Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change Related to the Nullification and Adjustment of Options Transactions, 167-173 [2016-31766]
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Federal Register / Vol. 82, No. 1 / Tuesday, January 3, 2017 / Notices
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–79697; File No. SR–CBOE–
2016–088]
Self-Regulatory Organizations;
Chicago Board Options Exchange,
Incorporated; Notice of Filing of a
Proposed Rule Change Related to the
Nullification and Adjustment of
Options Transactions
December 27, 2016.
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 December
14, 2016, 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. 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 seeks to amend Rule
6.25. 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.
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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
Last year, the Exchange and other
options exchanges adopted a new,
1 15
2 17
U.S.C. 78s(b)(1).
CFR 240.19b–4.
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harmonized rule related to the
adjustment and nullification of
erroneous options transactions,
including a specific provision related to
coordination in connection with largescale events involving erroneous
options transactions.3 The Exchange
believes that the changes the options
exchanges implemented with the new,
harmonized rule have led to increased
transparency and finality with respect to
the adjustment and nullification of
erroneous options transactions.
However, as part of the initial initiative,
the Exchange and other options
exchanges deferred a few specific
matters for further discussion.
Specifically, the options exchanges
have been working together to identify
ways to improve the process related to
the adjustment and nullification of
erroneous options transactions as it
relates to complex orders 4 and stockoption orders. The goal of the process
that the options exchanges have
undertaken is to further harmonize rules
related to the adjustment and
nullification of erroneous options
transactions. As described below, the
Exchange believes that the changes the
options exchanges and the Exchange
have agreed to propose will provide
transparency and finality with respect to
the adjustment and nullification of
erroneous complex order and stockoption order transactions. Particularly,
the proposed changes seek to achieve
consistent results for participants across
U.S. options exchanges while
maintaining a fair and orderly market,
protecting investors and protecting the
public interest.
The Proposed Rule is the culmination
of this coordinated effort and reflects
discussions by the options exchanges
whereby the exchanges that offer
complex orders and/or stock-option
orders will universally adopt new
provisions that the options exchanges
collectively believe will improve the
handling of erroneous options
transactions that result from the
execution of complex orders and stockoption orders.5
The Exchange believes that the
Proposed Rule supports an approach
consistent with long-standing principles
in the options industry under which the
general policy is to adjust rather than
nullify transactions. The Exchange
3 See Securities Exchange Act Release No. 74898
(May 7, 2015), 80 FR 27354 (May 13, 2015) (SR–
CBOE–2015–039) (the ‘‘Initial Filing’’).
4 See Rule 6.53C(a) (defining complex orders and
stock-option orders).
5 An exchange that does not offer complex orders
and/or stock-option orders will not adopt these new
provisions until such time as the exchange offers
complex orders and/or stock-option orders.
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acknowledges that adjustment of
transactions is contrary to the operation
of analogous rules applicable to the
equities markets, where erroneous
transactions are typically nullified
rather than adjusted and where there is
no distinction between the types of
market participants involved in a
transaction. For the reasons set forth
below, the Exchange believes that the
distinctions in market structure between
equities and options markets continue
to support these distinctions between
the rules for handling obvious errors in
the equities and options markets.
Various general structural differences
between the options and equities
markets point toward the need for a
different balancing of risks for options
market participants and are reflected in
this proposal. Option pricing is
formulaic and is tied to the price of the
underlying stock, the volatility of the
underlying security and other factors.
Because options market participants can
generally create new open interest in
response to trading demand, as new
open interest is created, correlated
trades in the underlying or related series
are generally also executed to hedge a
market participant’s risk. This pairing of
open interest with hedging interest
differentiates the options market
specifically (and the derivatives markets
broadly) from the cash equities markets.
In turn, the Exchange believes that the
hedging transactions engaged in by
market participants necessitates
protection of transactions through
adjustments rather than nullifications
when possible and otherwise
appropriate.
The options markets are also quote
driven markets dependent on liquidity
providers to an even greater extent than
equities markets. In contrast to the
approximately 7,000 different securities
traded in the U.S. equities markets each
day, there are more than 500,000
unique, regularly quoted option series.
Given this breadth in options series the
options markets are more dependent on
liquidity providers than equities
markets; such liquidity is provided most
commonly by registered market makers
but also by other professional traders.
With the number of instruments in
which registered market makers must
quote and the risk attendant with
quoting so many products
simultaneously, the Exchange believes
that those liquidity providers should be
afforded a greater level of protection. In
particular, the Exchange believes that
liquidity providers should be allowed
protection of their trades given the fact
that they typically engage in hedging
activity to protect them from significant
financial risk to encourage continued
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liquidity provision and maintenance of
the quote-driven options markets.
In addition to the factors described
above, there are other fundamental
differences between options and
equities markets which lend themselves
to different treatment of different classes
of participants that are reflected in this
proposal. For example, there is no trade
reporting facility in the options markets.
Thus, all transactions must occur on an
options exchange. This leads to
significantly greater retail customer
participation directly on exchanges than
in the equities markets, where a
significant amount of retail customer
participation never reaches the
Exchange but is instead executed in offexchange venues such as alternative
trading systems, broker-dealer market
making desks and internalizers. In turn,
because of such direct retail customer
participation, the exchanges have taken
steps to afford those retail customers—
generally Priority Customers—more
favorable treatment in some
circumstances.
Complex Orders and Stock-Option
Orders
As more fully described below, the
Proposed Rule applies much of the
Current Rule to complex orders and
stock-option orders.6 The Proposed Rule
deviates from the Current Rule only to
account for the unique qualities of
complex orders and stock-option orders.
The Proposed Rule reflects the fact that
complex orders can execute against
other complex orders or can execute
against individual simple orders in the
leg markets. When a complex order
executes against the leg markets there
may be different counterparties on each
leg of the complex order, and not every
leg will necessarily be executed at an
erroneous price. With regards to stockoption orders, the Proposed Rule
reflects the fact that stock-option orders
contain a stock component that is
executed on a stock trading venue, and
the Exchange may not be able to ensure
that the stock trading venue will adjust
or nullify the stock execution in the
event of an obvious or catastrophic
error. In order to apply the Current Rule
and account for the unique
characteristics of complex orders and
stock-option orders, proposed
Interpretation and Policy .07 is split into
three parts—paragraphs (a), (b), and (c).
First, proposed Interpretation and
Policy .07(a) governs the review of
complex orders that are executed
6 In order for a complex order or stock-option
order to qualify as an obvious or catastrophic error
at least one of the legs must itself qualify as an
obvious or catastrophic error under the Current
Rule. See Proposed Rule .07(a)–(c).
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against individual legs (as opposed to a
complex order that executes against
another complex order).7 Proposed Rule
6.25.07(a) provides:
If a complex order executes against
individual legs and at least one of the legs
qualifies as an Obvious or Catastrophic Error
under this Rule 6.25, then the leg(s) that is
an Obvious or Catastrophic Error will be
adjusted in accordance with paragraphs
(c)(4)(A) or (d)(3), respectively, regardless of
whether one of the parties is a Customer.
However, any Customer order subject to this
paragraph (a) will be nullified if the
adjustment would result in an execution
price higher (for buy transactions) or lower
(for sell transactions) than the Customer’s
limit price on the complex order or
individual leg(s). If any leg of a complex
order is nullified, the entire transaction is
nullified.
As previously noted, at least one of the
legs of the complex order must qualify
as an obvious or catastrophic error
under the Current Rule in order for the
complex order to receive obvious or
catastrophic error relief. Thus, when the
Exchange is notified (within the
timeframes set forth in paragraph (c)(2)
or (d)(2)) of a complex order that is a
possible obvious error or catastrophic
error, the Exchange will first review the
individual legs of the complex order to
determine if one or more legs qualify as
an obvious or catastrophic error.8 If no
leg qualifies as an obvious or
catastrophic error, the transaction
stands—no adjustment and no
nullification.
Reviewing the legs to determine
whether one or more legs qualify as an
obvious or catastrophic error requires
the Exchange to follow the Current Rule.
In accordance with paragraphs (c)(1)
and (d)(1) of the Current Rule, the
Exchange compares the execution price
of each individual leg to the Theoretical
Price of each leg (as determined by
paragraph (b) of the Current Rule). If the
execution price of an individual leg is
higher or lower than the Theoretical
Price for the series by an amount equal
to at least the amount shown in the
obvious error table in paragraph (c)(1) of
7 The leg market consists of quotes and/or orders
in single options series. A complex order may be
received by the Exchange electronically, and the
legs of the complex order may have different
counterparties. For example, Market-Maker 1 may
be quoting in ABC calls and Market-Maker 2 may
be quoting in ABC puts. A complex order to buy
the ABC calls and puts may execute against the
quotes of Market-Maker 1 and Market-Maker 2.
8 Because a complex order can execute against the
leg market, the Exchange may also be notified of a
possible obvious or catastrophic error by a
counterparty that received an execution in an
individual options series. If upon review of a
potential obvious error the Exchange determines an
individual options series was executed against the
leg of a complex order or stock-option order,
proposed Rule 6.25.07 will govern.
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the Current rule or the catastrophic error
table in paragraph (d)(1) of the Current
Rule, the individual leg qualifies as an
obvious or catastrophic error, and the
Exchange will take steps to adjust or
nullify the transaction.9
To illustrate, consider a Customer
submits a complex order to the
Exchange consisting of leg 1 and leg 2—
Leg 1 is to buy 100 ABC calls and leg
2 is to sell 100 ABC puts. Also, consider
that Market-Maker 1 is quoting the ABC
calls $1.00–1.20 and Market-Maker 2 is
quoting the ABC puts $2.00–2.20. If the
complex order executes against the
quotes of Market-Makers 1 and 2, the
Customer buys the ABC calls for $1.20
and sells the ABC puts for $2.00. As
with the obvious/catastrophic error
reviews for simple orders, the execution
price of leg 1 is compared to the
Theoretical Price 10 of Leg 1 in order to
determine if Leg 1 is an obvious error
under paragraph (c)(1) of the Current
Rule or a catastrophic error under
paragraph (d)(1) of the Current Rule.
