Document ID: SEC-2019-1239-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Cboe Exchange, Inc.
Posted Date: 2019-08-29T04:00Z

[Federal Register Volume 84, Number 168 (Thursday, August 29, 2019)]
[Notices]
[Pages 45565-45568]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-18626]

[[Page 45565]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-86744; File No. SR-CBOE-2019-049]

Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of 
Filing of a Proposed Rule Change Relating To Make Permanent Certain 
Options Market Rules That Are Linked to the Equity Market Plan To 
Address Extraordinary Market Volatility

August 23, 2019.
    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 August 21, 2019, Cboe Exchange, Inc. (the ``Exchange'' or 
``Cboe Options'') filed with the Securities and Exchange Commission 
(the ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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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 Substance 
of the Proposed Rule Change

    Cboe Exchange, Inc. (``Cboe'' or the ``Exchange'') is filing with 
the Securities and Exchange Commission (the ``Commission'') to make 
permanent certain options market rules that are linked to the equity 
market Plan to Address Extraordinary Market Volatility. The text of the 
proposed rule change is attached [sic] as Exhibit 5.
    The text of the proposed rule change is also available on the 
Exchange's website (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the 
Secretary, and at the Commission's Public Reference Room.

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

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

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

1. Purpose
    The purpose of the proposed rule change is to make permanent 
certain options market rules in connection with the equity market Plan 
to Address Extraordinary Market Volatility (the ``Limit Up-Limit Down 
Plan'' or the ``Plan''). This change is being proposed in connection 
with the recently approved amendment to the Limit Up-Limit Down Plan 
that allows the Plan to continue to operate on a permanent basis 
(``Amendment 18'').\3\
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    \3\ See Securities Exchange Act Release No. 85623 (April 11, 
2019), 84 FR 16086 (April 17, 2019) (Order Approving Amendment No. 
18).
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    In an attempt to address extraordinary market volatility in NMS 
Stocks, and, in particular, events like the severe volatility on May 6, 
2010, U.S. national securities exchanges and the Financial Industry 
Regulatory Authority, Inc. (collectively, ``Participants'') drafted the 
Plan pursuant to Rule 608 of Regulation NMS under the Act.\4\ On May 
31, 2012, the Commission approved the Plan, as amended, on a one-year 
pilot basis.\5\ Though the Plan was primarily designed for equity 
markets, the Exchange believed it would, indirectly, potentially impact 
the options markets as well. Thus, the Exchange has previously adopted 
and amended Rules 6.3A, 6.3B and Interpretation and Policy .01 to Rule 
6.25 to ensure the option markets were not harmed as a result of the 
Plan's implementation and implemented such rules on a pilot basis that 
has coincided with the pilot period for the Plan (collectively, the 
``Options Pilots'').\6\ Rule 6.3A essentially serves as a roadmap for 
the Exchange's universal changes due to the implementation of the Plan, 
Rule 6.3B provides for trading halts whenever a market-wide trading 
halt is initiated due to extraordinary market conditions pursuant to 
the Plan, and Rule 6.25.01 provides that transactions executed during a 
limit or straddle state are not subject to the obvious and catastrophic 
error rules. A limit or straddle state occurs when at least one side of 
the National Best Bid (``NBB'') or Offer (``NBO'') bid/ask is priced at 
a non-tradable level. Specifically, a straddle state exists when the 
NBB is below the lower price band while the NBO is inside the prices 
band or when the NBO is above the upper price band and the NBB is 
within the band, while a limit state occurs when the NBO equals the 
lower price band (without crossing the NBB), or the NBB equals the 
upper price band (without crossing the NBO). The Exchange adopted the 
Options Pilots to protect investors because when an underlying security 
is in a limit or straddle state, there will not be a reliable price for 
the security to serve as a benchmark for the price of the option. 
Specifically, the Exchange adopted Rule 6.25.01 because the application 
of the obvious and catastrophic error rules would be impracticable 
given the potential for lack of a reliable NBBO in the options market 
during limit and straddle states. When adjusting or busting a trade 
pursuant to the obvious error rule, the determination of theoretical 
value of a trade generally references the NBB (for erroneous sell 
transactions) or NBO (for erroneous buy transactions) just prior to the 
trade in question, and is therefore not reliable when at least one side 
of the NBBO is priced at a non-tradeable level, as is the case in limit 
and straddle states. In such a situation, determining theoretical value 
may often times be a very subjective rather than an objective 
determination and could give rise to additional uncertainty and 
confusion for investors. As a result, application of the obvious and 
catastrophic error rules would be impracticable given the lack of a 
reliable NBBO in the options market during limit and straddle states, 
and may produce undesirable effects or unanticipated consequences. The 
Exchange adopted additional measures via other Options Pilot rules that 
are designed to protect investors during limit and straddle states. For 
example, the Exchange will reject market orders and not elect stop 
orders \7\ during a

