[Federal Register Volume 77, Number 34 (Tuesday, February 21, 2012)]
[Notices]
[Pages 10020-10026]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-3901]



[[Page 10020]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66393; File No. SR-C2-2012-004]


 Self-Regulatory Organizations; C2 Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Related to 
Stock-Option Processing

February 14, 2012.
    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 February 7, 2012, the C2 Options Exchange, Incorporated (the 
``Exchange'' or ``C2'') filed with the Securities and Exchange 
Commission (the ``Commission'') the proposed rule change as described 
in Items I 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.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    The Exchange is proposing to amend its electronic complex order 
rules to adopt procedures for processing stock-option orders. The text 
of the rule proposal is available on the Exchange's Web site (http://www.c2exchange.com/Legal/RuleFilings.aspx), at the Exchange's Office of 
the Secretary and at the Commission.

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

    In its filing with the Commission, the self-regulatory organization 
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 those 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 parts of such statements.

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

1. Purpose
    The Exchange proposes to adopt procedures for processing stock-
option orders under Rule 6.13. In particular, the Exchange is proposing 
to amend Rule 6.13 to (i) adopt a definition of a stock-option order 
(as well as include a definition of a complex order); (ii) include 
procedures for routing the stock leg of a stock-option order; (iii) 
provide that there will be no ``legging'' of stock-options, except in 
one limited context; (iv) describe the electronic allocation algorithm 
applicable for stock-option orders in the complex order book (``COB'') 
and the complex order RFR auction (``COA'');\3\ and (v) incorporate 
certain price check parameter and re-COA features (described in more 
detail below) applicable to the electronic processing of stock-option 
orders.
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    \3\ COA is a process for auctioning eligible complex orders for 
price improvement. See Rule 6.13(c).
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Definitions
    The first purpose of this proposed rule change is to include a 
definition of stock-option order within Rule 6.13. The definition would 
provide that a stock-option order is as [sic] an 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 options contract(s) on the opposite side of the 
market representing either (i) the same number of units of the 
underlying stock or convertible security, or (ii) the number of units 
of the underlying stock necessary to create a delta neutral position, 
but in no case in a ratio greater than eight (8) options contracts per 
unit of trading of the underlying stock or convertible security 
established for that series by The Options Clearing Corporation 
(referred to in the text as the ``Clearing Corporation'') (or such 
lower ratio as may be determined by the Exchange on a class-by-class 
basis). In addition, only those stock-option orders with no more than 
the applicable number of legs, as determined by the Exchange on a 
class-by-class basis, will be eligible for processing.
    The Exchange is also proposing to adopt a definition of a complex 
order. For purposes of the rule, a complex order will be defined as any 
order involving the execution of two or more different options series 
in the same underlying security, for the same account, 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 (3.00) (or such 
lower ratio as may be determined by the Exchange on a class-by-class 
basis) and for the purpose of executing a particular investment 
strategy. Only those complex orders with no more than the applicable 
number of legs,\4\ as determined by the Exchange on a class-by-class 
basis, are eligible for processing.
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    \4\ Currently the rule limits the number of legs to four. See 
existing Rule 6.13(b)(2).
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    These definitions would conform with definitions used in other 
exchanges' rules \5\ and is modeled after the generic definitions 
approved for use for exemptions from Trade Through Liability by the 
Options Linkage Authority as described in the ``Plan For The Purpose of 
Creating And Operation An Intermarket Options Linkage'' and as provided 
in Exchange Chapter 6, Section E (which cross-references Chicago Board 
Options Exchange Incorporated (``CBOE'') Rule 6.80(4)).
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    \5\ See, e.g., International Securities Exchange (``ISE'') Rule 
722(a).
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Designated Broker-Dealer
    The second purpose of this proposed rule change is to adopt 
procedures for routing the stock leg of a stock-option order. The 
Exchange proposes to provide that the Exchange will electronically 
transmit orders related to a stock leg for execution by a broker-dealer 
designated by the Exchange (a ``designated broker-dealer'') on behalf 
of the parties to the trade. The Exchange will transmit the underlying 
stock leg order to a designated broker-dealer for execution once the 
Exchange trading system determines that a stock-option order trade is 
possible and at what net prices. The stock leg component will be 
transmitted to the designated broker-dealer as two paired orders with a 
designated limit price, subject to one limited exception pertaining to 
the stock leg of an unmatched market stock-option order (which is 
described in more detail below). The designated broker-dealer will act 
as agent for the stock leg of the stock-option orders. The designated 
broker-dealer may determine to match the orders on an exchange or 
``over-the-counter.''
    To participate in this automated process for stock-option orders, 
an Exchange Permit Holder (``PH'') must enter into a customer agreement 
with one or more designated broker-dealers that are not affiliated with 
the Exchange.\6\ In addition, PHs may only

