Self-Regulatory Organizations; C2 Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change, as Modified by Amendment No. 1 Thereto, Relating to Price Protection Mechanisms, 77047-77056 [2015-31280]

Download as PDF Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices uses percentage and dollar thresholds, which is consistent with the parameters used in its limit order price check, while the proposed rule uses tick distance, which is consistent with the parameters used in CBOE’s limit order price check); and • the maximum value acceptable price range is substantially similar to NASDAQ OMX PHLX, Inc. (‘‘PHLX’’) Rule 1080, Interpretation and Policy .07(g) (note that the PHLX rule applies to vertical and time spreads, while the proposed rule applies to vertical, true butterfly and box spreads). The fourth price check is an expansion of the applicability of a price check already included in CBOE’s rules. jstallworth on DSK7TPTVN1PROD with NOTICES B. Self-Regulatory Organization’s Statement on Burden on Competition CBOE does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. The proposed rule change adds price protection mechanisms for orders and quotes of all Trading Permit Holders submitted to CBOE to help further prevent potentially erroneous executions, which benefits all market participants. The price checks apply to all incoming orders and quotes of all Trading Permit Holders in the same manner. The quote price reasonability check applies only to Market-Maker quotes, because the Rules currently have a similar price check that applies to orders. Additionally, the Exchange believes this type of protection for Market-Makers is appropriate given their unique role in the market and may encourage Market-Makers to quote tighter and deeper markets, which will increase liquidity and enhance competition, given the additional protection these price checks provide. The Exchange believes the proposed rule change would provide market participants with additional protection from anomalous or erroneous executions. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others The Exchange neither solicited nor received comments on the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or within such longer period up to 90 days (i) as the Commission may VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the Exchange consents, the Commission will: A. By order approve or disapprove such proposed rule change, or B. institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as modified by Amendment No. 1, is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– CBOE–2015–107 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–CBOE–2015–107. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make PO 00000 Frm 00122 Fmt 4703 Sfmt 4703 77047 available publicly. All submissions should refer to File Number SR–CBOE– 2015–107 and should be submitted on or before January 4, 2016. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.42 Robert W. Errett, Deputy Secretary. [FR Doc. 2015–31281 Filed 12–10–15; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–76584; File No. SR–C2– 2015–033] Self-Regulatory Organizations; C2 Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change, as Modified by Amendment No. 1 Thereto, Relating to Price Protection Mechanisms December 8, 2015. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on November 25, 2015, C2 Options Exchange, Incorporated (the ‘‘Exchange’’ or ‘‘C2’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. On December 4, 2015, the Exchange filed Amendment No. 1 to the proposal.3 The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to enhance current and adopt new price protection mechanisms for orders and quotes. The text of the proposed rule change is available on the Exchange’s Web site (https://www.c2exchange.com/Legal/), at the Exchange’s Office of the Secretary, and at the Commission’s Public Reference Room. 42 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 In Amendment No. 1, the Exchange proposed changes to amend the proposed rule text of Rule 6.13, Interpretation and Policy .04(c) in Exhibit 5 and the purpose and statutory basis sections of each of the Form 19b–4 and Exhibit 1 regarding the applicability of the proposed enhancement to the debit/credit price reasonability check to index options with European-style exercises. The Exchange also switched the order of the rule text in Exhibit 5 so that Rule 6.13 appears before Rule 6.17. 1 15 E:\FR\FM\11DEN1.SGM 11DEN1 77048 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange has in place various price check mechanisms that are designed to prevent incoming orders from automatically executing at potentially erroneous prices.4 These mechanisms are designed to help maintain a fair and orderly market by mitigating potential risks associated with orders trading at prices that are extreme and potentially erroneous. The Exchange proposes to adopt Rule 6.17(d) and (e) and amend Rule 6.13, Interpretation and Policy .04, to add new, as well as enhance current, price protection mechanisms for orders and quotes to help further prevent potentially erroneous executions. Put Strike Price and Call Underlying Value Checks jstallworth on DSK7TPTVN1PROD with NOTICES Proposed Rule 6.17(d) provides price protections for simple orders to buy put and call options based on the strike price or underlying value, respectively. The proposed rule provides that the System 5 will reject back to the Participant a quote 6 or buy limit order for (i) a put if the price of the quote bid or order is equal to or greater than the strike price of the option or (ii) a call if the price of the quote bid or order is equal to or greater than the consolidated last sale price of the underlying security, with respect to equity and exchange-traded fund (‘‘ETF’’) options, or the last disseminated underlying 4 See, e.g., Rules 6.13, Interpretation and Policy .04 (price check parameters for complex orders), 6.17(a) (market-width and drill-through price check parameters), 6.17(b) (limit order price parameters), and 8.12 (quote risk monitor). 5 The ‘‘System’’ means the automated trading system used by the Exchange for the trading of options contracts. See Rule 1.1. 6 The term quote includes both sides of a quote that is entered as a two-sided quote. VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 index value, with respect to index options.7 With respect to put options, a Participant seeks to buy an option that could be exercised into the right to sell the underlying. The value of a put can never exceed the strike price of the option, even if the underlying goes to zero. For example, one put for stock ABC with a strike price of $50 gives the holder the right to sell 100 shares of ABC for $50, no more or less. Therefore, it would be illogical to pay more than $50 for the right to sell shares of ABC, regardless of the price of ABC. Pursuant to proposed Rule 6.17(d)(i)(A), the Exchange would deem any put bid or buyer order with a price that equals or exceeds the strike price of the option to be erroneous, and the Exchange believes it would be appropriate to reject these bids and buy orders. With respect to call options, a Participant seeks to buy an option that could be exercised into the right to buy the underlying. The Exchange does not believe that a derivative product that conveys the right to buy the underlying should ever be priced higher than the prevailing value of the underlying itself. In that case, a market participant could just purchase the underlying at the prevailing value rather than pay a larger amount for the call. Accordingly, pursuant to proposed Rule 6.17(d)(i)(B), the Exchange believes it is appropriate to reject bids or buy orders for call options with prices that are equal to or in excess of the value of the underlying. As an example, suppose a Participant submits Order 1 to buy an ABC call for $8 and Order 2 to buy an ABC call for $11 when the last sale price for stock ABC is $10. Because the price to buy for Order 2 is greater than the last sale price of the underlying, the System will reject Order 2. The System will either execute or book Order 1 in accordance with C2’s rules. Pursuant to the proposed rule, with respect to equity and ETF options, the Exchange would use the consolidated last sale price of the underlying security, with respect to equity and ETF options, and the last disseminated value of the underlying index, with respect to index options. The Exchange notes that, in certain circumstances, the last sale price or index value, as applicable, may be from the close of the previous trading 7 These price checks would also apply to buy auction responses submitted in the various Exchange auctions, such as the Hybrid Agency Liaison (‘‘HAL’’) and the Automated Improvement Mechanism (‘‘AIM’’). See proposed Rule 6.17(d)(iii). The Exchange believes responses can cause erroneous executions in the same manner as quotes and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. PO 00000 Frm 00123 Fmt 4703 Sfmt 4703 day. These circumstances include during the pre-opening period or a delayed opening. As an additional risk control feature, if a Market-Maker submits a quote in a series in which the Market-Maker already has a resting quote (thus, was attempting to update a quote) and the System rejects that quote pursuant to either of these proposed checks, the System will cancel the Market-Maker’s resting quote 8 in the series. The Exchange believes it is appropriate to reject or cancel, as applicable, both sides of a quote (whether submitted as a two-sided quote or resting, respectively) because Market-Makers generally submit two-sided quotes, as their trading strategies and risk profiles are based in part on the spreads of their quotes, and rejecting and cancelling, as applicable, quotes on both sides of the series is consistent with this practice. The Exchange believes this operates as an additional safeguard that causes the Market-Maker to re-evaluate its quotes in the series before attempting to update its quotes again. Additionally, when a Market-Maker submits a new quote, that Market-Maker is implicitly instructing the Exchange to cancel any resting quote in the same series. Thus, even if the new quote is rejected as a result of this proposed check, the Market-Maker’s implicit instruction to cancel the resting quote remains valid nonetheless. As an example, suppose a MarketMaker has a resting two-sided quote in Series 1 for stock ABC of 14.00 to 16.00. The options in Series 1 are puts with a strike price of $18.00. The MarketMaker submits an updated two-sided quote of 18.00 to 19.00. Because the quote bid is the same as the strike price for Series 1, the System will reject the 18.00 quote bid and the 19.00 quote offer. Additionally, the System will cancel the Market-Maker’s resting quote in Series 1 of 14.00 to 16.00. The Market-Maker then submits a new twosided quote of 16.00 to 17.00, which the System accepts. Proposed Rule 6.17(d)(ii) provides that the Exchange may determine not to apply to a class either the put check or the call check described above if a senior official at the Exchange’s Help Desk determines it should not apply in the interest of maintaining a fair and orderly market.9 Additionally, the call check does not apply to adjusted classes or if the data for the underlying is not available. As these price checks are 8 This includes any quote on the same side and opposite side in the series. 9 Pursuant to Exchange procedures, any decision to not apply the put check or call check, as well as the reason for the decision, will be documented and retained. E:\FR\FM\11DEN1.SGM 11DEN1 jstallworth on DSK7TPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices intended to assist with the maintenance of fair and orderly markets, the Exchange may believe it is appropriate to disable either of these checks in response to a market event (for example, if dissemination of data was delayed and resulting in unreliable underlying values). If the data for the underlying is not available (for example, if the underlying exchange is not disseminating data or if the applicable securities information processor is down), then the System cannot perform the check, which is why the check will not apply in that situation. Additionally, the call check does not apply to options in an adjusted series, which is an option series for which, as a result of a corporate action by the issuer of the security underlying such option series, one option contract in the series represents the delivery of other than 100 shares of underlying stock or units. After a corporate action and subsequent adjustment to the existing options, the series receives a new symbol, while exchanges listing options on the underlying security that undergoes a corporate action resulting in an adjusted series will generally list a new standard option series for that underlying. Therefore, because trading of options in adjusted series may not accurately reflect the value of the underlying (as the new standard series would), the Exchange believes it appropriate to not apply these checks to options in these series. To the extent a Participant submits a pair of orders to AIM 10 or the Solicitation Auction Mechanism (‘‘SAM’’),11 these proposed checks will apply to both orders in the pair. If the System rejects either order in the pair pursuant to the applicable check, then the System will also cancel the paired order. It is the intent of these paired orders to execute against each other. Thus, the Exchange believes it is appropriate to reject both orders if one does not satisfy the price checks to be consistent with the intent of the submitting Participant. Notwithstanding the foregoing, with respect to an AIM order that instructs the System to process the agency order as an unpaired order if an AIM auction cannot be initiated (for example, if the contra-side order does not stop the agency order at the price required by Rule 6.51(a)(2)), if the System rejects the agency order pursuant to the applicable check, then the System will also reject the contraside order. However, if the System 10 See Rule 6.51 for a description of the AIM auction process. 11 See Rule 6.52 for a description of the SAM auction process. VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 rejects the contra-side order pursuant to the applicable check, the System will accept the agency order (assuming it satisfies the applicable check). The purpose of the contingency to treat the agency order as an unpaired order provides the opportunity for that order (which is a customer of the submitting Participant) to execute despite not entering an AIM auction pursuant to which the order may execute against a facilitation or solicitation order of the Participant. The Exchange believes the proposed rule change is consistent with that contingency. Quote Inverting NBBO Check Currently, the Exchange applies price reasonability checks to limit orders.12 Proposed Rule 6.17(e) sets forth a national best bid or offer (‘‘NBBO’’) price reasonability check that would apply to Market-Maker quotes. This check would similarly compare quote bids with the national best offer (‘‘NBO’’) and quote offers with the national best bid (‘‘NBB’’). Specifically, if C2 is at the NBO (NBB), the System will reject a quote 13 back to a MarketMaker if the quote bid (offer) crosses the NBO (NBB) 14 by more than a number of ticks specified by the Exchange (which will be no less than three minimum increment ticks and announced to Participants by Regulatory Circular). If C2 is not at the NBO (NBB), the System rejects a quote back to a Market-Maker if the quote bid (offer) locks or crosses the NBO (NBB). The System will reject any inbound Market-Maker quotes that do not satisfy these parameters as presumptively erroneous. The Exchange believes that using specified tick distance is appropriate because that is the parameter used for the corresponding limit order reasonability check and because it provides MarketMakers a precise price protection.15 While the limit order price check parameter indicates the Exchange may set the acceptable tick distance to be no less than five minimum increments, the Exchange believes it is reasonable to be able to set the acceptable tick distance to be tighter for the quote price reasonability check (no less than three minimum increments) to provide additional protection to Market-Makers given their unique role in the market, which could encourage Market-Makers to quote tighter and deeper markets. The Exchange believes having a minimum 12 See Rule 6.17(b). supra note 6. 14 If the NBBO is unavailable, locked or crossed (and thus unreliable), then this check will compare the quote to the Exchange’s best bid or offer (‘‘BBO’’) (if available). See proposed Rule 6.17(e)(i). 15 See supra note 12. 