[Federal Register Volume 78, Number 47 (Monday, March 11, 2013)]
[Notices]
[Pages 15385-15392]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-05543]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69040; File No. SR-BX-2013-016]


Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Notice of 
Filing of Proposed Rule Change To Adopt a Directed Order Process

March 5, 2013.
    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 February 21, 2013, NASDAQ OMX BX, Inc. (``BX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II, 
and III, below, which Items have been prepared by the Exchange. 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange has filed a proposed rule change offering a new 
enhancement [sic] to adopt a Direct Order process.
    The text of the proposed rule change is below. Proposed new 
language is in italics; deletions are bracketed.
* * * * *

Chapter VI Trading Systems

* * * * *

[[Page 15386]]

Sec. 1 Definitions

    The following definitions apply to Chapter VI for the trading of 
options listed on BX Options.
    (a)-(d) No change.
    (e) The term ``Order Type'' shall mean the unique processing 
prescribed for designated orders that are eligible for entry into the 
System, and shall include:
    (1) [Reserved.] Directed Order. The term ``Directed Order'' means 
an order to buy or sell which has been directed (pursuant to the 
Exchange's instructions on how to direct an order) to a particular 
Market Maker (``Directed Market Maker'') after the opening. Directed 
Orders are handled within the System pursuant to Chapter VI, Section 
10(3).
    (2)-(11) No change.
    (f)-(h) No change.
* * * * *

Sec. 6 Acceptance of Quotes and Orders

    All bids or offers made and accepted on BX Options in accordance 
with the BX Options Rules shall constitute binding contracts, subject 
to applicable requirements of the Rules of the Exchange and the Rules 
of the Clearing Corporation.
    (a) General--A System order is an order that is entered into the 
System for display and/or execution as appropriate. Such orders are 
executable against marketable contra-side orders in the System.
    (1) All System Orders shall indicate whether they are a call or put 
and buy or sell and a price, if any. Systems Orders can be designated 
as Immediate or Cancel (``IOC''), Good-till-Cancelled (``GTC''), Day 
(``DAY'') or WAIT.
    (2) A System order may also be designated as a Directed Order, 
Limit Order, a Minimum Quantity Order, a Market Order, a Price 
Improving Order, an All-or-None Order or a Post-Only Order.
    (b)-(c) No change.
* * * * *

Sec. 10 Book Processing

    System orders shall be executed through the BX Book Process set 
forth below:
    (1)-(2) No change.
    (3) [Price Improvement--any potential price improvement resulting 
from an execution in the System shall accrue to the party that is 
removing liquidity previously posted to the Book.]
    Directed Order Processing.
    (i) When BX's disseminated price is the NBBO and the Directed 
Market Maker is quoting at BX's disseminated price, the Directed Order 
shall be executed and allocated as follows:
    (A) If the option is subject to the Price/Time execution algorithm, 
the Directed Market Maker shall receive 40% of the Directed Order at a 
particular price (``Directed Allocation''), unless such Directed Market 
Maker was first in time priority, in which case such Directed Market 
Maker shall receive the amount of the Directed Order equal to the 
Directed Market Maker's quote/order size at that price. If there are 
multiple resting quotes/orders from the same Directed Market Maker, the 
Directed Allocation will be distributed among them in time sequence. 
Then, the remainder of the Directed Order shall be allocated to other 
participants in price/time priority, including any remaining contracts 
of the Directed Market Maker and multiple quotes/orders from the same 
firm.
    (B) If the option is subject to the Pro-Rata execution algorithm, 
Public Customer limit orders resting on the limit order book at the 
execution price will execute against the Directed Order first. Then, 
the Directed Market Maker shall receive the greater of: the pro-rata 
allocation to which such Directed Market Maker would otherwise be 
entitled or the Directed Allocation of 40% of the Directed Order at a 
particular price. If there are multiple quotes/orders from the same 
Directed Market Maker, the Directed Allocation will be distributed 
among those quotes/orders on a size pro rata basis. Once the Directed 
Allocation is determined, any remaining contracts associated with the 
Directed Market Maker's quotes/orders are excluded from the remaining 
pro-rata allocation. If there are any remaining contracts of the 
Directed Order, they will be allocated on a size pro rata basis among 
the remaining Participants (except the Directed Market Maker).
    (ii) When BX's disseminated price is the NBBO, and the quotation 
disseminated by the Directed Market Maker on the opposite side of the 
market from the Directed Order is inferior to the NBBO, the Directed 
Order shall be automatically executed and allocated to those quotations 
and orders at the NBBO in accordance with this Section.
    (iii) If BX's disseminated price is not the NBBO, the Directed 
Order shall be processed in accordance with Chapter VI, Sections 7, 10 
and 11.
    (iv) In addition, the following will apply:
    (A) A Directed Market Maker shall not be entitled to receive a 
number of contracts that is greater than the size associated with their 
order or quote at a particular price level.
    (B) Directed Allocations are rounded up to the next whole number.
    (C) The Directed Allocation is available for the life of the order 
and the Directed Market Maker is entitled to the Directed Allocation at 
all price levels that the Directed Market Maker has an order or quote.
    (D) Directed Market Makers are subject to the quoting requirements 
of Chapter VII, Section 6(d)(i)(4).
    (E) The Exchange will determine which options are subject to 
Directed Allocation.
    (4)-(7) No change.
    (8) Price Improvement--any potential price improvement resulting 
from an execution in the System shall accrue to the party that is 
removing liquidity previously posted to the Book.
* * * * *