The same goes for Leg 2. The execution
price of Leg 2 is compared to the
Theoretical Price of Leg 2. If it is
determined that one or both of the legs
are an obvious or catastrophic error,
then the leg (or legs) that is an obvious
or catastrophic error will be adjusted in
accordance with paragraphs (c)(4)(A) or
(d)(3) of the Current Rule, regardless of
whether one of the parties is a
Customer.11 Although a single-legged
execution that is deemed to be an
obvious error under the Current Rule is
nullified whenever a Customer is
involved in the transaction, the
Exchange believes adjusting execution
prices is generally better for the
marketplace than nullifying executions
because liquidity providers often
execute hedging transactions to offset
options positions. When an options
transaction is nullified the hedging
position can adversely affect the
liquidity provider. With regards to
complex orders that execute against
individual legs, the additional rationale
for adjusting erroneous execution prices
when possible is the fact that the
counterparty on a leg that is not
executed at an obvious or catastrophic
error price cannot look at the execution
price to determine whether the
9 Only the execution price on the leg (or legs) that
qualifies as an obvious or catastrophic error
pursuant to any portion of Proposed Rule 6.25.07
will be adjusted. The execution price of a leg (or
legs) that does not qualify as an obvious or
catastrophic error will not be adjusted.
10 See Rule 6.25(b) (defining the manner in which
Theoretical Price is determined).
11 See Rule 6.25(a)(1) (defining Customer for
purposes of Rule 6.25 as not including a brokerdealer, Professional Customer, or Voluntary
Professional Customer).
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execution may later be nullified (as
opposed to the counterparty on singlelegged order that is executed at an
obvious error or catastrophic error
price).
Paragraph (c)(4)(A) of the Current
Rule mandates that if it is determined
that an obvious error has occurred, the
execution price of the transaction will
be adjusted pursuant to the table set
forth in (c)(4)(A). Although for simple
orders paragraph (c)(4)(A) is only
applicable when no party to the
transaction is a Customer, for the
purposes of complex orders paragraph
(a) of Interpretation and Policy .07 will
supersede that limitation; therefore, if it
is determined that a leg (or legs) of a
complex order is an obvious error, the
leg (or legs) will be adjusted pursuant to
(c)(4)(A), regardless of whether a party
to the transaction is a Customer. The
Size Adjustment Modifier defined in
subparagraph (a)(4) will similarly apply
(regardless of whether a Customer is on
the transaction) by virtue of the
application of paragraph (c)(4)(A).12 The
Exchange notes that adjusting all market
participants is not unique or novel.
When the Exchange determines that a
simple order execution is a Catastrophic
Error pursuant to the Current Rule,
paragraph (d)(3) already provides for
adjusting the execution price for all
market participants, including
Customers.
Furthermore, as with the Current
Rule, Proposed Rule 6.25.07(a) provides
protection for Customer orders, stating
that where at least one party to a
complex order transaction is a
Customer, the transaction will be
nullified if adjustment would result in
an execution price higher (for buy
transactions) or lower (for sell
transactions) than the Customer’s limit
price on the complex order or
individual leg(s). For example, assume
Customer enters a complex order to buy
leg 1 and leg 2.
• Assume the NBBO for leg 1 is
$0.20–1.00 and the NBBO for leg 2 is
$0.50–1.00 and that these have been the
NBBOs since the market opened.
• A split-second prior to the
execution of the complex order a
Customer enters a simple order to sell
the leg 1 options series at $1.30, and the
simple order enters the Exchange’s book
so that the BBO is $.20–$1.30. The limit
price on the simple order is $1.30.
12 See Rule 6.25(c)(4)(A) (stating that any nonCustomer Obvious Error exceeding 50 contracts will
be subject to the Size Adjustment Modifier defined
in sub-paragraph (a)(4)). The Size Adjustment
Modifier may also apply to the option leg of a stockoption order that is adjusted pursuant to Proposed
Rule 6.25.07(c).
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• The complex order executes leg 1
against the Exchange’s best offer of
$1.30 and leg 2 at $1.00 for a net
execution price of $2.30.
• However, leg 1 executed on a wide
quote (the NBBO for leg 1 was $0.20–
1.00 at the time of execution, which is
wider than $0.75).13 Leg 2 was not
executed on a wide quote (the market
for leg 2 was $0.50–1.00); thus, leg 2
execution price stands.
• The Exchange determines that the
Theoretical Price for leg 1 is $1.00,
which was the best offer prior to the
execution. Leg 1 qualifies as an obvious
error because the difference between the
Theoretical Price ($1.00) and the
execution price ($1.30) is larger than
$0.25.14
• According to Proposed Rule
6.25.07(a) Customers will also be
adjusted in accordance with Rule
6.25(c)(4)(A), which for a buy
transaction under $3.00 calls for the
Theoretical Price to by adjusted by
adding $0.15 15 to the Theoretical Price
of $1.00. Thus, adjust execution price
for leg 1 would be $1.15.
• However, adjusting the execution
price of leg 1 to $1.15 violates the limit
price of the Customer’s sell order on the
simple order book for leg 1, which was
$1.30.
• Thus, the entire complex order
transaction will be nullified 16 because
the limit price of a Customer’s sell order
would be violated by the adjustment.17
As the above example demonstrates,
incoming complex orders may execute
against resting simple orders in the leg
market. If a complex order leg is deemed
to be an obvious error, adjusting the
execution price of the leg may violate
the limit price of the resting order,
which will result in nullification if the
resting order is for a Customer. In
contrast, Interpretation and Policy .02 to
Rule 6.25 provides that if an adjustment
would result in an execution price that
is higher than an erroneous buy
transaction or lower than an erroneous
sell transaction the execution will not
be adjusted or nullified.18 If the
adjustment of a complex order would
violate the complex order Customer’s
limit price, the transaction will be
nullified.
As previously noted, paragraph (d)(3)
of the Current Rule already mandates
13 See
Rule 6.25(b)(3).
Rule (c)(1).
15 See Rule 6.25(c)(4)(A).
16 If any leg of a complex order is nullified, the
entire transaction is nullified. See Proposed Rule
6.25.07(a).
17 The simple order in this example is not an
erroneous sell transaction because the execution
price was not erroneously low. See Rule 6.25(a)(2).
18 See Rule 6.25.02.
14 See
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169
that if it is determined that a
catastrophic error has occurred, the
execution price of the transaction will
be adjusted pursuant to the table set
forth in (d)(3). For purposes of complex
orders under Proposed Rule .07(a), if
one of the legs of a complex orders is
determined to be a Catastrophic Error
under paragraph (d)(3), all market
participants will be adjusted in
accordance with the table set forth in
(d)(3). Again, however, where at least
one party to a complex order transaction
is a Customer, the transaction will be
nullified if adjustment would result in
an execution price higher (for buy
transactions) or lower (for sell
transactions) than the Customer’s limit
price on the complex order or
individual leg(s). Again, if any leg of a
complex order is nullified, the entire
transaction is nullified. Additionally, as
is the case today, if an Official
determines that a Catastrophic Error has
not occurred, the Trading Permit Holder
will be subject to a charge of $5,000.19
Other than honoring the limit prices
established for Customer orders, the
Exchange has proposed to treat
Customers and non-Customers the same
in the context of the complex orders that
trade against the leg market. When
complex orders trade against the leg
market, it is possible that at least some
of the legs will execute at prices that
would not be deemed obvious or
catastrophic errors, which gives the
counterparty in such situations no
indication that the execution will later
by adjusted or nullified. The Exchange
believes that treating Customers and
non-Customers the same in this context
will provide additional certainty to nonCustomers (especially Market-Makers)
with respect to their potential exposure
and hedging activities, including
comfort that even if a transaction is later
adjusted, such transaction will not be
fully nullified. However, as noted
above, under the Proposed Rule where
at least one party to the transaction is a
Customer, the trade will be nullified if
the adjustment would result in an
execution price higher (for buy
transactions) or lower (for sell
transactions) than the Customer’s limit
price on the complex order or
individual leg(s). The Exchange has
retained the protection of a Customer’s
limit price in order to avoid a situation
where the adjustment could be to a
price that a Customer would not have
expected, and market professionals such
as non-Customers would be better
prepared to recover in such situations.
Therefore, adjustment for nonCustomers is more appropriate.
19 See
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Second, proposed Interpretation and
Policy .07(b) governs the review of
complex orders that are executed
against other complex orders. Proposed
Rule 6.25.07(b) provides:
If a complex order executes against another
complex order and at least one of the legs
qualifies as an Obvious Error under
paragraph (c)(1) or a Catastrophic Error under
paragraph (d)(1), then the leg(s) that is an
Obvious or Catastrophic Error will be
adjusted or busted in accordance with
paragraph (c)(4) or (d)(3), respectively, so
long as either: (i) the width of the National
Spread Market for the complex order strategy
just prior to the erroneous transaction was
equal to or greater than the amount set forth
in the wide quote table of paragraph (b)(3) or
(ii) the net execution price of the complex
order is higher (lower) than the offer (bid) of
the National Spread Market for the complex
order strategy just prior to the erroneous
transaction by an amount equal to at least the
amount shown in the table in paragraph
(c)(1). If any leg of a complex order is
nullified, the entire transaction is nullified.
For purposes of Rule 6.25, the National
Spread Market for a complex order strategy
is determined by the National Best Bid/Offer
of the individual legs of the strategy.
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As described above in relation to
Proposed Rule 6.25.07(a), the first step
is for the Exchange to review (upon
receipt of a timely notification in
accordance with paragraphs (c)(2) or
(d)(2) of the Current Rule) the
individual legs to determine whether a
leg or legs qualifies as an obvious or
catastrophic error. If no leg qualifies as
an obvious or catastrophic error, the
transaction stands—no adjustment and
no nullification.
