[Federal Register Volume 69, Number 248 (Tuesday, December 28, 2004)]
[Notices]
[Pages 77790-77795]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-28276]



[[Page 77790]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50880; File No. SR-CBOE-2004-83]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change and Amendment Nos. 1 and 2 
Thereto by the Chicago Board Options Exchange, Inc. To Amend Its 
Obvious Error Rule

December 17, 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 December 9, 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 proposed 
rule change has been filed by CBOE as a ``non-controversial'' rule 
change pursuant to Section 19(b)(3)(A) of the Act \3\ and Rule 19b-
4(f)(6) thereunder.\4\ On December 13, 2004, CBOE submitted Amendment 
No. 1 to the proposed rule change.\5\ On December 16, 2004, CBOE 
submitted Amendment No. 2 to the proposed rule change.\6\ 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\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
    \5\ In Amendment No. 1, CBOE proposes to adopt new 
Interpretations and Policies .03 to Rule 6.25. The purpose of 
adopting this provision is to provide a definition of ``erroneous 
buy'' and ``erroneous sell'' transaction. Additionally, the Exchange 
proposes to capitalize the term ``Theoretical Price'' in the last 
sentence of proposed paragraph (a)(1) of CBOE Rule 6.25.
    \6\ In Amendment No. 2, CBOE proposes to replace paragraph (c) 
of proposed CBOE Rule 24.16 and to make a technical correction to 
proposed paragraph (a)(1) of CBOE Rule 6.25 by replacing the word 
``with'' with the word ``within.''
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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. Additions are 
italicized. Deletions are bracketed.
* * * * *

Rule 6.25 Nullification and Adjustment of [Electronic] Equity Options 
Transactions

    This Rule governs the nullification and adjustment of [options 
trades] transactions involving equity options. Rule 24.16 governs the 
nullification and adjustment of transactions involving index options 
and options on ETFs and HOLDRs. Paragraphs (a)(1), and (2)[, (6), and 
(7)] of this Rule have no applicability to trades executed in open 
outcry.
(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) Obvious Price Error: [An obvious pricing error will be deemed 
to have occurred when the execution price of a transaction is above or 
below the fair market value of the option by at least a prescribed 
amount. For series trading with normal bid-ask differentials as 
established in Rule 8.7(b)(iv), the prescribed amount shall be: (a) The 
greater of $0.10 or 10% for options trading under $2.50; (b) 10% for 
options trading at or above $2.50 and under $5; or (c) $0.50 for 
options trading at $5 or higher. For series trading with bid-ask 
differentials that are greater than the widths established in Rule 
8.7(b)(iv), the prescribed error amount shall be: (a) The greater of 
$0.20 or 20% for options trading under $2.50; (b) 20% for options 
trading at or above $2.50 and under $5; or (c) $1.00 for options 
trading at $5 or higher.
    (i) Definition of Fair Market Value: For purposes of this Rule 
only, the fair market value of an option is the midpoint of the 
national best bid and national best offer for the series (across all 
exchanges trading the option). In multiply listed issues, if there are 
no quotes for comparison purposes, fair market value shall be 
determined by Trading Officials. For singly-listed issues, fair market 
value shall be the first quote after the transaction(s) in question 
that does not reflect the erroneous transaction(s). For transactions 
occurring as part of the Rapid Opening System (``ROS trades'') or 
Hybrid Opening System (``HOSS''), fair market value shall be the first 
quote after the transaction(s) in question that does not reflect the 
erroneous transaction(s).]
    An obvious pricing error occurs when the execution price of an 
electronic transaction is above or below the Theoretical Price for the 
series by an amount equal to at least the amount shown below:

------------------------------------------------------------------------
                                                               Minimum
                     Theoretical price                          amount
------------------------------------------------------------------------
Below $2...................................................        $0.25
$2 to $5...................................................         0.40
Above $5 to $10............................................         0.50
Above $10 to $20...........................................         0.80
Above $20..................................................         1.00
------------------------------------------------------------------------