Chapter VII Market Participants

* * * * *

Sec. 6 Market Maker Quotations

    (a)-(c) No change.
    (d) Continuous Quotes. A Market Maker must enter continuous bids 
and offers for the options to which it is registered, as follows:
    i. On a daily basis, a Market Maker must during regular market 
hours make markets consistent with the applicable quoting requirements 
specified in these rules, on a continuous basis [in at least sixty 
percent (60%) of the series] in options in which the Market Maker is 
registered.
    (1) To satisfy this requirement [with respect to quoting a series], 
a Market Maker must quote[ such series] 60[90]% of the trading day (as 
a percentage of the total number of minutes in such trading day) or 
such higher percentage as BX may announce in advance. BX Regulation may 
consider exceptions to the requirement to quote 60[90]% (or higher) of 
the trading day based on demonstrated legal or regulatory requirements 
or other mitigating circumstances. This obligation will apply to all of 
a Market Maker's registered options collectively, rather than on an 
option-by-option basis. Compliance with this obligation will be 
determined on a monthly basis.
    (2) Notwithstanding the foregoing, Market Makers shall not be 
required to make two-sided markets pursuant to Section 5(a)(i) of these 
rules in any Quarterly Option Series, any adjusted option series, and 
any option series until the time to expiration for such series is less 
than nine months. Accordingly, the continuous quotation obligations set 
forth in this rule shall not apply to Market Makers respecting 
Quarterly Option Series, adjusted option

[[Page 15387]]

series, and series with an expiration of nine months or greater. For 
purposes of this subsection (2), an adjusted option series is an option 
series wherein one option contract in the series represents the 
delivery of other than 100 shares of underlying stock or Exchange-
Traded Fund Shares.
    (3) If a technical failure or limitation of a system of BX prevents 
a Market Maker from maintaining, or prevents a Market Maker from 
communicating to BX Options timely and accurate quotes, the duration of 
such failure or limitation shall not be included in any of the 
calculations under this subparagraph (i) with respect to the affected 
quotes.
    (4) In options in which it receives Directed Orders, a Directed 
Market Maker must quote such options 90% of the trading day (as a 
percentage of the total number of minutes in such trading day) or such 
higher percentage as BX may announce in advance, applied collectively 
to all series in all of the options in which the Directed Market Maker 
receives Directed Orders (rather than on an option-by-option basis). 
Compliance with this obligation will be determined on a monthly basis.
    ii.-iii. No change.
    (e) 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 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 the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The BX Options market launched on June 29, 2012 as a fully 
automated, price/time priority execution system built on the core 
functionality of the NASDAQ Options Market (``NOM'').\3\ BX Options 
operates as an all-electronic system (``System'') with no physical 
trading floor and provides for the electronic display and execution of 
orders. In its proposed rule change to create the BX Options market, BX 
stated that, initially, BX Options would have the same market structure 
and rules as NOM, focusing on a price/time priority market.\4\ BX 
further stated that, over time, as the BX Options market secured more 
participants, it would introduce additional, innovative 
functionality.\5\ Accordingly, BX recently introduced a Size Pro-Rata 
execution algorithm for BX Options,\6\ which executes orders at a 
particular price level based on the size of each Participant's quote or 
order as a percentage of the total size of all orders and quotes 
resting at that price. BX intends for some options to employ one 
algorithm while others employ a different one.
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    \3\ See BX Options Rules, Chapter VI, Section 1(e)(11). 
Securities Exchange Act Release No. 67256 (June 26, 2012), 77 FR 
39277 (July 2, 2012) (SR-BX-2012-030) (Approving the establishment 
of the BX Options market).
    \4\ See id. at 39278.
    \5\ Securities Exchange Act Release No. 66983 (May 14, 2012), 77 
FR 29730 (May 18, 2012) (Notice of filing of SR-BX-2012-030).
    \6\ Securities Exchange Act Release No. 68041 (October 11, 
2012), 77 FR 63903 (October 17, 2012) (SR-BX-2012-065).
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    At this time, BX proposes its next enhancement to BX Options by 
offering a directed order process.\7\ BX proposes to amend various 
rules to establish the process. First, BX proposes to define a Directed 
Order in Chapter VI, Section 1(e)(1) as an order to buy or sell which 
has been directed (pursuant to the Exchange's instructions on how to 
direct an order) to a particular Market Maker (``Directed Market 
Maker'') after the opening.\8\ It further provides that Directed Orders 
are handled within the System pursuant to Chapter VI, Section 10(3), 
which is proposed new language.\9\
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    \7\ The term directed order has a different meaning on equities 
markets. See e.g., NASDAQ Rule 4751(a)(9)[sic].
    \8\ BX also proposes to amend Chapter VI, Section 6(a)(2) to add 
Directed Orders to the list of System orders.
    \9\ Currently, Section 10(3) governs price improvement. It is 
being moved to new Section 10(8).
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    Pursuant to proposed Chapter VI, Section 10(3)(i), when BX's 
disseminated price is the National Best Bid/Offer (``NBBO'') and the 
Directed Market Maker is quoting at BX's disseminated price, the 
Directed Order shall be executed and allocated pursuant to one of BX's 
two execution algorithms for options.\10\ If the option is subject to 
the Price/Time execution algorithm,\11\ the Directed Market Maker shall 
receive 40% of the Directed Order (``Directed Allocation''), unless 
such Directed Market Maker was first in time priority, in which case 
such Directed Market Maker shall receive the amount of the Directed 
Order equal to the Directed Market Maker's quote/order size at that 
price. If there are multiple resting quotes/orders from the same 
Directed Market Maker, the Directed Allocation will be distributed 
among them in time sequence. Then, the remainder of the Directed Order 
shall be allocated to other participants in price/time priority, 
including any remaining contracts of the Directed Market Maker and 
multiple quotes/orders from the same firm.\12\
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    \10\ Chapter VI, Section 10(1).
    \11\ Chapter VI, Section 10(1)(A).
    \12\ The BX Options trading system identifies Directed Market 
Makers by a particular code called an IFI, which BX will use to 
consider which quotes/orders are from the same firm.
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Example 1 (Price/Time)

