42350 Federal Register / Vol. 74, No. 161 / Friday, August 21, 2009 / Notices 

11 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

3See Securities Exchange Act Release No. 59435 

(February 23, 2009), 74 FR 9115 (‘‘Notice’’). 

4See Letter from Michael J. Simon, Secretary, 

International Securities Exchange, LLC (‘‘ISE’’), to 

Nancy M. Morris, Secretary, Commission dated 

March 25, 2009 (‘‘ISE Letter’’). 

5See Letter from Jennifer M. Lamie, Assistant 

General Counsel, CBOE, to Elizabeth M. Murphy, 

Secretary, Commission dated August 11, 2009 

(‘‘CBOE Letter’’). 

6According to the Exchange, if the orders that 

comprise a solicited transaction are not suitably 

exposed to the order interaction process on the 

CBOE floor, the execution of such orders would not 

be consistent with CBOE rules designed to promote 

order interaction in an open-outcry auction. For 

example, CBOE Rule 6.43, Manner of Bidding and 

Offering, requires bids and offers to be made at the 

post by public outcry, and Rule 6.74 imposes 

specific order exposure requirements on floor 

brokers seeking to cross buy orders with sell orders. 

See Notice, supra note 3, at 9116. 

7CBOE Rule 6.9(e) defines ‘‘related instrument’’ 

to mean ‘‘in reference to an index option, an order 

to buy or sell securities comprising ten percent or 

more of the component securities in the index or 

an order to buy or sell a futures contract on any 

economically equivalent index. With respect to an 

SPX option, an OEX option is a related instrument, 

and vice versa.’’ 

8See Notice, supra note 3, at 9116 (discussing 

CBOE’s rationale behind its proposal). 

9See id. at 9120. 

All submissions should refer to File 

Number SR–NYSE–2009–80. 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, please use 

only one method. The Commission will 

post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/ 

rules/sro.shtml). Copies of the 

submission, all subsequent 

amendments, all written statements 

with respect to the proposed rule 

change that are filed with the 

Commission, and all written 

communications relating to the 

proposed rule change between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for inspection and copying in 

the Commission’s Public Reference 

Room, 100 F Street, NE., Washington, 

DC 20549, on official business days 

between the hours of 10 a.m. and 3 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–NYSE–2009–80 and should 

be submitted on or before September 11, 

2009. 

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.11

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. E9–20130 Filed 8–20–09; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–60499; File No. SR–CBOE– 

2009–007] 

Self-Regulatory Organizations; 

Chicago Board Options Exchange, 

Incorporated; Notice of Filing of 

Amendment No. 1 and Order Granting 

Accelerated Approval to a Proposed 

Rule Change, as Modified by 

Amendment No. 1 Thereto, Relating to 

Tied Hedge Transactions 

August 13, 2009. 

I. Introduction 

On February 13, 2009, the Chicago 

Board Options Exchange, Incorporated 

(‘‘CBOE’’ or the ‘‘Exchange) filed with 

the Securities and Exchange 

Commission (‘‘Commission’’), pursuant 

to Section 19(b)(1) of the Securities 

Exchange Act of 1934 (‘‘Act’’)1 and Rule 

19b–4 thereunder,2 a proposed rule 

change to allow hedging stock, security 

futures, or futures contract positions to 

be represented currently with option 

facilitations or solicitations in the 

trading crowd (‘‘tied hedge’’ orders). 

The proposed rule change was 

published for comment in the Federal 

Register on March 2, 2009.3 The 

Commission received one comment 

letter on the proposal.4 CBOE responded 

to the comment letter on August 11, 

2009.5 CBOE filed Amendment No. 1 to 

the proposed rule change on August 11, 

2009. This notice and order provides 

notice of filing of Amendment No. 1 to 

the proposed rule change, and grants 

accelerated approval to the proposed 

rule change, as modified by Amendment 

No. 1. 

II. Description of the Proposal 

CBOE Rule 6.74 generally sets forth 

the procedures by which a floor broker 

may cross an order with a contra-side 

order. Transactions executed pursuant 

to Rule 6.74 are subject to the 

restrictions of paragraph (e) of Rule 6.9, 

Solicited Transactions, which prohibits 

trading based on knowledge of 

imminent undisclosed solicited 

transactions (commonly referred to as 

‘‘anticipatory hedging’’). 

A. Anticipatory Hedging Rule 

CBOE Rule 6.9, adopted in 1994, was 

originally designed to preserve the right 

to solicit orders in advance of 

submitting a proposed trade to the 

crowd, while at the same time assuring 

that orders that are the subject of a 

solicitation are exposed to the auction 

market in a meaningful way.6 In 

addition to requiring disclosure of 

orders and clarifying the priority 

principles applicable to solicited 

transactions, CBOE Rule 6.9 provides 

that it is inconsistent with just and 

equitable principles of trade for any 

member or associated person who has 

knowledge of all the material terms of 

an original order and a solicited order 

(including a facilitation order) that 

matches the original order’s price to 

enter an order to buy or sell an option 

of the same class as any option that is 

the subject of the solicitation prior to 

the time the original order’s terms are 

disclosed to the crowd or the execution 

of the solicited transaction can no 

longer reasonably be considered 

imminent. This prohibition extends to 

orders to buy or sell the underlying 

security or any ‘‘related instrument.’’7

B. Proposed Exception to Anticipatory 

Hedging Rule 

In order to address CBOE’s perceived 

concerns associated with increased 

volatility and decreased liquidity and to 

more effectively compete with the overthe-counter market,8 the Exchange is 

now proposing to adopt a limited 

exception to its anticipatory hedging 

restrictions that would permit the 

representation of hedging stock 

positions in conjunction with option 

orders, including complex orders, in the 

options trading crowd (a ‘‘tied hedge’’ 