    Definition of Theoretical Price. For purposes of this Rule only, 
the Theoretical Price of an option series is, for series traded on at 
least one other options exchange, the last bid price with respect to an 
erroneous sell transaction and the last offer price with respect to an 
erroneous buy transaction, just prior to the trade, disseminated by the 
competing options exchange that has the most liquidity in that option 
class in the previous two calendar months.
    If there are no quotes for comparison, designated Trading Officials 
will determine the Theoretical Price. For transactions occurring as 
part of the Rapid Opening System (``ROS trades'') or Hybrid Opening 
System (``HOSS''), Theoretical Price shall be the first quote after the 
transaction(s) in question that does not reflect the erroneous 
transaction(s).
    Price Adjustment or Nullification: Obvious Pricing Errors will be 
adjusted or nullified in accordance with the following:
    Transactions Between CBOE Market Makers: Where both parties to the 
transaction are CBOE Market-Makers, the execution price of the 
transaction will be adjusted by Trading Officials to the prices 
provided in Paragraphs (A) and (B) below, minus (plus) an adjustment 
penalty (``adjustment penalty''), unless both parties agree to adjust 
the transaction to a different price or agree to bust the trade within 
fifteen (15) minutes of being notified by Trading Officials of the 
Obvious Error.
    A. Erroneous buy transactions will be adjusted to their Theoretical 
Price plus an adjustment penalty of either $.15 if the Theoretical 
Price is under $3 or $.30 if the Theoretical Price is at or above $3.
    B. Erroneous sell transactions will be adjusted to their 
Theoretical Price minus an adjustment penalty of either $.15 if the 
Theoretical Price is under $3 or $.30 if the Theoretical Price is at or 
above $3.
    Transactions Involving at least one non-CBOE Market Maker: Where 
one of the parties to the transaction is not a CBOE market maker, the 
transactions will be nullified by Trading Officials unless both parties 
agree to an adjustment price for the transaction within thirty (30) 
minutes of being notified by Trading Officials of the Obvious Error.
    (2) [Obvious Quantity Error: An obvious error in the quantity term 
will

[[Page 77791]]