[[Page 10021]]

submit complex orders with a stock component if such orders comply with 
the Qualified Contingent Trade Exemption (the ``QCT Exemption'') from 
Rule 611(a) of Regulation NMS.\7\ PHs submitting such complex orders 
represent that such orders comply with the QCT Exemption. The Exchange 
intends to address fees related to routing the stock portion of stock-
option trades in a separate rule change filing.
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    \6\ This provision for a designated broker-dealer is similar to 
a provision in ISE Rule 722.02, except that C2's proposed provision 
makes it clear the broker-dealer(s) that are designated by the 
Exchange to perform this function are not affiliated with C2. The 
Exchange also notes that the stock-option processing provisions will 
include an order marking requirement for stock-option orders. In 
particular, the Exchange is proposing to provide that, if the stock 
leg of a stock-option order submitted to the COB or COA is a sell 
order, then the stock leg must be marked ``long, ``short,'' or 
``short exempt'' in compliance with Regulation SHO, 17 CFR 
242.200(g). See proposed Rule 6.13.06(e). This proposed marking 
provision is modeled after CBOE Rule 6.53C.06(g).
    \7\ 17 CFR 242.611(a).
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    The Exchange believes that the electronic communication of the 
orders by the Exchange to the designated broker-dealer is an efficient 
means for processing stock-option orders. The designated broker-dealer 
will be responsible for the proper execution, trade reporting and 
submission to clearing of the stock trade that is part of a stock 
option order. In this regard, once the orders are communicated to the 
broker-dealer for execution, the broker-dealer has complete 
responsibility for determining whether the orders may be executed in 
accordance with all the rules applicable to execution of equity orders, 
including compliance with the applicable short sale, trade-through and 
trade reporting rules. If the broker-dealer cannot execute the equity 
orders at the designated price, the stock-option combination order will 
not be executed on the Exchange.
    With respect to trade throughs in particular, the Exchange believes 
that the stock component of a stock-option order is eligible for the 
QCT Exemption from Rule 611(a) of Regulation NMS. A Qualified 
Contingent Trade (``QCT'') is a transaction consisting of two or more 
component orders, executed as agent or principal, that satisfy the six 
elements in the Commission's order exempting QCTs from the requirements 
of Rule 611(a), which requires trading centers to establish, maintain, 
and enforce written policies and procedures that are reasonably 
designed to prevent trade-throughs.\8\ The Exchange believes that the 
stock portion of a complex order under this proposal complies with all 
six requirements.\9\ Moreover, as explained below, the Exchange's 
system will validate compliance with each requirement such that any 
matched order received by a designated broker-dealer under this 
proposal has been checked for compliance with the exemption to the 
extent noted below:
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    \8\ See Securities Exchange Act Release No. 57620 (April 4, 
2008), 73 FR 19271 (April 9, 2008) (``QCT Release''); see also 
Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR 
52829 (September 7, 2006).
    \9\ As discussed in more detail below, the stock component of 
all stock-option orders will be transmitted to a designated routing 
broker as paired stock orders with a specified limit price, with one 
limited exception. The exception pertains to the stock leg of an 
unmatched market stock-option order. In the limited circumstances 
when the Exchange transmits the stock component leg of an unmatched 
market stock-option order to the designed [sic] routing broker, such 
a stock component leg will be subject to NBBO pricing (and therefore 
not be processed subject to the QCT Exemption).
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    (1) At least one component order is in an NMS stock: the stock 
component must be an NMS stock, which is validated by the Exchange's 
system;
    (2) 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: a complex order, 
by definition, is executed at a single net credit/debit price and this 
price contingency applies to all the components of the order, such that 
the stock price computed and sent to the designated broker-dealer 
allows the stock order to be executed at the proper net debit/credit 
price based on the execution price of each of the option legs, which is 
determined by the Exchange's system;
    (3) The execution of one component is contingent upon the execution 
of all other components at or near the same time: once a stock-option 
[sic] is accepted and validated by the Exchange's system, the entire 
package is processed as a single transaction and each of the option 
leg(s) and stock components are simultaneously processed;
    (4) 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: stock-option orders, upon 
entry, must have a size for each component and a net debit/credit price 
(or market price), which the Exchange's system validates and processes 
to determine the ratio between the components; an order is rejected if 
the net debit/credit price (or market price) and size are not provided 
on the order;
    (5) 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: under this proposal, 
the stock component must be the underlying security respecting the 
option leg(s), which is validated by the Exchange's system; and
    (6) The transaction is fully hedged (without regard to any prior 
existing position) as a result of the other components of the 
contingent trade: under this proposal, the ratio between the options 
and stock must be a conforming ratio (e.g., largest option leg to stock 
cannot exceed a ratio of eight-to-one and multiple options legs cannot 
exceed a ratio of three-to-one), which the Exchange's system validates, 
and which under reasonable risk valuation methodologies, means that the 
stock position is fully hedged. In addition, if all option and stock 
components are on the same side of the market, which the Exchange's 
system also validates, then the order will not be eligible for 
electronic processing pursuant to Rule 6.13.
    Furthermore, as noted above, proposed Rule 6.13.06(a) provides that 
PHs may only submit complex orders with a stock component if such 
orders comply with the QCT Exemption. PHs submitting such complex 
orders with a stock component represent that such orders comply with 
the QCT Exemption. Thus, the Exchange believes that complex orders 
consisting of a stock component will comply with the exemption and that 
the Exchange's system will validate such compliance as noted above to 
assist its designed routing broker(s) in carrying out its 
responsibilities as agent for these orders.
    The Exchange believes the proposed process offers effective and 
efficient automatic execution for both the options and stock components 
of a stock-option order and it should promote just and equitable 
principles of trade and remove impediments to and perfect the mechanism 
of a free and open market and a national market system by enhancing the 
electronic processing of the stock-option orders. However, this process 
is not exclusive. The Exchange notes that PHs can also utilize other 
exchanges' systems (several of which offer stock-option processing) or 
avoid using stock-option orders.
Legging
    The third purpose of this proposed rule change is to provide that 
``legging'' against the individual orders and quotes in the Exchange's 
electronic book (the ``Book'') will not occur for stock-option orders, 
except that that [sic] legging may occur in a limited instance 
described below for eligible market orders that have been subject to a 
COA.\10\ The Exchange believes that limiting the electronic trading of 
stock-option orders pursuant to Rule 6.13 to executions

