[Federal Register Volume 69, Number 146 (Friday, July 30, 2004)]
[Notices]
[Pages 45858-45860]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-17389]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50079; File No. SR-CBOE-2004-44]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to a Proposed Rule Change by the Chicago 
Board Options Exchange, Inc., Relating to Permanent Approval of the $5 
Quote Width Pilot Program

July 26, 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 July 19, 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 and 
II below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice and order to solicit comments on 
the proposed rule change from interested persons and to grant 
accelerated approval to the proposed rule change.
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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

    In January 2004, the CBOE implemented a pilot program (``Pilot 
Program''), which expires on July 29, 2004, that permits quote spread 
parameters of up to $5, regardless of the price of the bid, for up to 
200 options classes traded on the CBOE's Hybrid Trading System 
(``Hybrid'').\3\ The CBOE subsequently expanded the Pilot Program to 
include all options classes traded on Hybrid \4\ and limited the 
applicability of the $5 quote spreads permitted under the Pilot Program 
to quotations that are submitted electronically to Hybrid.\5\ The CBOE 
requests permanent approval of the Pilot Program.
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    \3\ See Securities Exchange Act Release Nos. 49153 (January 29, 
2004), 69 FR 5620 (February 5, 2004) (notice of filing and immediate 
effectiveness of File No. SR-CBOE-2003-50) (``Pilot Notice''); and 
49919 (June 25, 2004), 69 FR 40424 (notice of filing and immediate 
effectiveness of File No. SR-CBOE-2004-36) (extending the Pilot 
Program through July 29, 2004).
    \4\ See Securities Exchange Act Release No. 49318 (February 25, 
2004), 69 FR 10085 (March 3, 2004) (notice of filing and immediate 
effectiveness of File No. SR-CBOE-2004-10) (``February Notice'').
    \5\ See Securities Exchange Act Release No. 49791 (June 2, 
2004), 69 FR 32389 (June 9, 2004) (order approving File No. SR-CBOE-
2004-20) (``June Order'').
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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 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
    The Pilot Program became effective in January 2004 and designated 
200 options classes that could be quoted with a difference not to 
exceed $5 between the bid and offer regardless of the price of the 
bid.\6\ In February 2004, the CBOE expanded the number of options 
classes in the Pilot Program to include all options classes trading on 
Hybrid.\7\ The CBOE subsequently limited the applicability of the $5 
quote spreads permitted under the Pilot Program to quotations that are 
submitted electronically to Hybrid.\8\
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    \6\ See Pilot Notice, supra note 3.
    \7\ See February Notice, supra note 4.
    \8\ See June Order, supra note 5.
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    The Pilot Program expires on July 29, 2004. As part of the Pilot 
Program, the CBOE prepared and submitted to the Commission a report 
assessing the operation of the Pilot Program and, in particular, the 
quality of the quotations for the options included in the Pilot 
Program. Specifically, the CBOE's Pilot Program report compared and 
analyzed the Average Quote Width Analysis (``AQWA'') scores for each 
stock included in the Pilot Program prior to the implementation of the 
Pilot Program and during the operation of the Pilot Program.
    According to the CBOE, the Pilot Program report indicates that the 
implementation of $5 quote widths had no deleterious effects on average 
quote widths during the pilot period. To the contrary, the CBOE 
maintains that the implementation of the Pilot Program had little, if 
any, effect on average AQWA scores.
    The CBOE believes that the Pilot Program has been successful and 
has helped to contribute to the maintenance of efficient markets. The 
CBOE notes

[[Page 45859]]

that, as it expected, the statistics in the Pilot Program report show 
that market makers in any particular options class did not widen their 
quotes to the maximum allowable $5 width at all times. Instead, the 
CBOE believes that the Pilot Program provided market makers with a tool 
to manage their risk when they believed that wider quotes were 
necessary. The CBOE notes that in an environment with high degrees of 
both intra- and inter-market competition, a market maker that 
consistently quotes $5 wide at all times likely will never trade. 
Nevertheless, the CBOE notes that there are instances when a market 
maker may need to widen his or her quotes and, in this regard, the 
ability to quote $5 wide gives some measure of protection to the market 
maker.\9\ The CBOE believes that this is where the Pilot Program has 
been most beneficial.
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    \9\ CBOE Rule 8.7(d) imposes a minimum quote size obligation of 
10 contracts on market makers. The CBOE notes that market makers may 
not quote lower than this number even if the underlying market has 
disseminated erroneous quotes or reported bad trades. According to 
the CBOE, in the absence of the ability to quote one-up, quoting $5 
wide is one of the few remaining methods by which a market maker may 
limit his or her risk.
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    The CBOE notes that on July 12, 2004, the Commission approved a 
CBOE proposal to allow the introduction of competing e-Designated 
Primary Market Makers (``e-DPMs'') on the CBOE.\10\ According to the 
CBOE, e-DPMs will effectively function as remote competing specialists 
in the most active Hybrid classes. The CBOE believes that adding more 
well-capitalized quoters may greatly increase the already robust level 
of intramarket competition, thereby contributing to even greater depth 
of markets and more competitively-priced quotes. For these reasons, the 
CBOE asks the Commission to permanently approve the Pilot Program.
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    \10\ See Securities Exchange Act Release No. 50003 (July 12, 
2004), 69 FR 43028 (July 19, 2004) (order approving File No. SR-
CBOE-2004-24).
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2. Statutory Basis
    The CBOE 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.\11\ Specifically, the CBOE believes the 
proposed rule change is consistent with the section 6(b)(5)\12\ 
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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    \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

