Document ID: SEC-2006-0541-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Chicago Board Options Exchange, Inc.
Posted Date: 2006-04-26T04:00Z

[Federal Register: April 26, 2006 (Volume 71, Number 80)]
[Notices]               
[Page 24767-24769]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26ap06-129]                         

[[Page 24767]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53672; File No. SR-CBOE-2005-63]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Proposed Rule Change and Amendments 
No. 1 and 2 Thereto Relating to the Nullification and Adjustment of 
Equity Options Transactions

April 18, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 12, 2005, the Chicago Board Options Exchange, Incorporated 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On October 28, 2005, the CBOE submitted Amendment No. 1 to 
the proposed rule change.\3\ On April 7, 2006, the CBOE submitted 
Amendment No. 2 to the proposed rule change.\4\ 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.
    \3\ Amendment No. 1 replaces the original filing in its 
entirety.
    \4\ Amendment No. 2 clarifies and revised the examples set forth 
in the purpose section of the filing.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to amend Exchange Rule 6.25 to provide for an 
adjustment provision for transactions during opening rotation resulting 
from obvious errors between a non-broker-dealer customer and CBOE 
Market-Maker(s), as well as transactions during opening rotation 
between a non-broker-dealer customer and at least one non-CBOE Market-
Maker(s).
    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in [brackets].
* * * * *

Rules of the Chicago Board Options Exchange

* * * * *

Chapter VI

Doing Business on the Exchange Floor (Rules 6.1-6.85)

Section B: Member Activities on the Floor

Rule 6.25. Nullification and Adjustment of Equity Options Transactions

    This Rule governs the nullification and adjustment of transactions 
involving equity options. Rule 24.16 governs the nullification and 
adjustment of transactions involving index options and options on ETFs 
and HOLDRs. Paragraphs (a)(1), and (2) of this Rule have no 
applicability to trades executed in open outcry.
    (a) Trades Subject to Review
    A member or person associated with a member may have a trade 
adjusted or nullified if, in addition to satisfying the procedural 
requirements of paragraph (b) below, one of the following conditions is 
satisfied:
    (1) Obvious Price Error: An obvious pricing error occurs when the 
execution price of an electronic transaction is above or below the 
Theoretical Price for the series by an amount equal to at least the 
amount shown below:

------------------------------------------------------------------------
                                                               Minimum
                     Theoretical price                          amount
------------------------------------------------------------------------
Below $2...................................................        $0.25
$2 to $5...................................................         0.40
Above $5 to $10............................................         0.50
Above $10 to $20...........................................         0.80
Above $20..................................................         1.00
------------------------------------------------------------------------

    Definition of Theoretical Price. For purposes of this Rule only, 
the Theoretical Price of an option series is, for series traded on at 
least one other options exchange, the last bid price with respect to an 
erroneous sell transaction and the last offer price with respect to an 
erroneous buy transaction, just prior to the trade, disseminated by the 
competing options exchange that has the most liquidity in that option 
class in the previous two calendar months. If there are no quotes for 
comparison, designated Trading Officials will determine the Theoretical 
Price. For transactions occurring as part of the Rapid Opening System 
(``ROS trades'') or Hybrid Opening System (``HOSS''), Theoretical Price 
shall be the first quote after the transaction(s) in question that does 
not reflect the erroneous transaction(s).
    Price Adjustment or Nullification: Obvious Pricing Errors will be 
adjusted or nullified in accordance with`` (i), (ii), (iii) or (iv) 
below or any combination thereof'' [the following]:
    (i) Transactions Between CBOE Market-Makers: Where both parties to 
the transaction are CBOE Market-Makers, the execution price of the 
transaction will be adjusted by Trading Officials to the prices 
provided in Paragraphs (A) and (B) below, minus (plus) an adjustment 
penalty (``adjustment penalty''), unless both parties agree to adjust 
the transaction to a different price or agree to bust the trade within 
fifteen (15) minutes of being notified by Trading Officials of the 
Obvious Error.
    A. Erroneous buy transactions will be adjusted to their Theoretical 
Price plus an adjustment penalty of either $.15 if the Theoretical 
Price is under $3 or $.30 if the Theoretical Price is at or above $3.
    B. Erroneous sell transactions will be adjusted to their 
Theoretical Price minus an adjustment penalty of either $.15 if the 
Theoretical Price is under $3 or $.30 if the Theoretical Price is at or 
above $3.
    (ii) Transactions during Opening Rotation Between a non-broker-
dealer Customer and CBOE Market-Maker(s): After the fifteen minute 
notification period as described in (b)(1) below and until 3:30 pm 
central time (``CT'') on the subject trade date, where parties to the 
transaction are a non-broker dealer customer and CBOE Market-Maker(s), 
the non-broker-dealer customer may request review of the subject 
transaction, and the execution price of the transaction will be 
adjusted (provided the adjustment does not violate the customer's limit 
price) by Trading Officials to the prices provided in Paragraphs (A) 
and (B) above, without the adjustment penalty, unless both parties 
agree to adjust the transaction to a different price or agree to bust 
the trade within fifteen (15) minutes of being notified by Trading 
Officials of the Obvious Error. The option contract quantity of any 
adjustment shall not exceed the disseminated size by the competing 
options exchange that has the most liquidity in that option class in 
the previous two calendar months. In the event a non-CBOE Market-Maker 
is also party to the transaction, the adjustment procedures described 
below shall also apply.
    (iii) Transactions during Opening Rotation Between a non-broker-
dealer Customer and at least one non-CBOE Market-Maker(s): After the 
fifteen minute notification period as described in (b)(1) below and 
until 3:30 pm CT on the subject trade date, where parties to the 
transaction are a non-broker Dealer customer and a non-CBOE Market-
Maker(s), the non-broker-dealer customer may request review of the 
subject transaction and, the execution price of the transaction will be 
adjusted