transaction). The Exchange believes this 

limited exception would be consistent 

with the original design of CBOE Rule 

6.9(e), but would set forth a more 

practicable approach that would 

facilitate hedging in today’s trading 

environment while still encouraging 

meaningful competition among upstairs 

and floor traders.9

With a tied hedge transaction, 

Exchange members would be permitted 

to first hedge an option and then 

forward the option order and the 

hedging position to an Exchange floor 

broker with instructions to represent the 

option order together with the hedging 

position to the options trading crowd. 

Under the proposal, the original option 

order must be within designated size 

parameters, which would be determined 

by the Exchange and could not be 

smaller than 500 contracts. In addition, 

the original option order must be in a 


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10The proposed definition of a ‘‘related 

instrument’’ with respect to an index option is 

modeled after the definition that currently applies 

under Rule 6.9(e). 

11For example, a tied hedge order involving 

options on the iShares Russell 2000 Index ETF 

might involve a hedge position in the underlying 

ETF, security futures overlying the ETF, or futures 

contracts overlying the Russell 2000 Index. 

12The Commission notes that, while a tied hedge 

may be treated the same as a complex order for 

purposes of CBOE’s intra-market priority, an 

original single-sided customer order would not 

otherwise constitute a complex order solely by 

virtue of being packaged into a tied hedge 

transaction. Accordingly, when a single-sided 

customer order is packaged into a tied hedge 

transaction, the execution of the option leg will not 

qualify for the ‘‘complex trade’’ exception from the 

Options Linkage Plan. 13On July 28, 2000, the Commission approved the 

Options Linkage Plan as a national market system 

plan for the purpose of creating and operating an 

intermarket options market linkage proposed by the 

American Stock Exchange LLC (n/k/a NYSE Amex 

LLC), CBOE, and International Securities Exchange, 

LLC (‘‘ISE’’). See Securities Exchange Act Release 

No. 43086 (July 28, 2000), 65 FR 48023 (August 4, 

2000) (File No. 4–429). Subsequently, Philadelphia 

Stock Exchange, Inc. (n/k/a NASDAQ OMX PHLX, 

Inc.), Pacific Exchange, Inc. (n/k/a NYSE Arca), 

Boston Stock Exchange, Inc. (n/k/a NASDAQ OMX 

BX, Inc.), and The NASDAQ Stock Market LLC 

joined the Options Linkage Plan. See Securities 

Exchange Act Release Nos. 43573 (November 16, 

2000), 65 FR 70851 (November 28, 2000) (File No. 

4–429); 43574 (November 16, 2000), 65 FR 70850 

(November 28, 2000) (File No. 4–429); 49198 

(February 5, 2004), 69 FR 7029 (February 12, 2004) 

(File No. 4–429); and 57545 (March 21, 2008), 73 

FR 16394 (March 27, 2008) (File No. 4–429). The 

Commission recently approved a new national 

market system plan regarding intermarket options 

linkage, the Options Order Protection and Locked/ 

Crossed Market Plan, which carries over the 

complex order exception from the Options Linkage 

Plan. See Securities Exchange Act Release No. 

60405 (July 30, 2009), 74 FR 39362 (August 6, 2008) 

(File No. 4–546). See also Securities Exchange Act 

Release No. 60187 (June 29, 2009), 74 FR 32664 

(July 8, 2009) (SR–CBOE–2009–040) (notice of filing 

of CBOE’s new Options Linkage rules). 

14See ISE Letter, supra note 4. 

15See CBOE Letter, supra note 5. 

16See ISE Letter, supra note 4, at 1. 

17See id. at 1. 

18See CBOE Letter, supra note 5, at 2–3. 

19See id. at 3. 

20See id. at note 5. 

21See ISE Letter, supra note 4, at 1–2. 

22See CBOE Letter, supra note 5, at 3. 

class designated as eligible for a tied 

hedge transaction. Eligible hedging 

positions would be determined by the 

Exchange for each eligible class and 

may include (i) the same underlying 

stock applicable to the option order, (ii) 

a security future overlying the same 

stock applicable to the option order, or 

(iii) in reference to an option on an 

index, exchange-traded fund (‘‘ETF’’), or 

options on HOLding Company 

Depository ReceiptS (‘‘HOLDRS’’), a 

related instrument may be used as a 

hedge. A ‘‘related instrument’’ would 

mean, in reference to an index option, 

securities comprising ten percent or 

more of the component securities in the 

index or a futures contract on any 

economically equivalent index 

applicable to the option order. With 

respect to SPX, OEX would be an 

economically equivalent index, and vice 

versa.10 A ‘‘related instrument’’ would 

mean, in reference to an ETF or 

HOLDRS option, a futures contract on 

any economically equivalent index 

applicable to the ETF or HOLDRS 

underlying the option order.11

The proposal would require that the 

entire hedging position, which could 

not exceed the options order on a delta 

basis, be brought without undue delay 

to the trading crowd, announced to the 

trading crowd concurrently with the 

option order, offered to the crowd in its 

entirety, and offered at the execution 

price received by the member or 

member organization introducing the 

order to any in-crowd market 

participant who has established parity 

or priority for the related options. 