[[Page 45566]]

Limit Up-Limit Down state to ensure that only those orders with a limit 
price will be executed during a limit or straddle state given the 
uncertainty of market prices during such a state. Additionally, the 
Exchange will initiate a trading halt whenever a market-wide trading 
halt is initiated, which ensures that investors have an opportunity to 
become aware of and respond to significant price movements. 
Furthermore, the Exchange believes that eliminating the application of 
obvious error rules during a limit or straddle state eliminates the re-
evaluation of a transaction executed during such a state that could 
potentially create an unreasonable adverse selection opportunity due to 
lack of a reliable reference price on one side of the market or another 
and discourage participants from providing liquidity during limit and 
straddle states, which is contrary to the goal in limiting 
participants' adverse selection with the application of the obvious 
error rule during normal trading states. For these reasons, the 
Exchange believes the Options Pilots are designed to add certainty on 
the options markets, which encourages more investors to participate in 
light of the changes associated with the Plan. The Plan was originally 
implemented on a pilot-basis in order to allow the public, the 
participating exchanges, and the Commission to assess the operation of 
the Plan and whether the Plan should be modified prior to approval on a 
permanent basis. As stated, the Exchange adopted the Option Pilots to 
coincide with this pilot; to continue the protections therein while the 
industry gains further experience operating the Plan.
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    \4\ See Securities Exchange Act Release No. 64547 (May 25, 
2011), 76 FR 31647 (June 1, 2011) (File No. 4-631).
    \5\ See Securities and Exchange Act Release No. 67091 (May 31, 
2012) 77 FR 33498 (June 6, 2012).
    \6\ See Securities Exchange Act Release Nos. 69328 (April 5, 
2013), 78 FR 21642 (April 11, 2013) (SR-CBOE-2013-030) (amending 
certain options rules to coincide with the pilot period for the 
Plan, including Rule 6.3A and Rule 6.25); 65438 (September 28, 
2011), 76 FR 61447 (October 4, 2011) (SR-CBOE-2011-087) (amending 
Rule 6.3B for determining when to halt trading in all stocks and 
stock options due to extraordinary market volatility); 68770 
(January 30, 2013), 78 FR 8211 (February 5, 2013) (SR-CBOE-2013-011) 
(amending Rule 6.3B to delay the operative date of the pilot to 
coincide with the initial date of operations of the Plan); and 85616 
(April 11, 2019), 84 FR 16093 (April 17, 2019) (SR-CBOE-2019-020) 
(proposal to extend the pilot for certain options pilots).
    \7\ This includes rules in connection with special handling for 
market orders, market-on-close orders, stop orders, and stock-option 
orders, as well as for certain electronic order handling features in 
a Limit Up-Limit Down state, the obvious error rules, and providing 
that the Exchange will not require Market-Makers to quote in series 
of options when the underlying security is in a Limit Up-Limit Down 
state.
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    In connection with the order approving the establishment of the 
obvious error pilot, as well as the extensions of the obvious error 
pilot, the Exchange committed to submit monthly data regarding the 
program and to submit an overall analysis of the obvious error pilot in 
conjunction with the data submitted under the Plan and any other data 
as requested by the Commission. Pursuant to a rule filing, approved on 
April 3, 2014, each month, the Exchange committed to provide the 
Commission, and the public, a dataset containing the data for each 
straddle and limit state in optionable stocks that had at least one 
trade on the Exchange.\8\ The Exchange has continued to provide the 
Commission with this data on a monthly basis from October 2015. For 
each trade on the Exchange, the Exchange provides (a) the stock symbol, 
option symbol, time at the start of the straddle or limit state, an 
indicator for whether it is a straddle or limit state, and (b) for the 
trades on the Exchange, the executed volume, time-weighted quoted bid-
ask spread, time-weighted average quoted depth at the bid, time-
weighted average quoted depth at the offer, high execution price, low 
execution price, number of trades for which a request for review for 
error was received during straddle and limit states, an indicator 
variable for whether those options outlined above have a price change 
exceeding 30% during the underlying stock's limit or straddle state 
