Document ID: SEC-2009-0907-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of a Proposed Rule Change Regarding a New Options Market Linkage Structure
Posted Date: 2009-07-08T04:00Z

[Federal Register: July 8, 2009 (Volume 74, Number 129)]
[Notices]               
[Page 32664-32667]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08jy09-120]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60187; File No. SR-CBOE-2009-040]

 
Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change Regarding a 
New Options Market Linkage Structure

June 29, 2009.
    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 June 24, 2009, the Chicago Board Options Exchange, Incorporated 
(the ``Exchange'' or ``CBOE'') 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

    The filing proposes to adopt certain new order handling rules in 
connection with a new options industry linkage structure. The text of 
the proposed rule change is available on the Exchange's Web site 
(http://www.cboe.org/legal), at the Exchange's Principal office, 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 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 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    This filing proposes to adopt rules to facilitate the Exchange's 
transition to a new intermarket linkage structure. Since

[[Page 32665]]

2000, the Exchange has been a participant in the Plan for the Purpose 
of Creating and Operating an Intermarket Option Linkage (the ``Old 
Plan''). That plan achieved intermarket order protection via a spoke-
and-hub connectivity structure between options exchanges. The Options 
Clearing Corporation acted as the hub and provided connectivity between 
exchanges. This connectivity, which did not require the transmission of 
orders to an exchange through a member of that exchange, allowed for 
the sending of three order types: P/A orders (which are for the 
principal account of a market-maker on behalf of a non-broker-dealer 
customer), P Orders (orders for the proprietary account of a market-
maker), and Satisfaction Orders (orders reflecting the terms of a non-
broker-dealer customer order resting on an exchange that was traded-
through by another market).
    The Participants of the Old Plan have established a new plan to 
provide a more modern framework for options market order protection and 
locked/crossed markets. The new plan is called the Options Order 
Protection and Locked/Crossed Market Plan (the ``Plan'' or ``New 
Plan''). The New Plan does not route orders through a hub. Instead it 
requires Participants to access better-priced quotations on another 
market through a member of that market and via the transmission of a 
new order-type: The Intermarket Sweep Order (``ISO''). The New Plan's 
order protection provisions are modeled after Regulation NMS Rule 611.
    As described below, this filing adopts rules that correspond to the 
order protection provisions of the New Plan (these rules will generally 
be uniform with the rules of the other Participants). It also modifies 
certain Exchange order handling rules to facilitate implementation of 
the New Plan.

