[Federal Register Volume 63, Number 242 (Thursday, December 17, 1998)]
[Notices]
[Pages 69696-69699]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33365]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40780; File No. SR-CBOE-98-48]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendments Nos. 1 and 2 by the Chicago Board Options 
Exchange, Inc. Relating to the Exchange's Rapid Opening System (ROS)

December 10, 1998.
    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 November 4, 1998, the Chicago Board Options Exchange, Inc. (``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 CBOE. On December 
9, 1998, the CBOE filed Amendment No. 1 to the proposed rule change 
with the Commission.\3\ On December 9, 1998, the CBOE also filed 
Amendment No. 2 to the proposed rule change with the Commission.\4\ The

[[Page 69697]]

Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 204.19b-4.
    \3\ In Amendment No. 1, the Exchange replaced its original 
proposal. See Letter from Timothy Thompson, Director, Regulatory 
Affairs, Legal Department, CBOE, to Michael Walinskas, Deputy 
Associate Director, Division of Market Regulation (``Division''), 
Commission, dated December 8, 1998 (``Amendment No. 1'').
    \4\ In Amendment No. 2, the Exchange corrected technical errors 
in the notice. See Letter from Timothy Thompson, Director, 
Regulatory Affairs, Legal Department, CBOE, to Michael Walinskas, 
Deputy Associate Director, Division, Commission, dated December 8, 
1998 (``Amendment No. 2''). Additional technical amendments 
corrected errors in the proposal. Telephone conversations between 
Timothy Thompson, Director, Regulatory Affairs, Legal Department, 
CBOE, and Kenneth Rosen, Attorney, Division, Commission (December 
10, 1998).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to adopt new CBOE Rule 6.2A, Rapid Opening 
System, and a related rule change to CBOE Rule 6.2 to govern the 
operation of, and the eligibility to participate in, the Exchange's new 
Rapid Opening System.
    The text of the proposed rule change is available at the Office of 
the Secretary, CBOE and at the Commission.

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 CBOE 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 CBOE 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 purpose of the proposed rule change is to adopt rules to govern 
the operation of, and the eligibility to participate in, the Exchange's 
new Rapid Opening System (``ROS''). ROS will provide the Exchange the 
ability to automate the opening of its various option classes, thereby 
avoiding the lengthier opening rotations that can occur under the 
present circumstances when there is a large influx of orders entered 
before or during the opening rotation. As the opening occurs, fill 
reports on all participating orders will be generated automatically and 
immediately, opening market quotes and last sales will be disseminated, 
and market-makers will receive notification of assigned trades.
    By entering into open trading more quickly using ROS (and nearly 
instantaneously in many circumstances), the Exchange believes that its 
customers will be better served by being able to have their orders 
addressed in open trading in a more timely manner. Under the current 
circumstances, in those situations where there is a longer than normal 
opening rotation, orders entered after the opening rotation begins are 
locked out and these orders become subject to substantial market risk 
as the quotes may change from the time the series is opened to the time 
the rotation is completed. ROS should provide the Exchange's market-
makers with the ability to open option classes within seconds of the 
opening of the underlying security.
    Availability of ROS. ROS may be used to open a class of options at 
the beginning of the day and it may be used to re-open a class of 
options during the trading day e.g., following a trading halt. The 
appropriate Floor Procedure Committee (``FPC'') for each option class 
traded on the floor will determine to what extent ROS will be 
available, although it is anticipated that ROS will be nearly 
