[Federal Register Volume 68, Number 234 (Friday, December 5, 2003)]
[Notices]
[Pages 68128-68129]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-30250]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48858; File No. SR-CBOE-2003-07]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment No. 1 by the Chicago Board Options Exchange, Inc., 
Relating to the Trading of Ratio Orders

December 1, 2003.

I. Introduction

    On February 24, 2003, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC''), 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 allow ratio orders to be 
executed through the CBOE. The CBOE filed Amendment No. 1 to the 
proposal on October 8, 2003.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from James M. Flynn, Attorney II, Legal Division, 
CBOE, to Yvonne Fraticelli, Division of Market Regulation, 
Commission, dated October 6, 2003 (``Amendment No. 1''). Amendment 
No. 1 revises the proposal to provide that the permissible ratio for 
a ratio order is any ratio that is equal to or greater than one-to-
three (.333) and less than or equal to three-to-one (3.0).
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    The proposed rule change and Amendment No. 1 were published for 
comment in the Federal Register on October 28, 2003.\4\ The Commission 
received no comments regarding the proposal. This order approves the 
proposed rule change, as amended.
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    \4\ See Securities Exchange Act Release No. 48672 (October 21, 
2003), 68 FR 61499.
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II. Description of the Proposal

    The CBOE proposes to amend CBOE Rule 6.53, ``Certain Types of 
Orders Defined,'' to allow ratio orders with certain permissible ratio 
limits, as defined below, to be executed through the CBOE. In addition, 
the CBOE proposes to revise paragraph (e) of CBOE Rule 6.45, ``Priority 
of Bids and Offers--Allocation of Trades,'' to include these types of 
permissible ratio orders in CBOE Rule 6.45(e), thereby providing such 
ratio orders with the exception to the priority rules that CBOE Rule 
6.45(e) provides currently for spread, straddle, and combination 
orders.\5\ The CBOE believes that because ratio orders are slight 
variations on the types of complex orders currently permitted on the 
CBOE, it is appropriate to treat ratio orders like spread, straddle, 
and combination orders for purposes of CBOE Rule 6.45(e).
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    \5\ CBOE Rule 6.45(e), ``Complex Order Priority Exception,'' 
currently states that: ``A member holding a spread, straddle, or 
combination order (or a stock-option order as defined in Rule 
1.1(ii)(b)) and bidding (offering) on a net debit or credit basis 
(in a multiple of the minimum increment) may execute the order with 
another member without giving priority to equivalent bids (offers) 
in the trading crowd or in the book provided at least one leg of the 
order betters the corresponding bid (offer) in the book. Stock-
option orders, as defined in Rule 1.1(ii)(a), have priority over 
bids (offers) of the trading crowd but not over bids (offers) of 
public customers in the limit order book.''
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    CBOE Rule 6.53 lists and defines several types of orders that are 
executed through the CBOE including, among others, three types of 
complex orders: spread orders, combination orders, and straddle orders. 
The CBOE proposes to add certain ratio orders within permissible 
established limits to the list of orders included in CBOE Rule 6.53. 
CBOE Rule 6.53(n) would define a ratio order as either a spread, 
straddle, or combination order in which the stated number of option 
contracts to buy (sell) is not equal to the stated number of option 
contracts to sell (buy), provided that the number of contracts differs 
by a permissible ratio. Under CBOE Rule 6.53(n), a permissible ratio 
would be any ratio that is equal to or greater than one-to-three (.333) 
or less than or equal to three-to-one (3.0). For example, a one-to-two 
(.5) ratio, a two-to-three (.667) ratio, or a two-to-one (2.0) ratio is 
permissible, whereas a one-to-four (.25) ratio or a four-to-one (4.0) 
ratio is not.

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 \6\ and, in 
particular, with the requirements of section 6(b)(5) of the Act,\7\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and to protect 
investors and the public interest.
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    \6\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \7\ 15 U.S.C. 78f(b)(5).
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    The proposal will allow certain ratio orders to be executed through 
the CBOE. As described above, a ratio order is a spread, straddle, or 
combination order in which the stated number of option contracts to buy 
(sell) is not equal to the stated number of option contracts to sell 
(buy), provided that the number of contracts differs by a permissible 
ratio.\8\ The Commission believes that ratio orders within certain 
permissible ratios may provide market participants with greater 
flexibility and precision in effectuating trading and hedging 
strategies. In addition, the Commission believes that including such 
ratio orders in the exception to the priority rules provided in CBOE 
Rule 6.45(e) will facilitate the execution of ratio orders. In this 
regard, the Commission believes that the procedures governing the 
execution of complex orders, such as ratio orders, serve to reduce the 
risk of incomplete or inadequate executions while increasing efficiency 
and competitive pricing by requiring price improvement before the order 
can receive priority over other orders.\9\ The Commission also notes 
that the rules of other options exchanges treat certain ratio orders 
like other complex orders for purposes of their priority rules.\10\
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    \8\ Under the proposal, a permissible ratio is any ratio that is 
equal to or greater than one-to-three (.333) or less than or equal 
to three-to-one (3.0).
    \9\ See, e.g., CBOE Rule 6.45(e). See also Securities Exchange 
Act Release No. 44955 (October 18, 2001), 66 FR 53819 (October 24, 
2001) (order approving File No. SR-ISE-2001-18).
    \10\ See, e.g., ISE rule 722(b)(2), ``Complex Order Priority,'' 
and PHLX Rule 1033(g), ``Ratio Spread Type Priority.''
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    The CBOE's rule also provides specific examples of permissible 
ratio orders. Specifically, the rule provides that a permissible ratio 
is any ratio that is equal to or greater than one-to-three and less 
than or equal to three-to-one. For example, as indicated in the rule, a 
one-to-two ratio, a two-to-three ratio, or a two-to-one ratio is 
permissible, whereas a one-to-four ratio or a four-to-one ratio is not. 
This should help to provide guidance to CBOE members of the permissible 
ratios allowed under CBOE rules for such ratio orders.
    The Commission believes that permitting ratio orders to have ratios 
equal to or greater than one-to-three or

[[Page 68129]]

less than or equal to three-to-one will help market participants to 
tailor their positions more precisely to implement their trading and 
hedging strategies. Because of concerns that a higher ratio could 
provide market participants with a means to enter a ratio order that 
was designed primarily to gain priority over orders on the limit order 
book or in the trading crowd, rather than to effectuate a bona fide 
trading or hedging strategy, the Commission would need to examine 
closely any proposal to provide a higher ratio for ratio orders and 
would be concerned about whether such a proposal would be consistent 
with investor protection and the public interest under the Act.\11\
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    \11\ In this regard, the Commission notes that one exchange 
stated that a proposed three-to-one cap on the ratio for foreign 
currency option orders ``would prevent a trader seeking priority 
over an order on the book or in the crowd from restating an order as 
a ratio order. For example, such a cap would prevent a trader from 
recasting an order to buy 100 calls and sell one out-of-the-money 
put.'' See Securities Exchange Act Release No. 25503 (March 23, 
1988), 53 FR 10323 (March 30, 1988) (order approving File No. SR-
PHLX-87-33).
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IV. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-CBOE-2003-07), as amended, 
is approved.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-30250 Filed 12-4-03; 8:45 am]
BILLING CODE 8010-01-P