[Federal Register Volume 77, Number 66 (Thursday, April 5, 2012)]
[Notices]
[Pages 20675-20680]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-8171]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66702; File No. SR-CBOE-2011-123]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving Proposed Rule Change To Establish an 
Automated Improvement Mechanism and a Solicitation Auction Mechanism 
for FLEX Options

March 30, 2012.

I. Introduction

    On December 20, 2011, the Chicago Board Options Exchange, 
Incorporated (``Exchange'' or ``CBOE'') 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

[[Page 20676]]

thereunder,\2\ a proposed rule change to establish an Automated 
Improvement Mechanism (``AIM'') and Solicitation Auction Mechanism 
(``SAM'') for FLEX Options. The proposed rule change was published for 
comment in the Federal Register on January 4, 2012.\3\ The Commission 
received two comment letters regarding the proposal.\4\ The Exchange 
submitted a response on March 20, 2012.\5\ This order approves the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 66052 (January 4, 
2012), 77 FR 306.
    \4\ See Letters to Elizabeth M. Murphy, Secretary, Commission 
from Todd Weingart, Spot On Brokerage Services, Division of Trading 
Block, William O'Keefe, Spot On Brokerage Services, Division of 
Trading Block, and Steve Stepanek, The SJS Group, Inc., dated 
January 20, 2012 (``Spot Letter'') and from Jonathan Grodnick, 
Chicago Trading Company, dated February 7, 2012 (``CTC Letter'').
    \5\ See Letter to Elizabeth M. Murphy, Secretary, Commission 
from Jennifer M. Lamie, CBOE dated March 20, 2012 (``CBOE 
Response'').
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II. Description of the Proposal

    The Exchange is proposing new Rules 24B.5A and 24B.5B to establish 
an AIM and SAM for FLEX Options. Currently, the AIM and SAM are 
available for non-FLEX Options under Rules 6.74A and 6.74B. The FLEX 
versions of the AIM and SAM mechanisms are described below.