universally available on the floor and will be used routinely. Because 
the initial version of ROS will employ the Exchange's AutoQuote system, 
only those option classes that employ the AutoQuote system may use ROS 
initially. While most option classes on the floor use the Exchange's 
AutoQuote system, certain index options (including DJX, NDX, and OEX 
\5\) and classes traded at certain Designated Primary Market Maker 
(``DPM'') trading stations do not currently employ the Exchange's 
AutoQuote system. Those DPMs that do not use the Exchange's AutoQuote 
system may decide to do so (or may be required to do so by the 
appropriate FPC) at least at the opening to take advantage of ROS. 
Later versions of ROS may accommodate inputs from systems other than 
the Exchange's AutoQuote system.
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    \5\ These are the Dow Jones Industrial Average, Nasdaq-100, and 
Standard & Poors 100 index options.
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    When ROS is first introduced (currently anticipated to be in 
December 1998, pending SEC approval), it may be introduced initially to 
a few classes so that the system can be tested. The Exchange expects 
ROS to be implemented throughout the floor wherever it may be 
accommodated soon after its introduction. Pursuant to its authority 
under CBOE Rule 6.2, the appropriate FPC, chairman or designee may 
decide where ROS should be used. Once implemented, the Exchange expects 
ROS will be used routinely and every day for those option classes where 
it is employed. If there remain option classes where ROS can be 
employed but is not employed, two Floor Officials may permit an Order 
Book Official (``OBO'') to use ROS on a case-by-case basis pursuant to 
Interpretation .01(b) of CBOE Rule 6.2.
    Obligations and Eligibility of Market-Makers. Each morning the 
market-makers who plan to participate on ROS must log onto ROS and 
identify the classes of options in which they will participate. If ROS 
was being employed in a DPM trading crowd, the DPM would be expected to 
participate on ROS. As with RAES, any DPM designee (all of whom are 
permitted to act as both market-makers and floor brokers) would be 
entitled to log onto ROS and share equally in any imbalance to trade at 
the opening price. To participate in the opening, the market-makers 
must log in prior to the opening or by some other earlier time 
designated by the appropriate FPC. (Similarly, in a delayed opening or 
a re-opening during the day, the participating market-makers must be 
logged on prior to the operation of ROS or by some earlier time.) Any 
market-maker that will be present at a particular trading station for 
the opening may log onto ROS for a class traded at that station \6\ but 
once a market-maker has logged onto ROS for that class during an 
expiration month, that market-maker must log onto ROS any time he is 
going to be present in the crowd at the opening during the remainder of 
the expiration cycle. This requirement is intended to ensure that those 
market-makers who participate in ROS will be obligated to participate 
on those more volatile or busy days.
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    \6\ Because the openings generally will occur simultaneously, it 
will generally be possible to possible on ROS only in those classes 
traded at one particular trading station on any given day. A market-
maker is not permitted to log onto ROS for classes at two or more 
stations when those openings are expected to occur at approximately 
the same time.
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    Similar to the Exchange's rules governing the eligibility to 
participate on the Exchange's Retail Automatic Execution System 
(``RAES''), i.e., CBOE Rule 6.8, there are two other provisions to help 
ensure the viability of the system in various market situations. First, 
the appropriate Market Performance Committee (``MPC'') may determine to 
require a market-maker to log onto ROS for specified classes traded at 
a particular trading station.
    Second, notwithstanding the limitations in proposed CBOE Rule 6.2A

