[Federal Register Volume 88, Number 175 (Tuesday, September 12, 2023)]
[Notices]
[Pages 62612-62618]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-19593]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-98304; File No. SR-CBOE-2023-044]
Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of
Filing of a Proposed Rule Change To Adopt a Quote Protection Timer
September 6, 2023.
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 August 30, 2023, Cboe Exchange, Inc. (``Exchange'') filed with the
Securities and Exchange Commission (``Commission'') the proposed rule
change as described in Items I and II 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
Cboe Exchange, Inc. (the ``Exchange'' or ``Cboe Options'') proposes
to amend Rule 5.32. The text of the proposed rule change is provided in
Exhibit 5.
The text of the proposed rule change is also available on the
Exchange's website (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the
Secretary, and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to amend Rule 5.32 to adopt a passive quote
protection mechanism.
The options market is driven by Market-Maker quotes, and thus
Market-Maker quotes are critical to provide liquidity to the market and
contribute to price discovery for investors. If Market-Makers do not
have sufficient time to refresh their resting quotes (the primary
source of liquidity for customers in the market) in response to market
updates before executing against incoming interest that has
incorporated those market updates, this increased risk of execution at
stale prices may cause Market-Makers to widen their quotes to the
detriment of investors or otherwise withhold liquidity. This reduced
liquidity may reduce execution opportunities or cause executions to
occur at worse prices for customers. Further, Market-Makers must comply
with various obligations, including to provide continuous electronic
quotes and to update quotes in response to market conditions.\3\ It
takes time for Market-Makers to update quotes in series in their
appointed classes, which may not take effect until after faster market
participants have updated orders. The Exchange believes it is
appropriate to provide Market-Maker quotes with a reasonable amount of
protection to allow them to execute at prices reflective of market
updates given not only the Exchange-imposed requirements to provide and
updates such quotes but also the resources Market-Makers expend to
comply with those requirements.
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\3\ See Rule 5.51.
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Market-Maker quotes are based generally on pricing models that rely
on various factors, including the price of the underlying security and
that security's volatility. As these variables change, a Market-Maker's
pricing model automatically will enter updates to a number of its bids
and offers. Additionally, a Market-Maker's system may also
automatically enter orders in response to changes in those variables as
part of their market-making activity, such as hedging. As a result,
there can be a multitude of instances in which the bids and offers of
multiple Market-Makers attempting to update their quotes and submit
orders in response to market changes inadvertently interact with each
other, which can lead to significant risk and exposure. This may occur,
for example, when one Market-Maker's price update system is faster than
systems used by other Market-Makers. In this respect, a Market-Maker's
system that updates options prices microseconds, or even nanoseconds,
faster than another Market-Maker's system may lock or cross its bids
(offers) against the other Market-Maker's offers (bids) every time its
bid (offer) adjusts to the offer (bid) of the second Market-Maker even
if the second Market-Maker's system was also in the process of updating
that offer (bid).
For example, suppose three Market-Makers for class XYZ have the
following displayed markets:
Market-Maker A: (10) 10.00-10.20 (10)
Market-Maker B: (5) 10.05-10.20 (5)
Market-Maker C: (5) 9.95-10.15 (5)
Each of the Market-Maker's systems identify an increase in the price of
stock XYZ, which causes those systems to send updated quotes. However,
Market-Maker A, as a result of its own technological investment, has
the fastest system, which received the updated price of stock XYZ three
microseconds before the systems of the other two Market-Makers, and
thus sent its updated quotes to the Exchange three microseconds before
the systems of the other two Market-Makers. Market-Maker a sent a
revised two-sided market of (10) 10.20-10.40 (10) based on the updated
price of XYZ. Because the quotes for Market-Maker A's updated market
reached the Exchange before the updated markets of Market-Makers B and
C, Market-Maker A's bid will execute against Market-Maker C's offer of
10.15 and Market-Maker B's offer of 10.20, which offers were based on a
lower stock price. Market-Maker B's and C's updated markets of (5)
10.25-10.40 (5) and (5) 10.15-10.35 (5) reached the Exchange after this
execution, despite those Market-Makers no longer being interested in
selling at the price of 10.15 or 10.20. Market-Maker A likely submitted
its updated market to display liquidity available for customer prices
at an updated price, rather than remove liquidity from other liquidity
providers at outdated prices. This could happen contemporaneously in a
large number of series within the class, such that instead of locking
one quote, Market-Maker A may lock 20 of Market-Maker B's and Market-
Maker C's quotes. This may expose each Market-Maker to significant risk
due to these unintended executions and prevent orders intended to
provide liquidity in the Book from doing so.