NBBO: $1.00 x $1.05

BX Options Book \13\
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    \13\ In each example, quotes and orders are listed in the 
sequence in which they were received.
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Firm1 Order A Sell 20 at $1.05
Firm2 Order B Sell 20 at $1.05
MM3 Quote C $1.00 x $1.05 (size 100 x 100)
Firm4 Order D Sell 50 at $1.05
BX Options Best Offer: 190 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to 
MM3:
    40 contracts execute against MM3 Quote C as a Directed Allocation: 
40% of 100 contracts
    20 contracts execute against Firm1 Order A based on time priority
    20 contracts execute against Firm2 Order B based on time priority
    20 additional contracts execute against MM3 Quote C based on time 
priority
The Directed Order is fully executed
No contracts execute against Firm4 because it is behind Firm1, Firm2, 
and MM3 in time priority and no more contracts remain

    BX notes that, in this example, MM3 receives additional contracts 
beyond the Directed Allocation under the proposed rule, which permits 
the Directed Market Maker to retain its position in time priority for 
the remainder of the contracts. BX believes that it is reasonable and 
encourages Directed Market Makers to display their entire size, which 
benefits the quality of BX's market.
    BX further notes that if a Public Customer order is involved, the 
Directed Allocation is nevertheless available to the Directed 
Participant, before the Public Customer order is executed. For example:

[[Page 15388]]

Example 1A (Price/Time With a Public Customer)

NBBO: $1.00 x $1.05

BX Options Book
Firm1 Public Customer Order A Sell 20 at $1.05
Firm2 Broker Dealer Order B Sell 20 at $1.05
MM3 Quote C $1.00 x $1.05 (size 100 x 100)
Firm4 Broker Dealer Order D Sell 50 at $1.05
BX Options Best Offer: 190 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to 
MM3:
    40 contracts execute against MM3 Quote C as a Directed Allocation: 
40% of 100 contracts
    20 contracts execute against Firm1 Public Customer Order A based on 
time priority
    20 contracts execute against Firm2 Order B based on time priority
    20 additional contracts execute against MM3 Quote C based on time 
priority
The Directed Order is fully executed
No contracts execute against Firm4 because it is behind Firm1, Firm2, 
and MM3 in time priority and no more contracts remain

