[Federal Register Volume 69, Number 48 (Thursday, March 11, 2004)]
[Notices]
[Pages 11678-11681]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5550]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49367; File No. SR-CBOE-2004-14]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change and Amendment No. 1 Thereto by 
the Chicago Board Options Exchange, Inc. to Adopt Rules and Procedures 
Governing the Execution of Complex Orders Involving Options and 
Security Futures

March 5, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on February 23, 2004, the Chicago Board Options 
Exchange, Inc. (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by the Exchange. On March 4, 2004, CBOE submitted 
Amendment No. 1 to the proposed rule change. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to adopt rules and procedures governing the execution 
of complex orders involving options and security futures. The text of 
the proposed rule change follows. Additions are in italics. Deleted 
text is in brackets.

Chicago Board Options Exchange, Incorporated Rules

* * * * *

CHAPTER I--Definitions

* * * * *

Rule 1.1. Definitions

* * * * *

Stock-Option Order

    (ii) A stock-option order is an order to buy or sell a stated 
number of units of an underlying or a related security coupled with 
either (a) the purchase or sale of option contract(s) [of the same 
series] on the opposite side of the market representing either the same 
number of units of the underlying or related security or the number of 
units of the underlying security necessary to

[[Page 11679]]

create a delta neutral position or (b) the purchase [and] or sale of an 
equal number of put and call option contracts, each having the same 
exercise price, expiration date and each representing the same number 
of units of [the underlying or related security] stock as, and on the 
opposite side of the market from, [representing in aggregate twice the 
number of units of] the underlying or related security portion of the 
order.
* * * * *

Security Future-Option Order

    (zz) A security future-option order, which shall be deemed a type 
of Inter-regulatory Spread Order as that term is defined in Rule 
1.1(ll), is an order to buy or sell a stated number of units of a 
security future or a related security convertible into a security 
future (``convertible security future'') coupled with either (a) the 
purchase or sale of option contract(s) on the opposite side of the 
market representing either the same number of the underlying for the 
security future or convertible security future or the number of units 
of the underlying for the security future or convertible security 
future necessary to create a delta neutral position or (b) the purchase 
or sale of an equal number of put and call option contracts, each 
having the same exercise price, expiration date and each representing 
the same number of the underlying for the security future or 
convertible security future, as and on the opposite side of the market 
from, the underlying for the security future or convertible security 
future portion of the order.
* * * * *

CHAPTER VI--Doing Business on the Exchange Floor

* * * * *

Rule 6.9. Solicited Transactions

    A member or member organization representing an order respecting an 
option traded on the Exchange (an ``original order''), including a 
spread, combination, or straddle order as defined in Rule 6.53, [or] a 
stock-option order as defined in Rule 1.1(ii) or a security future-
option order as defined in Rule 1.1(zz), may solicit a member or member 
organization or a non-member customer or broker-dealer (the ``solicited 
person'') to transact in-person or by order (a ``solicited order'') 
with the original order. In addition, whenever a floor broker who is 
aware of, but does not represent, an original order solicits one or 
more persons or orders in response to an original order, the persons 
solicited and any resulting orders are solicited persons or solicited 
orders subject to this Rule. Original orders and solicited orders are 
subject to the following conditions.
    (a)-(f) No change.
* * * * *

Rule 6.45. Priority of Bids and Offers--Allocation of Trades

    Except as provided by Rules, including but not limited to Rule 
6.2A, 6.8, 6.9, 6.13, 6.45A, Rule 6.47, Rule 6.74, Rule 8.87, and CBOE 
Regulatory Circulars approved by the SEC concerning Participation 
Rights, the following rules of priority shall be observed with respect 
to bids and offers:
    (a)-(d) No change.
    (e) Complex Order Priority Exception: A member holding a spread, 
straddle, combination, or ratio order (or a stock-option order or 
security future-option order, as defined in Rule 1.1(ii)(b) and Rule 
1.1(zz)(b), respectively) 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 and security future-option orders, as defined in Rule 
1.1(ii)(a) and Rule 1.1(zz)(a), respectively, have priority over bids 
(offers) of the trading crowd but not over bids (offers) of public 
customers in the limit order book.
* * * * *