Unlike Proposed Rule 6.25.07(a), the
Exchange is also proposing to compare
the net execution price of the entire
complex order package to the National
Spread Market (‘‘NSM’’) for the complex
order strategy.20 Complex orders are
exempt from the order protection rules
of the options exchanges.21 Thus,
depending on the manner in which the
systems of an options exchange are
calibrated, a complex order can execute
without regard to the prices offered in
the complex order books or the leg
markets of other options exchanges. In
certain situations, reviewing the
execution prices of the legs in a vacuum
would make the leg appear to be an
obvious or catastrophic error, even
though the net execution price on the
complex order is not an erroneous price.
20 NSM is the derived net market for a complex
order package. See e.g., Rule 6.53C.04 (utilizing the
term derived net market in the context of complex
order strategies). For example, if the NBBO of Leg
1 is $1.00–2.00 and the NBBO of Leg 2 is $5.00–
7.00, then the NSM for a complex order to buy Leg
1 and buy Leg 2 is $6.00–9.00.
21 See Rule 6.81(b)(7). All options exchanges have
the same order protection rule.
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For example, assume the Exchange
receives a complex order to buy ABC
calls and sell ABC puts.
• If the BBO for the ABC calls is
$5.50–7.50 and the BBO for ABC puts is
$3.00–4.50, then the Exchange’s spread
market is $1.00–4.50.22
• If the NBBO for the ABC calls is
$6.00–6.50 and the NBBO for the ABC
puts is $3.50–4.00, then the NSM is
$2.00–3.00.
• If the Customer buys the calls at
$7.50 and sells the puts at $4.00, the
complex order Customer receives a net
execution price of $3.00 (debit), which
is the expected net execution price as
indicated by the NSM offer of $3.00.
If the exchange were to solely focus
on the $7.50 execution price of the ABC
calls or the $4.00 execution price of the
ABC puts, the execution would qualify
as an obvious or catastrophic error
because the execution price on the legs
was outside the NBBO, even though the
net execution price is accurate. Thus,
the additional review of the NSM to
determine if the complex order was
executed at a truly erroneous price is
necessary. The same concern is not
present when a complex order executes
against the leg market under Rule
6.25.07(a) because the Exchange is
modifying its system in order to ensure
the leg will execute at or within the
NBBO of the leg markets.23
In order to incorporate NSM, Rule
6.25.07(b) provides that if the Exchange
determines that a leg or legs does
qualify as on obvious or catastrophic
error, the leg or legs will be adjusted or
busted in accordance with paragraph
(c)(4) or (d)(3) of the Current Rule, so
long as either: (i) the width of the NSM
for the complex order strategy just prior
to the erroneous transaction was equal
to or greater than the amount set forth
in the wide quote table of paragraph
(b)(3) of the Current Rule or (ii) the net
execution price of the complex order is
higher (lower) than the offer (bid) of the
NSM for the complex order strategy just
prior to the erroneous transaction by an
amount equal to at least the amount
shown in the table in paragraph (c)(1) of
the Current Rule.
22 The complex order is to buy ABC calls and sell
ABC puts. The Exchange’s best offer for ABC puts
is $7.50 and Exchange’s best bid for is $3.00. If the
Customer were to buy the complex order strategy,
the Customer would receive a debit of $4.50 (buy
ABC calls for $7.50 minus selling ABC puts for
$3.00). If the Customer were to sell the complex
order strategy the Customer would receive a credit
of $1.00 (selling the ABC calls for $5.50 minus
buying the ABC puts for $4.50). Thus, the
Exchange’s spread market is $1.00–4.50.
23 The proposed rule change to modify Exchange
systems to ensure the legs of a complex order will
execute against legs in the simple order market
within the NBBO of the simple order market will
be in a separate filing.
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For example, assume an individual
leg or legs qualifies as an obvious or
catastrophic error and the width of the
NSM of the complex order strategy just
prior to the erroneous transaction is
$6.00–9.00. The complex order will
qualify to be adjusted or busted in
accordance with paragraph (c)(4) of the
Current Rule because the wide quote
table of paragraph (b)(3) of the Current
Rule indicates that the minimum
amount is $1.50 for a bid price between
$5.00 to $10.00. If the NSM were instead
$6.00–7.00 the complex order strategy
would not qualify to be adjusted or
busted pursuant to .07(b)(i) because the
width of the NSM is $1.00, which is less
than the required $1.50. However, the
execution may still qualify to be
adjusted or busted in accordance with
paragraph (c)(4) or (d)(3) of the Current
Rule pursuant to .07(b)(ii). Focusing on
the NSM in this manner will ensure that
the obvious/catastrophic error review
process focuses on the net execution
price instead of the execution prices of
the individual legs, which may have
execution prices outside of the NBBO of
the leg markets.
Again, assume an individual leg or
legs qualifies as an obvious or
catastrophic error as described above. If
the NSM is $6.00–7.00 (not a wide quote
pursuant to the wide quote table in
paragraph (b)(3) of the Current Rule) but
the execution price of the entire
complex order package (i.e., the net
execution price) is higher (lower) than
the offer (bid) of the NSM for the
complex order strategy just prior to the
erroneous transaction by an amount
equal to at least the amount in the table
in paragraph (c)(1) of the Current Rule,
then the complex order qualifies to be
adjusted or busted in accordance with
paragraph (c)(4) or (d)(3) of the Current
Rule. For example, if the NSM for the
complex order strategy just prior to the
erroneous transaction is $6.00–7.00 and
the net execution price of the complex
order transaction is $7.75, the complex
order qualifies to be adjusted or busted
in accordance with paragraph (c)(4) of
the Current Rule because the execution
price of $7.75 is more than $0.50 (i.e.,
the minimum amount according to the
table in paragraph (c)(1) when the price
is above $5.00 but less than $10.01)
from the NSM offer of $7.00. Focusing
on the NSM in this manner will ensure
that the obvious/catastrophic error
review process focuses on the net
execution price instead of the execution
prices of the individual legs, which may
have execution prices outside of the
NBBO of the leg markets.
Although the Exchange believes
adjusting execution prices is generally
better for the marketplace than
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nullifying executions because liquidity
providers often execute hedging
transactions to offset options positions,
the Exchange recognizes that complex
orders executing against other complex
orders is similar to simple orders
executing against other simple orders
because both parties are able to review
the execution price to determine
whether the transaction may have been
executed at an erroneous price. Thus,
for purposes of complex orders that
meet the requirements of Rule
6.25.07(b), the Exchange proposes to
apply the Current Rule and adjust or
bust obvious errors in accordance with
paragraph (c)(4) (as opposed to applying
paragraph (c)(4)(A) as is the case under
.07(a)) and catastrophic errors in
accordance with (d)(3).
Therefore, for purposes of complex
orders under Proposed Rule 6.25.07(b),
if one of the legs is determined to be an
obvious error under paragraph (c)(1), all
Customer transactions will be nullified,
unless a Trading Permit Holder (‘‘TPH’’)
submits 200 or more Customer
transactions for review in accordance
with (c)(4)(C).24 For purposes of
complex orders under Proposed Rule
6.25.07(b), if one of the legs is
determined to be a catastrophic error
under paragraph (d)(3) and all of the
other requirements of Rule 6.25.07(b)
are met, all market participants will be
adjusted in accordance with the table
set forth in (d)(3). Again, however,
pursuant to paragraph (d)(3) where at
least one party to a complex order
transaction is a Customer, the
transaction will be nullified if
adjustment would result in an execution
price higher (for buy transactions) or
lower (for sell transactions) than the
Customer’s limit price on the complex
order or individual leg(s). Also, if any
leg of a complex order is nullified, the
entire transaction is nullified.
Third, proposed Interpretation and
Policy .07(c) governs stock-option
orders. Proposed Rule 6.25.07(c)
provides:
If the option leg of a stock-option order
qualifies as an Obvious Error under
paragraph (c)(1) or a Catastrophic Error under
paragraph (d)(1), then the option leg that is
an Obvious or Catastrophic Error will be
adjusted in accordance with paragraph
(c)(4)(A) or (d)(3), respectively, regardless of
whether one of the parties is a Customer.
However, the option leg of any Customer
order subject to this paragraph (c) will be
nullified if the adjustment would result in an
execution price higher (for buy transactions)
or lower (for sell transactions) than the
24 Rule 6.25(c)(4)(C) also requires the orders
resulting in 200 or more Customer transactions to
have been submitted during the course of 2 minutes
or less.
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Customer’s limit price on the stock-option
order, and the Exchange will attempt to
nullify the stock leg. Whenever a stock
trading venue nullifies the stock leg of a
stock-option order or whenever the stock leg
cannot be executed, the Exchange will nullify
the option leg upon request of one of the
parties to the transaction or in accordance
with paragraph (c)(3).
Similar to proposed Interpretation
and Policy .07(a), an options leg (or legs)
of a stock-option order must qualify as
an obvious or catastrophic error under
the Current Rule in order for the stockoption order to qualify as an obvious or
catastrophic error. Also similar to
Proposed Rule 6.25.07(a), if an options
leg (or legs) does qualify as an obvious
or catastrophic error, the option leg (or
legs) will be adjusted in accordance
with paragraph (c)(4)(A) or (d)(3),
respectively, regardless of whether one
of the parties is a Customer. Again, as
with Proposed Rule 6.25.07(a), where at
least one party to a complex order
transaction is a Customer, the Exchange
will nullify the option leg and attempt
to nullify the stock leg if adjustment
would result in an execution price
higher (for buy transactions) or lower
(for sell transactions) than the
Customer’s limit price on the complex
order or individual leg(s).
The stock leg of a stock-option order
is not executed on the Exchange; rather,
the stock leg is sent to a stock trading
venue for execution. The Exchange is
unaware of a mechanism by which the
Exchange can guarantee that the stock
leg will be nullified by the stock trading
venue in the event of an obvious or
catastrophic error on the Exchange.