13 See PO 00000 Frm 00124 Fmt 4703 Sfmt 4703 77049 tick distance of more than three would be ineffective. As an additional risk control feature, if a Market-Maker submits a quote in a series in which the Market-Maker already has a resting quote (thus, was attempting to update a quote) and the System rejects that quote pursuant to this proposed check, the System will cancel the Market-Maker’s resting quote 16 in the series. The Exchange believes it is appropriate to reject or cancel, as applicable, both sides of a quote (whether submitted as a two-sided quote or resting, respectively) because Market-Makers generally submit twosided quotes, as their trading strategies and risk profiles are based in part on the spreads of their quotes, and rejecting and cancelling, as applicable, quotes on both sides of the series is consistent with this practice. The Exchange believes this operates as an additional safeguard that causes the Market-Maker to re-evaluate its quotes in the series before attempting to update its quotes again. Additionally, when a MarketMaker submits a new quote, that Market-Maker is implicitly instructing the Exchange to cancel any resting quote in the same series. Thus, even if the new quote is rejected as a result of this proposed check, the Market-Maker’s implicit instruction to cancel the resting quote remains valid nonetheless. For example, suppose the Exchange has set a tick distance of three in a class. The minimum increment for that class is $0.05 for series quoted below $3 and $0.10 for series quotes at $3 and above,17 and the NBBO is 3.10 to 3.40. Suppose a Market-Maker submits a bid of 3.80. Because this bid is more than three ticks above the NBO of 3.40, the System rejects the bid. Similarly, suppose a Market-Maker submits an offer of 2.85. Because this offer is more than three ticks below the NBB of 3.10, the System rejects the offer. Proposed Rule 6.17(e)(ii) provides that the Exchange may determine not to apply this proposed check to quotes entered during the pre-opening, a trading rotation or a trading halt, which it will announce to Participants by Regulatory Circular. The Exchange believes it is appropriate to have the ability to not apply this check during the pre-open or opening rotation so that the check does not impact the determination of the opening price. However, the Exchange may determine that there is sufficient information during those times (such as if another exchange is disseminating pricing 16 This includes any quote on the same side and opposite side in the series. 17 See Rule 6.4. E:\FR\FM\11DEN1.SGM 11DEN1 jstallworth on DSK7TPTVN1PROD with NOTICES 77050 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices information) to apply the check. The Exchange also may not want to apply this check during halts, as pricing during that time may be volatile and inaccurate. Additionally, this check will not apply if a senior official at the Exchange’s Help Desk determines it should not apply in the interest of maintaining a fair and orderly market.18 The Exchange believes it is appropriate to have this flexibility to determine times when the check should not apply to respond to market events, such as times of extreme price volatility. Proposed Rule 6.17(e)(iii) states that if the System accepts a quote that locks or crosses the NBBO (which may occur if the proposed check is not applied to a quote pursuant to the proposed rule or if a quote inverts the NBBO but by no more than the specified number of ticks), the System will execute the quote bid (offer) against quotes and orders in the book at a price(s) that is the same or better than the best price disseminated by away exchanges up to the size available on the Exchange. If there is any remaining size of the quote after this execution, the System either (i) cancels any remaining size of the quote, if the price of the quote locks or crosses the price disseminated by the away exchange(s) or (ii) books any remaining size of the quote, if the price of the quote does not lock or cross the price of the away exchange(s). While the Exchange believes Market-Makers are generally willing to accept executions of their quotes that exceed the NBBO to a certain extent, it also believes executions of quotes that exceed the NBBO by too much may be potentially erroneous executions. The Exchange believes blocking these potentially erroneous executions is consistent with expectations of Market-Makers and helps them manage their risk. Cancelling the remaining size of the quote after it partially executes against orders and quotes on the Exchange if the remaining size would be at a price that locks or crosses the best price disseminated from an away market is similarly intended to prevent tradethroughs and displays of crossed markets. Similarly, rejecting quotes that would lock or cross the NBBO if C2 was not at the NBBO is intended to prevent trade-throughs and displays of locked and crossed markets. Unlike orders that may be routed to other options exchanges for executions, quotes may only execute against quotes or orders on C2. Thus, if C2 is not at the NBBO, a quote may not execute against a quote or order that is at the NBBO. 18 See supra note 9. VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 For example, suppose the NBBO is 1.00 to 1.20, and a Market-Maker submits a quote bid for 100 contracts at 1.24. Assuming this class has a minimum increment of 0.01 and the Exchange set the tick distance for this check at five, the System accepts this quote because it only inverts the NBO by four ticks. C2 has an order to sell 10 at 1.20, an order to sell 20 at 1.21, an order to sell 10 at 1.22, an order to sell 10 at 1.23 and an order to sell 20 at 1.24 resting on the book. The best offer disseminated by an away exchange is 1.23. The incoming quote bid will execute against the order to sell at 1.20 (10 contracts), the order to sell at 1.21 (20 contracts), the order to sell at 1.22 (10 contracts) and the order to sell at 1.23 (10 contracts), for a total of 50 contracts. The quote will not execute against the order to sell at 1.24, because that would result in a trade-through of the best disseminated offer from an away exchange of 1.23. The System cancels the remaining 50 contracts, because the bid price of 1.23 would invert the best disseminated market from an away exchange. If, instead, the quote bid in the above example was for 1.22 rather than 1.24, it would execute against the order to sell at 1.20 (10 contracts), the order to sell at 1.21 (20 contracts) and the order to sell at 1.22 (10 contracts). The System would book the remaining 60 contracts of the quote at the bid price of 1.22, which would not lock or cross the best disseminated offer by an away exchange (1.23 in the above example). Alternatively, if in the above example the NBO of 1.20 was disseminated from an away exchange, the System would reject the quote bid of 1.24, because it would cross the best disseminated offer of an away exchange. Debit/Credit Price Reasonability Checks Current Rule 6.13, Interpretation and Policy .04(c) provides that the System will not automatically execute certain vertical and butterfly complex orders 19 19 The proposed rule change adds definitions for vertical and butterfly complex orders (or spreads) and proposes to use these terms for the various price checks in Interpretation and Policy .04, as applicable, as those are the common trading terms used by market participants in the industry that refer to these strategies. See, e.g., CBOE Options Dictionary, available at https://www.cboe.com/ LearnCenter/Glossary.aspx; and NASDAQ Options Trading Glossary, available at https://www.stocksoptions-trading.com/glossary_options.asp. A ‘‘vertical’’ spread is a two-legged complex order with one leg to buy a number of calls (puts) and one leg to sell the same number of calls (puts) with the same expiration date but different exercise prices. A ‘‘butterfly’’ spread is a three-legged complex order with two legs to buy (sell) the same number of calls (puts) and one leg to sell (buy) twice as many calls (puts), all with the same expiration date but different exercise prices, and the exercise price of the middle leg is between the PO 00000 Frm 00125 Fmt 4703 Sfmt 4703 that appear to be erroneously priced because the prices are inconsistent with particular complex order strategies.20 Specifically, the System will not automatically execute a limit order with a net credit price when it clearly should have been entered at a net debit price, a limit order with a net debit price when it clearly should have been entered at a net credit price, or a market order that would be executed at a net debit price when it clearly should execute at a net credit price.21 The proposed rule change expands the applicability of this price check to all complex orders for which the System can determine whether they are debits (orders to buy) or credits (orders to sell). The proposed rule change simplifies the current rule text in subparagraphs (c)(1) and (2) and combines them into proposed subparagraph (c)(1) to state that the System will not automatically execute a limit order for a debit strategy with a net credit price, a limit order for a credit strategy with a net debit price, or a market order for a credit strategy that would be executed at a net debit price.22 The System will reject back to the Participant any limit order, and cancel any market order (or remaining size after partial execution of the order), that does not satisfy this proposed check.23 exercise prices of the other legs. If the exercise price of the middle leg is halfway between the exercise prices of the other legs, it is a ‘‘true’’ butterfly; otherwise, it is a ‘‘skewed’’ butterfly. 20 Pursuant to the introductory paragraph of Rule 6.13, Interpretation and Policy .04, the current debit/credit price reasonability check in subparagraph (c) does not apply to stock-option orders. The proposed debit/credit price reasonability check will apply to stock-option orders; therefore, the proposed rule change deletes the reference to subparagraph (c) from that introductory paragraph statement. 21 A market order with a debit strategy that would result in an execution at a net credit price (i.e., the net sale proceeds from the series being sold are more than the net purchase cost of the series being bought) but would normally execute at a net debit price (i.e., the net sale proceeds from the series being sold are less than the net purchase cost of the series being bought) would be a favorable execution for the market order, and thus this price check would not block its execution. 22 This proposed price check will apply to auction responses. See proposed subparagraph (c)(4). As discussed above, the Exchange believes these responses can cause erroneous executions in the same manner as bids and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. See supra note 7. 23 See current and proposed subparagraph (c)(3). The proposed rule change amends this provision to indicate that the System rejects back the order rather than does not accept the order, as the proposed language more accurately reflects the System’s actions, which is to send a reject message to the submitting Participant. Additionally, the language regarding partial executions in current subparagraph (c)(3) is included in proposed subparagraph (c)(3), with the change that the E:\FR\FM\11DEN1.SGM 11DEN1 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices jstallworth on DSK7TPTVN1PROD with NOTICES The System determines whether an order is a debit or credit based on general options volatility and pricing principles, which the Exchange understands are used by market participants in their option pricing models. With respect to options with the same underlying: • If two calls have the same expiration date, the price of the call with the lower exercise price is more than the price of the call with the higher exercise price; • if two puts have the same expiration date, the price of the put with the higher exercise price is more than the price of the put with the lower exercise price; and • if two calls (puts) have the same exercise price, the price of the call (put) with the nearer expiration is less than the price of the call (put) with the farther expiration. The principles in the first two bullets are based on the standard trading principle of ‘‘buy low, sell high.’’ The ability to buy stock at a lower price is more valuable than the ability to buy stock at a higher price, and thus a call with a lower strike price has more value, and thus is more expensive, than a call with a higher strike price. Similarly, the ability to sell stock at a higher price is more valuable than the ability to sell stock at a lower price, and thus a put with a higher strike price has more value, and thus is more expensive, than a put with a lower strike price. The principle in the last bullet is based on the general concept that locking in a price further into the future involves more risk for the buyer and seller and thus is more valuable, making an option (call or put) with a farther expiration more expensive than an option with a nearer expiration. This is similar, for example, to interest rates for mortgages: In general, an interest rate on a 30-year mortgage is higher than the interest rate on a 15-year mortgage due to the risk of potential interest rate changes over the longer period of time to both the mortgagor and mortgagee.24 Based on these general rules, proposed subparagraph (c)(2) provides that the System will define a complex order as follows: • A call butterfly spread for which the middle leg is to sell (buy) and twice remainder of the order that cannot execute is rejected rather than routed for manual handling and other nonsubstantive changes to simplify the language. 24 The general principle described in the third bullet above does not necessarily apply to European-style index options, and thus the aspect of the proposed price check that is based on that general principle does not apply to those options, as described below. See proposed subparagraph (c)(2). VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 the exercise price of that leg is greater than or equal to the sum of the exercise prices of the buy (sell) legs is a debit (credit) (because the ‘‘aggregate’’ exercise price of the sell (buy) leg is the same or higher than the ‘‘aggregate’’ exercise price of the buy (sell) legs and thus the sell (buy) leg is for the less (more) expensive option); • a put butterfly spread for which the middle leg is to sell (buy) and twice the exercise price of that leg is less than or equal to the sum of the exercise prices of the buy (sell) legs is a debit (credit) (because the ‘‘aggregate’’ exercise price of the sell (buy) leg is the same or less than the ‘‘aggregate’’ exercise price of the buy (sell) leg and thus the sell (buy) leg is for the less (more) expensive option); and • an order for which all pairs and loners are debits (credits) is a debit (credit). The Exchange believes that these categories are consistent with Participants’ expectations of pricing for these strategies. A ‘‘pair’’ is a pair of legs in an order for which both legs are calls or both legs are puts, one leg is a buy and one leg is a sell, and both legs have the same expiration date but different exercise prices or, for all options except European-style index options, the same exercise price but different expiration dates. Based on the general option pricing rules described above, the System can determine whether a pair is a debit or credit. Being able to determine whether a pair of legs with the same exercise price but different expiration dates is a debit or credit is based on the general principle above that if two calls (puts) have the same exercise price, the price of the call (put) with the nearer expiration is less than the price of the call (put) with the farther expiration. As discussed above, this principle does not apply to European-style index options. Therefore, legs of complex orders for European-style index options may be paired only if they have the same expiration date but different exercise prices (and meet the other pairing criteria described above), but not if they have the same exercise price but different expiration dates—the System will skip this pairing step for Europeanstyle index options—and instead will be loners. A ‘‘loner’’ is any leg in an order that the System cannot pair with another leg in the order (including, as noted earlier in this paragraph, legs in orders for European-style index options that have the same exercise price but PO 00000 Frm 00126 Fmt 4703 Sfmt 4703 77051 different expiration dates).25 The System will first pair legs to the extent possible within each expiration date, pairing one leg with the leg that has the next highest exercise price. The System will then, for all options except European-style index options, pair legs to the extent possible with the same exercise price across expiration dates, pairing one leg with the leg that has the next nearest expiration date. • A pair of calls is a credit (debit) if the exercise price of the buy (sell) is higher than the exercise price of the sell (buy) leg (if the pair has the same expiration date) or if the expiration date of the sell (buy) leg is farther than the expiration date of the buy (sell) leg (if the pair has the same exercise price). • A pair of puts is a credit (debit) if the exercise price of the sell (buy) leg is higher than the exercise price of the buy (sell) leg (if the pair has the same expiration date) or if the expiration date of the sell (buy) leg is farther than the expiration date of the buy (sell) leg (if the pair has the same exercise price). • A loner to buy is a debit. • A loner to sell is a credit. If the System cannot determine whether a complex order is a debit or credit based on these categories, it will not apply this proposed check to the order. Based on this proposed provision, a vertical spread to buy one call (put) and sell one call (put) will have one pair. A vertical spread to buy more than one call (put) and sell more than one call (put) will have the same number of pairs as calls (puts) in each leg of the spread. For example, a vertical spread to buy three Jan 10 calls and three Jan 20 calls contains three identical pairs that each consist of a buy Jan 10 call and a sell Jan 20 call. Because the pairs are identical, they will all be debits or credits, and thus the System can define vertical spreads as debits or credits. The System would pair the orders in a vertical spread in accordance with the proposed provision set forth above to determine whether it is a credit or debit. Below are a number of examples demonstrating how the System determines whether a complex order is a debit or credit, and whether the system will reject the order pursuant to