New Plan Rules

    The filing proposes to eliminate all of the language in the rules 
relating to the Old Plan (Rules 6.80 through 6.85) and replace that 
language with rules mirroring the terms of the New Plan. The new 
Section E of Chapter 6 would contain a rule providing applicable 
definitions (Rule 6.80), a rule governing order protection (Rule 6.81), 
a rule governing locked and crossed markets (Rule 6.82), and a 
temporary rule regarding the transition from the Old Plan framework to 
the New Plan (Rule 6.83).
    Revised Rule 6.81 provides that members shall not effect trade-
throughs. It also lists the various exceptions to trade-through 
liability. These are: (1) If an Eligible Exchange repeatedly fails to 
respond within one second to incoming orders attempting to access its 
Protected Quotations (provided certain notification, assessment, and 
documentation requirements are met); (2) a transaction effected during 
a trading rotation; (3) a transaction during a Crossed Market; (4) the 
execution of an order identified as an ISO, or an execution effected on 
the Exchange while it simultaneously routs an ISO to execute against 
the full displayed size of any better-priced Protected Quotation; (5) 
the Eligible Exchange displaying the Protected Quotation that was 
traded through had displayed, within one second prior to execution of 
the Trade-Through, a Best bid or Best offer, as applicable, for the 
options series with a price that was equal or inferior to the price of 
the Trade-Through transaction; (6) the Protected Quotation traded 
through was being disseminated from an Eligible Exchange whose 
Quotations were Non-Firm with respect to such options series; (7) the 
execution of a Complex Trade; (8) the execution of an order for which, 
at the time of receipt of the order, a Member had guaranteed an 
execution at no worse than a specified price, where (i) the stopped 
order was for the account of a Customer, (ii) the Customer agreed to 
the specified price on an order-by-order basis, and (iii) the price of 
the Trade-Through was, for a stopped buy (sell) order, lower (higher) 
than the national Best Bid (Offer) in the options series at the time of 
execution; (9) the execution of an order that was stopped at a price 
that did not Trade-Through an Eligible Exchange at the time of the 
stop; and (10) the execution of an order at a price that was not based, 
directly or indirectly, on the quoted price of the options series at 
the time of execution and for which the material terms were not 
reasonably determinable at the time the commitment to execute the order 
was made.
    Proposed Rule 6.82 provides that members shall reasonably avoid 
(and shall not engage in a pattern of) locking and crossing Protected 
Quotations. The Rule contains the following exceptions: (1) The locking 
or crossing quotation was displayed at a time when the Exchange was 
experiencing a failure, material delay, or malfunction of its systems 
or equipment; (2) The locking or crossing quotation was displayed at a 
time when there is a Crossed Market; (3) The Member simultaneously 
routed an ISO to execute against the full displayed size of any locked 
or crossed Protected Bid or Protected Offer; and (4) The locking 
quotation is permissible pursuant to Rules 6.45A(d) and 6.45B(d).\3\
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    \3\ CBOE Rules 6.45A(d) and 6.45B(d) allow the Exchange to 
temporarily disseminate a lock between Exchange Market-Makers. This 
lock is firm for all buy and sell orders.
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    Temporary Rule 6.83 provides that during the transition to the New 
Plan, the Exchange will continue to receive and execute (and may send) 
P/A and P orders if the Exchange is the NBBO. Once all Participants 
have completely migrated to the New Plan structure, this Rule would 
cease to be necessary. In connection with the transition, CBOE intends 
to access other Participants via the use of P/A and P orders on a 
temporary basis pursuant to exemptive relief we are requesting from the 
Commission until the Exchange's roll-out of the new functionality is 
complete (once ISO outbound routing is available for a class, the 
Exchange will cease using P and P/A orders as well as ``old'' HAL 
functionality for that class). The Exchange anticipates that the 
migration to the New Plan functionality will take several weeks. The 
Exchange will keep members informed of the rollout schedule via 
circular and will identify on a class-by-class basis which classes are 
trading pursuant to the temporary rule and utilizing ``old'' HAL as 
well as which classes are trading pursuant to the ``new'' linkage rules 
and HAL2.

HAL2

    The Exchange proposes to adopt a new Hybrid Agency Liaison System 
(``HAL2'') in proposed Rule 6.14A. The Exchange will determine the 
eligible order size, eligible order type, eligible order origin code 
(i.e., public customer orders, non-Market Maker broker-dealer orders, 
and Market Maker broker-dealer orders), and classes for HAL2.\4\ When 
the Exchange receives a qualifying order that is marketable against the 
NBBO and/or the Exchange's BBO,\5\ HAL2 will ``flash'' the order at the 
NBBO price to allow CBOE Market-Makers appointed in that class as well 
as all members acting as agent for orders at the top of the Exchange's 
book in the relevant series (and other members if allowed by the 
Exchange) to step-up to the NBBO price. The duration of the flash 
period shall not exceed 1 second. The first responder to indicate an 
interest to trade at the NBBO price will trade against the flashed 
order up to the size of the response (the flash period will continue

[[Page 32666]]

