[Federal Register Volume 78, Number 75 (Thursday, April 18, 2013)]
[Notices]
[Pages 23323-23327]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-09098]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69368; File No. SR-BOX-2013-20]
Self-Regulatory Organizations; BOX Options Exchange LLC; Notice
of Filing and Immediate Effectiveness of Proposed Rule Change To
Suspend Certain Provisions in Rule 7170 Regarding Obvious Errors During
Limit Up-Limit Down States in Securities That Underlie Options Traded
on the Exchange on a Pilot Basis
April 12, 2013.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on April 8, 2013, BOX Options Exchange LLC (the
``Exchange'') filed with the Securities and Exchange
[[Page 23324]]
Commission (``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 from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend IM-7080-1 (Trading Conditions During
Limit State or Straddle State) to permit the Exchange to suspend
certain provisions in BOX Rule 7170 (Obvious and Catastrophic Errors)
during limit up-limit down states in securities that underlie options
traded on the Exchange on a pilot basis. The text of the proposed rule
change is available from the principal office of the Exchange, at the
Commission's Public Reference Room and also on the Exchange's Internet
Web site at http://boxexchange.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 self-regulatory organization
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 self-regulatory organization
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 proposes to amend IM-7080-1 (Trading Conditions During
Limit State or Straddle State) to permit the Exchange to suspend
certain provisions in BOX Rule 7170 (Obvious and Catastrophic Errors)
during limit up-limit down states in securities that underlie options
traded on the Exchange on a pilot basis. This is a competitive filing
that is based on a proposal recently submitted by International
Securities Exchange, LLC (``ISE'') and approved by the Commission.\3\
---------------------------------------------------------------------------
\3\ See Securities Exchange Act Release No. 69329 (April 5,
2013) (SR-ISE-2013-22).
---------------------------------------------------------------------------
Background
On May 31, 2012, the Commission approved the Plan to Address
Extraordinary Market Volatility (the ``Plan''),\4\ which establishes
procedures to address extraordinary volatility in NMS Stocks. The
procedures provide for market-wide limit up-limit down requirements
that prevent trades in individual NMS Stocks from occurring outside of
specified Price Bands. These limit up-limit down requirements are
coupled with Trading Pauses to accommodate more fundamental price
moves. The Plan procedures are designed, among other things, to protect
investors and promote fair and orderly markets.\5\
---------------------------------------------------------------------------
\4\ Securities Exchange Act Release No. 67091 (May 31, 2012), 77
FR 33498 (June 6, 2012) (File No. 4-631) (``Plan Approval Order'').
\5\ Id. at 33511 (Preamble to the Plan).
---------------------------------------------------------------------------
BOX is not a participant in the Plan because it does not trade NMS
Stocks. However, BOX trades options contracts overlying NMS Stocks.
Because options pricing models are highly dependent on the price of the
underlying security and the ability of options traders to effect
hedging transactions in the underlying security, the implementation of
the Plan will impact the trading of options classes traded on the
Exchange. Specifically, under the Plan, upper and lower price bands
will be calculated based on a reference price for each NMS Stock.\6\
When one side of the market for an individual security is outside the
applicable price band, the national best bid or national best offer
will be disseminated with a flag identifying it as non-executable
(i.e., a ``Straddle State''). When the other side of the market reaches
the applicable price band, such national best bid or offer will be
disseminated with a flag identifying it as a Limit State Quotation.\7\
If trading for a security does not exit a Limit State within 15
seconds, a Trading Pause will be declared by the Primary Listing
Exchange.\8\ The Trading Pause will last at least five minutes\9\ and
will end when the Primary Listing Exchange disseminates a Reopening
Price.\10\
---------------------------------------------------------------------------
\6\ The reference price equals the arithmetic mean price of
eligible reported transactions for the NMS Stock over the
immediately preceding five-minute period. See Section I(T) of the
Plan.
\7\ See Section I(D) of the Plan. The Limit State will end when
the entire size of all Limit State Quotations are executed or
cancelled.