[[Page 62613]]
The Exchange understands Market-Makers primarily use bulk message
quotes to input and update quote prices for purposes of providing
liquidity, as bulk messages allow Market-Makers to update efficiently
quotes in multiple series using a single message. To protect these
quotes--Market-Makers' primary liquidity source--from inadvertent
executions as well as executions at stale prices due to technological
disparities between Market-Maker systems, the Exchange adopted the
functionality in current Rules 5.6(c)(3) and 5.32(c)(6), which prevents
executions of incoming Market-Maker interest against resting Market-
Maker interest. The purpose of this functionality is to provide resting
Market-Maker quotes with time to update before execution so that
executions occur at prices based on then-current market, which the
Exchange believes encourages Market-Makers to provide competitive
markets on the Exchange. Specifically, Rule 5.32(c)(6) provides that
the System cancels or rejects a Cancel Back \4\ Book Only \5\ bulk
message bid (offer) or order bid (offer) (or unexecuted portion)
submitted by a Market-Maker with an appointment in the class through a
bulk port if it would execute against or lock a resting offer (bid)
with a Capacity of M. In other words, a Cancel Back Book Only Market-
Maker quote or order submitted through a bulk port will be rejected if
it would execute against resting Market-Maker interest. Additionally,
pursuant to Rule 5.32(b), the System adjusts the price of a Price
Adjust (i.e., an order designated Price Adjust or not designated as
Cancel Back) Book Only bulk message quote submitted through a bulk port
if, at the time of entry, would lock or cross a resting order or quote
with Capacity M.\6\ In other words, a Price Adjust Book Only Market-
Maker quote or order submitted through a bulk port will rest on the
Book at one increment away from a resting order or quote with Capacity
M. This functionality is designed to protect resting Market-Maker
quotes from executions at potentially stale prices due to technology
disparities (1) rather than the intention of Market-Maker quote and
order updates to trade against resting Market-Maker quotes (and thus
eliminate displayed liquidity) and (2) against incoming Market-Maker
orders (that may be submitted for the purpose of providing liquidity or
to trade for other Market-Maker purposes, such as hedging) with prices
that have incorporated market updates.
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\4\ A ``Cancel Back'' order is an order (including a bulk
message) designated to not be subject to the price adjust process
pursuant to Rule 5.32 (as described below) that the System cancels
or rejects if displaying the order on the Book would create a locked
or crossed market or if the order cannot otherwise be executed or
displayed in the Book at its limit price. See Rule 5.6(c)
(definition of ``Cancel Back'').
\5\ A ``Book Only'' order is an order the System ranks and
executes pursuant to Rule 5.32, subjects to the price adjust process
pursuant to Rule 5.32, or cancels, as applicable (in accordance with
User instructions), without routing away to another exchange. See
Rule 5.6(c) (definition of ``Book Only'').
\6\ Rule 5.32(b) describes additional price adjust scenarios,
but these scenarios are not relevant to the proposed rule change.
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The protection in Rule 5.32(c)(6) specifically prevents incoming
appointed Market-Maker interest (which may be Book Only and thus
otherwise eligible for execution against resting interest on the Book)
from executing against resting Market-Maker interest. To further
protect liquidity of Market-Makers in appointed classes (which
liquidity is subject to quoting obligations, as noted above), Rule
5.6(c)(3) provides that bulk messages used by Market-Makers in non-
appointed classes may be Post Only only, which would prevent executions
of these incoming quotes against resting interest (including resting
appointed Market-Maker interest) in those classes.
This current functionality also recognizes that resting Market-
Maker interest needs protection from orders (in addition to quotes) of
all users, including non-Market-Makers, as orders submitted through
bulk ports by Users other than appointed Market-Makers may also only be
Post Only, which again would prevent executions of these incoming
orders against resting interest (including resting appointed Market-
Maker interest). Given the primary purpose of bulk ports is to allow
Market-Makers and other users to provide liquidity to the Book, the
Exchange adopted functionality to prevent executions of interest
submitted through bulk ports against resting Market-Maker interest due
to technological disparities (as demonstrated in the example above to
protect the primary liquidity source to the Exchange.
