Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change, as Modified by Amendment No. 1 Thereto, Relating to Price Protection Mechanisms, 77038-77047 [2015-31281]
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Federal Register / Vol. 80, No. 238 / Friday, December 11, 2015 / Notices
withdrew the proposed rule change
(SR–CBOE–2015–101).
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.4
Brent J. Fields,
Secretary.
[FR Doc. 2015–31179 Filed 12–10–15; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–76585; File No. SR–CBOE–
2015–107]
Self-Regulatory Organizations;
Chicago Board 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
24, 2015, Chicago Board Options
Exchange, Incorporated (the ‘‘Exchange’’
or ‘‘CBOE’’) 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,
as modified by Amendment No. 1, 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.cboe.com/AboutCBOE/
CBOELegalRegulatoryHome.aspx), at
the Exchange’s Office of the Secretary,
and at the Commission’s Public
Reference Room.
4 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
6.53C, Interpretation and Policy .08(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 amended Item 7(d) of the Form 19b–
4 to delete redundant language.
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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 6.14,
which was previously deleted, and
amend Rule 6.53C, Interpretation and
Policy .08, 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
Proposed Rule 6.14(a) 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 Trading
Permit Holder 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
4 See, e.g., Rules 6.12(a)(3) and (4) (limit order
price parameters), 6.13(b)(v) (market-width and
drill-through price check parameters), 6.53C,
Interpretation and Policy .08 (price check
parameters for complex orders), and 8.18 (quote risk
monitor).
5 The ‘‘System’’ refers to the Exchange’s Hybrid
Trading System, which is (i) the Exchange’s trading
platform that allows Market-Makers to submit
electronic quotes in their appointed classes and (ii)
any connectivity to the foregoing trading platform
that is administered by or on behalf of the
Exchange, such as a communications hub. See Rule
1.1(aaa).
6 The term quote includes both sides of a quote
that is entered as a two-sided quote.
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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
With respect to put options, a Trading
Permit Holder 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 6.14(a)(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 Trading
Permit Holder 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
6.14(a)(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
Trading Permit Holder 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
CBOE’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
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 6.14(a)(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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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.
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 6.14(a)(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
8 This includes any quote on the same side and
opposite side in the series.
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orderly market.9 The Exchange may also
determine not to apply the call check to
a class during Extended Trading Hours
(which the Exchange will announce to
Trading Permit Holders by Regulatory
Circular). 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
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. With respect
to Extended Trading Hours, the
underlying may not always be available
(for example, if an underlying index is
not calculated during those hours or if
an underlying stock is not traded during
those hours), or may not be appropriate
to use due to decreased liquidity and
trading during those hours, and thus the
Exchange may determine to not apply
the call check during Extended Trading
Hours in the interest of maintaining a
fair and orderly market. 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 Trading Permit Holder
submits a pair of orders to AIM,10 the
Solicitation Auction Mechanism
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.
10 See Rule 6.74A for a description of the AIM
auction process.
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(‘‘SAM’’),11 or as a qualified crosscontingent order (‘‘QCC order’’),12 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 (with respect to AIM
and SAM orders) or as a single
transaction (with respect to QCC
orders). 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 Trading Permit Holder.
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,
because there are not three MarketMakers quoting in the series as required
by Rule 6.74A(a)(4) or if the contra-side
order does not stop the agency order at
the price required by Rule 6.74A(a)(2) or
(3)), 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 Trading Permit Holder) to
execute despite not entering an AIM
auction pursuant to which the order
may execute against a facilitation or
solicitation order of the Trading Permit
Holder. 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.13
Proposed Rule 6.14(b) 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 CBOE is at the NBO (NBB), the
System will reject a quote 14 back to a
Market-Maker if the quote bid (offer)
11 See Rule 6.74B for a description of the SAM
auction process.
12 See Rule 6.53(u) for a definition of QCC orders.
13 See Rule 6.12(a)(3).
14 See supra note 4.
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crosses the NBO (NBB) 15 by more than
a number of ticks specified by the
Exchange (which will be no less than
three minimum increment ticks and
announced to Trading Permit Holders
by Regulatory Circular). If CBOE 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.16
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.
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 17 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
15 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 6.14(b)(i).
16 See supra note 11.
17 This includes any quote on the same side and
opposite side in the series.
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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,18 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 6.14(b)(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 Trading Permit
Holders 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
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.19
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 6.14(b)(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,
18 See
19 See
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supra note 7.