the proposed check (for purposes of these examples, assume the orders are not for European-style index options). Example #1—Limit Call Vertical Spread A Participant enters a vertical spread to buy 10 Sept 30 XYZ calls and sell 10 Sept 20 XYZ calls at a net debit price 25 The System treats the stock leg of a stockoption order as a loner. E:\FR\FM\11DEN1.SGM 11DEN1 77052 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices of ¥$10.00. The System defines this order as a credit, because the buy leg is for the call with the higher exercise price (and is thus the less expensive leg). The System rejects the order back to the Participant because it is a limit order for a credit strategy that contains a net debit price. Example #2—Limit Put Vertical Spread A Participant submits a vertical spread to buy 20 Oct 30 XYZ puts and sell 20 Oct 20 XYZ puts at a net credit price of $9.00. The System defines this order as a debit, because the buy leg is for the put with the higher exercise price (and is thus the more expensive leg). The System rejects the order back to the Participant because it is a limit order for a debit strategy that contains a net credit price. Example #3—Market Call Vertical Spread A Participant enters a market vertical spread to buy 30 Nov 20 XYZ calls and sell 30 Nov 10 XYZ calls. The System defines this order as a credit, because the buy leg is for the call with the higher exercise price (and is thus the less expensive leg). The current bid in the market for this strategy is a net debit price of ¥$20.00. The System rejects the order back to the Participant because it is a market order for a credit strategy that would otherwise be executed at a net debit price. Example #4—Market Put Vertical Spread A Participant submits a market vertical spread to buy 10 Oct 20 XYZ puts and sell 10 Oct 10 XYZ put. The System defines this order as a debit, because the buy leg is for the put with the higher exercise price (and is thus the more expensive leg). The current offer in the market for this strategy is a net credit price of $8.00. The order executes at a net credit price of $8.00, because that is a more favorable execution for the Participant, and thus the price check would not block execution of this order. jstallworth on DSK7TPTVN1PROD with NOTICES Example #5—Limit Call Butterfly Spread (Sell 2 Outside Legs, Buy Middle Leg) A Participant submits a butterfly spread to sell 5 Jul 20 XYZ calls, buy 10 Jul 30 XYZ calls and sell 5 Jul 40 XYZ calls at a net debit price of ¥$15.00. The ‘‘aggregate’’ exercise price of the middle buy leg of 60 (2 × 30) is equal to the ‘‘aggregate’’ exercise price of the two outside sell legs of 60 (20 + 40), and thus the System defines this order as a credit. The System rejects the order back to the Participant because it is a limit VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 order for a credit strategy with a net debit price.26 Example #6—Limit Call Butterfly Spread (Buy 2 Outside Legs, Sell Middle Leg) A Participant submits a butterfly spread to buy 10 Feb 20 XYZ calls, sell 20 Feb 25 XYZ calls and buy 10 Feb 35 XYZ calls at a net credit price of $20.00. The ‘‘aggregate’’ exercise price of the middle sell leg of 50 (2 × 25) is less than the ‘‘aggregate’’ exercise price of the two outside legs of 55 (20 + 35), and thus the System cannot determine whether the order is to buy or sell. The System therefore does not block execution of this order based on this price check. If the exercise price of the middle leg was 30 (making the ‘‘aggregate’’ exercise price of that leg 60), the System would have defined this order as a debit and rejected the order back to the Participant, since it would be an order for a debit strategy with a net credit price.27 Example #7—Limit Put Butterfly Spread (Sell 2 Outside Legs, Buy Middle Leg) A Participant submits a butterfly spread to sell 20 Aug 10 XYZ puts, buy 40 Aug 20 XYZ puts and sell 20 Aug XYZ 30 puts at a net debit price of ¥$20.00. The ‘‘aggregate’’ exercise price of the middle buy leg of 40 (2 × 20) is equal to the ‘‘aggregate’’ exercise price of the two outside sell legs of 40 (10 + 30), and thus the System defines this order as a credit. The System rejects the order back to the Participant because it is a limit order for a credit strategy with a net debit price.28 Example #8—Limit Put Butterfly Spread (Buy 2 Outside Legs, Sell Middle Leg) A Participant submits a butterfly spread to buy 5 Apr 35 XYZ puts, sell 10 Apr 45 XYZ puts and buy 5 Apr 50 XYZ puts at a net credit price of $25.00. The ‘‘aggregate’’ exercise price of the middle sell leg of 90 (2 × 45) is more than the ‘‘aggregate’’ exercise price of the two outside legs of 85 (35 + 50), and thus the System cannot determine whether the order is a debit or credit. The System therefore does not block execution of this order based on this price check. If the exercise price of the middle leg was 40 (making the 26 Similar to the result in Example #3, if this butterfly spread was a market order, the System would reject back to the Participant the order because it is a market order for a credit strategy that would otherwise be executed at a net debit price. 27 Similar to the result in Example #4, if this alternative butterfly spread was a market order, the order would execute at a net credit price, because that is a more favorable execution for the Participant, and thus the price check would not block execution of the market order. 28 See supra note 26. PO 00000 Frm 00127 Fmt 4703 Sfmt 4703 ‘‘aggregate’’ exercise price of that leg 80), the System would have defined this order as a debit and rejected the order back to the Participant, since it would be a limit order for a debit strategy with a net credit price.29 Example #9—3-Legged Complex Order (Same Expiration, Different Strikes) A Participant submits a complex order to buy 1 Jan 10 XYZ calls, sell 2 Jan 20 XYZ calls and buy 1 Jan 15 XYZ put at a net debit price of ¥$8.00. The System pairs one of the sell Jan 20 calls with the buy Jan 10 call and defines it as a debit, because the buy leg is for the lower exercise price (and thus is more expensive). There are two loners remaining: the other sell Jan 20 call, which the System defines as a credit, and the buy Jan 15 put, which the System defines as a debit. Because not all pairs and loners are debits or credits (the pair and one loner are debits and the other loner is a credit), the System cannot determine whether the order is a debit or credit. The System therefore does not block execution of this order based on this price check. Example #10—4-Legged Complex Order (Same Strike, Different Expirations) A Participant submits a complex order to buy 1 Feb 15 XYZ call, to sell 1 Jan 15 XYZ call, to buy 1 Jun 15 XYZ put, and to sell 1 Apr 15 XYZ put at a net credit price of $12.00. The System pairs the two calls, which the System defines a debit (because the buy leg is for the call with the farther expiration date and is thus more expensive), and the two puts, which the System defines as a debit (because the buy leg is for the call with the farther expiration date and is thus more expensive). There are no loners. Because all pairs are debits, the System defines this order as a debit. The System rejects the order back to the Participant, since it is a limit order for a debit strategy with a net credit price. Example #11—7-Legged Complex Order 30 (Different Strikes and Expirations) A Participant submits a complex order with the following legs: • Sell 1 Apr 10 XYZ put; • buy 1 Mar 20 XYZ call; • buy 1 Mar 25 XYZ call; • buy 2 Mar 30 XYZ put; • sell 2 Mar 35 XYZ put; • buy 2 Jun 20 XYZ calls; and 29 See supra note 27. the System only accepts complex order with two, three or four legs. This example is included to demonstrate the pairing of orders. To the extent the Exchange determines to accept complex orders with more than four legs, the pairing in this example would apply. 30 Currently, E:\FR\FM\11DEN1.SGM 11DEN1 jstallworth on DSK7TPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices • sell 2 Jul 20 XYZ calls. The System pairs (i) the buy 1 Mar 20 call with one of the sell Jul 20 calls and (ii) one of the buy Jun 20 calls with the other sell Jul 20 calls (there are no call pairs with the same expiration date but different exercise prices). The System defines both of these call pairs as credits because the buy leg of each pair has the nearer expiration date and is thus less expensive. There are two loner calls remaining: The buy Mar 25 call and the other buy Jun 20 call, both of which the System defines as debits. The System then pairs (i) one of the buy Mar 30 puts with one of the sell Mar 35 puts and (ii) the other buy Mar 30 put with the other sell Mar 35 put. The System defines both of these put pairs as credits because the buy leg of each pair is for the lower exercise price (and is thus less expensive). The sell Apr 10 put is the remaining loner put, which the System defines as a credit. Because not all pairs and loners are debits or credits (four pairs and one loner are credits but two other loners are debits), the System cannot define the order as a debit or credit. The System therefore does not block execution of this order based on this price check. To the extent a Participant submits a pair of orders to AIM or SAM, this proposed check will apply to both orders in the pair. If the System rejects either order in the pair pursuant to the applicable check, then the System will also cancel the paired order. As discussed above, it is the intent of these paired orders to execute against each other. Thus, the Exchange believes it is appropriate to reject both orders if one does not satisfy the price checks to be consistent with the intent of the submitting Participant. Notwithstanding the foregoing, with respect to an AIM order that instructs the System to process the agency order as an unpaired order if an AIM auction cannot be initiated (for example, if the contra-side order does not stop the agency order at the price required by Rule 6.51(a)(2)), if the System rejects the agency order pursuant to the applicable check, then the System will also reject the contraside order. However, if the System rejects the contra-side order pursuant to the applicable check, the System will accept the agency order (assuming it satisfies the applicable check).31 The purpose of the contingency to treat the agency order as an unpaired order provides the opportunity for that order (which is a customer of the submitting Participant) to execute despite not entering an AIM auction pursuant to which the order may execute against a 31 See proposed subparagraph (c)(5). VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 facilitation or solicitation order of the Participant. The Exchange believes the proposed rule change is consistent with that contingency. Maximum Value Acceptable Price Range Proposed Rule 6.13, Interpretation and Policy .04(h) adds an additional price check for vertical, true butterfly and box spreads.32 These strategies have quantifiable maximum possible values, and the Exchange proposes to subject these strategies to a price check that would block executions at prices that exceed their maximum possible values by more than a reasonable amount. While the Exchange believes Participants are generally willing to accept executions at prices that exceed the maximum possible value of the applicable spread to a certain extent, executions that exceed the maximum possible value by too much may be erroneous. The Exchange believes blocking these potentially erroneous executions are consistent with expectations of Participants with respect to these strategies. This check is intended to be a second layer of protection to prevent executions of orders at potentially erroneous prices that were not on face erroneous (and thus not rejected pursuant to the proposed debit/credit check described above). For example, a limit order for a debit strategy at a net debit price will not be rejected pursuant to the proposed debit/credit check above; however, the net debit price may be too far above the maximum possible value of the order that it is potentially erroneous. Specifically, proposed paragraph (h) states that if an order is a vertical, true butterfly or box spread, the System will not automatically execute a limit order for a net credit price or net debit price, or a market order for a debit strategy if it would execute at a net debit price, that is outside of an acceptable price range.33 Pursuant to proposed 32 See supra note 19 for definitions of vertical and true butterfly spreads. The proposed rule change also adds a definition for box spreads and proposes to use these terms for the various price checks in Interpretation and Policy .04, as applicable, it is also the common trading term used by market participants in the industry that refers to this strategy. See, e.g., CBOE Options Dictionary, available at https://www.cboe.com/LearnCenter/ Glossary.aspx; and NASDAQ Options Trading Glossary, available at https://www.stocks-optionstrading.com/glossary_options.asp. A ‘‘box spread’’ is a four-legged complex order with one leg to buy calls and one leg to sell puts with one strike price, and one leg to sell calls and one leg to buy puts with another strike price, all of which have the same expiration date and are for the same number of contracts. 33 This proposed price check will also apply to auction responses. See proposed subparagraph (h)(3). As discussed above, the Exchange believes PO 00000 Frm 00128 Fmt 4703 Sfmt 4703 77053 subparagraph (h)(1), the System determines the acceptable price range as follows: • The maximum possible value of a vertical spread is the difference between the exercise prices of the two legs. • The maximum possible value of a true butterfly spread is the difference between the exercise prices of the middle leg and the legs on either side. • The maximum possible value of a box spread is the difference between the exercise prices of each pair of legs. • The minimum possible value of the spread is zero. • The System will calculate the amount that is a percentage of the maximum possible value of the spread (the ‘‘percentage amount’’), which percentage the Exchange will determine and announce to Participants by Regulatory Circular. • The acceptable price range is zero to the maximum possible value of the spread plus: • The percentage amount, if that amount is not outside a pre-set range (the Exchange will determine the pre-set range minimum and maximum amounts and announce them to Participants by Regulatory Circular); • the pre-set minimum, if the percentage amount is less than the preset minimum; or • the pre-set maximum, if the percentage amount is greater than the pre-set maximum. The System will reject back to the Participant any limit order, and cancel any market order (or remaining size after partial execution of the order), that does not satisfy this proposed check.34 Example #1—Vertical Spread Assume the pre-set range is 0.05 to 0.50 and the percentage is 5%. A Participant submits a complex order to buy 1 Aug 25 XYZ call and sell 1 Aug 30 XYZ call, which is a market order for a debit strategy. The maximum possible value of the vertical spread is $5 (30¥25), and the percentage amount is 0.25 (5% of $5), which is within the preset range. Therefore, the acceptable price range is 0 to 5.25. The best net offer price is $6.60. The System rejects the order back to the Participant, because the order would otherwise execute at a price that is outside of the acceptable price range. If the market changed so that the best net offer price is $5.20 and the Participant resubmitted the order, the System would not block these responses can cause erroneous executions in the same manner as bids and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. See supra note 7. 34 See proposed subparagraph (h)(2). E:\FR\FM\11DEN1.SGM 11DEN1 77054 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices execution of the order, as the execution price would be within the acceptable price range. jstallworth on DSK7TPTVN1PROD with NOTICES Example # 2—Butterfly Spread Assume the pre-set range is 0.30 to 0.90 and the percentage is 2%. A Participant submits a complex order to buy 1 Nov 10 XYZ put, sell 2 Nov 20 XYZ puts and buy 1 Nov 30 XYZ, which is an order for a debit strategy with a net debit price of $7.00.35 The maximum possible value of true butterfly spread is $10 (20¥10, 30¥20) and the percentage amount is 0.2 (2% of $10), which is less than the pre-set range minimum amount of 0.30. Therefore, the acceptable price range is 0 to 5.30. The System rejects the order back to the Participant, because the net debit price of $7.00 is outside of the acceptable price range. If the Participant resubmitted the order with a net debit price of $5.00, the System would not block execution of the order, as the limit price is within the acceptable price range. Example # 3—Box Spread Assume the pre-set range is 0.20 to 0.60 and the percentage is 3%. A Participant submits a complex order to buy 1 Mar 45 XYZ call, sell 1 Mar 45 XYZ put, sell 1 Mar 20 XYZ call and buy 1 Mar 20 XYZ put, which is an order for a credit strategy with a net credit price of $28.00. The maximum possible value of the box spread is $25 (45¥20), and the percentage amount is 0.75 (3% of $25), which is more than the pre-set range maximum amount of 0.60. Therefore, the acceptable price range is 0 to 25.60. The System rejects the order back to the Participant, because the net credit price of $28.00 is outside of the acceptable price range. If the Participant resubmitted the order with a net credit price of $24.00, the System would not block execution of the order, as the limit price is within the acceptable price range. To the extent a Participant submits a pair of orders to AIM or SAM, this proposed check will apply to both orders in the pair. If the System rejects either order in the pair pursuant to the applicable check, then the System will also cancel the paired order. As discussed above, it is the intent of these paired orders to execute against each other. Thus, the Exchange believes it is appropriate to reject both orders if one does not satisfy the price checks to be consistent with the intent of the submitted Participant. Notwithstanding the foregoing, with respect to an AIM 35 Generally, a net debit price is referred to as having a negative price (e.g., ¥$7.00). For purposes of this proposed check, the absolute value of the net debit price (e.g., $7.00) is used. VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 order that instructs the System to process the agency order as an unpaired order if an AIM auction cannot be initiated (for example, if the contra-side order does not stop the agency order at the price required by Rule 6.51(a)(2)), if the System rejects the agency order pursuant to the applicable check, then the System will also reject the contraside order. However, if the System rejects the contra-side order pursuant to the applicable check, the System will accept the agency order (assuming it satisfies the applicable check).36 The purpose of the contingency to treat the agency order as an unpaired order provides the opportunity for that order (which is a customer of the submitting Participant) to execute despite not entering an AIM auction pursuant to which the order may execute against a facilitation or solicitation order of the Participant. The Exchange believes the proposed rule change is consistent with that contingency. 