[Federal Register Volume 69, Number 24 (Thursday, February 5, 2004)]
[Notices]
[Pages 5620-5622]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-2359]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49153; File No. SR-CBOE-2003-50]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by 
the Chicago Board Options Exchange, Inc., Relating to a Pilot Program 
for Quotation Spreads in Hybrid Classes

January 29, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 31, 2003, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. The CBOE 
submitted Amendment No. 1 to the proposed rule change on January 7, 
2004.\3\ The CBOE has submitted the proposed rule change under section 
19(b)(3)(A) of the Act \4\ and Rule 19b-4(f)(6) thereunder,\5\ which 
renders the proposal effective upon filing with the Commission.\6\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Stephen Youhn, CBOE, to Kelly Riley, Senior 
Special Counsel, Division of Market Regulation, Commission, dated 
January 6, 2004 (``Amendment No. 1''). In Amendment No. 1, the CBOE 
proposed to limit its proposed rule change to 200 options classes 
trading on the CBOE's Hybrid Trading System for a pilot period of 
six months. In addition, the CBOE agreed to provide the Commission 
with a pilot program report comparing the Average Quote Width 
Analysis (``AQWA'') scores for each pilot program option prior to 
the commencement of the pilot with the AQWA scores for each pilot 
program option during the pilot period. Finally, the CBOE amended 
Items 7 and 8 of its Form 19b-4 to designate the filing as ``non-
controversial'' pursuant to Rule 19b-4(f)(6) and to indicate that 
its proposed rule change is substantially similar to an approved 
pilot program of the International Securities Exchange, Inc.
    \4\ 15 U.S.C. 78s(b)(3)(A).
    \5\ 17 CFR 240.19b-4(f)(6).
    \6\ For purposes of determining the effective date and 
abrogation date of this filing, the Commission considers January 7, 
2004, the date on which the CBOE filed Amendment No. 1, to be the 
filing date of this proposed rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to amend CBOE Rule 8.7, ``Obligations of Market 
Makers,'' to adopt a six-month pilot program through June 29, 2004 that 
would permit quote spread parameters of up to $5 on up to 200 option 
classes traded on the CBOE's Hybrid Trading System (``Hybrid''). The 
text of the proposed rule change appears below. Proposed new language 
is italicized.

Rule 8.7 Obligations of Market Makers

    (a) No change.
    (b)
    (i)-(iii) No change.
    (iv) To price options contracts fairly by, among other things, 
bidding and/or offering so as to create differences of no more than 
0.25 between the bid and offer for each option contract for which the 
bid is less than $2, no more than $0.40 where the bid is at least $2 
but does not exceed $5, no more than $0.50 where the bid is more than 
$5 but does not exceed $10, no more than $0.80 where the bid is more 
than $10 but does not exceed $20, and no more than $1 where the bid is 
more than $20, provided that the appropriate Market Performance 
Committee may establish differences other than the above for one or 
more options series. The bid/ask differentials stated above shall not 
apply to in-the-money series where the underlying securities market is 
wider than the differentials set forth above. For these series, the 
bid/ask differential may be as wide as the quotation on the primary 
market of the underlying security.
    (A) For a six month period expiring on August 5, 2004, the Exchange 
may designate options on up to two hundred (200) underlying securities 
that may be quoted with a difference not to exceed $5 between the bid 
and offer regardless of the price of the bid. The $5 quote widths shall 
only apply to classes trading on the Hybrid system and only following 
the opening rotation in each security i.e., the widths specified in 
paragraph (b)(iv) above shall apply during opening rotation).