    BX is proposing to afford a Directed Allocation when there is a 
Public Customer order eligible to trade with the Directed Order. BX 
understands that other options exchanges' rules respecting directed 
orders do not provide a directed allocation to a directed market maker 
when there is a customer order ahead of a directed market maker at a 
particular price.\14\ However, BX believes it is reasonable and 
consistent with applicable statutory standards for the Directed 
Allocation to occur, as proposed herein. The Public Customer order is 
not precluded from participating in the trade, but rather continues to 
stand in time priority once the Directed Allocation occurs. The Public 
Customer may not receive a full execution, but had the Directed Order 
not been sent to BX, the Public Customer may not have received an 
execution at all. The Directed Participant and their relationship with 
the provider of that Directed Order may have attracted the order to BX, 
to the benefit of the Public Customer order as well as all potential 
contra-side orders on the book. Accordingly, there is no particular 
reason for a Directed Allocation to operate differently just because a 
Public Customer order is involved; the very nature of the price/time 
priority model is that Public Customer orders are like all other orders 
and do not jump ahead in priority. BX does not believe that this is 
unfair to Public Customer orders; it is merely a different model.
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    \14\ For example, the directed order is allocated pursuant to 
the price/time priority rule on NYSE Arca. See NYSE Arca Rule 
6.76A(a)(1)(A)(ii).
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    New Section 10(3)(i)(B) provides that if the option is subject to 
the Size Pro-Rata execution algorithm,\15\ Public Customer limit orders 
resting on the limit order book at the execution price will execute 
against the Directed Order first. Then, the Directed Market Maker shall 
receive the greater of: the pro-rata allocation to which such Directed 
Market Maker would otherwise be entitled pursuant to the Size Pro-Rata 
execution algorithm or the Directed Allocation of 40% of the Directed 
Order. If there are multiple resting quotes/orders from the same 
Directed Market Maker, the Directed Allocation will be allocated among 
those quotes/orders on a size pro-rata basis. Once the Directed 
Allocation is determined, any remaining contracts associated with the 
Directed Market Maker's quotes/orders are excluded from the remaining 
pro-rata allocation. If there are any remaining contracts of the 
Directed Order, they will be allocated on a size pro-rata basis among 
the remaining Participants (except the Directed Market Maker). For 
example:
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    \15\ Chapter VI, Section 10(1)(B).
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Example 2 (Pro-Rata)

NBBO: $1.00 x $1.05

BX Options Book
Firm1 Public Customer Order A Sell 20 at $1.05
MM2 Quote B $1.00 x $1.05 (size 100 x 100)
MM3 Quote C $1.00 x $1.05 (size 50 x 50)
MM4 Quote D $1.00 x $1.05 (size 100 x 100)
BX Options Best Offer: 270 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to 
MM3:
    20 contracts execute against Firm1 Public Customer Order A due to 
Public Customer priority
    40 contracts execute against MM3 Quote C as a Directed Allocation 
(40% of 100 contract buy order)
    MM2 and MM4 each receive 20 contracts on a size pro-rata basis (50% 
each of 40 remaining contracts)

    New Section 10(3)(ii) deals with the situation where BX's 
disseminated price is the NBBO but the quotation disseminated by the 
Directed Market Maker on the opposite side of the market from the 
Directed Order is inferior to the NBBO. In such case, the Directed 
Order shall be automatically executed and allocated to those quotations 
and orders at the NBBO in accordance with this Section as follows:

Example 3 (Price/Time or Pro-Rata--Same Outcome)

NBBO: $1.00 x $1.05

BX Options Book
Firm1 Order A Sell 100 at $1.05
MM2 Quote C $1.00 x $1.06 (size 100 x 100)
BX Options Best Offer: 100 at $1.05
BX receives a Directed Order to buy 50 contracts directed to MM2:
    50 contracts execute against Firm1 Order A
The Directed Order is completely filled
MM2 does not receive a Directed Allocation because Quote C is not part 
of BX Options' best offer nor the NBBO

    New Section 10(3)(iii) covers the situation where BX's disseminated 
price is not the NBBO; then, the Directed Order shall be processed in 
accordance with Chapter VI, Sections 7, 10 and 11.

Example 4 (Price/Time or Pro-Rata--Same Outcome)

CBOE Quote: $1.00 x $1.05 (size 10 x 10)

BX Options Book
MM1 Quote A $1.00 x $1.06 (size 100 x 100)
MM2 Quote B $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 150 at $1.06
NBBO: $1.00 x $1.05 (size 160 x 10)
BX receives a Directed Order to buy 110 contracts at $1.06 directed to 
MM2:
    10 contracts are routed and executed against the better away offer 
of $1.05 (CBOE)
    Because the CBOE offer is executed, BX Options is now the NBBO
    40 contracts execute against MM2 Quote B as a Directed Allocation 
(40% of 100 contracts remaining from the Directed Order)
    60 contracts execute against MM1 Quote A

    In this example, BX was not initially at the NBBO, but once the 
National Best Offer (``NBO'') was exhausted, BX's offer of 150 
contracts at $1.06 became the NBO. BX proposes to permit the Directed 
Allocation at the next price level, even though the Directed 
Participant was not at the NBBO at the time of order receipt, as 
described further below. BX understands that other options exchanges' 
directed order programs limit directed allocations to situations where 
the directed party is at the NBBO at the time of receipt of the