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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).20 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 CBOE
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 CBOE. Thus, if CBOE 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. CBOE 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
20 A quote that inverts another quote will
continue to be subject to Rule 6.45A(d)(ii) or
6.45B(d)(ii), which states that the System will not
disseminate an internally crossed market (i.e., the
CBOE best bid is higher than the CBOE best offer).
If a Market-Maker submits a quote that would invert
an existing quote, the System will change the
incoming quote such that it locks the first quote.
Locked markets are handled in accordance with the
quote lock provision in Rule 6.45A(d)(i) or
6.45B(d)(i), as applicable. During the lock period, if
the existing quote is cancelled subsequent to the
time the incoming quote is changed, the incoming
quote will automatically be restored to its original
terms.
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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.
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Debit/Credit Price Reasonability Checks
Current Rule 6.53C, Interpretation and
Policy .08(c) provides that the System
will not automatically execute certain
vertical and butterfly complex orders 21
that appear to be erroneously priced
because the prices are inconsistent with
particular complex order strategies.22
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
21 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 .08, 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
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.
22 Pursuant to the introductory paragraph of Rule
6.53C, Interpretation and Policy .08, 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.
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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.23
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.24 The System will reject back to
the Trading Permit Holder any limit
order, and cancel any market order (or
remaining size after partial execution of
the order), that does not satisfy this
proposed check.25
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
23 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.
24 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 5.
25 See current subparagraph (c)(3) and proposed
subparagraph (c)(6). 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 Trading Permit
Holder. Additionally, the proposed rule change
moves the language regarding partial executions in
current subparagraph (c)(3) to 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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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.26
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
26 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. Additionally, this proposed
price check will not apply to multi-class spreads,
as these general principles do not necessarily apply
to pricing of legs in different classes. See proposed
subparagraphs (c)(2) and (c)(6).
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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 Trading
Permit Holders’ 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
different expiration dates).27 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
27 The System treats the stock leg of a stockoption order as a loner.
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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 the
examples, assume the orders are not for
index options with European-style
exercises).
Example #1—Limit Call Vertical Spread
A Trading Permit Holder enters a
vertical spread to buy 10 Sept 30 XYZ
calls and sell 10 Sept 20 XYZ calls at
a net debit price 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 Trading Permit
Holder because it is a limit order for a
credit strategy that contains a net debit
price.
Example #2—Limit Put Vertical Spread
A Trading Permit Holder 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
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expensive leg). The System rejects the
order back to the Trading Permit Holder
because it is a limit order for a debit
strategy that contains a net credit price.
Example #3—Market Call Vertical
Spread
A Trading Permit Holder 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 Trading
Permit Holder 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 Trading Permit Holder 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 Trading Permit Holder, 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 Trading Permit Holder 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 Trading Permit
Holder because it is a limit order for a
credit strategy with a net debit price.28
Example #6—Limit Call Butterfly
Spread (Buy 2 Outside Legs, Sell Middle
Leg)
A Trading Permit Holder 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
28 Similar to the result in Example #3, if this
butterfly spread was a market order, the System
would reject back to the Trading Permit Holder the
order because it is a market order for a credit
strategy that would otherwise be executed at a net
debit price.
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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 Trading Permit Holder, since
it would be an order for a debit strategy
with a net credit price.29
Example #7—Limit Put Butterfly Spread
(Sell 2 Outside Legs, Buy Middle Leg)
A Trading Permit Holder 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 Trading Permit
Holder because it is a limit order for a
credit strategy with a net debit price.30
jstallworth on DSK7TPTVN1PROD with NOTICES
Example #8—Limit Put Butterfly Spread
(Buy 2 Outside Legs, Sell Middle Leg)
A Trading Permit Holder 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 ‘‘aggregate’’ exercise price of that leg
80), the System would have defined this
order as a debit and rejected the order
back to the Trading Permit Holder, since
it would be a limit order for a debit
strategy with a net credit price.31
Example #9—3-Legged Complex Order
(Same Expiration, Different Strikes)
A Trading Permit Holder submits a
complex order to buy 1 Jan 10 XYZ
calls, sell 2 Jan 20 XYZ calls and buy
29 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 Trading
Permit Holder, and thus the price check would not
block execution of the market order.
30 See supra note 26.
31 See supra note 27.
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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 Trading Permit Holder 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 Trading Permit
Holder, since it is a limit order for a
debit strategy with a net credit price.