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

    Generally: The rules of priority and order allocation procedures 
set forth in this rule shall apply only to option classes designated by 
the Exchange to be traded on the CBOE Hybrid System.
    (a) No change.
    (b)(i)-(ii) No change.
    (b)(iii) Exception: Complex Order Priority: A member holding a 
spread, straddle, or combination order (or a stock-option order or 
security future-option order, as defined in Rule 1.1(ii)(b) and Rule 
1.1(zz)(b), respectively) 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 electronic book provided at 
least one leg of the order betters the corresponding bid (offer) in the 
book. Stock-option orders and security future-option orders, as defined 
in Rule 1.1(ii)(a) and Rule 1.1(zz)(a), respectively, have priority 
over bids (offers) of the trading crowd but not over bids (offers) of 
public customers in the limit order book.
    (c)-(e) No change.
* * * * *

Rule 6.48. Contract Made on Acceptance of Bid or Offer

    (a) No change.
    (b) Stock-option orders and security future-option orders. (i) A 
bid or offer that is identified to the Exchange trading crowd as part 
of a stock-option order, as defined in Rule 1.1(ii), or a security 
future-option order, as defined in Rule 1.1(zz), is made and accepted 
subject to the following conditions:
    (A) At the time the stock-option order or security future-option 
order is announced, the member initiating the order must disclose to 
the crowd all legs of the order and must identify the specific 
market(s) on which and the price(s) at which the non-option leg(s) of 
the order is to be filled, and
    (B) Concurrent with the execution of the options leg of the order, 
the initiating member and each member that agrees to be a contra-party 
on the non-option leg(s) of the order must take steps immediately to 
transmit the non-option leg(s) to the identified market(s) for 
execution.
    (ii) A trade representing the execution of the options leg of a 
stock-option order or a security future-option order may be cancelled 
at the request of any member that is a party to that trade only if 
market conditions in any of the non-Exchange market(s) prevent the 
execution of the non-option leg(s) at the price(s) agreed upon.
    (c) No change.
* * * * *

Rule 6.74. ``Crossing'' Orders

    (a)-(e) No change.
* * * * *

* * * Interpretations and Policies

    .01-.02 No change.
    .03 Spread, straddle, stock-option (as defined in Rule 1.1(ii)), 
inter-regulatory spread as defined in Rule 1.1([kk]ll) (including 
security future-option orders as defined in Rule 1.1 (zz)) or 
combination orders on opposite sides of the market may be crossed, 
provided that the Floor Broker holding such orders proceeds in the 
manner described in paragraphs (a) or (b) above as appropriate. Members 
may not prevent a spread, straddle, stock-option, inter-regulatory 
spread (including a security future-option order) or combination cross 
from being completed by giving a competing bid or offer for one 
component of such order.

[[Page 11680]]

    .04 [With the exception of inter-regulatory spreads, where] Where a 
related [transaction] order must be effected in another market, the 
member must take steps to transmit the related order(s) concurrently 
with the execution of the options leg(s) of the order [the transaction 
must be effected prior to effecting the options transaction]. A trade 
representing the execution of the options leg of a stock-option order 
or a security future-option order may be cancelled at the request of 
any member that is a party to that trade only if market conditions in 
any of the non-Exchange market(s) prevent the execution of the non-
option leg(s) at the price(s) agreed upon.
* * * * *

CHAPTER XXVII--Buy-Write Option Unitary Derivatives (``BOUNDs'')

* * * * *

Rule 27.1. Definitions

* * * * *

Security Future-Option Order

    (m) Security Future-Option Order--A security future-option order as 
used in respect of a BOUND means an order to buy or sell a stated 
number of units of a security future or a related security convertible 
into a security future (``convertible security future'') coupled with a 
transaction in a BOUND contract on the opposite side of the market 
representing the same number of underlying units for the security 
future or convertible security future.
* * * * *

