[Federal Register Volume 62, Number 127 (Wednesday, July 2, 1997)]
[Notices]
[Pages 35862-35864]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17317]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38782; File No. SR-CBOE-97-15]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Inc.; Order Approving Proposed Rule Change and Amendment No. 1 Thereto 
Relating to OEX-SPX Spread Orders, and Notice of Filing and Order 
Granting Accelerated Approval to Amendment No. 2 to the Proposed Rule 
Change

June 26, 1997.

I. Introduction

    On March 4, 1997, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to establish a rule to facilitate 
the transaction of spread orders between S&P 500 Index options 
(``SPX'') and S&P 100 Index options (``OEX''). On May 15, 1997, CBOE 
submitted an amendment (``Amendment No. 1'') to the proposed rule 
change.\3\ On June 13, 1997, CBOE submitted a second amendment 
(``Amendment No. 2'') to clarify textual language regarding how the 
rule operates.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the CBOE revised the proposed language 
of Rule 24.18 to better reflect the intent of the proposal and 
provide additional justification for the proposal. See Letter from 
Timothy Thompson, Senior Attorney, CBOE, to Elaine Darroch, 
Attorney, Division of Market Regulation, Securities and Exchange 
Commission (May 14, 1997).
    \4\ Amendment No. 2 clarified that no leg of a spread order can 
trade at a price outside currently displayed bids or offers or bids 
or offers in the customer limit order book. See Letter from Timothy 
Thompson, Senior Attorney, CBOE, to Elaine Darroch, Attorney, 
Division of Market Regulation, Securities and Exchange Commission 
(June 12, 1997).
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    The proposed rule change and Amendment No. 1 thereto was published 
for comment in Securities Exchange Act Release No. 38650 (May 16, 
1997), 62 FR 28525 (May 23, 1997). No comments were received on the 
proposal. This order approves the proposed rule change and Amendment 
No. 1 thereto, and accelerates approval of Amendment No. 2.

II. Description of the Proposal

    Exchange Rule 6.45 establishes the rules of priority for bids and 
offers. Generally, the highest bid and the lowest offer shall have 
priority, with certain designated exceptions. Rule 6.45(d) provides one 
such exception to the rule for members holding a spread, straddle or 
combination order and bidding or offering in a multiple of \1/16\. The 
exception, however, is limited to spread orders involving the same 
class of options. Accordingly, members seeking to execute OEX-SPX 
spread orders (``spread orders'' or ``orders''), which involve two 
different classes of options, currently must execute individual legs of 
the transaction at two different trading posts. Because OEX-SPX orders 
cannot be quoted at one price and traded at the same post, market 
participants wishing to trade such options face a risk that the market 
will move in the time it takes to execute the second leg of the order 
at the other trading post.
    The Exchange proposes to add new Rule 24.18 (``Rule'') to 
facilitate the transaction of OEX-SPX spread orders. Paragraph (a) of 
the Rule defines an OEX-SPX spread order as an order to buy a stated 
number of OEX (SPX) contracts and to sell an equal number of OEX (SPX) 
contracts. Paragraph (b) of the Rule sets forth the procedures to be 
followed in representing and filling an OEX-SPX spread order. An OEX-
SPX spread order may be represented initially at either the OEX or SPX 
trading post. The trading post where the order is first represented 
will be the ``primary trading station'' for purposes of the Rule. 
Immediately after the order is represented at the primary trading 
station, or concurrent with the announcement of such order, the