[[Page 24768]]

(provided the adjustment does not violate non-CBOE Market-Maker's limit 
price) by Trading Officials to the prices provided in Paragraphs (A) 
and (B) above, without the adjustment penalty, unless both parties 
agree to adjust the transaction to a different price or agree to bust 
the trade within fifteen (15) minutes of being notified by Trading 
Officials of the Obvious Error. The option contract quantity of any 
adjustment shall not exceed the disseminated size by the competing 
options exchange that has the most liquidity in that option class in 
the previous two calendar months.''
    (iv) Transactions Involving at least one non-CBOE Market-Maker: 
Where one of the parties to the transaction is not a CBOE Market-Maker, 
and Paragraphs (a)(1)(i), (ii), or (iii) above do not apply the 
transactions will be nullified by Trading Officials unless both parties 
agree to an adjustment price for the transaction within thirty (30) 
minutes of being notified by Trading Officials of the Obvious Error.
    (2)-(5) No change.
(b) Procedures for Reviewing Transactions
    (1) Notification: Any member or person associated with a member 
that believes it participated in a transaction that may be adjusted or 
nullified in accordance with paragraph (a) must notify any Trading 
Official promptly but not later than fifteen (15) minutes after the 
execution in question, except for the time frame set forth in 
Paragraphs (a)(1)(ii) or (a)(1)(iii). Absent unusual circumstances, 
Trading Officials shall not grant relief under this Rule unless 
notification is made within the prescribed time periods. In the absence 
of unusual circumstances, Trading Officials (either on their own motion 
or upon request of a member) must initiate action pursuant to paragraph 
(a)(3) above within sixty (60) minutes of the occurrence of the 
verifiable disruption or malfunction. When Trading Officials take 
action pursuant to paragraph (a)(3), the members involved in the 
transaction(s) shall receive verbal notification as soon as is 
practicable.
    (2) No change.
    (c)-(e) No change.