Example #11—7-Legged Complex
Order 32 (Different Strikes and
Expirations)
A Trading Permit Holder 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
• 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
32 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.
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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 Trading Permit Holder
submits a pair of orders to AIM, SAM
or as a QCC orders, 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 (with respect
to AIM and SAM orders) or as a single
transaction (with respect to QCC
orders). 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 Trading Permit Holder.
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,
because there are not three MarketMakers quoting in the series as required
by Rule 6.74A(a)(4) or if the contra-side
order does not stop the agency order at
the price required by Rule 6.74A(a)(2) or
(3)), 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).33 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 Trading
Permit Holder) to execute despite not
entering an AIM auction pursuant to
which the order may execute against a
facilitation or solicitation order of the
Trading Permit Holder. The Exchange
believes the proposed rule change is
consistent with that contingency.
33 See
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jstallworth on DSK7TPTVN1PROD with NOTICES
Maximum Value Acceptable Price
Range
Proposed Rule 6.53C, Interpretation
and Policy .08(g) adds an additional
price check for vertical, true butterfly
and box spreads.34 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 Trading
Permit Holders 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 Trading Permit Holders
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 (g)
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.35 Pursuant to proposed
34 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 .08, 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.
35 This proposed price check will also apply to
auction responses. See proposed subparagraph
(g)(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 5.
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subparagraph (g)(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 Trading Permit
Holders 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 Trading Permit
Holders 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
Trading Permit Holder any limit order,
and cancel any market order (or
remaining size after partial execution of
the order), that does not satisfy this
proposed check.36
Example #1—Vertical Spread
Assume the pre-set range is 0.05 to
0.50 and the percentage is 5%. A
Trading Permit Holder 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 Trading Permit Holder, 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 Trading Permit Holder resubmitted
the order, the System would not block
execution of the order, as the execution
36 See
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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
Trading Permit Holder 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
$7.00.37 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 Trading Permit Holder,
because the net debit price of $7.00 is
outside of the acceptable price range. If
the Trading Permit Holder 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
Trading Permit Holder 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
Trading Permit Holder, because the net
credit price of $28.00 is outside of the
acceptable price range. If the Trading
Permit Holder 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 Trading Permit Holder
submits a pair of orders to AIM, SAM
or as a QCC order, 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 (with respect
to AIM and SAM orders) or as a single
transaction (with respect to QCC
orders). Thus, the Exchange believes it
is appropriate to reject both orders if
37 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.
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one does not satisfy the price checks to
be consistent with the intent of the
submitted Trading Permit Holder.
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,
because there are not three MarketMakers quoting in the series as required
by Rule 6.74A(a)(4) or if the contra-side
order does not stop the agency order at
the price required by Rule 6.74A(a)(2) or
(3)), 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).38 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 Trading
Permit Holder) to execute despite not
entering an AIM auction pursuant to
which the order may execute against a
facilitation or solicitation order of the
Trading Permit Holder. The Exchange
believes the proposed rule change is
consistent with that contingency.
jstallworth on DSK7TPTVN1PROD with NOTICES
2. Statutory Basis
The Exchange believes the proposed
rule change is consistent with the
Securities Exchange Act of 1934 (the
‘‘Act’’) and the rules and regulations
thereunder applicable to the Exchange
and, in particular, the requirements of
Section 6(b) of the Act.39 Specifically,
the Exchange believes the proposed rule
change is consistent with the Section
6(b)(5) 40 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) 41 requirement that
the rules of an exchange not be designed
38 See
proposed subparagraph (g)(4).
U.S.C. 78f(b).
40 15 U.S.C. 78f(b)(5).