compared to the last available option price as reported by OPRA before 
the start of the limit or straddle state. In addition, to help evaluate 
the impact of the pilot program, the Exchange has provided to the 
Commission, and the public, assessments relating to the impact of the 
operation of the obvious error rules during limit and straddle states 
including: (1) An evaluation of the statistical and economic impact of 
limit and straddle states on liquidity and market quality in the 
options markets, and (2) an assessment of whether the lack of obvious 
error rules in effect during the straddle and limit states are 
problematic. The Exchange has concluded that the obvious error pilot 
does not negatively impact market quality during normal market 
conditions,\9\ and that there has been insufficient data to assess 
whether a lack of obvious error rules is problematic, however, the 
Exchange believes the continuation of Rule 6.25.01 functions to protect 
against any unanticipated consequences in the options markets during a 
limit or straddle state and add certainty on the options markets.
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    \8\ See Securities Exchange Act Release No. 71857 (April 3, 
2014), 79 FR 19678 (April 9, 2014) (SR-CBOE-2014-033); see also Cboe 
Global Markets, LULD Limit and Straddle Reports, available at http://markets.cboe.com/us/options/market_statistics/luld_reports/?mkt=opt.
    \9\ See also Cboe Global Markets, LULD Limit and Straddle 
Reports, available at http://markets.cboe.com/us/options/market_statistics/luld_reports/?mkt=opt. During the most recent 
Review Period the Exchange did not receive any obvious error review 
requests for Limit Up-Limit Down trades, and Limit Up-Limit Down 
trade volume accounted for nominal overall trade volume.
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    The Commission recently approved the Plan on a permanent basis 
(Amendment 18).\10\ In connection with this approval, the Exchange now 
proposes to amend Exchange Rules 6.3A, 6.3B and Interpretation and 
Policy .01 to Rule 6.25 that currently implement the provisions of the 
Plan on a pilot basis to eliminate the pilot basis, which effectiveness 
expires on October 18, 2019, and to make such rules permanent. In its 
approval order to make the Plan permanent, the Commission recognized 
that, as a result of the Participants' and industry analysis of the 
Plan's operation, the Limit Up-Limit Down mechanism effectively 
addresses extraordinary market volatility. Indeed, the Plan benefits 
markets and market participants by helping to ensure orderly markets, 
but also, the Exchange believes, based on the data made available to 
the public and the Commission during the pilot period, that the obvious 
error pilot does not negatively impact market quality during normal 
market conditions.\11\ Rather, the Exchange believes the obvious error 
pilot functions to protect against any unanticipated consequences in 
the options markets during a limit or straddle state and add certainty 
on the options markets. The Exchange also believes the other Options 
Pilots rules provide additional measures designed to protect investors 
during limit and straddle states. For example, the Exchange will reject 
market orders and not elect stop orders \12\ during a Limit Up-Limit 
Down state to ensure that only those orders with a limit price will be 
executed during a limit or straddle state given the uncertainty of 
market prices during such a state. In addition to this, the Exchange 
will initiate a trading halt whenever a market-wide trading halt is 
initiated, which ensures that investors have an opportunity to become 
aware of and respond to significant price movements. This removes 
impediments to and perfects the mechanism of a free and open market and 
national market system by encouraging more investors to participate in 
light of the changes associated with the Plan. The Exchange believes 
that if approved on a permanent basis, the Options Pilots would 
permanently provide investors with the above-described additional 
certainty of market prices and mitigation of unanticipated consequences 
and unreasonable adverse selection risk during limit and straddle 
states.
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    \10\ See supra note 3.
    \11\ See supra note 9.
    \12\ See supra note 7.
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    The Exchange understands that the other national securities 
exchanges will also file similar proposals to make permanent their 
respective pilot programs. Since the Commission's approval of Amendment 
18 allowing the Plan to operate on a permanent basis, the Exchange and 
other national