[[Page 15389]]

directed order. BX believes that it is consistent with the purpose of 
the NBBO requirement to structure its Directed Order program as 
proposed herein for the following reasons.
    The purpose of the requirement for the directed participant to be 
at the NBBO is to encourage such participant to quote competitively 
rather than to quote a wide market and wait for directed orders to 
arrive. BX believes that permitting the Directed Market Maker to 
receive a Directed Allocation even if such market maker was not on the 
NBBO at the time of receipt of the Directed Order still encourages 
competitive quoting. The Directed Order will trade at the NBBO at the 
time it was received with whatever contracts are available. If, and 
only if, contracts remain, then the order can execute at the next price 
level. At that next price level that is the new NBBO, the Directed 
Market Maker must be on the NBBO. Under the proposal, such market maker 
is being rewarded for being at the next best price, consistent with the 
purposes of the NBBO requirement. The market maker has an incentive to 
quote competitively because quoting a tick or two away from the NBBO is 
likely to result in very little trading for that market maker, 
especially if other quotes and orders are at or closer to the NBBO and 
especially in more liquid options.
    Providing market makers with an enhanced allocation for order flow 
that is specifically directed to that market maker when the market 
maker is not initially on the NBBO is fair and does not create 
incentives to avoid quoting at the NBBO. There is fierce competition 
within the BX Options market and within the broader options market 
place. Within the BX Options market, there are many market makers who 
compete for available order flow on the basis of their quoted price. If 
a market maker's price is not equal to or better than all other quoted 
prices, they will simply not trade until all other market makers (and 
all other participants) trade at the superior price. This creates and 
supports healthy competition among market makers to quote the best 
price possible. In addition to the competition among market makers, 
there are also other market participants (broker-dealer, Public 
Customer, professional, etc.) who compete against each other and 
against market makers based on price, thus providing a further 
incentive for market makers to provide the best price possible. 
Finally, in the broader options marketplace, BX Options market makers 
not only have to compete with the market makers and participants on the 
BX Options market, but also with the plethora of market makers and 
other participants who quote or post orders on options exchanges other 
than BX Options. Indeed, the incentive to provide a competitive quote 
is strong due to the inherently competitive nature of today's options 
markets. Necessarily, a market maker who does not match or improve the 
NBBO on a consistent basis does not trade often. This proposal does not 
create a disincentive for a market maker to match or improve the NBBO. 
BX believes that this is an issue of timing of the directed allocation 
and not whether it is appropriate to afford a directed allocation at 
the next price level.
    Providing directed order functionality should also add an 
additional layer of competition among those market makers who attempt 
to attract directed order flow. When market makers approach order flow 
providers to send directed order flow, the order flow providers expect 
clear data as evidence that directing order flow to the market maker 
will benefit the order flow provider and more importantly the order 
flow provider's customers. As more market makers attempt to attract 
order flow, they will likely need to show ever improving quote 
statistics. If a market maker were to quote $0.01 outside the NBBO in 
hopes of capturing some miniscule amount of order flow at a better 
price than everyone else, the order flow provider would see this in 
their quality of execution statistics and simply stop directing order 
flow to the market maker. Here again, there is a strong incentive to be 
matching or improving the NBBO in order to attract order flow and 
trade.
    BX notes that at the time of the approval of the first directed 
order programs, routing among the options exchanges occurred through a 
central linkage process and executions through multiple price levels 
were not as seamless and efficient as today. In the current 
environment, executions occur across multiple price levels with 
simultaneous outbound routing. BX believes that order execution should 
not be inhibited by the artificial constraint of limiting directed 
allocations to directed participants who are on the NBBO at the time of 
order receipt in an options marketplace with vigorous competition and 
actively changing markets. It is sufficient for the directed 
participant to be on the NBBO at the time of execution.
    New Section 10(3)(iv) incorporates several additional provisions 
respecting the Directed Order process. Specifically, a Directed Market 
Maker shall not be entitled to receive a number of contracts that is 
greater than the size associated with their order or quote at a 
particular price level. This provision is common in other options 
exchanges' directed order programs and is intended to incent Directed 
Market Makers to show more size. Much like a market maker has an 
incentive to match or improve the NBBO in order to trade more often, a 
market maker also has the incentive to display as much liquidity as 
possible in order to trade more volume. The resulting additional size 
at the NBBO benefits investors by making the market more liquid, which, 
in turn, makes it easier for investors to enter and exit their specific 
options positions.
    In addition, Directed Allocations are rounded up to the next whole 
number.