In-crowd market participants that 

participate in the option transaction 

must participate in the hedging position 

on a proportionate basis and would not 

be permitted to prevent the option 

transaction from occurring by giving a 

competing bid or offer for one 

component of the tied hedge order. 

In addition, the proposal would 

require that, prior to entering tied hedge 

orders on behalf of customers, the 

member must deliver to the customer a 

one-time written notification informing 

the customer that its order may be 

executed using the Exchange’s tied 

hedge procedures. A member also 

would be required to create an 

electronic record of the tied hedge order 

in a form and manner prescribed by the 

Exchange. 

C. Amendment No. 1 

In Amendment No. 1, the Exchange 

reflected in rule text the priority 

treatment applicable to all tied hedge 

transactions (regardless of whether the 

original order is a simple order or a 

complex order) by clarifying that such 

transactions will be treated the same as 

complex orders for purposes of CBOE’s 

open outcry allocation and reporting 

procedures.12 CBOE also clarified that 

where an original order is a simple 

order, the initial execution of the option 

leg will not qualify for the ‘‘complex 

trade’’ exception from the Plan for the 

Purpose of Creating and Operating an 

Intermarket Option Linkage (‘‘Options 

Linkage Plan’’).13 The text of 

Amendment No. 1 is available on the 

Exchange’s Web site (http:// 

www.cboe.org/Legal), at the Exchange’s 

Office of the Secretary, and at the 

Commission’s Public Reference Room. 

III. Summary of Comments and CBOE 

Response 

The Commission received one 

comment on the proposed rule change 

from the ISE.14 CBOE submitted a letter 

to the Commission responding to ISE’s 

comment letter.15

ISE argued that the proposed tied 

hedge transaction was similar to frontrunning and may disadvantage the 

trading crowd competing for the order 

in the auction process as well as the 

order being executed.16 ISE believed 

that CBOE’s proposal would allow a 

member with knowledge of a pending 

transaction to have an advantage over 

others in the auction market process, 

which could result in less competition 

and worse prices for customers.17

In response, CBOE explained that it 

did not believe a firm that establishes a 

hedge position pursuant to the proposal 

would be taking advantage of material, 

nonpublic information as contemplated 

by the front-running prohibitions.18

Rather, CBOE noted that its proposal 

provides the options trading crowd with 

the same access to a hedge as the 

solicited party, thereby allowing the 

crowd to compete on the same terms, 

because the tied hedge position would 

be required to be brought without undue 

delay to the trading crowd and 

announced concurrently with the option 

order, offered to the crowd in its 

entirety, and offered at the execution 

price received by the member to any incrowd market participant who 

establishes parity or priority for the 

related option order.19 The Exchange 

asserted its belief that the tied hedge 

proposal may result in narrow spreads 

and improved customer prices.20

In addition, ISE expressed concern 

that the proposed hedging activity may 

cause movement in the price of the 

underlying security and consequently 

the option, resulting in a worse price for 

the options customer.21 In response, 

CBOE explained that its proposal 

attempts to address this concern by 

providing a mechanism to facilitate 

hedging that it believes will not be 

detrimental to the options orders being 

hedged nor the auction market.22 CBOE 

noted that participants will continue to 

be governed by, among other things, 

their best execution responsibilities. 

ISE further opined that CBOE’s 

proposal, because it does not permit the 

trading crowd to execute the options 

order without taking a proportionate 

share of the hedge, could increase 

internalization and lead to less vigorous 


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23See ISE Letter, supra note 4, at 2. 

24See CBOE Letter, supra note 5, at 3. 

25See id. 

26 ISE Letter, supra note 4, at 2. 

27See CBOE Letter, supra note 5, at 3. 

28See ISE Letter, supra note 4, at 2. 

29See CBOE Letter, supra note 5, at 6. 

30See ISE Letter, supra note 4, at 3. 

31See CBOE Letter, supra note 5, at 4. 

32See ISE Letter, supra note 4, at 3. 

33See CBOE Letter, supra note 5, at 5. 

34See ISE Letter, supra note 4, at 3. 

35See id. at 4. 

36See CBOE Letter, supra note 5, at 5. 

37See id. 

38See id. 

39 In approving this rule change, the Commission 

notes that it has considered the proposed rule’s 

impact on efficiency, competition, and capital 

formation. See 15 U.S.C. 78c(f). 

40 15 U.S.C. 78f(b)(5). 

