[Federal Register Volume 71, Number 244 (Wednesday, December 20, 2006)]
[Notices]
[Pages 76393-76395]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-21654]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54926; File No. SR-CBOE-2006-62]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change and Amendment 
No. 1 Thereto Amending its Index Obvious Error Rule

 December 13, 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 July 7, 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, II, and III below, which Items have been substantially 
prepared by the Exchange. On October 30, 2006, the CBOE submitted 
Amendment No. 1 to the proposed rule change.\3\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 (``Amendment No. 1'') supersedes and 
replaces the original filing in its entirety. The substance of 
Amendment No. 1 is incorporated into this notice.
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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 CBOE Rule 24.16 (``Rule''), which is 
the Exchange's rule applicable to the nullification and adjustment of 
transactions in index options, options on exchange-traded funds 
(``ETFs''), and options on HOLDing Company Depository ReceiptS 
(``HOLDRS''). The Exchange is proposing to amend the Rule in order to: 
(i) re-define what constitutes an ``obvious price error;'' (ii) provide 
for a Market-Maker to Market-Maker adjustment of obvious price errors 
(currently such erroneous transactions are subject to nullification); 
(iii) eliminate the nullification and adjustments provisions for 
erroneous quantity errors; and (iv) make various non-substantive 
changes to the text of the Rule.
    Below is the text of the proposed rule change. Proposed new 
language is in italics and proposed deletions are in [brackets].
Chicago Board Options Exchange, Incorporated
Rules
* * * * *
Rule 24.16. Nullification and Adjustment of [Index Option] Transactions 
in Index Options, Options on ETFs and Options on HOLDRS
    RULE 24.16. This Rule only governs the nullification and adjustment 
of transactions involving index options and options on ETFs or 
HOLDRS[s]. Rule 6.25 governs the nullification and adjustment of 
transactions involving equity options. Paragraphs (a)(1), [(2),] ([6]5) 
and ([7]6) 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, as provided herein, 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 price[ing] 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 
minimum error amount. For series trading with normal bid-ask 
differentials as established in Rule 8.7(b)(iv), the prescribed minimum 
error 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.]

------------------------------------------------------------------------
                                                                Minimum
                      Fair market value                          error
                                                                 amount
------------------------------------------------------------------------
Below $2.....................................................     $0.125
$2 to $5.....................................................      $0.20
Above $5 to $10..............................................      $0.25
Above $10 to $20.............................................      $0.40
Above $20....................................................      $0.50
------------------------------------------------------------------------

    For series trading with bid-ask differentials that are [greater 
than]a multiple of the widths established in Rule 8.7(b)(iv), the 
prescribed minimum error amount shall have the same multiple applied to 
the minimum error amount prescribed above[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;

[[Page 76394]]

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 midpoint of 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 midpoint of the first quote after the transaction(s) in question 
that does not reflect the erroneous transaction(s). The determination 
of fair market value shall be made by Trading Officials in accordance 
with the provisions of this paragraph.
    (ii) Price Adjustment or Nullification: Obvious price errors will 
be adjusted or nullified in accordance with the following:
    (A) 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 upon notification 
pursuant to paragraph (b) and in accordance with the adjustment and 
nullification provisions of paragraph (c)(1) below.
    (B) Transactions involving at least one non-CBOE Market-Maker: 
Where one of the parties to the transaction is not a CBOE Market-Maker, 
the transaction will be adjusted or nullified by Trading Officials upon 
notification pursuant to paragraph (b) and in accordance with the 
adjustment and nullification provisions of paragraph (c)(3) below.
    [(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)-(7) Renumbered to (2)-(6)
    (b) No change.
    (c) Adjustments and Nullifications
    (1) Transactions between CBOE Market-Makers pursuant to paragraph 
(a)(1) shall be adjusted to the fair market value minus (plus) the 
prescribed minimum error amount with respect to an erroneous sell (buy) 
transaction. If the adjusted price is not in a multiple of the 
applicable minimum trading increment, the adjusted price will be 
rounded down (up) to the next price that is a multiple of the 
applicable minimum trading increment with respect to an erroneous sell 
(buy) transaction.
    (2) Transactions between CBOE Market-Makers pursuant to paragraphs 
(a)(2)-(a)(5) shall be nullified.
    (3) [Unless otherwise specified in Rule 24.16(a)(1)-(6), 
t]Transactions involving at least one non-CBOE Market-Maker pursuant to 
paragraphs (a)(1) through (a)(5) will be adjusted provided the adjusted 
price does not violate the [customer's]non-CBOE Market-Maker's limit 
price. Otherwise, the transaction will be nullified. With respect to 
Rule 24.16(a)(1)(ii)(B)-(a)(4)[(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 Rule 24.16(a)([6]5), the transaction shall be adjusted to a price 
that is $0.10 under parity.
    (d)-(e) 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, as 
amended, and discussed any comments it received on the proposed rule 
change, as amended. 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
    The Exchange is proposing to make various amendments to CBOE Rule 
24.16, which is its obvious error rule pertaining to index options, 
options on ETFs, and options on HOLDRS. First, the Exchange states that 
the proposal would revise the scale used to identify the minimum error 
amount necessary to constitute an obvious price error. Specifically, an 
``obvious price error'' would be deemed to have occurred for series 
trading with normal bid-ask differentials as established in CBOE rule 
8.7(b)(iv) when the execution price of a transaction is above or below 
the fair market value of the option by at least: $0.125 for options 
trading under $2; $0.20 for options trading at or above $2 and up to 
$5; $0.25 for options trading above $5 and up to $10; $0.40 for options 
trading above $10 and up to $20; and $0.50 for options trading above 
$20. For series trading with bid-ask differentials that are a multiple 
of the widths established in CBOE rule 8.7(b)(iv), the prescribed error 
amount would have the same multiple applied to the amounts prescribed 
above. For example, if double-wide bid-ask relief has been granted in 
an option that currently trades at a price of $6, the minimum error 
amount would be $0.50 above or below the fair market value.\4\
    Second, the Exchange states that the proposal would revise the 
obvious price error provision as it relates to the handling of 
transactions involving only CBOE Market-Makers. Under the current rule, 
such erroneous price transactions are nullified. Under the proposal, 
these CBOE-Market-Maker-to-CBOE-Market-Maker transactions would be 
subject to adjustment.\5\ The Exchange states that

