[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