be deemed to occur when the transaction size exceeds the responsible 
broker or dealer's average disseminated size over the previous four 
hours by a factor of five (5) times. The quantity to which a 
transaction shall be adjusted from an obvious quantity error shall be 
the responsible broker or dealer's average disseminated size over the 
previous four trading hours (which may include the previous trading 
day).]
    No Bid Series: Electronic transactions in series quoted no bid at a 
nickel (i.e., $0.05 offer) will be nullified provided at least one 
strike price below (for calls) or above (for puts) in the same options 
class was quoted no bid at a nickel at the time of execution.
    (3) Verifiable Disruptions or Malfunctions of Exchange Systems: 
Electronic or open outcry transactions [Trades] arising out of a 
``verifiable disruption or malfunction'' in the use or operation of any 
Exchange automated quotation, dissemination, execution, or 
communication system [may] will either be nullified or adjusted by 
Trading Officials. Transactions that qualify for price adjustment will 
be adjusted to Theoretical Price, as defined in paragraph (a)(1) above.
    (4) Erroneous Print in Underlying: A trade resulting from an 
erroneous print disseminated by the underlying market which is later 
cancelled or corrected by that underlying market may be [adjusted or] 
nullified. In order to be [adjusted or] nullified, however, the trade 
must be the result of an erroneous print that is higher or lower than 
the average trade in the underlying security during a two-minute period 
before and after the erroneous print by an amount at least five times 
greater than the average quote width for such underlying security 
during the same period.
    For purposes of this Rule, the average trade in the underlying 
security shall be determined by adding the prices of each trade during 
the four minute time period referenced above (excluding the trade in 
question) and dividing by the number of trades during such time period 
(excluding the trade in question). For purposes of this Rule, the 
average quote width shall be determined by adding the quote widths of 
each separate quote during the four minute time period referenced above 
(excluding the quote in question) and dividing by the number of quotes 
during such time period (excluding the quote in question).
    [(5) Erroneous Quote in Underlying: A trade resulting from an 
erroneous quote in the underlying security may be adjusted or 
nullified. An erroneous quote occurs when the underlying security has a 
width of at least $1.00 and has a width at least five times greater 
than the average quote width for such underlying security on the 
primary market during the time period encompassing two minutes before 
and after the dissemination of such quote.
    (6) Trades Below Intrinsic Value: An obvious pricing error will be 
deemed to occur when the transaction price of an equity option is more 
than $0.10 below the intrinsic value of the same option (an option that 
trades at its intrinsic value is sometimes said to trade at 
``parity''). Paragraph (6) shall not apply to transactions occurring 
during the last two minutes of the trading day (which is typically 
3:00:01 p.m. (CT) to 3:02 p.m. (CT)) on days with regular trading 
hours).
    (i) Definition of Intrinsic Value: For purposes of this Rule, the 
intrinsic value of an equity call option equals the value of the 
underlying stock (measured from the bid or offer as described below) 
minus the strike price, and the intrinsic value of an equity put option 
equals the strike price minus the value of the underlying stock 
(measured from the bid or offer as described below), provided that in 
no case is the intrinsic value of an option less than zero. In the case 
of purchasing call options and selling put options, intrinsic value is 
measured by reference to the bid in the underlying security, and in the 
case of purchasing put options and selling call options, intrinsic 
value is measured by reference to the offer in the underlying security.
    (7) No Bid Series: Electronic transactions in series quoted no bid 
at a nickel (i.e., $0.05 offer) will be nullified provided at least one 
strike price below (for calls) or above (for puts) in the same options 
class was quoted no bid at a nickel at the time of execution.]
(b) Procedures for Reviewing Transactions
    (1) Notification: Any member or person associated with a member 
that believes it participated in a transaction that may be adjusted or 
nullified in accordance with paragraph (a) must notify any Trading 
Official promptly but not later than fifteen (15) minutes after the 
execution in question. [For transactions occurring after 2:45 p.m. 
(CST), notification must be provided promptly but not later than 
fifteen (15) minutes after the close of trading of that security on 
CBOE.] Absent unusual circumstances, Trading Officials shall not grant 
relief under this Rule unless notification is made within the 
prescribed time periods. In the absence of unusual circumstances, 
Trading Officials (either on their own motion or upon request of a 
member) must initiate action pursuant to paragraph (a)(3) above within 
sixty (60) minutes of the occurrence of the verifiable disruption or 
malfunction. When Trading Officials take action pursuant to paragraph 
(a)(3), the members involved in the transaction(s) shall receive verbal 
notification as soon as is practicable.
    (2) Review and Determination: Once a party to a transaction has 
applied to a Trading Official for review, the transaction shall be 
reviewed and a determination rendered, unless both parties to the 
transaction agree to withdraw the application for review prior to the 
time a decision is rendered. Absent unusual circumstances (e.g., a 
large number of disputed transactions arising out of the same 
incident), Trading Officials must render a determination within sixty 
(60) minutes of receiving notification pursuant to paragraph (b)(1) 
above. [If the transaction(s) in question occurred after 2:30 p.m., 
Trading Officials shall have until 9:30 a.m. the following morning to 
render a determination.] Trading Officials shall promptly provide 
verbal notification of a determination to the members involved in the 
disputed transaction and to the control room.
    [(c) Adjustments
    Unless otherwise specified in Rule 6.25(a)(1)-(6), transactions 
will be adjusted provided the adjusted price does not violate the 
customer's limit price. Otherwise, the transaction will be nullified. 
With respect to 6.25(a)(1)-(5), the price to which a transaction shall 
be adjusted shall be the National Best Bid (Offer) immediately 
following the erroneous transaction with respect to a sell (buy) order 
entered on the Exchange. For ROS or HOSS transactions, the price to 
which a transaction shall be adjusted shall be based on the first non-
erroneous quote after the erroneous transaction on CBOE. With respect 
to 6.25(a)(6), the transaction shall be adjusted to a price that is 
$0.10 under parity.]
(c) Obvious Error Panel
    (i) Composition. An Obvious Error Panel will be comprised of at 
least one (1) Trading Floor Liaison (TFL) and four (4) Exchange 
members. Fifty percent of the number of Exchange members on the Obvious 
Error Panel must be directly engaged in market making activity and 
fifty percent of the number of Exchange members on the Obvious Error 
Panel must act in the capacity of a non-DPM floor broker. The Exchange 
members shall be representatives from any of the following Committees: 
Equity Options Procedure Committee, Equity Market Performance 
Committee, and Floor Officials Committee.