\8\ See Section VII(A) of the Plan. The Primary Listing Exchange
is the market on which an NMS Stock is listed. If an NMS Stock is
listed on more than one market, the Primary Listing Exchange is the
market on which the security has been listed the longest. See
Section I(O) of the Plan. A trading pause may also be declared when
the national best bid (offer) is below (above) the lower (upper)
price band and the security is not in a Limit State, and trading in
that security deviates from normal trading characteristics. See
Section VII(A)(2) of the Plan.
\9\ A Trading Pause may last longer than 5 minutes if, for
example, the Primary Market declares a Regulatory Halt, or if there
is a significant order imbalance. See Section VII(B) of the Plan. If
the Primary Listing Exchange does not report a Reopening Price
within ten minutes after the declaration of a trading Pause and has
not declared a Regulatory Halt, all trading centers may begin
trading the security. Id.
\10\ The Reopening Price is the price of a transaction that
reopens trading on the Primary Listing Exchange following a Trading
Pause or a Regulatory Halt, or, if the Primary Listing Exchange
reopens with quotations, the midpoint of those quotations. The
Exchange notes that under BOX Rule IM-7080-11 (IM-7080-12 as of 4/
7), trading on the Exchange is halted whenever trading in the
underlying security has been paused by the primary listing market.
Accordingly, the Exchange need not adopt any rule changes to address
this aspect of the Plan.
---------------------------------------------------------------------------
Proposal
When the national best bid (offer) for a security underlying an
options class is non-executable, the ability for options market
participants to purchase (sell) shares of the underlying security and
the price at which they may be able to purchase (sell) shares will
become uncertain, as there will be a lack of transparency regarding the
availability of liquidity for the security.\11\ This uncertainty will
be factored into the options pricing models of market professionals,
such as options market makers, which will likely result in wider
spreads and less liquidity at the best bid and offer for the options
class. Accordingly, during a Limit State, the Exchange will
automatically reject all incoming orders that do not contain a limit
price to protect them from being executed at prices that may be vastly
inferior to the prices available immediately prior to or following a
Limit State or Straddle State.\12\ Such un-priced orders include Market
Orders and BOX-Top Orders, which become market orders when the stop
price is elected. The Exchange will also cancel any resting Market
Orders and BOX-Top Orders.
---------------------------------------------------------------------------
\11\ See Letter to Boris Ilyevsky, Managing Director, ISE, from
Thomas Price, Managing Director, Securities Industry and Financial
Markets Association, dated October 4, 2012 (``SIFMA Letter'').
\12\ See Securities Exchange Act Release No. 69186 (March 20,
2013), 78 FR 18413 (March 26, 2013) (SR-BOX-2013-12).
---------------------------------------------------------------------------
The Exchange proposes to exclude transactions executed during a
Limit State or Straddle State from certain provisions in BOX Rule 7170,
on a one-year pilot basis. This will not include Rule 7170(e) and (f),
which specify when a trade resulting from an erroneous print or quote
in the underlying security may be adjusted or busted.
The remaining provisions in BOX Rule 7170 provide a process by
which a transaction may be busted or adjusted
[[Page 23325]]
when the execution price of a transaction deviates from the option's
theoretical price by a certain amount. Under these provisions, the
theoretical price is the national best bid price for the option with
respect to a sell order and the national best offer for the option with
respect to a buy order.\13\ As discussed above, during a Limit State or
Straddle State, options prices may deviate substantially from those
available prior to or following the limit state. The Exchange believes
these provisions would give rise to much uncertainty for market
participants as there is no bright line definition of what the
``theoretical value'' should be for an option when the underlying NMS
stock has an unexecutable bid or offer or both. Determining
``theoretical value'' in such a situation would be often times very
subjective as opposed to an objective determination, giving rise to
additional uncertainty and confusion for investors. Accordingly, the
Exchange does not believe that the approach employed under Rule 7170,
which by definition depends upon a reliable national best bid and offer
in the option, is appropriate during a Limit State or Straddle
State.\14\
---------------------------------------------------------------------------
\13\ Rule 7170 provides that if there are no quotes from other
options exchanges for comparison purposes, the theoretical price
will be determined by designated personnel in the MRC. However,
given that options market makers and other industry professionals
will have difficulty pricing options during Limit States and
Straddle States, the Exchange does not believe it would be
reasonable for BOX personnel to derive theoretical prices to be
applied to transactions executed during such unusual market
conditions.
