[Federal Register Volume 78, Number 47 (Monday, March 11, 2013)]
[Notices]
[Pages 15385-15392]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-05543]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69040; File No. SR-BX-2013-016]
Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Notice of
Filing of Proposed Rule Change To Adopt a Directed Order Process
March 5, 2013.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on February 21, 2013, NASDAQ OMX BX, Inc. (``BX'' or ``Exchange'')
filed with the Securities and Exchange Commission (``SEC'' or
``Commission'') the proposed rule change as described in Items I, II,
and III, below, which Items have been prepared by the Exchange. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange has filed a proposed rule change offering a new
enhancement [sic] to adopt a Direct Order process.
The text of the proposed rule change is below. Proposed new
language is in italics; deletions are bracketed.
* * * * *
Chapter VI Trading Systems
* * * * *
[[Page 15386]]
Sec. 1 Definitions
The following definitions apply to Chapter VI for the trading of
options listed on BX Options.
(a)-(d) No change.
(e) The term ``Order Type'' shall mean the unique processing
prescribed for designated orders that are eligible for entry into the
System, and shall include:
(1) [Reserved.] Directed Order. The term ``Directed Order'' means
an order to buy or sell which has been directed (pursuant to the
Exchange's instructions on how to direct an order) to a particular
Market Maker (``Directed Market Maker'') after the opening. Directed
Orders are handled within the System pursuant to Chapter VI, Section
10(3).
(2)-(11) No change.
(f)-(h) No change.
* * * * *
Sec. 6 Acceptance of Quotes and Orders
All bids or offers made and accepted on BX Options in accordance
with the BX Options Rules shall constitute binding contracts, subject
to applicable requirements of the Rules of the Exchange and the Rules
of the Clearing Corporation.
(a) General--A System order is an order that is entered into the
System for display and/or execution as appropriate. Such orders are
executable against marketable contra-side orders in the System.
(1) All System Orders shall indicate whether they are a call or put
and buy or sell and a price, if any. Systems Orders can be designated
as Immediate or Cancel (``IOC''), Good-till-Cancelled (``GTC''), Day
(``DAY'') or WAIT.
(2) A System order may also be designated as a Directed Order,
Limit Order, a Minimum Quantity Order, a Market Order, a Price
Improving Order, an All-or-None Order or a Post-Only Order.
(b)-(c) No change.
* * * * *
Sec. 10 Book Processing
System orders shall be executed through the BX Book Process set
forth below:
(1)-(2) No change.
(3) [Price Improvement--any potential price improvement resulting
from an execution in the System shall accrue to the party that is
removing liquidity previously posted to the Book.]
Directed Order Processing.
(i) When BX's disseminated price is the NBBO and the Directed
Market Maker is quoting at BX's disseminated price, the Directed Order
shall be executed and allocated as follows:
(A) If the option is subject to the Price/Time execution algorithm,
the Directed Market Maker shall receive 40% of the Directed Order at a
particular price (``Directed Allocation''), unless such Directed Market
Maker was first in time priority, in which case such Directed Market
Maker shall receive the amount of the Directed Order equal to the
Directed Market Maker's quote/order size at that price. If there are
multiple resting quotes/orders from the same Directed Market Maker, the
Directed Allocation will be distributed among them in time sequence.
Then, the remainder of the Directed Order shall be allocated to other
participants in price/time priority, including any remaining contracts
of the Directed Market Maker and multiple quotes/orders from the same
firm.
(B) If the option is subject to the Pro-Rata execution algorithm,
Public Customer limit orders resting on the limit order book at the
execution price will execute against the Directed Order first. Then,
the Directed Market Maker shall receive the greater of: the pro-rata
allocation to which such Directed Market Maker would otherwise be
entitled or the Directed Allocation of 40% of the Directed Order at a
particular price. If there are multiple quotes/orders from the same
Directed Market Maker, the Directed Allocation will be distributed
among those quotes/orders on a size pro rata basis. Once the Directed
Allocation is determined, any remaining contracts associated with the
Directed Market Maker's quotes/orders are excluded from the remaining
pro-rata allocation. If there are any remaining contracts of the
Directed Order, they will be allocated on a size pro rata basis among
the remaining Participants (except the Directed Market Maker).
(ii) When BX's disseminated price is the NBBO, and the quotation
disseminated by the Directed Market Maker on the opposite side of the
market from the Directed Order is inferior to the NBBO, the Directed
Order shall be automatically executed and allocated to those quotations
and orders at the NBBO in accordance with this Section.
(iii) If BX's disseminated price is not the NBBO, the Directed
Order shall be processed in accordance with Chapter VI, Sections 7, 10
and 11.
(iv) In addition, the following will apply:
(A) A Directed Market Maker shall not be entitled to receive a
number of contracts that is greater than the size associated with their
order or quote at a particular price level.
(B) Directed Allocations are rounded up to the next whole number.