    The 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 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.

III. 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. 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-2004-44 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-2004-44. 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. 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. All submissions should refer to File Number SR-
CBOE-2004-44 and should be submitted on or before August 20, 2004.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    After careful review, 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.\13\ In particular, the Commission finds that the proposal is 
consistent with section 6(b)(5) of the Act \14\ 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 of a free and open market and a national market 
system and, in general, to protect investors and the public interest.
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    \13\ 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).
    \14\ 15 U.S.C. 78f(b)(5).
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    Although the Commission believes generally that maximum quotation 
spread parameters in the options market could provide an important 
safeguard to ensure that market maker quotes in options are not 
unnecessarily wide,\15\ the Commission believes that the CBOE's Hybrid 
system provides sufficiently strong incentives for market makers 
submitting quotations electronically to Hybrid to disseminate 
competitive quotations without maximum quotation spread parameters.\16\ 
In this regard, the Commission notes that in Hybrid each market maker 
quotes independently, customers and broker-dealers may enter orders in 
the limit order book at prices better than those posted by market 
makers, and incoming orders are allocated based on the price and size 
of orders and quotes resting in the book.\17\ Under the CBOE's matching 
algorithm, the larger the size of a market maker's quotation at the 
best price, the greater

[[Page 45860]]

the size of the allocation he or she receives.\18\ The Commission 
believes that these attributes and rules of the CBOE provide strong 
market incentives for market makers submitting quotations 
electronically to Hybrid to maintain narrow and competitive quotation 
spreads.
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    \15\ See e.g., Securities Exchange Act Release No. 47532 (March 
19, 2003), 68 FR 55685 (March 26, 2003) (order approving File No. 
SR-ISE-2001-15) (establishing a six-month pilot program permitting 
$5 quotation spreads in up to 50 options classes on the 
International Securities Exchange, Inc.).
    \16\ As noted above, the $5 quotation spreads permitted under 
the Pilot Program apply only to quotations that are submitted 
electronically to Hybrid. See June Order, supra note 5.
    \17\ See Pilot Notice, supra note 3.
    \18\ See Pilot Notice, supra note 3.
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    The Commission believes that the Pilot Program report submitted by 
the CBOE indicates that the spreads in market maker quotations 
submitted electronically to Hybrid did not widen significantly during 
the operation of the Pilot Program. Accordingly, the Commission 
believes that permanent approval of the Pilot Program is consistent 
with the Act.
    The Commission finds good cause for approving the proposal prior to 
the thirtieth day after the date of publication of notice thereof in 
the Federal Register. As noted above, the CBOE's Pilot Program report 
indicated that the spreads in market maker quotations submitted 
electronically to Hybrid did not widen significantly during the 
operation of the Pilot Program. In addition, the CBOE's Pilot Program 
is substantially similar to a pilot program implemented by the 
International Securities Exchange, Inc. (``ISE''), that the Commission 
approved permanently.\19\ The Commission received no comments on either 
the ISE's pilot program or the CBOE's Pilot Program. Accordingly, the 
Commission believes that good cause exists, consistent with sections 
6(b)(5) and 19(b)(2) of the Act,\20\ to grant accelerated approval to 
the proposal.
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    \19\ See Securities Exchange Act Release No. 50015 (July 14, 
2004), 69 FR 43872 (July 22, 2004) (order approving File No. SR-ISE-
2003-22).
    \20\ 15 U.S.C. 78f(b)(5) and 78s(b)(2).
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V. Conclusion

    For the foregoing reasons, the Commission finds that the proposal 
is consistent with the requirements of the Act and rules and 
regulations thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-CBOE-2004-44) is approved on 
an accelerated basis.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-17389 Filed 7-29-04; 8:45 am]
BILLING CODE 8010-01-P