[Federal Register Volume 72, Number 248 (Friday, December 28, 2007)]
[Notices]
[Pages 73919-73921]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-25187]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57005; File No. SR-CBOE-2007-122]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of a Proposed Rule Change as Modified by 
Amendment No. 1 Thereto Amending Its Obvious Error Rule for Options on 
Indices, ETFs, and HOLDRS

December 20, 2007.
    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 October 31, 2007, 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 December 14, 2007, the CBOE submitted 
Amendment No. 1 to the proposed rule change. 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.
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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, 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 to change the 
manner in which it applies the obvious price error provision to 
transactions occurring as part of the Hybrid Opening System (``HOSS'') 
process. The text of the proposed rule change is available at the 
Exchange, the Commission's Public Reference Room, and http://www.cboe.com.

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
    The Exchange is proposing to amend CBOE Rule 24.16, which is its 
obvious error rule pertaining to index options, options on ETFs, and 
options on HOLDRS. The proposal would revise the obvious price error 
provision that pertains to transactions occurring as part of the HOSS 
opening rotation process. Currently, Rule 24.16 provides that an 
obvious price error would be deemed to have occurred when the execution 
price of a buy (sell) transaction is above (below) the fair market 
value of the option by at least a prescribed minimum error amount.\3\ 
For purposes of transactions occurring on HOSS, ``fair market value'' 
is currently defined as the midpoint of the first quote after the 
transaction(s) in question that does not reflect the erroneous 
transaction(s). The Exchange is proposing to revise the fair market 
value calculation to provide additional conditions that would apply 
during regular HOSS rotations and during HOSS rotations in index 
options series that are being used to calculate the final settlement 
price of volatility indexes. The additional conditions are intended to 
reasonably factor the amount of available liquidity into the fair 
market value calculation during these rotations.
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    \3\ For example, for series trading with normal bid-ask 
differentials as established in CBOE Rule 8.7(b)(iv), the prescribed 
minimum error amount is as follows: $0.125 if the fair market value 
is below $2, $0.20 if the fair market value is $2 to $5, $0.25 if 
the fair market value is above $5 to 10, $0.40 if the fair market 
value is above $10 to 20, and $0.50 if the fair market value is 
above $20. See CBOE Rule 24.16(a)(1).
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    With respect to regular HOSS rotations, the Exchange is proposing 
to add a condition that the option contract quantity subject to 
nullification or adjustment would not exceed the size of the first 
quote after the transaction(s) in question that does not reflect the 
erroneous transaction(s).\4\ For example, assume that the opening 
transactions in series XYZ totaled 200 contracts at a price $0.75. Also 
assume that a member representing non-CBOE Market-Maker A sold 200 
contracts, trading 100 contracts with CBOE Market-Maker B and 100 
contracts with non-CBOE Market-Maker C. Finally, assume that the first 
quote after the transaction in question that does not reflect the 
erroneous transaction is bid 100 contracts for $0.95 and offered 150 
contracts at $1.15. In this scenario, an erroneous sell transaction 
would be deemed to have occurred in accordance with the obvious price 
error provision because the $0.75 price received by non-CBOE Market-
Maker A is at least $0.125 lower than the fair market value of 
$1.05.\5\ In addition, because the size of the bid in the first quote 
after that does not reflect the erroneous transaction is for 100 
contracts, up to 100 contracts executed on the opening on behalf of 
non-CBOE Market-Maker A would be subject to