[[Page 76395]]

this change is intended to address feedback from Exchange members that 
an adjustment is preferential to having a transaction nullified because 
in many instances the CBOE Market-Makers that are parties to the 
transaction may have already hedged the option position before being 
alerted to the erroneous price error. The CBOE notes that the change is 
also consistent with the Exchange's current procedures for adjusting 
erroneous price errors in equity options involving CBOE Market-
Makers.\6\
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    \4\ The Exchange states that under the current rule, an 
``obvious pricing error'' is 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 CBOE 
rule 8.7(b)(iv), the prescribed amount is: (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 CBOE rule 8.7(b)(iv), the 
prescribed error amount is: (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. See CBOE rule 24.16(a)(1). The Exchange states that the 
definition of fair market value will continue to apply as it 
currently does today. However, the Exchange is proposing to clarify 
in the text of the rule that, with respect to singly-listed issues 
and transactions occurring as part of ROS or HOSS, the fair market 
value is the midpoint of the first quote after the transaction(s) in 
question that does not reflect the erroneous transaction(s). 
Additionally, the Exchange is proposing to clarify that the 
determination of fair market value is made by Trading Officials in 
accordance with the provisions of CBOE rule 24.16(a)(1)(i). 
Telephone conference between Michou H.M. Nguyen, Special Counsel, 
Division of Market Regulation, Commission, and Jennifer Lamie, 
Managing Senior Attorney, Exchange, on October 31, 2006.
    \5\ The Exchange states that the proposed revisions to the text 
of the rule make clear that the manner in which obvious price errors 
involving at least one non-CBOE Market-Maker are handled will 
continue to apply unchanged. In addition, the proposed revisions to 
the text of the rule make clear that the manner in which other 
obvious errors (i.e., obvious errors related to verifiable 
disruptions or malfunctions of Exchange systems, erroneous prints or 
quotes in the underlying, trades below intrinsic value, and no bid 
series) will also continue to apply unchanged. See proposed 
revisions to CBOE rule 24.16(c).
    \6\ See CBOE rule 6.25(a)(1).
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    The Exchange states that in applying the proposed CBOE Market-Maker 
adjustment provision to index options/ETF/HOLDRS, the adjustment price 
would be equal to the fair market value of the option minus the minimum 
error amount in the case of an erroneous sell transaction or the fair 
market value plus the minimum error amount in the case of an erroneous 
buy transaction. If the adjusted price is not in a multiple of the 
applicable minimum trading increment, the adjusted price would be 
rounded down (up) to the next price that is a multiple of the 
applicable minimum trading increment with respect to an erroneous sell 
(buy) transaction. For example, if an erroneous sale transaction 
involving two CBOE Market-Makers occurred in an option with a fair 
market value of $6.075 and a minimum trading increment of $0.10, the 
adjusted price would be $5.80 ($6.075 - $0.25 = $5.825, which is 
rounded down to the nearest $0.10 increment of $5.80).
    Third, the Exchange states that the proposal would eliminate 
obvious quantity errors as a type of transaction that is subject to 
obvious error review. The Exchange represents that elimination of this 
provision is consistent with the Exchange's current rule for equity 
options, which does not have an obvious error review for quantity 
errors.\7\
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    \7\ See CBOE rule 6.25(a).
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    Fourth, the Exchange states that the proposal would make various 
non-substantive changes to CBOE rule 24.16, such as making cross-
reference updates to correspond to the above-described revisions, 
changing the title of the rule to reflect its application to options on 
ETFs and HOLDRS (currently the title only references index options), 
clarifying that fair market value is as determined by Exchange Trading 
Officials who administer the obvious error rule, and making other non-
substantive changes for ease of understanding the existing text.
2. Statutory Basis
    The Exchange believes the proposed rule change, as amended, 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 
it is designed to promote just and equitable principles of trade, 
prevent fraudulent and manipulative acts, 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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    \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, as 
amended, 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 by the Exchange with 
respect to the proposed rule change, as amended.

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 Exchange consents, the Commission will:
    A. By order approve the proposed rule change, as amended, 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-2006-62 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 20549-1090.

All submissions should refer to File Number SR-CBOE-2006-62. 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 Exchange. 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-2006-62 and should be submitted on or before January 10, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E6-21654 Filed 12-19-06; 8:45 am]
BILLING CODE 8011-01-P