Interpretations and Policies * * *

    .01-.03 No change.
* * * * *

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 Exchange proposes to revise its obvious error rule (CBOE Rule 
6.25). The CBOE states that the purpose of this filing is to protect 
non-broker-dealer customers from obvious errors during the opening 
rotation when they do not discover the error within 15 minutes of the 
execution of the erroneous transaction. The current 15-minute 
notification period for nullification of the transaction would not be 
modified. Under the proposed rule, non-broker-dealer customers would be 
permitted to request an obvious error review for adjustment of the 
transaction from Trading Officials until 3:30 pm Central Time (``CT'') 
on the day that the transaction occurs. The term ``Trading Officials'' 
means two Exchange members designated as Floor Officials and one member 
of the Exchange's trading floor liaison staff. The extent of the 
adjustment would depend on whether or not the party trading with the 
non-broker-dealer is a CBOE Market-Maker. The CBOE states that the 
intention of this filing is to protect the non-broker-dealer customer 
who fails to discover an obvious error within 15 minutes of execution 
from being forced to accept an execution price that results from an 
obvious error during the opening rotation.
    For transactions during opening rotation between a non-broker-
dealer customer and a CBOE Market-Maker, after 15 minutes have elapsed 
since the trade containing the obvious error occurred but before 3:30 
pm CT on the same trading day, the non-broker-dealer customer would be 
able to request an obvious error review. In determining how to adjust 
the transaction, the Trading Official would look to the away competing 
exchange with the most liquidity in the option class over the two 
preceding months. The transaction would be adjusted to the competing 
exchange's disseminated price at the time the trade occurred (provided 
the adjustment does not violate the non-broker-dealer customer's limit 
price), but only up to the number of contracts that the competing 
exchange was listing as its disseminated size at the time the trade 
occurred.
    For transactions during opening rotation between a non-broker-
dealer and at least one non-CBOE Market-Maker, which could include (but 
is not limited to) an away specialist, an upstairs firm, or another 
non-broker-dealer customer, after the 15-minute notification period has 
passed but before 3:30 pm CT on the same trading day, the non-broker-
dealer customer would be able to request an obvious error review. In 
determining how to adjust the transaction, the Trading Official would 
look to the away competing exchange with the most liquidity in the 
options class over the two preceding calendar months, but would not 
adjust the price beyond the non-CBOE Market-Maker's limit price, and 
not for a size greater than the disseminated size of the aforementioned 
away competing exchange.

Example

    In a hypothetical situation, a non-broker-dealer customer 
(``Customer XYZ'') enters a limit order to buy 100 contracts in an 
options class at $3.80 prior to the opening. Assume that prior to the 
opening, a Market-Maker (``Market-Maker A'') was offered at $3.80 for 
50 contracts and prior to the opening, a non-CBOE Market-Maker (``BD 
Firm ABC'') entered an order to sell 50 contracts at a price of $3.80. 
Now assume that the Hybrid Opening System (``HOSS'') established an 
opening price of $3.80 and the opening rotation is complete and 
Customer XYZ purchased 100 contracts at $3.80 during opening 
rotation.\5\
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    \5\ See Amendment No. 2, note 4, supra.
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    For purposes of this example, the away competing exchange with the 
most liquidity in the option class in the previous two calendar months 
is the International Securities Exchange (``ISE''). However, Customer 
XYZ did not check the execution status of his order until 12:30 pm CT 
(more than the 15 minute notification period for a nullification under 
Exchange Rule 6.25(b)(1)). Disseminated quote and size for the option 
class at ISE at the time the 100 contracts printed from the opening

[[Page 24769]]

HOSS rotation on CBOE at a price of $3.80 was:

------------------------------------------------------------------------
           Exchange                 Bid         Offer          Size
------------------------------------------------------------------------
ISE...........................        $3.30        $3.40  100 x 100
------------------------------------------------------------------------

    Because the $3.80 price is at least $.40 higher than the best offer 
\6\ on the ISE, these trades would be obvious price errors under 
Exchange Rule 6.25. Pursuant to the proposed rule, 50 option contracts 
Customer XYZ executed against Market-Maker A would have a price 
adjustment to $3.40 (obvious error trades with a CBOE Market-Maker 
would be adjusted to the disseminated price for the disseminated size 
listed on the competing exchange with the most liquidity in the options 
class for the preceding two months (here, ISE)). The 50 option 
contracts executed with BD Firm ABC would execute at $3.80, because the 
adjustment would not exceed the non-CBOE Market-Makers limit price 
(here BD Firm ABC had a limit price of $3.80). The adjustment involving 
the transaction against the Market-Maker could occur as long as the 
non-broker-dealer customer reported the obvious error more than 15 
minutes after the erroneous transaction occurred, but before 3:30 pm CT 
on the same trading day.
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    \6\ Id.
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2. Statutory Basis
    The Exchange believes the proposed rule change, as amended, is 
consistent with Section 6(b) of the Act,\7\ in general, and furthers 
the objectives of Section 6(b)(5) of the Act,\8\ 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 to protect investors and the 
public interest.
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    \7\ 15 U.S.C. 78f(b).
    \8\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes the proposed rule change, as amended, will 
impose no burden on competition that is 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

    No written comments were solicited or received by the Exchange on 
this proposal.

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

    Within 35 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 Exchange consents, the Commission will:
    (A) By order approve the proposed rule change, as amended, or
    (B) Institute proceedings to determine whether the proposed rule 
change, as amended, 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, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-CBOE-2005-63 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CBOE-2005-63. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, all 

written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. 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; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-CBOE-2005-63 and should be submitted on or before May 17, 2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-6231 Filed 4-25-06; 8:45 am]

BILLING CODE 8010-01-P