Example 5 (Price/Time or Pro-Rata--Same Outcome)

NBBO: $1.00 x $1.05

BX Options Book
MM1 Quote A $1.00 x $1.05 (size 100 x 100)
MM2 Quote B $1.00 x $1.05 (size 50 x 50)
BX Options Best Offer: 150 at $1.05
BX receives a Directed Order to buy 91 contracts at $1.05 directed to 
MM2:
    37 contracts execute against MM2 Quote B as a Directed Allocation 
(40% of 91 = 36.4 rounded up to 37)
    54 contracts execute against MM1 Quote A

    BX understands that the directed order programs of other options 
exchanges have generally limited the amount of the directed allocation 
to 40% of the size of the directed order, which is what BX has proposed 
herein. Because BX intends to round that allocation up to the nearest 
whole number, BX acknowledges that it is mathematically possible for 
its proposed Directed Allocation to exceed 40% in certain situations, 
but, of course, because it is rounding to the nearest whole number, 
rounding will necessarily never result in more than one additional 
options contract being added to the Directed Allocation. Even if such 
one additional contract caused the Directed Allocation to exceed 40%, 
BX believes that this is appropriate and reasonable because it is only 
one contract, regardless of the percentage.\16\ Other options 
entitlement programs approved by the Commission sometimes exceed a 40% 
guarantee, also in limited, mathematically-driven situations. For

[[Page 15390]]

example, the specialist or lead market maker entitlement permits the 
allocation of five contracts and less to a particular participant, 
which is much greater than the one contract proposed herein (i.e. the 
specialist entitlement allows for a 100% allocation for orders of 5 
contracts or less).\17\ Furthermore, specialist entitlement programs 
also provide for a 60% allocation in situations where the split is 
between two participants. Furthermore, pursuant to proposed 
subparagraph (iv)(C), the Directed Allocation is available for the life 
of the order. If a Directed Order is not executed upon receipt, it 
retains its status as a Directed Order, such that, once it becomes 
executable, it is subject to Directed Order Handling under new Section 
10(3).
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    \16\ Generally, the larger the number of contracts being 
rounded, the smaller the percentage, with some mathematical 
variation. For example, an order of 9 contracts would round up from 
3.6 to 4 contracts or 44.44% of the order, whereas an order for 
91contracts would be rounded up for directed allocation purposes 
from 36.4 to 37 contracts or 40.66% of the order.
    \17\ The specialist on NYSE MKT receives a 100% allocation on 
orders of 5 contracts or less and 40% of other eligible orders, even 
though the specialist's quoting obligation is the same as the 
proposed BX Options Directed Market Maker quoting obligation.
---------------------------------------------------------------------------

Example 6 (Price/Time or Pro-Rata--Same Outcome)

CBOE Quote: $1.00 x $1.05 (size 10 x 10)

NBBO: $1.00 x $1.05 (size 160 x 10)

BX Options Book
MM1 Quote A $1.00 x $1.06 (size 100 x 100)
MM2 Quote B $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 150 at $1.06
BX receives a non-routable Directed Order to buy 100 contracts at $1.06 
directed to MM2:
The order is posted on the BX Options book at $1.05 and displayed at 
$1.04 \18\
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    \18\ See Chapter VI, Section 11.
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CBOE updates its quote to $1.00 x $1.07 (size 10 x 10)
The new NBBO is $1.00 x $1.06 (size 160 x 150)
The Directed Order can now execute against the BX Options book at $1.06 
as follows:
    40 contracts execute against MM2 Quote B as a Directed Allocation 
(40% of the 100 contract buy order)
    60 contracts execute against MM1 Quote A

    The Exchange believes that it is useful and beneficial for the 
order to retain its status as a Directed Order, because this handling 
is consistent with the order instructions and original intent of the 
submitting Participant. On other options exchanges, the ``directed 
order'' designation is only considered upon receipt of the order.\19\ 
BX believes that its Participants may find this feature attractive; 
otherwise, Participants might consider cancelling and re-entering the 
order so it is treated as a Directed Order, which would be less 
efficient and would increase message traffic. BX does not believe that 
retaining directed order status on the book is controversial or 
inconsistent with the Act. Nor does BX believe that it undermines the 
policy underpinnings of directed order programs. Rather, it is an 
innovative enhancement intended to make entering directed orders more 
efficient and modern. It is possible that more directed allocations 
will occur because orders retain their directed order status, but the 
same result could be achieved today by, inefficiently, reentering 
directed orders rather than leaving them on the book as non-directed 
orders.
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    \19\ See e.g., Phlx Rule 1080(l)(ii), which provides: When the 
Exchange's disseminated price is the NBBO at the time of receipt of 
the Directed Order, and the Directed Specialist, SQT or RSQT is 
quoting at the Exchange's disseminated price, the Directed Order 
shall be automatically executed and allocated in accordance with 
Rule 1014(g)(viii).
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    In addition, the Directed Market Maker is entitled to the Directed 
Allocation at all price levels at which the Directed Market Maker has 
an order or quote. This is intended to reflect that orders are 
executable at multiple price levels, and that, today, market makers can 
enter orders at multiple price levels.