[[Page 10022]]

against other stock-option orders in the manner proposed will provide 
for more efficient execution and processing of stock-option orders and 
will assist with the maintenance of fair and orderly markets by helping 
to mitigate the potential risks associated with legging stock-option 
orders, including the risk of one leg of the stock-option order going 
unexecuted (and thereby not achieving a complete stock-option order 
execution and having a partial position that is unhedged).\11\
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    \10\ The Exchange notes that at least one other options exchange 
that offers electronic complex order processing does not ``leg'' 
stock-option orders. See, e.g., NASDAQ OMX PHLX LLC (``Phlx'') Rule 
1080.08(f)(iii)(A)(1).
    \11\ That is not to say that the Exchange would not determine to 
permit additional ``legging'' of stock-option orders under Rule 6.13 
in the future. Any such change to the electronic processing of 
stock-option orders under Rule 6.13 would be subject to a separate 
rule change filing.
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    The limited exception where legging would be permitted would 
provide that, if at the conclusion of a COA a stock-option order that 
is an eligible market order \12\ cannot be filled in whole or in a 
permissible ratio, then any remaining balance of the option leg(s) 
would be routed to the Exchange's system for processing as a simple 
market order(s) consistent with the Exchange's order execution rules 
and any remaining balance of the stock leg would be routed to the 
designated broker-dealer, who will represent the order on behalf of the 
party that submitted the stock-option order.\13\ The Exchange notes 
that when a stock-option order is legged in this manner, it is possible 
for the Exchange to route the option leg(s) to another options 
exchange, consistent with its rules.\14\
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    \12\ For purposes of this legging functionality, an ``eligible 
market order'' would mean a stock-option order that is within 
designated size and order type parameters, determined by the 
Exchange on a class-by-class basis, and for which the national best 
bid or offer (``NBBO'') is within designated size and price 
parameters, as determined by the Exchange for the individual leg. 
The designated NBBO price parameters will be determined based on a 
minimum bid price for sell orders and a maximum offer price for buy 
orders. The Exchange may also determine to limit the trading times 
within regular trading hours that the legging functionality will be 
available. See proposed 6.13.06(d). Pursuant to Rule 6.13.01, any 
determination by the Exchange on these parameters would be announced 
via Regulatory Circular.
    \13\ Pursuant to Rule 6.13.01, any determination by the Exchange 
to route stock-option market orders in this manner will be announced 
via Regulatory Circular.
    \14\ See, e.g., C2 Rule 6.36, Order Routing to Other Exchanges.
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    This alternate legging functionality is intended to assist in the 
automatic execution and processing of stock-option orders that are 
market orders. The Exchange believes the order eligibility parameters 
provide the Exchange with the flexibility to assist with the 
maintenance of orderly markets by helping to mitigate the potential 
risks associated with legging stock option orders, e.g., the risk of a 
order drilling through multiple price points on another exchange 
(thereby resulting in execution at prices that are away from the NBBO 
and potentially erroneous), and/or the risk of one leg of the stock-
option order going unexecuted (thereby not achieving a complete stock-
option order execution and having a partial position that is unhedged).
Allocation Algorithms
    The fourth purpose of this proposed rule change is to describe the 
electronic allocation algorithm applicable for stock-option orders in 
COB and COA. With respect to COB, the Exchange is proposing to provide 
that stock-option orders that are marketable against each other will 
automatically execute. In the event there are multiple stock-option 
orders at the same price, they will be allocated pursuant to the rules 
of trading priority otherwise applicable to incoming electronic orders 
in the individual series legs (or such other allocation algorithm as 
the Exchange may designate pursuant to Rule 6.13.05).\15\