[[Page 45567]]

securities exchanges have determined that no further amendments should 
be made to the Options Pilots; \13\ the current Options Pilots 
effectively address extraordinary market volatility, are reasonably 
designed to comply with the requirements of the Plan, facilitate 
compliance with the Plan and should now operate on a permanent basis, 
consistent with the Plan. The Exchange does not propose any substantive 
or additional changes to Exchange Rules 6.3A, 6.3B or Interpretation 
and Policy .01 to Rule 6.25.
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    \13\ See Securities Exchange Act Release No. 85616 (April 11, 
2019), 84 FR 16093 (April 17, 2019) (SR-CBOE-2019-020) (proposal to 
extend the pilot for certain options market rules linked to the 
Plan).
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
the Securities Exchange Act of 1934 (the ``Act'') and the rules and 
regulations thereunder applicable to the Exchange and, in particular, 
the requirements of Section 6(b) of the Act.\14\ Specifically, the 
Exchange believes the proposed rule change is consistent with the 
Section 6(b)(5) \15\ requirements that the rules of an exchange be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. Additionally, 
the Exchange believes the proposed rule change is consistent with the 
Section 6(b)(5) \16\ requirement that the rules of an exchange not be 
designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers.
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    \14\ 15 U.S.C. 78f(b).
    \15\ 15 U.S.C. 78f(b)(5).
    \16\ Id.
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    In particular, the Exchange believes that the proposed rule 
supports the objectives of perfecting the mechanism of a free and open 
market and the national market system because it promotes transparency 
and uniformity across markets concerning rules for options markets 
adopted to coincide with the Plan. The Exchange believes that 
eliminating the pilot basis for the Options Pilots and making such 
rules permanent facilitates compliance with the Plan by adding 
certainty to the markets during periods of market volatility, which has 
been approved and found by the Commission to be reasonably designed to 
prevent potentially harmful price volatility in NMS Stocks. It has been 
determined by the Commission that the Plan benefits markets and market 
participants by helping to ensure orderly markets, and, based on the 
data made available to the public and the Commission during the pilot 
period for Rule 6.25.01, the Plan does not negatively impact options 
market quality during normal market conditions. Rather, the Plan, as it 
is implemented under the obvious error pilot, functions to protect 
against any unanticipated consequences in the options markets during a 
limit or straddle state and add certainty on the options markets. 
During a limit or straddle state, determining theoretical value of an 
option may be a subjective rather than an objective determination given 
the lack of a reliable NBBO, which may create an unreasonable adverse 
selection opportunity and discourage participants from providing 
liquidity during limit and straddle states. Therefore, the Exchange 
believes eliminating obvious error review in such states would, in 
turn, eliminate uncertainty and confusion for investors and benefit 
investors by encouraging more participation in light of the changes 
associated with the Plan. As stated, the Exchange believes the other 
Options Pilots rules provide additional measures designed to protect 
investors during limit and straddle states. For example, the Exchange 
will reject market orders and not elect stop orders \17\ during a Limit 
Up-Limit Down state to ensure that only those orders with a limit price 
will be executed during a limit or straddle state given the uncertainty 
of market prices during such a state. Additionally, the Exchange will 
initiate a trading halt whenever a market-wide trading halt is 
initiated, which ensures that investors have an opportunity to become 
aware of and respond to significant price movements. Accordingly, the 
Exchange believes that making the Options Pilots permanent will further 
the goals of investor protection and fair and orderly markets as the 
rules effectively address extraordinary market volatility pursuant to 
the Plan.
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    \17\ See supra note 7.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change would 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act. The proposed rule change is 
necessary to reflect that the Plan no longer operates as a pilot and 
has been approved to operate on a permanent basis by the Commission. As 
such, Exchange Rules 6.3A, 6.3B or Interpretation and Policy .01 to 
Rule 6.25, which implement protections in connection with the Plan, 
should be amended to operate on a permanent basis. The Exchange 
understands that the other national securities exchanges will also file 
similar proposals to make permanent their respective pilot programs. 
Thus, the proposed rule change will help to ensure consistency across 
market centers without implicating any competitive issues.

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

    The Exchange neither solicited nor received comments on the 
proposed rule change.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the 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

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2019-049 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2019-049. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your

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comments more efficiently, please use only one method. The Commission 
will post all comments on the Commission's internet website (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 website viewing and printing in the Commission's Public 
Reference Room, 100 F Street NE, Washington, DC 20549 on official 
business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of 
the filing also will be available for inspection and copying at the 
principal office of the Exchange. All comments received will be posted 
without change. Persons submitting comments are cautioned that we do 
not redact or edit personal identifying information from comment 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
CBOE-2019-049, and should be submitted on or before September 19, 2019.
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    \18\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-18626 Filed 8-28-19; 8:45 am]
BILLING CODE 8011-01-P