[[Page 35863]]

member initiating the order must contact the Order Book Official at the 
other trading station (OEX or SPX). The announcement at the other 
trading station must specify the terms of the order, a contact person 
for the order, and the telephone number of the contact person at the 
primary trading station.\5\ The form of the announcement in the other 
trading station will be determined by the appropriate Floor Procedure 
Committee for the trading station where the announcement is to be made.
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    \5\ The contact person does not have to, but may, provide 
brokerage to the members of the other trading crowd. The notice, 
however, will inform the members of the other trading crowd who they 
should contact if they want to participate in the trade.
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    Once the order has been represented at the primary trading station 
and the order has been announced at the other trading station, the 
member representing the order may fill the order at the best net debit 
or credit, whether from the primary trading station or from the other 
trading station, provided the conditions described below are met. The 
priority of the bids and offers on OEX-SPX spread orders will be 
determined by the same concept that applies to spread orders on a 
single class of options as set forth in Rule 6.45(d). Paragraph 
(b)(iii) of the Rule provides that a member holding an order on an OEX-
SPX spread that is priced net at a multiple of \1/16\ (i.e., \1/4\, \3/
8\, \7/16\, \1/2\, etc.) will have priority over bids and offers in the 
trading crowd (``crowd'') if both legs of the OEX-SPX spread would 
trade at a price that is at least equivalent to the quotes in the 
crowd. Similarly, such an order has priority over bids and offers in 
the customer limit order book \6\ (``limit order book'' or ``book'') if 
at least one leg of the OEX-SPX spread would trade at a price that is 
better than the corresponding bid or offer in the book and no leg of 
the order would trade at a price outside the corresponding bid or offer 
in the book. Bids or offers that are part of an OEX-SPX spread order 
and that are not priced at a net multiple of \1/16\, while permissible, 
will not be entitled to priority under (b)(iii) to Rule 24.18.
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    \6\ The Exchange notes that one of the conditions for executing 
a spread order at the best net debit or credit is that the member 
has determined that the order may not be executed by a combination 
of transactions with the bids and offers displayed in the OEX or SPX 
customer limit order book or by the displayed quotes of the trading 
crowds. The Exchange states that paragraph (b)(iii) of Rule 24.18 
may be reasonably and fairly interpreted to mean that if the order 
can be executed in the marketplace at the order's price or at a 
better price, then the order cannot be executed as a spread order at 
the best net debit or credit. See Amendment No. 1, supra note 3.
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    As an illustration, assume that the relevant OEX option, Option O, 
is quoted at 5 bid, 5-\1/8\ asked, and the relevant SPX option, Option 
S, is quoted at 6 bid, 6-\1/8\ asked, and assume that four quotes are 
represented in the book. In that instance, a spread involving the 
purchase (or sale) of Option O and the sale (or purchase) of Option S 
may trade at a net credit or debit of 1 (e.g., a net credit of 1 if 
Option O is bought at 5 and Option S is sold at 6, or a net debit if 
Option O is sold at 5-\1/8\ and Option S 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 one side of the spread at the book price, but bettering the 
book price on the other side of the market, the spread would receive 
priority. (That is, in the spread consisting of the purchase of Option 
O at 5 and the sale of Option S at 6, only the purchase of Option O 
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 S at 6 betters the book, 
because the ask price in the book is 6-\1/8\.) In this example, it 
would not be permissible under paragraph (b)(iii) of Rule 24.18 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.
    Paragraph (b)(iv) permits bids and offers from the other trading 
crowd to participate equally with equal bids and offers from the 
primary trading station if those bids and offers from the other trading 
station are received promptly. The determination of whether an order is 
received promptly will depend on the size and the complexity of the 
order involved. For example, a large spread order might take a minute 
to execute, while a small spread order of ten contracts might require 
only 15 seconds to execute. The amount of time to satisfy the time 
requirement would be different in these two circumstances.\7\
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    \7\ Id.
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III. 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. In particular, 
the Commission believes the proposal is consistent with the Section 
6(b)(5) \8\ of the Act in that it is designed to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in facilitating transactions in securities, to 
remove impediments to and perfect the mechanism of a free and open 
market, and, in general, to protect investors and the public. In 
addition, the Commission believes the rule does not permit unfair 
discrimination between customers, issues, brokers, or dealers.
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    \8\ 15 U.S.C. Sec. 78f(b)(5).
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    In this regard, the Commission finds that the new priority rules 
regarding the OEX-SPX spread orders should facilitate transactions in 
securities by providing an efficient manner for executing both legs of 
the transactions at one trading post. At the same time, the Commission 
believes that the proposal should not significantly undermine the rules 
of priority for bids or offers in the limit order books and for the 
trading crowds. The Commission finds that the rule strikes an 
appropriate balance by providing a spread order mechanism that should 
tighten and enhance the market in OEX-SPX spread orders, while setting 
limitations on when such spread orders can be executed ahead of bids 
and offers in the limit order books and displayed by the trading 
crowds.
    In particular, the Commission notes that customers and traders 
alike often employ spread strategies between SPX and OEX options for 
hedging and risk management. Many customers and traders currently hedge 
their OEX option positions with S&P 100 futures because there are no 
widely available securities exchange products with the S&P 100 as the 
underlying. The Commission agrees with the Exchange that implementation 
of the proposed spread priority rule will encourage the use of OEX-SPX 
spread orders as an effective risk management tool, providing an 
alternative to cross market hedging of OEX options.\9\
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    \9\ The Commission previously recognized the important 
relationship between SPX and OEX options when it permitted haircut 
relief for offsetting positions. Securities Exchange Act Release No. 
38248 (February 6, 1997), 62 FR 6474 (February 12, 1997).
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    The Commission notes that the CBOE has represented that traders 
often have difficulty in executing spread orders between the OEX and 
SPX trading posts. When the two legs of the order cannot be quoted at 
one price and traded at the same post, there is a risk that the market 
will move in the time it takes to execute the second leg of the OEX-SPX 
spread order. Consequently, the second leg of the strategy may not be 
filled at a price that makes the strategy feasible. Depending on the 
movement of the market, the execution of the second leg of the order 
may exacerbate the risk that the strategy was intended to hedge. The 
Commission agrees with the Exchange that this proposal will eliminate 
the risk of market movement for this strategy.