Example 7 (Price/Time or Pro-Rata--Same Outcome)

NBBO: $1.00 x $1.05

BX Options Book
MM1 Quote A $1.00 x $1.05 (size 20 x 20)
MM2 Quote B $1.00 x $1.05 (size 10 x 10)
MM3 Quote C $1.00 x $1.06 (size 100 x 100)
MM2 Quote D $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 30 at $1.05
BX receives a Directed Order to buy 110 contracts at $1.06 directed to 
MM2:
    20 contracts execute against MM1 Quote A
    10 contracts execute against MM2 Quote B
    $1.05 price level is completely exhausted
    32 contracts execute against MM2 Quote D as a Directed Allocation 
(40% of 80 remaining contracts from buy order)
    48 contracts execute against MM3 Quote C

New Quoting Requirement for All Market Makers

    BX also proposes to change the quoting obligation applicable to its 
Market Makers. Currently, Chapter VII, Section 6(d) provides that on a 
daily basis, a Market Maker must during regular market hours make 
markets consistent with the applicable quoting requirements specified 
in these rules, on a continuous basis in at least sixty percent (60%) 
of the series in options in which the Market Maker is registered. It 
further provides that, to satisfy this requirement with respect to 
quoting a series, a Market Maker must quote such series 90% of the 
trading day (as a percentage of the total number of minutes in such 
trading day) or such higher percentage as BX may announce in advance. 
BX Regulation may consider exceptions to the requirement to quote 90% 
(or higher) of the trading day based on demonstrated legal or 
regulatory requirements or other mitigating circumstances.
    BX proposes to better align its market maker quoting requirement 
with that of other exchanges, such as NYSE Arca and NYSE MKT. 
Specifically, BX proposes to reduce the quoting requirement for non-
Directed BX Options Market Makers as follows: A Market Maker must quote 
such options 60% of the trading day (as a percentage of the total 
number of minutes in such trading day) or such higher percentage as BX 
may announce in advance. BX Regulation may consider exceptions to the 
requirement to quote 60% (or higher) of the trading day based on 
demonstrated legal or regulatory requirements or other mitigating 
circumstances. This obligation will apply to all of a Market Maker's 
registered options collectively, rather than on an option-by-option 
basis. Compliance with this obligation will be determined on a monthly 
basis. This is the same requirement as on other options exchanges.\20\
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    \20\ See NYSE Arca Rule 6.88 and NYSE MKT Rule 964.1NY.
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    BX believes that this is appropriate for two reasons. First, BX's 
current Market Maker quoting requirement is much more stringent than 
certain other exchanges. Quoting each series 90% of the trading day is 
much more stringent than looking at all options in which a Market Maker 
is registered, because it allows for some number of series not to be 
quoted at all, as long as the overall standard is met. This better 
accommodates the occasional issues that may arise in a particular 
series, whether technical or manual. The existing requirement may at 
times discourage liquidity in particular options series because a 
market maker is forced to focus on a momentary lapse rather than using 
the appropriate resources to focus on the options series

[[Page 15391]]

that need and consume additional liquidity. As a new market, BX 
believes that it can better attract Market Makers to the BX Options 
market and grow its market if its quoting obligation is more in line 
with that of other exchanges. In addition, as BX seeks to introduce 
directed orders, the market maker quoting obligation has become an 
obstacle to crafting a competitive, attractive directed order program. 
Specifically, because the Commission has required directed participants 
to be subject to heightened quoting obligations as compared to non-
directed market makers, BX would have to adopt a Directed Market Maker 
quoting obligation more stringent than the current 90% of the time/60% 
of the series requirement for regular BX Options Market Makers. BX does 
not believe that a quoting requirement for greater than 90% of the time 
would attract Directed Market Makers to BX Options, as BX embarks on 
growing its market with new functionality and features. In fact, a more 
stringent quoting requirement would likely discourage new market makers 
from participating in the BX Options market and inhibit current market 
makers' ability to provide liquidity effectively.