\14\ See SIFMA Letter, supra note 11 (requesting that exchange
obvious error rules that reference theoretical prices be reviewed to
ensure that options exchange officials do not have the discretion to
cancel executions of limit orders and stop limit orders during a
limit or straddle state).
---------------------------------------------------------------------------
After careful consideration, the Exchange believes the application
of the current provisions in Rule 7170 would be impracticable given the
lack of a reliable national best bid or offer in the options market
during Limit States and Straddle States, and produce undesirable
effects. Pursuant to Rule 7170, market participants have five minutes
(in the case of a Market Maker) and 20 minutes (in the case of a non-
Market Maker Options Participant) to notify the Exchange to review a
transaction as an obvious error under 7170(g)(1) and Participants have
until 8:30 a.m. the following day to request that the Exchange review a
trade as a catastrophic error under Rule 7170(h)(1).\15\ The Exchange
believes that during periods of extraordinary volatility, the review
period for transactions under the obvious error and catastrophic error
provisions would allow market participants to re-evaluate a transaction
that occurred during a Limit State or Straddle State at a later time,
which is potentially unfair to other market participants and would
discourage market participants from providing liquidity during Limit
States or Straddle States. For example, 20 minutes after a transaction
that occurs during extraordinary volatility that triggers a Limit State
or Straddle State the market could look drastically different from a
price and liquidity level The Exchange believes that market
participants should not be able to benefit from the time frame to
review their transactions in these situations. Suspending application
of certain provisions in Rule 7170 would mitigate two of the
undesirable aspects described above--(i) the moral hazard associated
with granting a second look to trades that went against the market
participant after market conditions have changed and (ii) gaming the
obvious error rule to retroactively adjust market maker quotes by
adjusting the execution price at a later time.
---------------------------------------------------------------------------
\15\ For transactions in expiring options series that take place
on expiration Friday, a Participant must notify MOC by 5:00 p.m.
Eastern Time on that same day. See Rule 7170(h)(1).
---------------------------------------------------------------------------
The Exchange notes that there are additional protections in place
outside of the Obvious and Catastrophic Error Rule that will continue
to safeguard customers. First, SEC Rule 15c3-5 requires that,
``financial risk management controls and supervisory procedures must be
reasonably designed to prevent the entry of orders that exceed
appropriate pre-set credit or capital thresholds, or that appear to be
erroneous.''\16\ Secondly, the Exchange has price checks applicable to
limit orders that reject limit orders that are priced sufficiently far
through the NBBO that it seems likely an error occurred. The
requirements placed upon broker dealers to adopt controls to prevent
the entry of orders that appear to be erroneous, coupled with Exchange
functionality that filters out orders that appear to be erroneous,
serve to sharply reduce the incidence of errors arising from situations
where, for example, a participant mistakenly enters an order to pay $20
for an option offered at $2. The Exchange also notes that pursuant to
BOX Rule 7230(e), the Exchange may compensate Options Participants for
losses resulting directly from the malfunction of the Exchange's
systems, and that this protection is independent from the provisions in
BOX Rule 7170. Accordingly, the Exchange believes it is appropriate to
eliminate any potential protection applying the obvious error rule
might provide during Limit and Straddle States, as its application may
produce inequitable results.
---------------------------------------------------------------------------
\16\ See Securities and Exchange Act Release No. 63241, 75 FR
69791 (November 15, 2010) (S7-03-10).
---------------------------------------------------------------------------
The Exchange notes that Rule 15010 (Order Protection) will continue
to apply during Limit and Straddle States. Accordingly, only orders
identified as Intermarket Sweep Orders will trade through protected
bids and offers during Limit and Straddle States, and as a result, the
only trades that would potentially have been reviewed under Rule 7170
during Limit and Straddle States are those involving Intermarket Sweep
Orders. The Exchange believes that this is an additional factor that
supports its proposal to suspend certain provisions in Rule 7170 during
Limit and Straddle States.
