[Federal Register Volume 69, Number 135 (Thursday, July 15, 2004)]
[Notices]
[Pages 42473-42476]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-16049]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49990; File No. SR-CBOE-2003-39]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment Nos. 1, 2, and 3 Thereto by the Chicago Board 
Options Exchange, Inc. Relating to Quote Sizes

July 8, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on September 12, 2003, 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 October 29, 2003, the CBOE filed Amendment No. 1 to the 
proposed rule change.\3\ On

[[Page 42474]]

June 10, 2004, the CBOE filed Amendment No. 2 to the proposed rule 
change.\4\ On June 28, 2004, the CBOE filed Amendment No. 3 to the 
proposed rule change.\5\ 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, Senior Attorney, CBOE, to 
Deborah Flynn, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated October 28, 2003 (``Amendment No. 
1'').
    \4\ See letter from Steve Youhn, Senior Attorney, CBOE, to Nancy 
Sanow, Assistant Director, Division, Commission, dated June 9, 2003 
(``Amendment No. 2''). In Amendment No. 2, CBOE replaced the 
original rule filing in its entirety.
    \5\ See letter from Steve Youhn, Senior Attorney, CBOE, to Nancy 
Sanow, Assistant Director, Division, Commission, dated June 25, 2003 
(``Amendment No. 3''). In Amendment No. 3, CBOE made technical 
corrections to the proposed rule text.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend its rules relating to options market 
maker quote size requirements. Below is the text of the proposed rule 
change. Proposed new language is in italics; proposed deletions are in 
[brackets].
* * * * *
Rule 8.7 Obligations of Market Makers
    (a)-(c) No change.
    (d) Market Making Obligations Applicable in Hybrid Classes.
* * * * *
    (i) Market Maker Trades Less Than 20% Contract Volume 
Electronically.
* * * * *
    (A) No Change
    (B) Continuous Electronic Quoting Obligation: The Market-Maker will 
not be obligated to quote electronically in any designated percentage 
of series within that class. If a market maker quotes electronically, 
its undecremented quote must be for at least ten contracts[.] (``10-
up''), unless the underlying primary market disseminates a 100-share 
quote, in which case the Market-Maker's undecremented quote may be for 
as low as 1-contract (``1-up''). The ability to quote 1-up when the 
underlying primary quotes 100 shares is expressly conditioned on the 
process being automated (i.e., a Market-Maker may not manually adjust 
his quotes to reflect 1-up sizes). Quotes must automatically return to 
at least 10-up when the underlying primary market no longer 
disseminates a 100-share quote. Market-Makers that have not automated 
this process may not avail themselves of the relief provided herein. 
The ability to quote 1-up shall operate on a pilot basis and shall 
terminate (insert date one year from date of approval).
    (C)-(D) No Change.
    (ii) Market Maker Trades More Than 20% Contract Volume 
Electronically.
* * * * *
    (A) No Change.
    (B) Continuous Quoting Obligation: A market maker will be required 
to maintain continuous two-sided quotes for at least ten contracts 
(undecremented size) in a designated percentage of series within the 
class, in accordance with the schedule below[:]. If the underlying 
primary market disseminates a 100-share quote, a Market-Maker may quote 
1-up, however, this ability is expressly conditioned on the process 
being automated (i.e., a Market-Maker may not manually adjust his 
quotes to reflect 1-up sizes). Quotes must automatically return to at 
least 10-up when the underlying primary market no longer disseminates a 
100-share quote. Market-Makers that have not automated this process may 
not avail themselves of the relief provided herein. The ability to 
quote 1-up shall operate on a pilot basis and shall terminate (insert 
date one year from date of approval).
* * * * *
    (C) No Change.
    Interpretations and Policies * * *
    .01-.04 No change.
    .05 Unless an options class is exempted by the appropriate Market 
Performance Committee, under normal market conditions a Market-Maker's 
bid or offer for a series of options of unspecified size is for five 
contracts, except that a Market-Maker may be compelled to buy or sell a 
specific number of contracts at the disseminated bid or offer pursuant 
to his obligations under Rule 8.51. [In classes in which the CBOE 
Hybrid system is operational such that each market participant is 
deemed the responsible broker-dealer for its quotations, a Market-
Maker's initial bid or offer must be accompanied by a size (for at 
least ten (10) contracts), indicating the number of contracts for which 
the Market-Maker will buy (sell) at his price.]
    .06-.13 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 aspects of such 
statements.

