its own motion during a Limit State or Straddle
State.
Finally, the Exchange has proposed that the changes be implemented
on a one year pilot basis. The Commission believes that it is important
to implement the proposal as a pilot. The one year pilot period will
allow the Exchange time to assess the impact of the Plan on the options
marketplace and allow the Commission to further evaluate the effect of
the proposal prior to any proposal or determination to make the changes
permanent. To this end, the Exchange has committed to: (1) Evaluate the
options market quality during Limit States and Straddle States; (2)
assess the character of incoming order flow and transactions during
Limit States and Straddle States; and (3) review any complaints from
members and their customers concerning executions during Limit States
and Straddle States. Additionally, the Exchange has agreed to provide
the Commission with data requested to evaluate the impact of the
elimination of
[[Page 21648]]
the obvious error rule, including data relevant to assessing the
various analyses noted above. On April 4, 2013, the Exchange submitted
a letter stating that it would provide specific data to the Commission
and the public and certain analysis to the Commission to evaluate the
impact of Limit States and Straddle States on liquidity and market
quality in the options markets.\44\ This will allow the Commission, the
Exchange, and other interested parties to evaluate the quality of the
options markets during Limit States and Straddle States and to assess
whether the additional protections noted by the Exchange are sufficient
safeguards against the submission of erroneous trades, and whether the
Exchange's proposal appropriately balances the protection afforded to
an erroneous order sender against the potential hazards associated with
providing market participants additional time to review trades
submitted during a Limit State or Straddle State.
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\44\ In particular, the Exchange represented that, at least two
months prior to the end of the one year pilot period of proposed
Interpretation and Policy .06 to Rule 6.25, it would provide to the
Commission an evaluation of (i) the statistical and economic impact
of Straddle States on liquidity and market quality in the options
market and (ii) whether the lack of obvious error rules in effect
during the Limit States and Straddle States are problematic. In
addition, the Exchange represented that each month following the
adoption of the proposed rule change it would provide to the
Commission and the public a dataset containing certain data elements
for each Limit State and Straddle State in optionable stocks. The
Exchange stated that the options included in the dataset will be
those that meet the following conditions: (i) the options are more
than 20% in the money (strike price remains greater than 80% of the
last stock trade price for calls and strike price remains greater
than 120% of the last stock trade price for puts when the Limit
State or Straddle State is reached); (ii) the option has at least
two trades during the Limit State or Straddle State; and (iii) the
top ten options (as ranked by overall contract volume on that day)
meeting the conditions listed above. For each of those options
affected, each dataset will include, among other information: stock
symbol, option symbol, time at the start of the Limit State or
Straddle State and an indicator for whether it is a Limit State or
Straddle State. For activity on the exchange in the relevant
options, the Exchange has agreed to provide executed volume, time-
weighted quoted bid-ask spread, time-weighted average quoted depth
at the bid, time-weighted average quoted depth at the offer, high
execution price, low execution price, number of trades for which a
request for review for error was received during Straddle States and
Limit States, an indicator variable for whether those options
outlined above have a price change exceeding 30% during the
underlying stock's Limit State or Straddle State compared to the
last available option price as reported by OPRA before the start of
the Limit or Straddle state (1 if observe 30% and 0 otherwise), and
another indicator variable for whether the option price within five
minutes of the underlying stock leaving the Limit State or Straddle
State (or halt if applicable) is 30% away from the price before the
start of the Limit State or Straddle state. See CBOE Letter, supra
note 6.
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In addition, the Commission finds good cause, pursuant to Section
19(b)(2) of the Act \45\ for approving the proposed rule change on an
accelerated basis. This proposal is related to the Plan, which will
become operative on April 8, 2013, and aspects of the proposal, such as
rejecting market orders and not electing Stop Orders during a limit up-
limit down state, are designed to prevent such orders from receiving
poor executions during those times. In granting accelerated approval,
the proposed rule change, and its corresponding protections, will take
effect upon the Plan's implementation date. Accordingly, the Commission
finds that good cause exists for approving the proposed rule change on
an accelerated basis.
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\45\ 15 U.S.C. 78s(b)(2)
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\46\ that the proposed rule change (SR-CBOE-2013-030), as modified
by Amendments Nos. 1 and 2, be, and it hereby is, approved on an
accelerated basis.
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\46\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\47\
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\47\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-08473 Filed 4-10-13; 8:45 am]
BILLING CODE 8011-01-P