Thus, in the event of the nullification of
the option leg pursuant to Proposed
Rule 6.25.07(c), the Exchange will
attempt to have the stock leg nullified
by the stock trading venue by either
contacting the stock trading venue or
notifying the parties to the transaction
that the option leg is being nullified.
The party or parties to the transaction
may ultimately need to contact the stock
trading venue to have the stock portion
nullified.
Finally, the Exchange proposes to
provide guidance that whenever the
stock trading venue nullifies the stock
leg of a stock-option order, the option
will be nullified upon request of one of
the parties to the transaction or by an
Official acting on their own motion in
accordance with paragraph (c)(3). There
are situations in which buyer and seller
agree to trade a stock-option order, but
the stock leg cannot be executed. The
Exchange proposes to provide guidance
that whenever the stock portion of a
stock-option order cannot be executed,
the Exchange will nullify the option leg
PO 00000
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171
upon request of one of the parties to the
transaction or on an Official’s own
motion.
2. Statutory Basis
The Exchange believes that its
proposal is consistent with the
requirements of the Act and the rules
and regulations thereunder that are
applicable to a national securities
exchange, and, in particular, with the
requirements of Section 6(b) of the
Act.25 Specifically, the proposal is
consistent with Section 6(b)(5) of the
Act 26 because it would promote just
and equitable principles of trade,
remove impediments to, and perfect the
mechanism of, a free and open market
and a national market system, and, in
general, protect investors and the public
interest.
As described above, the Exchange and
other options exchanges are seeking to
adopt harmonized rules related to the
adjustment and nullification of
erroneous options transactions. The
Exchange believes that the Proposed
Rule will provide greater transparency
and clarity with respect to the
adjustment and nullification of
erroneous options transactions.
Particularly, the proposed changes seek
to achieve consistent results for
participants across U.S. options
exchanges while maintaining a fair and
orderly market, protecting investors and
protecting the public interest. Based on
the foregoing, the Exchange believes
that the proposal is consistent with
Section 6(b)(5) of the Act 27 in that the
Proposed Rule will foster cooperation
and coordination with persons engaged
in regulating and facilitating
transactions.
The Exchange believes the various
provisions allowing or dictating
adjustment rather than nullification of a
trade are necessary given the benefits of
adjusting a trade price rather than
nullifying the trade completely. Because
options trades are used to hedge, or are
hedged by, transactions in other
markets, including securities and
futures, many TPHs, and their
customers, would rather adjust prices of
executions rather than nullify the
transactions and, thus, lose a hedge
altogether. As such, the Exchange
believes it is in the best interest of
investors to allow for price adjustments
as well as nullifications.
The Exchange does not believe that
the proposal is unfairly discriminatory,
even though it differentiates in many
places between Customers and non25 15
U.S.C. 78f(b).
U.S.C. 78f(b)(5).
27 15 U.S.C. 78f(b)(5).
26 15
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172
Federal Register / Vol. 82, No. 1 / Tuesday, January 3, 2017 / Notices
Customers. As with the Current Rule,
Customers are treated differently, often
affording them preferential treatment.
This treatment is appropriate in light of
the fact that Customers are not
necessarily immersed in the day-to-day
trading of the markets, are less likely to
be watching trading activity in a
particular option throughout the day,
and may have limited funds in their
trading accounts. At the same time, the
Exchange reiterates that in the U.S.
options markets generally there is
significant retail customer participation
that occurs directly on (and only on)
options exchanges such as the
Exchange. Accordingly, differentiating
among market participants with respect
to the adjustment and nullification of
erroneous options transactions is not
unfairly discriminatory because it is
reasonable and fair to provide
Customers with additional protections
as compared to non-Customers.
The Exchange believes that its
proposal to adopt the ability to adjust a
Customer’s execution price when a
complex order is deemed to be an
Obvious or Catastrophic Error is
consistent with the Act. A complex
order that executes against individual
leg markets may receive an execution
price on an individual leg that is not an
Obvious or Catastrophic error but
another leg of the transaction is an
Obvious or Catastrophic Error. In such
situations where the complex order is
executing against at least one individual
or firm that is not aware of the fact that
they have executed against a complex
order or that the complex order has been
executed at an erroneous price, the
Exchange believes it is more appropriate
to adjust execution prices if possible
because the derivative transactions are
often hedged with other securities.
Allowing adjustments instead of
nullifying transactions in these limited
situations will help to ensure that
market participants are not left with a
hedge that has no position to hedge
against.
The Exchange also believes its
proposal related to stock-option orders
is consistent with the Act. Stock-option
orders consist of an option component
and a stock component. Due to the fact
that the Exchange has no control over
the venues on which the stock is
executed the proposal focuses on the
option component of the stock-option
order by adjusting or nullifying the
option in accordance with paragraph
(c)(4)(A) or (d)(3). Also, nullifying the
option component if the stock
component cannot be executed ensures
that market participants receive the
execution for which they bargained.
Stock-option orders are negotiated and
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agreed to as a package; thus, if for any
reason the stock portion of a stockoption order cannot ultimately be
executed, the parties should not be
saddled with an options position sans
stock.
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.
Importantly, the Exchange believes
the proposal will not impose a burden
on intermarket competition but will
rather alleviate any burden on
competition because it is the result of a
collaborative effort by all options
exchanges to harmonize and improve
the process related to the adjustment
and nullification of erroneous options
transactions. The Exchange does not
believe that the rules applicable to such
process is an area where options
exchanges should compete, but rather,
that all options exchanges should have
consistent rules to the extent possible.
Particularly where a market participant
trades on several different exchanges
and an erroneous trade may occur on
multiple markets nearly simultaneously,
the Exchange believes that a participant
should have a consistent experience
with respect to the nullification or
adjustment of transactions. The
Exchange understands that all other
options exchanges that trade complex
orders and/or stock-option orders intend
to file proposals that are substantially
similar to this proposal.
The Exchange does not believe that
the proposed rule change imposes a
burden on intramarket competition
because the provisions apply to all
market participants equally within each
participant category (i.e., Customers and
non-Customers). With respect to
competition between Customer and
non-Customer market participants, the
Exchange believes that the Proposed
Rule acknowledges competing concerns
and tries to strike the appropriate
balance between such concerns. For
instance, the Exchange believes that
protection of Customers is important
due to their direct participation in the
options markets as well as the fact that
they are not, by definition, market
professionals. At the same time, the
Exchange believes due to the quotedriven nature of the options markets,
the importance of liquidity provision in
such markets and the risk that liquidity
providers bear when quoting a large
breadth of products that are derivative
of underlying securities, that the
protection of liquidity providers and the
PO 00000
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Fmt 4703
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practice of adjusting transactions rather
than nullifying them is of critical
importance. As described above, the
Exchange will apply specific and
objective criteria to determine whether
an erroneous transaction has occurred
and, if so, how to adjust or nullify a
transaction.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
The Exchange neither solicited nor
received comments on the proposed
rule change.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period
up to 90 days (i) as the Commission may
designate if it finds such longer period
to be appropriate and publishes its
reasons for so finding or (ii) as to which
the Exchange consents, the Commission
will:
A. by order approve or disapprove
such proposed rule change, or
B. institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
CBOE–2016–088 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Brent J. Fields, Secretary, Securities
and Exchange Commission, 100 F Street
NE., Washington, DC 20549–1090.
All submissions should refer to File
Number SR–CBOE–2016–088. 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
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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 such
filing also will be available for
inspection and copying at the principal
office of the Exchange. All comments
received will be posted without change;
the Commission does not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
available publicly. All submissions
should refer to File Number SR–CBOE–
2016–088, and should be submitted on
or before January 24, 2017.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.28
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2016–31766 Filed 12–30–16; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–79696; File No. SR–CBOE–
2016–093]
Self-Regulatory Organizations;
Chicago Board Options Exchange,
Incorporated; Notice of Filing and
Immediate Effectiveness of a Proposed
Rule Change To Amend Rule 6.54
sradovich on DSK3GMQ082PROD with NOTICES
December 27, 2016.
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 December
20, 2016, 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 and II
below, which Items have been prepared
by the Exchange. The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
28 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
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I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange proposes to extend its
program that allows transactions to take
place at a price that is below $1 per
option contract through March 5, 2018.
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
An ‘‘accommodation’’ or ‘‘cabinet’’
trade refers to trades in listed options on
the Exchange that are worthless or not
actively traded. Cabinet trading is
generally conducted in accordance with
the Exchange Rules, except as provided
in Exchange Rule 6.54, Accommodation
Liquidations (Cabinet Trades), which
sets forth specific procedures for
engaging in cabinet trades. Rule 6.54
currently provides for cabinet
transactions to occur via open outcry at
a cabinet price of $1 per option contract
in any options series open for trading in
the Exchange, except that the Rule is not
applicable to trading in option classes
participating in the Penny Pilot
Program. Under the procedures, bids
and offers (whether opening or closing
a position) at a price of $1 per option
contract may be represented in the
trading crowd by a Floor Broker or by
a Market-Maker or provided in response
to a request by a PAR Official/OBO, a
Floor Broker or a Market-Maker, but
must yield priority to all resting orders
in the PAR Official/OBO cabinet book
(which resting cabinet book orders may
be closing only). So long as both the
buyer and the seller yield to orders
resting in the cabinet book, opening
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173
cabinet bids can trade with opening
cabinet offers at $1 per option contract.