A. Automated Improvement Mechanism

    The Exchange is proposing to establish an AIM mechanism for FLEX 
Options. Under the AIM process, a FLEX Trader \6\ (``Initiating TPH'') 
that represents agency orders may submit an order it represents as 
agent (an ``Agency Order'') along with a second order (a principal 
order and/or solicited order(s) for the same amount as the Agency 
Order) \7\ into the AIM mechanism where other FLEX Trader participants 
could compete with the Initiating TPH's second order to execute against 
the Agency Order.
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    \6\ A ``FLEX Trader'' means a FLEX-participating Trading Permit 
Holder (``TPH'') who has been approved by the Exchange to trade on 
the System. See Rule 24B.1(l).
    \7\ Any solicited orders submitted by the Initiating TPH to 
trade against the Agency Order may not be for the account of a FLEX 
Market-Maker assigned to the option class. See proposed Rule 
24B.5A.04.
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    To be eligible, the Agency Order must be in a FLEX class designated 
as eligible for AIM Auctions and within the designated AIM Auction 
order eligibility size parameters. The Exchange will announce such 
classes and size parameters via circular to FLEX Traders. In addition, 
an Initiating TPH must stop the entire Agency Order as principal and/or 
with a solicited order(s) at the better of the best bid or offer 
(``BBO'') or the Agency Order's limit price.\8\
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    \8\ See proposed Rule 24B.5A(a).
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    Only one AIM may be ongoing at any given time in a series and AIM 
auctions in the same series may not queue or overlap. In addition, 
unrelated FLEX Orders may not be submitted to the electronic book for 
the duration of an AIM auction.\9\ To initiate an AIM auction, the 
Initiating TPH must mark the Agency Order for AIM processing and enter 
the second order in one of two formats: (i) a specified single price at 
which it seeks to cross the Agency Order with the second order (a 
``single-priced submission''), or (ii) a non-price specific commitment 
for the second order to automatically match the price and size of all 
auction responses that are received during the auction (an ``auto-
match''), in which case the Agency Order will be stopped at the better 
of the BBO or the Agency Order's limit price. When using the auto-match 
feature, the Initiating TPH would have no control over the ultimate 
match price. Once the Initiating TPH has submitted an Agency Order for 
AIM processing, such submission cannot be cancelled by the Initiating 
TPH.\10\
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    \9\ See proposed Rule 24B.5A(b).
    \10\ See proposed Rule 24B.5A(b)(1)(i).
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    Upon receipt of an Agency Order (and second order), the Exchange 
will issue a request for responses (``RFR''), detailing the side and 
size of the Agency Order.\11\ The duration of the RFR response period 
(i.e., the auction period) would be established by the Exchange on a 
class-by-class basis and shall not be less than three (3) seconds. 
During that period, RFR responses may be submitted by FLEX Traders. 
These responses must specify price and size and may not cross the 
Exchange's BBO on the opposite side of the market. RFR responses are 
not visible to any other participants and shall not be disseminated to 
the Options Price Reporting Authority (``OPRA''). RFR responses may be 
modified or cancelled so long as they are modified or cancelled before 
the conclusion of the RFR response period. Lastly, the minimum price 
increment for RFR responses and for an Initiating TPH's single price 
submission shall be set by the Exchange at no less than one cent.\12\
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    \11\ Each RFR will be sent to those FLEX Traders electing to 
receive RFRs (i.e., those FLEX Traders who have established the 
necessary systems connectivity to receive RFRs). Thus, such election 
to receive RFRs would not be on a case-by-case basis.
    \12\ See proposed Rule 24B.5A(b)(1)(ii)-(ix).
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    Normally, an AIM Auction ends at the conclusion of the RFR response 
period (which will be no less than three seconds). However, the 
proposal provides that the AIM Auction would end prior to the 
conclusion of the RFR response period any time an RFR response matches 
the BBO on the opposite side of the market from the RFR responses.\13\ 
At the conclusion of the AIM Auction, the Agency Order would be 
allocated at the best price(s) and contra-side interest will be ranked 
and matched based on price-time priority, subject to the following:
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    \13\ See proposed Rule 24B.5A(b)(2).
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    <bullet> Such best prices may include non-AIM Auction FLEX Orders 
(to the extent the Exchange has determined to make available an 
electronic book).
    <bullet> Public customers and non-TPH broker-dealers RFR responses 
and FLEX Orders would have priority.
    <bullet> No FLEX Appointed Market-Maker participation entitlement 
would apply with respect to the AIM Auction.
    <bullet> If the best price equals the Initiating TPH's single-price 
submission, the Initiating TPH's single-price submission shall be 
allocated the greater of one contract or a certain percentage of the 
order, which percentage would be determined by the Exchange and may not 
be larger than 40%. However, if only one other FLEX Trader matches the 
Initiating TPH's single price submission, then the Initiating TPH may 
be allocated up to 50% of the order.
    <bullet> If the Initiating TPH selected the auto-match option of 
the AIM Auction, the Initiating TPH shall be allocated its full size at 
each price point until a price point is reached where the balance of 
the order can be fully executed. At such price point, the Initiating 
TPH shall be allocated the greater of one contract or a certain 
percentage of the remainder of the Agency Order, which percentage would 
be determined by the Exchange and may not be larger than 40%.
    <bullet> Any remaining RFR responses and FLEX Orders will be 
allocated based on time priority. The Initiating TPH would not 
participate on any such balance unless the Agency Order would otherwise 
go unfilled.
    <bullet> If the final AIM Auction price locks a public customer or 
non-TPH broker-dealer order in the electronic book on the same side of 
the market as the Agency Order, then, unless there is sufficient size 
in the AIM Auction responses to execute both the Agency Order and the 
booked public customer or non-TPH broker-dealer order (in which case 
they will both execute at the final AIM Auction price), the Agency 
Order will execute against RFR responses at one minimum RFR response 
increment worse than the final AIM Auction price against the AIM

[[Page 20677]]