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    \15\ The allocation algorithms for the individual series legs 
include price-time, pro-rata, and price-time with primary public 
customer and secondary trade participation right priority and an 
optional priority overlays [sic] pertaining to market turner 
priority. See Rules 6.12, Order Execution and Priority.
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    As a condition for a stock-option order to execute against another 
stock-option order in COB, the execution must be at a net price where 
the individual options series leg(s) of the stock-option order has 
priority over the individual orders and quotes residing in the 
Exchange's Book (the ``Book Priority Condition''). To satisfy the Book 
Priority Condition, the individual option series leg(s) of a stock-
option order (i) must not trade through the Exchange's best bid (offer) 
in the individual component series, and (ii) must not trade at the 
Exchange's best bid (offer) in the individual component series if one 
or more public customer orders are resting at the best bid (offer) in 
each of the component series and the stock-option order could otherwise 
be executed in full (or in a permissible ratio).
    With respect to COA, the Exchange is proposing to provide that, in 
the event there are multiple stock-option orders at the same price, 
they will trade in the following sequence: (i) Public customer stock-
option orders resting in COB before, or that are received during, the 
COA Response Time Interval \16\ and public customer responses 
collectively have first priority, with multiple orders ranked by time 
priority; (ii) non-public customer stock-option orders resting in the 
COB before the COA Response Time Interval have second priority, with 
multiple orders subject to the rules of trading priority otherwise 
applicable to incoming orders in the individual component legs; and 
(iii) non-public customer stock-option orders resting in COB that are 
received during the Response Time Interval and non-public customer 
responses collectively have third priority, with multiple orders 
subject to the rules of trading priority otherwise applicable to 
incoming orders in the individual component legs.
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    \16\ The COA ``Responses [sic] Time Interval'' means the period 
of time during which responses to the RFR may be entered. The 
Exchange determines the length of the Response Time Interval on a 
class-by-class basis, however, the duration shall not exceed three 
(3) seconds. See Rule 6.13(c)(3)(B).
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    As with COB, as a condition for a stock-option order to execute 
against another stock-option order through COA, would be that the 
execution must satisfy the Book Priority Condition described above.
    The system also has some features that would apply to the extent 
that a stock-option order is or becomes marketable. First, to the 
extent that a marketable stock-option order cannot automatically 
execute in full (or in a permissible ratio) when it is routed to COB or 
after being subject to COA because there are individual orders and 
quotes residing in the Book that have priority (but the order resting 
in COB would not trade against them because there will be no 
``legging''), any part of the order that may be executed would be 
executed automatically and the part that cannot automatically execute 
would be cancelled. Second, to the extent that a stock-option order 
resting in COB becomes marketable against the derived net market (and 
cannot automatically execute because there is no ``legging''), the full 
order would be subject to COA (and the processing described above). For 
purposes of this feature, the ``derived net market'' for a given stock-
option strategy would be calculated using the Exchange's best bid or 
offer in the individual option series leg(s) and the NBBO in the stock 
leg. The Exchange notes this feature would only be applicable to 
resting stock-option orders that become marketable against the derived 
net market. This feature would not be applicable to resting stock-
option [sic] that would become marketable with other stock-option 
orders. Having the system automatically initiate a COA once such a 
stock-option order resting in COB becomes marketable against the 
derived net market provides an opportunity for other market 
participants to match or