2. Statutory Basis The Exchange believes the proposed rule change is consistent with the Act and the rules and regulations thereunder applicable to the Exchange and, in particular, the requirements of Section 6(b) of the Act.37 Specifically, the Exchange believes the proposed rule change is consistent with the Section 6(b)(5) 38 requirements that the rules of an exchange be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest. Additionally, the Exchange believes the proposed rule change is consistent with the Section 6(b)(5) 39 requirement that the rules of an exchange not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers. In particular, the Exchange believes the proposed price protection mechanisms will protect investors and the public interest and maintain fair and orderly markets by mitigating potential risks associated with market participants entering orders at clearly unintended prices and orders trading at prices that are extreme and potentially 36 See proposed subparagraph (h)(4). U.S.C. 78f(b). 38 15 U.S.C. 78f(b)(5). 39 Id. 37 15 PO 00000 Frm 00129 Fmt 4703 Sfmt 4703 erroneous, which may likely have resulted from human or operational error. The proposed put strike price and call underlying value checks of the reasonability of quotes and orders will assist in the maintenance of a fair and orderly market and protect investors by rejecting quotes and orders that exceed the corresponding benchmark (the strike price for puts and the value of the underlying for calls). The Exchange believes the additional risk control feature to reject a quote (both sides if entered as a two-sided quote) and cancel a Market-Maker’s resting quote (on both sides) if the System rejects an updated/ incoming quote in that series pursuant to this proposed price check is appropriate, because Market-Makers generally submit two-sided quotes, as their trading strategies and risk profiles are based in part on the spreads of their quotes, and rejecting or cancelling, as applicable, quotes on both sides of the series is consistent with this practice. The Exchange believes this operates as an additional safeguard that causes the Market-Maker to re-evaluate its quotes in the series before attempting to update its quotes again. Additionally, when a Market-Maker submits a new quote, that Market-Maker is implicitly instructing the Exchange to cancel any resting quote in the same series. Thus, even if the new quote is rejected as a result of this proposed check, the Market-Maker’s implicit instruction to cancel the resting quote remains valid nonetheless. The Exchange believes it is appropriate to apply this check to auction responses, as these responses can cause erroneous executions in the same manner as bids and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. The Exchange also believes the proposed rule change regarding how the proposed check will apply to AIM and SAM orders is reasonable, as the proposed rule change is consistent with the contingencies attached to those types of orders. In addition, the Exchange believes it is appropriate to not apply the call price check if that value is unavailable, because the proposed call price check references the last value of the underlying, or to an adjusted series, because trading of options in adjusted series may not accurately reflect the value of the underlying (as the new standard series would). Without the current value of the underlying or with a potentially inaccurate underlying value, if the System continued to attempt to perform the check, there is risk that the System may reject appropriately priced orders, quotes or E:\FR\FM\11DEN1.SGM 11DEN1 jstallworth on DSK7TPTVN1PROD with NOTICES Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices responses, which could negatively impact market participants. The Exchange also believes it is appropriate to have the flexibility to disable the put or call check in response to a market event (for example, if dissemination of data was delayed and resulting in unreliable underlying values) to maintain a fair and orderly market. This will promote just and equitable principles of trade and ultimately protect investors. The Exchange believes the quote inverting NBBO check will help mitigate the risks associated with the entry of quotes that are priced a specified number of ticks through the prevailing contra-side market, which the Exchange believes is evidence of an error with the quotes. By rejecting these quotes, the Exchange believes it is promoting just and equitable principles of trade by preventing potential price dislocation that could result from erroneous Market-Maker quotes sweeping through multiple price points resulting in executions that cross the NBBO. Specifically, the Exchange believes rejecting Market-Maker quotes that cross the NBBO (or the BBO when the NBBO is not available) by more than an acceptable tick distance will remove impediments to and perfect the mechanism of a free and open market and protect investors and the public interest because it would enable the Exchange to avoid the submission of erroneous quotes that otherwise may cause price dislocation before such quotes could cause harm to the market. Cancellation of any remaining size of a quote that would lock or cross the best disseminated price by an away exchange, and rejection of a quote that locks or crosses the NBBO if C2 is not at the NBBO prevents trade-throughs and the display of locked of crossed market, consistent with the options linkage plan. The Exchange believes that using a specified tick distance is appropriate because that is the parameter used for the corresponding limit order reasonability check and because it provides Market-Makers a precise price protection. The Exchange believes it is reasonable to be able to set the acceptable tick distance to be tighter for the quote price reasonability check to provide additional protection to MarketMakers given their unique role in the market, which could encourage MarketMakers to quote tighter and deeper markets and thus enhance liquidity. The Exchange believes it is appropriate to execute quotes that are no more than the specified number of ticks away from the NBBO, because while the Exchange believes Market-Makers are generally VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 willing to accept executions of their quotes that exceed the NBBO to a certain extent, it also believes executions of quotes that exceed the NBBO by too much may be erroneous. The Exchange believes blocking these potentially erroneous executions is consistent with expectations of MarketMakers and helps them manage their risk, and thus benefits investors and promotes just and equitable principles of trade. Similar to the put strike price and call underlying value check, the Exchange believes the additional risk control feature to reject a quote (both sides if entered as a two-sided quote) and cancel a Market-Maker’s resting quote (on both sides) if the System rejects an updated/ incoming quote in that series pursuant to this proposed price check is appropriate, because Market-Makers generally submit two-sided quotes, as their trading strategies and risk profiles are based in part on the spreads of their quotes, and rejecting or cancelling, as applicable, quotes on both sides of the series is consistent with this practice. The Exchange believes this operates as an additional safeguard that causes the Market-Maker to re-evaluate its quotes in the series before attempting to update its quotes again. Additionally, when a Market-Maker submits a new quote, that Market-Maker is implicitly instructing the Exchange to cancel any resting quote in the same series. Thus, even if the new quote is rejected as a result of this proposed check, the Market-Maker’s implicit instruction to cancel the resting quote remains valid nonetheless. The Exchange believes it is appropriate to have the flexibility to determine not to apply this proposed check to quotes entered during the preopening, a trading rotation or a trading halt (and to apply this check to a quote entered during those times after trading opens or resumes, as applicable, and prior to their entry into the Book) so that the check does not impact the determination of the opening price or the entry of quotes during times when pricing may be volatile and inaccurate. Additionally, this check will not apply if a senior official at the Exchange’s Help Desk determines it should not apply in the interest of maintaining a fair and orderly market. Similarly, the Exchange believes it is appropriate to have this flexibility to determine times when the check should not apply to respond to market events, such as times of extreme price volatility. This assists the Exchange’s maintenance of a fair and orderly market, which ultimately removes impediments to and perfects the mechanism of a free and open PO 00000 Frm 00130 Fmt 4703 Sfmt 4703 77055 market and protects investors and the public interest. The proposed debit and credit price reasonability checks expand the applicability of the current check to additional complex orders for which the Exchange can determine whether the order is a debit or credit. By expanding the orders to which these checks apply, the Exchange can further assist with the maintenance of a fair and orderly market by mitigating the potential risks associated with additional complex orders trading at prices that are inconsistent with their strategies (which may result in executions at prices that are extreme and potentially erroneous), which ultimately protects investors. The Exchange believes the methodology the System will use to determine whether an order is a debit or credit is consistent with general option and volatility pricing principles, which the Exchange understands are used by market participants in their option pricing models and promote just and equitable principles of trade. Because one of these principles does not necessarily apply to European-style index options, the Exchange believes it is reasonable to not apply the aspect of this proposed price check based on that principle to those options classes. In addition, the Exchange believes it is appropriate to apply this check to auction responses, as these responses can cause erroneous executions in the same manner as bids and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. The Exchange also believes the proposed rule change regarding how the proposed check will apply to AIM and SAM orders is reasonable, as the proposed rule change is consistent with the contingencies attached to those pairs of orders. The nonsubstantive changes to this provision and the addition of defined strategies clarify the applicability of the price check using terms generally used throughout the industry, which will benefit investors. The proposed maximum value acceptable price range will further assist with the maintenance of a fair and orderly market by helping to mitigate the potential risks associated with orders that have strategies with quantifiable maximum possible values trading at prices that are extreme or ‘‘too far away’’ from that value and thus that are potentially erroneous. While the Exchange believes Participants are generally willing to accept executions at prices that exceed the maximum possible value of the applicable spread to a certain extent, executions that exceed the maximum possible value by E:\FR\FM\11DEN1.SGM 11DEN1 jstallworth on DSK7TPTVN1PROD with NOTICES 77056 Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices too much may be erroneous. The Exchange believes the methodology to determine the acceptable price range is reasonable because using a percentage amount provides Participants with precise protection, while the pre-set range amounts ensure that, with respect to strategies with larger or smaller maximum values, the acceptable price range cannot be too wide or narrow to the point that the price check would become ineffective. The Exchange believes blocking these potentially erroneous executions are consistent with expectations of Participants with respect to these strategies and will thus protect investors. As discussed above, the Exchange believes it is appropriate to apply this check to auction responses, as these responses can cause erroneous executions in the same manner as bids and orders and thus should be subject to this proposed price protection to further help prevent potentially erroneous executions. The Exchange also believes the proposed rule change regarding how the proposed check will apply to AIM and SAM orders is reasonable, as the proposed rule change is consistent with the contingencies attached to those pairs of orders. Three of the proposed price checks are substantially similar to those included in other options exchanges’ rules: • The put strike price and call underlying value checks are substantially similar to NYSE Arca, Inc. (‘‘NYSE Arca’’) Rule 6.61(a)(2) and (3) (note that C2’s proposed checks apply to orders and quotes (as well as auction responses) while NYSE Arca’s checks apply only to quotes); • the quote price reasonability check is substantially similar to NYSE Arca Rule 6.61(a)(1) (note that NYSE Arca uses percentage and dollar thresholds, which is consistent with the parameters used in its limit order price check, while the proposed rule uses tick distance, which is consistent with the parameters used in C2’s limit order price check); and • the maximum value acceptable price range is substantially similar to NASDAQ OMX PHLX, Inc. (‘‘PHLX’’) Rule 1080, Interpretation and Policy .07(g) (note that the PHLX rule applies to vertical and time spreads, while the proposed rule applies to vertical, true butterfly and box spreads). The fourth price check is an expansion of the applicability of a price check already included in C2’s rules. competition that is not necessary or appropriate in furtherance of the purposes of the Act. The proposed rule change adds price protection mechanisms for orders and quotes of all Participants submitted to C2 to help further prevent potentially erroneous executions, which benefits all market participants. The price checks apply to all incoming orders and quotes of all Participants in the same manner. The quote price reasonability check applies only to Market-Maker quotes, because the Rules currently have a similar price check that applies to orders. Additionally, the Exchange believes this type of protection for Market-Makers is appropriate given their unique role in the market and may encourage MarketMakers to quote tighter and deeper markets, which will increase liquidity and enhance competition, given the additional protection these price checks provide. The Exchange believes the proposed rule change would provide market participants with additional protection from anomalous or erroneous executions. B. Self-Regulatory Organization’s Statement on Burden on Competition C2 does not believe that the proposed rule change will impose any burden on Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or VerDate Sep<11>2014 14:55 Dec 10, 2015 Jkt 238001 C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others The Exchange neither solicited nor received comments on the proposed rule change. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or within such longer period up to 90 days (i) as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the Exchange consents, the Commission will: A. by order approve or disapprove such proposed rule change, or B. institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as modified by Amendment No. 1, is consistent with the Act. Comments may be submitted by any of the following methods: PO 00000 Frm 00131 Fmt 4703 Sfmt 9990 • Send an email to rule-comments@ sec.gov. Please include File Number SR– C2–2015–033 on the subject line. Paper Comments • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–C2–2015–033. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–C2– 2015–033 and should be submitted on or before January 4, 2016. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.40 Robert W. Errett, Deputy Secretary. [FR Doc. 2015–31280 Filed 12–10–15; 8:45 am] BILLING CODE 8011–01–P 40 17 E:\FR\FM\11DEN1.SGM CFR 200.30–3(a)(12). 11DEN1