[[Page 35864]]

Further, the Commission believes that the market for such orders will 
likely be tighter and more competitive when both legs are executed at 
the same post.
    The Commission does not believe that investors with public orders 
on the limit order book and represented in the trading crowd will be 
significantly disadvantaged by the proposed rule change. Exchange Rule 
24.18 provides that OEX-SPX spread orders can only be executed ahead of 
corresponding bids or offers in the limit order book or the crowd under 
specified conditions. The member representing an OEX-SPX spread order 
must check the limit order books before filling the order. The member 
also must provide notice to the other trading crowd. In order to 
achieve priority over the books, at least one leg of the OEX-SPX spread 
order must improve the bids or offers in the books while the other leg 
cannot be outside the bids or offers in the books. Executing at least 
one leg of the order at a better price than the established bid or 
offer will improve the market on at least one side. In order to be 
executed ahead of bids and offers in the trading crowd, the spread 
order must trade at a price at least equivalent to the quotes in the 
crowd. These conditions ensure that OEX-SPX spread order priority will 
only be allowed when such priority is necessary to ensure the 
appropriate execution of OEX-SPX spread orders, and only when such 
orders are priced equal to (or better) than customer orders represented 
in the trading crowd \10\ and customer limit order book, as described 
in greater detail above.
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    \10\ The rule also protects broker-dealer proprietary orders in 
the trading crowd.
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    The Commission finds good cause to approve Amendment No. 2 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Specifically, because the revised rule language contained in Amendment 
No. 2 merely clarifies the Exchange's original intent, it raises no new 
regulatory concerns. In addition, the CBOE's rule proposal was 
published for the entire twenty-one day comment period and generated no 
responses. Accordingly, the Commission believes that it is consistent 
with Sections 6(b) \11\ and 19(b)(2) \12\ of the Act to approve 
Amendment No. 2 to the proposed rule change on an accelerated basis.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78s(b)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file fix copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the CBOE. All 
submissions should refer to File No. SR-CBOE-97-15 and should be 
submitted by July 23, 1997.

V. Conclusion

    It is therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-CBOE-97-15) is approved.

    \13\ 15 U.S.C. Sec. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17317 Filed 7-1-97; 8:45 am]
BILLING CODE 8010-01-M