[[Page 10023]]

improve the net price and allows for an opportunity for an automatic 
execution before a marketable stock-option order is cancelled.\17\ As 
noted above, after being subject to COA, any part of the order that may 
be executed would be executed automatically and the part of the order 
that cannot automatically execute would be cancelled.
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    \17\ The Exchange notes that, in these circumstances when a 
resting stock-option order becomes marketable, COA will 
automatically initiate regardless of whether a PH has requested that 
the stock-option order be COA'd pursuant to Rule 6.13.02. In this 
regard, the Exchange notes that, currently, all of its PHs have 
elected to have their COA-eligible orders COA'd. In addition, the 
Exchange notes that other markets have programs in place that 
provide for the automatic auctioning of complex orders. See, e.g., 
Phlx Rule 1080(e)(i)(A) which, among other things, provides that a 
complex order live auction (``COLA'') will initiate if the Phlx 
system receives a complex order that improves the Phlx complex order 
best debit or credit price respecting the specific complex order 
strategy that is the subject of the complex order. During a COLA, 
Phlx market participants may bid and offer against the COLA-eligible 
order pursuant to the Phlx Rule.
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    The following examples illustrate the operation of the proposed 
system functionality:

    Example 1: Assume an incoming market stock-option order for 75 
units is submitted to COA, where the strategy involves the sale of 
75 call contracts and purchase of 7,500 stock shares. At the 
conclusion of COA, assume the best net price response is $9.13 for 
50 units and the best derived net market price is 9.15 for 100 
units. The incoming market order to purchase 75 units of the stock-
option strategy will receive a partial execution of 50 units at a 
net price of $9.13. Because the remaining 25 units are marketable 
against individual orders and quotes in the Book, the 25 units will 
be cancelled.\18\
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    \18\ However, if the Exchange has activated the market stock-
option order ``legging'' functionality and the and the [sic] order 
is eligible, in lieu of routing to PAR or a booth, any remaining 
balance of the option leg will route to the CBOE Hybrid Trading 
System for processing as a simple market order and any remaining 
balance of the stock leg will be electronically transmitted by the 
Exchange to a designated broker-dealer, who will represent the order 
on behalf of the party that submitted the stock-option order. See 
note 12, supra, and surrounding discussion on Legging.
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    Example 2: Assume a stock-option order for 75 units is resting 
in COB, where the strategy involves the sale of 75 call contracts 
and purchase of 7,500 stock shares at a net debit price of $9.13. By 
virtue of the fact that it is resting [sic] the COB, the stock-
option order is not marketable--meaning there are no orders or 
quotes within the derived net market price or other stock-option 
orders within COB against which the resting stock-option order may 
trade. Assume there are no other stock-option orders representing 
[sic] in the COB for the strategy and also assume the best derived 
net market price for the strategy is a net price of $9.15 per unit 
for 100 units. If the price of the component option series leg or 
the stock is thereafter updated such that the derived net market 
price becomes $9.13 per unit for 100 units, then the full size of 
the resting stock-option order will become marketable but cannot 
automatically execute. As a result, the full size (75 units) of the 
resting stock-option order would be subject to COA. At the 
conclusion of COA, any part of the stock-option order that may be 
executed against other stock-option orders or auction responses will 
be automatically executed. Any part of the order that is marketable 
and cannot automatically execute (because the stock-option order 
cannot ``leg'' against the derived net market) will be cancelled. To 
the extent any part of the stock-option order is not marketable, it 
will continue resting in COB.
Price Protection and Re-COA Features
    Finally, the fifth purpose of this proposed rule change is to adopt 
a new price check parameter applicable to the electronic processing of 
stock-option orders. In addition, the Exchange is proposing to extend 
the application of an existing price check parameter to include stock-
option orders.
    In particular, under the proposed new price check parameter, the 
Exchange is proposing to provide that, on a class-by-class basis, the 
Exchange may determine (and announce via Regulatory Circular) to not 
automatically execute a stock-option order that is marketable if, 
following COA, the execution would not be within the acceptable derived 
net market for the strategy that existed at the start of COA. As 
indicated above, a ``derived net market'' for a strategy will be 
calculated using the Exchange's best bid or offer in the individual 
option series leg(s) and the NBBO in the stock leg. The ``acceptable 
derived net market'' for a strategy will be calculated using the 
Exchange's best bid or offer in the individual option series leg(s) and 
the NBBO in the stock leg plus/minus an acceptable tick distance. The 
``acceptable tick distance'' will be determined by the Exchange on a 
class-by-class and premium basis.\19\ Such a stock-option order would 
be cancelled. The Exchange believes that users are more concerned about 
obtaining a net price execution of their stock-option strategy orders 
than about achieving an execution of the stock leg at the NBBO. The 
price check parameter, however, would serve to prevent automatic 
executions at extreme prices beyond the NBBO.
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    \19\ It should be noted that this is simply a parameter for 
determining whether a stock-option order will be subject to 
automatic execution, or routed to PAR, a booth or cancelled. A 
stock-option order that is subject to automatic execution remains 
subject to the applicable priority requirements prescribed in Rule 
6.13.
    It should also be noted that the Exchange has not proposed to 
prescribe a minimum acceptable tick distance for this parameter 
(e.g., the acceptable tick distance may be established at 0). This 
will provide the Exchange with the flexibility to set the price 
check feature so that automatic executions of stock-option orders 
must be within the derived net market, which considers the 
Exchange's best bid or offer for the options component leg(s) and 
the NBBO for the stock component leg. The Exchange believes it is 
reasonable and appropriate to utilize the Exchange best bid and 
offer in the calculation as the option component leg(s) are not 
permitted to trade at a price inferior to the Exchange's best bid 
and offer. The Exchange also believes it is reasonable and 
appropriate to consider the NBBO for the stock component leg in the 
calculation as the NBBO should serve as a reasonable proxy for what 
may be considered a reasonable price for the automatic execution of 
the stock component leg. However, the Exchange also recognizes that 
some range outside the NBBO may also be appropriate for determining 
whether an automatic execution should occur as the QCT Exemption 
does not require the stock component leg of a qualifying stock- 
option order to be executed at the NBBO. The proposed parameter 
therefore provides the Exchange with the flexibility to determine to 
utilize the NBBO (which equates to an acceptable tick distance of 0) 
or some range outside the NBBO (which equates to the derived net 
part plus/minus an acceptable tick distance of 1, 2, 3 or some other 
number of ticks) for determining whether to automatically execute a 
stock-option order.
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    The following example illustrates the operation of the proposed 
system functionality:

    Example 3: Assume that at the start of COA the Exchange's best 
bid and offer for the option leg of a stock-option strategy is 
$1.00-$1.20 (100 x 100) and the NBBO for the stock leg of the 
strategy is $10.05-$10.15 (10,000 x 10,000). Thus, the derived net 
market for the strategy is $8.85-$9.15 (calculated as $1.20-$10.05 
and -$1.00 + $10.15, respectively). In addition, assume that the 
acceptable tick distance for the stock leg is two ticks ($0.02). 
Under this parameter, an order to sell stock could not execute at a 
price below $10.03 and an order to buy stock could not execute at a 
price above $10.17. Thus, the acceptable derived net market for the 
strategy would be calculated as $8.83-$9.17 (calculated as $1.20-
$10.03 and -$1.00 + $10.17, respectively). Under this scenario, 
following COA, a marketable stock-option order to sell the option 
series and buy the stock that would trade with another stock-option 
order at net debit price of $9.17 (within the acceptable derived net 
market for the strategy) will be executed. However, a marketable 
stock-option to sell the option series and buy the stock that would 
trade with another stock-option order at a net debit price of $9.18 
($0.01 outside the acceptable derived net market for the strategy) 
will be cancelled.

    In addition to the foregoing, additional parameters would apply. In 
classes where these price check parameters are available, they will 
also be available for COA stock-option responses under Rule 6.13(c), 
stock-option orders and responses under Rules 6.51, Automated 
Improvement Mechanism (``AIM''), and 6.52, Solicitation Auction 
Mechanism (``SAM''), or AIM customer-to-customer immediate cross of 
stock-option orders

[[Page 10024]]

under Rule 6.51.08 (``CTC'').\20\ Under these provisions, such paired 
stock-option orders and responses would not be accepted.\21\ In this 
regard, if any paired stock-option order submitted by an order entry 
firm for AIM, SAM or CTC processing exceeds the parameters, then both 
the order that exceeds the parameters and the paired contra-side order 
would not be accepted regardless of whether the contra-side order 
exceeds the parameters. However, to the extent that only the paired 
contra-side order submitted by an order entry firm for AIM or SAM 
processing would exceed the price check parameter, the paired contra-
side order would not be accepted while the original Agency Order would 
not be accepted or, at the order entry firm's discretion, would 
continue processing as an unpaired stock-option order (e.g., the 
original Agency Order would route to COB or COA for processing). The 
proposal also provides that, to the extent a contra-side order or 
response is marketable, its price will be capped at the price inside 
the acceptable derived net market.
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    \20\ AIM, SAM and CTC are mechanisms that may be used to cross 
two paired orders. COA is a mechanism that may be used to expose an 
unpaired complex order for price improvement. Orders submitted for 
COA, AIM or SAM processing are exposed for price improvement through 
an auction (and thus other market participants may submit 
responses), whereas orders submitted for CTC processing are executed 
immediately without exposure.
    \21\ In conjunction with this rule change, the Exchange is also 
proposing a change to revise the text of Rule 6.13 in various places 
to use the phrase ``not be accepted'' to replace various references 
``rejected.'' This change is non-substantive and is just intended to 
provide consistency in the wording of the text. See proposed changes 
to Rule 6.13.04(c) and (d).

    Example 4: Assume the acceptable derived net market is $1.00-
$1.20. Also assume two paired stock-option orders are submitted to 
an AIM auction. If the original Agency Order to sell the option leg 
and buy the stock is a market order, but the contra-side order to 
buy the option leg and sell the stock has a net credit price of 
$1.25, the AIM auction will not initiate because the contra-side 
order does not satisfy the price check parameter. Such a contra-side 
order would not be accepted because it is outside the acceptable net 
market price range. The paired original Agency Order would either 
not be accepted along with the contra-side order or, at the order 
entry firm's discretion, would continue processing as an unpaired 
complex order. By comparison, if the contra-side order has a net 
---------------------------------------------------------------------------
credit price of $0.95, the price will be capped at $1.01.

