[Federal Register Volume 69, Number 62 (Wednesday, March 31, 2004)]
[Notices]
[Pages 16998-17000]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-7143]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49462, File No. SR-CBOE-2004-02]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Board Options 
Exchange, Inc., To Amend the Obvious Error Rule Relating to ``No-Bid'' 
Options

March 23, 2004.
    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 January 8, 2004, 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 Exchange. On 
February 2, 2004, CBOE submitted Amendment No. 1 to the proposed rule 
change.\3\ 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. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Steve Youhn, Legal Division, CBOE, to Nancy 
J. Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated January 30, 2004 (``Amendment No. 
1''). Amendment No. 1 replaced and superseded the original filing in 
its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to amend its obvious error rule, CBOE Rule 6.25, 
relating to ``no-bid'' options. Proposed new language is italicized.
* * * * *
Rule 6.25 Nullification and Adjustment of Electronic Transactions
(a) Trades Subject to Review
    A member or person associated with a member may have a trade 
adjusted or nullified if, in addition to satisfying the procedural 
requirements of paragraph (b) below, one of the following conditions is 
satisfied:
    (1)-(6) No change.
    (7) No Bid Series: Buyers of options series quoted no bid may 
request that their execution be nullified provided: (a) the bid in that 
series immediately preceding the execution was zero; (b) at least one 
strike price below (for calls) or above (for puts) in the same options 
class was quoted no bid immediately before the execution; and (c) the 
bid following the execution in that series was zero.

[[Page 16999]]

    (b)-(e) No change.
Interpretations and Policies * * *
    .01-.02 No change.
* * * * *

I. 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 III 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
    Recently, the Commission approved CBOE's obvious error rule, CBOE 
Rule 6.25,\4\ which establishes six specific objective guidelines that 
may be used as the basis for adjusting or nullifying a transaction. The 
Exchange proposes to adopt one additional guideline, relating to ``no-
bid''\5\ options, which may be used as a basis for nullifying trades. 
Under this guideline, buyers of options that were quoted no-bid may 
request that their execution be nullified provided:
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    \4\ Securities Exchange Act Release No. 48827 (November 24, 
2003), 68 FR 67498 (December 2, 2003).
    \5\ ``No-bid'' is synonymous with ``zero-bid.''
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    (a) The bid in that series immediately preceding the execution(s) 
in question was zero;
    (b) At least one strike price below (for calls) or above (for puts) 
in the same options class was quoted no-bid immediately before the 
execution(s) in question; and
    (c) The bid following the execution(s) in question in that series 
was zero.
    A ``zero-bid'' or ``no-bid'' option refers to an option where the 
bid price is $0.00.\6\ According to CBOE, series of options quoted 
zero-bid are usually deep out-of-the-money series that are perceived as 
having little if any chance of expiring in-the-money. For this reason, 
relatively few transactions occur in these series and those that do are 
usually the result of a momentary pricing error. In some cases, the 
pricing error is substantial enough such that CBOE Rule 6.25(a)(1) 
becomes applicable. In many cases, though, the pricing error is not 
substantial enough to warrant adjustment under CBOE Rule 6.25(a)(1). 
The proposed rule would apply to these transactions.
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    \6\ The offer price is typically $0.05. In this instance, the 
option typically is referred to as ``no bid at a nickel.''
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    For example, if the underlying stock trades at $21 during December 
expiration week, related options with the strike price of 30, 35, and 
40 likely would trade no-bid at a nickel. Assume a momentary pricing 
anomaly occurs, resulting in a quoted price of $0.10-0.20 in the 40s 
and, as a result, an electronic order to sell immediately executes 
against the $0.10 bid. The displayed quote immediately returns to no-
bid at a nickel. In this case, the market maker has just purchased a 
worthless option for $0.10.\7\ Because the displayed quote prior to the 
trade was zero-bid, the 35s were zero-bid, and the quote after the 
erroneous transaction in question was zero-bid, this transaction would 
qualify for relief under the rule.
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    \7\ This trade does not qualify as an obvious pricing error 
because it is less than $0.10 from fair market value.
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    According to CBOE, the proposed rule is similar to Pacific 
Exchange, Inc. (``PCX'') Rule 6.87(g)(2)(F) \8\ with a few notable 
differences, as described below. First, CBOE believes its proposed rule 
is more restrictive in that it requires the bid following the execution 
in question to return to zero. CBOE believes that this serves as an 
added measure of protection designed to ensure that the transaction 
really was erroneous.
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    \8\ Under PCX Rule 6.87(g)(2)(F), parties to a trade may have a 
trade nullified or its price adjusted if any such party makes a 
timely documented request and the trade resulted in an execution 
price in a series quoted no bid and at least one strike price below 
(for calls) or above (for puts) in the same class were quoted no bid 
at the time of the erroneous execution.
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    Second, the PCX rule requires at least one strike below (calls) or 
above (puts) be quoted no-bid ``at the time of execution'' while CBOE 
uses ``immediately prior to the execution'' as the reference point. 
CBOE believes that this is an important distinction only if more than 
one series of the same class is affected. With respect to the example 
above, assume that at the same time the 30s, 35s, and 40s all go from 
no-bid to $0.10-0.20, and a few seconds later an execution occurs in 
each series, and then the price in each series returns to zero-bid. In 
this scenario, using the PCX reference point of ``at the time of 
execution,'' none of the trades could be adjusted because the second 
criteria (i.e., at least one strike below is quoted zero-bid) is not 
satisfied.\9\ Using the CBOE reference point of ``immediately prior to 
execution'' allows the trades in all three series, which CBOE believes 
clearly are erroneous, to be nullified.\10\ Finally, CBOE's proposed 
rule only allows for the nullification of trades, whereas the PCX rule 
would allow for the nullification or adjustment of trades. Practically, 
CBOE believes that these trades cannot be adjusted because the adjusted 
price would be zero.
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    \9\ For example, the trade in the 40s could not be nullified, 
because at the time of execution the strike below (i.e., the 35s) 
were not quoted no bid. Rather, they were quoted $0.10-0.20. The 
same goes with the trade in the 35s: at the time of execution, the 
30s were not quoted zero bid.
    \10\ This assumes, however, that the strike below the 30s is 
quoted zero bid.
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2. Statutory Basis
    CBOE represents that the filing provides for the nullification of 
no-bid trades executed at clearly erroneous prices due to the 
occurrence of an inaccurate pricing anomaly. In addition, CBOE notes 
that a substantially similar provision has already been approved on 
PCX. Therefore, the Exchange believes that the proposed rule change is 
consistent with section 6(b) of the Act \11\ in general, and furthers 
the objectives of section 6(b)(5) \12\ in particular, in that it is 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism for a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 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

    CBOE did not solicit or receive written comments on 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

[[Page 17000]]

publishes its reasons for so finding, or (ii) as to which the Exchange 
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 proposed rule change, 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 may also be submitted electronically at the 
following e-mail address: [email protected]. All comment letters 
should refer to File No. SR-CBOE-2004-02. 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 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 be submitted by April 21, 2004.

    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. 04-7143 Filed 3-30-04; 8:45 am]
BILLING CODE 8010-01-P