[[Page 77792]]

    (ii) Scope of Review. If a party affected by a determination made 
under this Rule so requests within the time permitted in paragraph (b), 
an Obvious Error Panel will review decisions made by the Trading 
Officials under this Rule, including whether an obvious error occurred, 
whether the correct Theoretical Price was used, and whether the correct 
adjustment was made at the correct price. A party may also request that 
the Obvious Error Panel provide relief as required in this Rule in 
cases where the party failed to provide the notification required in 
paragraph (b) and the Trading Officials declined to grant an extension, 
but unusual circumstances must merit special consideration.
    (iii) Procedure for Requesting Review. A request for review must be 
made in writing within (30) minutes after a party receives verbal 
notification of a final determination by the Trading Officials under 
this Rule, except that if notification is made after 2:30 p.m. Central 
Time (``CT''), either party has until 8:30 a.m. CT the next trading day 
to request review. The Obvious Error Panel shall review the facts and 
render a decision on the day of the transaction, or the next trade day 
in the case where a request is properly made the next trade day.
    (iv) Panel Decision. The Obvious Error Panel may overturn or modify 
an action taken by the Trading Officials under this Rule upon agreement 
by a majority of the Panel representatives. All determinations by the 
Obvious Error Panel may be appealed in accordance with paragraph (d) of 
this rule.
(d) Review by the Appeals Committee
    A member affected by a determination made under this rule may 
appeal such determination to the Appeals Committee, in accordance with 
Chapter XIX of the Exchange's rules. For purposes of this Rule, a 
member must be aggrieved as described in Rule 19.1. Notwithstanding any 
provision in Rule 19.2 to the contrary, a request for review must be 
made in writing (in a form and manner prescribed by the Exchange) no 
later than the close of trading on the next trade date after the member 
receives verbal notification of such determination by Trading 
Officials.
(e) Negotiated Trade Nullification
    A trade may be nullified if the parties to the trade agree to the 
nullification. When all parties to a trade have agreed to a trade 
nullification one party must promptly disseminate cancellation 
information in OPRA format.
    Interpretations and Policies* * *
    .01 Applicability: Trading Officials may also allow for the 
execution of ROS trades (and assign those trades to participating ROS 
market-makers) that were not executed on the opening but that should 
have been executed had ROS opened the series at the non-erroneous 
quote. The Exchange will endeavor to notify its members as soon as 
practicable after the correction of an erroneous print and will 
indicate that this may result in the adjustment of trades executed 
pursuant to ROS. The only trades that will be adjusted are those that 
were executed on the opening or those that should have executed on the 
opening. All adjustments will be made during the day when the 
correction of the erroneous print occurred.
    .02 Trading Officials: The term ``Trading Officials'' means two 
Exchange members designated as Floor Officials and one member of the 
Exchange's trading floor liaison (TFL) staff.
    .03 Definitions: For purposes of this Rule, an ``erroneous sell 
transaction'' is one in which the price received by the person selling 
the option is erroneously low, and an ``erroneous buy transaction'' is 
one in which the price paid by the person purchasing the option is 
erroneously high.
* * * * *

Rule 24.16 Nullification and Adjustment of Index Option Transactions

    This Rule only governs the nullification and adjustment of 
transactions involving index options and options on ETFs or HLDRs. Rule 
6.25 governs the nullification and adjustment of transactions involving 
equity options. Paragraphs (a)(1), (2), (6) and (7) of this Rule have 
no applicability to trades executed in open outcry.
(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) Obvious Price Error: An obvious pricing error will be deemed to 
have occurred when the execution price of a transaction is above or 
below the fair market value of the option by at least a prescribed 
amount. For series trading with normal bid-ask differentials as 
established in Rule 8.7(b)(iv), the prescribed amount shall be: (a) the 
greater of $0.10 or 10% for options trading under $2.50; (b) 10% for 
options trading at or above $2.50 and under $5; or (c) $0.50 for 
options trading at $5 or higher. For series trading with bid-ask 
differentials that are greater than the widths established in Rule 
8.7(b)(iv), the prescribed error amount shall be: (a) the greater of 
$0.20 or 20% for options trading under $2.50; (b) 20% for options 
trading at or above $2.50 and under $5; or (c) $1.00 for options 
trading at $5 or higher.
    (i) Definition of Fair Market Value: For purposes of this Rule 
only, the fair market value of an option is the midpoint of the 
national best bid and national best offer for the series (across all 
exchanges trading the option). In multiply listed issues, if there are 
no quotes for comparison purposes, fair market value shall be 
determined by Trading Officials. For singly-listed issues, fair market 
value shall be the first quote after the transaction(s) in question 
that does not reflect the erroneous transaction(s). For transactions 
occurring as part of the Rapid Opening System (``ROS trades'') or 
Hybrid Opening System (``HOSS''), fair market value shall be the first 
quote after the transaction(s) in question that does not reflect the 
erroneous transaction(s).
    (2) Obvious Quantity Error: An obvious error in the quantity term 
will be deemed to occur when the transaction size exceeds the 
responsible broker or dealer's average disseminated size over the 
previous four hours by a factor of five (5) times. The quantity to 
which a transaction shall be adjusted from an obvious quantity error 
shall be the responsible broker or dealer's average disseminated size 
over the previous four trading hours (which may include the previous 
trading day).
    (3) Verifiable Disruptions or Malfunctions of Exchange Systems: 
Trades arising out of a ``verifiable disruption or malfunction'' in the 
use or operation of any Exchange automated quotation, dissemination, 
execution, or communication system may either be nullified or adjusted 
by Trading Officials.
    (4) Erroneous Print in Underlying: A trade resulting from an 
erroneous print disseminated by the underlying market which is later 
cancelled or corrected by that underlying market may be adjusted or 
nullified. In order to be adjusted or nullified, however, the trade 
must be the result of an erroneous print that is higher or lower than 
the average trade in the underlying security during a two-minute period 
before and after the erroneous print by an amount at least five times 
greater than the average quote width for such underlying security 
during the same period.