    The Exchange is also proposing to make two existing price 
protection features that it has available for other complex orders 
available for stock-option orders. In particular, the Exchange is 
proposing to modify its existing ``market width'' parameters under Rule 
6.13.04(a) to extend the application of the individual series leg width 
parameters to stock-option orders. Under this price check parameter, 
eligible market complex orders will not be automatically executed if 
the width between the Exchange's best bid and best offer in any 
individual series leg is not within an acceptable price range.\22\ As 
proposed, the Exchange may also determine on a class-by-class basis to 
make this price check parameter available for market and marketable 
limit stock-option orders. In addition, the Exchange has a price 
protection feature that it refers to as the ``buy-buy (sell-sell) 
strategy'' price check parameter under Rule 6.13.04(d). Under this 
parameter, the system will not automatically execute a limit order 
where (i) all the components of the strategy are to buy and the order 
is priced at zero, any net credit price, or a net debit price that is 
less than the number of individual option series legs in the strategy 
(or applicable ratio) multiplied by the applicable minimum net price 
increment for the complex order; or (ii) all the components of the 
strategy are to sell and the order is priced at zero, any net debit 
price, or a net credit price that is less than the number of individual 
option series legs in the strategy (or applicable ratio) multiplied by 
the applicable minimum net price increment for the complex order. Such 
complex orders under this price check parameter are rejected.\23\ In 
classes where this price check parameter is available, the Exchange is 
also proposing to make it available for stock-option orders. In such 
instances, the minimum net price increment calculation noted above 
would only apply to the individual option series legs.\24\
---------------------------------------------------------------------------

    \22\ The ``acceptable price range'' is determined by the 
Exchange on a class-by-class basis (and announced via Regulatory 
Circular) on a series by series basis for each series comprising a 
complex order. See also SR-C2-2012-003 (wherein the Exchange is 
proposing, among other things, to expand the application of this 
price check parameter to include marketable limit orders (currently 
the rule text only addresses market complex orders) and to correct a 
typographical error by changing the minimum acceptable price range 
specified in the rule text for orders in option series where the bid 
is less than $2 from $0.37 to $0.375.
    \23\ The Exchange notes that it is proposing to amend the text 
to use the phrase ``not be accepted'' to replace the reference to 
``rejected.'' See note 21, supra.
    \24\ See proposed changes to Rule 6.13(d).
---------------------------------------------------------------------------

    The Exchange believes that the application of these price 
protection features will assist with the maintenance of fair and 
orderly markets by helping to mitigate the potential risks associated 
with stock-option orders drilling through multiple price points 
(thereby resulting in executions at prices that are extreme and 
potentially erroneous) and with stock-option orders entered at net 
limit prices that are inconsistent with the particular ``buy-buy'' or 
``sell-sell'' strategy (thereby resulting in execution at prices that 
are extreme and potentially erroneous). Rather than automatically 
executing or booking orders at extreme and potentially erroneous 
prices, the Exchange would cancel orders that are not within the price 
check parameters so that the orders can be further evaluated.
    Finally, the Exchange is proposing to extend the application of its 
``re-COA'' feature to stock-option orders. Under this feature, to the 
extent any non-marketable order resting at the top of the COB is priced 
within the acceptable tick distance of the derived net market, the full 
order would be subject to COA (and the processing describe above) 
(referred to herein as a ``re-COA'').\25\ The Exchange notes that this 
re-COA feature for resting orders would only be applicable to resting 
non-marketable stock-option orders that move close to the derived net 
market. This feature is not applicable to resting stock-option orders 
that become marketable with other stock-option orders. The Exchange may 
also determine on a class-by-class and strategy basis to limit the 
frequency of re-COA auctions initiated for stock-option orders resting 
in COB. For example, the Exchange might determine to limit the 
frequency of re-COA auctions to once every ``X'' seconds (the 
``interval timer'') for a total of ``Y'' intervals. Once this cycle is 
complete, the Exchange may determine to wait for a period of time ``Z'' 
(the ``sleep timer'') and then reactivate the re-COA feature.\26\ All 
timers would be reset if a new stock-option order improves the top of 
the COB (i.e., improves the best net price bid or offer of the stock-
option orders resting in COB). These limitations on the frequency of 
COA auctions due to the re-COA feature are intended to address system 
efficiency and effectiveness considerations, such as limiting repeated 
initiations of COA auctions (and related messaging) when there are 
flickering quotes. Once the re-COA feature is initiated for a resting 
order, all other aspects of the COA process described in Rule 6.13 
would apply unchanged. The Exchange

[[Page 10025]]

believes this re-COA feature facilitates the orderly execution of 
stock-option orders by providing an automated opportunity for price 
improvement to (and execution of) resting orders priced near the 
current market, similar to what a PH might seek to do if the PH were 
representing a stock-option order in open outcry on another exchange 
(or just entering an order initially into COB).
---------------------------------------------------------------------------

    \25\ This feature will apply regardless of whether the stock-
option order was subject to COA before it was booked in COB. See 
note 17, supra.
    \26\ Determinations by the Exchange regarding the classes where 
the re-COA feature is activated and related tick distance and 
frequency parameters will be announced via Regulatory Circular.
---------------------------------------------------------------------------

    The following example illustrates the operation of this proposed 
system functionality:

    Example 5: Assume that the acceptable tick distance to re-COA is 
2 ticks ($0.02). Also assume the frequency for the re-COA feature is 
limited to once every 15 seconds (the interval timer) for 1 
interval. Under this setting, only 1 re-COA auction could be 
triggered--the original re-COA auction.\27\ No further auctions 
would be triggered until the sleep timer expires, and only then if a 
quote update which is received AFTER the sleep timer expires would 
result in the order being within 2 ticks of the derived net market. 
Assume the sleep timer is set at 60 minutes. Assume the current 
derived net market is $8.85-$9.15. If a stock-option order resting 
in the COB is priced at a net credit price of $8.88, the stock-
option order is not marketable and is priced inside the derived net 
market by 3 ticks. If subsequently the individual leg prices are 
updated such that the current derived net market for the strategy 
moves to a net price of $8.86-$9.14, the resting order priced at a 
net credit price of $8.88 would trigger the re-COA feature and 
initiate the re-COA auction process (as the order is now priced 
within 2 ticks of the derived net market). If there are no 
responses, the order would be placed back in COB. The resting order 
would not initiate the re-COA feature again until the 60-minute 
sleep timer has expired, and then only if a quote update received 
AFTER the 60-minute sleep timer expires would result in the order 
being within 2 ticks of the derived net market.
---------------------------------------------------------------------------

    \27\ In a prior rule change filing, the Exchange provided an 
example indicating that if the setting for the interval timer was 
once every 15 seconds for 1 interval, then a total of 2 re-COA 
auctions would occur during the interval--the original re-COA 
auction and a second re-COA auction after the expiration of the 15-
second interval timer. See Securities Exchange Act Release No. 65938 
(December 12, 2011), 76 FR 78706 (December 19, 2011) (SR-C2-2011-
039). However, the Exchange notes that only one re-COA auction will 
occur under these settings. Therefore, Example 5 above is intended 
to update the previous example and provide a more detailed 
illustration of the interval timer.
---------------------------------------------------------------------------

    If the number of attempts was set to a value greater than 1 
(assume 2 for the below discussion), then when the 15-second 
interval timer expires, the order would be eligible to initiate the 
re-COA feature again if the current market moves after the 
expiration of the timer and the order meets the tick distance 
parameter (the order would not automatically initiate the re-COA 
feature after the expiration of the interval timer; instead there 
must be an update to the current market after the expiration of the 
interval timer and the order must meet the tick distance parameter 
for the system to re-COA again). For example, if after the end of 
the 15-second interval timer the derived net market moves to $8.87-
$9.13 (or, for example, if the derived market moves back to $8.85-
$9.15 and then, after the end of the 15-second interval timer moves 
back again to $8.86-$9.14), then the resting complex order would 
again initiate the re-COA feature. If there are no responses, the 
order would be placed back in COB. The cycle is complete. Now that 
the resting order has been subject to COA 2 times since it was 
booked in COB, the 60-minute sleep timer will begin and the resting 
order will not be eligible for the re-COA feature again until the 
sleep timer expires and there is a quote update after that timer 
expires that is within the tick distance parameter. All timers would 
be reset anytime there is a price change at the top of the COB. For 
example, if five minutes into the sleep interval a second stock-
option order is entered to rest in COB at a price of $8.87 ($0.01 
better than the original resting order priced at $8.88), the 
original resting order would no longer be at the top of the COB and 
subject to the re-COA feature. The timers would reset and the second 
complex order (which now represents the top of the COB) would be 
subject to the re-COA process. If, for example, the second order 
subsequently trades (constituting a price change at the top of the 
COB), the original order would be at the top of the COB again and 
could become subject to the re-COA feature again.
2. Statutory Basis
    The proposed rule change is consistent with Section 6(b) of the Act 
\28\ in general and furthers the objectives of Section 6(b)(5) of the 
Act \29\ in particular in that it should promote just and equitable 
principles of trade, serve to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and 
protect investors and the public interest. The Exchange believes the 
proposed rule change will assist in the electronic processing of stock-
option orders by providing an efficient mechanism for carrying out 
these strategies in the Exchange's electronic trading environment. The 
Exchange also believes the proposed stock-option related price check 
parameters will enhance the functionality and assist with the 
maintenance of fair and orderly markets by helping to mitigate the 
potential risks associated with an order drilling through multiple 
price points (thereby resulting in execution at prices that are extreme 
and potentially erroneous) and an order trading at prices that are 
inconsistent with particular stock-option strategies (thereby resulting 
in executions at prices that are extreme and potentially erroneous).
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78f(b).
    \29\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange 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 Act.

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 
proposal.

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 (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization 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

    <bullet> Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
    <bullet> Send an email to <a href="/cdn-cgi/l/email-protection#4032352c256d232f2d2d252e3433003325236e272f36"><span class="__cf_email__" data-cfemail="4f3d3a232a622c2022222a213b3c0f3c2a2c61282039">[email protected]</span></a>. Please include 
File Number SR-C2-2012-004 on the subject line.

Paper Comments

    <bullet> Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-C2-2012-004. 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

[[Page 10026]]

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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549-1090, 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-C2-2012-004, and should be 
submitted on or before March 13, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\30\
---------------------------------------------------------------------------

    \30\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-3901 Filed 2-17-12; 8:45 am]
BILLING CODE 8011-01-P


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