41 Id.
39 15
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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
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, SAM and QCC 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,
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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
responses, which could negatively
impact market participants. Similarly,
the Exchange believes it is appropriate
to have the flexibility to not apply the
call price check during Extended
Trading Hours, as there may be no
underlying value or the underlying
value may not be appropriate to use due
to decreased liquidity and trading
during those hours. The Exchange
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 CBOE is
not at the NBBO prevents tradethroughs 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
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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
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
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Jkt 238001
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
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. Additionally, the
Exchange believes it is reasonable to not
apply this proposed check to multi-class
spreads, as these rules do not apply to
pricing of legs in different 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, SAM and QCC
orders is reasonable, as the proposed
rule change is consistent with the
contingencies attached to those pairs of
orders. The nonsubstantive changes to
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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 Trading Permit
Holders 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 the
methodology to determine the
acceptable price range is reasonable
because using a percentage amount
provides Trading Permit Holders 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 Trading Permit
Holders 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, SAM and QCC
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 CBOE’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
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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
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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
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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
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]]>Agencies
[Federal Register Volume 80, Number 238 (Friday, December 11, 2015)]
[Notices]
[Pages 77038-77047]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-31281]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-76585; File No. SR-CBOE-2015-107]
Self-Regulatory Organizations; Chicago Board 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 24, 2015, Chicago Board Options Exchange, Incorporated
(the ``Exchange'' or ``CBOE'') 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, as modified by Amendment No. 1,
from interested persons.
---------------------------------------------------------------------------
\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 6.53C, Interpretation and Policy
.08(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 amended Item 7(d) of the Form 19b-4 to delete redundant
language.
---------------------------------------------------------------------------
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.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx),
at the Exchange's Office of the Secretary, and at the Commission's
Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange 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 6.14, which
was previously deleted, and amend Rule 6.53C, Interpretation and Policy
.08, to add new, as well as enhance current, price protection
mechanisms for orders and quotes to help further prevent potentially
erroneous executions.
---------------------------------------------------------------------------
\4\ See, e.g., Rules 6.12(a)(3) and (4) (limit order price
parameters), 6.13(b)(v) (market-width and drill-through price check
parameters), 6.53C, Interpretation and Policy .08 (price check
parameters for complex orders), and 8.18 (quote risk monitor).
---------------------------------------------------------------------------
Put Strike Price and Call Underlying Value Checks
Proposed Rule 6.14(a) 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 Trading Permit Holder 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\
---------------------------------------------------------------------------
\5\ The ``System'' refers to the Exchange's Hybrid Trading
System, which is (i) the Exchange's trading platform that allows
Market-Makers to submit electronic quotes in their appointed classes
and (ii) any connectivity to the foregoing trading platform that is
administered by or on behalf of the Exchange, such as a
communications hub. See Rule 1.1(aaa).
\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 6.14(a)(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.
---------------------------------------------------------------------------
With respect to put options, a Trading Permit Holder 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
6.14(a)(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 Trading Permit Holder 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 6.14(a)(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 Trading Permit Holder 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 CBOE'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
[[Page 77039]]
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.
---------------------------------------------------------------------------
\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 6.14(a)(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\ The Exchange may also determine not to apply the
call check to a class during Extended Trading Hours (which the Exchange
will announce to Trading Permit Holders by Regulatory Circular).
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
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. With respect to Extended Trading Hours, the underlying may
not always be available (for example, if an underlying index is not
calculated during those hours or if an underlying stock is not traded
during those hours), or may not be appropriate to use due to decreased
liquidity and trading during those hours, and thus the Exchange may
determine to not apply the call check during Extended Trading Hours in
the interest of maintaining a fair and orderly market. 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.
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\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.
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To the extent a Trading Permit Holder submits a pair of orders to
AIM,\10\ the Solicitation Auction Mechanism (``SAM''),\11\ or as a
qualified cross-contingent order (``QCC order''),\12\ 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 (with respect to AIM and
SAM orders) or as a single transaction (with respect to QCC orders).
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 Trading Permit Holder. 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, because there are not three Market-Makers quoting in the
series as required by Rule 6.74A(a)(4) or if the contra-side order does
not stop the agency order at the price required by Rule 6.74A(a)(2) or
(3)), 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 Trading Permit Holder) to
execute despite not entering an AIM auction pursuant to which the order
may execute against a facilitation or solicitation order of the Trading
Permit Holder. The Exchange believes the proposed rule change is
consistent with that contingency.
---------------------------------------------------------------------------
\10\ See Rule 6.74A for a description of the AIM auction
process.
\11\ See Rule 6.74B for a description of the SAM auction
process.
\12\ See Rule 6.53(u) for a definition of QCC orders.
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Quote Inverting NBBO Check
Currently, the Exchange applies price reasonability checks to limit
orders.\13\ Proposed Rule 6.14(b) 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 CBOE is at the NBO (NBB), the System
will reject a quote \14\ back to a Market-Maker if the quote bid
(offer)
[[Page 77040]]
crosses the NBO (NBB) \15\ by more than a number of ticks specified by
the Exchange (which will be no less than three minimum increment ticks
and announced to Trading Permit Holders by Regulatory Circular). If
CBOE 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.\16\ 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.