While this current functionality protects resting Market-Maker
interest from execution at stale prices against incoming Market-Maker
and non-Market-Maker interest submitted through bulk ports, resting
Market-Maker interest remains unprotected from Market-Maker orders that
may be submitted through non-bulk ports. As noted above, Market-Makers
may submit orders for other market-making purposes, such as hedging,
which orders can be generated from the same systems generating bulk
message quotes. As a result, resting Market-Maker interest remains
subject to risk of execution at stale prices against incoming Market-
Maker non-bulk port orders due to technological disparities. Given the
critical role Market-Makers play in the options market, the Exchange
believes it is imperative to have the ability to protect Market-Makers'
resting quotes from execution at stale prices against incoming Market-
Maker interest resulting from technological disparities between Market-
Makers. The Exchange believes it should be able to extend this
protection to incoming interest from Market-Makers, regardless of the
type of port through which it was submitted, as it can expose Market-
Makers to the same level of risk. Ultimately, this exposure may
negatively impact liquidity to the detriment of the entire market.
Unlike quotes and orders submitted through bulk ports, the primary
purpose of which is generally to rest on the Book and provide
liquidity, it is likely the intention of orders submitted through non-
bulk ports to execute against the resting interest (including Market-
Maker quotes). As a result, the Exchange believes it is important to
balance the need to protect resting Market-Maker quotes from executions
at stale prices with the need to provide opportunities for this
incoming interest to execute against those quotes.
The proposed rule change proposes to adopt a quote protection timer
(``QPT'') to provide the Exchange with the ability to provide Market-
Maker quotes with this additional protection. The purpose of QPT is to
provide Market-Makers with opportunities to update the prices of their
resting quotes prior to execution against aggressing non-bulk port
incoming Market-Maker interest while still providing that incoming
interest with the opportunity to execute against resting liquidity.
Specifically, the Exchange proposes to adopt Rule 5.32(h), which
provides the Exchange with the ability to determine on a class basis to
activate a QPT. In a class in which the Exchange has activated the QPT,
if an incoming order (including an incoming complex order legging into
the Book pursuant to Rule 5.33(g), but excluding paired orders, orders
(or unexecuted portions) that routed to another exchange(s), and orders
routed from PAR) enters the Book \7\ in that class
[[Page 62614]]
with Capacity M that a User submitted through a non-bulk port (the
``initial aggressor order'') and that is marketable against a resting
bulk message quote (except for a quote offer a price equal to the
minimum increment for the class) \8\ with Capacity M (the ``initial
protected quote'') at the time the initial aggressor order enters the
Book, the initial aggressor order executes against any resting orders
and quotes with a Capacity other than M at the same price as the
initial protected quote.\9\ After that, as set forth in proposed Rule
5.32(h)(2), except for a non-ISO IOC order for which the Trading Permit
Holder (``TPH'') opts out of QPT (in which case the System cancels any
portion of the order not executed pursuant to proposed subparagraph
(1)),\10\ the System initiates the QPT,\11\ the start time of which is
the time when the initial aggressor order enters (or a complex order
\12\ Legs into) the Book (the ``quote protection period''), provided if
there is an ongoing QPT in every leg of a complex order that Legs into
the Book, the length of the QPT for the complex order equals the
longest remaining time of the leg QPTs.\13\
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\7\ This includes Immediate-or-Cancel (``IOC'') orders and
Intermarket Sweep Orders (``ISOs''). See Rule 5.6(c). Contingent
orders (i.e., stop, stop-limit, market-on-close, and limit-on-close)
are excluded from the QPT (except for market-on-close and limit-on-
close orders submitted to the Exchange within the specified amount
of time set by the Exchange pursuant to Rule 5.6(d), as they would
just be market or limit orders at that point), as by definition
these orders are not executable upon entry (they become executable
once the applicable contingency is satisfied), so it is unnecessary
to prevent from immediate execution against resting Market-Maker
quotes. The Exchange believes the proposed exclusions are
appropriate, as they would by definition provide resting quotes with
time to update before potential execution. For example, paired
orders would go through an auction (such as pursuant to Rule 5.37 or
5.38 (the automated improvement mechanism for simple and complex
orders)), during which Market-Maker quotes could update before they
would potentially execute against those orders after the auction.
Similarly, if an order routes away to another exchange because that
exchange has better prices available than those on the Exchange, by
the time any portion of that order comes back to the Exchange for
execution against the Book, any resting Market-Maker quotes could
have been updated before executing against that returned order.
Likewise, if an order routes from PAR for electronic execution, it
would have first been handled by a person on the trading floor after
entry and before execution against interest in the Book, giving
quotes sufficient time for update before potential execution against
that order.
\8\ The Exchange believes this exclusion is appropriate, as
there would be no price at which an incoming bid could adjust to and
rest during the quote protection period if the resting offer is
equal to the minimum increment for the class. For example, if the
minimum increment for a class is $0.05, and the market is $0-$0.05
on the Exchange, if an incoming order is priced at $0.05, as further
described below, during the quote protection period, the price of
the order is adjusted to one increment below the offer to prevent a
locked market. However, that would make the adjusted price of the
incoming order $0, which is not a permissible price for an order.
