[Federal Register Volume 78, Number 250 (Monday, December 30, 2013)]
[Notices]
[Pages 79539-79541]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-31129]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71173; File No. SR-NASDAQ-2013-156]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing and Immediate Effectiveness of Proposed Rule Change To 
Adopt a New Options Execution Algorithm With Priority Overlays

December 23, 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 December 16, 2013, The NASDAQ Stock Market LLC (``Nasdaq'' 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.
---------------------------------------------------------------------------

    \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 Chapter VI, Section 10, of the Rules 
of the NASDAQ Options Market (``NOM''). Specifically, NASDAQ proposes 
to add an additional execution algorithm and priority overlays to 
govern the priority of orders, as explained more fully below.
    The text of the proposed rule change is below; proposed new 
language is in italics.
* * * * *

Chapter VI Trading Systems

* * * * *

Sec. 10 Book Processing

    System orders shall be executed through the Nasdaq Book Process set 
forth below:
    (1) Execution Algorithm--The Exchange will determine to apply, for 
each option, one of the following execution algorithms described in 
paragraphs (A) or (B). The Exchange will issue an Options Alert 
specifying which execution algorithm will govern which options any time 
it is modified.
    (A) Price/Time--The System shall execute trading interest within 
the System in price/time priority, meaning it will execute all trading 
interest at the best price level within the System before executing 
trading interest at the next best price. Within each price level, if 
there are two or more quotes or orders at the best price, trading 
interest will be executed in time priority.
    (B) Size Pro-Rata--The System shall execute trading interest within 
the System in price priority, meaning it will execute all trading 
interest at the best price level within the System before executing 
trading interest at the next best price. Within each price level, if 
there are two or more quotes or orders at the best price, trading 
interest will be executed 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. If the result is not a whole number, it will be 
rounded down to the nearest whole number. If there are residual 
contracts remaining after rounding, such contracts will be distributed 
one contract at a time to the remaining Participants in time priority.
    (C) Priority Overlays Applicable to Size Pro-Rata Execution 
Algorithm: The Exchange will apply the following designated Participant 
priority overlays, which are always in effect when the Size Pro-Rata 
execution algorithm is in effect.
    (i) Public Customer Priority: the highest bid and lowest offer 
shall have priority except that Public Customer orders shall have 
priority over non-Public Customer orders at the same price. If there 
are two or more Public Customer orders for the same options series at 
the same price, priority shall be afforded to such Public Customer 
orders in the sequence in which they are received by the System. For 
purposes of this Rule, a Public Customer order does not include a 
Professional Order.
    (ii) Market Maker Priority: After all Public Customer orders have 
been fully executed, Options Market Makers shall have priority over all 
other Participant orders at the same price. If there are two or more 
Options Market Maker quotes and orders for the same options series at 
the same price, those shall be executed based on the Size Pro-Rata 
execution algorithm. If there are contracts remaining after all Market 
Maker interest has been fully executed, such contracts shall be 
executed based on the Size Pro-Rata execution algorithm.
(2)-(7) 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 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NOM operates as an all-electronic system (``System'' or ``Trading 
System'') with no physical trading floor and provides for the 
electronic display and execution of orders in price/time priority 
without regard to the status of the entities that are entering orders. 
NOM now seeks to introduce a different priority rule in certain options 
in order to create additional incentives for firms to provide liquidity 
on NOM.
    Currently, Chapter VI, Section 10, Book Processing, provides that 
the System will have a single execution algorithm based on price/time 
priority. The System and rules provide for the ranking, display, and 
execution of all orders in price/time priority without regard to the 
status of the entity entering an order. For each order, among equally-
priced or better-priced trading interest, the System currently executes 
against available contra-side displayed contract amounts in full, in 
price/time priority.
    At this time, the Exchange proposes to amend Chapter VI, Section 
10, to provide for a Size Pro-Rata execution algorithm. In order to 
make clear that only one of the two execution algorithms is applicable 
to a particular option, NASDAQ proposes to add introductory language to 
Section 10(1) to state that the Exchange will determine to apply, for 
each option, one of the execution algorithms described in subparagraphs 
(A) \3\ or (B). The

[[Page 79540]]

Exchange will issue an Options Alert specifying which execution 
algorithm will govern which options any time a change is made.
---------------------------------------------------------------------------

    \3\ NASDAQ is also proposing to amend subparagraph (A) to 
provide that, respecting the price/time execution algorithm, within 
each price level, if there are two or more quotes or orders at the 
best price, trading interest will be executed in time priority. This 
is intended to be clearer and match the new language in subparagraph 
(B).
---------------------------------------------------------------------------

    Further, NASDAQ proposes to adopt new subparagraph (B) to provide 
that when the Size Pro-Rata execution algorithm is in effect the System 
shall execute trading interest in price priority, meaning it will 
execute all trading interest at the best price level within the System 
before executing trading interest at the next best price. Within each 
price level, if there are two or more quotes or orders at the best 
price, trading interest will be executed 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. If this is not a whole number, 
it will be rounded down to the nearest whole number. If there are 
residual contracts remaining after rounding, such contracts will be 
distributed one contract at a time to the remaining Participants in 
time priority.\4\ The Size Pro-Rata execution algorithm will, 
initially, always operate with the priority overlays, as described 
further below.
---------------------------------------------------------------------------

    \4\ This is substantially similar to BX Options, Chapter VI, 
Section 10(1)(B).