Agencies

[Federal Register Volume 80, Number 238 (Friday, December 11, 2015)]
[Notices]
[Pages 77047-77056]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-31280]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-76584; File No. SR-C2-2015-033]


Self-Regulatory Organizations; C2 Options Exchange, Incorporated; 
Notice of Filing of a Proposed Rule Change, as Modified by Amendment 
No. 1 Thereto, Relating to Price Protection Mechanisms

December 8, 2015.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on November 25, 2015, C2 Options Exchange, Incorporated (the 
``Exchange'' or ``C2'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I, II, and III below, which Items have been prepared by the 
Exchange. On December 4, 2015, the Exchange filed Amendment No. 1 to 
the proposal.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange proposed changes to amend 
the proposed rule text of Rule 6.13, Interpretation and Policy 
.04(c) in Exhibit 5 and the purpose and statutory basis sections of 
each of the Form 19b-4 and Exhibit 1 regarding the applicability of 
the proposed enhancement to the debit/credit price reasonability 
check to index options with European-style exercises. The Exchange 
also switched the order of the rule text in Exhibit 5 so that Rule 
6.13 appears before Rule 6.17.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to enhance current and adopt new price 
protection mechanisms for orders and quotes. The text of the proposed 
rule change is available on the Exchange's Web site (https://www.c2exchange.com/Legal/), at the Exchange's Office of the Secretary, 
and at the Commission's Public Reference Room.

[[Page 77048]]

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

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

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

1. Purpose
    The Exchange has in place various price check mechanisms that are 
designed to prevent incoming orders from automatically executing at 
potentially erroneous prices.\4\ These mechanisms are designed to help 
maintain a fair and orderly market by mitigating potential risks 
associated with orders trading at prices that are extreme and 
potentially erroneous. The Exchange proposes to adopt Rule 6.17(d) and 
(e) and amend Rule 6.13, Interpretation and Policy .04, to add new, as 
well as enhance current, price protection mechanisms for orders and 
quotes to help further prevent potentially erroneous executions.
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    \4\ See, e.g., Rules 6.13, Interpretation and Policy .04 (price 
check parameters for complex orders), 6.17(a) (market-width and 
drill-through price check parameters), 6.17(b) (limit order price 
parameters), and 8.12 (quote risk monitor).
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Put Strike Price and Call Underlying Value Checks
    Proposed Rule 6.17(d) provides price protections for simple orders 
to buy put and call options based on the strike price or underlying 
value, respectively. The proposed rule provides that the System \5\ 
will reject back to the Participant a quote \6\ or buy limit order for 
(i) a put if the price of the quote bid or order is equal to or greater 
than the strike price of the option or (ii) a call if the price of the 
quote bid or order is equal to or greater than the consolidated last 
sale price of the underlying security, with respect to equity and 
exchange-traded fund (``ETF'') options, or the last disseminated 
underlying index value, with respect to index options.\7\
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    \5\ The ``System'' means the automated trading system used by 
the Exchange for the trading of options contracts. See Rule 1.1.
    \6\ The term quote includes both sides of a quote that is 
entered as a two-sided quote.
    \7\ These price checks would also apply to buy auction responses 
submitted in the various Exchange auctions, such as the Hybrid 
Agency Liaison (``HAL'') and the Automated Improvement Mechanism 
(``AIM''). See proposed Rule 6.17(d)(iii). The Exchange believes 
responses can cause erroneous executions in the same manner as 
quotes and orders and thus should be subject to this proposed price 
protection to further help prevent potentially erroneous executions.
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    With respect to put options, a Participant seeks to buy an option 
that could be exercised into the right to sell the underlying. The 
value of a put can never exceed the strike price of the option, even if 
the underlying goes to zero. For example, one put for stock ABC with a 
strike price of $50 gives the holder the right to sell 100 shares of 
ABC for $50, no more or less. Therefore, it would be illogical to pay 
more than $50 for the right to sell shares of ABC, regardless of the 
price of ABC. Pursuant to proposed Rule 6.17(d)(i)(A), the Exchange 
would deem any put bid or buyer order with a price that equals or 
exceeds the strike price of the option to be erroneous, and the 
Exchange believes it would be appropriate to reject these bids and buy 
orders.
    With respect to call options, a Participant seeks to buy an option 
that could be exercised into the right to buy the underlying. The 
Exchange does not believe that a derivative product that conveys the 
right to buy the underlying should ever be priced higher than the 
prevailing value of the underlying itself. In that case, a market 
participant could just purchase the underlying at the prevailing value 
rather than pay a larger amount for the call. Accordingly, pursuant to 
proposed Rule 6.17(d)(i)(B), the Exchange believes it is appropriate to 
reject bids or buy orders for call options with prices that are equal 
to or in excess of the value of the underlying. As an example, suppose 
a Participant submits Order 1 to buy an ABC call for $8 and Order 2 to 
buy an ABC call for $11 when the last sale price for stock ABC is $10. 
Because the price to buy for Order 2 is greater than the last sale 
price of the underlying, the System will reject Order 2. The System 
will either execute or book Order 1 in accordance with C2's rules.
    Pursuant to the proposed rule, with respect to equity and ETF 
options, the Exchange would use the consolidated last sale price of the 
underlying security, with respect to equity and ETF options, and the 
last disseminated value of the underlying index, with respect to index 
options. The Exchange notes that, in certain circumstances, the last 
sale price or index value, as applicable, may be from the close of the 
previous trading day. These circumstances include during the pre-
opening period or a delayed opening.
    As an additional risk control feature, if a Market-Maker submits a 
quote in a series in which the Market-Maker already has a resting quote 
(thus, was attempting to update a quote) and the System rejects that 
quote pursuant to either of these proposed checks, the System will 
cancel the Market-Maker's resting quote \8\ in the series. The Exchange 
believes it is appropriate to reject or cancel, as applicable, both 
sides of a quote (whether submitted as a two-sided quote or resting, 
respectively) because Market-Makers generally submit two-sided quotes, 
as their trading strategies and risk profiles are based in part on the 
spreads of their quotes, and rejecting and cancelling, as applicable, 
quotes on both sides of the series is consistent with this practice. 
The Exchange believes this operates as an additional safeguard that 
causes the Market-Maker to re-evaluate its quotes in the series before 
attempting to update its quotes again. Additionally, when a Market-
Maker submits a new quote, that Market-Maker is implicitly instructing 
the Exchange to cancel any resting quote in the same series. Thus, even 
if the new quote is rejected as a result of this proposed check, the 
Market-Maker's implicit instruction to cancel the resting quote remains 
valid nonetheless.
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    \8\ This includes any quote on the same side and opposite side 
in the series.
---------------------------------------------------------------------------

    As an example, suppose a Market-Maker has a resting two-sided quote 
in Series 1 for stock ABC of 14.00 to 16.00. The options in Series 1 
are puts with a strike price of $18.00. The Market-Maker submits an 
updated two-sided quote of 18.00 to 19.00. Because the quote bid is the 
same as the strike price for Series 1, the System will reject the 18.00 
quote bid and the 19.00 quote offer. Additionally, the System will 
cancel the Market-Maker's resting quote in Series 1 of 14.00 to 16.00. 
The Market-Maker then submits a new two-sided quote of 16.00 to 17.00, 
which the System accepts.
    Proposed Rule 6.17(d)(ii) provides that the Exchange may determine 
not to apply to a class either the put check or the call check 
described above if a senior official at the Exchange's Help Desk 
determines it should not apply in the interest of maintaining a fair 
and orderly market.\9\ Additionally, the call check does not apply to 
adjusted classes or if the data for the underlying is not available. As 
these price checks are

[[Page 77049]]

intended to assist with the maintenance of fair and orderly markets, 
the Exchange may believe it is appropriate to disable either of these 
checks in response to a market event (for example, if dissemination of 
data was delayed and resulting in unreliable underlying values). If the 
data for the underlying is not available (for example, if the 
underlying exchange is not disseminating data or if the applicable 
securities information processor is down), then the System cannot 
perform the check, which is why the check will not apply in that 
situation. Additionally, the call check does not apply to options in an 
adjusted series, which is an option series for which, as a result of a 
corporate action by the issuer of the security underlying such option 
series, one option contract in the series represents the delivery of 
other than 100 shares of underlying stock or units. After a corporate 
action and subsequent adjustment to the existing options, the series 
receives a new symbol, while exchanges listing options on the 
underlying security that undergoes a corporate action resulting in an 
adjusted series will generally list a new standard option series for 
that underlying. Therefore, because trading of options in adjusted 
series may not accurately reflect the value of the underlying (as the 
new standard series would), the Exchange believes it appropriate to not 
apply these checks to options in these series.
---------------------------------------------------------------------------

    \9\ Pursuant to Exchange procedures, any decision to not apply 
the put check or call check, as well as the reason for the decision, 
will be documented and retained.
---------------------------------------------------------------------------

    To the extent a Participant submits a pair of orders to AIM \10\ or 
the Solicitation Auction Mechanism (``SAM''),\11\ these proposed checks 
will apply to both orders in the pair. If the System rejects either 
order in the pair pursuant to the applicable check, then the System 
will also cancel the paired order. It is the intent of these paired 
orders to execute against each other. Thus, the Exchange believes it is 
appropriate to reject both orders if one does not satisfy the price 
checks to be consistent with the intent of the submitting Participant. 
Notwithstanding the foregoing, with respect to an AIM order that 
instructs the System to process the agency order as an unpaired order 
if an AIM auction cannot be initiated (for example, if the contra-side 
order does not stop the agency order at the price required by Rule 
6.51(a)(2)), if the System rejects the agency order pursuant to the 
applicable check, then the System will also reject the contra-side 
order. However, if the System rejects the contra-side order pursuant to 
the applicable check, the System will accept the agency order (assuming 
it satisfies the applicable check). The purpose of the contingency to 
treat the agency order as an unpaired order provides the opportunity 
for that order (which is a customer of the submitting Participant) to 
execute despite not entering an AIM auction pursuant to which the order 
may execute against a facilitation or solicitation order of the 
Participant. The Exchange believes the proposed rule change is 
consistent with that contingency.
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    \10\ See Rule 6.51 for a description of the AIM auction process.
    \11\ See Rule 6.52 for a description of the SAM auction process.
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Quote Inverting NBBO Check
    Currently, the Exchange applies price reasonability checks to limit 
orders.\12\ Proposed Rule 6.17(e) sets forth a national best bid or 
offer (``NBBO'') price reasonability check that would apply to Market-
Maker quotes. This check would similarly compare quote bids with the 
national best offer (``NBO'') and quote offers with the national best 
bid (``NBB''). Specifically, if C2 is at the NBO (NBB), the System will 
reject a quote \13\ back to a Market-Maker if the quote bid (offer) 
crosses the NBO (NBB) \14\ by more than a number of ticks specified by 
the Exchange (which will be no less than three minimum increment ticks 
and announced to Participants by Regulatory Circular). If C2 is not at 
the NBO (NBB), the System rejects a quote back to a Market-Maker if the 
quote bid (offer) locks or crosses the NBO (NBB). The System will 
reject any inbound Market-Maker quotes that do not satisfy these 
parameters as presumptively erroneous. The Exchange believes that using 
specified tick distance is appropriate because that is the parameter 
used for the corresponding limit order reasonability check and because 
it provides Market-Makers a precise price protection.\15\ While the 
limit order price check parameter indicates the Exchange may set the 
acceptable tick distance to be no less than five minimum increments, 
the Exchange believes it is reasonable to be able to set the acceptable 
tick distance to be tighter for the quote price reasonability check (no 
less than three minimum increments) to provide additional protection to 
Market-Makers given their unique role in the market, which could 
encourage Market-Makers to quote tighter and deeper markets. The 
Exchange believes having a minimum tick distance of more than three 
would be ineffective.
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    \12\ See Rule 6.17(b).
    \13\ See supra note 6.
    \14\ If the NBBO is unavailable, locked or crossed (and thus 
unreliable), then this check will compare the quote to the 
Exchange's best bid or offer (``BBO'') (if available). See proposed 
Rule 6.17(e)(i).
    \15\ See supra note 12.
---------------------------------------------------------------------------

