[Federal Register Volume 64, Number 32 (Thursday, February 18, 1999)]
[Notices]
[Pages 8156-8160]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-3958]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41033; File No. SR-CBOE-98-48]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 3 and 4 To Proposed Rule Change By the Chicago Board 
Options Exchange, Inc. Relating to the Exchange's Rapid Opening System

February 9, 1999.

I. Introduction

    On November 4, 1998, 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 implement a new Rapid Opening 
System (``ROS''). On December 9, 1998, the CBOE filed Amendment Nos. 1 
and 2 to the proposed rule change.\3\ The proposed rule change, as 
amended, was published for comment in the Federal Register on December 
17, 1998.\4\ The Commission received no comments regarding the 
proposal. On January 15, 1999, the CBOE filed Amendment No. 3 to the 
proposed rule change.\5\ On February 9, 1999, the CBOE filed Amendment 
No. 4 to the proposed rule change.\6\ This order approves the proposed 
ROS pilot until March 31, 2000, as amended. In addition, the Commission 
is publishing this notice to solicit comments on Amendment Nos. 3 and 4 
to the proposed rule change and is simultaneously approving Amendment 
Nos. 3 and 4 on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange replaced its original 
proposal. See Letter from Timothy Thompson, Director, Regulatory 
Affairs, Exchange, to Michael Walinskas, Deputy Associate Director, 
Division of Market Regulation (``Division''), Commission, dated 
December 8, 1998 (``Amendment No. 1''). In Amendment No. 2, the 
Exchange corrected technical errors in the proposal. See Letter from 
Timothy Thompson, Director, Regulatory Affairs, Exchange, to Michael 
Walinskas, Deputy Associate Director, Division, Commission, dated 
December 8, 1998 (``Amendment No. 2'').
    \4\ Securities Exchange Act Release No. 40780 (December 10, 
1998), 63 FR 69696.
    \5\ In Amendment No. 3, the Exchange clarified the operation of 
the new electronic system. See Letter from Timothy Thompson, 
Director, Regulatory Affairs, Legal Department, exchange, to Michael 
Walinskas, Deputy Associate Director, Division, Commission, dated 
January 13, 1999 (``Amendment No. 3'').
    \6\ In Amendment No. 4, the Exchange further clarified the 
conduct of openings and priority under the new system and its 
intention to implement the system on a pilot basis. See Letter from 
Timothy Thompson, Director, Regulatory Affairs, Legal Department, 
Exchange, to Michael Walinskas, Deputy Associate Director, Division, 
Commission, dated February 9, 1999 (``Amendment No. 4'').
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II. Background

    Some variation exists as to how different trading crowds on the 
CBOE handle opening rotations today, but generally a crowd conducts a 
reverse rotation under which it opens further out series first and 
nearer term series later.\7\ Once a trading crowd sets the quotes for a 
particular series, the series will automatically lock in the Exchange's 
Electronic Book if there are market orders, or limit orders between the 
bid/ask. In an Order Book Official (``OBO'') crowd,\8\ floor brokers 
and OBOs then announced their respective positions to the crowd for 
final price discovery. That particular series remains locked until the 
opening price is manually entered by the book staff. Open trading for 
the series, however, does not commence until all series in the class 
have undergone these same opening price discovery procedures. Depending 
on the volatility in the marketplace and the number of orders received, 
an opening rotation may take anywhere from a few minutes to a half hour 
to complete. During the rotation, new orders queue up and cannot be 
addressed until open trading begins. In light of such delays, the 
Exchange now proposes to conduct its opening electronically through 
ROS. The Exchange believes that ROS should allow the Exchange to 
transition into open trading much faster than under the current system 
and that the backlog of orders that sometimes develops during the 
opening should rarely, if every, occur.
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    \7\ See Amendment No. 3.
    \8\ The CBOE also uses Designated Primary Market Maker (``DPM'') 
crowds, where DPMs conduct some of the functions otherwise performed 
by an OBO.
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III. Description of the Proposal

    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 
ROS. ROS would allow the Exchange to automate the opening of 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 would be generated 
automatically and immediately, opening market quotes and last sales 
would be disseminated, and market-makers would receive notification of 
assigned trades.
    Because the new system allows quicker entry into open trading, the 
Exchange believes that ROS would serve all market participants. 
Currently, orders entered after the opening rotation begins are locked 
out. Such orders become subject to market risk as the quotes may change 
from the time the series is opened to the time the rotation is 
completed. The CBOE believes that ROS should enable the Exchange's 
market-makers to open option classes within seconds of the underlying 
security's opening.