\9\ See proposed Rule 5.32(h)(1).
\10\ The Exchange believes it is appropriate to permit TPHs to
opt out of QPT for their non-ISO IOC orders (and just have them
execute against any resting interest with a Capacity other than M,
cancelling any remainder) because it is consistent with the IOC
instruction, pursuant to which a user desires execution in whole or
in part as soon as the System receives it. See Rule 5.6(d)
(definition of IOC time-in-force instruction).
\11\ The Exchange determines the length of the timer in
microseconds on a class basis, which may not exceed five
milliseconds. The Exchange believes this flexibility is reasonable
so it can apply a timer length that appropriately reflects market
structure differences among classes, as discussed above regarding
why it is appropriate to provide the Exchange with flexibility to
determine whether to apply QPT on a class basis. The Exchange has
this same flexibility for other Exchange functionality, such as
auction timers. See, e.g., Rule 5.37(c)(3) (providing the Exchange
with flexibility to determine the length of an AIM auction period on
a class basis).
\12\ The Exchange understands complex orders may similarly cause
executions against protected quotes due to technical disparities in
the same manner as simple orders.
\13\ The Exchange believes this is appropriate, as the resting
quotes in each leg of the complex order that are intended to be
protected by this proposed functionality will be subject to the full
length of the quote protection period before the legs of the complex
order in this scenario can execute against them.
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The Exchange believes it is reasonable to permit the Exchange to
determine whether to activate QPT on a class basis to address market
structure differences that apply to different classes. This is
consistent with other Exchange functionality, such as auctions, which
the Exchange may activate on a class basis.\14\ For example, in classes
in which there is high retail customer order volume, the Exchange
believes Market-Makers may be willing to accept additional execution
risk for the additional opportunities to execute against a significant
number of customer orders, which may ultimately offset any stale-priced
executions against faster-acting professional customers. To the
contrary, in low volume classes or classes comprised mostly of
professional investor volume, the execution risk is greater as there
are fewer potential executions against customers to offset the risk.
Additionally, in classes with smaller minimum increments, the execution
risk is higher because Market-Maker quote updates may be more granular
and thus more frequent. Therefore, in a non-penny class, a ``stale''
execution price may be wider than it might be in a penny class and thus
still within a Market-Maker's pricing parameters and risk profile. The
Exchange notes it does not believe this class flexibility is necessary
for its current protection functionality (which applies to all
classes), as the Exchange understands Market-Makers primarily use bulk
port functionality to provide liquidity and satisfy their quoting
obligations. As there are Market-Makers appointed to all classes
trading on the Exchange, the Exchange believes it is appropriate to
prevent this interest (orders and bulk messages) submitted through bulk
ports in all classes from executing against resting Market-Maker
interest, as much of the incoming interest was likely submitted to rest
on the Book (and satisfy quoting obligations to provide liquidity to
the market) rather than execute upon entry.
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\14\ See, e.g., Rule 5.37(a)(1) (permitting the Exchange to
determine in which classes orders may be submitted into an automated
improvement mechanism (``AIM'') auction for potential price
improvement).
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The Exchange also believes limiting the proposed rule change to
orders of Market-Makers (Capacity M) is appropriate because it is
consistent with current and prior functionality, which protected
resting Market-Maker interest from incoming Market-Maker interest.\15\
As noted above, Market-Maker systems may automatically generate order
and quote updates in response to market changes. The Exchange believes
resting Market-Maker interest should be protected from stale execution
against all incoming Market-Maker interest generated by those same
systems, regardless of the type of port through which the interest is
submitted.
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\15\ The Exchange notes current functionality also prevents
execution of orders with Capacities other than M against resting
Market-Maker quotes. See Rule 5.5(c)(3) (requiring users other than
appointed Market-Makers to submit orders through bulk ports as Post
Only, which cannot execute upon entry against resting interest). If
the Securities and Exchange Commission (``Commission'') approves the
proposed rule change, the Exchange may determine to submit a
separate rule filing to propose to extend QPT to other Capacities.