[[Page 69698]]

requiring the market-maker to be present in the crowd for the opening 
and to log onto ROS by a designated time, if insufficient market-maker 
participation exists for a particular class, two Floor Officials of the 
appropriate MPC will have the authority to log onto ROS those market-
makers who are members of the trading crowd, as defined in CBOE Rule 
8.50, or those Floor Officials may allow market-makers in other classes 
of options to log onto ROS in such classes.
    Participation on ROS will be monitored by the OBOs or DPMs at the 
particular trading station. The ROS screen in each trading crowd will 
indicate the number of market-makers that have signed onto ROS. If for 
any reason the OBO, the DPM, or the participating market-makers believe 
that the participation rate is inadequate, then the OBO or DPM may call 
Floor Officials to either have them log on other market-makers or 
conduct an opening rotation under the manual procedures employed 
currently.
    Participation Rate for ROS. ROS will be designed to assign the 
contracts to trade for a particular class equally among all 
participating market-makers for that class to the extent possible. For 
example, if there are twenty-one contracts for the market-makers who 
are logged onto ROS to trade after the customer orders have been 
crossed and there are four market-makers logged onto ROS for that 
class, then three market-makers would be assigned five contracts and 
the fourth market-maker would be assigned six contracts.
    Orders Participating on ROS and in the Opening. When ROS is 
employed, all pre-open orders that are routed to the Exchange's 
Electronic Book will participate automatically in the opening process. 
All customer orders (both markets and limit orders) without 
contingencies are eligible to be placed on the Electronic Book prior to 
the opening. Orders that cannot be placed on the Electronic Book, 
including broker-dealer and customer contingency orders will be 
accommodated in the opening manually.
    To entitle these orders to participate, the brokers representing 
these orders must inform the OBO or DPM and the logged-in ROS market-
makers of the terms of the order (including limit price and volume) 
prior to the opening bell or by some earlier time as established by the 
appropriate FPC. This notification will enable the quantity of orders 
and any imbalance they represent to be taken into account in 
establishing the opening price as described below. Although these 
orders will not be represented in the ROS algorithm (discussed further 
below), the market-makers will be able to consider the effect of those 
orders when they decide whether to adjust their AutoQuote values. Once 
ROS determines the opening price, the participating market-makers will, 
as described below, trade at the opening price electronically with the 
imbalance of the booked orders and via open outcry with non-bookable 
orders that are deserving a fill \7\ at the same opening price. The 
Exchange anticipates that a futrue release of ROS will incorporate non-
bookable orders electronically. The Exchange notes that there are few 
broker-dealer orders entered prior to the opening today and the 
Exchange believes this is likely to be true when ROS is employed on the 
floor.
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    \7\ These procedures were designed to ensure an order is filled 
under proposed CBOE Rule 6.2A as if the standard opening procedures 
were in place. A non-bookable order will be filled by market-makers 
in the crowd if it is a (1) market order; (2) limit order and the 
limit price betters the opening price, or (3) limit order and the 
limit price equals the opening price and equals or exceeds the 
opposite side of the AutoQuote bid and offer (as it may have been 
adjusted by the market-makers) that is submitted to ROS. If the non-
bookable order is a limit order and the limit price equals the 
opening price and is between the AutoQuote bid and offer, then this 
order may be filled against any orders in the Exchange's book.
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    Operation of ROS. To determine a single opening price, AutoQuotes 
for all series will be provided to ROS. Generally, one participating 
market-maker will determine the variables that will determine the 
AutoQuote values. However, any participating market-maker will have the 
opportunity to improve individual quotes before the AutoQuotes values 
are sent to ROS. ROS will not open a class until it has received 
AutoQuotes for all eligible series. The market-makers participating in 
ROS for a particular option class will determine collectively when they 
will send the AutoQuote values to ROS. In making this determination, 
the participating market-makers will have access to information that 
indicates the total contracts that would be traded on the opening just 
as do specialists on other exchanges in setting their opening prices 
today. The information will be available on a screen at each trading 
station that employs ROS. Each screen will provide the following 
information: the number of market-makers logged onto ROS for the class, 
the total delta of all the orders in a particular class of options, the 
total contracts to trade, the last sale price of the underlying, the 
AuteQuote calculation values for the underlying. Individuals at the 
trading station can also access a detail screen that provides 
information on the number of long and short contracts to trade on a 
series basis, series AutoQuote values, contracts to trade on a series 
basis, total delta on a series basis, and thresholds for the class.
    Before the start of the trading day, participating market-makers, 
who together share the obligation to trade at the opening price, will 
have established thresholds for the aggregate risk and aggregate number 
of contracts to trade they as a group are willing to assume for a 
particular class. If the actual aggregate risk and number of contracts 
to trade at the opening are both below these established thresholds, 
ROS will automatically open that particular class without any further 
intervention by the market-makers once AutoQuote has received input of 
the underlying stock value. In these cases, the opening quotes and last 
sales will be disseminated immediately. In those cases whether either 
the aggregate risk or the aggregate contracts to trade exceed the 
established thresholds, a participating market-maker may manually 
adjust the AutoQuote values as is done under the opening rotations 
currently.
    To adjust the AutoQuote values, a participating market-maker must 
touch a button to ``lock'' the particular class. The ``lock'' feature 
allows market-makers to adjust the AutoQuote values to account for the 
risk in the positions and contracts to trade, while incoming orders 
queue (just as orders queue during opening rotations today). Those 
orders entered during the ``lock'' will not be eligible to participate 
in the opening. The Exchange expects that the lock feature generally 
only will be used for very brief periods. Once the market-makers have 
adjusted AutoQuote, they will send the values of ROS and the class will 
open. ROS should allow the Exchange to transition into open trading 
much faster than under the current system and the backlog of orders 
that sometimes develops during the opening should rarely, if ever, 
occur.
    In both those cases in which the opening is automatic and in those 
cases where market-makers adjust the AutoQuote values while a class is 
locked, the actual single opening price that ROS calculates for each 
series will be determined based upon the bid/ask values sent from 
AutoQuotes (as they may be adjusted by the market-makers) and the 
orders contained in the book. The exact price will be sent according to 
an algorithm, or a set of rules coded into the system, designed to 
maximize the number of customer orders able to be traded at or between 
the bid-ask values.\8\ Once the price is determined,

