[Federal Register Volume 59, Number 194 (Friday, October 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-24842]


[[Page Unknown]]

[Federal Register: October 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34764; File No. SR-CBOE-93-54]

 

Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change by the Chicago Board 
Options Exchange, Inc., Relating to Pricing Increments and Priority 
Principles of Spreads, Straddles and Combinations

September 30, 1994.
    On November 17, 1993, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Rules 6.42 and 6.45 and 
Interpretations and Policies to Rule 6.42 concerning pricing and 
priorities on spread, straddle, and combination orders (``combined 
trades''). On July 14, 1994, the CBOE submitted Amendment No. 1 
(``Amendment No. 1'') to the proposed rule change.\3\ On September 29, 
1994, the CBOE submitted Amendment No. 2 (``Amendment No. 2'') to the 
proposal to amend Interpretation .02 to Rule 6.42.\4\
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    \1\15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\17 CFR Sec. 240.19b-4 (1993).
    \3\See Letter from Barbara J. Casey, Vice President, Department 
of Market Regulation, CBOE, to Michael Walinskas, Derivative 
Products Regulation, SEC, dated July 13, 1994.
    \4\See Letter from Dan Schneider, Schiff Hardin & Waite, to 
Sharon Lawson, Assistant Director, SEC, dated September 29, 1994.
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    Notice of the proposed rule change and Amendment No. 1 was 
published for comment in Securities Exchange Act Release No. 34397 
(July 18, 1994), 59 FR 37794 (July 25, 1994). No comments were received 
on the proposal. This order approves the proposal.

I. Description of the Proposal

    The purpose of CBOE's proposed rule change is twofold: first, to 
clarify Rule 6.42 and add a new Interpretation and Policy, .02 to 
permit quotes for combined trades and stock-option orders, as defined 
by CBOE Rule 1.1(ii) (``stock-option orders'') to be expressed in any 
fractional or decimal price;\5\ and, second, to alter the priority 
principles applicable to combined trades and stock-option combination 
orders, as defined by CBOE Rule 1.1(ii)(b) (``stock-option 
combinations''), when priced net at a multiple of one sixteenth of a 
dollar.\6\ The CBOE believes that these changes will facilitate the 
orderly execution of combined trades and stock-option orders.
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    \5\See Amendment No. 2. Under Rule 1.1(ii)(b), a stock-option 
combination order is an order to buy or sell a stated number of 
units of an underlying or a related security coupled with the 
purchase and sale of an equal number of put and call option 
contracts, each having the same exercise price, expiration date and 
number of units of the underlying or related security, on the 
opposite side of the market representing in aggregate twice the 
number of units of the underlying or related security.
    \6\Id.
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    Rule 6.42 currently permits a CBOE member holding an order on a 
combined trade or stock-option combination to attain priority over bids 
and offers in the trading crowd (``crowd'') and the customer limit 
order book (``limit order book'' or ``book'') provided all legs of the 
combined trade or stock-option combination trade at a price that is at 
least equivalent to quotes in the crowd or on the book. As revised, 
combined trades and stock-option combinations priced net at a multiple 
