[Federal Register Volume 71, Number 12 (Thursday, January 19, 2006)]
[Notices]
[Pages 3138-3141]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-519]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53101; File No. SR-CBOE-2006-03]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing and Immediate Effectiveness of Proposed 
Rule Change To Expand the Matching Algorithm Possibilities for Equity 
Options To Match Those Available for Index Options

January 11, 2006.
    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 9, 2006, the Chicago Board Options Exchange, Incorporated 
(``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 CBOE. The 
Exchange has filed the proposal pursuant to section 19(b)(3)(A) of the 
Act \3\ and Rule 19b-4(f)(6) thereunder,\4\ which renders the proposal 
effective upon filing with the Commission. 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.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to expand the matching algorithm 
possibilities for equity options to match those available for index 
options. The Exchange has designated this proposal as non-controversial 
and has requested that the Commission waive the 30-day pre-operative 
waiting period contained in Rule 19b-4(f)(6)(iii) under the Act.\5\
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    \5\ 17 CFR 240.19b-4(f)(6)(iii).
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    The text of the proposed rule change is available on the Exchange's 
Web site (http://www.cboe.com), at the principal office of the 
Exchange, and at the Commission's Public Reference Room. The text of 
the proposed rule change is also set forth below. Proposed new language 
is italicized; deletions are in [brackets].

Rule 6.45A. Priority and Allocation of Equity Option Trades on the CBOE 
Hybrid System

* * * * *
    (a) Allocation of Incoming Electronic Orders: [The Exchange shall 
apply, for each class of options, the following rules of trading 
priority.] The appropriate Exchange procedures committee will determine 
to apply, for each class of options, one of the following rules of 
trading priority described in paragraphs (i) or (ii). The Exchange will 
issue a Regulatory Circular periodically specifying which priority 
rules will govern which classes of options any time the appropriate 
Exchange committee changes the priority.
    (i) Ultimate Matching Algorithm (``UMA''): No change.
    (A) Priority of Orders in the Electronic Book--No Change.
    (ii) Price-Time or Pro-Rata Priority
    Price-Time Priority: Under this method, resting quotes and orders 
in the book are prioritized according to price and time. If there are 
two or more quotes or orders at the best price then priority is 
afforded among these quotes or orders in the order in which they were 
received by the Hybrid System; or
    Pro-Rata Priority: Under this method, resting quotes and orders in 
the book are prioritized according to price. If there are two or more 
quotes or orders at the best price then trades are allocated 
proportionally according to size (in a pro-rata fashion). The 
executable quantity is allocated to the nearest whole number, with 
fractions \1/2\ or greater rounded up and fractions less than \1/2\ 
rounded down. If there are two market participants that both are 
entitled to an additional \1/2\ contract and there is only one contract 
remaining to be distributed, the additional contract will be 
distributed to the market participant whose quote or order has time 
priority.
    Additional Priority Overlays Applicable to Price-Time or Pro-Rata 
Priority Methods
    In addition to the base allocation methodologies set forth above, 
the appropriate Exchange procedures committee may determine to apply, 
on a class-by-class basis, one or more of the following designated 
market participant overlay priorities in a sequence determined by the 
appropriate Exchange procedures committee. The

[[Page 3139]]