The Exchange proposes to review the operation of this proposal
during the one-year pilot period from the operative date and analyze
the impact of the Limit and Straddle States accordingly.\17\ In this
respect, the Exchange notes that its current obvious error rule does
not contain a provision that permits the Exchange to review trades on
its own motion. The Exchange believes that in normal market conditions,
such a provision is not necessary and undermines the objective nature
of the rule. However, during the pilot period, the Exchange will
evaluate whether adopting such a provision for reviewing trades during
Limit and Straddle states is necessary and appropriate.
---------------------------------------------------------------------------
\17\ During the pilot, the Exchange will provide the Commission
with data regarding the how Limit and Straddle States affect the
quality of the options market.
---------------------------------------------------------------------------
Additionally, the Exchange represents that it will conduct its own
analysis concerning the elimination of the obvious error rule during
Limit and Straddle States and agrees to provide the Commission with
relevant data to assess the impact of this proposed rule change. As
part of its analysis, the Exchange will evaluate (1) the options market
quality during Limit and Straddle States, (2) assess the character of
incoming order flow and transactions during Limit and Straddle States,
and (3) review any complaints from members and their customers
concerning executions during Limit and Straddle States. The Exchange
also agrees to provide to the Commission data requested to evaluate the
impact of the elimination of the obvious error rule, including data
relevant to assessing the various analyses noted above. The Exchange
notes that these proposed changes are consistent with the views of the
Securities Industry and
[[Page 23326]]
Financial Markets Association's (``SIFMA'') Listed Options Trading
Committee.\18\
---------------------------------------------------------------------------
\18\ Id.
---------------------------------------------------------------------------
Specifically, the Exchange agrees to provide the following data to
the Commission to help evaluate the impact of the proposal. At least
two months prior to the end of the pilot period the Exchange shall
provide an assessment that evaluates the statistical and economic
impact of Straddle States on liquidity and market quality in the
options markets; and assess whether the lack of obvious error rules in
effect during the Straddle and Limit States is problematic. On a
monthly basis, the Exchange shall provide both the Commission and
public a dataset containing the data for each Straddle and Limit State
in optionable stocks.\19\
---------------------------------------------------------------------------
\19\ The dataset will include the options for each underlying
security that reaches a straddle state and meets the following
conditions: the option is more than 20% in the money (strike price
remains < 80% of last stock trade price for calls and strike price
remains > 120% of last stock trade price for puts when the straddle
or limit state is reached); the option has at least 2 trades during
the straddle or limit state; and any of the top 10 options (as
ranked by overall contract volume on that day) that meet the
conditions above. For each of those options affected the data record
will contain the stock symbol, option symbol, time at the start of
the straddle or limit state, an indicator for whether it is a
straddle or limit state. For activity on the Exchange the data
record will contain the executed volume, time-weighted quoted bid-
ask spread, time-weighted average quoted depth at the bid, time-
weighted average quoted depth at the offer, high execution price,
low execution price, number of trades for which a request for review
for error was received during straddle or limit states, an indicator
variable for whether those options outlined above have a price
change exceeding 30% during the underlying stock's straddle or limit
state compared to the last available option price as reported by
OPRA before the start of the straddle or limit state (1 if observe
30% and 0 otherwise), and another indicator variable for whether the
option price within five minutes of the underlying stock leaving
straddle or limit state (or halt if applicable) is 30% away from the
price before the start of the straddle or limit state.
---------------------------------------------------------------------------
2. Statutory Basis
The Exchange believes that the proposal is consistent with the
requirements of Section 6(b) of the Securities Exchange Act of 1934
(the ``Act''),\20\ in general, and Section 6(b)(4) of the Act,\21\ 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, to 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.
---------------------------------------------------------------------------
\20\ 15 U.S.C. 78f(b).
\21\ 15 U.S.C. 78f(b)(4).