(C) The Directed Allocation is available for the life of the order
and the Directed Market Maker is entitled to the Directed Allocation at
all price levels that the Directed Market Maker has an order or quote.
(D) Directed Market Makers are subject to the quoting requirements
of Chapter VII, Section 6(d)(i)(4).
(E) The Exchange will determine which options are subject to
Directed Allocation.
(4)-(7) No change.
(8) Price Improvement--any potential price improvement resulting
from an execution in the System shall accrue to the party that is
removing liquidity previously posted to the Book.
* * * * *
Chapter VII Market Participants
* * * * *
Sec. 6 Market Maker Quotations
(a)-(c) No change.
(d) Continuous Quotes. A Market Maker must enter continuous bids
and offers for the options to which it is registered, as follows:
i. On a daily basis, a Market Maker must during regular market
hours make markets consistent with the applicable quoting requirements
specified in these rules, on a continuous basis [in at least sixty
percent (60%) of the series] in options in which the Market Maker is
registered.
(1) To satisfy this requirement [with respect to quoting a series],
a Market Maker must quote[ such series] 60[90]% of the trading day (as
a percentage of the total number of minutes in such trading day) or
such higher percentage as BX may announce in advance. BX Regulation may
consider exceptions to the requirement to quote 60[90]% (or higher) of
the trading day based on demonstrated legal or regulatory requirements
or other mitigating circumstances. This obligation will apply to all of
a Market Maker's registered options collectively, rather than on an
option-by-option basis. Compliance with this obligation will be
determined on a monthly basis.
(2) Notwithstanding the foregoing, Market Makers shall not be
required to make two-sided markets pursuant to Section 5(a)(i) of these
rules in any Quarterly Option Series, any adjusted option series, and
any option series until the time to expiration for such series is less
than nine months. Accordingly, the continuous quotation obligations set
forth in this rule shall not apply to Market Makers respecting
Quarterly Option Series, adjusted option
[[Page 15387]]
series, and series with an expiration of nine months or greater. For
purposes of this subsection (2), an adjusted option series is an option
series wherein one option contract in the series represents the
delivery of other than 100 shares of underlying stock or Exchange-
Traded Fund Shares.
(3) If a technical failure or limitation of a system of BX prevents
a Market Maker from maintaining, or prevents a Market Maker from
communicating to BX Options timely and accurate quotes, the duration of
such failure or limitation shall not be included in any of the
calculations under this subparagraph (i) with respect to the affected
quotes.
(4) In options in which it receives Directed Orders, a Directed
Market Maker must quote such options 90% of the trading day (as a
percentage of the total number of minutes in such trading day) or such
higher percentage as BX may announce in advance, applied collectively
to all series in all of the options in which the Directed Market Maker
receives Directed Orders (rather than on an option-by-option basis).
Compliance with this obligation will be determined on a monthly basis.
ii.-iii. No change.
(e) No change.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
The BX Options market launched on June 29, 2012 as a fully
automated, price/time priority execution system built on the core
functionality of the NASDAQ Options Market (``NOM'').\3\ BX Options
operates as an all-electronic system (``System'') with no physical
trading floor and provides for the electronic display and execution of
orders. In its proposed rule change to create the BX Options market, BX
stated that, initially, BX Options would have the same market structure
and rules as NOM, focusing on a price/time priority market.\4\ BX
further stated that, over time, as the BX Options market secured more
participants, it would introduce additional, innovative
functionality.\5\ Accordingly, BX recently introduced a Size Pro-Rata
execution algorithm for BX Options,\6\ which executes orders at a
particular price level based on the size of each Participant's quote or
order as a percentage of the total size of all orders and quotes
resting at that price. BX intends for some options to employ one
algorithm while others employ a different one.
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\3\ See BX Options Rules, Chapter VI, Section 1(e)(11).
Securities Exchange Act Release No. 67256 (June 26, 2012), 77 FR
39277 (July 2, 2012) (SR-BX-2012-030) (Approving the establishment
of the BX Options market).
\4\ See id. at 39278.
\5\ Securities Exchange Act Release No. 66983 (May 14, 2012), 77
FR 29730 (May 18, 2012) (Notice of filing of SR-BX-2012-030).
\6\ Securities Exchange Act Release No. 68041 (October 11,
2012), 77 FR 63903 (October 17, 2012) (SR-BX-2012-065).
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At this time, BX proposes its next enhancement to BX Options by
offering a directed order process.\7\ BX proposes to amend various
rules to establish the process. First, BX proposes to define a Directed
Order in Chapter VI, Section 1(e)(1) as an order to buy or sell which
has been directed (pursuant to the Exchange's instructions on how to
direct an order) to a particular Market Maker (``Directed Market
Maker'') after the opening.\8\ It further provides that Directed Orders
are handled within the System pursuant to Chapter VI, Section 10(3),
which is proposed new language.\9\
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\7\ The term directed order has a different meaning on equities
markets. See e.g., NASDAQ Rule 4751(a)(9)[sic].
