[Federal Register Volume 69, Number 18 (Wednesday, January 28, 2004)]
[Notices]
[Pages 4187-4189]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-1759]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49108; File No. SR-CBOE-2004-01]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Board Options 
Exchange, Incorporated Relating to the UMA Calculation for the CBOE 
Hybrid System

January 21 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934,\1\ notice is hereby given that on January 8, 2004, the Chicago 
Board Options Exchange, Incorporated (``CBOE'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``Commission'' or ``SEC'') 
the proposed rule change as described in Items I, II, and III below, 
which Items have been prepared by the CBOE. On January 20, 2004, the 
Exchange submitted amendment No. 1 to the proposed rule change.\2\ The 
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. 78(b)(1).
    \2\ See Letter from Stephen Youhn, Counsel, CBOE, to Deborah 
Flynn, Assistant Director, Division, Commission, dated January 20, 
2004. In Amendment No. 1, CBOE replaced in its entirety the original 
proposed rule filing.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to allow the appropriate Index Floor Procedure 
Committee (``IFPC'') to vary the component weightings of the Ultimate 
Matching Algorithm (``UMA'') formula by product. The text of the 
proposed rule change appears below. Proposed new language is in 
italics; proposed deletions are in [brackets].

Rule 6.45A Priority and Allocation of Trades for CBOE Hybrid System

    (a)(i)
    (A) No change
    (B)(1) No change
    (B)(2) More than One Market Participant Quoting at BBO: When more 
than one market participant is quoting at the BBO, inbound electronic 
orders shall be allocated pursuant to the following allocation 
algorithm:

Allocation Algorithm
[GRAPHIC] [TIFF OMITTED] TN28JA04.006

Where:
    Component A: The percentage to be used for Component A shall be an 
equal percentage, derived by dividing 100 by the number of market 
participants quoting at the BBO.
    Component B: Size Prorata Allocation. The percentage to be used for 
Component B of the Allocation Algorithm formula is that percentage that 
the size of each market participant's quote at the best price 
represents relative to the total number of contracts in the 
disseminated quote.
    Final Weighting: The final weighting formula for equity options, 
which shall be determined by the appropriate FPC and apply uniformly 
across all options under its jurisdiction, shall be a

[[Page 4188]]

weighted average of the percentages derived for Components A and B 
multiplied by the size of the incoming order. Initially, the weighting 
of components A and B shall be equal, represented mathematically by the 
formula: ((Component A Percentage + Component B Percentage)/2)* 
incoming order size.
    [The final weighting shall apply uniformly across all options under 
the jurisdiction of the appropriate FPC.] The final weighting formula 
for index options and options on ETFs shall be established by the 
appropriate FPC and may vary by product. Changes made to the percentage 
weightings of Components A and B shall be announced to the membership 
[in advance of implementation] via Regulatory Circular at least one day 
before implementation of the change.
    (C) No change
    (b) No change
    (c)
    (i) No change
    (ii) Multiple Market Participant Trade with the Electronic Book: 
Each market participant that submits an order or quote to buy (sell) an 
order in the electronic book within a period of time not to exceed 5 
seconds of the first market participant to submit an order (``N-second 
group'') shall be entitled to receive an allocation of the order in the 
electronic book pursuant to the following allocation algorithm:

Allocation Algorithm
[GRAPHIC] [TIFF OMITTED] TN28JA04.007

Where:
    Component A: The percentage to be used for Component A shall be an 
equal percentage, derived by dividing 100 by the number of market 
participants in the ``N-second group.''
    Component B: Size Prorata Allocation. The percentage to be used for 
Component B of the Allocation Algorithm formula is that percentage that 
each market participant ``N-second group's'' quote at the best price 
represents relative to the total number of contracts of all market 
participants of the ``N-second group.'' The appropriate FPC may 
determine that the maximum quote size to be used for each market 
participant in the Component B calculation shall be no greater than the 
cumulative size of orders resident in the electronic book at the best 
price at which market participants are attempting to buy (sell).
    Final Weighting: The final weighting formula for equity options, 
which shall be determined by the appropriate FPC and apply uniformly 
across all options under its jurisdiction, shall be a weighted average 
of the percentages derived for Components A and B multiplied by the 
size of the order(s) in the electronic book. Initially, the weighting 
of components A and B shall be equal, represented mathematically by the 
formula: ((Component A Percentage + Component B Percentage)/2)* 
electronic book size.
    The final weighting formula for index options and options on ETFs 
shall be established by the appropriate FPC and may vary by product. 
Changes made to the percentage weightings of Components A and B shall 
be announced to the membership via Regulatory Circular at least one day 
before implementation of the change.