41CBOE’s proposed exception is similar to an 

exception that had been proposed in 2003 by the 

Philadelphia Stock Exchange (‘‘Phlx’’). See 

Securities Exchange Act Release No. 48875 

(December 4, 2003), 68 FR 70072 (December 16, 

2003) (SR–Phlx-2003–75). At the time of the Phlx 

proposal, which was withdrawn, CBOE commented 

that the proposal should not be approved unless 

certain amendments were made. For example, 

CBOE suggested that the tied hedge procedures 

should be limited to scenarios where the order 

cannot be satisfied by the displayed national best 

competition for price improvement.23

ISE believed that requiring the crowd to 

take the hedge at the same price will 

prevent the crowd from giving the 

options customer the best price for its 

options transaction. In response, CBOE 

stated that the requirement to 

participate in the entire package is 

designed to keep the initiating member 

and in-crowd market participants on 

equal footing.24 CBOE further argued 

that, since the trading crowd will have 

access to the same downside protection 

as the solicited party that executed the 

hedge position, the crowd should be 

willing to provide price improvement to 

the tied hedge order just as much as, if 

not more than, any other facilitation/ 

solicited order.25

ISE also inquired whether CBOE’s 

proposal would prohibit a firm from 

taking securities from inventory.26

CBOE clarified that the tied hedge 

procedure would not permit a firm to 

take hedging securities from inventory 

and stated that, in contrast, the proposal 

explicitly requires that the hedge 

position be bought or sold following the 

receipt of an option order and prior to 

announcing such order in the trading 

crowd.27

ISE noted the possibility under 

CBOE’s proposal that a customer order 

would not be executable because of 

market conditions in any of the nonCBOE markets in the underlying.28 In 

response, CBOE noted that it recognized 

that market conditions in any of the 

non-CBOE market(s) may prevent the 

execution of the non-options leg(s) at 

the price(s) agreed upon. CBOE stated 

that in the event that the conditions in 

the non-CBOE market continue to 

prevent the execution of the non-option 

leg(s) at the agreed price(s), the trade 

representing the options leg(s) of the 

tied hedge transaction, as with any other 

complex order, may ultimately be 

cancelled in accordance with CBOE’s 

existing rules.29

In addition, ISE expressed concern 

regarding the treatment of CBOE’s tiedhedge transactions under the tradethrough protections contained in the 

Options Linkage Plan as well as the 

contingent trade exemption under 

Regulation NMS.30 ISE noted that tiedhedge transactions are not, by default, 

complex orders unless they meet the 

definition of a ‘‘complex trade’’ under 

the uniform linkage rules. ISE also 

commented that tied hedge transactions 

in which the original customer order is 

a non-complex order for a single options 

series that it would not qualify for the 

qualified contingent trade exception to 

Rule 611(a) of Regulation NMS. ISE also 

opined that the exception for complex 

orders and exemption for qualified 

contingent trades require that the trades 

involve multiple legs for the same 

account, whereas a tied hedge would 

likely include components for multiple 

accounts of unrelated parties. 

CBOE responded by noting that an incrowd participant would be trading all 

legs of a tied hedge package like any 

other complex order, and, accordingly, 

it believes that contra-side executions 

would qualify as complex trades.31

Further, in Amendment No. 1, CBOE 

clarified that where an original order is 

a simple order, the execution of the 

option leg will not qualify for the 

‘‘complex trade’’ exception from the 

Options Linkage Plan. 

Further, ISE stated its belief that a tied 

hedge differs from a complex order in 

that a stock-option order requires the 

stock leg to be on the opposite side of 

the options leg, whereas under CBOE’s 

proposal the stock leg in the tied hedge 

transaction would be on the same side 

of the market as the options leg.32

CBOE’s response confirmed that under 

the proposal the stock leg of the tied 

hedge package would be on the opposite 

side from the option leg.33

ISE also argued that CBOE should 

explore further the mechanics of how 

tied hedge transactions would be 

executed on CBOE.34 In particular, ISE 

inquired as to whether and how 

participants would execute the hedge in 

sub-penny increments. ISE also asked 

whether CBOE intended to impose any 

limit on who is permitted to participate 

in the auction for the order.35

CBOE responded that, as discussed in 

the Notice, tied hedge transactions 

would be treated the same as any other 

complex order with priority afforded in 

accordance with the Exchange’s existing 

open outcry allocation and reporting 

procedures for complex orders.36 In 

addition, CBOE stated that tied hedge 

transactions would also be subject to the 

existing national best bid or offer 

(‘‘NBBO’’) trade-through requirements 

for options and stock, as applicable. 

CBOE noted that it discussed in the 

Notice that market conditions in any of 

the non-CBOE markets may prevent the 

execution of the non-options leg(s) at 

the price(s) agreed upon and in such 

case the options leg(s) of the tied hedge 

transaction, as with any other complex 

order, may ultimately be cancelled in 

accordance with CBOE’s existing 

rules.37 CBOE further explained that in 

scenarios where the hedge would result 

in a net sub-penny price, the hedge 

would be executed with orders at 

multiple price points necessary to 

receive the same overall net price in 

much the same manner that the original 

stock hedge was obtained.38

IV. Discussion 

After careful review of the proposed 

rule change, as amended, the comment 

letter, and CBOE’s response to the 

comment letter, the Commission finds 

that the proposed rule change is 

consistent with the requirements of the 

Act and the rules and regulations 

thereunder applicable to a national 

securities exchange.39 In particular, the 

proposal is consistent with Section 

6(b)(5) of the Act,40 which requires, 

among other things, that the rules of a 

national securities exchange be 

designed to promote just and equitable 

principles of trade, to remove 

impediments to and perfect the 

mechanism of a free and open market 

and a national market system and, in 

general, to protect investors and the 

public interest, and not be designed to 

permit unfair discrimination between 

customers, issuers, brokers, or dealers. 

Further, the Commission believes that 

CBOE has sufficiently responded to the 

issues raised by the ISE in its comment 

letter. 

In the Notice, CBOE justified its 

proposal by explaining that changes in 

the marketplace have caused it to reevaluate the effectiveness and efficiency 

of its anticipatory hedging rule, as well 

as its previous objections to an 

exception proposed by another 

exchange for its proposed equivalent 

rule in 2003.41 When the prohibition on 


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bid or offer (‘‘NBBO’’) or, for similar reasons, the 

order is of a significantly larger than average size. 