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Pursuant to proposed Rule 5.32(h)(3), during the quote protection
period, neither the initial aggressor order (or unexecuted portion) nor
any other incoming marketable orders with Capacity M received during
the quote protection period (together with the initial aggressor order,
the ``aggressor orders'') may execute against the protected quote or
any other contra-side bulk message quotes with Capacity M that enter
the Book (together with the initial protected quote, the ``protected
quotes''), and the System ranks (in time priority) and displays the
aggressor orders at one minimum price variation below (above) the price
of the displayed protected offer (bid).\16\ In other words, during the
quote protection period, no aggressor orders may execute against
protected quotes resting in the Book. Therefore, all aggressor orders
in a series that are entered during an ongoing quote protection period
are similarly prevented from executing against any protected quote
(whether
[[Page 62615]]
the initial protected quote or any protected quote in that series that
is entered during the quote protection period and rests on the Book).
Additionally, by having incoming aggressor orders ``join'' the initial
aggressor order and incoming protected quotes ``join'' the initial
protected quotes, a series with protected quotes will be subject to a
full quote protection period for the protected quotes in that series.
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\16\ This is similar to the Exchange's Price Adjust
functionality (see Rule 5.32(b)), which prevents the Exchange from
disseminating a locked or crossed market.
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The TPH that submitted any aggressor order during the quote
protection period, or the Market-Maker that submitted any protected
quote during the quote protection period, may update the price of its
order or quote, as applicable; however, those orders and quotes remain
firm at their displayed prices in accordance with Rule 5.59 until
updated. Therefore, aggressor orders and protected quotes may continue
to execute at their resting prices (which is an adjusted price with
respect to aggressor orders, as described above) against incoming
interest. This provides other interest that enters the Book during the
quote protection period with potential execution opportunities.
Specifically:
an incoming order with a Capacity other than M (``non-
aggressor order'') executes against resting contra-side interest at its
displayed price in accordance with the allocation algorithm applicable
to the class;
an incoming aggressor order executes against resting non-
protected quote contra-side interest at its adjusted price in
accordance with the allocation algorithm applicable to the class; and
an incoming contra-side order or quote executes against
resting aggressor and non-aggressor orders at their displayed prices in
accordance with the allocation algorithm applicable to the class.
If (a) for simple orders, there are no more protected quotes at the
initial prices of any price-adjusted aggressor orders, the System
unadjusts the prices of the aggressor buy (sell) orders to one minimum
price variation below (above) the next lowest (highest) priced
protected quote (to their limit prices); or (b) for complex orders, the
SBO (SBB) increases (decreases), the System unadjusts the prices of the
aggressor buy (sell) complex orders to one minimum variation below
(above) the then-current SBO (SBB) (to their limit prices).
Proposed Rule 5.32(h)(4) provides at the conclusion of the quote
protection period, the System unadjusts the prices of the aggressor
orders (or unexecuted portions) to their initial prices, which then
execute (in time priority) against any remaining marketable contra-side
interest, including the protected quotes, in accordance with the
allocation algorithm applicable to the class; \17\ and any unexecuted
portions of aggressor orders rest on the Book and unexecuted portions
of protected quotes remain on the Book.\18\
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\17\ See Rule 5.33(a).
\18\ If the market closes or the Exchange halts trading in the
affected series prior to the conclusion of the quote protection
period, the QPT concludes without execution.
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The Exchange believes the proposed rule change to delay execution
of resting Market-Maker quotes against incoming aggressor Market-Maker
interest is appropriate, rather than prevention of execution (as occurs
in current functionality described above), because as noted above,
unlike interest submitted through bulk ports (the primary purpose of
which is to provide liquidity on the Book), the primary purpose of
orders submitted through non-bulk ports is to execute against interest
resting on the Book.\19\ Therefore, the Exchange believes it is
important to provide this incoming interest with execution
opportunities, after a slight delay, to provide Market-Makers with
opportunities to effect their quote updates. Additionally, execution of
bulk messages (which may only be submitted through bulk ports) exposes
Market-Makers to increased risk compared to order execution. For
example, the System will not determine whether a Market-Maker's risk
monitor mechanism \20\ thresholds have been exceeded until all quotes
within a bulk message have been processed, unlike orders, which may
result in execution in only one series before the System determines
whether those thresholds have been exceeded. The Exchange believes the
proposed rule change will close a gap that currently exposes Market-
Maker liquidity resting on the Book to executions at potentially stale
prices due to technology disparities against the orders submitted by
Market-Makers through non-bulk ports. The quote protection timer will
provide a balance between protecting resting Market-Maker quotes in
order to maintain liquidity and providing incoming Market-Maker
interest with execution opportunities.
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\19\ It is possible some liquidity providers, including Market-
Makers, are submitting orders through non-bulk ports for the
provision of liquidity, but the Exchange believes this represents a
small portion of non-bulk port order flow.