Auction participants that submitted the final AIM Auction price and any 
balance shall trade against the public customer or non-TPH broker-
dealer order in the book at such order's limit price.\14\
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    \14\ See proposed Rule 24B.5A(b)(3).
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    The Exchange proposes that the AIM may only be used where there is 
a genuine intention to execute a bona fide transaction.\15\ In 
addition, it would be deemed conduct inconsistent with just and 
equitable principles of trade and a violation of CBOE Rule 4.1 to 
engage in a pattern of conduct where the Initiating TPH breaks-up an 
Agency Order into separate orders for two (2) or few contracts for the 
purpose of gaining a higher allocation percentage than the Initiating 
TPH would have otherwise received in accordance with the allocation 
procedures.
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    \15\ See proposed Rule 24B.5A.01.
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    The Exchange also may determine on a class-by-class basis to make 
the AIM Auction available for complex orders. In such classes, complex 
orders may be executed through the AIM Auction at a net debit or net 
credit price provided the AIM Auction eligibility requirements are 
satisfied and the Agency Order is eligible for the AIM Auction 
considering its complex order type, order origin code, class, and 
marketability as determined by the Exchange. Complex orders will only 
be eligible to trade with other complex orders through the AIM 
Auction.\16\
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    \16\ See proposed Rule 24B.5A.05. To the extent the Exchange 
determines to make an electronic book available for resting FLEX 
Orders, there will be no ``legging'' of complex orders with FLEX 
Orders that may be represented in the individual series legs 
represented in the electronic book. Order allocation shall be the 
same as would be applicable for simple orders. In addition, the 
individual series legs of a complex order would not trade through 
equivalent bids (offers) in the individual series legs represented 
in the electronic book and at least one leg must better the 
corresponding bid (offer) of public customers and non-TPH broker-
dealers in the electronic book.
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    Initially, and for at least a pilot period expiring on July 18, 
2012, there will be no minimum size requirement for orders to be 
eligible for the AIM Auction. During this Pilot Period, the Exchange 
will submit certain data, periodically as required by the Commission, 
to provide supporting evidence that, among other things, there is a 
meaningful competition for all size orders and that there is an active 
and liquid market functioning on the Exchange outside of the AIM 
Auction. Any data which is submitted to the Commission will be provided 
on a confidential basis.\17\
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    \17\ See proposed Rule 24B.5A.03.
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    Any determinations made by the Exchange pursuant to the proposed 
rule, such as eligible classes, order size parameters and the minimum 
price increment, would be communicated in a circular.\18\
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    \18\ See proposed Rule 24B.5A.06.
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B. Solicitation Auction Mechanism

    The Exchange also proposes to establish a SAM mechanism for FLEX 
Options. The SAM permits a FLEX Trader to electronically execute 
larger-sized Agency Orders against solicited orders.\19\ To be 
eligible, the Agency Order must be in a FLEX class designated as 
eligible for SAM Auctions and within the designated SAM Auction order 
eligibility size parameters determined by the Exchange (however, the 
eligible order size would not be less than 500 contracts). Such classes 
and size parameters will be determined by the Exchange and announced 
via circular to FLEX Traders. Each order entered into the SAM would be 
designated all-or-none (i.e., an order will be executed in its entirety 
or not at all).\20\
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    \19\ Any solicited orders submitted by the Initiating TPH to 
trade against the Agency Order may not be for the account of a FLEX 
Market-Maker assigned to the option class. See proposed Rule 
24B.5B.03.
    \20\ See proposed Rule 24B.5B(a).
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    Once the Initiating TPH has submitted an Agency Order for SAM 
processing, such submission cannot be cancelled by the Initiating TPH. 
To initiate the SAM, the Initiating TPH must mark the Agency Order for 
SAM processing, and specify a single price at which it seeks to cross 
the Agency Order with a solicited order. Upon receipt of an Agency 
Order (and second order), an RFR message will be sent to all FLEX 
Traders that have elected to receive such messages, detailing the price 
and size of the Agency Order. The duration of the RFR response period 
(i.e., the auction period) would be established by the Exchange on a 
class-by-class basis and shall not be less than three (3) seconds. 
During that period, RFR responses may be submitted by FLEX Traders 
(specifying prices and sizes), except that responses may not be entered 
for the account of an options Market-Maker from another options 
exchange. Responses shall not be visible for other SAM participants and 
shall not be disseminated to OPRA. RFR responses may be modified or 
cancelled so long as they are modified or cancelled before the 
conclusion of the RFR response period.\21\ Lastly, the minimum price 
increment for RFR responses and for an Initiating TPH's single price 
submission shall be set by the Exchange at no less than one cent.\22\
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    \21\ See proposed Rule 24B.5B(b)(1).
    \22\ See proposed Rule 24B.5B(a)(3) and (b)(1)(v).
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    Normally, a SAM ends at the conclusion of the RFR response period. 
However, as with AIM, the proposal provides that the SAM would end 
prior to the conclusion of the RFR response period any time an RFR 
response matches the BBO on the opposite side of the market from the 
RFR responses.\23\ At the conclusion of the SAM auction, the Agency 
Order would be executed against the second/solicited order unless there 
is sufficient size to execute the entire Agency Order at a price (or 
prices) that improves the proposed crossing price. In the case where 
there are one or more public customers or non-TPH broker-dealers at the 
proposed execution price on the opposite side of the Agency Order, the 
second/solicited order would be cancelled and the Agency Order would be 
executed against other bids (offers) if there is sufficient size at the 
bid (offer) to execute the entire size of the Agency Order (size would 
be measured considering RFR responses and resting FLEX Orders, to the 
extent the Exchange has determined to make available an electronic 
book). If there is not sufficient size to execute the entire Agency 
Order, the proposed cross would not be executed and both the Agency 
Order and second/solicited order would be cancelled. Additionally, the 
proposed cross would not be executed and both the Agency Order and 
second/solicited order would be cancelled if the execution price would 
be inferior to the BBO.\24\
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    \23\ See proposed Rule 24B.5B(b)(2).
    \24\ See proposed Rule 24B.5B(b)(3).
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    In the event the Agency Order is executed at an improved price(s) 
or at the proposed execution price against RFR responses and FLEX 
Orders, the allocation priority at a given price would be as follows: 
(i) RFR responses and FLEX Orders for the account of public customers 
and non-TPH broker-dealers, based on time priority; (ii) any RFR 
responses and FLEX Orders that are subject to a FLEX Appointed Market-
Maker participation entitlement, based on a participation entitlement 
formula specified in Rule 24B.5(d)(2)(ii); then (iii) all other RFR 
responses and FLEX Orders, based on time priority.\25\
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    \25\ See proposed Rule 24B.5B(b)(3)(i)(D).
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    The Exchange proposes to apply the SAM mechanism to complex orders, 
on a class-by-class basis. In such classes, complex orders may be 
executed through the SAM at a net debit or net credit price provided 
the SAM eligibility requirements are satisfied and the Agency Order is 
eligible for the SAM considering its complex order type, order origin 
code, class, and