See letters from Edward J. Joyce, President and 

Chief Operating Officer, CBOE, to Jonathan G. Katz, 

Secretary, Commission, dated January 14, 2004 

(‘‘CBOE Letter I’’) and May 20, 2004 (‘‘CBOE Letter 

II’’). 

42See Notice, supra note 3, at 9116. 

43See id. at 9116–17. 

44See id. at 9119. 

45The designated classes and minimum order 

size applicable to each class would be 

communicated to the membership via Regulatory 

Circular. For example, the Exchange could 

determine to make the tied hedge transaction 

procedures available in options class XYZ for 

orders of 1000 contracts or more. Such a 

determination would be announced via Regulatory 

Circular, which would include a cumulative list of 

all classes and corresponding sizes for which the 

tied hedge procedures are available. 

46 In determining whether an individual original 

order satisfies the eligible order size requirement, 

any complex order must contain one leg alone that 

is for the eligible order size or greater. This 

approach to the eligible order size requirement for 

complex orders is analogous to Rule 6.74(d)(iii), 

which provides that a complex order must contain 

one leg alone that is for the eligible order size or 

greater to be eligible for an open outcry crossing 

entitlement. 

47As discussed above supra note 41, in 

commenting on the prior Phlx proposal, CBOE 

suggested that the tied hedge procedures be limited 

to scenarios where the order cannot be satisfied by 

the NBBO or, for similar reasons, the order is of a 

significantly larger than average size. CBOE’s 

reasoning was that there may not be as much 

benefit to delaying the representation and execution 

of smaller orders that may be immediately fillable 

or executed more quickly by sending an order to the 

options crowd (as opposed to tying up such an 

order with stock). See CBOE Letter II, supra note 

41, at 3–4. The Exchange now believes the 

decreased liquidity available at the NBBO, the 

frequency with which quotes may flicker, and 

differing costs associated with accessing liquidity 

on various markets, as well as for ease of 

administration, that its proposed 500 contract 

minimum is sufficient to address these 

considerations. See Notice, supra note 3, at 9117. 

48See Notice, supra note 3, at 9117. 

49See ISE Rule 716(e)(3) (Solicited Order 

Mechanism). 

50As with designated classes and minimum order 

size, the eligible hedging positions applicable to 

each class would be communicated to the 

membership via Regulatory Circular, which would 

include a cumulative list of all classes and 

corresponding sizes for which the tied hedge 

procedures are available. 

51For example, if an in-crowd market 

participant’s allocation is 100 contracts out of a 500 

contract option order (1⁄5), the same in-crowd 

market participant would trade 10,000 shares of a 

50,000 stock hedge position tied to that option 

order (1⁄5). 

52 In the Notice, the Exchange notes that there 

may be scenarios were the introducing member 

purchases (sells) less than the delta, e.g., when 

there is not enough stock is available to buy (sell) 

Continued 

anticipatory hedging was originally 

adopted, CBOE believed that it was 

necessary to prevent members and 

associated persons from using 

undisclosed information about 

imminent solicited option transactions 

to trade the relevant option or any 

closely-related instrument in advance of 

persons represented in the relevant 

options crowd. The Exchange now 

believes that increased volatility in the 

markets, as well as the advent of penny 

trading in underlying stocks and 

resultant decreased liquidity at the top 

of each underlying market’s displayed 

national best bid or offer, has made it 

increasingly difficult for members and 

member organizations to assess ultimate 

execution prices and the extent of 

available stock to hedge related options 

facilitation/solicitation activities, and to 

manage that market risk.42 These 

circumstances may make it more 

difficult to obtain a hedge, to quote 

orders, and to achieve executions. In 

addition, the Exchange believes that 

market-makers’ trading strategies have 

evolved to focus less on delta risk and 

more on volatility.43 The proposed tied 

hedge transaction procedures are 

intended to reflect CBOE’s perceived 

shift by members toward a volatility 

trading strategy, and to make it more 

desirable for market makers to compete 

for orders that are exposed through the 

solicitation process. The Exchange 

further expects its proposal to allow 

members to hedge an original order and 

thus minimize delta risk and, thus, 

should provide an opportunity for 

members to provide customers with 

tighter quotes to the extent they are able 

to use the tied hedge procedure to better 

hedge and compete for orders.44

Minimum Size. Under the proposal, 

the original option order must be within 

designated tied hedge eligibility size 

parameters, which could not be smaller 

than 500 contracts.45 The minimum 

order size would apply to an individual 

original order, and multiple original 

orders could not be aggregated to satisfy 

the requirement.46 The Commission 

believes that this requirement is 

reasonable and should limit use of the 

tied hedge procedures to institutional 

customers who are in a better position 

to understand the mechanics of the 

process and who may benefit from the 

ability to execute a facilitating hedge on 

CBOE.47

Written Notification. The proposal 

also requires that, prior to entering tied 

hedge orders on behalf of customers, the 

CBOE member must deliver to its 

customer a one-time written notification 

informing the customer that his order 

may be executed using the Exchange’s 

tied hedge procedures and disclosing 

the terms and conditions contained in 

the proposed rule. Given the minimum 

size requirement of 500 contracts per 

order, the Exchange believes that use of 

the tied hedge procedures will generally 

consist of orders for the accounts of 

institutional or sophisticated, high net 

worth investors.48 Given the target 

audience and the considerable 

minimum size requirement, the 

Commission believes that a one-time 

notification is sufficient and is 

consistent with similar notification 

requirements on other exchanges.49

Eligible Hedging Positions. The 

proposed rule would require that the 

hedging position associated with the 

tied hedge order be composed of a 

position that is designated as eligible for 

a tied hedge transaction. Eligible 

hedging positions would be determined 

by the Exchange for each eligible class 

and may include (i) the same underlying 

stock applicable to the option order, (ii) 