[[Page 77793]]

    For purposes of this Rule, the average trade in the underlying 
security shall be determined by adding the prices of each trade during 
the four minute time period referenced above (excluding the trade in 
question) and dividing by the number of trades during such time period 
(excluding the trade in question). For purposes of this Rule, the 
average quote width shall be determined by adding the quote widths of 
each separate quote during the four minute time period referenced above 
(excluding the quote in question) and dividing by the number of quotes 
during such time period (excluding the quote in question).
    (5) Erroneous Quote in Underlying: A trade resulting from an 
erroneous quote in the underlying security may be adjusted or 
nullified. An erroneous quote occurs when the underlying security has a 
width of at least $1.00 and has a width at least five times greater 
than the average quote width for such underlying security on the 
primary market during the time period encompassing two minutes before 
and after the dissemination of such quote.
    (6) Trades Below Intrinsic Value: An obvious pricing error will be 
deemed to occur when the transaction price of an equity option is more 
than $0.10 below the intrinsic value of the same option (an option that 
trades at its intrinsic value is sometimes said to trade at 
``parity''). Paragraph (6) shall not apply to transactions occurring 
during the last two minutes of the trading day (which is typically 
3:00:01 p.m. (CT) to 3:02 p.m. (CT)) on days with regular trading 
hours).
    (i) Definition of Intrinsic Value: For purposes of this Rule, the 
intrinsic value of an equity call option equals the value of the 
underlying stock (measured from the bid or offer as described below) 
minus the strike price, and the intrinsic value of an equity put option 
equals the strike price minus the value of the underlying stock 
(measured from the bid or offer as described below), provided that in 
no case is the intrinsic value of an option less than zero. In the case 
of purchasing call options and selling put options, intrinsic value is 
measured by reference to the bid in the underlying security, and in the 
case of purchasing put options and selling call options, intrinsic 
value is measured by reference to the offer in the underlying security.
    (7) No Bid Series: Electronic transactions in series quoted no bid 
at a nickel (i.e., $0.05 offer) will be nullified provided at least one 
strike price below (for calls) or above (for puts) in the same options 
class was quoted no bid at a nickel at the time of execution.
(b) Procedures for Reviewing Transactions
    (1) Notification: Any member or person associated with a member 
that believes it participated in a transaction that may be adjusted or 
nullified in accordance with paragraph (a) must notify any Trading 
Official promptly but not later than fifteen (15) minutes after the 
execution in question. For transactions occurring after 2:45 p.m. 
(CST), notification must be provided promptly but not later than 
fifteen (15) minutes after the close of trading of that security on 
CBOE. Absent unusual circumstances, Trading Officials shall not grant 
relief under this Rule unless notification is made within the 
prescribed time periods. In the absence of unusual circumstances, 
Trading Officials (either on their own motion or upon request of a 
member) must initiate action pursuant to paragraph (a)(3) above within 
sixty (60) minutes of the occurrence of the verifiable disruption or 
malfunction. When Trading Officials take action pursuant to paragraph 
(a)(3), the members involved in the transaction(s) shall receive verbal 
notification as soon as is practicable.
    (2) Review and Determination: Once a party to a transaction has 
applied to a Trading Official for review, the transaction shall be 
reviewed and a determination rendered, unless both parties to the 
transaction agree to withdraw the application for review prior to the 
time a decision is rendered. Absent unusual circumstances (e.g., a 
large number of disputed transactions arising out of the same 
incident), Trading Officials must render a determination within sixty 
(60) minutes of receiving notification pursuant to paragraph (b)(1) 