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 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 Commodity Futures Modernization Act of 2000 \3\ lifted the ban 
on the trading of single stock futures and futures on narrow-based 
security indices (together, ``security futures'') in the United States. 
This proposed rule change addresses complex orders involving options 
and security futures and also revises the definition of stock-option 
order. Specifically, the proposed rule change (i) amends the definition 
of stock-option order, (ii) creates a new definition for a security 
futures option order (``security future-option order'') based on the 
proposed definition of stock-option order and grants certain execution 
priorities to security future-option orders, (iii) authorizes the 
execution of security future-option orders according to procedures that 
are identical to CBOE's current execution procedures for stock-option 
orders and (iv) incorporates the security future-option order concept 
into other CBOE rules where stock-option orders are addressed.
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    \3\ Pub. L. No. 106-554, Appendix E, 114 Stat. 2763.
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    The Exchange's current definition of stock-option order \4\ does 
not provide for the execution of stock-option orders to create delta 
neutral positions. The Exchange states that complex orders that create 
delta neutral positions are effective hedging strategies that would 
permit Exchange members to initially offset the risk of price movements 
in an option position with a corresponding purchase or sale of stock 
underlying the option position. The Exchange notes that the language in 
the proposed amendment to the definition of stock-option order mirrors 
the corresponding language contained in International Securities 
Exchange, Inc. (``ISE'') Rule 722--Complex Orders.\5\
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    \4\ Current CBOE Rule 1.1(ii) defines stock-option order as ``an 
order to buy or sell a stated number of units of an underlying or a 
related security coupled with either (a) the purchase or sale of 
option contract(s) of the same series on the opposite side of the 
market representing the same number of units of the underlying or 
related security or (b) the purchase and sale of an equal number of 
put and call option contracts, each having the same exercise price, 
expiration date and number of units of the underlying or related 
security, on the opposite side of the market representing in 
aggregate twice the number of units of the underlying or related 
security.''
    \5\ ISE Rule 722(a)(5)(i) defines a stock-option order as ``an 
order to buy or sell a stated number of units of an underlying stock 
or a security convertible into the underlying stock (``convertible 
security'') coupled with either (A) the purchase or sale of option 
contract(s) on the opposite side of the market representing either 
the same number of units of the underlying stock or convertible 
security or the number of units of the underlying stock necessary to 
create a delta neutral position; or (B) the purchase or sale of an 
equal number of put and call option contracts, each having the same 
exercise price, expiration date, and each representing the same 
number of units of stock, as and on the opposite side of the market 
from, the stock or convertible security portion of the order.''
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    The proposed rule change creates a new definition of security 
future-option order for a complex order involving security futures and 
options that is based on the proposed definition of stock-option order. 
Therefore, complex orders consisting of security futures and options 
legs that fall within the proposed definition of security future-option 
order will be entitled to the same priorities that the proposed 
definition of stock-option order affords to certain complex orders 
involving stocks and options. The Commission approved the definition of 
a single stock future-option order for ISE that the Exchange states is 
substantially similar to its proposed definition of a security future-
option order.\6\
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    \6\ See Securities Exchange Act Release No. 46390 (August 21, 
2002), 67 FR 55290 (August 28, 2002) (Order Approving SR-ISE-2002-
18). See also Securities Exchange Act Release No. 48894 (December 8, 
2003), 68 FR 70328 (December 17, 2003) (Notice of Filing and 
Immediate Effectiveness of SR-PCX-2003-42).
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    The proposed rule change amends CBOE Rules 6.45(e) and 
6.45A(b)(iii) to permit Exchange members to execute security future-
option orders, the options legs of which will have priority over bids 
or offers of the trading crowd but not over bids or offers of public 
customers in the book. The proposed rules also provide that members 
holding security future-option orders and bidding or offering on a net 
debit or credit basis may execute the order with another member without 
giving priority to equivalent bids or offers in the trading crowd or 
the book, provided at least one option leg of the order betters the 
corresponding bid or offer in the book. The priority rules in the 
previous two sentences are identical to the current Exchange priority 
rules governing stock-option orders.
    The proposed rule change also amends CBOE Rule 6.48(b) to provide 
execution procedures for security future-option orders. Proposed CBOE 
Rule 6.48(b) provides that the initiating member and the contra-parties 
with respect to a security future-option order must take steps to 
transmit the security futures leg to a futures exchange concurrent with 
the execution of the options leg(s) of the order.\7\ Because security 
futures products may not be fungible between markets, the member 
initiating the security future-option order must identify the specific 
market of execution. As with stock-option orders, if the security 
futures leg of the security future-option order cannot be