Availability of ROS

    The Exchange intends to introduce ROS to a few classes to test the 
proposed new system. The Exchange expects that soon after its 
introduction ROS will be implemented throughout the floor, wherever it 
may be accommodated. Pursuant to its authority under CBOE Rule 6.2, the 
appropriate Floor Procedure Committee (``FPC''), chairman, or designee 
may decide where ROS should be used. Once implemented, the Exchange 
expects ROS will be used routinely and daily for

[[Page 8157]]

those option classes where it is employed.\9\
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    \9\ Under the proposal, two Floor Officials may permit an OBO or 
DPM to use ROS on a class-by-class basis pursuant to Interpretation 
.01(b) of CBOE Rule 6.2.
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    ROS could be used to open a class of options at the beginning of 
the day and under certain circumstances (e.g., following a trading 
halt) to re-open a class of options during the trading day. The 
appropriate FPC for each option class traded on the floor would 
determine the availability of ROS. Because the initial version of ROS 
employs the Exchange's AutoQuote system (``AutoQuote''), only those 
open classes that employ AutoQuote may use ROS initially. While most 
option classes on the floor use AutoQuote, some index options 
(including DJX, NDX, and OEX \10\) and classes traded at certain DPM 
trading stations do not currently employ AutoQuote. To allow the use of 
ROS, DPMs, that do not use AutoQuote may decide to do so (or may be 
required to do so by the appropriate FPC), at least at the opening. 
Later versions of ROS may accommodate inputs from systems other than 
AutoQuote.
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    \10\ These are the Dow Jones Industrial Average, Nasdaq-100, and 
Standard & Poor's 100 index options.
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Operation of ROS

    To determine a single opening price, CBOE market-makers will 
provide AutoQuotes for all series 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 AutoQuote 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. 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, and AutoQuote 
calculation values for the underlying. Individuals at the trading 
station also can 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 threshold for the aggregate risk and aggregate number 
of contracts to trade that 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 where 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). 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.\11\ Once the market-makers have 
adjusted AutoQuote, they will send the values to Ross and the class 
will open.
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    \11\ Under ROS, the Exchange expects classes to be locked for no 
more than thirty seconds. See Amendment No. 3.
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    Regardless of whether market-makers adjust the AutoQuote values, 
the single opening price that ROS calculates for each series will be 
determined based upon the bid/ask values sent from AutoQuote (as they 
may be adjusted by the market-makers) and the orders contained in the 
book. The opening price will be set according to an algorithm, or a set 
of rules coded into the system, fed by the relevant AutoQuote and order 
information.\12\ The CBOE represents that the algorithm was designed to 
maximize the number of customer orders able to be traded at or between 
the bid-ask values.
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    \12\ The algorithm rules, which ROS 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 the ``zero bid rule'' will be 
used. This rule states that 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 offering price 
than at any other price point, then the opening price will be set at 
the offering price.
    (3) If neither (1) or (2) is satisfied, then ROS will look for 
other price points at which the maximum number of contracts are 
priced to 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 ROS will open at that price point.
    (6) If there are multiple price points at which the maximum 
number of contracts may be traded then ROS will follow rules 7 
through 10.
    (7) If there is only one price point at which the net between 
the number of contracts to buy and sell is 0 and at which the 
maximum number of contracts can be traded, then ROS will 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 ROS will 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 point closest to the 
midpoint of the best quote, then ROS will 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 ROS will 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 number of 
contracts to buy or sell at that price. Use the net change rule if 
necessary.
    Net change rule: If the direction of the last price change of 
the security underlying the option class is positive and the option 
is a call, then ROS will open at the higher price. If the option is 
a put, ROS will open at the lower price. For a negative change for 
the underlying, if it is a call option ROS will open at the lower 
price. If it is a put option, ROS will open at the higher price.
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    Once ROS determines an opening price, all customer orders that 
should be crossed at that opening price will be crossed. Any balance of 
orders will be assigned to participating market-makers if the opening 
price is at either the AutoQuote bid or offer.\13\ 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. Non-
bookable orders (discussed below) 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.\14\ As ROS completes the 
opening for each class, public customers will receive an