[[Page 69699]]

all customer orders that should be crossed at that opening price will 
be crossed, while the balance of orders, if any, will be assigned to 
participating market-makers if the opening price is at either the 
AutoQuote bid or offer. If the opening price is between the AutoQuote 
bid or offer, then no trades will be assigned to participating market-
makers. However, any orders that are not executed as part of the 
opening will remain in the Exchange's Electronic Book and will be 
reflected in the opening bid or offer improving the AutoQuote bid or 
offer. Non-bookable orders that were presented to the OBO or DPM prior 
to the opening in accordance with proposed CBOE Rule 6.2A(a)(ii) will 
be filled by the market-makers in the crowd at the opening price if the 
order is deserving of such price. As ROS completes the opening for each 
class, public customers will receive an electronic fill report for each 
order traded, quotes and last sales will be disseminated to Options 
Price Reporting Authority, market-makers will be informed of their 
participating via an electronic trade notification or a paper notice, 
and trade match records will be created for clearance.
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    \8\ The algorithm looks for the maximum number of orders to 
trade at the QutoQuote bid or offer or at any price in between. The 
rules, which the system proceeds through in the following order, 
are:
    (1) If there are more contracts to trade at the bid price than 
at any other price point, then the opening price will be set at the 
bid price. If the bid equals, 0, then use the zero bid rule. This 
rule states if there is a net to sell at 0, any buy volume will be 
crossed at \1/16\ with the available sell volume. If there is a 
balance remaining to sell, the sell volume will be booked at \1/16\. 
If there is no buy volume, then, as with the current EBook 
functionality, there are 0 to sell at \1/16\ and the orders will be 
booked at \1/16\.
    (2) If there are more contracts to trade at the offer price than 
at any other price point, then the opening price will be set at the 
offering price.
    (3) If neither (1) nor (2) is satisfied, then look for the other 
price point at which the maximum number of contracts will be traded.
    (4) There may be no contracts to trade at any of the price 
points.
    (5) If there is only one price point at which the maximum number 
of contracts may be traded, then open at that price point.
    (6) If there are multiple price points at which the maximum 
number of contracts may be traded then follow rules 7 through 10.
    (7) If there is only one price point at which the net between 
number of contracts to buy and sell is 0 and at which the maximum 
number of contracts can be traded, then open at that price point.
    (8) If there are multiple points where the net between buys and 
sells is 0 and at which the maximum number of contracts can be 
traded, then calculate what the best quote will be coming out of 
rotation, and open at the net zero point closest to the midpoint of 
the best quote.
    (9) If there is not a single net zero closest to the midpoint of 
the best quote, then use the net change rule (discussed below) to 
determine the opening price.
    (10) If there are no points where the net between buys and sells 
is zero and at which the maximum number of contracts can be traded, 
then open at a price at which the maximum number of contracts can be 
traded and where the net between buys and sells is greater than zero 
but less than or equal to the total buys or sells at that price. Use 
the net change rule if necessary.
    Net change rule: If the direction of the last underlying change 
is positive and the option is to a call, open at the higher price, 
and if it is a put, open at the lower price. Similarly, for negative 
change, if it is a call option open at the lower price and if it is 
a put option, open at the higher price.
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    Surveillance of Market-Maker Procedures. The market-maker 
participating on ROS will be required to price the contracts fairly, in 
a manner consistent with their obligations under CBOE Rule 8.7(b)(iv). 
The Exchange believes that a number of factors including scrutiny by 
customers and firms representing customer orders will ensure that 
market-makers adjust the AutoQuote values consistent with their 
obligations. In addition, if an OBO notices any unusual activity in the 
setting of AutoQuote values, the OBO will fill out an OBO Unusual 
Activity Report which will be investigated by the Exchange. Finally, 
the Exchange's AutoQuote has an audit trail log that details every key 
stroke employed in the use of AutoQuote. This audit trail report can be 
studied in the event of any concerns with the way the AutoQuote values 
were established for ROS.
2. Statutory Basis
    The proposed rule changes are consistent with Section 6(b) of the 
Act in general and further the objectives of Section 6(b)(5) in 
particular in that they are designed to promote just and equitable 
principles of trade and to protect investors and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The CBOE does not believe that the proposed rule change will impose 
any burden on competition.

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. Persons making written submissions 
should file six 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 in the 
Commission's Public Reference Room. 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-98-48 and should 
be submitted by January 7, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-33365 Filed 12-16-98; 8:45 am]
BILLING CODE 8010-01-M