[[Page 73920]]

nullification or adjustment under the obvious price error provision.\6\ 
Any nullifications or adjustments would occur on a pro rata basis 
considering the overall size of the HOSS opening trade. Thus, 50 
contracts executed against CBOE Market-Maker B would have a price 
adjustment to $1.05 (provided the adjusted price does not violate A's 
limit price) and 50 contracts executed against non-CBOE Market-Maker C 
would have a price adjustment to $1.05 (provided the adjusted price 
does not violate A's or C's limit price).
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    \4\ For erroneous sell transactions, the size of the bid would 
be used. For erroneous buy transactions, the size of the offer would 
be used.
    \5\ $1.05 is the midpoint of $0.95 and $1.15.
    \6\ A HOSS transaction involving a non-CBOE Market-Maker is 
adjusted based on the first non-erroneous quote after the erroneous 
transaction on CBOE, provided the price does not violate the non-
CBOE Market-Maker's limit price. Otherwise, the transaction is 
nullified. See Rule 24.16(a)(1)(ii)(B) and (c)(3).
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    With respect to HOSS rotations in index options series being used 
to calculate the final settlement price of a volatility index,\7\ the 
Exchange is proposing to add a condition that the first quote after the 
transaction(s) in question that does not reflect the erroneous 
transaction(s) must be for at least the overall size of the HOSS 
opening transaction(s).\8\ If the size of the quote is less than the 
overall size of the opening transaction(s), then the obvious price 
error provision shall not apply. For example, if the opening trade in 
Series XYZ is for a total of 200 contracts and the bid or offer, as 
applicable, of the first quote after the transaction(s) in question 
that does not reflect the erroneous transaction(s) is for 500 
contracts, then the quote would be used to determine the fair market 
value and whether an obvious price error occurred. If the bid or offer, 
as applicable, of the quote is for only 100 contracts, then the trade 
would not be subject to nullification or adjustment under the obvious 
price error provision.
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    \7\ The Exchange states that CBOE's and the CBOE Futures 
Exchange, LLC's (a designated contract market approved by the 
Commodity Futures Trading Commission and a wholly-owned subsidiary 
of CBOE) rules provide for the listing and trading of options and 
futures, as applicable, on various volatility indexes. This proposed 
obvious price error provision would be utilized only for those index 
options series used to calculate the final settlement price of a 
volatility index and only on the final settlement date of the 
options and futures contracts on the applicable volatility index in 
each expiration month. Thus, for example, the proposed obvious price 
error provision would be used for the relevant Standard & Poor's 500 
Stock Index (``SPX'') options series on settlement days for CBOE 
Volatility Index (``VIX'') options and futures contracts. The 
Exchange notes that, during the final settlement date, traders 
holding hedged volatility futures positions to settlement can be 
expected to trade out of their SPX options on that date. Traders who 
hold short, hedged VIX futures would liquidate that hedge by selling 
their SPX options, while traders holding long, hedged VIX positions 
would liquidate their hedge by buying SPX options. In order to seek 
convergence with the VIX final settlement value, these traders would 
be expected to liquidate their hedges by submitting orders in the 
appropriate SPX option series during the SPX opening on the final 
settlement date of the VIX futures contract. To the extent: (i) 
traders who are liquidating hedges predominately are on one side of 
the market (e.g., seek to buy the particular SPX options); and (ii) 
those traders' orders predominate over other orders during the SPX 
opening on the final settlement date for the VIX futures contract, 
trades to liquidate hedges may contribute to an order imbalance 
during the SPX opening on that date. The same is equally applicable 
with respect to the final settlement dates of other volatility index 
options and futures. In light of this potential for a large order 
imbalance in the applicable series on these dates, the Exchange 
believes that the application of a modified obvious price error 
provision is reasonable and appropriate and will contribute to a 
fair and orderly opening.
    \8\ See supra note 4.
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2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with 
Section 6(b) of the Act,\9\ in general, and furthers the objectives of 
Section 6(b)(5) of the Act,\10\ in particular, in that it is designed 
to promote just and equitable principles of trade, serve to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and to protect investors and the public 
interest.
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    \9\ 15 U.S.C. 78f(b).
    \10\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition 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.

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, 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 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-2007-122 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-2007-122. 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, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such 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-2007-122 and should be 
submitted on or before January 18, 2008.


[[Page 73921]]


    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-25187 Filed 12-27-07; 8:45 am]
BILLING CODE 8011-01-P