    As an additional risk control feature, if a Market-Maker submits a 
quote in a series in which the Market-Maker already has a resting quote 
(thus, was attempting to update a quote) and the System rejects that 
quote pursuant to this proposed check, the System will cancel the 
Market-Maker's resting quote \16\ in the series. The Exchange believes 
it is appropriate to reject or cancel, as applicable, both sides of a 
quote (whether submitted as a two-sided quote or resting, respectively) 
because Market-Makers generally submit two-sided quotes, as their 
trading strategies and risk profiles are based in part on the spreads 
of their quotes, and rejecting and cancelling, as applicable, quotes on 
both sides of the series is consistent with this practice. The Exchange 
believes this operates as an additional safeguard that causes the 
Market-Maker to re-evaluate its quotes in the series before attempting 
to update its quotes again. Additionally, when a Market-Maker submits a 
new quote, that Market-Maker is implicitly instructing the Exchange to 
cancel any resting quote in the same series. Thus, even if the new 
quote is rejected as a result of this proposed check, the Market-
Maker's implicit instruction to cancel the resting quote remains valid 
nonetheless.
---------------------------------------------------------------------------

    \16\ This includes any quote on the same side and opposite side 
in the series.
---------------------------------------------------------------------------

    For example, suppose the Exchange has set a tick distance of three 
in a class. The minimum increment for that class is $0.05 for series 
quoted below $3 and $0.10 for series quotes at $3 and above,\17\ and 
the NBBO is 3.10 to 3.40. Suppose a Market-Maker submits a bid of 3.80. 
Because this bid is more than three ticks above the NBO of 3.40, the 
System rejects the bid. Similarly, suppose a Market-Maker submits an 
offer of 2.85. Because this offer is more than three ticks below the 
NBB of 3.10, the System rejects the offer.
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    \17\ See Rule 6.4.
---------------------------------------------------------------------------

    Proposed Rule 6.17(e)(ii) provides that the Exchange may determine 
not to apply this proposed check to quotes entered during the pre-
opening, a trading rotation or a trading halt, which it will announce 
to Participants by Regulatory Circular. The Exchange believes it is 
appropriate to have the ability to not apply this check during the pre-
open or opening rotation so that the check does not impact the 
determination of the opening price. However, the Exchange may determine 
that there is sufficient information during those times (such as if 
another exchange is disseminating pricing

[[Page 77050]]

information) to apply the check. The Exchange also may not want to 
apply this check during halts, as pricing during that time may be 
volatile and inaccurate. Additionally, this check will not apply if a 
senior official at the Exchange's Help Desk determines it should not 
apply in the interest of maintaining a fair and orderly market.\18\ The 
Exchange believes it is appropriate to have this flexibility to 
determine times when the check should not apply to respond to market 
events, such as times of extreme price volatility.
---------------------------------------------------------------------------

    \18\ See supra note 9.
---------------------------------------------------------------------------

    Proposed Rule 6.17(e)(iii) states that if the System accepts a 
quote that locks or crosses the NBBO (which may occur if the proposed 
check is not applied to a quote pursuant to the proposed rule or if a 
quote inverts the NBBO but by no more than the specified number of 
ticks), the System will execute the quote bid (offer) against quotes 
and orders in the book at a price(s) that is the same or better than 
the best price disseminated by away exchanges up to the size available 
on the Exchange. If there is any remaining size of the quote after this 
execution, the System either (i) cancels any remaining size of the 
quote, if the price of the quote locks or crosses the price 
disseminated by the away exchange(s) or (ii) books any remaining size 
of the quote, if the price of the quote does not lock or cross the 
price of the away exchange(s). While the Exchange believes Market-
Makers are generally willing to accept executions of their quotes that 
exceed the NBBO to a certain extent, it also believes executions of 
quotes that exceed the NBBO by too much may be potentially erroneous 
executions. The Exchange believes blocking these potentially erroneous 
executions is consistent with expectations of Market-Makers and helps 
them manage their risk. Cancelling the remaining size of the quote 
after it partially executes against orders and quotes on the Exchange 
if the remaining size would be at a price that locks or crosses the 
best price disseminated from an away market is similarly intended to 
prevent trade-throughs and displays of crossed markets. Similarly, 
rejecting quotes that would lock or cross the NBBO if C2 was not at the 
NBBO is intended to prevent trade-throughs and displays of locked and 
crossed markets. Unlike orders that may be routed to other options 
exchanges for executions, quotes may only execute against quotes or 
orders on C2. Thus, if C2 is not at the NBBO, a quote may not execute 
against a quote or order that is at the NBBO.
    For example, suppose the NBBO is 1.00 to 1.20, and a Market-Maker 
submits a quote bid for 100 contracts at 1.24. Assuming this class has 
a minimum increment of 0.01 and the Exchange set the tick distance for 
this check at five, the System accepts this quote because it only 
inverts the NBO by four ticks. C2 has an order to sell 10 at 1.20, an 
order to sell 20 at 1.21, an order to sell 10 at 1.22, an order to sell 
10 at 1.23 and an order to sell 20 at 1.24 resting on the book. The 
best offer disseminated by an away exchange is 1.23. The incoming quote 
bid will execute against the order to sell at 1.20 (10 contracts), the 
order to sell at 1.21 (20 contracts), the order to sell at 1.22 (10 
contracts) and the order to sell at 1.23 (10 contracts), for a total of 
50 contracts. The quote will not execute against the order to sell at 
1.24, because that would result in a trade-through of the best 
disseminated offer from an away exchange of 1.23. The System cancels 
the remaining 50 contracts, because the bid price of 1.23 would invert 
the best disseminated market from an away exchange. If, instead, the 
quote bid in the above example was for 1.22 rather than 1.24, it would 
execute against the order to sell at 1.20 (10 contracts), the order to 
sell at 1.21 (20 contracts) and the order to sell at 1.22 (10 
contracts). The System would book the remaining 60 contracts of the 
quote at the bid price of 1.22, which would not lock or cross the best 
disseminated offer by an away exchange (1.23 in the above example). 
Alternatively, if in the above example the NBO of 1.20 was disseminated 
from an away exchange, the System would reject the quote bid of 1.24, 
because it would cross the best disseminated offer of an away exchange.
Debit/Credit Price Reasonability Checks
    Current Rule 6.13, Interpretation and Policy .04(c) provides that 
the System will not automatically execute certain vertical and 
butterfly complex orders \19\ that appear to be erroneously priced 
because the prices are inconsistent with particular complex order 
strategies.\20\ Specifically, the System will not automatically execute 
a limit order with a net credit price when it clearly should have been 
entered at a net debit price, a limit order with a net debit price when 
it clearly should have been entered at a net credit price, or a market 
order that would be executed at a net debit price when it clearly 
should execute at a net credit price.\21\
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    \19\ The proposed rule change adds definitions for vertical and 
butterfly complex orders (or spreads) and proposes to use these 
terms for the various price checks in Interpretation and Policy .04, 
as applicable, as those are the common trading terms used by market 
participants in the industry that refer to these strategies. See, 
e.g., CBOE Options Dictionary, available at https://www.cboe.com/LearnCenter/Glossary.aspx; and NASDAQ Options Trading Glossary, 
available at https://www.stocks-options-trading.com/glossary_options.asp. A ``vertical'' spread is a two-legged complex 
order with one leg to buy a number of calls (puts) and one leg to 
sell the same number of calls (puts) with the same expiration date 
but different exercise prices. A ``butterfly'' spread is a three-
legged complex order with two legs to buy (sell) the same number of 
calls (puts) and one leg to sell (buy) twice as many calls (puts), 
all with the same expiration date but different exercise prices, and 
the exercise price of the middle leg is between the exercise prices 
of the other legs. If the exercise price of the middle leg is 
halfway between the exercise prices of the other legs, it is a 
``true'' butterfly; otherwise, it is a ``skewed'' butterfly.
    \20\ Pursuant to the introductory paragraph of Rule 6.13, 
Interpretation and Policy .04, the current debit/credit price 
reasonability check in subparagraph (c) does not apply to stock-
option orders. The proposed debit/credit price reasonability check 
will apply to stock-option orders; therefore, the proposed rule 
change deletes the reference to subparagraph (c) from that 
introductory paragraph statement.
    \21\ A market order with a debit strategy that would result in 
an execution at a net credit price (i.e., the net sale proceeds from 
the series being sold are more than the net purchase cost of the 
series being bought) but would normally execute at a net debit price 
(i.e., the net sale proceeds from the series being sold are less 
than the net purchase cost of the series being bought) would be a 
favorable execution for the market order, and thus this price check 
would not block its execution.
---------------------------------------------------------------------------

    The proposed rule change expands the applicability of this price 
check to all complex orders for which the System can determine whether 
they are debits (orders to buy) or credits (orders to sell). The 
proposed rule change simplifies the current rule text in subparagraphs 
(c)(1) and (2) and combines them into proposed subparagraph (c)(1) to 
state that the System will not automatically execute a limit order for 
a debit strategy with a net credit price, a limit order for a credit 
strategy with a net debit price, or a market order for a credit 
strategy that would be executed at a net debit price.\22\ The System 
will reject back to the Participant any limit order, and cancel any 
market order (or remaining size after partial execution of the order), 
that does not satisfy this proposed check.\23\
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    \22\ This proposed price check will apply to auction responses. 
See proposed subparagraph (c)(4). As discussed above, the Exchange 
believes these responses can cause erroneous executions in the same 
manner as bids and orders and thus should be subject to this 
proposed price protection to further help prevent potentially 
erroneous executions. See supra note 7.
    \23\ See current and proposed subparagraph (c)(3). The proposed 
rule change amends this provision to indicate that the System 
rejects back the order rather than does not accept the order, as the 
proposed language more accurately reflects the System's actions, 
which is to send a reject message to the submitting Participant. 
Additionally, the language regarding partial executions in current 
subparagraph (c)(3) is included in proposed subparagraph (c)(3), 
with the change that the remainder of the order that cannot execute 
is rejected rather than routed for manual handling and other 
nonsubstantive changes to simplify the language.

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[[Page 77051]]

    The System determines whether an order is a debit or credit based 
on general options volatility and pricing principles, which the 
Exchange understands are used by market participants in their option 
pricing models. With respect to options with the same underlying:
     If two calls have the same expiration date, the price of 
the call with the lower exercise price is more than the price of the 
call with the higher exercise price;
     if two puts have the same expiration date, the price of 
the put with the higher exercise price is more than the price of the 
put with the lower exercise price; and
     if two calls (puts) have the same exercise price, the 
price of the call (put) with the nearer expiration is less than the 
price of the call (put) with the farther expiration.
    The principles in the first two bullets are based on the standard 
trading principle of ``buy low, sell high.'' The ability to buy stock 
at a lower price is more valuable than the ability to buy stock at a 
higher price, and thus a call with a lower strike price has more value, 
and thus is more expensive, than a call with a higher strike price. 
Similarly, the ability to sell stock at a higher price is more valuable 
than the ability to sell stock at a lower price, and thus a put with a 
higher strike price has more value, and thus is more expensive, than a 
put with a lower strike price. The principle in the last bullet is 
based on the general concept that locking in a price further into the 
future involves more risk for the buyer and seller and thus is more 
valuable, making an option (call or put) with a farther expiration more 
expensive than an option with a nearer expiration. This is similar, for 
example, to interest rates for mortgages: In general, an interest rate 
on a 30-year mortgage is higher than the interest rate on a 15-year 
mortgage due to the risk of potential interest rate changes over the 
longer period of time to both the mortgagor and mortgagee.\24\
---------------------------------------------------------------------------

    \24\ The general principle described in the third bullet above 
does not necessarily apply to European-style index options, and thus 
the aspect of the proposed price check that is based on that general 
principle does not apply to those options, as described below. See 
proposed subparagraph (c)(2).
---------------------------------------------------------------------------