\20\ See Rule 5.34(c)(4), pursuant to which a user's (including
a Market-Maker's) interest may be cancelled after that user's risk
limits have been exceeded. As a result, quotes in a bulk message
will complete executions before determination of whether a user's
risk limits have been exceeded. This makes execution risk of bulk
message greater than an order, which only has a bid or offer for one
series.
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2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Securities Exchange Act of 1934 (the ``Act'') and the rules and
regulations thereunder applicable to the Exchange and, in particular,
the requirements of Section 6(b) of the Act.\21\ Specifically, the
Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \22\ requirements that the rules of an exchange be
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 regulating, clearing,
settling, processing information with respect to, and 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. Additionally,
the Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \23\ requirement that the rules of an exchange not be
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers.
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\21\ 15 U.S.C. 78f(b).
\22\ 15 U.S.C. 78f(b)(5).
\23\ Id.
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In particular, the Exchange believes the proposed rule change will
promote just and equitable principles of trade, remove impediments to
and perfect the mechanism of a national market system, and protect
investors. The proposed rule change is intended to prevent incoming
Market-Maker orders submitted through non-bulk ports from immediately
executing against resting Market-Maker interest at potentially stale
prices due to technological disparities between Market-Makers. The
Exchange believes the proposed functionality will reduce execution of
resting Market-Maker interest at prices that do not reflect the then-
current market, which executions may impede certain liquidity
providers' ability to competitively price their bids and offers.
Specifically, this increased risk of execution at stale prices may
cause Market-Makers to widen their quotes or otherwise withhold
liquidity to the detriment of investors. The Exchange expects the
proposed rule change to increase liquidity and enhance competition in
the market, because Market-Makers may be able to quote more
aggressively with less concern about exposure to execution risk due to
technological disparities in their quoting systems compared to other
[[Page 62616]]
market participants' order entry systems. As a result, the Exchange
believes this protection for resting Market-Maker interest, and
resulting increased liquidity and competition, would ultimately remove
impediments to the market and benefit all investors.
Given the critical role Market-Makers play in the options market,
the Exchange believes it is imperative to have the ability to protect
Market-Makers' resting quotes from execution at stale prices against
incoming Market-Maker interest due to technological disparities between
Market-Makers. The Exchange believes it should be able to extend this
protection to incoming Market-Maker interest from non-bulk ports, as
technological disparities between Market-Makers can expose Market-
Makers to the same level of risk regardless of which type of port
Market-Makers submit interest. Ultimately, this exposure to risk from
may negatively impact liquidity to the detriment of the entire market.
Unlike quotes and orders submitted through bulk ports, the primary
purpose of which is generally to rest on the Book and provide
liquidity, it is likely the intention of orders submitted through non-
bulk ports to execute against the resting interest (including Market-
Maker quotes). As a result, the Exchange believes it is important to
balance the need to protect resting Market-Maker quotes from executions
at stale prices with the need to provide opportunities for this
incoming interest to execute against those quotes. The Exchange
believes the proposed rule change to slightly delay execution of
certain aggressing interest provides an equitable balance between the
need to protect resting Market-Maker interest and provide incoming
interest with execution opportunities.
The Exchange believes the proposed rule change is not designed to
permit unfair discrimination by providing the Exchange with the ability
to provide Market-Maker quotes with additional protection. The options
market is driven by Market-Maker quotes, and thus Market-Maker quotes
are critical to provide liquidity to the market and contribute to price
discovery for investors. If Market-Makers do not have sufficient time
to refresh their resting quotes (the primary source of liquidity for
customers in the market) in response to market updates before executing
against incoming interest that has incorporated those market updates,
this increased risk of execution at stale prices may cause Market-
Makers to widen their quotes to the detriment of investors or otherwise
withhold liquidity. This reduced liquidity may reduce execution
opportunities or cause executions to occur at worse prices for
customers. Further, Market-Makers must comply with various obligations,
including to provide continuous electronic quotes and to update quotes
in response to market conditions.\24\ It takes time for Market-Makers
to update quotes in series in their appointed classes, which may not
take effect until after faster market participants have updated orders.
The Exchange believes it is appropriate to provide Market-Maker quotes
with a reasonable amount of protection (as the proposed rule change
would provide) to allow them to execute at prices reflective of market
updates given the Market-Makers' need to comply with these obligations
and the resources they expend to comply with these obligations.\25\ As
described above, the protected quotes and aggressor orders will remain
firm during the quote protection period, and executions will continue
during that period.
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\24\ See Rule 5.51.
\25\ See id.