[[Page 20678]]

marketability as determined by the Exchange. Complex orders will only 
be eligible to trade with other complex orders through the SAM.\26\
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    \26\ See proposed Rule 24B.5B.01. To the extent the Exchange 
determines to make an electronic book available for resting FLEX 
Orders, there will be no ``legging'' of complex orders with FLEX 
Orders that may be represented in the individual series legs 
represented in the electronic book. Order allocation shall be the 
same as would be applicable for simple orders. In addition, the 
individual series legs of a complex order would not trade through 
equivalent bids (offers) in the individual series legs represented 
in the electronic book, and at least one leg must better the 
corresponding bid (offer) of public customers and non-TPH broker-
dealers in the electronic book.
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    The proposed rule also requires TPHs to deliver to customers a 
written document, in a form approved by the Exchange, describing the 
terms and conditions of the SAM mechanism prior to executing Agency 
Orders using the SAM mechanism.\27\ The proposed rule further specifies 
that TPHs may not use the SAM mechanism to circumvent the Exchange's 
rules limiting principal order transactions.\28\ The Exchange also 
proposes that any determinations made by the Exchange pursuant to the 
proposed SAM Auction rule, such as eligible classes, order size 
parameters and the minimum price increment, would be communicated in a 
circular.\29\
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    \27\ See proposed Rule 24B.5B.02.
    \28\ See proposed Rule 24B.5B.03
    \29\ See proposed Rule 24B.5B.04.
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III. Discussion and Commission Findings

    After careful consideration, 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 \30\ and, in particular, the requirements of Section 6 of the 
Act.\31\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(5) of the Act,\32\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and, in general, to protect 
investors and the public interest. The Commission believes that 
approving the Exchange's proposal to establish the AIM and SAM for FLEX 
Options should confer benefits to the public by increasing competition 
between and among the options exchanges, resulting in better prices and 
executions for investors.\33\ The Commission therefore finds that for 
the reasons discussed below, the Exchange's proposal is consistent with 
the Act.
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    \30\ In approving the proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \31\ 15 U.S.C. 78f.
    \32\ 15 U.S.C. 78f(b)(5).
    \33\ The Commission notes, that it previously found the non-FLEX 
AIM and SAM mechanisms consistent with the Act. See, e.g., 
Securities Exchange Act Release Nos. 53222 (February 3, 2006), 71 FR 
7089 (February 10, 2006) (SR-CBOE-2005-60) (Order Approving AIM) and 
57610 (April 3, 2008), 73 FR 19535 (April 10, 2008) (SR-CBOE-2008-
14) (Order Approving SAM).
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A. Automated Improvement Mechanism