The Exchange has temporarily
amended the procedures through
January 5, 2017 to allow transactions to
take place in open outcry at a price of
at least $0 but less than $1 per option
contract.3 These lower priced
transactions are traded pursuant to the
same procedures applicable to $1
cabinet trades, except that (i) bids and
offers for opening transactions are only
permitted to accommodate closing
transactions in order to limit use of the
procedure to liquidations of existing
positions, and (ii) the procedures are
also available for trading in option
classes participating in the Penny Pilot
Program.4 The Exchange believes that
allowing a price of at least $0 but less
than $1 better accommodates the closing
of options positions in series that are
worthless or not actively traded,
particularly due to market conditions
which may result in a significant
number of series being out-of-the3 See Securities Exchange Act Release Nos. 59188
(December 30, 2008), 74 FR 480 (January 6, 2009)
(SR–CBOE–2008–133) (adopting the amended
procedures on a temporary basis through January
30, 2009), 59331 (January 30, 2009), 74 FR 6333
(February 6, 2009)(extending the amended
procedures on a temporary basis through May 29,
2009), 60020 (June 1, 2009), 74 FR 27220 (June 8,
2009) (SR–CBOE–2009–034) (extending the
amended procedures on a temporary basis through
June 1, 2010), 62192 (May 28, 2010), 75 FR
31828(June 4, 2010) (SR–CBOE–2010–052)
(extending the amended procedures on a temporary
basis through June 1, 2011); 64403 (May 4, 2011),
76 FR 27110 (May 10, 2011) (SR–CBOE–2011–048)
(extending the amended procedures on a temporary
basis through December 30, 2011); 65872 (December
2, 2011), 76 FR 76788 (December 8, 2011) (SR–
CBOE–2011–113) (extending the amended
procedures on a temporary basis through June 29,
2012) 67144 (June 6, 2012), 77 FR 35095 (June 12,
2012) (SR–CBOE–2012–053) (extending the
amended procedures on a temporary basis through
June 28, 2013), and 69854 (June 25, 2013), 78 FR
39424 (July 1, 2013) (SR–CBOE–2013–063); 69893
(June 28, 2013), 78 FR 40539 (July 5, 2013) (both
extending the amended procedures on a temporary
basis through January 5, 2014), 71090 [sic]
(December 17, 2013), 78 FR 77532 (December 23,
2013) (SR–CBOE–2013–118) (extending the
amended procedures on a temporary basis through
January 5, 2015), 73974 (December 31, 2014), 80 FR
911 (January 7, 2015) (SR–CBOE–2014–093)
(extending the amended procedures on a temporary
basis through January 5, 2016), and 76566
(December 7, 2015), 80 FR 77061 (December 11,
2015) (SR–CBOE–2015–108) (extending the
amended procedures on a temporary basis through
January 5, 2017).
4 Currently the $1 cabinet trading procedures are
limited to options classes traded in $0.05 or $0.10
standard increment. The $1 cabinet trading
procedures are not available in Penny Pilot Program
classes because in those classes an option series can
trade in a standard increment as low as $0.01 per
share (or $1.00 per option contract with a 100 share
multiplier). Because the temporary procedures
allow trading below $0.01 per share (or $1.00 per
option contract with a 100 share multiplier), the
procedures are available for all classes, including
those classes participating in the Penny Pilot
Program.
E:\FR\FM\03JAN1.SGM
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]]>Agencies
[Federal Register Volume 82, Number 1 (Tuesday, January 3, 2017)]
[Notices]
[Pages 167-173]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-31766]
[[Page 167]]
=======================================================================
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-79697; File No. SR-CBOE-2016-088]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Notice of Filing of a Proposed Rule Change Related to the
Nullification and Adjustment of Options Transactions
December 27, 2016.
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 December 14, 2016, 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. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange seeks to amend Rule 6.25. 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
Last year, the Exchange and other options exchanges adopted a new,
harmonized rule related to the adjustment and nullification of
erroneous options transactions, including a specific provision related
to coordination in connection with large-scale events involving
erroneous options transactions.\3\ The Exchange believes that the
changes the options exchanges implemented with the new, harmonized rule
have led to increased transparency and finality with respect to the
adjustment and nullification of erroneous options transactions.
However, as part of the initial initiative, the Exchange and other
options exchanges deferred a few specific matters for further
discussion.
---------------------------------------------------------------------------
\3\ See Securities Exchange Act Release No. 74898 (May 7, 2015),
80 FR 27354 (May 13, 2015) (SR-CBOE-2015-039) (the ``Initial
Filing'').
---------------------------------------------------------------------------
Specifically, the options exchanges have been working together to
identify ways to improve the process related to the adjustment and
nullification of erroneous options transactions as it relates to
complex orders \4\ and stock-option orders. The goal of the process
that the options exchanges have undertaken is to further harmonize
rules related to the adjustment and nullification of erroneous options
transactions. As described below, the Exchange believes that the
changes the options exchanges and the Exchange have agreed to propose
will provide transparency and finality with respect to the adjustment
and nullification of erroneous complex order and stock-option order
transactions. Particularly, the proposed changes seek to achieve
consistent results for participants across U.S. options exchanges while
maintaining a fair and orderly market, protecting investors and
protecting the public interest.
---------------------------------------------------------------------------
\4\ See Rule 6.53C(a) (defining complex orders and stock-option
orders).
---------------------------------------------------------------------------
The Proposed Rule is the culmination of this coordinated effort and
reflects discussions by the options exchanges whereby the exchanges
that offer complex orders and/or stock-option orders will universally
adopt new provisions that the options exchanges collectively believe
will improve the handling of erroneous options transactions that result
from the execution of complex orders and stock-option orders.\5\
---------------------------------------------------------------------------
\5\ An exchange that does not offer complex orders and/or stock-
option orders will not adopt these new provisions until such time as
the exchange offers complex orders and/or stock-option orders.
---------------------------------------------------------------------------
The Exchange believes that the Proposed Rule supports an approach
consistent with long-standing principles in the options industry under
which the general policy is to adjust rather than nullify transactions.
The Exchange acknowledges that adjustment of transactions is contrary
to the operation of analogous rules applicable to the equities markets,
where erroneous transactions are typically nullified rather than
adjusted and where there is no distinction between the types of market
participants involved in a transaction. For the reasons set forth
below, the Exchange believes that the distinctions in market structure
between equities and options markets continue to support these
distinctions between the rules for handling obvious errors in the
equities and options markets.
Various general structural differences between the options and
equities markets point toward the need for a different balancing of
risks for options market participants and are reflected in this
proposal. Option pricing is formulaic and is tied to the price of the
underlying stock, the volatility of the underlying security and other
factors. Because options market participants can generally create new
open interest in response to trading demand, as new open interest is
created, correlated trades in the underlying or related series are
generally also executed to hedge a market participant's risk. This
pairing of open interest with hedging interest differentiates the
options market specifically (and the derivatives markets broadly) from
the cash equities markets. In turn, the Exchange believes that the
hedging transactions engaged in by market participants necessitates
protection of transactions through adjustments rather than
nullifications when possible and otherwise appropriate.
The options markets are also quote driven markets dependent on
liquidity providers to an even greater extent than equities markets. In
contrast to the approximately 7,000 different securities traded in the
U.S. equities markets each day, there are more than 500,000 unique,
regularly quoted option series. Given this breadth in options series
the options markets are more dependent on liquidity providers than
equities markets; such liquidity is provided most commonly by
registered market makers but also by other professional traders. With
the number of instruments in which registered market makers must quote
and the risk attendant with quoting so many products simultaneously,
the Exchange believes that those liquidity providers should be afforded
a greater level of protection. In particular, the Exchange believes
that liquidity providers should be allowed protection of their trades
given the fact that they typically engage in hedging activity to
protect them from significant financial risk to encourage continued
[[Page 168]]
liquidity provision and maintenance of the quote-driven options
markets.
In addition to the factors described above, there are other
fundamental differences between options and equities markets which lend
themselves to different treatment of different classes of participants
that are reflected in this proposal. For example, there is no trade
reporting facility in the options markets. Thus, all transactions must
occur on an options exchange. This leads to significantly greater
retail customer participation directly on exchanges than in the
equities markets, where a significant amount of retail customer
participation never reaches the Exchange but is instead executed in
off-exchange venues such as alternative trading systems, broker-dealer
market making desks and internalizers. In turn, because of such direct
retail customer participation, the exchanges have taken steps to afford
those retail customers--generally Priority Customers--more favorable
treatment in some circumstances.
Complex Orders and Stock-Option Orders
As more fully described below, the Proposed Rule applies much of
the Current Rule to complex orders and stock-option orders.\6\ The
Proposed Rule deviates from the Current Rule only to account for the
unique qualities of complex orders and stock-option orders. The
Proposed Rule reflects the fact that complex orders can execute against
other complex orders or can execute against individual simple orders in
the leg markets. When a complex order executes against the leg markets
there may be different counterparties on each leg of the complex order,
and not every leg will necessarily be executed at an erroneous price.
With regards to stock-option orders, the Proposed Rule reflects the
fact that stock-option orders contain a stock component that is
executed on a stock trading venue, and the Exchange may not be able to
ensure that the stock trading venue will adjust or nullify the stock
execution in the event of an obvious or catastrophic error. In order to
apply the Current Rule and account for the unique characteristics of
complex orders and stock-option orders, proposed Interpretation and
Policy .07 is split into three parts--paragraphs (a), (b), and (c).
---------------------------------------------------------------------------
\6\ In order for a complex order or stock-option order to
qualify as an obvious or catastrophic error at least one of the legs
must itself qualify as an obvious or catastrophic error under the
Current Rule. See Proposed Rule .07(a)-(c).
---------------------------------------------------------------------------
First, proposed Interpretation and Policy .07(a) governs the review
of complex orders that are executed against individual legs (as opposed
to a complex order that executes against another complex order).\7\
Proposed Rule 6.25.07(a) provides:
---------------------------------------------------------------------------
\7\ The leg market consists of quotes and/or orders in single
options series. A complex order may be received by the Exchange
electronically, and the legs of the complex order may have different
counterparties. For example, Market-Maker 1 may be quoting in ABC
calls and Market-Maker 2 may be quoting in ABC puts. A complex order
to buy the ABC calls and puts may execute against the quotes of
Market-Maker 1 and Market-Maker 2.
If a complex order executes against individual legs and at least
one of the legs qualifies as an Obvious or Catastrophic Error under
this Rule 6.25, then the leg(s) that is an Obvious or Catastrophic
Error will be adjusted in accordance with paragraphs (c)(4)(A) or
(d)(3), respectively, regardless of whether one of the parties is a
Customer. However, any Customer order subject to this paragraph (a)
will be nullified if the adjustment would result in an execution
price higher (for buy transactions) or lower (for sell transactions)
than the Customer's limit price on the complex order or individual
leg(s). If any leg of a complex order is nullified, the entire
---------------------------------------------------------------------------
transaction is nullified.