above. If the transaction(s) in question occurred after 2:30 p.m., 
Trading Officials shall have until 9:30 a.m. the following morning to 
render a determination. Trading Officials shall promptly provide verbal 
notification of a determination to the members involved in the disputed 
transaction and to the control room.
(c) Adjustments
    Unless otherwise specified in Rule 24.16(a)(1)-(6), transactions 
will be adjusted provided the adjusted price does not violate the 
customer's limit price. Otherwise, the transaction will be nullified. 
With respect to 24.16(a)(1)-(5), the price to which a transaction shall 
be adjusted shall be the National Best Bid (Offer) immediately 
following the erroneous transaction with respect to a sell (buy) order 
entered on the Exchange. For ROS or HOSS transactions, the price to 
which a transaction shall be adjusted shall be based on the first non-
erroneous quote after the erroneous transaction on CBOE. With respect 
to 24.16(a)(6), the transaction shall be adjusted to a price that is 
$0.10 under parity.
(d) Review by the Appeals Committee
    A member affected by a determination made under this rule may 
appeal such determination to the Appeals Committee, in accordance with 
Chapter XIX of the Exchange's rules. For purposes of this Rule, a 
member must be aggrieved as described in Rule 19.1. Notwithstanding any 
provision in Rule 19.2 to the contrary, a request for review must be 
made in writing (in a form and manner prescribed by the Exchange) no 
later than the close of trading on the next trade date after the member 
receives verbal notification of such determination by Trading 
Officials.
(e) Negotiated Trade Nullification
    A trade may be nullified if the parties to the trade agree to the 
nullification. When all parties to a trade have agreed to a trade 
nullification one party must promptly disseminate cancellation 
information in OPRA format.
    Interpretations and Policies* * *
    .01 Applicability: Trading Officials may also allow for the 
execution of ROS trades (and assign those trades to participating ROS 
market-makers) that were not executed on the opening but that should 
have been executed had ROS opened the series at the non-erroneous 
quote. The Exchange will endeavor to notify its members as soon as 
practicable after the correction of an erroneous print and will 
indicate that this may result in the adjustment of trades executed 
pursuant to ROS. The only trades that will be adjusted are those that 
were executed on the opening or those that should have executed on the 
opening. All adjustments will be made during the day when the 
correction of the erroneous print occurred.
    .02 Trading Officials: The term ``Trading Officials'' means two 
Exchange members designated as Floor Officials and one member of the 
Exchange's trading floor liaison (TFL) staff.
* * * * *

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

[[Page 77794]]

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
    The Exchange's obvious error rule (CBOE Rule 6.25) establishes 
guidelines for the adjustment and nullification of transactions in both 
equity and index options. The Rule defines what constitutes an obvious 
error, provides an objective process members must follow to seek relief 
under the rule, and provides an appeals process for members seeking to 
challenge an initial determination. The Exchange's Rule operates 
completely independent of the other options exchanges' obvious error 
rules and is structured differently. In other words, transactions that 
might qualify as an obvious error on one options exchange might not 
qualify as such on CBOE, or vice versa. Because of this disparity and 
the potential for confusion, customers that routinely send orders to 
multiple exchanges have indicated that a more uniform obvious error 
pricing rule with respect to equity options would be beneficial to 
them. Accordingly, in response to the requests of its customers, CBOE 
proposes to adopt an obvious error pricing rule for equity options that 
is structured more like that of other options exchanges. The Exchange 
intends to keep its current obvious error for index options as well as 
options on ETFs and HOLDRS.\7\
---------------------------------------------------------------------------