New Quoting Requirement for Directed Market Makers

    New Section 10(3)(iv)(D) makes clear that Directed Market Makers 
are subject to the quoting requirements of new Chapter VII, Section 
6(d)(iv). Specifically, in options in which it receives Directed 
Orders, a Directed Market Maker must quote 90% of the trading day (as a 
percentage of the total number of minutes in such trading day) or such 
higher percentage as BX may announce in advance. BX Regulation may 
consider exceptions to the requirement to quote 90% (or higher) of the 
trading day based on demonstrated legal or regulatory requirements or 
other mitigating circumstances. This obligation will apply collectively 
to all series in all of the options in which the Directed Market Maker 
receives Directed Orders, rather than on an option-by-option basis. 
Compliance with this obligation will be determined on a monthly basis. 
This quoting obligation is more stringent than that which is applicable 
to regular BX Options Market Makers, who will now have to quote, under 
this proposal, at least 60% of the time the Exchange is open for 
trading in registered options. Such quotations must meet the quote 
width requirements of Chapter VII, Section 6(d)(ii). Once a Directed 
Market Maker receives a Directed Order, the heightened quoting 
obligation is triggered and applies to the options in which the 
Directed Market Maker receives Directed Orders.
    Lastly, Section 10(3)(iv)(E) will provide that the Exchange will 
determine which options have the Directed Allocation functionality 
available.\21\ BX will issue an Options Trader Alert to inform its 
Participants in which options the Directed Allocation will be 
available.
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    \21\ Directed Orders received in options where BX Options is not 
offering Directed Order processing will not be rejected; instead, 
such orders will be handled normally as non-Directed Orders.
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Conclusion

    In summary, BX seeks to compete with the many options exchanges 
that offer directed orders in their respective markets and seeks to 
introduce directed order functionality, as described above.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \22\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \23\ in particular, in that it is designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in facilitating transactions in 
securities, and to remove impediments to and perfect the mechanisms of 
a free and open market and a national market system, and, in general, 
to protect investors and the public interest, because it will establish 
a directed order process similar to what operates on other exchanges, 
as explained in detail herein, which will provide Participants with 
additional choices among the many competing exchanges with regard to 
their execution needs and strategies. BX Options operates in an 
intensely competitive environment and seeks to offer the same services 
that its competitors offer and in which its customers find value.
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    \22\ 15 U.S.C. 78f(b).
    \23\ 15 U.S.C. 78f(b)(5).
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    In its approval of other options exchange directed order programs, 
the Commission has, like proposals to amend a specialist guarantee, 
focused on whether the percentage of the ``entitlement'' would rise to 
a level that could have a material adverse impact on quote competition 
within a particular exchange, and concluded that such programs do not 
jeopardize market integrity or the incentive for market participants to 
post competitive quotes.\24\ BX's proposed Directed Allocation of 40% 
is consistent with the directed order allocations of other options 
exchanges, except for the impact of rounding up, as described above, 
which BX does not believe is significant. BX notes that the remaining 
portion of each order will still be allocated based on the competitive 
bidding of market participants. In addition, at the time of execution, 
a BX Options Directed Market Maker will have to be quoting at the NBBO 
for the size of the Directed Allocation to receive the Directed 
Allocation, which is intended to incent the Directed Market Maker to 
quote aggressively, because he cannot merely step up and match the NBBO 
after the Directed Order is received. Similarly, BX believes there is 
an incentive for Directed Market Makers to quote competitively even 
though they may receive a Directed Allocation when such Directed Market 
Maker is not on the NBBO at the time of order receipt, but is at the 
time of execution. BX also notes that BX Options Directed Market Makers 
will have greater quoting obligations than other BX Options Market 
Makers.
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    \24\ See Securities Exchange Act Release No. 51759 (May 27, 
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91).
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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. The competition among the 
options exchanges is vigorous and this proposal is intended to afford 
the BX Options market the opportunity to compete for directed order 
flow. In that regard, the proposal is pro-competitive and will offer 
market participants an additional venue for the execution of directed 
orders. The Exchange does not believe that the proposal imposes a 
burden on intra-market competition not necessary or appropriate in 
furtherance of the purposes of the Act, because the ability to send 
directed orders is available to all Participants, and the ability to 
become a Market Maker is available to all Market Makers.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

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

    Within 45 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

[[Page 15392]]

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 shall: (a) By order approve or 
disapprove such 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. The Commission also requests and 
encourages interested persons to submit comments on the following 
specific questions:
     Unlike the Directed Order rules of other options 
exchanges, BX's proposed rule would not require that a Directed Market 
Maker be quoting at the NBBO at the time a Directed Order is received. 
Would the lack of the NBBO quoting requirement impact market makers' 
incentives to quote competitively? If so, how? If not, why? If other 
options exchanges eliminated the requirement that Directed Market 
Makers quote at the NBBO to receive Directed Orders as part of their 
Directed Order process, what, if any impact would there be on market 
maker quoting behavior, and more generally on the quality of quotations 
in the options markets?
     Under the proposed rule, a Directed Market Maker to whom 
an order is directed in an option subject to the exchange's Price/Time 
execution algorithm would receive a 40% allocation ahead of orders of 
other market participants, including customer orders that had time 
priority over the Directed Market Maker's quotation. What, if any, 
concerns does this raise for the options markets?
    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 email to [email protected]. Please include 
File Number SR-BX-2013-016 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-BX-2013-016. This file 
number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 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-BX-2013-016, and should be 
submitted on or before April 1, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-05543 Filed 3-8-13; 8:45 am]
BILLING CODE 8011-01-P