    Example 1--rounding approach Order 1: Buy 10 contracts for 1.84, 
Non-Market Maker broker-dealer
Order 2: Buy 10 contracts for 1.84, Public Customer
Quote: 1.84 (70) x 1.86 (10) MM1
Order 3: Buy 10 contracts for 1.84, Market Maker
Market: 1.84 (100 contracts total) x 1.86 (10 contracts)
Sell order received: Sell 25 contracts at 1.84
Execution:
Order 1 represents 10 of 100 (10%) total contracts at 1.84.
10% of 25 contracts (which is the sell order) execute = 2.5, rounds 
down to 2 contracts.
Order 2 represents 10 of 100 (10%) total contracts at 1.84.
10% of 25 contracts (which is the sell order) execute = 2.5, rounds 
down to 2 contracts.
MM1's quote represents 70 of 100 (70%) total contracts at 1.84.
Again, 70% of 25 contracts execute = 17.5, rounds down to 17 
contracts.
Order 3 represents 10 of 100 (10%) total contracts at 1.84.
10% of 25 contracts (which is the sell order) execute = 2.5, rounds 
down to 2 contracts.
Total executed: 23. There are 2 residual contracts remaining from 
the 25 contract sell order.
The remaining 2 contracts are allocated one at a time based on time 
as follows:
Order 1 receives 1 additional residual contract.
Order 2 receives 1 additional residual contract.
    The 25 contract sell order is now completely executed.

    In addition, NASDAQ proposes to adopt two priority overlays. The 
new subparagraph (C), Priority Overlays Applicable to Size Pro-Rata 
Execution Algorithm, will provide that the Exchange may apply these 
priority overlays. NASDAQ plans to implement the Size Pro-Rata 
execution algorithm with both the Public Customer and Market Maker 
priority overlays.
    The first priority overlay, Public Customer Priority, is proposed 
to be subparagraph (1)(C)(i). Under this priority overlay, interest at 
the highest bid and lowest offer shall have priority except that Public 
Customer orders shall have priority over non-Public Customer orders at 
the same price. If there are two or more Public Customer orders for the 
same options series at the same price, priority shall be afforded to 
such Public Customer orders in the sequence in which they are received 
by the System. For purposes of this Rule, a Public Customer order does 
not include a Professional Order. This is substantially similar to BX 
Options, Chapter VI, Section 10.
    The second proposed priority overlay is contained in subparagraph 
(1)(C)(ii), Market Maker Priority. Under this priority overlay, the 
highest bid and lowest offer shall have priority except that Options 
Market Maker orders, after all Public Customer orders have been fully 
executed in time priority, shall have priority over all other 
Participant orders at the same price. The Public Customer priority is 
always a part of the Market Maker Priority overlay and both overlays 
will always apply to the Size Pro-Rata execution algorithm initially. 
If there are two or more Options Market Maker quotes and orders for the 
same options series at the same price, those orders shall be executed 
based on the Size Pro-Rata execution algorithm. If there are contracts 
remaining after all Market Maker interest has been fully executed 
(meaning, Non-Public Customer and Non-Market Maker), such contracts 
shall be executed based on the Size Pro-Rata execution algorithm.\5\
---------------------------------------------------------------------------

    \5\ This is substantially similar to BX Options, Chapter VI, 
Section 10(1)(C).
---------------------------------------------------------------------------

    The following is an example of the Public Customer and Market Maker 
priority overlays applied to the proposed Size Pro-Rata execution 
algorithm:

    Example 2: 
Order 1: Buy 10 contracts for 1.84, Non-MM broker-dealer
Order 2: Buy 10 contracts for 1.84, Public Customer
Quote MM1: 1.84 (10) x 1.86 (10)
Order 3: Buy MM 1.84 (10)
Sell order received: Sell 21 contracts at 1.84
Execution:
Order 2 allocated 10 contracts because of Public Customer priority
Quote MM1 represents 10 of 20 (50%) total MM contracts at 1.84. 50% 
of 11 contracts to execute = 5.5, rounds down to 5 contracts.
Order 3 represents 10 of 20 (50%) total MM contracts at 1.84. 50% of 
11 contracts to execute = 5.5, rounds down to 5 contracts.
Remaining 1 contract is allocated to MM1 based on time among MMs.
Order 1 is not executed because Market Makers have priority over 
non-Market Maker broker-dealers. Order 1 would only be executed if 
all interest at the Public Customer priority level and the Market 
Maker level was first completely executed.