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Further, the Exchange believes the proposed rule change to provide
the Exchange with flexibility to determine whether to enable QPT on a
class basis, and in such classes to provide the Exchange with
flexibility to determine the length of the quote protection period, is
not designed to permit unfair discrimination. The Exchange believes
this flexibility is appropriate to address market structure
differences, including differences among market participants and
activity levels, within different classes, which flexibility the
Exchange has with respect to other functionality, such as auctions.\26\
For example, in classes in which there is high retail customer order
volume, the Exchange believes Market-Makers may be willing to accept
additional execution risk for the additional opportunities to execute
against a significant number of customer orders, which may ultimately
offset any stale-priced executions against faster-acting professional
customers. To the contrary, in low volume classes or classes comprised
mostly of professional investor volume, the execution risk is greater
as there are fewer potential executions against customers to offset the
risk. Additionally, in classes with smaller minimum increments, the
execution risk is higher because Market-Maker quote updates may be more
granular and thus more frequent. Therefore, in a non-penny class, a
``stale'' execution price may be wider than it might be in a penny
class. The Exchange notes it does not believe this class flexibility is
necessary for its current protection functionality (which applies to
all classes), as the Exchange understands Market-Makers primarily use
bulk port functionality to provide liquidity and satisfy their quoting
obligations. As there are Market-Makers appointed to all classes
trading on the Exchange, the Exchange believes it is appropriate to
prevent this interest (orders and bulk messages) submitted through bulk
ports in all classes from executing against resting Market-Maker
interest, as much of the incoming interest was likely submitted to rest
on the Book (and satisfy quoting obligations to provide liquidity to
the market) rather than execute upon entry.
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\26\ See, e.g., Rule 5.37(a)(1) (permitting the Exchange to
determine in which classes orders may be submitted into an AIM
auction for potential price improvement) and (c)(3) (permitting the
Exchange to determine the length of the AIM auction period on a
class basis).
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The Exchange also believes limiting the proposed rule change to
orders of Market-Makers (Capacity M) is appropriate because it is
consistent with current and prior functionality, which protected
resting Market-Maker interest from incoming Market-Maker interest.\27\
As noted above, Market-Maker systems may automatically generate order
and quote updates in response to market changes. The Exchange believes
resting Market-Maker interest should be protected from stale execution
against all incoming Market-Maker interest generated by those same
systems, regardless of the type of port through which the interest is
submitted. Therefore, the Exchange believes the proposed rule change to
close this current gap exposing resting Market-Maker interest to
execution risk against incoming Market-Maker interest submitted through
non-bulk ports due to technological disparities will remove impediments
to and perfect the mechanism of a free and open market and a national
market system, and protect investors and the public interest.
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\27\ The Exchange notes current functionality also prevents
execution of orders with Capacities other than M against resting
Market-Maker quotes. See Rule 5.5(c)(3) (requiring users other than
appointed Market-Makers to submit orders through bulk ports as Post
Only, which cannot execute upon entry against resting interest). If
the Securities and Exchange Commission (``Commission'') approves the
proposed rule change, the Exchange may determine to submit a
separate rule filing to propose to extend QPT to other Capacities.
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The Exchange notes the underlying purpose of this proposed rule
change, which is to provide resting Market-Maker quotes with time to
update in response to market condition changes, is the same as the
primary purpose of functionality and previously available
[[Page 62617]]
on the Exchange.\28\ The Exchange believes the proposed rule change to
delay execution of resting Market-Maker quotes against incoming
aggressor interest is appropriate, rather than prevention of execution
(as occurs in current functionality described above), because as noted
above, unlike interest submitted through bulk ports (the primary
purpose of which is to provide liquidity on the Book), the primary
purpose of orders submitted through non-bulk ports is to execute
against interest resting on the Book.\29\ Therefore, the Exchange
believes it is important to provide this incoming interest with
execution opportunities, after a slight delay, to provide Market-Makers
with opportunities to effect their quote updates. Additionally,
execution of bulk messages (which may only be submitted through bulk
ports) exposes Market-Makers to increased risk compared to order
execution. For example, the System will not determine whether a Market-
Maker's risk monitor mechanism \30\ thresholds have been exceeded until
all quotes within a bulk message have been processed, unlike orders,
which may result in execution in only one series before the System
determines whether those thresholds have been exceeded. The Exchange
believes the proposed rule change will close a gap that currently
exposes Market-Maker liquidity resting on the Book to executions at
potentially stale prices due to technology disparities against Market-
Maker orders submitted through non-bulk ports. The quote protection
timer will provide a balance between protecting resting Market-Maker
quotes in order to maintain liquidity and providing incoming interest
with execution opportunities.