Exchange will issue a Regulatory Circular periodically which will 
specify which classes of options are subject to these additional 
priorities as well as any time the appropriate Exchange procedures 
committee changes these priorities.
    (1) Public Customer: When this priority overlay is in effect, the 
highest bid and lowest offer shall have priority except that public 
customer orders shall have priority over non-public customer orders at 
the same price. If there are two or more public customer orders for the 
same options series at the same price, priority shall be afforded to 
such public customer orders in the sequence in which they are received 
by the System, even if the Pro-Rata Priority allocation method is the 
chosen allocation method. For purposes of this Rule, a Public Customer 
order is an order for an account in which no member, non-member 
participant in a joint-venture with a member, or non-member broker-
dealer (including a foreign broker-dealer) has an interest.
    (2) Participation Entitlement: The appropriate Exchange procedures 
committee may determine to grant Market-Makers participation 
entitlements pursuant to the provisions of Rules 8.87, 8.13, or 8.15B. 
In allocating the participation entitlement, all of the following shall 
apply:
    (A) To be entitled to their participation entitlement, the Market-
Maker's order and/or quote must be at the best price on the Exchange.
    (B) The Market-Maker may not be allocated a total quantity greater 
than the quantity that it is quoting (including orders not part of 
quotes) at that price. If Pro-Rata Priority is in effect, and Market-
Maker's allocation of an order pursuant to its participation 
entitlement is greater than its percentage share of quotes/orders at 
the best price at the time that the participation entitlement is 
granted, the Market-Maker shall not receive any further allocation of 
that order.
    (C) In establishing the counterparties to a particular trade, the 
participation entitlement must first be counted against that Market-
Maker's highest priority bids or offers.
    (D) The participation entitlement shall not be in effect unless the 
Public Customer priority is in effect in a priority sequence ahead of 
the participation entitlement and then the participation entitlement 
shall only apply to any remaining balance.
    (3) Market Turner: ``Market Turner'' means a party that was the 
first to enter an order or quote at a better price than the previous 
best disseminated Exchange price and the order (quote) is continuously 
in the market until the particular order (quote) trades. There may be a 
Market Turner for each price at which a particular order trades. When 
this priority overlay is in effect, the Market Turner has priority at 
the highest bid or lowest offer that he established. The Market Turner 
priority at a given price remains with the order (quote) once it is 
earned. For example, if the market moves in the same direction as the 
direction in which the order from the Market Turner moved the market, 
and then the market moves back to the Market Turner's original price, 
then the Market Turner retains priority at the original price. Market 
Turner priority cannot be established until after the opening print 
and/or the conclusion of the opening rotation and, once established, 
shall remain in effect until the conclusion of the trading session.
    The appropriate Exchange procedures committee may determine, on a 
class-by-class basis, to reduce the Market Turner priority to a 
percentage of each inbound order that is executable against the Market 
Turner. In such cases, the Market Turner may participate in the balance 
of an order, pursuant to the allocation procedure in effect, after the 
Market Turner priority has been applied. To the extent the Market 
Turner order (quote) is not fully exhausted, it shall retain Market 
Turner priority for subsequent inbound orders until the conclusion of 
the trading session.
    (b) Allocation of Orders Represented in Open Outcry: The allocation 
of orders that are represented in open outcry by floor brokers or PAR 
Officials shall be as described below in subparagraphs (b)(i) and 
(b)(ii). With respect to subparagraph (b)(ii), the floor broker or PAR 
Official representing the order shall determine the sequence in which 
bids (offers) are made.
    (i) Priority of Orders in the Electronic Book.
    (A) Public Customer Orders: No change.
    (B) Broker-dealer Orders: If pursuant to Rule 7.4(a) the 
appropriate FPC determines to allow broker-dealer orders to be placed 
in the electronic book, then for purposes of this rule, the cumulative 
number of broker-dealer orders in the electronic book at the best price 
shall be deemed one ``book market participant'' regardless of the 
number of broker-dealer orders in the book. The allocation due the 
broker-dealer orders in the electronic book by virtue of their being 
deemed a ``book market participant'' shall be in accordance with 
paragraph (ii) below and shall be distributed among each broker-dealer 
order comprising the ``book market participant'' in accordance with the 
Allocation Algorithm formula in effect pursuant to Rule 6.45A(a) 
[described in paragraph 6.45A(a)(i)(B)].
    (ii)-(iv) No change.
    (c)-(e) No change.

* * * Interpretations and Policies:

    .01-.02 No change.
* * * * *

Rule 6.45B Priority and Allocation of Trades in Index Options and 
Options on ETFs on the CBOE Hybrid System

* * * * *
    (a) No change.
    (b) Allocation of Orders Represented in Open Outcry: The allocation 
of orders that are represented in the trading crowd by floor brokers or 
PAR Officials shall be as described below in subparagraphs (b)(i) and 
(b)(ii). With respect to subparagraph (b)(ii), the floor broker or PAR 
Official representing the order shall determine the sequence in which 
bids (offers) are made.
    (i) Priority of Orders in the Electronic Book.
    (A) Public Customer Orders: No change.
    (B) Broker-dealer Orders: If pursuant to Rule 7.4(a) the 
appropriate Exchange procedures committee determines to allow broker-
dealer orders to be placed in the electronic book, then for purposes of 
this rule, the cumulative number of broker-dealer orders in the 
electronic book at the best price shall be deemed one ``book market 
participant'' regardless of the number of broker-dealer orders in the 
book. The allocation due the broker-dealer orders in the electronic 
book by virtue of their being deemed a ``book market participant'' 
shall be in accordance with paragraph (ii) below and shall be 
distributed among each broker-dealer order comprising the ``book market 
participant'' in accordance with the Allocation Algorithm formula in 
effect pursuant to Rule 6.45B(a) [described in paragraph 
6.45B(a)(ii)(B)].
    (ii)-(iii) No change.
    (c)-(d) No change.

* * * Interpretations and Policies:

    .01-.02 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

[[Page 3140]]