[[Page 8158]]

electronic fill report for each order traded. Quotes and list sales 
will be disseminated to the Options Price Reporting Authority. Market-
makers will be informed of their participation via an electronic trade 
notification or a paper notice, and trade match records will be created 
for clearance.
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    \13\ If the opening price is between the AutoQuote bid or offer, 
then no trades will be assigned to participating market-makers.
    \14\ See note 17 infra.
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Obligations and Eligibility of Market-Makers

    Each morning market-maker planning to participate on ROS must log 
on to ROS and identify the classes of options in which they will 
participate. If ROS is being employed in a DPM trading crowd, the DPM 
will be expected to participate on ROS. Any DPM designee (all of whom 
are permitted to act as both market-maker and floor brokers) would be 
entitled to log on to ROS and share equally in any trading imbalance at 
the opening price. To participate in the opening, the market-maker must 
log on 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-maker 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 
on to ROS for a class traded at that station,\15\ but once a market-
maker has logged on to ROS for that class during an expiration month, 
that market-maker must log on to 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-maker 
who participate in ROS will be obligated to participate on more 
volatile or busy days.
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    \15\ Because the openings generally will occur simultaneously, 
typically it will be possible to participate on ROS only in those 
classes traded at one particular trading station on any given day. A 
market-maker is not permitted to log on to ROS for classes at two or 
more stations when those openings are expected to occur at 
approximately the same time.
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    Two other provisions are intended to help ensure the viability of 
the system in various market situations. First, the appropriate Market 
Performance Committee (``MPC'') may require a market-maker to log on to 
ROS for specified classes traded at a particular trading station. 
Second, notwithstanding the limitations in proposed CBOE Rule 6.2A 
requiring the market-maker to be present in the crowd for the opening 
and to log on to 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 long on to ROS those market-
makes who are members of the trading crowd, as defined in CBOE Rule 
8.50. Those Floor Officials also may allow market-makers in other 
classes of options to log on to 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 on to 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 either to have them log on other market-makers or 
conduct an opening rotation under the manual procedures currently 
employed.

Participation Rate for ROS

    ROS will 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, after all customer orders have been 
crossed, there remain twenty-one contracts for the market-makers who 
are logged on the ROS to trade and there are four market-makers logged 
on to ROS for that class, then one market-maker would be assigned six 
contracts and the other three market-makers would be assigned five 
contracts.

Order 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 market 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 (non-bookable 
orders), including broker-dealer and customer contingency orders, will 
be accommodated manually in the opening. To entitle a on-bookable order 
to participate, the broker representing the order must inform the OBO 
or DPM and the market-makers that are logged on to ROS of the terms of 
the order (including limit price and volume) prior to the time the 
market-makers for a particular class lock that class under ROS. This 
notification deadline is the same time at which orders entered on the 
book will no longer be accepted in ROS which should help to ensure that 
different categories of orders are treated consistently.\16\ This 
notification deadline will enable the quantity of orders and imbalance 
they represent to be taken into account in establishing the opening 
price.\17\ Although these orders will not be represented in the ROS 
algorithm, the market-makers will be able to consider the effect of 
those orders when they decide whether to adjust their AutoQuote values.
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    \16\ See Amendment No. 4.
    \17\ In Amendment Nos. 3 and 4, the exchange further explained 
the incorporation and execution of non-bookable orders at the 
opening. Market-makers will have the opportunity to adjust their 
AutoQuote to account for such orders, assisting efforts to price 
contracts fairly. See Amendment Nos. 3 and 4. Under certain 
circumstances, market-makers must adjust AutoQuote values to account 
for one of more non-booked limit orders. Market-makers will be 
required to make such adjustments if (i) the limit price of such 
non-booked orders is better than the AutoQuote bid or offer (as 
appropriate) and (ii) the imbalance of the non-booked orders that 
would be traded at such better limit price is equal to or greater 
than the imbalance or orders for that series in the book on the 
opposite side of the market. See Amendment No. 4.
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    Once ROS determines the opening price, the participating market-
makers will 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 \18\ at the same opening 
price.\19\ The Exchange anticipates that a