    The Exchange proposes that the Initiating TPH must stop the Agency 
Order at the better of the BBO or the Agency Order's limit price. The 
Commission believes that the proposed stop price should provide 
customers with an opportunity for price improvement over the Exchange's 
BBO. The Commission believes that it is reasonable to stop the Agency 
Order at the better of the BBO or the Agency Order's limit price, 
versus the National Best Bid or Offer, because FLEX options are 
generally not multiply-listed and are not subject to a consolidated 
quotation reporting program. In addition, the FLEX AIM will only 
process Agency Orders with limit prices, not market orders. The 
Commission also believes that the proposal should provide FLEX Traders 
with incentives to compete in AIM auctions. The Commission notes that 
once an Agency Order is submitted into the AIM, the submission may not 
be modified or cancelled. Therefore, the Agency Order submitted to the 
AIM will be guaranteed an execution price of at least the BBO and, 
moreover, will be given an opportunity for execution at a price better 
than the BBO.
    The Exchange also proposes to send an RFR to all FLEX Traders that 
have elected to receive RFRs, and RFR responses may be submitted by 
FLEX Traders. The Commission believes that permitting access to the AIM 
auction for all FLEX Traders who may wish to compete for an Agency 
Order should be sufficient to provide opportunities for a meaningful, 
competitive auction.
    With respect to the RFR period, the Exchange proposes that the 
duration of the RFR response period will be established by the Exchange 
on a class-by-class basis and shall not be less than three seconds. One 
commenter argued that the proposed three second RFR period for a new 
FLEX strike and cross would present an exceptional technological 
challenge to market making firms attempting to provide liquidity in 
FLEX Options. The commenter suggested that the response time in the AIM 
and SAM for newly added flex strikes be increased from three seconds to 
one minute.\34\ CBOE disagreed, stating that in today's market, a one-
minute timer far exceeds the standards that have been set for any other 
exchange timer. CBOE notes that while the FLEX market may be thinly 
traded or a bit more complex given its customized nature; however, this 
does not mean that the AIM or SAM should be subject to unnecessarily 
lengthy timers. According to CBOE, FLEX AIM and SAM are intended to be 
automated and FLEX Traders desiring to participate in the FLEX AIM and 
SAM need to dedicate resources to program to the auctions. Assuming a 
FLEX Trader develops the technology to electronically trade, CBOE 
believes the three second interval is sufficient to electronically 
process and respond to an auction in today's markets.\35\
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    \34\ See CTC Letter, supra note 4, at 1. The Commission also 
received another comment letter regarding the proposed rule change. 
See Spot Letter, supra note 4. The Spot Letter suggested that there 
be an additional phase, the Decision Phase, in the RFQ process. 
During this Decision Phase, the initiator of an RFQ would have a 
brief period of time, during which no changes of any type to market 
quotes would be permitted, in order to decide to trade or cancel 
their RFQ. The Commission notes that the subject of the comment 
letter (the RFQ process for FLEX Options) is not related to the 
CBOE's proposal to establish a separate AIM and SAM for FLEX 
Options.
    \35\ See CBOE Response, supra note 5, at 3.
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    The Commission agrees that the three-second electronic auction 
proposed by the Exchange should provide sufficient time for an 
electronic crowd to compete for an Agency Order. The Commission notes 
that the RFR response period of three seconds is consistent with the 
existing minimum exposure period for FLEX Option crossing pursuant to 
the existing FLEX crossing procedures.\36\
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    \36\ See Rule 24B.5(b)(3)(iii).
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    Under the proposal, allocation will be based on price-time 
priority, subject to public customer and non-TPH broker-dealer 
priority. No FLEX Appointed Market-Maker participation entitlement 
shall apply. If the best price equals the Initiating TPH's single-price 
submission, the Initiating TPH's single-price submission shall be 
allocated the greater of one contract or up to 40% of the order.\37\ If 
the Initiating TPH selected the auto-match option of the AIM Auction, 
the Initiating TPH shall be allocated its full size at each price point 
until a price point is reached where the balance of the order can be 
fully executed. At such price point, the Initiating TPH shall be 
allocated the greater of one contract or up to 40% of