---------------------------------------------------------------------------
\13\ See Rule 6.12(a)(3).
\14\ See supra note 4.
\15\ 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 6.14(b)(i).
\16\ See supra note 11.
---------------------------------------------------------------------------
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 \17\ 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.
---------------------------------------------------------------------------
\17\ 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,\18\ 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.
---------------------------------------------------------------------------
\18\ See Rule 6.42(3).
---------------------------------------------------------------------------
Proposed Rule 6.14(b)(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 Trading Permit Holders 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 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.\19\ 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.
---------------------------------------------------------------------------
\19\ See supra note 7.
---------------------------------------------------------------------------
Proposed Rule 6.14(b)(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).\20\ 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 CBOE 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 CBOE. Thus, if CBOE is not at the NBBO, a quote may not
execute against a quote or order that is at the NBBO.
---------------------------------------------------------------------------
\20\ A quote that inverts another quote will continue to be
subject to Rule 6.45A(d)(ii) or 6.45B(d)(ii), which states that the
System will not disseminate an internally crossed market (i.e., the
CBOE best bid is higher than the CBOE best offer). If a Market-Maker
submits a quote that would invert an existing quote, the System will
change the incoming quote such that it locks the first quote. Locked
markets are handled in accordance with the quote lock provision in
Rule 6.45A(d)(i) or 6.45B(d)(i), as applicable. During the lock
period, if the existing quote is cancelled subsequent to the time
the incoming quote is changed, the incoming quote will automatically
be restored to its original terms.
---------------------------------------------------------------------------
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. CBOE 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
[[Page 77041]]
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 6.53C, Interpretation and Policy .08(c) provides that
the System will not automatically execute certain vertical and
butterfly complex orders \21\ that appear to be erroneously priced
because the prices are inconsistent with particular complex order
strategies.\22\ 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.\23\
---------------------------------------------------------------------------
\21\ 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 .08,
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.
\22\ Pursuant to the introductory paragraph of Rule 6.53C,
Interpretation and Policy .08, 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.
\23\ 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.\24\ The System
will reject back to the Trading Permit Holder any limit order, and
cancel any market order (or remaining size after partial execution of
the order), that does not satisfy this proposed check.\25\
---------------------------------------------------------------------------
\24\ 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 5.
\25\ See current subparagraph (c)(3) and proposed subparagraph
(c)(6). 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 Trading Permit Holder. Additionally, the proposed rule
change moves the language regarding partial executions in current
subparagraph (c)(3) to 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.
---------------------------------------------------------------------------
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.\26\
---------------------------------------------------------------------------
\26\ 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.
Additionally, this proposed price check will not apply to multi-
class spreads, as these general principles do not necessarily apply
to pricing of legs in different classes. See proposed subparagraphs
(c)(2) and (c)(6).
---------------------------------------------------------------------------
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
[[Page 77042]]
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 Trading
Permit Holders' 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).\27\ 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.
---------------------------------------------------------------------------
\27\ 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 the examples, assume the orders are not for index options
with European-style exercises).
Example #1--Limit Call Vertical Spread
A Trading Permit Holder enters a vertical spread to buy 10 Sept 30
XYZ calls and sell 10 Sept 20 XYZ calls at a net debit price 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 Trading Permit
Holder because it is a limit order for a credit strategy that contains
a net debit price.
Example #2--Limit Put Vertical Spread
A Trading Permit Holder 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 Trading Permit Holder
because it is a limit order for a debit strategy that contains a net
credit price.
Example #3--Market Call Vertical Spread
A Trading Permit Holder 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 Trading Permit Holder 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 Trading Permit Holder 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 Trading Permit Holder, 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 Trading Permit Holder 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
Trading Permit Holder because it is a limit order for a credit strategy
with a net debit price.\28\
---------------------------------------------------------------------------
\28\ Similar to the result in Example #3, if this butterfly
spread was a market order, the System would reject back to the
Trading Permit Holder 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 Trading Permit Holder 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
[[Page 77043]]
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 Trading Permit
Holder, since it would be an order for a debit strategy with a net
credit price.\29\
---------------------------------------------------------------------------
\29\ 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
Trading Permit Holder, 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 Trading Permit Holder 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 Trading Permit Holder because it is a limit order for a credit
strategy with a net debit price.\30\
---------------------------------------------------------------------------
\30\ See supra note 26.