    In summary, this proposed rule change will allow for a different 
execution algorithm for NOM. To be clear, two different execution 
algorithms will not operate in the same option. In addition, when the 
Size Pro-Rata execution algorithm is selected by NASDAQ, the proposed 
new priority overlays will be applied first as part of the execution 
algorithm used to allocate the order. These additional priority 
overlays are Public Customer priority and Market Maker priority, which 
will only apply to the Size Pro-Rata execution algorithm. NASDAQ notes 
that the execution algorithm will be selected and communicated by 
NASDAQ to NOM Participants. The Public Customer and Market Maker 
priority overlays will always operate with the Size Pro-Rata execution 
algorithm.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \6\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \7\ in particular, in that it is designed to promote 
just and equitable principles of trade and to protect investors and the 
public interest, because it will provide an additional execution 
algorithm with priority overlays on NOM. This additional execution 
algorithm with priority overlays should provide Participants with 
additional choices among the many competing exchanges with regard to 
their execution needs and strategies, which should promote just and 
equitable principles of trade. The Exchange believes that adding this 
flexibility to its rules will allow for greater customization, 
resulting in enhanced service to its customers and users, which would 
continue to be a purely objective method for allocating option trades. 
The Exchange is seeking to create additional incentives for firms

[[Page 79541]]

to provide liquidity on NOM. The Exchange believes that, while the 
price/time execution algorithm encourages liquidity providers to set 
the price, the Size Pro-Rata execution algorithm encourages liquidity 
providers to add size to a bid/offer at a particular price, even if 
that Participant did not set the price. Rewarding liquidity providers 
who add size should encourage larger displayed markets, which should, 
in turn, benefit and protect investors and the public interest. The 
Exchange believes that the public customer priority overlay is designed 
to promote just and equitable principles of trade and to protect 
investors and the public interest, because it recognizes the unique 
status of customers in the marketplace and the role their orders play 
in price competition and adding depth to the marketplace. The Exchange 
believes that the market maker priority overlay is designed to promote 
just and equitable principles of trade and to protect investors and the 
public interest, because it strikes a reasonable balance between 
encouraging vigorous price competition and rewarding market makers for 
their unique obligations.\8\ Overall, the overlays represent a careful 
balancing by the Exchange of the rewards and obligations of various 
types of market participants.
---------------------------------------------------------------------------

    \6\ 15 U.S.C. 78f(b).
    \7\ 15 U.S.C. 78f(b)(5).
    \8\ See NOM Rules, Chapter VII, Sections 5 and 6.
---------------------------------------------------------------------------

    With respect to the proposed language in subparagraph (A) 
respecting the price/time execution algorithm, the Exchange believes 
that the clarification (that within each price level, if there are two 
or more quotes or orders at the best price, trading interest will be 
executed in time priority) is designed to promote just and equitable 
principles of trade and to protect investors and the public interest by 
making the rule clearer and structured in a way that is user-friendly.

(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. With respect to inter-market 
competition, the proposal should enhance NOM's competitive position, as 
NOM competes vigorously with many other options exchanges. With respect 
to intra-market competition, the Exchange believes that the proposal 
will encourage liquidity providers to compete based on the size of 
their bids/offers. The Exchange does not believe that this will impose 
a burden on competition not necessary or appropriate in furtherance of 
the purposes of the Act, because the size pro-rata allocation 
algorithms are prevalent on options exchanges, and liquidity providers 
can also choose to operate on price/time exchanges instead.

(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

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
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)(ii) of the Act \9\ and 
subparagraph (f)(6) of Rule 19b-4 thereunder.\10\
---------------------------------------------------------------------------

    \9\ 15 U.S.C. 78s(b)(3)(a)(ii).
    \10\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6) 
requires a self-regulatory organization to give the Commission 
written notice of its intent to file 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.
---------------------------------------------------------------------------

    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is: (i) 
Necessary or appropriate in the public interest; (ii) for the 
protection of investors; or (iii) otherwise in furtherance of the 
purposes of the Act. If the Commission takes such action, the 
Commission shall institute proceedings to determine whether the 
proposed rule should be approved or 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 email to [email protected]. Please include File Number 
SR-NASDAQ-2013-156 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-NASDAQ-2013-156. 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-NASDAQ-2013-156 and should 
be submitted on or before January 21, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
---------------------------------------------------------------------------

    \11\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-31129 Filed 12-27-13; 8:45 am]
BILLING CODE 8011-01-P