for any unexecuted balance). Responders will also be allowed to respond 
at prices worse than the NBBO but equal to or better than the 
Exchange's BBO. At the end of the response period (if no responders 
have matched the NBBO price or if there is a remainder on the flashed 
order) the HAL2 system will ascertain the best available price(s) 
between all pending responses and the best disseminated prices on other 
exchanges, and then execute the flashed order at the best price(s) by 
trading it against flash responses first and transmitting ISOs to other 
exchanges second.
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    \4\ As classes migrate to the New Plan on CBOE, the Exchange 
will be able to utilize HAL2 for those classes (i.e. HAL2 will only 
be available for classes trading pursuant to the New Plan).
    \5\ Unless the Exchange's quotation contains resting orders and 
does not contain sufficient Market-Maker quotation interest to 
satisfy the entire order.
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    For example, CBOE's best offer is 1.22 for 200 contracts, and the 
NBBO is 1.19 for 10 contracts with one other market disseminating a 
1.20 offer for 20 contracts. An order to buy 100 contracts at 1.22 is 
received. The order will be flashed at 1.19. Market-Maker A immediately 
submits a response to trade 10 contracts at 1.19. As a result 10 
contracts trade against Market-Maker A at 1.19 (leaving 90 contracts on 
the order). During the remaining flash period Market-Maker B submits a 
response to trade 20 contracts at 1.21. As soon as the flash period 
concludes (assuming the away market prices have not changed), the 
system will simultaneously: Route an ISO to buy 10 contracts at 1.19 to 
the NBBO market, route an ISO to buy 20 contracts at 1.20 to the market 
displaying the 1.20 offer, execute 20 at 1.21 against Market-Maker B, 
and execute the remaining 40 against the Exchange's 1.22 offer using 
the matching algorithm in effect for the class.
    If any portion of an order that is routed away returns unfilled, 
the Exchange will deem it a ``new'' order for processing purposes and 
trade it against the best bid/offer on the Exchange unless another 
exchange is quoting a better price in which case the Exchange will 
attempt to access such better price with a new ISO order. Any 
executions at the Exchange's best bid/offer will be handled in two 
batches: First against all interest resting at that price at the time 
the flashed order was received, and second against any interest that 
joined at that price after the flash process commenced (in both cases 
the matching algorithm in effect for that class will be used). The 
Exchange also notes that order senders can bypass HAL2 processing by 
submitting Immediate or Cancel Orders.
    Paragraph (d) of proposed Rule 6.14A lists the circumstances in 
which a flash period would terminate early. Those are: (1) If the 
Exchange receives an unrelated order on the same side of the market as 
the flashed order that is priced equal to or better than the flashed 
order; (2) if, in the case of an exposed order that is marketable 
against the Exchange's BBO, Market-Maker interest at the BBO decrements 
to a size that would be equal to or smaller than the size of the 
exposed order; and (3) if an unrelated order or quote on the opposite 
side of the market from the exposed order is received that could trade 
against the exposed order at the prevailing NBBO or better in which 
case the orders would trade at the NBBO unless the unrelated order is a 
customer order in which case the orders would trade at the midpoint of 
the unrelated order's limit price and the NBBO (e.g. the NBBO/flash 
price for a buy order is 1.15, during the exposure period a customer 
limit order to sell at 1.13 is received, the orders will be matched to 
the greatest extent possible at 1.14 providing price improvement to 
both orders).\6\
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    \6\ If the unrelated order was smaller than the exposed order, 
then the flash would continue for the unexecuted balance of the 
exposed order.
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    Lastly, Interpretation and Policy .01 to Rule 6.14A provides that 
the Exchange will limit redistribution of exposed order messages to 
third parties. Essentially, the purpose of this provision is to provide 
the Exchange with flexibility to restrict members from passing on or 
redistributing flash messages to others. Of course, the provisions of 
Exchange Rule 4.1 (Just and Equitable Principles of Trade) and 4.18 
(Prevention of the Misuse of Material, Nonpublic Information) apply to 
all HAL2 trading.

Price Check Parameter

    A new price check parameter is also being adopted in connection 
with the new HAL2 process (this new parameter is in Rule 6.13(vi)). For 
classes in which HAL2 is activated, the Exchange will not automatically 
execute orders that are marketable if the NBBO width is not within an 
acceptable price range established by the Exchange (APR), or if an 
execution would follow an initial partial execution and occur at a 
price that is not within an acceptable tick distance from the initial 
execution as established by the Exchange (ATD). If an execution is 
suspended because of the APR, the order will route to PAR for handling. 
If an execution is suspended because of the ATD, the order will be 
exposed pursuant to the HAL2 process using the ATD as the exposure 
price. If a quantity remains after the HAL2 process, the balance will 
route to PAR (in this regard, the HAL2 processing for these orders is 
different that normal HAL2 processing). The Exchange notes that users 
may bypass this processing by submitting orders with an immediate or 
cancel designation.