---------------------------------------------------------------------------
The Exchange believes that it is necessary and appropriate in the
interest of promoting fair and orderly markets to exclude transactions
executed during a Limit State or Straddle State from the provision of
BOX Rule 7170. The Exchange believes the application of the current
rule will be impracticable given the lack of a reliable national best
bid or offer in the options market during Limit States and Straddle
States, and that the resulting actions (i.e., busted trades or adjusted
prices) may not be appropriate given market conditions. This change
would ensure that limit orders that are filled during a Limit State or
Straddle State would have certainty of execution in a manner that
promotes just and equitable principles of trade, removes impediments
to, and perfects the mechanism of a free and open market and a national
market system. Moreover, given that options prices during brief Limit
States or Straddle States may deviate substantially from those
available shortly following the Limit State or Straddle State, the
Exchange believes giving market participants five minutes (in the case
of a Market Maker) and 20 minutes (in the case of a non-Market Maker
Options Participant) to re-evaluate a transaction would create an
unreasonable adverse selection opportunity that would discourage
participants from providing liquidity during Limit States or Straddle
States. In this respect, the Exchange notes that by rejecting market
orders and cancelling pending market orders, only those orders with a
limit price will be executed during a Limit State or Straddle State.
Therefore, on balance, the Exchange believes that removing the
potential inequity of busting or adjusting executions occurring during
Limit States or Straddle States outweighs any potential benefits from
applying Rule 7170 during such unusual market conditions. Additionally,
as discussed above, there are additional pre-trade protections in place
outside of the Obvious and Catastrophic Error Rule that will continue
to safeguard customers.
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. In this regard and as indicated
above, the Exchange notes that the rule change is being proposed as a
competitive response to a filing submitted by ISE that was recently
approved by the Commission.\22\ The Exchange does not believe that the
proposal will have any impact on competition among exchanges or market
participants on the Exchange, as the proposal provides that
transactions executed during such states will not be reviewed pursuant
to provisions in Rule 7170.
---------------------------------------------------------------------------
\22\ See supra note 3.
---------------------------------------------------------------------------
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received from Members, Participants, or Others
The Exchange has neither solicited nor received comments on the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Because the foregoing proposed rule change does not significantly
affect the protection of investors or the public interest, does not
impose any significant burden on competition, and, by its terms, does
not become operative for 30 days from the date on which it was filed,
or such shorter time as the Commission may designate, it has become
effective pursuant to Section 19(b)(3)(A) of the Act \23\ and Rule 19b-
4(f)(6) thereunder.\24\
---------------------------------------------------------------------------
\23\ 15 U.S.C. 78s(b)(3)(A).
\24\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii)
requires the Exchange to give the Commission written notice of the
Exchange's 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. The
Exchange has satisfied this requirement.
---------------------------------------------------------------------------
The Exchange has requested that the Commission waive the 30-day
operative delay. The Commission believes that waiver of the operative
delay is consistent with the protection of investors and the public
interest because the proposal is substantially similar to those of
other exchanges that have been approved by the Commission to exclude
transactions executed during a Limit State or Straddle State from
certain provisions of the obvious error rules.\25\ Further, the
Commission notes that the Plan, to which these rules relate, was
implemented on April 8, 2013. Therefore, the Commission designates the
proposal operative upon filing.\26\
---------------------------------------------------------------------------
\25\ See, e.g., supra note 3.
\26\ For purposes only of waiving the 30-day operative delay,
the Commission has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
---------------------------------------------------------------------------
At any time within 60 days of the filing of the proposed rule
change, the Commission summarily may temporarily suspend such rule
change if
[[Page 23327]]
it appears to the Commission that such action is necessary or
appropriate in the public interest, for the protection of investors, or
otherwise in furtherance of the purposes of the Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change 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 email to [email protected]. Please
include File Number SR-BOX-2013-20 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-BOX-2013-20. 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 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-BOX-2013-20 and should be
submitted on or before May 9, 2013.
---------------------------------------------------------------------------
\27\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\27\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-09098 Filed 4-17-13; 8:45 am]
BILLING CODE 8011-01-P