[[Page 20679]]

the remainder of the Agency Order. Any remaining RFR responses and FLEX 
Orders will be allocated based on time priority. In addition, it will 
be deemed conduct inconsistent with just and equitable principles of 
trade and a violation of Rule 4.1 to engage in a pattern of conduct 
where the Initiating TPH breaks-up an Agency Order into separate orders 
for 2 or fewer contracts for the purpose of gaining a higher allocation 
percentage than the Initiating TPH would have otherwise received in the 
AIM.
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    \37\ However, if only one other FLEX Trader matches the 
Initiating TPH's single price submission, then the Initiating TPH 
may be allocated up to 50% of the order.
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    The Commission believes that the priority and allocation rules are 
reasonable and consistent with the Act.\38\ The Commission believes 
that the matching algorithm set forth in the FLEX AIM rule is 
sufficiently clear regarding how orders are allocated in the AIM 
auction. The Commission notes that the proposal to provide both public 
customers and non-TPH broker-dealers with first priority in the FLEX 
AIM auction is consistent with how other FLEX allocation algorithms 
currently operate.\39\ In addition, the Commission notes that public 
customer priority/non-TPH broker-dealer priority and price-time 
priority have previously been found consistent with the Act.\40\
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    \38\ The Commission also believes that the proposed priority and 
allocation rules for electronic FLEX trading in the AIM are 
consistent with Section 11(a) of the Act. 15 U.S.C. 78k(a) Section 
11(a)(1) prohibits a member of a national securities exchange from 
effecting transactions on that exchange for its own account, the 
account of an associated person, or an account over which it or its 
associated person exercises discretion unless an exception applies. 
FLEX Market-Makers qualify for the market-maker exception. With 
respect to non-market-maker members, the auction appears reasonably 
designed to cause RFR Quotes constituting the RFR Market and the RFR 
Order that trades against the RFR Market to yield to non-member 
interest, consistent with the ``G'' exception. See 15 U.S.C. 
78k(a)(1)(G) (setting forth all requirements for the ``G'' 
exception).
    \39\ See, e.g., Rule 24B.5(a)(1)(iii)(C) and (D).
    \40\ See, e.g., Securities Exchange Act Release Nos. 51822 (June 
10, 2005), 70 FR 35321 (June 17, 2005) (SR-CBOE-2004-87) (Adopting 
rules pertaining to priority and allocation of trades for index 
options) and 56792 (November 15, 2007), 72 FR 65776 (November 23, 
2007) (SR-CBOE-2006-99) (Adopting rules providing for the trading of 
FLEX Options on an electronic platform).
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    Like the Exchange's AIM for non-FLEX options, the FLEX AIM auction 
would be available for orders of fewer than 50 contracts. Under the 
Exchange's proposal, there would be no minimum size requirement for 
orders entered into the AIM, for a pilot period expiring on July 18, 
2012. The Commission believes that the Exchange's proposal should 
provide small customer orders with the opportunity for price 
improvement, and is consistent with the Act. In particular, any Agency 
Order for less than 50 contracts that is entered into the AIM is 
guaranteed an execution at the end of the auction at a price at least 
the BBO. The Commission will evaluate the AIM auction during the Pilot 
Period to determine whether it would be beneficial to customers and to 
the options market as a whole to approve any proposal requesting 
permanent approval to permit orders of fewer than 50 contracts to be 
submitted to the AIM auction. In addition, the Commission will examine 
the data submitted by the Exchange with respect to situations in which 
the AIM auction is terminated prematurely by an RFR response. To aid 
the Commission in its evaluation, the CBOE represents that it will 
provide the following information each month:

    (1) The number of orders of fewer than 50 contracts entered into 
the FLEX AIM auction;
    (2) The percentage of all orders of fewer than 50 contracts sent 
to CBOE that are entered into CBOE's FLEX AIM auction;
    (3) The percentage of all CBOE FLEX trades represented by orders 
of fewer than 50 contracts;
    (4) The percentage of all CBOE FLEX trades effected through the 
FLEX AIM auction represented by orders of fewer than 50 contracts;
    (5) The percentage of all FLEX contracts traded on CBOE 
represented by orders of fewer than 50 contracts;
    (6) The percentage of all FLEX contracts effected through the 
FLEX AIM auction represented by orders of fewer than 50 contracts;
    (7) The spread in the option, at the time an order of fewer than 
50 contracts is submitted to the FLEX AIM auction;
    (8) The number of orders of 50 contracts or greater entered into 
the FLEX AIM auction;
    (9) The percentage of all FLEX orders of 50 contracts or greater 
sent to CBOE that are entered into CBOE's FLEX AIM auction;
    (10) The spread in the option, at the time an order of 50 
contracts or greater is submitted to the FLEX AIM auction;
    (11) Of FLEX AIM trades for orders of fewer than 50 contracts, 
the percentage done at the BBO, BBO plus $.01, BBO plus $.02, BBO 
plus $.03, etc.;
    (12) Of FLEX AIM trades for orders of 50 contracts or greater, 
the percentage done at the BBO, BBO plus $.01, BBO plus $.02, BBO 
plus $.03, etc.;
    (13) The number of orders submitted by FLEX Traders when the 
spread was $.05, $.10, $.15, etc. For each spread, specify the 
percentage of contracts in orders of fewer than 50 contracts 
submitted to CBOE's FLEX AIM that were traded by:
    (a) The Initiating TPH that submitted the order to the FLEX AIM;
    (b) CBOE Market Makers assigned to the class;
    (c) Other FLEX Traders;
    (d) Public Customer Orders;
    (e) Non-TPH broker-dealers; and
    (f) Other non-AIM FLEX Orders.