    Based on these general rules, proposed subparagraph (c)(2) provides 
that the System will define a complex order as follows:
     A call butterfly spread for which the middle leg is to 
sell (buy) and twice the exercise price of that leg is greater than or 
equal to the sum of the exercise prices of the buy (sell) legs is a 
debit (credit) (because the ``aggregate'' exercise price of the sell 
(buy) leg is the same or higher than the ``aggregate'' exercise price 
of the buy (sell) legs and thus the sell (buy) leg is for the less 
(more) expensive option);
     a put butterfly spread for which the middle leg is to sell 
(buy) and twice the exercise price of that leg is less than or equal to 
the sum of the exercise prices of the buy (sell) legs is a debit 
(credit) (because the ``aggregate'' exercise price of the sell (buy) 
leg is the same or less than the ``aggregate'' exercise price of the 
buy (sell) leg and thus the sell (buy) leg is for the less (more) 
expensive option); and
     an order for which all pairs and loners are debits 
(credits) is a debit (credit).
    The Exchange believes that these categories are consistent with 
Participants' expectations of pricing for these strategies.
    A ``pair'' is a pair of legs in an order for which both legs are 
calls or both legs are puts, one leg is a buy and one leg is a sell, 
and both legs have the same expiration date but different exercise 
prices or, for all options except European-style index options, the 
same exercise price but different expiration dates. Based on the 
general option pricing rules described above, the System can determine 
whether a pair is a debit or credit. Being able to determine whether a 
pair of legs with the same exercise price but different expiration 
dates is a debit or credit is based on the general principle above that 
if two calls (puts) have the same exercise price, the price of the call 
(put) with the nearer expiration is less than the price of the call 
(put) with the farther expiration. As discussed above, this principle 
does not apply to European-style index options. Therefore, legs of 
complex orders for European-style index options may be paired only if 
they have the same expiration date but different exercise prices (and 
meet the other pairing criteria described above), but not if they have 
the same exercise price but different expiration dates--the System will 
skip this pairing step for European-style index options--and instead 
will be loners. A ``loner'' is any leg in an order that the System 
cannot pair with another leg in the order (including, as noted earlier 
in this paragraph, legs in orders for European-style index options that 
have the same exercise price but different expiration dates).\25\ The 
System will first pair legs to the extent possible within each 
expiration date, pairing one leg with the leg that has the next highest 
exercise price. The System will then, for all options except European-
style index options, pair legs to the extent possible with the same 
exercise price across expiration dates, pairing one leg with the leg 
that has the next nearest expiration date.
---------------------------------------------------------------------------

    \25\ The System treats the stock leg of a stock-option order as 
a loner.
---------------------------------------------------------------------------

     A pair of calls is a credit (debit) if the exercise price 
of the buy (sell) is higher than the exercise price of the sell (buy) 
leg (if the pair has the same expiration date) or if the expiration 
date of the sell (buy) leg is farther than the expiration date of the 
buy (sell) leg (if the pair has the same exercise price).
     A pair of puts is a credit (debit) if the exercise price 
of the sell (buy) leg is higher than the exercise price of the buy 
(sell) leg (if the pair has the same expiration date) or if the 
expiration date of the sell (buy) leg is farther than the expiration 
date of the buy (sell) leg (if the pair has the same exercise price).
     A loner to buy is a debit.
     A loner to sell is a credit.
    If the System cannot determine whether a complex order is a debit 
or credit based on these categories, it will not apply this proposed 
check to the order.
    Based on this proposed provision, a vertical spread to buy one call 
(put) and sell one call (put) will have one pair. A vertical spread to 
buy more than one call (put) and sell more than one call (put) will 
have the same number of pairs as calls (puts) in each leg of the 
spread. For example, a vertical spread to buy three Jan 10 calls and 
three Jan 20 calls contains three identical pairs that each consist of 
a buy Jan 10 call and a sell Jan 20 call. Because the pairs are 
identical, they will all be debits or credits, and thus the System can 
define vertical spreads as debits or credits. The System would pair the 
orders in a vertical spread in accordance with the proposed provision 
set forth above to determine whether it is a credit or debit.
    Below are a number of examples demonstrating how the System 
determines whether a complex order is a debit or credit, and whether 
the system will reject the order pursuant to the proposed check (for 
purposes of these examples, assume the orders are not for European-
style index options).
Example #1--Limit Call Vertical Spread
    A Participant enters a vertical spread to buy 10 Sept 30 XYZ calls 
and sell 10 Sept 20 XYZ calls at a net debit price

[[Page 77052]]

of -$10.00. The System defines this order as a credit, because the buy 
leg is for the call with the higher exercise price (and is thus the 
less expensive leg). The System rejects the order back to the 
Participant because it is a limit order for a credit strategy that 
contains a net debit price.
Example #2--Limit Put Vertical Spread
    A Participant submits a vertical spread to buy 20 Oct 30 XYZ puts 
and sell 20 Oct 20 XYZ puts at a net credit price of $9.00. The System 
defines this order as a debit, because the buy leg is for the put with 
the higher exercise price (and is thus the more expensive leg). The 
System rejects the order back to the Participant because it is a limit 
order for a debit strategy that contains a net credit price.
Example #3--Market Call Vertical Spread
    A Participant enters a market vertical spread to buy 30 Nov 20 XYZ 
calls and sell 30 Nov 10 XYZ calls. The System defines this order as a 
credit, because the buy leg is for the call with the higher exercise 
price (and is thus the less expensive leg). The current bid in the 
market for this strategy is a net debit price of -$20.00. The System 
rejects the order back to the Participant because it is a market order 
for a credit strategy that would otherwise be executed at a net debit 
price.
Example #4--Market Put Vertical Spread
    A Participant submits a market vertical spread to buy 10 Oct 20 XYZ 
puts and sell 10 Oct 10 XYZ put. The System defines this order as a 
debit, because the buy leg is for the put with the higher exercise 
price (and is thus the more expensive leg). The current offer in the 
market for this strategy is a net credit price of $8.00. The order 
executes at a net credit price of $8.00, because that is a more 
favorable execution for the Participant, and thus the price check would 
not block execution of this order.
Example #5--Limit Call Butterfly Spread (Sell 2 Outside Legs, Buy 
Middle Leg)
    A Participant submits a butterfly spread to sell 5 Jul 20 XYZ 
calls, buy 10 Jul 30 XYZ calls and sell 5 Jul 40 XYZ calls at a net 
debit price of -$15.00. The ``aggregate'' exercise price of the middle 
buy leg of 60 (2 x 30) is equal to the ``aggregate'' exercise price of 
the two outside sell legs of 60 (20 + 40), and thus the System defines 
this order as a credit. The System rejects the order back to the 
Participant because it is a limit order for a credit strategy with a 
net debit price.\26\
---------------------------------------------------------------------------

    \26\ Similar to the result in Example #3, if this butterfly 
spread was a market order, the System would reject back to the 
Participant the order because it is a market order for a credit 
strategy that would otherwise be executed at a net debit price.
---------------------------------------------------------------------------

    Example #6--Limit Call Butterfly Spread (Buy 2 Outside Legs, Sell 
Middle Leg)
    A Participant submits a butterfly spread to buy 10 Feb 20 XYZ 
calls, sell 20 Feb 25 XYZ calls and buy 10 Feb 35 XYZ calls at a net 
credit price of $20.00. The ``aggregate'' exercise price of the middle 
sell leg of 50 (2 x 25) is less than the ``aggregate'' exercise price 
of the two outside legs of 55 (20 + 35), and thus the System cannot 
determine whether the order is to buy or sell. The System therefore 
does not block execution of this order based on this price check. If 
the exercise price of the middle leg was 30 (making the ``aggregate'' 
exercise price of that leg 60), the System would have defined this 
order as a debit and rejected the order back to the Participant, since 
it would be an order for a debit strategy with a net credit price.\27\
---------------------------------------------------------------------------

    \27\ Similar to the result in Example #4, if this alternative 
butterfly spread was a market order, the order would execute at a 
net credit price, because that is a more favorable execution for the 
Participant, and thus the price check would not block execution of 
the market order.
---------------------------------------------------------------------------

Example #7--Limit Put Butterfly Spread (Sell 2 Outside Legs, Buy Middle 
Leg)
    A Participant submits a butterfly spread to sell 20 Aug 10 XYZ 
puts, buy 40 Aug 20 XYZ puts and sell 20 Aug XYZ 30 puts at a net debit 
price of -$20.00. The ``aggregate'' exercise price of the middle buy 
leg of 40 (2 x 20) is equal to the ``aggregate'' exercise price of the 
two outside sell legs of 40 (10 + 30), and thus the System defines this 
order as a credit. The System rejects the order back to the Participant 
because it is a limit order for a credit strategy with a net debit 
price.\28\
---------------------------------------------------------------------------

    \28\ See supra note 26.
---------------------------------------------------------------------------

Example #8--Limit Put Butterfly Spread (Buy 2 Outside Legs, Sell Middle 
Leg)
    A Participant submits a butterfly spread to buy 5 Apr 35 XYZ puts, 
sell 10 Apr 45 XYZ puts and buy 5 Apr 50 XYZ puts at a net credit price 
of $25.00. The ``aggregate'' exercise price of the middle sell leg of 
90 (2 x 45) is more than the ``aggregate'' exercise price of the two 
outside legs of 85 (35 + 50), and thus the System cannot determine 
whether the order is a debit or credit. The System therefore does not 
block execution of this order based on this price check. If the 
exercise price of the middle leg was 40 (making the ``aggregate'' 
exercise price of that leg 80), the System would have defined this 
order as a debit and rejected the order back to the Participant, since 
it would be a limit order for a debit strategy with a net credit 
price.\29\
---------------------------------------------------------------------------

    \29\ See supra note 27.
---------------------------------------------------------------------------

Example #9--3-Legged Complex Order (Same Expiration, Different Strikes)
    A Participant submits a complex order to buy 1 Jan 10 XYZ calls, 
sell 2 Jan 20 XYZ calls and buy 1 Jan 15 XYZ put at a net debit price 
of -$8.00. The System pairs one of the sell Jan 20 calls with the buy 
Jan 10 call and defines it as a debit, because the buy leg is for the 
lower exercise price (and thus is more expensive). There are two loners 
remaining: the other sell Jan 20 call, which the System defines as a 
credit, and the buy Jan 15 put, which the System defines as a debit. 
Because not all pairs and loners are debits or credits (the pair and 
one loner are debits and the other loner is a credit), the System 
cannot determine whether the order is a debit or credit. The System 
therefore does not block execution of this order based on this price 
check.
Example #10--4-Legged Complex Order (Same Strike, Different 
Expirations)
    A Participant submits a complex order to buy 1 Feb 15 XYZ call, to 
sell 1 Jan 15 XYZ call, to buy 1 Jun 15 XYZ put, and to sell 1 Apr 15 
XYZ put at a net credit price of $12.00. The System pairs the two 
calls, which the System defines a debit (because the buy leg is for the 
call with the farther expiration date and is thus more expensive), and 
the two puts, which the System defines as a debit (because the buy leg 
is for the call with the farther expiration date and is thus more 
expensive). There are no loners. Because all pairs are debits, the 
System defines this order as a debit. The System rejects the order back 
to the Participant, since it is a limit order for a debit strategy with 
a net credit price.
Example #11--7-Legged Complex Order \30\ (Different Strikes and 
Expirations)
---------------------------------------------------------------------------

    \30\ Currently, the System only accepts complex order with two, 
three or four legs. This example is included to demonstrate the 
pairing of orders. To the extent the Exchange determines to accept 
complex orders with more than four legs, the pairing in this example 
would apply.
---------------------------------------------------------------------------

    A Participant submits a complex order with the following legs:
     Sell 1 Apr 10 XYZ put;
     buy 1 Mar 20 XYZ call;
     buy 1 Mar 25 XYZ call;
     buy 2 Mar 30 XYZ put;
     sell 2 Mar 35 XYZ put;
     buy 2 Jun 20 XYZ calls; and

[[Page 77053]]

     sell 2 Jul 20 XYZ calls.
    The System pairs (i) the buy 1 Mar 20 call with one of the sell Jul 
20 calls and (ii) one of the buy Jun 20 calls with the other sell Jul 
20 calls (there are no call pairs with the same expiration date but 
different exercise prices). The System defines both of these call pairs 
as credits because the buy leg of each pair has the nearer expiration 
date and is thus less expensive. There are two loner calls remaining: 
The buy Mar 25 call and the other buy Jun 20 call, both of which the 
System defines as debits. The System then pairs (i) one of the buy Mar 
30 puts with one of the sell Mar 35 puts and (ii) the other buy Mar 30 
put with the other sell Mar 35 put. The System defines both of these 
put pairs as credits because the buy leg of each pair is for the lower 
exercise price (and is thus less expensive). The sell Apr 10 put is the 
remaining loner put, which the System defines as a credit. Because not 
all pairs and loners are debits or credits (four pairs and one loner 
are credits but two other loners are debits), the System cannot define 
the order as a debit or credit. The System therefore does not block 
execution of this order based on this price check.
    To the extent a Participant submits a pair of orders to AIM or SAM, 
this proposed check will apply to both orders in the pair. If the 
System rejects either order in the pair pursuant to the applicable 
check, then the System will also cancel the paired order. As discussed 
above, it is the intent of these paired orders to execute against each 
other. Thus, the Exchange believes it is appropriate to reject both 
orders if one does not satisfy the price checks to be consistent with 
the intent of the submitting Participant. Notwithstanding the 
foregoing, with respect to an AIM order that instructs the System to 
process the agency order as an unpaired order if an AIM auction cannot 
be initiated (for example, if the contra-side order does not stop the 
agency order at the price required by Rule 6.51(a)(2)), if the System 
rejects the agency order pursuant to the applicable check, then the 
System will also reject the contra-side order. However, if the System 
rejects the contra-side order pursuant to the applicable check, the 
System will accept the agency order (assuming it satisfies the 
applicable check).\31\ The purpose of the contingency to treat the 
agency order as an unpaired order provides the opportunity for that 
order (which is a customer of the submitting Participant) to execute 
despite not entering an AIM auction pursuant to which the order may 
execute against a facilitation or solicitation order of the 
Participant. The Exchange believes the proposed rule change is 
consistent with that contingency.
---------------------------------------------------------------------------