of \1/16\ will attain priority over orders in the book only if one leg 
of the transaction trades at a price that is better than the 
corresponding bid or offer in the book while the remaining legs of the 
transaction are at least equivalent to the established bids or offers 
in the crowd or book. The principles for attaining priority over the 
crowd remain unchanged. Bids or offers that are part of a combined 
trade or stock-option combination which is not priced at a net multiple 
of \1/16\, while permissible, will not be entitled to priority under 
the exception contained in paragraph (d) to Rule 6.45. Finally, only 
the net price of the combination will be quoted in fractional or 
decimal prices; the individual legs of the combination must still be 
quoted in accordance with Rule 6.42.\7\
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    \7\See Letter from Barbara Casey, Vice President, Department of 
Market Regulation, CBOE, to Michael Walinskas, Derivative Products 
Regulation, SEC, dated August 24, 1994 (``August 24, 1994 Letter''). 
Rule 6.42 requires bids and offers for all option series trading 
above $3 to be expressed in 1/8ths of $1, while bids and offers for 
all option series trading below $3 are to be expressed in 1/16ths of 
$1.
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    As an illustration, assume that Option A is quoted at 5 bid, 5\1/8\ 
asked, and option B is quoted at 6 bid, 6\1/8\ asked, and assume that 
all four quotes are represented in the book. In that instance, a spread 
involving the purchase (or sale) of option A and the sale (or purchase) 
of option B may trade at a net credit or debit of 1 (e.g., a net credit 
of 1 if option A is bought at 5 and option B sold at 6, or a net debit 
of 1 if option A is sold at 5\1/8\ and option B is bought at 6\1/8\. In 
this example, because the net price is a multiple of \1/16\ and the 
execution of the spread involves taking the same side of the market as 
the book on only one side of the spread, the spread would receive 
priority even though it ``touches'' quotes in the book on both sides. 
(That is, in the spread consisting of the purchase of option A at 5 and 
the sale of option B at 6, only the purchase of option A occurs at the 
same price and on the same side of the market as the book, which is bid 
at 5; the sale of option B at 6 is on the opposite side of the market 
in the book, which is bid at 6.) In the same example, it would not be 
permissible under Rule 6.45(d) to trade the spread at a net debit of 
\7/8\ by selling the first option at 5\1/8\ and buying the second at 6, 
because this trade would be executed at the same price and on the same 
side of the market as the book on both sides of the spread.
    To qualify for priority treatment, combined trades and stock-option 
combinations must meet the existing requirements of Rule 6.45(d), i.e, 
one member must represent all legs of the transaction, each leg must 
cover the same number of options, and the trade must be executed 
against one other member. In those circumstances, the CBOE believes it 
is fair to give these transactions priority when priced net at a 
multiple of \1/16\. Additionally, the CBOE represents that it will 
continue to disseminate the individual legs with a prefix to identify 
trades effected as part of a combined trade or stock-option 
combination.\8\
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    \8\See August 24, 1994 Letter.
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II. Discussion