[[Page 11681]]

executed at the price(s) agreed upon due to market conditions, a trade 
representing the execution of the options leg of the transaction may be 
cancelled at the request of any member that is a party to that trade.
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    \7\ The proposed rule change amends Interpretation .04 to CBOE 
Rule 6.74 to reflect the execution procedures for stock-option 
orders and security future-option orders provided in proposed CBOE 
Rule 6.48(b).
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    CBOE also proposes to amend CBOE Rule 6.9 to permit member 
solicitation of a security future-option order, and CBOE Rule 27.1, 
which would create a new definition of a security future-option order 
with respect to an order involving a Buy-Write Option Unitary 
Derivative (``BOUND''),\8\ as that term is defined in CBOE Rule 
27.1(a).\9\ The proposed rules also make clear in the text of 
Interpretation .03 to CBOE Rule 6.74 that as a type of inter-regulatory 
spread order, a security future-option order may be crossed. A 
typographical error is also fixed in the text of Interpretation .03 to 
CBOE Rule 6.74.
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    \8\ CBOE Rule 27.1(a) defines a BOUND as ``a security issued, or 
subject to issuance, by The Options Clearing Corporation pursuant to 
the Rules of The Options Clearing Corporation which gives holders 
and writers thereof such rights and obligations as may be provided 
for in the Rules of the Options Clearing Corporation.''
    \9\ The proposed definition of security future-option order with 
respect to a BOUND is based on the definition of stock-option order 
with respect to a BOUND. CBOE Rule 27.1(l) defines stock-option 
order with respect to a BOUND as ``an order to buy or sell a stated 
number of units of an underlying or a related security coupled with 
a transaction in a BOUND contract on the opposite side of the market 
representing the same number of units of the underlying or a related 
security.''
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2. Statutory Basis
    Since the proposed rule change offers execution priorities for 
certain orders that CBOE believes are of a similar degree of complexity 
to those approved by the Commission for special priority rules and 
would offer investors additional opportunities to manage risks while 
protecting priority of orders of public customers, CBOE believes that 
the proposed rule change is consistent with Section 6(b) of the Act 
\10\ in general and furthers the objectives of Section 6(b)(5) \11\ in 
particular in that it should promote just and equitable principles of 
trade, serve to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and protect 
investors and the public interest.
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    \10\ 15 U.S.C. 78f(b).
    \11\ 15 U.S.C. 78f(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 that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    The foregoing rule change has become effective pursuant to Section 
19(b)(3)(A) of the Act \12\ and subparagraph (f)(6) of Rule 19b-4 \13\ 
thereunder because it does not: (i) Significantly affect the protection 
of investors or the public interest; (ii) impose any significant burden 
on competition; (iii) become operative for 30 days from the date on 
which it was filed, or such shorter time as the Commission may 
designate; and the Exchange has given the Commission written notice of 
its intention to file the proposed rule change at least five business 
days prior to filing. At any time within 60 days of the filing of such 
proposed rule change, the Commission may summarily abrogate such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.\14\
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    \12\ 15 U.S.C. 78s(b)(3)(A).
    \13\ 17 CFR 240.19b-4(f)(6).
    \14\ For purposes of calculating the 60-day abrogation date, the 
Commission considers the 60-day period to have commenced on March 4, 
2004, the date CBOE filed Amendment No. 1.
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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, NW., Washington, DC 20549-0609. 
Comments should be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-CBOE-2004-14. 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 hard 
copy 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 at the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-CBOE-2004-14 and should be 
submitted by April 1, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-5550 Filed 3-10-04; 8:45 am]
BILLING CODE 8010-01-P