New Order Routing Rule

    The Exchange proposes to adopt new Rule 6.14B which would govern 
the Exchange's process for routing sweep orders to other markets. The 
Exchange intends to contract with one or more routing brokers that are 
not affiliated with the Exchange to route sweep orders to other 
exchanges. Any such contract will restrict the use of any confidential 
and proprietary information that the routing broker receives to 
legitimate business purposes necessary for routing orders at the 
direction of the Exchange. Routing services would be available to 
members only and are optional. Members that do not want orders routed 
can use the Immediate or Cancel designation to avoid routing.
    The rule also provides that (1) the Exchange shall establish and 
maintain procedures and internal controls reasonably designed to 
adequately restrict the flow of confidential and proprietary 
information between the Exchange and the routing broker, and any other 
entity, including any affiliate of the routing broker, and, if the 
routing broker or any of its affiliates engages in any other business 
activities other than providing routing services to the Exchange, 
between the segment of the routing broker or affiliate that provides 
the other business activities and the segment of the routing broker 
that provides the routing services; (2) the Exchange may not use a 
routing broker for which the Exchange or any affiliate of the Exchange 
is the designated examining authority; (3) the Exchange will provide 
its Routing Services in compliance with the provisions of the Act and 
the rules thereunder, including, but not limited to, the requirements 
in Section 6(b)(4) and (5) of the Act that the rules of a national 
securities exchange provide for the equitable allocation of reasonable 
dues, fees, and other charges among its members and issuers and other 
persons using its facilities, and not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers; (4) the 
Exchange will determine the logic that provides when, how, and where 
orders are routed away to other exchanges; (5) the routing broker 
cannot change the terms of an order or the routing instructions, nor 
does the routing broker have any discretion about where to route an 
order; and, (6) any bid or offer entered on the Exchange routed to 
another exchange via a routing broker that results in an execution 
shall be

[[Page 32667]]

binding on the member that entered such bid/offer.

New Order Types

    The filing proposes to adopt several new order types that would be 
added to Rule 6.53: (1) AIM Sweep Order. An AIM sweep order (AIM ISO) 
is the transmission of two orders for crossing pursuant to Rule 6.74A 
without regard for better priced Protected Bids/Offers because the 
member transmitting the AIM ISO to the Exchange has, simultaneously 
with the routing of the AIM ISO, routed one or more ISOs, as necessary, 
to execute against the full displayed size of any Protected Bid/Offer 
that is superior to the starting AIM auction price and has swept all 
interest in the Exchange's book priced better than the proposed auction 
starting price (with any execution(s) resulting from such sweeps shall 
accrue to the AIM Agency Order); (2) Sweep and AIM Order. A sweep and 
AIM order is the transmission of two orders for crossing pursuant to 
Rule 6.74A with an auction starting price that does not need to be 
within the Exchange's best bid and offer and where the Exchange will 
``sweep'' all Protected Bids/Offers by routing one or more ISOs, as 
necessary, to execute against the full displayed size of any Protected 
Bid/Offer that is superior to the starting AIM auction price, as well 
as sweep all interest in the Exchange's book priced better than the 
proposed auction starting price concurrent with the commencement of the 
AIM auction with any execution(s) resulting from such sweeps accruing 
to the AIM Agency Order; and, (3) CBOE-Only Order. A CBOE-only order is 
an order to buy or sell that is to be executed in whole or in part on 
the Exchange without routing the order to another market center and 
that is to be cancelled if routing would be required under the 
Exchange's Rules.

Other Changes

    In connection with the new linkage structure and the adoption of 
the rules described above, the Exchange is also making minor changes to 
other Exchange rules including adding reference to HAL2 to Rule 6.2B, 
eliminating The ``Removal of Unreliable Quotes'' provision of Rule 
6.13, eliminating references in the Exchanges crossing mechanisms 
(6.74A and 6.74B) to the block trade exemption of the Old Plan, and 
deletion of Rule 8.52 relating to the now defunct Pilot Program for 
Away Market Maker Access.

Implementation

    The Exchange represents that the proposed rules will not become 
operative until the Exchange has withdrawn from the Old Plan.
2. Statutory Basis
    The Exchange believes the proposed rule change 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, by making the 
linkage process more efficient and offering users greater control over 
order routing, it is designed to 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. Moreover, the 
Exchange believes that adopting rules that implement the Plan will 
facilitate the trading of options in a national market system by 
establishing more efficient protection against trade-throughs.
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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

    CBOE 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

    No written comments were solicited or received with respect to the 
proposed rule change.

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 self-regulatory organization consents, the Commission will:
    (A) By order approve 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 e-mail to rule-comments@sec.gov. Please include 
File Number SR-CBOE-2009-040 on the subject line.

Paper Comments

     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-CBOE-2009-040. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing will also be available for 
inspection and copying at the principal office of the self-regulatory 
organization. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
CBOE-2009-040 and should be submitted on or before July 29, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-15992 Filed 7-7-09; 8:45 am]

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