a security future overlying the same 

stock applicable to the option order, or 

(iii) in reference to an option on an 

index, ETF or HOLDRS, a ‘‘related 

instrument’’ (as described above). For 

example, for options overlying XYZ 

stock, the Exchange may determine to 

designate the underlying XYZ stock or 

XYZ security futures or both as eligible 

hedging positions.50 The Commission 

believes that this provision will provide 

for a definitive hedge that is easily 

understood by other market 

participants, and consequently should 

allow members who may be considering 

participating in a tied hedge order to 

evaluate more readily the risk associated 

with the option in light of the hedge. 

Presentation to the Crowd. The 

proposal would require that the entire 

hedging position be brought promptly 

and without ‘‘undue delay’’ to the 

trading crowd. In addition, the proposal 

would require that the hedging position 

be announced to the trading crowd 

concurrently with the option order, 

offered to the crowd in its entirety, and 

offered at the execution price received 

by the member or member organization 

introducing the order to any in-crowd 

market participant who has established 

parity or priority for the related options. 

In-crowd market participants that 

participate in the option transaction 

would be required to participate in the 

hedging position on a proportionate 

basis 51 and would not be permitted to 

prevent the option transaction from 

occurring by giving a competing bid or 

offer for one component of the tied 

hedge order. The Commission believes 

that these requirements are reasonably 

designed to encourage access to and 

participation by the trading crowd in 

the tied hedge transaction. 

Further, while delta estimates may 

vary slightly, the introducing member 

would be required to assume a hedging 

position that does not exceed the 

equivalent size of the options order on 

a delta basis.52 For example, with a tied 


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at the desired price. In such scenarios, the 

introducing member would present the stock that 

was purchased (sold) and share it with the in-crowd 

market participants on equal terms. This risk of 

obtaining less than a delta hedge is a risk that exists 

under the current rules because of the uncertainty 

that exists when market participants price an option 

and have to anticipate the price at which they will 

be able to obtain a hedge. The proposed tied hedge 

procedures are designed to help reduce this risk, 

but the initiating member may still be unable to 

execute enough stock at the desired price. See 

Notice, supra note 3, at 9118. 

53 Generally, a complex order may be expressed 

in any increment and executed at a net debit or 

credit price with another member without giving 

priority to equivalent bids (offers) in the individual 

series legs that are represented in the trading crowd 

or in the public customer options limit order book 

provided at least one leg of the order betters the 

corresponding bid (offer) in the public customer 

options limit order book. For stock-option orders 

and security future-option orders, this means that 

the options leg of the order has priority over bids 

(offers) of the trading crowd but not over bids 

(offers) in the public customer options limit order 

book. In addition, for complex orders with nonoption leg(s), such as stock-option orders, a bid or 

offer is made and accepted subject to certain other 

conditions, including that the options leg(s) may be 

cancelled at the request of any member that is a 

party to the transaction if market conditions in any 

non-CBOE market(s) prevent the execution of the 

non-options leg(s) at the agreed price(s). See, e.g., 

CBOE Rules 6.42, Minimum Increments for Bids 

and Offers, 6.45, Priority of Bids and Offers— 

Allocation of Trades, 6.45A(b), Allocation of Orders 

Represented in Open Outcry (for equity options), 

6.45B(b), Allocation of Orders Represented in Open 

Outcry (for index options and options on ETFs), 

6.48, Contract Made on Acceptance of Bid or Offer, 

and 6.74. Any crossing participation entitlement 

would also apply to the tied hedge procedures in 

accordance with Rule 6.74(d). 

54Where the original order is a simple order, the 

execution of the option leg will not qualify for the 

‘‘complex trade’’ exception from the Options 

Linkage Plan. Thus, a member could not tie a 

customer single-sided options order to a hedging 

position for the sole purpose of availing the tied 

hedge package to the complex trade exception from 

the Options Linkage Plan. A ‘‘complex trade’’ is 

defined as: (i) The execution of an order in an 

option series in conjunction with the execution of 

one or more related orders in different option series 

in the same underlying security occurring at or near 

the same time in a ratio that is equal to or greater 

than one-to-three (.333) and less than or equal to 

three-to-one (3.0) and for the purpose of executing 

a particular investment strategy; or (ii) the 

execution of a stock option order to buy or sell a 

stated number of units of an underlying stock or a 

security convertible into the underlying stock 

(‘‘convertible security’’) coupled with the purchase 

or sale of option contract(s) on the opposite side of 

the market representing either (A) the same number 

of units of the underlying stock or convertible 

security, or (B) the number of units of the 

underlying stock or convertible security necessary 

to create a delta neutral position, but in no case in 

a ratio greater than 8 option contracts per unit of 

trading of the underlying stock or convertible 

security established for that series by the Options 

Clearing Corporation. See paragraph (4) of CBOE 

Rule 6.80, Definitions (applicable to Options 

Linkage), and subparagraph (b)(7) to CBOE Rule 

6.83, Order Protection. The new Options Linkage 

Plan was recently approved by the Commission and 

carries over the complex order exception. See 

Securities Exchange Act Release No. 60405 (July 30, 

2009) (File No. 4–546). See also Securities Exchange 

Act Release No. 60187 (June 29, 2009), 74 FR 32664 

(July 8, 2009) (notice of filing of CBOE’s new 

Options Linkage rules). 