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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    CBOE Rule 6.45A sets forth, among other things, the manner in which 
electronic Hybrid trades in equity options are allocated. Paragraph (a) 
of CBOE Rule 6.45A essentially governs how orders received 
electronically by the Exchange are electronically executed against 
interest in the CBOE quote. Paragraph (a) of CBOE Rule 6.45A currently 
provides that such electronic trades be allocated pursuant to a 
matching algorithm called the Ultimate Matching Algorithm (``UMA''). 
CBOE Rule 6.45B establishes the manner in which electronic Hybrid 
trades in Index options and options on exchange traded funds (``ETFs'') 
are allocated.\6\ Unlike CBOE Rule 6.45A, which is applicable to equity 
options (which essentially requires UMA for all electronic Hybrid 
equity option trading), CBOE Rule 6.45B provides a ``menu'' of matching 
algorithms to choose from for each product traded pursuant to that 
rule. That menu includes UMA as well as price-time priority and pro-
rata priority matching scheme (with several optional priority 
overlays). The menu format allows the Exchange to utilize different 
matching algorithms by product.
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    \6\ For details on that rule, see Securities Exchange Release 
No. 51822 (June 10, 2005), 70 FR 35321 (June 17, 2005) (SR-CBOE-
2004-87).
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    The Exchange states that the purpose of the proposed rule change is 
to adopt a menu for equity option trading by carrying over the matching 
options available under CBOE Rules 6.45B(a) to 6.45A(a). The Exchange 
states that this will enable the Exchange to utilize price-time 
priority or pro-rata priority (along with the optional market turner 
priority,\7\ customer priority, and participation entitlement priority 
overlays) for equity option trading. As proposed, these ``new'' 
matching algorithms are identical to the matching algorithms available 
to index and ETF options. Thus, the Exchange states that there are no 
new types of matching algorithms being proposed herein, and this 
proposed rule change would merely expand the products that can use 
these other priority allocation algorithms.
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    \7\ For information on market-turner priority, see Securities 
Exchange Release No. 52659 (October 24, 2005), 70 FR 62149 (October 
28, 2005) (SR-CBOE-2005-85).
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    Moreover, the proposed rule change also proposes a minor change to 
the open outcry section of the Hybrid trading rules (CBOE Rule 6.45A(b) 
for equity options and CBOE Rule 6.45B(b) for index options) to ensure 
they are consistent with whichever electronic matching algorithm is in 
place pursuant to paragraph (a) of both rules. More specifically, 
paragraph (b) of both rules governs how orders represented in open 
outcry interact with interest resting in the Hybrid quote. The Exchange 
states that broker-dealer orders resting in that quote at the execution 
price are deemed one ``book market participant'' for purposes of 
determining how many contracts should be allocated to the broker-
dealers' orders collectively. Once that determination has been made, 
however, the allocation of those contracts between the broker-dealer 
orders is handled systematically. Currently, the rules provide that the 
UMA formula is used to systematically distribute the contracts between 
those orders (that is because UMA is the only available algorithm for 
equity options under CBOE Rule 6.45A). However, the system is 
programmed to allocate those contracts between those broker-dealer 
orders using whichever matching algorithm is in place for electronic 
executions for the subject option class under paragraph (a) of both 
rules (which under the ``menu'' structure could be matching algorithms 
other than UMA). As proposed, CBOE Rule 6.45A(b) as well as CBOE Rule 
6.45B(b) would be modified to reflect that possibility.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \8\ in general, and furthers the 
objectives of section 6(b)(5) of the Act \9\ in particular, in that the 
rules of an exchange be designed to promote just and equitable 
principles of trade, and to protect investors and the public interest.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 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 
result in 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

    Written comments were neither solicited nor received.

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

    The foregoing proposed rule change is subject to section 
19(b)(3)(A)(iii) of the Act \10\ and Rule 19b-4(f)(6) thereunder \11\ 
because the proposal: (i) Does not significantly affect the protection 
of investors or the public interest; (ii) does not impose any 
significant burden on competition; and (iii) does not become operative 
prior to 30 days after the date of filing or such shorter time as the 
Commission may designate if consistent with the protection of investors 
and the public interest; provided that the Exchange has given the 
Commission 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, or such shorter time as designated by the Commission.
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    \10\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \11\ 17 CFR 240.19b-4(f)(6).
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    The CBOE has satisfied the five-day pre-filing requirements. In 
addition, the Exchange has requested that the Commission waive the 30-
day operative delay. The Commission notes that this proposal would 
provide equity option products with a similar menu of priority 
allocation methodologies currently available for index option products 
(such as price-time, pro-rata, and several optional priority overlays). 
Thus, the Commission believes that there is no new regulatory issues 
herein such that waiving the 30-day operative delay is consistent with 
the protection of investors and the public interest. The waiver will 
permit the Exchange to implement the proposed rule change without delay 
and thereby providing additional priority allocation options to equity 
option trading on the Exchange. For these reasons, the Commission 
designates the proposal to be effective and operative upon filing with 
the Commission.\12\
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    \12\ 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 such proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is

[[Page 3141]]

necessary or appropriate in the public interest, for the protection of 
investors or otherwise in furtherance of the purposes of the Act.\13\
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    \13\ See section 19(b)(3)(C) of the Act, 15 U.S.C. 78s(b)(3)(C).
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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. 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-2006-03 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303

.All submissions should refer to File Number SR-CBOE-2006-03. 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 Room. Copies of the 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-2006-03 and should be submitted on or before February 9, 2006.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-519 Filed 1-18-06; 8:45 am]
BILLING CODE 8010-01-P