[[Page 5621]]

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

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

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

1. Purpose
    The purpose of the proposed rule change, as amended, is to 
establish a six-month pilot program to relax the quotation spread 
requirements on the CBOE for up to 200 option classes traded on Hybrid. 
Currently, CBOE Rule 8.7(b)(iv) establishes maximum bid-ask 
differentials (also referred to as quote spread requirements) that vary 
from $0.25 to $1.00, depending upon the price of the option.\7\ The 
primary purpose of the quote spread requirements is to help to maintain 
narrow spreads in options. According to the CBOE, these requirements 
can have the unintended consequence of requiring market makers to quote 
at prices that are unnecessarily narrow, thereby exposing them to great 
risk if markets move quickly.
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    \7\ The allowable bid-ask differentials are: $0.25 for options 
under $2, $0.40 for options between $2 and $5, $0.50 for options 
between $5 and $10, $0.80 for options between $10 and $20, and $1.00 
for options above $20. See CBOE Rule 8.7(b)(iv).
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    The CBOE believes that given the competitive market making 
structure of Hybrid and the existence of vigorous inter-market 
competition, the mandatory quote spread requirements may not be 
necessary to ensure narrow and competitive spreads in options. In this 
regard, the CBOE states that the Hybrid market structure creates strong 
incentives for competing market makers and other market participants to 
disseminate competitive prices. The Exchange notes that in Hybrid each 
market maker quotes independently, and customers and broker-dealers can 
enter limit orders in the limit order book at prices better than those 
posted by market makers. The Exchange automatically collects this 
trading interest information, calculates the CBOE best bid and offer, 
and disseminates that value to the Options Price Reporting Authority. 
Accordingly, the CBOE believes that its Hybrid market is competitive, 
accessible and transparent.
    In addition, the CBOE states that market participants in Hybrid 
have strong incentives to quote competitively. The CBOE allocates 
incoming orders based on the price and size of orders and quotes 
resting in the book. Under the CBOE's Ultimate Matching Algorithm 
(``UMA''), the larger the size of a market maker's quote at the best 
price, the greater the size of the allocation he or she receives. 
Conversely, if a market participant does not quote at the best price, 
the market participant will not participate in any electronic trade 
allocations. The CBOE believes, moreover, that given NBBO protections 
in place at each exchange as well as through the Options Market Linkage 
plan, market participants have even stronger incentives to quote at the 
best price, lest incoming orders be filled away. Thus, the CBOE 
believes that inter- and intra-market competitive forces provide strong 
incentives for market participants to quote competitively and enter 
quotes and orders that improve the price and depth of the market.
    For these reasons, CBOE proposes a pilot program to expand the 
allowable spread in Hybrid classes to $5 for up to 200 classes of 
options traded on Hybrid. The proposed quote spread requirements will 
apply after the opening trading rotation. During the opening trading 
rotation, market makers will be required to quote in accordance with 
the traditional bid-ask width requirements. The $5 quotation 
requirements would become operative immediately following the opening 
rotation. Non-Hybrid classes will remain subject to the current 
requirements of CBOE Rule 8.7(b)(iv).
    During the pilot program, the CBOE will monitor the quotation 
quality of all classes in the program and, based on the results, 
recommend either relaxing the spread requirements for all Hybrid 
classes, ending the pilot, or adjusting the spread requirements for all 
Hybrid classes. Immediately following the pilot period, the Exchange 
will prepare and submit to the Commission a report assessing the 
operation of the program and, in particular, the quality of the 
quotations for the pilot options.\8\ In this respect, the CBOE commits 
to provide to the Commission a report analyzing Average Quote Width 
Analysis (``AQWA'') scores for each of the pilot stocks. The Exchange's 
report will compare the AQWA scores for each option prior to 
implementation of the pilot program versus the AQWA scores for each 
option during the pilot period. The Exchange believes that this 
information will provide a meaningful comparison during these relevant 
periods so that the Exchange may determine the effect that $5 quote 
widths have on quote quality.
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    \8\ See Amendment No. 1, supra note 3.
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    The CBOE notes that the proposed quotation spread requirements are 
in effect on a pilot basis at the International Securities Exchange, 
Inc. (``ISE''). Specifically, on March 19, 2003, the Commission 
approved a six-month pilot program (``ISE Pilot'') permitting ISE 
market makers to expand the allowable spread in their quotations to 
$5.\9\ The ISE Pilot applies to options on 50 underlying stocks and 
expires on January 31, 2004.\10\ In September 2003, the ISE requested 
permanent approval of the ISE Pilot and sought to expand the terms of 
the ISE Pilot to all ISE-listed equity options.\11\ The CBOE represents 
that its proposed pilot program is similar to that of the ISE.
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    \9\ See Securities Exchange Act Release No. 47532 (March 19, 
2003), 68 FR 14728 (March 26, 2003) (order approving File No. SR-
ISE-2001-15).
    \10\ See Securities Exchange Act Release No. 48514 (September 
22, 2003), 68 FR 55685 (September 26, 2003) (notice of filing and 
immediate effectiveness of File No. SR-ISE-2003-21).
    \11\ See File No. SR-ISE-2003-22.
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Act and the rules and regulations under the Act applicable to a 
national securities exchange and, in particular, the requirements of 
section 6(b) of the Act.\12\ Specifically, the Exchange believes the 
proposed rule change is consistent with the section 6(b)(5) \13\ 
requirements that the rules of an exchange be designed to promote just 
and equitable principles of trade, to prevent fraudulent and 
manipulative acts and, in general, to protect investors and the public 
interest.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition not necessary or appropriate in furtherance 
of the purposes of the Exchange Act.