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\28\ See Rules 5.5(c)(3) and 5.32(c)(6); see also Securities
Exchange Act Release Nos. 86374 (July 15, 2019), 84 FR 34963 (July
19, 2019) (SR-CBOE-2019-033) (adoption of current Rules 5.5(c)(3)
and 5.32(c)(6)); and 51822 (June 10, 2005), 70 FR 35321 (June 17,
2005) (SR-CBOE-2004-87) (adoption of former Cboe Rule 6.45(c)).
\29\ It is possible some liquidity providers, including Market-
Makers, are submitting orders through non-bulk ports for the
provision of liquidity, but the Exchange believes this represents a
small portion of non-bulk port order flow.
\30\ See Rule 5.34(c)(4), pursuant to which a user's (including
a Market-Maker's) interest may be cancelled after that user's risk
limits have been exceeded. As a result, quotes in a bulk message
will complete executions before determination of whether a user's
risk limits have been exceeded. This makes execution risk of bulk
message greater than an order, which only has a bid or offer for one
series.
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The proposed temporary adjustment of aggressor order prices will
further perfect the mechanism of a free and open market and national
market system, as it will prevent the display of a locked or crossed
market consistent with the Linkage Plan.\31\ This proposed handling of
these orders is also consistent with the Exchange's current Price
Adjust functionality.\32\
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\31\ See Rule 5.66.
\32\ See Rule 5.32(g).
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As noted above, the options market is driven by Market-Maker
quotes, and thus Market-Maker quotes are critical to provide liquidity
to the market and contribute to price discovery for investors. The
proposed functionality is designed to permit the Exchange to provide
Market-Makers with further protection against executions at potentially
stale prices due to technology disparities while still providing
incoming Market-Maker orders submitted through non-bulk ports with
execution opportunities. The Exchange believes the proposed enhanced
functionality will permit liquidity providers to more efficiently enter
and update bids and offers. This may cause Market-Makers to quote
tighter and deeper markets, which will increase liquidity and enhance
competition to the ultimate benefit of all market participants.
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 that is not necessary or appropriate
in furtherance of the purposes of the Act. The Exchange does not
believe the proposed rule change will impose any burden on intramarket
competition that is not necessary or appropriate in furtherance of the
purposes of the Act, because it will apply in the same manner to all
incoming Market-Maker orders in non-bulk ports. The primary purpose of
the proposed rule change is to permit the Exchange to provide
additional protection to resting Market-Maker quotes from executions
against incoming Market-Maker interest at potentially stale prices
before they have the opportunity to update in response to market
condition changes. The Exchange believes it is reasonable to provide
additional protection to Market-Makers given their unique and critical
role in the options market and the various obligations that Market-
Makers must satisfy, as discussed above. Additionally, as noted above,
the proposed functionality supplements similar functionality currently
available on the Exchange, which similarly protects resting Market-
Maker interest against executions at potentially stale prices.\33\ The
Exchange does not believe the proposed flexibility to apply QPT on a
class basis, or determine the length of the timer on a class basis,
will impose any burden on intramarket competition that is not necessary
or appropriate in furtherance of the purposes of the Act, as such
flexibility is reasonable to address market structure differences among
classes, as discussed above.
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\33\ See Rule 5.32(c)(6).
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The Exchange does not believe the proposed rule change will impose
any burden on intermarket competition that is not necessary or
appropriate in furtherance of the purposes of the Act, because it
applies solely to the timing of executions against resting Market-Maker
quotes on the Exchange. As noted above, the proposed rule change is
consistent with the Linkage Plan.\34\
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\34\ See Rule 5.66.
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Additionally, the Exchange believes the proposed rule change will
relieve any burden on, or otherwise promote, competition. As discussed
above, the Exchange believe the proposed rule change may encourage the
provision of more aggressive liquidity, which may result in more
trading opportunities and tighter spreads, which contributes to price
discovery. This may improve overall market quality and enhance
competition on the Exchange.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The Exchange neither solicited nor received comments on the
proposed rule change.
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 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. Comments may be submitted by any of
the following methods:
[[Page 62618]]
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
file number SR-CBOE-2023-044 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to file number SR-CBOE-2023-044. 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 website (https://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 website 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
a.m. and 3 p.m. Copies of the filing also will be available for
inspection and copying at the principal office of the Exchange. Do not
include personal identifiable information in submissions; you should
submit only information that you wish to make available publicly. We
may redact in part or withhold entirely from publication submitted
material that is obscene or subject to copyright protection. All
submissions should refer to file number SR-CBOE-2023-044 and should be
submitted on or before October 3, 2023.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\35\
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\35\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-19593 Filed 9-11-23; 8:45 am]
BILLING CODE 8011-01-P