55A ‘‘qualified contingent trade’’ is defined as a 

transaction consisting of two or more component 

orders, executed as agent or principal, where: (i) At 

least one component order is in an NMS stock; (ii) 

all components are effected with a product or price 

contingency that either has been agreed to by the 

respective counterparties or arranged for by a 

broker-dealer as principal or agent; (iii) the 

execution of one component is contingent upon the 

execution of all other components at or near the 

same time; (iv) the specific relationship between the 

component orders (e.g., the spread between the 

prices of the component orders) is determined at 

the time the contingent order is placed; (v) the 

component orders bear a derivative relationship to 

one another, represent different classes of shares of 

the same issuer, or involve the securities of 

participants in mergers or with intentions to merge 

that have been announced or since cancelled; and 

(vi) any trade-throughs caused by the execution of 

an order involving one or more NMS stocks (each 

an ‘‘Exempted NMS Stock Transaction’’) is fully 

hedged (without regard to any prior existing 

position) as a result of the other components of the 

contingent trade. See Securities Exchange Act 

Release No. 57620 (April 4, 2008), 73 FR 19271 

(April 9, 2008). 

56See paragraph (b) to CBOE Rule 6.48. The 

Exchange notes that, in the event of a cancellation, 

members may be exposed to the risk associated 

with holding the hedge position. 

57See Notice, supra note 3, at 9119–20. 

hedge transaction involving the 

purchase of 50,000 shares of XYZ stock 

and the sale of 500 XYZ call contracts 

with a delta of 100, the order would be 

considered fully hedged by 50,000 

shares of stock. The Commission 

believes that prohibiting a tied hedge 

order from being deliberately overhedged should ensure that such 

transactions represent bona fide hedging 

activity and should not deter the 

willingness of the options crowd to 

participate in the order. 

Priority. The Exchange has not 

proposed any special priority provisions 

applicable to tied hedge transactions. 

Tied hedge transactions would be 

treated the same as complex orders 

(regardless of whether the original order 

was a simple or complex order) for 

purposes of CBOE’s intra-market 

priority.53 The Commission notes that 

while an original single-sided customer 

order would not constitute a complex 

order, particularly for purposes of the 

complex trade exception to the Options 

Linkage Plan, CBOE’s proposal to treat 

such order when it is packaged into a 

tied hedge transaction the same as a 

complex order for the limited purpose 

of determining CBOE’s intra-market 

priority is reasonable. Among other 

things, because a tied hedge transaction 

would be presented to the crowd as a 

package and crowd participants could 

only trade with both the order and the 

hedge on a proportionate basis, such 

treatment is appropriate under the 

circumstances with respect to CBOE’s 

intra-market priority. 

To the extent applicable and 

available, tied hedge transactions may 

also qualify for existing NBBO tradethrough exceptions for options and 

stock, including, for example, the 

complex trade exception to the Options 

Linkage Plan (which would apply when 

the original order is a complex order) 54

and the qualified contingent trade 

exception to Rule 611(a) for the stock 

component when an in-crowd 

participant participates in the 

transaction.55

Further, when a tied hedge 

transaction is executed, it is possible 

that market conditions in a non-CBOE 

market might prevent the execution of 

the non-options leg(s) at the price(s) 

agreed upon. In this event, the trade 

representing the options leg(s) of the 

tied hedge transaction may ultimately 

be cancelled in accordance with CBOE’s 

existing rules.56

The following example, which CBOE 

included in the Notice,57 illustrates the 

mechanics of a tied hedge transaction: 

• The CBOE member initiates a tied 

hedge based on either a simple or 

complex original customer order. For 

example, in a simple original order, the 

introducing member receives a customer 

order to buy 500 XYZ call options, 

which has a delta of 100. The 

introducing member then purchases 

50,000 shares of XYZ stock on the NYSE 

for an average price of $25.03 per share. 

Once the stock is executed on the NYSE, 

the introducing member, without undue 

delay, announces the 500 contract 

option order along with the 50,000 share 

tied stock hedge at $25.03 per share to 

the CBOE trading crowd. For a complex 

original order, the introducing member 

receives a customer stock-option order 

to buy 500 XYZ call options and sell 

50,000 shares of XYZ stock. The 

introducing member purchases 50,000 

shares of XYZ stock on the NYSE for an 

average price of $25.03 per share. Once 

the stock is executed on the NYSE, the 

introducing member, without undue 

delay, announces the tied hedge 

package to the trading crowd. 

• The in-crowd market participants 

would have an opportunity to provide 

competing quotes for the tied hedge 

package (but not for the individual 

component legs of the package). 

• The option order and hedging stock 

would be allocated among the in-crowd 

market participants that established 

priority or parity at that price, including 

the initiating member, in accordance 

with the allocation algorithm applicable 

to the options class, with the options leg 

being executed and reported on CBOE 

and the stock leg being executed and 


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58For example, the introducing member might 

trade 40% pursuant to an open outcry crossing 

entitlement (200 options contracts and 20,000 

shares of stock) and the remaining balance might be 

with three different market makers that each 

participated on 20% of the order (100 options 

contracts and 10,000 shares of stock per market 

maker). 