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

    No written comments were solicited or received.

[[Page 5622]]

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

    The CBOE has filed \14\ the proposed rule change pursuant to 
section 19(b)(3)(A) of the Act \15\ and subparagraph (f)(6) of Rule 
19b-4 thereunder.\16\ Because the foregoing proposed rule change: (1) 
Does not significantly affect the protection of investors or the public 
interest; (2) does not impose any significant burden on competition; 
and (3) is not proposed to become operative for 30 days, or such 
shorter time as the Commission may designate, and the CBOE provided the 
Commission with written notice of its intent to file the proposed rule 
change at least five business days prior to the filing date, the 
proposed rule change has become effective pursuant to section 
19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder.
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    \14\ See supra note 6.
    \15\ 15 U.S.C. 78s(b)(3)(A).
    \16\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under Rule 19b-4(f)(6) normally does 
not become operative prior to 30 days after the date of filing. 
However, Rule 19b-4(f)(6)(iii) permits the Commission to designate a 
shorter time if such action is consistent with the protection of 
investors and the public interest. The CBOE has requested that the 
Commission waive the 30-day operative delay to allow the CBOE to 
implement its pilot program, which is similar to the ISE Pilot, without 
delay.
    The Commission believes that waiving the 30-day operative delay is 
consistent with the protection of investors and the public 
interest.\17\ Specifically, the Commission believes that allowing the 
CBOE to establish a pilot program that is similar to the ISE Pilot will 
help the CBOE to compete with the ISE. In addition, the Commission 
notes that the CBOE's pilot program is substantially similar to the ISE 
Pilot, which the Commission approved previously on a six-month pilot 
basis and subsequently extended through January 31, 2004.\18\ The 
Commission believes that the CBOE's proposal raises no new issues or 
regulatory concerns that the Commission did not consider in approving 
the ISE Pilot. For these reasons, the Commission designates that the 
proposal become operative immediately, with the pilot program to extend 
through June 29, 2004.
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    \17\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \18\ See supra notes 8 and 9, and accompanying text.
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    At any time within 60 days of the filing of such proposed rule 
change,\19\ the Commission may summarily abrogate such rule change if 
it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.
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    \19\ See supra note 6.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Comments may also be submitted electronically at the 
following e-mail address: <a href="/cdn-cgi/l/email-protection#2755524b420a44484a4a424953546754424409404851"><span class="__cf_email__" data-cfemail="e391968f86ce808c8e8e868d9790a3908680cd848c95">[email protected]</span></a>. All comment letters 
should refer to File No. SR-CBOE-2003-50. This file number should be 
included on the subject line if e-mail is used. To help the Commission 
process and review your comments more efficiently, your comments should 
be sent in hardcopy or by e-mail but not by both methods.
    Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street, NW., 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-2003-50 and should be 
submitted by February 26 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-2359 Filed 2-4-04; 8:45 am]
BILLING CODE 8010-01-P


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