As previously noted, at least one of the legs of the complex order must
qualify as an obvious or catastrophic error under the Current Rule in
order for the complex order to receive obvious or catastrophic error
relief. Thus, when the Exchange is notified (within the timeframes set
forth in paragraph (c)(2) or (d)(2)) of a complex order that is a
possible obvious error or catastrophic error, the Exchange will first
review the individual legs of the complex order to determine if one or
more legs qualify as an obvious or catastrophic error.\8\ If no leg
qualifies as an obvious or catastrophic error, the transaction stands--
no adjustment and no nullification.
---------------------------------------------------------------------------
\8\ Because a complex order can execute against the leg market,
the Exchange may also be notified of a possible obvious or
catastrophic error by a counterparty that received an execution in
an individual options series. If upon review of a potential obvious
error the Exchange determines an individual options series was
executed against the leg of a complex order or stock-option order,
proposed Rule 6.25.07 will govern.
---------------------------------------------------------------------------
Reviewing the legs to determine whether one or more legs qualify as
an obvious or catastrophic error requires the Exchange to follow the
Current Rule. In accordance with paragraphs (c)(1) and (d)(1) of the
Current Rule, the Exchange compares the execution price of each
individual leg to the Theoretical Price of each leg (as determined by
paragraph (b) of the Current Rule). If the execution price of an
individual leg is higher or lower than the Theoretical Price for the
series by an amount equal to at least the amount shown in the obvious
error table in paragraph (c)(1) of the Current rule or the catastrophic
error table in paragraph (d)(1) of the Current Rule, the individual leg
qualifies as an obvious or catastrophic error, and the Exchange will
take steps to adjust or nullify the transaction.\9\
---------------------------------------------------------------------------
\9\ Only the execution price on the leg (or legs) that qualifies
as an obvious or catastrophic error pursuant to any portion of
Proposed Rule 6.25.07 will be adjusted. The execution price of a leg
(or legs) that does not qualify as an obvious or catastrophic error
will not be adjusted.
---------------------------------------------------------------------------
To illustrate, consider a Customer submits a complex order to the
Exchange consisting of leg 1 and leg 2--Leg 1 is to buy 100 ABC calls
and leg 2 is to sell 100 ABC puts. Also, consider that Market-Maker 1
is quoting the ABC calls $1.00-1.20 and Market-Maker 2 is quoting the
ABC puts $2.00-2.20. If the complex order executes against the quotes
of Market-Makers 1 and 2, the Customer buys the ABC calls for $1.20 and
sells the ABC puts for $2.00. As with the obvious/catastrophic error
reviews for simple orders, the execution price of leg 1 is compared to
the Theoretical Price \10\ of Leg 1 in order to determine if Leg 1 is
an obvious error under paragraph (c)(1) of the Current Rule or a
catastrophic error under paragraph (d)(1) of the Current Rule. The same
goes for Leg 2. The execution price of Leg 2 is compared to the
Theoretical Price of Leg 2. If it is determined that one or both of the
legs are an obvious or catastrophic error, then the leg (or legs) that
is an obvious or catastrophic error will be adjusted in accordance with
paragraphs (c)(4)(A) or (d)(3) of the Current Rule, regardless of
whether one of the parties is a Customer.\11\ Although a single-legged
execution that is deemed to be an obvious error under the Current Rule
is nullified whenever a Customer is involved in the transaction, the
Exchange believes adjusting execution prices is generally better for
the marketplace than nullifying executions because liquidity providers
often execute hedging transactions to offset options positions. When an
options transaction is nullified the hedging position can adversely
affect the liquidity provider. With regards to complex orders that
execute against individual legs, the additional rationale for adjusting
erroneous execution prices when possible is the fact that the
counterparty on a leg that is not executed at an obvious or
catastrophic error price cannot look at the execution price to
determine whether the
[[Page 169]]
execution may later be nullified (as opposed to the counterparty on
single-legged order that is executed at an obvious error or
catastrophic error price).
---------------------------------------------------------------------------
\10\ See Rule 6.25(b) (defining the manner in which Theoretical
Price is determined).
\11\ See Rule 6.25(a)(1) (defining Customer for purposes of Rule
6.25 as not including a broker-dealer, Professional Customer, or
Voluntary Professional Customer).
---------------------------------------------------------------------------
Paragraph (c)(4)(A) of the Current Rule mandates that if it is
determined that an obvious error has occurred, the execution price of
the transaction will be adjusted pursuant to the table set forth in
(c)(4)(A). Although for simple orders paragraph (c)(4)(A) is only
applicable when no party to the transaction is a Customer, for the
purposes of complex orders paragraph (a) of Interpretation and Policy
.07 will supersede that limitation; therefore, if it is determined that
a leg (or legs) of a complex order is an obvious error, the leg (or
legs) will be adjusted pursuant to (c)(4)(A), regardless of whether a
party to the transaction is a Customer. The Size Adjustment Modifier
defined in subparagraph (a)(4) will similarly apply (regardless of
whether a Customer is on the transaction) by virtue of the application
of paragraph (c)(4)(A).\12\ The Exchange notes that adjusting all
market participants is not unique or novel. When the Exchange
determines that a simple order execution is a Catastrophic Error
pursuant to the Current Rule, paragraph (d)(3) already provides for
adjusting the execution price for all market participants, including
Customers.
---------------------------------------------------------------------------
\12\ See Rule 6.25(c)(4)(A) (stating that any non-Customer
Obvious Error exceeding 50 contracts will be subject to the Size
Adjustment Modifier defined in sub-paragraph (a)(4)). The Size
Adjustment Modifier may also apply to the option leg of a stock-
option order that is adjusted pursuant to Proposed Rule 6.25.07(c).
---------------------------------------------------------------------------
Furthermore, as with the Current Rule, Proposed Rule 6.25.07(a)
provides protection for Customer orders, stating that where at least
one party to a complex order transaction is a Customer, the transaction
will be nullified if adjustment would result in an execution price
higher (for buy transactions) or lower (for sell transactions) than the
Customer's limit price on the complex order or individual leg(s). For
example, assume Customer enters a complex order to buy leg 1 and leg 2.
Assume the NBBO for leg 1 is $0.20-1.00 and the NBBO for
leg 2 is $0.50-1.00 and that these have been the NBBOs since the market
opened.
A split-second prior to the execution of the complex order
a Customer enters a simple order to sell the leg 1 options series at
$1.30, and the simple order enters the Exchange's book so that the BBO
is $.20-$1.30. The limit price on the simple order is $1.30.
The complex order executes leg 1 against the Exchange's
best offer of $1.30 and leg 2 at $1.00 for a net execution price of
$2.30.
However, leg 1 executed on a wide quote (the NBBO for leg
1 was $0.20-1.00 at the time of execution, which is wider than
$0.75).\13\ Leg 2 was not executed on a wide quote (the market for leg
2 was $0.50-1.00); thus, leg 2 execution price stands.
---------------------------------------------------------------------------
\13\ See Rule 6.25(b)(3).
---------------------------------------------------------------------------
The Exchange determines that the Theoretical Price for leg
1 is $1.00, which was the best offer prior to the execution. Leg 1
qualifies as an obvious error because the difference between the
Theoretical Price ($1.00) and the execution price ($1.30) is larger
than $0.25.\14\
---------------------------------------------------------------------------
\14\ See Rule (c)(1).
---------------------------------------------------------------------------
According to Proposed Rule 6.25.07(a) Customers will also
be adjusted in accordance with Rule 6.25(c)(4)(A), which for a buy
transaction under $3.00 calls for the Theoretical Price to by adjusted
by adding $0.15 \15\ to the Theoretical Price of $1.00. Thus, adjust
execution price for leg 1 would be $1.15.
---------------------------------------------------------------------------
\15\ See Rule 6.25(c)(4)(A).
---------------------------------------------------------------------------
However, adjusting the execution price of leg 1 to $1.15
violates the limit price of the Customer's sell order on the simple
order book for leg 1, which was $1.30.
Thus, the entire complex order transaction will be
nullified \16\ because the limit price of a Customer's sell order would
be violated by the adjustment.\17\
---------------------------------------------------------------------------
\16\ If any leg of a complex order is nullified, the entire
transaction is nullified. See Proposed Rule 6.25.07(a).
\17\ The simple order in this example is not an erroneous sell
transaction because the execution price was not erroneously low. See
Rule 6.25(a)(2).
---------------------------------------------------------------------------
As the above example demonstrates, incoming complex orders may
execute against resting simple orders in the leg market. If a complex
order leg is deemed to be an obvious error, adjusting the execution
price of the leg may violate the limit price of the resting order,
which will result in nullification if the resting order is for a
Customer. In contrast, Interpretation and Policy .02 to Rule 6.25
provides that if an adjustment would result in an execution price that
is higher than an erroneous buy transaction or lower than an erroneous
sell transaction the execution will not be adjusted or nullified.\18\
If the adjustment of a complex order would violate the complex order
Customer's limit price, the transaction will be nullified.
---------------------------------------------------------------------------
\18\ See Rule 6.25.02.
---------------------------------------------------------------------------
As previously noted, paragraph (d)(3) of the Current Rule already
mandates that if it is determined that a catastrophic error has
occurred, the execution price of the transaction will be adjusted
pursuant to the table set forth in (d)(3). For purposes of complex
orders under Proposed Rule .07(a), if one of the legs of a complex
orders is determined to be a Catastrophic Error under paragraph (d)(3),
all market participants will be adjusted in accordance with the table
set forth in (d)(3). Again, however, where at least one party to a
complex order transaction is a Customer, the transaction will be
nullified if adjustment would result in an execution price higher (for
buy transactions) or lower (for sell transactions) than the Customer's
limit price on the complex order or individual leg(s). Again, if any
leg of a complex order is nullified, the entire transaction is
nullified. Additionally, as is the case today, if an Official
determines that a Catastrophic Error has not occurred, the Trading
Permit Holder will be subject to a charge of $5,000.\19\
---------------------------------------------------------------------------
\19\ See Rule 6.25(d)(3).