59 15 U.S.C. 78s(b)(2). Pursuant to Section 19(b)(2) 

of the Act, the Commission may not approve any 

proposed rule change, or amendment thereto, prior 

to the thirtieth day after the date of publication of 

the notice thereof, unless the Commission finds 

good cause for so doing. 

60See Notice, supra note 3, at 9119. 

61This description by CBOE represents a change 

from the Notice, in which CBOE indicated all tied 

hedge transactions (regardless of whether the 

original order was a simple or complex order) 

would be treated as complex orders, and thus may 

qualify for the complex trade exception to the 

Options Linkage Plan. See Amendment No. 1. 

62 15 U.S.C. 78s(b)(2). 

63 17 CFR 200.30–3(a)(12). 

reported on the stock market specified 

by the initiating member.58

• The execution of the options leg 

would have to satisfy CBOE’s intramarket priority rules for complex orders 

(including that the execution price may 

not be outside the CBOE BBO). 

• Where the customer order is a 

complex order (not a simple order), the 

tied hedge transaction may qualify as a 

‘‘complex trade’’ under the Options 

Linkage Plan in which case the 

execution of the 500 option contracts 

with the market participants would not 

be subject to the NBBO for the particular 

option series. 

• If the crowd participates in the tied 

hedge transaction, the equities portion 

of the trade may qualify as a ‘‘qualified 

contingent trade’’ under Regulation 

NMS. For example, if the crowd takes 

an equivalent share representing 20,000 

shares of stock (from the original 50,000 

shares), the market participants would 

not be subject to the NBBO for the 

20,000 shares of underlying XYZ stock 

that they execute. 

• The execution of stock would have 

to satisfy the intra-market priority rules 

of the non-CBOE market(s) where the 

stock is to be executed. 

The Commission believes that CBOE 

has adequately described the mechanics 

of a proposed tied hedge order, and that 

the priority treatment afforded to a tied 

hedge transaction is appropriate and 

consistent with CBOE’s existing priority 

rules. 

V. Accelerated Approval 

The Commission finds good cause, 

pursuant to Section 19(b)(2) of the 

Act,59 for approving the proposed rule 

change, as modified by Amendment No. 

1, prior to the thirtieth day after 

publication of notice of filing of 

Amendment No. 1 in the Federal 

Register. In Amendment No. 1, the 

Exchange revised the proposed rule text 

to clarify that all tied hedge transactions 

(regardless of whether the original order 

was a simple order or a complex order 

such as a spread, straddle, combination, 

or stock-option order) will be treated as 

complex for purposes of CBOE’s open 

outcry allocation and reporting 

procedures. This treatment of tied hedge 

transactions was described by CBOE in 

the Notice.60 CBOE now proposes to 

reflect this priority provision in the rule 

text for the sake of clarity. 

CBOE also specified in the proposed 

rule text that the option and stock legs 

of a tied hedge transaction may qualify 

for various NBBO trade-through 

exceptions but, where the original order 

is a simple order, the execution of the 

option leg will not qualify for the 

‘‘complex trade’’ exception from the 

Options Linkage Plan.61 Accordingly, to 

the extent that a single-sided customer 

order was packaged to create a tied 

hedge transaction, such tied hedge 

would not qualify as a complex order 

for purposes of the Options Linkage 

Plan. 

The changes proposed in Amendment 

No. 1, discussed above, seek to clarify 

the operation of the proposal, 

particularly with respect to the priority 

rules applicable to a tied hedge 

transaction, and do not differ materially 

from the proposal as noticed in the 

Federal Register on March 2, 2009. 

Accordingly, the Commission finds that 

good cause exists to approve the 

proposed rule change, as modified by 

Amendment No. 1, on an accelerated 

basis. 

VI. Solicitation of Comments 

Interested persons are invited to 

submit written data, views, and 

arguments concerning Amendment No. 

1, including whether Amendment No. 1 

is consistent with the Act. Comments 

may be submitted by any of the 

following methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/sro.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

No. SR–CBOE–2009–007 on the subject 

line. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

Station Place, 100 F Street, NE., 

Washington, DC 20549–1090. 

All submissions should refer to File 

Number SR–CBOE–2009–007. 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, please use 

only one method. The Commission will 

post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/ 

rules/sro.shtml). Copies of the 

submission, all subsequent 

amendments, all written statements 

with respect to the proposed rule 

change that are filed with the 

Commission, and all written 

communications relating to the 

proposed rule change between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for inspection and copying in 

the Commission’s Public Reference 

Room, on official business days between 

the hours of 10 a.m. and 3 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– 

2009–007 and should be submitted on 

or before September 11, 2009. 

VII. Conclusion 

For the foregoing reasons, the 

Commission finds that the proposed 

rule change, as modified by Amendment 

No. 1, is consistent with the Act and the 

rules and regulations thereunder 

applicable to a national securities 

exchange. 

It is therefore ordered, pursuant to 

Section 19(b)(2) of the Act,62 that the 

proposed rule change (SR–CBOE–2009– 

007), as modified by Amendment No. 1, 

be, and hereby is, approved on an 

accelerated basis. 

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.63

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. E9–20062 Filed 8–20–09; 8:45 am] 

BILLING CODE 8010–01–P 


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