    \7\ See proposed CBOE Rule 24.16, which is a identical in 
substance to current CBOE Rule 6.25, except that it is limited in 
application to index options and options on ETFs and HOLDRs.
---------------------------------------------------------------------------

    a. Revised Rule CBOE 6.25, Nullification and Adjustment of Equity 
Options Transactions
    Under CBOE's current obvious error rule, there are seven types of 
transactions that qualify as obvious errors. The Exchange proposes to 
reduce this number to four, as described below.
i. Obvious Price Errors
    The Exchange proposes to adopt an obvious price error rule that 
operates almost identically to that of the International Securities 
Exchange (``ISE'') Rule 720, with minor differences. As such, an 
obvious pricing error will be deemed to have occurred when the 
execution price of an electronic transaction (not open outcry) varies 
from the Theoretical Price \8\ by a requisite amount.\9\ When an 
obvious price error occurs, CBOE either will adjust or nullify the 
transaction in accordance with the following principles:
---------------------------------------------------------------------------

    \8\ The Exchange proposes to use a similar definition for 
Theoretical Price as does the ISE. For multiply traded options, 
Theoretical Price will be the last bid (offer) price with respect to 
an erroneous sell (buy) transaction just prior to the trade that is 
disseminated by the competing options exchange with the most 
liquidity in that class over the preceding two calendar months. If 
there are no quotes for comparison purposes, trading officials shall 
determine Theoretical Price. For transactions occurring as part of 
the Rapid Opening System or Hybrid Opening System, Theoretical Price 
shall be the first quote after the transaction(s) in question that 
does not reflect the erroneous transaction(s).
    \9\ The requisite amount is: $0.25 for options below $2, $0.40 
for options priced from $2 to $5, $0.50 for options priced above $5 
to $10, $0.80 for options priced above $10 to $20, and $1.00 for 
options priced above $20.
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    Transactions Between CBOE Market Makers (``MMs''): Transactions 
between CBOE MMs will be adjusted to the Theoretical Price plus/minus 
an ``adjustment penalty'' of either $0.15 or $0.30. Erroneous buy 
transactions will be adjusted to Theoretical Price plus an adjustment 
penalty of either $0.15 if Theoretical Price is below $3 or $0.30 if 
the Theoretical Price is $3 or higher. Conversely, erroneous sell 
transactions will be adjusted to Theoretical Price minus an adjustment 
penalty of either $0.15 if Theoretical Price is below $3 or $0.30 if 
Theoretical Price is $3 or higher. Both parties to the transaction may 
agree to adjust to a different price or nullify the transaction 
altogether provided they do so within fifteen minutes of being notified 
by trading officials that an obvious error occurred.
    Transactions where One Party is not a CBOE MM: Where at least one 
party is not a CBOE MM, the transaction will be nullified by trading 
officials unless both parties agree to an adjustment price for the 
transaction within thirty minutes of being notified by trading 
officials of the obvious error. This is identical to the ISE Rule.
ii. No Bid Series
    This provision, which is identical to current paragraph (a)(7) of 
CBOE Rule 6.25, is renumbered as paragraph (a)(2) of CBOE Rule 6.25.
    iii. Verifiable Disruptions or Malfunctions of Exchange Systems
    This provision, which is identical to current paragraph (a)(3) of 
CBOE Rule 6.25, will apply to transactions occurring electronically or 
in open outcry. For those transactions qualifying for adjustment, there 
will be no adjustment penalty. Accordingly, transactions between CBOE 
MMs will be adjusted to the Theoretical Price. Transactions involving 
at least one CBOE non-member will be nullified unless the parties 
otherwise agree.
iv. Erroneous Print in Underlying
    The Exchange proposes to amend paragraph (a)(4) of CBOE Rule 6.25 
to clarify that a trade resulting from an erroneous print disseminated 
by the underlying market that is later cancelled or corrected by that 
underlying market may only be nullified. The current Rule allows these 
transactions to be adjusted or nullified.
b. Current Provisions Proposed for Elimination
    The Exchange proposes to eliminate current paragraphs (a)(2) 
(Obvious Quantity Error), (a)(5) (Erroneous Quote in Underlying), and 
(a)(6) (Trades Below Intrinsic Value) of CBOE Rule 6.25. Changes to the 
pricing error section, paragraph (a)(1) (Obvious Price Error), render 
these provisions unnecessary.
c. Procedures for Reviewing Transactions
    The Exchange retains its current procedures for reviewing 
transactions, with two minor modifications. First, the Exchange 
proposes to require notification within 15 minutes of the transaction 
in question, regardless of the time it occurred. Currently, for 
transactions occurring after 2:45 p.m. (CST), notification must be 
provided no later than fifteen (15) minutes after the close of trading 
of that security on CBOE. Second, the current Rule gives trading 
officials until 9:30 a.m. the following day to render determinations 
for transactions occurring after 2:30 p.m. Because this creates 
significant overnight exposure risk for both parties, the Exchange 
proposes to require trading officials to render a determination within 
60 minutes of notification, regardless of the time the transaction 
occurred.\10\
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    \10\ ISE also requires same-day determinations regardless of the 
time the transaction occurred. CBOE represents that trading 
officials will remain on Exchange premises until a determination is 
rendered.
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    Currently, the process for appealing determinations regarding 
obvious errors is governed by paragraph (d) of CBOE Rule 6.25, which 
provides for an appeals process under Chapter XIX of the Exchange's 
rules. The Exchange proposes to amend this process and create an 
Obvious Error Panel that will review decisions rendered by trading 
officials. The rules creating and governing the Obvious Error Panel are 
substantially similar to ISE Rule 720. Regarding the composition of the 
panel,