    \31\ See proposed subparagraph (c)(5).
---------------------------------------------------------------------------

Maximum Value Acceptable Price Range
    Proposed Rule 6.13, Interpretation and Policy .04(h) adds an 
additional price check for vertical, true butterfly and box 
spreads.\32\ These strategies have quantifiable maximum possible 
values, and the Exchange proposes to subject these strategies to a 
price check that would block executions at prices that exceed their 
maximum possible values by more than a reasonable amount. While the 
Exchange believes Participants are generally willing to accept 
executions at prices that exceed the maximum possible value of the 
applicable spread to a certain extent, executions that exceed the 
maximum possible value by too much may be erroneous. The Exchange 
believes blocking these potentially erroneous executions are consistent 
with expectations of Participants with respect to these strategies. 
This check is intended to be a second layer of protection to prevent 
executions of orders at potentially erroneous prices that were not on 
face erroneous (and thus not rejected pursuant to the proposed debit/
credit check described above). For example, a limit order for a debit 
strategy at a net debit price will not be rejected pursuant to the 
proposed debit/credit check above; however, the net debit price may be 
too far above the maximum possible value of the order that it is 
potentially erroneous.
---------------------------------------------------------------------------

    \32\ See supra note 19 for definitions of vertical and true 
butterfly spreads. The proposed rule change also adds a definition 
for box spreads and proposes to use these terms for the various 
price checks in Interpretation and Policy .04, as applicable, it is 
also the common trading term used by market participants in the 
industry that refers to this strategy. See, e.g., CBOE Options 
Dictionary, available at https://www.cboe.com/LearnCenter/Glossary.aspx; and NASDAQ Options Trading Glossary, available at 
https://www.stocks-options-trading.com/glossary_options.asp. A ``box 
spread'' is a four-legged complex order with one leg to buy calls 
and one leg to sell puts with one strike price, and one leg to sell 
calls and one leg to buy puts with another strike price, all of 
which have the same expiration date and are for the same number of 
contracts.
---------------------------------------------------------------------------

    Specifically, proposed paragraph (h) states that if an order is a 
vertical, true butterfly or box spread, the System will not 
automatically execute a limit order for a net credit price or net debit 
price, or a market order for a debit strategy if it would execute at a 
net debit price, that is outside of an acceptable price range.\33\ 
Pursuant to proposed subparagraph (h)(1), the System determines the 
acceptable price range as follows:
---------------------------------------------------------------------------

    \33\ This proposed price check will also apply to auction 
responses. See proposed subparagraph (h)(3). As discussed above, the 
Exchange believes these responses can cause erroneous executions in 
the same manner as bids and orders and thus should be subject to 
this proposed price protection to further help prevent potentially 
erroneous executions. See supra note 7.
---------------------------------------------------------------------------

     The maximum possible value of a vertical spread is the 
difference between the exercise prices of the two legs.
     The maximum possible value of a true butterfly spread is 
the difference between the exercise prices of the middle leg and the 
legs on either side.
     The maximum possible value of a box spread is the 
difference between the exercise prices of each pair of legs.
     The minimum possible value of the spread is zero.
     The System will calculate the amount that is a percentage 
of the maximum possible value of the spread (the ``percentage 
amount''), which percentage the Exchange will determine and announce to 
Participants by Regulatory Circular.
     The acceptable price range is zero to the maximum possible 
value of the spread plus:
     The percentage amount, if that amount is not outside a 
pre-set range (the Exchange will determine the pre-set range minimum 
and maximum amounts and announce them to Participants by Regulatory 
Circular);
     the pre-set minimum, if the percentage amount is less than 
the pre-set minimum; or
     the pre-set maximum, if the percentage amount is greater 
than the pre-set maximum.
    The System will reject back to the Participant any limit order, and 
cancel any market order (or remaining size after partial execution of 
the order), that does not satisfy this proposed check.\34\
---------------------------------------------------------------------------

    \34\ See proposed subparagraph (h)(2).
---------------------------------------------------------------------------

Example #1--Vertical Spread
    Assume the pre-set range is 0.05 to 0.50 and the percentage is 5%. 
A Participant submits a complex order to buy 1 Aug 25 XYZ call and sell 
1 Aug 30 XYZ call, which is a market order for a debit strategy. The 
maximum possible value of the vertical spread is $5 (30-25), and the 
percentage amount is 0.25 (5% of $5), which is within the pre-set 
range. Therefore, the acceptable price range is 0 to 5.25. The best net 
offer price is $6.60. The System rejects the order back to the 
Participant, because the order would otherwise execute at a price that 
is outside of the acceptable price range. If the market changed so that 
the best net offer price is $5.20 and the Participant resubmitted the 
order, the System would not block

[[Page 77054]]

execution of the order, as the execution price would be within the 
acceptable price range.
Example # 2--Butterfly Spread
    Assume the pre-set range is 0.30 to 0.90 and the percentage is 2%. 
A Participant submits a complex order to buy 1 Nov 10 XYZ put, sell 2 
Nov 20 XYZ puts and buy 1 Nov 30 XYZ, which is an order for a debit 
strategy with a net debit price of $7.00.\35\ The maximum possible 
value of true butterfly spread is $10 (20-10, 30-20) and the percentage 
amount is 0.2 (2% of $10), which is less than the pre-set range minimum 
amount of 0.30. Therefore, the acceptable price range is 0 to 5.30. The 
System rejects the order back to the Participant, because the net debit 
price of $7.00 is outside of the acceptable price range. If the 
Participant resubmitted the order with a net debit price of $5.00, the 
System would not block execution of the order, as the limit price is 
within the acceptable price range.
---------------------------------------------------------------------------

    \35\ Generally, a net debit price is referred to as having a 
negative price (e.g., -$7.00). For purposes of this proposed check, 
the absolute value of the net debit price (e.g., $7.00) is used.
---------------------------------------------------------------------------

Example # 3--Box Spread
    Assume the pre-set range is 0.20 to 0.60 and the percentage is 3%. 
A Participant submits a complex order to buy 1 Mar 45 XYZ call, sell 1 
Mar 45 XYZ put, sell 1 Mar 20 XYZ call and buy 1 Mar 20 XYZ put, which 
is an order for a credit strategy with a net credit price of $28.00. 
The maximum possible value of the box spread is $25 (45-20), and the 
percentage amount is 0.75 (3% of $25), which is more than the pre-set 
range maximum amount of 0.60. Therefore, the acceptable price range is 
0 to 25.60. The System rejects the order back to the Participant, 
because the net credit price of $28.00 is outside of the acceptable 
price range. If the Participant resubmitted the order with a net credit 
price of $24.00, the System would not block execution of the order, as 
the limit price is within the acceptable price range.
    To the extent a Participant submits a pair of orders to AIM or SAM, 
this proposed check will apply to both orders in the pair. If the 
System rejects either order in the pair pursuant to the applicable 
check, then the System will also cancel the paired order. As discussed 
above, it is the intent of these paired orders to execute against each 
other. Thus, the Exchange believes it is appropriate to reject both 
orders if one does not satisfy the price checks to be consistent with 
the intent of the submitted Participant. Notwithstanding the foregoing, 
with respect to an AIM order that instructs the System to process the 
agency order as an unpaired order if an AIM auction cannot be initiated 
(for example, if the contra-side order does not stop the agency order 
at the price required by Rule 6.51(a)(2)), if the System rejects the 
agency order pursuant to the applicable check, then the System will 
also reject the contra-side order. However, if the System rejects the 
contra-side order pursuant to the applicable check, the System will 
accept the agency order (assuming it satisfies the applicable 
check).\36\ The purpose of the contingency to treat the agency order as 
an unpaired order provides the opportunity for that order (which is a 
customer of the submitting Participant) to execute despite not entering 
an AIM auction pursuant to which the order may execute against a 
facilitation or solicitation order of the Participant. The Exchange 
believes the proposed rule change is consistent with that contingency.
---------------------------------------------------------------------------

    \36\ See proposed subparagraph (h)(4).
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Act and the rules and regulations thereunder applicable to the 
Exchange and, in particular, the requirements of Section 6(b) of the 
Act.\37\ Specifically, the Exchange believes the proposed rule change 
is consistent with the Section 6(b)(5) \38\ requirements that the rules 
of an exchange be designed to prevent fraudulent and manipulative acts 
and practices, to promote just and equitable principles of trade, to 
foster cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public interest. 
Additionally, the Exchange believes the proposed rule change is 
consistent with the Section 6(b)(5) \39\ requirement that the rules of 
an exchange not be designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 78f(b).
    \38\ 15 U.S.C. 78f(b)(5).
    \39\ Id.
---------------------------------------------------------------------------

    In particular, the Exchange believes the proposed price protection 
mechanisms will protect investors and the public interest and maintain 
fair and orderly markets by mitigating potential risks associated with 
market participants entering orders at clearly unintended prices and 
orders trading at prices that are extreme and potentially erroneous, 
which may likely have resulted from human or operational error. The 
proposed put strike price and call underlying value checks of the 
reasonability of quotes and orders will assist in the maintenance of a 
fair and orderly market and protect investors by rejecting quotes and 
orders that exceed the corresponding benchmark (the strike price for 
puts and the value of the underlying for calls). The Exchange believes 
the additional risk control feature to reject a quote (both sides if 
entered as a two-sided quote) and cancel a Market-Maker's resting quote 
(on both sides) if the System rejects an updated/incoming quote in that 
series pursuant to this proposed price check is appropriate, because 
Market-Makers generally submit two-sided quotes, as their trading 
strategies and risk profiles are based in part on the spreads of their 
quotes, and rejecting or cancelling, as applicable, quotes on both 
sides of the series is consistent with this practice. The Exchange 
believes this operates as an additional safeguard that causes the 
Market-Maker to re-evaluate its quotes in the series before attempting 
to update its quotes again. Additionally, when a Market-Maker submits a 
new quote, that Market-Maker is implicitly instructing the Exchange to 
cancel any resting quote in the same series. Thus, even if the new 
quote is rejected as a result of this proposed check, the Market-
Maker's implicit instruction to cancel the resting quote remains valid 
nonetheless. The Exchange believes it is appropriate to apply this 
check to auction responses, as these responses can cause erroneous 
executions in the same manner as bids and orders and thus should be 
subject to this proposed price protection to further help prevent 
potentially erroneous executions. The Exchange also believes the 
proposed rule change regarding how the proposed check will apply to AIM 
and SAM orders is reasonable, as the proposed rule change is consistent 
with the contingencies attached to those types of orders.
    In addition, the Exchange believes it is appropriate to not apply 
the call price check if that value is unavailable, because the proposed 
call price check references the last value of the underlying, or to an 
adjusted series, because trading of options in adjusted series may not 
accurately reflect the value of the underlying (as the new standard 
series would). Without the current value of the underlying or with a 
potentially inaccurate underlying value, if the System continued to 
attempt to perform the check, there is risk that the System may reject 
appropriately priced orders, quotes or

[[Page 77055]]

responses, which could negatively impact market participants. The 
Exchange also believes it is appropriate to have the flexibility to 
disable the put or call check in response to a market event (for 
example, if dissemination of data was delayed and resulting in 
unreliable underlying values) to maintain a fair and orderly market. 
This will promote just and equitable principles of trade and ultimately 
protect investors.
    The Exchange believes the quote inverting NBBO check will help 
mitigate the risks associated with the entry of quotes that are priced 
a specified number of ticks through the prevailing contra-side market, 
which the Exchange believes is evidence of an error with the quotes. By 
rejecting these quotes, the Exchange believes it is promoting just and 
equitable principles of trade by preventing potential price dislocation 
that could result from erroneous Market-Maker quotes sweeping through 
multiple price points resulting in executions that cross the NBBO. 
Specifically, the Exchange believes rejecting Market-Maker quotes that 
cross the NBBO (or the BBO when the NBBO is not available) by more than 
an acceptable tick distance will remove impediments to and perfect the 
mechanism of a free and open market and protect investors and the 
public interest because it would enable the Exchange to avoid the 
submission of erroneous quotes that otherwise may cause price 
dislocation before such quotes could cause harm to the market. 
Cancellation of any remaining size of a quote that would lock or cross 
the best disseminated price by an away exchange, and rejection of a 
quote that locks or crosses the NBBO if C2 is not at the NBBO prevents 
trade-throughs and the display of locked of crossed market, consistent 
with the options linkage plan.
    The Exchange believes that using a specified tick distance is 
appropriate because that is the parameter used for the corresponding 
limit order reasonability check and because it provides Market-Makers a 
precise price protection. The Exchange believes it is reasonable to be 
able to set the acceptable tick distance to be tighter for the quote 
price reasonability check to provide additional protection to Market-
Makers given their unique role in the market, which could encourage 
Market-Makers to quote tighter and deeper markets and thus enhance 
liquidity. The Exchange believes it is appropriate to execute quotes 
that are no more than the specified number of ticks away from the NBBO, 
because while the Exchange believes Market-Makers are generally willing 
to accept executions of their quotes that exceed the NBBO to a certain 
extent, it also believes executions of quotes that exceed the NBBO by 
too much may be erroneous. The Exchange believes blocking these 
potentially erroneous e
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