    For each spread, also specify the percentage of contracts in orders 
of 50 contracts or greater submitted to CBOE's FLEX AIM that were 
traded by:

    (a) The Initiating TPH that submitted the order to the FLEX AIM;
    (b) CBOE Market Makers assigned to the class;
    (c) Other FLEX Traders;
    (d) Public Customer Orders;
    (e) Non-Trading Permit Holder broker-dealers; and
    (f) Other non-AIM FLEX Orders.
    (14) The number of times that an RFR response matching the BBO 
on the opposite side of the market from the RFR responses 
prematurely ended the FLEX AIM auction, and the number of times such 
orders were entered by the same (or affiliated) firm that initiated 
the FLEX AIM auction that was terminated;
    (15) The percentage of FLEX AIM early terminations due to the 
receipt of an RFR response matching the BBO on the opposite side of 
the market from the RFR responses that occurred within a [frac12] 
second of the start of the AIM auction; the percentage that occurred 
within one second of the start of the AIM auction; the percentage 
that occurred within one and [frac12] second of the start of the AIM 
auction; the percentage that occurred within 2 seconds of the start 
of the AIM auction; the percentage that occurred within 2 and 
[frac12] seconds of the AIM auction; and the average amount of price 
improvement provided to the Agency Order where the AIM auction is 
terminated early at each of these time periods;
    (16) The average amount of price improvement provided to the 
Agency Order when the FLEX AIM auction is not terminated early 
(i.e., runs the full three seconds);
    (17) The percentage of all CBOE FLEX trades effected through the 
FLEX AIM auction in which the Initiating TPH has chosen the Auto-
Match feature, and the average amount of price improvement provided 
to the Agency Order when the Initiating TPH has chosen the Auto-
Match feature vs. the average amount of price improvement provided 
to the Agency Order when the Initiating TPH has chosen a single-
price submission;
    (18) For the first Wednesday of each month:
    (a) The total number of FLEX AIM auctions on that date;
    (b) The number of FLEX AIM auctions where the order submitted to 
the AIM was fewer than 50 contracts;
    (c) The number of FLEX AIM auctions where the order submitted to 
the AIM was 50 contracts or greater;
    (d) The number of FLEX AIM auctions (for orders of fewer than 50 
contracts) with 0 participants (excluding the initiating 
participant), 1 participant (excluding the initiating participant), 
2 participants (excluding the initiating participant), 3 
participants (excluding the initiating participant), 4 participants 
(excluding the initiating participant), etc., and
    (e) The number of FLEX AIM auctions (for orders of 50 contracts 
or greater) with 0 participants (excluding the initiating 
participant), 1 participant (excluding the initiating participant), 
2 participants

[[Page 20680]]

(excluding the initiating participant), 3 participants (excluding 
the initiating participant), 4 participants (excluding the 
initiating participant), etc.; and
    (19) For the third Wednesday of each month:
    (a) The total number of FLEX AIM auctions on that date;
    (b) The number of FLEX AIM auctions where the order submitted to 
the AIM was fewer than 50 contracts;
    (c) The number of FLEX AIM auctions where the order submitted to 
the AIM was 50 contracts or greater;
    (d) The number of FLEX AIM auctions (for orders of fewer than 50 
contracts) with 0 participants (excluding the initiating 
participant), 1 participant (excluding the initiating participant), 
2 participants (excluding the initiating participant), 3 
participants (excluding the initiating participant), 4 participants 
(excluding the initiating participant), etc., and
    (e) The number of FLEX AIM auctions (for orders of 50 contracts 
or greater) with 0 participants (excluding the initiating 
participant), 1 participant (excluding the initiating participant), 
2 participants (excluding the initiating participant), 3 
participants (excluding the initiating participant), 4 participants 
(excluding the initiating participant), etc.