[[Page 77795]]

CBOE, in addition to including one Exchange trading floor liaison, will 
require that the panel be comprised of an equal number of CBOE MMs and 
floor broker members. However, while determinations rendered by ISE's 
Obvious Error Panel constitute final exchange action, CBOE proposes to 
allow parties to appeal decisions of its Obvious Error Panel in 
accordance with the procedures set forth in Chapter XIX of CBOE's 
rules.
2. Statutory Basis
    CBOE represents that the filing provides objective guidelines for 
the nullification or adjustment of transactions executed at clearly 
erroneous prices. Moreover, the proposed rule provides more uniformity 
regarding obvious pricing errors, which will serve to benefit 
customers. For these reasons, 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.\11\ 
Specifically, the Exchange believes the proposed rule change is 
consistent with the requirements of Section 6(b)(5) of the Act \12\ 
that the rules of an exchange be designed to promote just and equitable 
principles of trade, to prevent fraudulent and manipulative acts and 
practices, and, in general, to protect investors and the public 
interest.
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    \11\ 15 U.S.C. 78(f)(b).
    \12\ 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

    No written comments were solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The foregoing proposed rule change (1) does not significantly 
affect the protection of investors or the public interest; (2) does not 
impose any significant burden on competition; and (3) by its terms, 
does not become operative until 30 days from the date on which it was 
filed, or such shorter time as the Commission may designate if 
consistent with the protection of investors and the public interest. 
Furthermore, the Exchange provided the Commission with written notice 
of its intent to file the proposed rule change, along with a brief 
description and text of the proposed rule change, at least five 
business days prior to the date of filing of the proposed rule change. 
Consequently, the proposed rule change has become effective pursuant to 
Section 19(b)(3)(A) of the Act \13\ and Rule 19b-4(f)(6) 
thereunder.\14\
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    \13\ 15 U.S.C. 78s(b)(3)(A).
    \14\ 17 CFR 240.19b-4(f)(6).
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    The Exchange has requested that the Commission waive the 30-day 
operative delay. The Commission believes that waiving the 30-day 
operative delay is consistent with the protection of investors and the 
public interest. The Commission notes that the proposal to amend CBOE's 
obvious error rule provisions is substantially similar to provisions 
contained in ISE Rule 720,\15\ and incorporates certain aspects of 
current CBOE Rule 6.25, which the Commission previously approved. Thus, 
the Commission does not believe that the proposed rule change raises 
any new regulatory issues. In addition, the Commission believes that 
waiver of the 30-day operative delay would enable the Exchange to 
implement the proposal as quickly as possible, and thereby provide for 
greater uniformity with respect to obvious error determinations for 
options transactions. For these reasons, the Commission designates the 
proposal to be effective and operative upon filing with the 
Commission.\16\
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    \15\ See Securities Exchange Act Release No. 48097 (June 26, 
2003), 68 FR 39604 (July 2, 2003) (approving ISE's obvious error 
rule).
    \16\ For purposes only of accelerating the operative date of 
this proposal, the Commission has considered the proposed rule's 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of this 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.

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-2004-83 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-2004-83. 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 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-2004-83 and should be 
submitted on or before January 18, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-28276 Filed 12-27-04; 8:45 am]
BILLING CODE 8010-01-P