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

1. Purpose
    CBOE Rules 8.7(d)(i)(B) and (d)(ii)(B), which only apply to classes 
trading on the Hybrid Trading System, impose a ten contract (``10-up'') 
minimum size requirement for market makers when such market makers 
quote electronically. Similarly, Interpretation .05 to CBOE Rule 8.7 
imposes a 10-up size requirement for a market maker's initial bid or 
offer. Generally, the Exchange believes that this ten contract quoting 
requirement imposes a reasonable obligation on market makers, who, in 
turn for satisfying this and other obligations, are entitled to receive 
maker maker margin treatment. Nevertheless, the Exchange believes that 
there are instances in which requiring market makers to quote 10-up 
imposes a heightened and inappropriate level of risk upon them. 
Accordingly, in the Exchange's view, the purpose of this filing is to 
adopt a limited exception to the 10-up minimum quoting requirement in 
one such specific instance on a one-year pilot basis.
    Under this proposed exception, market makers on the Hybrid Trading 
System would be able to quote a size less than ten contracts whenever 
the underlying primary market for the option (or ETF option) 
disseminates a 1-up market (i.e., a market that reflects a quotation 
for 100 shares of the underlying security). The Exchange believes that, 
when the underlying market disseminates a 1-up quote, it substantially 
restricts the amount of liquidity available in that security to 100 
shares on that particular side of the market. According to the 
Exchange, there is no restriction on the ability of a stock specialist 
in the underlying market to quote a 1-up market. The Exchange notes 
that options exchanges are derivative markets. In this regard, the 
Exchange believes that, with a minimum quote size requirement of ten 
contracts, when the underlying stock market is 1-up, an options 
exchange provides more than ten times the liquidity than does the 
underlying stock market. The Exchange also believes that, because an 
options exchange may list twenty or more options series for an 
underlying stock, options market makers end up providing exponentially 
more liquidity than is available in the

[[Page 42475]]

underlying market.\6\ Additionally, according to the Exchange, market 
makers must hedge their transactions by buying and/or selling stock, 
and when the underlying stock exchange posts a 1-up market, it 
restricts the market maker's ability to hedge, which does nothing but 
increase such market maker's financial exposure.\7\ For these reasons, 
the Exchange believes that market makers in this instance should have 
the ability to lower their quote sizes to one contract if they choose, 
thereby matching the amount of liquidity provided by the underlying.
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    \6\ For example, if a maker maker posts 10-up markets in twenty 
series, such market maker would be providing liquidity equivalent to 
20,000 shares, which would dwarf the underlying market's size 
commitment of 100 shares.
    \7\ NYSE Information memo 94-32 (August 9, 1994) indicates that 
1-up markets on the NYSE can last for as long as five minutes. The 
Exchange believes that, during this five-minute period, options 
market makers without the ability to post a 1-up market themselves 
will become the de facto liquidity providers for that security and 
will be unable to hedge their transactions.
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    The Exchange further proposes that the ability to quote 1-up when 
the underlying primary is 1-up is expressly conditioned on the process 
being automated (i.e., a market maker may not manually adjust his 
quotes to reflect 1-up sizes). As part of this automation, quotes must 
automatically return to at least 10-up when the underlying primary 
market no longer disseminates a 1-up quote. Market makers that have not 
automated this process may not avail themselves of the relief provided 
herein.
    The Exchange also proposes to delete the language that imposes a 
10-up size requirement for a market maker's initial bid or offer in 
Interpretation .05 to CBOE Rule 8.7, because that language is 
duplicative of what is already contained in Rule 8.7(d).
    The Exchange proposes that this exception operate on a one-year 
pilot basis. Prior to being able to participate in this pilot program, 
market makers or their vendors that provide their handheld quoting 
devices would be required to demonstrate to the Exchange that they have 
automated the process discussed above. Upon completion of the pilot 
period, the Exchange represents that it will provide to the Commission 
a report detailing the effectiveness of the program, along with a 
request either to eliminate or make permanent the pilot program.
    Finally, the Exchange believes that the proposal is consistent with 
CBOE Rule 8.51, which allows the appropriate Floor Procedure Committee 
to establish separate firm quote requirements for each series of 
option, which shall be for at least one contract for non-broker-dealer 
orders and broker-dealer orders. The Exchange believes that nothing in 
this proposal would affect a market maker's obligation to honor its 
firm quote requirements imposed by CBOE Rule 8.51. Accordingly, if a 
market maker disseminates a 1-up market, its firm quote obligation 
would be one contract.\8\
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    \8\ Telephone conversation between Steve Youhn, Senior Attorney, 
CBOE and Hong-Anh Tran, Special Counsel, Division, Commission, on 
July 7, 2004.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \9\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \10\ in particular, in that it is 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. The Exchange believes that the proposal provides for a 
very limited exception to the general requirement that market maker's 
quotes be for a minimum ten contracts. The Exchange believes that this 
exception, which in the Exchange's view, is narrowly-tailored and must 
be automated, will provide a measure of protection to marker makers 
when the underlying primary market disseminates 1-up markets. 
Accordingly, the Exchange believes the proposal serves to enhance the 
incentives of market makers to quote competitively and reduces the 
disincentives to quote competitively.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange 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

    The Exchange has neither solicited nor received 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 publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve the 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, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-CBOE-2003-39 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-CBOE-2003-39. 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, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 20549-0609. Copies of such filing also will 
be available for inspection and copying at the principal office of the 
CBOE. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.

[[Page 42476]]

    All submissions should refer to File Number SR-CBOE-2003-39 and 
should be submitted on or before August 5, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-16049 Filed 7-14-04; 8:45 am]
BILLING CODE 8010-01-P