[[Page 8159]]

future 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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    \18\ A non-bookable order will be filled for its entire size by 
market-makers in the crowd (assuming any contingency accompanying 
the order is satisfied) if that order is a (1) market order; (2) 
limit order and the limit price betters the opening price; or (3) 
customer limit order with a contingency where the limit price equals 
the opening price. If the order is a broker-dealer order and the 
limit price equals the opening price, the order will be entitled to 
be filled up to the lesser of the entire size of such order or an 
amount equal to a pro rata share of the orders assigned to the 
market-makers by ROS. If a broker holds more than one order to trade 
at the same limit price, that broker is nonetheless limited to no 
more than one pro rata share of the orders assigned to the market-
makers by ROS. See Amendment No. 4.
    Because the operation of ROS makes the application of 
traditional time priority rules difficult, the Exchange proposes to 
amend its priority rule, CBOE Rule 6.45, to reflect the above-stated 
method of filling non-bookable orders. The Exchange explains that 
under ROS, brokers are required to present their orders to the 
trading crowd before the market-makers finish adjusting the 
AutoQuote bid and offer. Notwithstanding the fact that the broker-
dealer's order will always be entered prior to the market-makers's 
bid and offer, the Exchange believes that the market-makers must be 
able to participate at the opening price even if the opening price 
equals the limit price of a broker-dealer order because the market-
makers are the group that ensures liquidity on the opening. See 
Amendment No. 4.
    \19\ The CBOE provided three scenarios to help illustrate the 
interaction of the various rules related to the manual handling of 
broker-dealer proprietary orders. For each of these scenarios, a 
broker-dealer presents an order to the crowd when the AutoQuote bid/
offer is at 6-6\1/2\ and 4 market-makers are logged on to ROS for 
the relevant options class.
    Scenario 1: There is no customer order to buy 50 contracts at 
the market in the Electronic book; there also is a broker-dealer 
order to sell 30 at a limit price of 6\1/8\. In this case, the 
market-makers in the crowd would not be expected to adjust their 
AutoQuote bid to reflect the broker-dealer bid because the demand to 
sell at a better price (30) is less than the supply to buy (50). The 
market-makers would sell 50 to the customer in ROS and manually buy 
30 from the broker-dealer in the crowd at 6.
    Scenario 2: There is one customer order to sell 50 contracts at 
the market in the Electronic book; there also is a broker-order to 
buy 50 at a limit price of 6\1/8\. In this case, the market-makers 
must adjust their AutoQuote bid to reflect the broker-dealer bid 
because the supply to buy at a better price satisfies all sellers. 
However, the market makers may also adjust the AutoQuote to 6\1/8\ 
for other reasons, such as a change in volatility. In either case, 
the market-makers would buy 50 from the customer in ROS at 6\1/8\. 
The market-makers would be required to sell 10 contracts (a pro rata 
share) to the broker-dealer at 6\1/8\. It is possible that the 
market-makers would fill the entire broker-dealer order at 6\1/8\.
    Scenario 3; There is one customer order to sell 50 contracts at 
the market in the Electronic book; there also is a broker-dealer 
order to buy 50 at a limit price of 6. In this case, if the 
AutoQuote values do not change, the market-makers in the crowd would 
buy 50 from the customer in ROS at 6. The market-makers would be 
required to sell up to 10 contracts (a pro rata share) to the 
broker-dealer at 6. See Amendment No. 4.
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Survelliance of Market-Maker Procedures

    The market-makers 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). In conjunction with the implementation of 
ROS, the Exchange plans to publish the regulatory circular to remind 
market-makers of their obligation to set AutoQuote fairly.\20\ 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 
obligation. In addition, if an OBO or DPM notices any unusual activity 
in the setting of AutoQuote values, the OBO or DPM must 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.
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    \20\ See Amendment No. 3.
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Pilot Implementation