---------------------------------------------------------------------------
Other than honoring the limit prices established for Customer
orders, the Exchange has proposed to treat Customers and non-Customers
the same in the context of the complex orders that trade against the
leg market. When complex orders trade against the leg market, it is
possible that at least some of the legs will execute at prices that
would not be deemed obvious or catastrophic errors, which gives the
counterparty in such situations no indication that the execution will
later by adjusted or nullified. The Exchange believes that treating
Customers and non-Customers the same in this context will provide
additional certainty to non-Customers (especially Market-Makers) with
respect to their potential exposure and hedging activities, including
comfort that even if a transaction is later adjusted, such transaction
will not be fully nullified. However, as noted above, under the
Proposed Rule where at least one party to the transaction is a
Customer, the trade will be nullified if the adjustment would result in
an execution price higher (for buy transactions) or lower (for sell
transactions) than the Customer's limit price on the complex order or
individual leg(s). The Exchange has retained the protection of a
Customer's limit price in order to avoid a situation where the
adjustment could be to a price that a Customer would not have expected,
and market professionals such as non-Customers would be better prepared
to recover in such situations. Therefore, adjustment for non-Customers
is more appropriate.
[[Page 170]]
Second, proposed Interpretation and Policy .07(b) governs the
review of complex orders that are executed against other complex
orders. Proposed Rule 6.25.07(b) provides:
If a complex order executes against another complex order and at
least one of the legs qualifies as an Obvious Error under paragraph
(c)(1) or a Catastrophic Error under paragraph (d)(1), then the
leg(s) that is an Obvious or Catastrophic Error will be adjusted or
busted in accordance with paragraph (c)(4) or (d)(3), respectively,
so long as either: (i) the width of the National Spread Market for
the complex order strategy just prior to the erroneous transaction
was equal to or greater than the amount set forth in the wide quote
table of paragraph (b)(3) or (ii) the net execution price of the
complex order is higher (lower) than the offer (bid) of the National
Spread Market for the complex order strategy just prior to the
erroneous transaction by an amount equal to at least the amount
shown in the table in paragraph (c)(1). If any leg of a complex
order is nullified, the entire transaction is nullified. For
purposes of Rule 6.25, the National Spread Market for a complex
order strategy is determined by the National Best Bid/Offer of the
individual legs of the strategy.
As described above in relation to Proposed Rule 6.25.07(a), the first
step is for the Exchange to review (upon receipt of a timely
notification in accordance with paragraphs (c)(2) or (d)(2) of the
Current Rule) the individual legs to determine whether a leg or legs
qualifies as an obvious or catastrophic error. If no leg qualifies as
an obvious or catastrophic error, the transaction stands--no adjustment
and no nullification.
Unlike Proposed Rule 6.25.07(a), the Exchange is also proposing to
compare the net execution price of the entire complex order package to
the National Spread Market (``NSM'') for the complex order
strategy.\20\ Complex orders are exempt from the order protection rules
of the options exchanges.\21\ Thus, depending on the manner in which
the systems of an options exchange are calibrated, a complex order can
execute without regard to the prices offered in the complex order books
or the leg markets of other options exchanges. In certain situations,
reviewing the execution prices of the legs in a vacuum would make the
leg appear to be an obvious or catastrophic error, even though the net
execution price on the complex order is not an erroneous price. For
example, assume the Exchange receives a complex order to buy ABC calls
and sell ABC puts.
---------------------------------------------------------------------------
\20\ NSM is the derived net market for a complex order package.
See e.g., Rule 6.53C.04 (utilizing the term derived net market in
the context of complex order strategies). For example, if the NBBO
of Leg 1 is $1.00-2.00 and the NBBO of Leg 2 is $5.00-7.00, then the
NSM for a complex order to buy Leg 1 and buy Leg 2 is $6.00-9.00.
\21\ See Rule 6.81(b)(7). All options exchanges have the same
order protection rule.
---------------------------------------------------------------------------
If the BBO for the ABC calls is $5.50-7.50 and the BBO for
ABC puts is $3.00-4.50, then the Exchange's spread market is $1.00-
4.50.\22\
---------------------------------------------------------------------------
\22\ The complex order is to buy ABC calls and sell ABC puts.
The Exchange's best offer for ABC puts is $7.50 and Exchange's best
bid for is $3.00. If the Customer were to buy the complex order
strategy, the Customer would receive a debit of $4.50 (buy ABC calls
for $7.50 minus selling ABC puts for $3.00). If the Customer were to
sell the complex order strategy the Customer would receive a credit
of $1.00 (selling the ABC calls for $5.50 minus buying the ABC puts
for $4.50). Thus, the Exchange's spread market is $1.00-4.50.
---------------------------------------------------------------------------
If the NBBO for the ABC calls is $6.00-6.50 and the NBBO
for the ABC puts is $3.50-4.00, then the NSM is $2.00-3.00.
If the Customer buys the calls at $7.50 and sells the puts
at $4.00, the complex order Customer receives a net execution price of
$3.00 (debit), which is the expected net execution price as indicated
by the NSM offer of $3.00.
If the exchange were to solely focus on the $7.50 execution price
of the ABC calls or the $4.00 execution price of the ABC puts, the
execution would qualify as an obvious or catastrophic error because the
execution price on the legs was outside the NBBO, even though the net
execution price is accurate. Thus, the additional review of the NSM to
determine if the complex order was executed at a truly erroneous price
is necessary. The same concern is not present when a complex order
executes against the leg market under Rule 6.25.07(a) because the
Exchange is modifying its system in order to ensure the leg will
execute at or within the NBBO of the leg markets.\23\
---------------------------------------------------------------------------
\23\ The proposed rule change to modify Exchange systems to
ensure the legs of a complex order will execute against legs in the
simple order market within the NBBO of the simple order market will
be in a separate filing.
---------------------------------------------------------------------------
In order to incorporate NSM, Rule 6.25.07(b) provides that if the
Exchange determines that a leg or legs does qualify as on obvious or
catastrophic error, the leg or legs will be adjusted or busted in
accordance with paragraph (c)(4) or (d)(3) of the Current Rule, so long
as either: (i) the width of the NSM for the complex order strategy just
prior to the erroneous transaction was equal to or greater than the
amount set forth in the wide quote table of paragraph (b)(3) of the
Current Rule or (ii) the net execution price of the complex order is
higher (lower) than the offer (bid) of the NSM for the complex order
strategy just prior to the erroneous transaction by an amount equal to
at least the amount shown in the table in paragraph (c)(1) of the
Current Rule.
For example, assume an individual leg or legs qualifies as an
obvious or catastrophic error and the width of the NSM of the complex
order strategy just prior to the erroneous transaction is $6.00-9.00.
The complex order will qualify to be adjusted or busted in accordance
with paragraph (c)(4) of the Current Rule because the wide quote table
of paragraph (b)(3) of the Current Rule indicates that the minimum
amount is $1.50 for a bid price between $5.00 to $10.00. If the NSM
were instead $6.00-7.00 the complex order strategy would not qualify to
be adjusted or busted pursuant to .07(b)(i) because the width of the
NSM is $1.00, which is less than the required $1.50. However, the
execution may still qualify to be adjusted or busted in accordance with
paragraph (c)(4) or (d)(3) of the Current Rule pursuant to .07(b)(ii).
Focusing on the NSM in this manner will ensure that the obvious/
catastrophic error review process focuses on the net execution price
instead of the execution prices of the individual legs, which may have
execution prices outside of the NBBO of the leg markets.
Again, assume an individual leg or legs qualifies as an obvious or
catastrophic error as described above. If the NSM is $6.00-7.00 (not a
wide quote pursuant to the wide quote table in paragraph (b)(3) of the
Current Rule) but the execution price of the entire complex order
package (i.e., the net execution price) is higher (lower) than the
offer (bid) of the NSM for the complex order strategy just prior to the
erroneous transaction by an amount equal to at least the amount in the
table in paragraph (c)(1) of the Current Rule, then the complex order
qualifies to be adjusted or busted in accordance with paragraph (c)(4)
or (d)(3) of the Current Rule. For example, if the NSM for the complex
order strategy just prior to the erroneous transaction is $6.00-7.00
and the net execution price of the complex order transaction is $7.75,
the complex order qualifies to be adjusted or busted in accordance with
paragraph (c)(4) of the Current Rule because the execution price of
$7.75 is more than $0.50 (i.e., the minimum amount according to the
table in paragraph (c)(1) when the price is above $5.00 but less than
$10.01) from the NSM offer of $7.00. Focusing on the NSM in this manner
will ensure that the obvious/catastrophic error review process focuses
on the net execution price instead of the execution prices of the
individual legs, which may have execution prices outside of the NBBO of
the leg markets.
Although the Exchange believes adjusting execution prices is
generally better for the marketplace than
[[Page 171]]
nullifying executions because liquidity providers often execute hedging
transactions to offset options positions, the Exchange recognizes that
complex orders executing against other complex orders is similar to
simple orders executing against other simple orders because both
parties are able to review the execution price to determine whether the
transaction may have been executed at an erroneous price. Thus, for
purposes of complex orders that meet the requirements of Rule
6.25.07(b), the Exchange proposes to apply the Current Rule and adjust
or bust obvious errors in accordance with paragraph (c)(4) (as opposed
to applying paragraph (c)(4)(A) as is the case under .07(a)) and
catastrophic errors in accordance with (d)(3).