B. Solicitation Auction Mechanism

    The Exchange is also proposing a SAM Auction for FLEX Options. The 
Commission believes that the proposal should allow for greater 
flexibility in pricing large-sized orders. The Commission further 
believes that the proposal includes appropriate terms and conditions to 
assure that the Agency Order is first exposed to FLEX Traders by RFR 
for the possibility of price improvement and that public customer 
orders on the Exchange are protected. The Commission also notes that 
the proposal is similar to requirements set forth in the CBOE SAM for 
non-FLEX Options.\41\
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    \41\ See Rule 6.74B.
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    The Exchange proposes that the duration of the RFR response period 
would be established by the Exchange on a class-by-class basis and 
shall not be less than three seconds. As with the AIM, one commenter 
suggested that the response time in the SAM for newly added flex 
strikes be increased from three seconds to one minute.\42\ The 
Commission believes that the three-second electronic auction proposed 
by the Exchange should provide sufficient time for an electronic crowd 
to compete for an Agency Order. The Commission notes that the RFR 
response period of three seconds is consistent with the existing 
minimum exposure period for FLEX Option crossing pursuant to the 
existing FLEX crossing procedures.\43\ The Commission believes that 
using the same period of time to respond to RFRs in SAM auctions should 
be appropriate for FLEX Traders.
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    \42\ See CTC Letter, supra note 4, at 1. See also discussion at 
Section III.A regarding the three-second RFR period for the AIM.
    \43\ See Rule 24B.5(b)(3)(iii).
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    Under the proposal, at the conclusion of the SAM, the Agency Order 
would be executed against the second/solicited order unless there is 
sufficient size to execute the entire Agency Order at a price(s) that 
improves the proposed crossing price. In the case where there are one 
or more public customers or non-TPH broker-dealers at the proposed 
execution price on the opposite side of the Agency Order, the second/
solicited order would be cancelled and the Agency Order would be 
executed against other bids (offers) if there is sufficient size at the 
bid (offer) to execute the Agency Order entirely. If there is not 
sufficient size to execute the entire Agency Order, or if the execution 
price would be inferior to the BBO, then the proposed cross would not 
be executed, and both the Agency Order and second/solicited order would 
be cancelled. In the event the Agency Order is executed at an improved 
price(s) or at the proposed execution price against RFR responses and 
FLEX Orders, priority would first go to RFR responses and FLEX Orders 
for the account of public customers and non-TPH broker-dealers based on 
time priority, then any RFR responses and FLEX Orders that are subject 
to a FLEX Appointed Market-Maker participation entitlement, and finally 
all other RFR responses and FLEX Orders. The Commission believes that 
the priority and allocation rules are reasonable and consistent with 
the Act.\44\
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    \44\ The Commission also believes, for the same reasons 
described above for the AIM, that the proposed priority and 
allocation rules for electronic FLEX trading in the SAM are 
consistent with Section 11(a) of the Act. See supra note 38.
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    The Commission also notes that the Exchange has included a 
provision stating that FLEX Traders may not use the SAM auction to 
circumvent Rule 24B.5 limiting principal transactions. The Exchange 
will also require written notification to customers prior to entering 
Agency Orders into the SAM on behalf of the customer and will require 
that determinations made by the Exchange regarding eligible classes, 
order size parameters, and the minimum price increment shall be 
communicated in a Regulatory Circular. The Exchange also proposes to 
permit the processing of complex orders. The Commission believes that 
the provisions help to clarify application of the SAM rule and may 
encourage further use of FLEX Options.
    One commenter asserted that the current FLEX auction mechanism 
should not be allowed to migrate to the CBOE Hybrid platform, arguing 
that participants that submit RFQs can receive quote responses that 
lock and/or cross markets.\45\ In response, CBOE stated that the 
comments have no relevance to the instant proposed rule change, which 
simply seeks to implement the two new FLEX AIM and SAM auctions and 
which does not propose any changes to the existing electronic RFQ 
auction mechanism.\46\
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    \45\ See CTC Letter, supra note 4, at 2.
    \46\ See CBOE Response, supra note 5, at 4. CBOE, however, notes 
that with respect to the FLEX SAM auction, the mechanism uses an 
all-or-none type allocation methodology and, by design it is 
possible for an agency order to receive an execution at a price that 
is through a response price. This is consistent with how the 
existing SAM auction for non-FLEX Options currently operates. Id.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\47\ that the proposed rule change (File No. SR-CBOE-2011-123), be, 
and hereby is, approved.
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    \47\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\48\
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    \48\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-8171 Filed 4-4-12; 8:45 am]
BILLING CODE 8011-01-P