    ROS would be implemented on a pilot basis through March 31, 
2000.\21\
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    \21\ See Amendment No. 4.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of Section 6 of 
the Act. In particular, the Commission believes the proposal is 
consistent with Section 6(b)(5) of the Act.\22\ Section 6(b)(5) 
requires, among other things, that the rules of the exchange be 
designed to remove impediments to and perfect the mechanism of a free 
and open market and a national market system and not be designed to 
permit unfair discrimination between customers, issuers, brokers or 
dealers.
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    \22\ 15 U.S.C. 78f(b)(5). In approving this rule, the Commission 
has considered the proposed rule's impact in efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
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    The proposed rule change represents an effort to facilitate the 
execution of orders at the opening by providing market-makers with a 
means of establishing electronically a single opening price. ROS 
replaces what has become an increasingly cumbersome process of arriving 
at the opening price by manually progressing through series after 
series of an options class. Significantly, until this process is 
completed for an options class, open trading generally does not 
commence in any of the class' series. This delay of open trading 
results in a backlog of orders that missed the opening and queue while 
awaiting open trading. ROS should alleviate such backlogs, thus 
improving market efficiency for all market participants. By 
facilitating an expedited opening of options classes on the CBOE, ROS 
should remove an impediment to and help perfect the mechanism of a free 
and open market consistent with the CBOE's responsibilities under 
Section 6 of the Act. Moreover, by integrating features into ROS, such 
as the crossing of customer orders, and by permitting the participation 
of non market-maker broker-dealer orders in the opening process, the 
Commission believes that the proposal should promote fair participation 
in ROS by all market participants.
    The Commission recognizes that certain aspects of ROS may require 
heightened scrutiny by the CBOE to ensure that market-makers are not 
permitted to use the flexibility they have to set an opening price to 
the disadvantage of investors and other market participants. In 
particular, ROS provides market-makers discretion to set certain 
thresholds and the AutoQuote value that drives the ROS algorithm. The 
Exchange has assured the Commission that it will ensure that market-
makers exercise their discretion in a manner consistent with their 
obligation to price options fairly. The Commission expects that the 
CBOE will develop objective, quantifiable standards for ensuring that 
the market-makers are satisfying those obligations and to surveil for 
such compliance. The pilot offers an opportunity for the Commission to 
evaluate the Exchange's efforts at surveilling market-maker activities 
associated with ROS. Prior to permanent approval, the Commission 
expects to review the results of the applied surveillance program.
    Although ROS is likely to greatly improve the opening on the CBOE, 
the Commission believes that the system can and should be improved to 
permit participation by orders that cannot presently be included on 
CBOE's Electronic Book. The Commission does not view the manual 
handling of non-bookable orders as the optimal solution for ensuring 
that those orders are fairly incorporated into the opening. Although 
market-makers may now adjust their AutoQuote manually to reflect non-
bookable orders, it would be preferable for such orders to be 
electronically incorporated into a ROS opening to fully interact with 
customer orders on the Electronic Book.
    Moreover, the proposed handling of non-bookable orders may result 
in such orders receiving an inferior level of priority than they would 
enjoy today. Although ROS and the proposed manual handling procedures 
require a sequence of events surrounding the opening that make 
traditional, strict time priority rules difficult to apply, the 
Exchange has proposed manual handling procedures that should minimize 
the proposal's impact on exactly which orders receive fills. For 
example, the Exchange clarified the participation rights of broker-
dealer proprietary limit orders equal to the ROS opening price.\23\ The 
Commission, however, expects that during the pilot period the Exchange 
will ensure that, in practice, non-bookable orders continue to receive 
fair treatment substantially comparable to that received today. Prior 
to permanent approval, the Commission expects the Exchange to develop a 
workable plan for electronic incorporation of non-bookable orders on 
ROS. Because such orders represent a small percentage of orders 
executed on the Exchange,\24\ however, and because of the great 
potential benefits ROS has for the opening, the Commission believes 
that in the interim it is prudent to allow ROS to be implemented on a 
pilot basis to alleviate problems associated with delays in the 
transition to open trading.
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    \23\ See Amendment No. 4.
    \24\ See Amendment No. 3.

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[[Page 8160]]

    The Commission finds good cause for approving proposed Amendment 
Nos. 3 and 4 prior to the thirteenth day after the date of publication 
of notice of filing of those amendments in the Federal Register. The 
amendments clarify the original proposal and the system's proposed 
operation, and propose implementing ROS on a pilot basis.\25\ By 
implementing ROS on a pilot basis, the Exchange can immediately address 
difficulties associated with lengthy opening rotations and study ROS 
under market conditions while giving the Commission an opportunity to 
view the operation of ROS under market conditions before approving it 
permanently.
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    \25\ See Amendment Nos. 3 and 4.
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    The Commission expects the CBOE to study issues related to the 
SEC's concerns during the pilot period and to report back to the 
Commission at least sixty days prior to seeking permanent approval of 
ROS. Among issues that the Exchange should explore are: how and when 
market-makers set ROS risk and size thresholds; how often such 
thresholds are exceeded and result in the adjustment of AutoQuote; the 
effect of AutoQuote adjustments on the quality of customer executions; 
any effects on existing order execution priority; and the handling of 
and adjustments made for non-bookable orders.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 3 and 4, including whether the 
proposed amendments are 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 March 11, 1999.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (SR-CBOE-98-48), as amended, is 
approved through March 31, 2000.

    \26\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-3958 Filed 2-17-99; 8:45 am]
BILLING CODE 8010-01-M