Therefore, for purposes of complex orders under Proposed Rule
6.25.07(b), if one of the legs is determined to be an obvious error
under paragraph (c)(1), all Customer transactions will be nullified,
unless a Trading Permit Holder (``TPH'') submits 200 or more Customer
transactions for review in accordance with (c)(4)(C).\24\ For purposes
of complex orders under Proposed Rule 6.25.07(b), if one of the legs is
determined to be a catastrophic error under paragraph (d)(3) and all of
the other requirements of Rule 6.25.07(b) are met, all market
participants will be adjusted in accordance with the table set forth in
(d)(3). Again, however, pursuant to paragraph (d)(3) where at least one
party to a complex order transaction is a Customer, the transaction
will be nullified if adjustment would result in an execution price
higher (for buy transactions) or lower (for sell transactions) than the
Customer's limit price on the complex order or individual leg(s). Also,
if any leg of a complex order is nullified, the entire transaction is
nullified.
---------------------------------------------------------------------------
\24\ Rule 6.25(c)(4)(C) also requires the orders resulting in
200 or more Customer transactions to have been submitted during the
course of 2 minutes or less.
---------------------------------------------------------------------------
Third, proposed Interpretation and Policy .07(c) governs stock-
option orders. Proposed Rule 6.25.07(c) provides:
If the option leg of a stock-option order qualifies as an
Obvious Error under paragraph (c)(1) or a Catastrophic Error under
paragraph (d)(1), then the option leg that is an Obvious or
Catastrophic Error will be adjusted in accordance with paragraph
(c)(4)(A) or (d)(3), respectively, regardless of whether one of the
parties is a Customer. However, the option leg of any Customer order
subject to this paragraph (c) will be nullified if the adjustment
would result in an execution price higher (for buy transactions) or
lower (for sell transactions) than the Customer's limit price on the
stock-option order, and the Exchange will attempt to nullify the
stock leg. Whenever a stock trading venue nullifies the stock leg of
a stock-option order or whenever the stock leg cannot be executed,
the Exchange will nullify the option leg upon request of one of the
parties to the transaction or in accordance with paragraph (c)(3).
Similar to proposed Interpretation and Policy .07(a), an options
leg (or legs) of a stock-option order must qualify as an obvious or
catastrophic error under the Current Rule in order for the stock-option
order to qualify as an obvious or catastrophic error. Also similar to
Proposed Rule 6.25.07(a), if an options leg (or legs) does qualify as
an obvious or catastrophic error, the option leg (or legs) will be
adjusted in accordance with paragraph (c)(4)(A) or (d)(3),
respectively, regardless of whether one of the parties is a Customer.
Again, as with Proposed Rule 6.25.07(a), where at least one party to a
complex order transaction is a Customer, the Exchange will nullify the
option leg and attempt to nullify the stock leg if adjustment would
result in an execution price higher (for buy transactions) or lower
(for sell transactions) than the Customer's limit price on the complex
order or individual leg(s).
The stock leg of a stock-option order is not executed on the
Exchange; rather, the stock leg is sent to a stock trading venue for
execution. The Exchange is unaware of a mechanism by which the Exchange
can guarantee that the stock leg will be nullified by the stock trading
venue in the event of an obvious or catastrophic error on the Exchange.
Thus, in the event of the nullification of the option leg pursuant to
Proposed Rule 6.25.07(c), the Exchange will attempt to have the stock
leg nullified by the stock trading venue by either contacting the stock
trading venue or notifying the parties to the transaction that the
option leg is being nullified. The party or parties to the transaction
may ultimately need to contact the stock trading venue to have the
stock portion nullified.
Finally, the Exchange proposes to provide guidance that whenever
the stock trading venue nullifies the stock leg of a stock-option
order, the option will be nullified upon request of one of the parties
to the transaction or by an Official acting on their own motion in
accordance with paragraph (c)(3). There are situations in which buyer
and seller agree to trade a stock-option order, but the stock leg
cannot be executed. The Exchange proposes to provide guidance that
whenever the stock portion of a stock-option order cannot be executed,
the Exchange will nullify the option leg upon request of one of the
parties to the transaction or on an Official's own motion.
2. Statutory Basis
The Exchange believes that its proposal is consistent with the
requirements of the Act and the rules and regulations thereunder that
are applicable to a national securities exchange, and, in particular,
with the requirements of Section 6(b) of the Act.\25\ Specifically, the
proposal is consistent with Section 6(b)(5) of the Act \26\ because it
would promote just and equitable principles of trade, remove
impediments to, and perfect the mechanism of, a free and open market
and a national market system, and, in general, protect investors and
the public interest.
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\25\ 15 U.S.C. 78f(b).
\26\ 15 U.S.C. 78f(b)(5).
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As described above, the Exchange and other options exchanges are
seeking to adopt harmonized rules related to the adjustment and
nullification of erroneous options transactions. The Exchange believes
that the Proposed Rule will provide greater transparency and clarity
with respect to the adjustment and nullification of erroneous options
transactions. Particularly, the proposed changes seek to achieve
consistent results for participants across U.S. options exchanges while
maintaining a fair and orderly market, protecting investors and
protecting the public interest. Based on the foregoing, the Exchange
believes that the proposal is consistent with Section 6(b)(5) of the
Act \27\ in that the Proposed Rule will foster cooperation and
coordination with persons engaged in regulating and facilitating
transactions.
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\27\ 15 U.S.C. 78f(b)(5).
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The Exchange believes the various provisions allowing or dictating
adjustment rather than nullification of a trade are necessary given the
benefits of adjusting a trade price rather than nullifying the trade
completely. Because options trades are used to hedge, or are hedged by,
transactions in other markets, including securities and futures, many
TPHs, and their customers, would rather adjust prices of executions
rather than nullify the transactions and, thus, lose a hedge
altogether. As such, the Exchange believes it is in the best interest
of investors to allow for price adjustments as well as nullifications.
The Exchange does not believe that the proposal is unfairly
discriminatory, even though it differentiates in many places between
Customers and non-
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Customers. As with the Current Rule, Customers are treated differently,
often affording them preferential treatment. This treatment is
appropriate in light of the fact that Customers are not necessarily
immersed in the day-to-day trading of the markets, are less likely to
be watching trading activity in a particular option throughout the day,
and may have limited funds in their trading accounts. At the same time,
the Exchange reiterates that in the U.S. options markets generally
there is significant retail customer participation that occurs directly
on (and only on) options exchanges such as the Exchange. Accordingly,
differentiating among market participants with respect to the
adjustment and nullification of erroneous options transactions is not
unfairly discriminatory because it is reasonable and fair to provide
Customers with additional protections as compared to non-Customers.
The Exchange believes that its proposal to adopt the ability to
adjust a Customer's execution price when a complex order is deemed to
be an Obvious or Catastrophic Error is consistent with the Act. A
complex order that executes against individual leg markets may receive
an execution price on an individual leg that is not an Obvious or
Catastrophic error but another leg of the transaction is an Obvious or
Catastrophic Error. In such situations where the complex order is
executing against at least one individual or firm that is not aware of
the fact that they have executed against a complex order or that the
complex order has been executed at an erroneous price, the Exchange
believes it is more appropriate to adjust execution prices if possible
because the derivative transactions are often hedged with other
securities. Allowing adjustments instead of nullifying transactions in
these limited situations will help to ensure that market participants
are not left with a hedge that has no position to hedge against.
The Exchange also believes its proposal related to stock-option
orders is consistent with the Act. Stock-option orders consist of an
option component and a stock component. Due to the fact that the
Exchange has no control over the venues on which the stock is executed
the proposal focuses on the option component of the stock-option order
by adjusting or nullifying the option in accordance with paragraph
(c)(4)(A) or (d)(3). Also, nullifying the option component if the stock
component cannot be executed ensures that market participants receive
the execution for which they bargained. Stock-option orders are
negotiated and agreed to as a package; thus, if for any reason the
stock portion of a stock-option order cannot ultimately be executed,
the parties should not be saddled with an options position sans stock.
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.
Importantly, the Exchange believes the proposal will not impose a
burden on intermarket competition but will rather alleviate any burden
on competition because it is the result of a collaborative effort by
all options exchanges to harmonize and improve the process related to
the adjustment and nullification of erroneous options transactions. The
Exchange does not believe that the rules applicable to such process is
an area where options exchanges should compete, but rather, that all
options exchanges should have consistent rules to the extent possible.
Particularly where a market participant trades on several different
exchanges and an erroneous trade may occur on multiple markets nearly
simultaneously, the Exchange believes that a participant should have a
consistent experience with respect to the nullification or adjustment
of transactions. The Exchange understands that all other options
exchanges that trade complex orders and/or stock-option orders intend
to file proposals that are substantially similar to this proposal.
The Exchange does not believe that the proposed rule change imposes
a burden on intramarket competition because the provisions apply to all
market participants equally within each participant category (i.e.,
Customers and non-Customers). With respect to competition between
Customer and non-Customer market participants, the Exchange believes
that the Proposed Rule acknowledges competing concerns and tries to
strike the appropriate balance between such concerns. For instance, the
Exchange believes that protection of Customers is important due to
their direct participation in the options markets as well as the fact
that they are not, by definition, market professionals. At the same
time, the Exchange believes due to the quote-driven nature of the
options markets, the importance of liquidity provision in such markets
and the risk that liquidity providers bear when quoting a large breadth
of products that are derivative of underlying securities, that the
protection of liquidity providers and the practice of adjusting
transactions rather than nullifying them is of critical importance. As
described above, the Exchange will apply specific and objective
criteria to determine whether an erroneous transaction has occurred
and, if so, how to adjust or nullify a transaction.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange neither solicited nor received comments on the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission will:
A. by order approve or disapprove such proposed rule change, or
B. institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to rule-comments@sec.gov. Please include
File Number SR-CBOE-2016-088 on the subject line.
Paper Comments
Send paper comments in triplicate to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-CBOE-2016-088. 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
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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 such filing also will be available for inspection
and copying at the principal office of the Exchange. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-CBOE-2016-088, and should be
submitted on or before January 24, 2017.
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\28\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\28\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2016-31766 Filed 12-30-16; 8:45 am]
BILLING CODE 8011-01-P