    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, and, in 
particular, the requirements of Section 6(b)(5).\9\ In particular, the 
Commission believes the proposal is consistent with the Section 6(b)(5) 
requirement that the rules of an exchange be designed to promote just 
and equitable principles of trade and not to permit unfair 
discrimination between customers, issuers, brokers, and dealers.
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    \9\15 U.S.C. Sec. 78f(b)(5) (1982).
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    The first change permits the quoting of combined trades and stock-
option orders in either fractional or decimal prices. Because these 
trades involve separate transactions effected at a net price, the 
Commission believes that the ability to quote net prices in either 
fractional or decimal prices will provide the CBOE with greater 
flexibility to permit market participants to price these orders more 
precisely, which should result in greater efficiency and improved 
liquidity in their execution, and better prices for investors. The 
Commission notes that the individual legs of combined trades and stock-
option combinations currently are, and will continue to be, reported 
separately with an ``S'' in the prefix field identifying it as part of 
a combination. Furthermore, the individual legs will continue to be 
input to the CBOE price reporting system and made available to vendors 
in the same manner as all other CBOE trades.\10\
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    \10\See August 24, 1994 Letter.
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    The Commission notes this change will not affect the existing 
priority rules applicable to these transactions except that, as 
discussed below, an exchange member will not be able to better an 
existing price by an increment less than \1/16\th and still attain 
priority. Therefore, the Commission is satisfied this change will not 
disadvantage existing orders on the book.
    The Commission notes that combined trades and stock-option 
combinations must be priced net at a multiple of \1/16\th in order to 
qualify for priority. These transactions will continue to take priority 
over orders in the crowd when all legs of the combination trade at a 
price that is at least equivalent to quotes in the crowd, in accordance 
with the current rule. However, as amended, combined trades and stock-
option combinations will only attain priority over the book when one 
leg of the transaction trades at a price that is better than the 
corresponding bid or offer in the book and the remaining legs of the 
transaction trades at a price that is at least equivalent to the 
established bids or offers in the crowd or book. The Commission notes 
that this change affords greater protection to the book since one leg 
of the combined trade or stock-option combination must now at least 
trade at a better price than the book (while all remaining legs must 
still at least touch the other bids or offers in the crowd or book) 
before the book loses priority. In addition, because the Rule currently 
requires that one member must represent all legs of the trade and that 
the trade may only be executed against one other member, public 
customers are still less likely to lose priority to combined trades and 
stock-option combinations.\11\ Finally, the change to Rule 6.42 assures 
that orders in the book will not lose priority to these transactions 
unless the net price is quoted in increments of \1/16\th. The 
Commission believes that the proposal is a reasonable effort by the 
CBOE to accommodate the ability to price combined trades and stock-
option combinations more competitively while at the same time not 
disadvantaging the public customer limit order book. The Commission 
also notes that the priority principles applicable to the type of 
stock-option order as defined by Rule 1.1(ii)(a), remain unchanged, 
except to the extent that this type of order must be quoted in 
increments of \1/16\th in order to attain priority over the crowd.\12\
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    \11\The Commission does not believe that investors with public 
orders in the limit order book will be disadvantaged by the granting 
of priority to combined trades or stock-option combination orders 
since Rule 6.45(d) provides that these transactions may only be 
executed ahead of the book if both parts of the combination order 
are executed with one other person at a net debit or credit. See 
Securities Exchange Act Release No. 18458 (Jan. 29, 1982).
    \12\Under Rule 6.45, stock-option orders, as defined by Rule 
1.1(ii)(a), consisting of an order to buy or sell a stated number of 
units of an underlying or a related security coupled with the 
purchase or sale of option contract(s) of the same series on the 
opposite side of the market representing the same number of units of 
the underlying or related security, may only attain priority over 
the trading crowd and not the limit order book, even if quoted in 
increments of \1/16\.
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    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Amendment No. 2 
amends Interpretation .02 to Rule 6.42 to allow stock-option orders, as 
defined in Rule 1.1(ii), to be priced net in any fractional or decimal 
price, but also states that the priority principles applicable to such 
transactions will not apply unless the net price is expressed in 
increments that are multiples of \1/16\. The Commission notes that a 
stock-option combination order is a transaction involving a combined 
trade and the purchase or sale of the underlying stock. The Commission 
does not believe it is appropriate to distinguish between combined 
trades and stock-option combinations simply because one transaction 
involves the purchase or sale of the underlying stock. The same 
concerns attendant to the pricing of combined trades apply equally to a 
combination coupled with the purchase of stock.\13\ Accordingly, the 
Commission believes it is consistent with Sections 6(b)(5) and 19(b) of 
the Act to approve Amendment No. 2 to the proposed rule change on an 
accelerated basis.
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    \13\CBOE Rule 6.45(d) currently treats stock-option combination 
orders and combined trades the same for priority purposes. See 
Securities Exchange Act Release No. 27418 (Nov. 1, 1989), 54 FR 
47003 (Nov. 8, 1989). The proposal will not create disparate 
treatment.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549. 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 at the Commission's Public Reference Section, 450 Fifth Street, 
NW., Washington, DC. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to the file 
number in the caption above and should be submitted by October 28, 
1994.
    It therefore is ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (SR-CBOE-93-54) is approved, as 
amended.

    \14\15 U.S.C. Sec. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\17 CFR Sec. 200.30-3(a)(12) (1993).
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Jonathan G. Katz,
Secretary.
[FR Doc. 94-24842 Filed 10-6-94; 8:45 am]
BILLING CODE 8010-01-M