    (A) No change
    (iii)-(iv) No change
* * * * *

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 Exchange 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 Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant parts of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    In May 2003, the Commission approved the CBOE's Hybrid System 
(``Hybrid System'').\3\ The Hybrid System merges the electronic and 
open outcry trading models, offering market participants the ability to 
stream electronically their own firm disseminated market quotes 
representing their trading interest. The Exchange currently trades 
equity options on Hybrid and recently commenced trading of index option 
and ETF option on Hybrid (``Index Hybrid filing'').\4\ As described in 
the Index Hybrid filing, the Exchange has the ability to trade on 
Hybrid index options and options on ETFs pursuant to the existing 
Hybrid rules currently applicable to equity options.
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    \3\ Exchange Act Release 47959 (May 30, 2003), 68 FR 34441 (June 
9, 2003) (``Hybrid Release'').
    \4\ Exchange Act Release 48953 (December 18, 2003), 68 FR 75004 
(December 29, 2003) (order approving SR-CBOE-2003-57).
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    CBOE Rule 6.45A governs the priority and allocation of trades on 
the CBOE Hybrid System. Paragraphs (a) and (c) of CBOE Rule 6.45A 
contain the UMA allocation model, which is a weighted formula that 
incorporates and blends the concepts of parity (Component A) and size 
prorata distribution (Component B). With respect to equity option 
trading, UMA assigns equal weighting percentages to Components A and B. 
Currently, all products under the jurisdiction of each floor procedure 
committee must utilize the same UMA weighting percentages (i.e., 
Components A and B must be weighted the same in all products under that 
FPC's jurisdiction). The purpose of this rule filing is to amend Rule 
6.45A(a) and (c) to allow the appropriate index FPC (``Index FPC'' or 
``IFPC'') to vary the final weighting percentages of Components A and B 
by index or ETF option product. For example, the IFPC may determine to 
weight Components A and B 50-50% for index XYZ while weighting the same 
components (60-40% for index ABC. The rule will remain unchanged on the 
equity side, thus, all equity options under the jurisdiction of the 
equity FPC must have the same UMA component weightings.
    The Exchange believes it is appropriate to allow the IFPC to vary 
the weightings of Components A and B by product for several reasons. 
First, the size of trading crowds can vary dramatically by index/ETF 
option product. The ability to increase or decrease the percentage of 
Component A may serve as a better inducement to competitive quoting 
than would an

[[Page 4189]]

equal-weighted formula.\5\ Second, because the composition of trading 
crowds varies by product, it is highly likely that some index/ETF 
option crowds may consist of more larger capitalized market-making 
organizations than do other crowds, thus increasing the possibility 
that a ``deep pocketed'' market maker could ``size out'' his smaller 
counterparts, thereby reducing their incentive to quote competitively. 
Varying the weightings by product would allow the IFPC to take into 
account this factor and adjust the weightings accordingly so as to 
enhance competition. A third reason involves the trading 
characteristics of the index/ETF option product. In less liquid 
products, the IFPC may determine that increasing the weighting of 
Component B serves to enhance better quoting competition. Finally, 
index prices can be much higher and fluctuate far more on the index/ETF 
option side, which can significantly affect a trader's risk profile. 
For example, the NDX index level (as of Mid December) was approximately 
1400. Strike prices on the NDX ranged from $500-1800 (in $25 and/or $50 
increments).\6\ The ability to vary the weightings of Components A and 
B will allow the IFPC to take into account the potential for tremendous 
swings in notional value due to the fluctuations in the indexes and the 
risk such swings can pose to traders.
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    \5\ For example, less active indexes, such as the S&P Small Cap 
600, may have trading crowds consisting of less than five market 
makers. More active indexes, such as the QQQ, may have as many as 20 
market makers in the trading crowd. A ``one-size-fits-all'' 
weighting methodology for UMA may not produce optimal results in 
indexes with such disparate sized trading crowds.
    \6\ The premium for the 775 DEC call was bid at $615.
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    The proposed rule requires that each time it changes the final 
weightings of UMA on a per product basis, it will provide at least one-
day's advance notice to the membership via Regulatory Circular. This 
precludes intra-days adjustments and serves to ensure sufficient 
advance notice to affected parties.\7\
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    \7\ In this respect, the Exchange has not changed the UMA 
weighting percentages for Components A and B on the equity side 
since implementation of trading on Hybrid.
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2. Statutory Basis
    The Exchange believes that allowing the IFPC to establish 
weightings for Components A and B of the UMA calculation at different 
levels for different index options and ETF option products will help to 
ensure optimal liquidity in each of these products under its 
jurisdiction. For this reason, the Exchange believes the proposed rule 
change is consistent with the Act and the rules and regulations under 
the Act applicable to a national securities exchange and, in 
particular, the requirements of Section 6(b) of the Act.\8\ 
Specifically, the Exchange believes the proposed rule change is 
consistent with the Section 6(b)(5) \9\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, to prevent fraudulent and manipulative acts and, in general, to 
protect investors and the public interest.
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    \8\ 15 U.S.C. 78(f)(b).
    \9\ 15 U.S.C. 78(f)(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange neither solicited nor received comments on the 
proposal.

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. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-CBOE-2004-01. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review your comments more efficiently, comments should be sent in 
hardcopy or by e-mail but not by both methods. 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 Section, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of such filing will also be available for inspection and copying 
at the Commission's Public Reference Room. Copies of such filing will 
also be available for inspection and copying at the principal office of 
CBOE. All submissions should refer to the File No. SR-CBOE-2004-01 and 
should be submitted by February 18, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-1759 Filed 1-27-04; 8:45 am]
BILLING CODE 8010-01-M