---------------------------------------------------------------------------
Example #8--Limit Put Butterfly Spread (Buy 2 Outside Legs, Sell Middle
Leg)
A Trading Permit Holder 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 Trading Permit
Holder, since it would be a limit order for a debit strategy with a net
credit price.\31\
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\31\ See supra note 27.
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Example #9--3-Legged Complex Order (Same Expiration, Different Strikes)
A Trading Permit Holder 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 Trading Permit Holder 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 Trading Permit Holder, since it is a limit order for a debit
strategy with a net credit price.
Example #11--7-Legged Complex Order \32\ (Different Strikes and
Expirations)
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\32\ 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.
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A Trading Permit Holder 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
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 Trading Permit Holder submits a pair of orders to
AIM, SAM or as a QCC orders, 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 (with respect to AIM and SAM
orders) or as a single transaction (with respect to QCC orders). 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 Trading Permit Holder. 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, because there are not three Market-Makers quoting in the
series as required by Rule 6.74A(a)(4) or if the contra-side order does
not stop the agency order at the price required by Rule 6.74A(a)(2) or
(3)), 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).\33\ 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 Trading Permit Holder) to
execute despite not entering an AIM auction pursuant to which the order
may execute against a facilitation or solicitation order of the Trading
Permit Holder. The Exchange believes the proposed rule change is
consistent with that contingency.
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\33\ See proposed subparagraph (c)(5).
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[[Page 77044]]
Maximum Value Acceptable Price Range
Proposed Rule 6.53C, Interpretation and Policy .08(g) adds an
additional price check for vertical, true butterfly and box
spreads.\34\ 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 Trading Permit Holders 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 Trading Permit Holders 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.
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\34\ 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 .08, 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.
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Specifically, proposed paragraph (g) 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.\35\
Pursuant to proposed subparagraph (g)(1), the System determines the
acceptable price range as follows:
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\35\ This proposed price check will also apply to auction
responses. See proposed subparagraph (g)(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 5.
---------------------------------------------------------------------------
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
Trading Permit Holders 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 Trading Permit Holders 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 Trading Permit Holder any limit
order, and cancel any market order (or remaining size after partial
execution of the order), that does not satisfy this proposed check.\36\
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\36\ See proposed subparagraph (g)(2).
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Example #1--Vertical Spread
Assume the pre-set range is 0.05 to 0.50 and the percentage is 5%.
A Trading Permit Holder 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
Trading Permit Holder, 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 Trading
Permit Holder resubmitted the order, the System would not block
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 Trading Permit Holder 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.\37\ 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 Trading Permit
Holder, because the net debit price of $7.00 is outside of the
acceptable price range. If the Trading Permit Holder 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.
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\37\ 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.
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Example #3--Box Spread
Assume the pre-set range is 0.20 to 0.60 and the percentage is 3%.
A Trading Permit Holder 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 Trading Permit Holder, because the net credit price of $28.00 is
outside of the acceptable price range. If the Trading Permit Holder
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 Trading Permit Holder submits a pair of orders to
AIM, SAM or as a QCC order, 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 (with respect to AIM and SAM
orders) or as a single transaction (with respect to QCC orders). Thus,
the Exchange believes it is appropriate to reject both orders if
[[Page 77045]]
one does not satisfy the price checks to be consistent with the intent
of the submitted Trading Permit Holder. 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, because there are not three Market-Makers quoting in the
series as required by Rule 6.74A(a)(4) or if the contra-side order does
not stop the agency order at the price required by Rule 6.74A(a)(2) or
(3)), 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).\38\ 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 Trading Permit Holder) to
execute despite not entering an AIM auction pursuant to which the order
may execute against a facilitation or solicitation order of the Trading
Permit Holder. The Exchange believes the proposed rule change is
consistent with that contingency.
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\38\ See proposed subparagraph (g)(4).
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2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Securities Exchange Act of 1934 (the ``Act'') and the rules and
regulations thereunder applicable to the Exchange and, in particular,
the requirements of Section 6(b) of the Act.\39\ Specifically, the
Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \40\ 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) \41\ requirement that the rules of an exchange not be
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers.
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\39\ 15 U.S.C. 78f(b).
\40\ 15 U.S.C. 78f(b)(5).
\41\ Id.
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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, SAM and QCC orders is reas