\8\ BX also proposes to amend Chapter VI, Section 6(a)(2) to add
Directed Orders to the list of System orders.
\9\ Currently, Section 10(3) governs price improvement. It is
being moved to new Section 10(8).
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Pursuant to proposed Chapter VI, Section 10(3)(i), when BX's
disseminated price is the National Best Bid/Offer (``NBBO'') and the
Directed Market Maker is quoting at BX's disseminated price, the
Directed Order shall be executed and allocated pursuant to one of BX's
two execution algorithms for options.\10\ If the option is subject to
the Price/Time execution algorithm,\11\ the Directed Market Maker shall
receive 40% of the Directed Order (``Directed Allocation''), unless
such Directed Market Maker was first in time priority, in which case
such Directed Market Maker shall receive the amount of the Directed
Order equal to the Directed Market Maker's quote/order size at that
price. If there are multiple resting quotes/orders from the same
Directed Market Maker, the Directed Allocation will be distributed
among them in time sequence. Then, the remainder of the Directed Order
shall be allocated to other participants in price/time priority,
including any remaining contracts of the Directed Market Maker and
multiple quotes/orders from the same firm.\12\
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\10\ Chapter VI, Section 10(1).
\11\ Chapter VI, Section 10(1)(A).
\12\ The BX Options trading system identifies Directed Market
Makers by a particular code called an IFI, which BX will use to
consider which quotes/orders are from the same firm.
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Example 1 (Price/Time)
NBBO: $1.00 x $1.05
BX Options Book \13\
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\13\ In each example, quotes and orders are listed in the
sequence in which they were received.
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Firm1 Order A Sell 20 at $1.05
Firm2 Order B Sell 20 at $1.05
MM3 Quote C $1.00 x $1.05 (size 100 x 100)
Firm4 Order D Sell 50 at $1.05
BX Options Best Offer: 190 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to
MM3:
40 contracts execute against MM3 Quote C as a Directed Allocation:
40% of 100 contracts
20 contracts execute against Firm1 Order A based on time priority
20 contracts execute against Firm2 Order B based on time priority
20 additional contracts execute against MM3 Quote C based on time
priority
The Directed Order is fully executed
No contracts execute against Firm4 because it is behind Firm1, Firm2,
and MM3 in time priority and no more contracts remain
BX notes that, in this example, MM3 receives additional contracts
beyond the Directed Allocation under the proposed rule, which permits
the Directed Market Maker to retain its position in time priority for
the remainder of the contracts. BX believes that it is reasonable and
encourages Directed Market Makers to display their entire size, which
benefits the quality of BX's market.
BX further notes that if a Public Customer order is involved, the
Directed Allocation is nevertheless available to the Directed
Participant, before the Public Customer order is executed. For example:
[[Page 15388]]
Example 1A (Price/Time With a Public Customer)
NBBO: $1.00 x $1.05
BX Options Book
Firm1 Public Customer Order A Sell 20 at $1.05
Firm2 Broker Dealer Order B Sell 20 at $1.05
MM3 Quote C $1.00 x $1.05 (size 100 x 100)
Firm4 Broker Dealer Order D Sell 50 at $1.05
BX Options Best Offer: 190 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to
MM3:
40 contracts execute against MM3 Quote C as a Directed Allocation:
40% of 100 contracts
20 contracts execute against Firm1 Public Customer Order A based on
time priority
20 contracts execute against Firm2 Order B based on time priority
20 additional contracts execute against MM3 Quote C based on time
priority
The Directed Order is fully executed
No contracts execute against Firm4 because it is behind Firm1, Firm2,
and MM3 in time priority and no more contracts remain
BX is proposing to afford a Directed Allocation when there is a
Public Customer order eligible to trade with the Directed Order. BX
understands that other options exchanges' rules respecting directed
orders do not provide a directed allocation to a directed market maker
when there is a customer order ahead of a directed market maker at a
particular price.\14\ However, BX believes it is reasonable and
consistent with applicable statutory standards for the Directed
Allocation to occur, as proposed herein. The Public Customer order is
not precluded from participating in the trade, but rather continues to
stand in time priority once the Directed Allocation occurs. The Public
Customer may not receive a full execution, but had the Directed Order
not been sent to BX, the Public Customer may not have received an
execution at all. The Directed Participant and their relationship with
the provider of that Directed Order may have attracted the order to BX,
to the benefit of the Public Customer order as well as all potential
contra-side orders on the book. Accordingly, there is no particular
reason for a Directed Allocation to operate differently just because a
Public Customer order is involved; the very nature of the price/time
priority model is that Public Customer orders are like all other orders
and do not jump ahead in priority. BX does not believe that this is
unfair to Public Customer orders; it is merely a different model.
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\14\ For example, the directed order is allocated pursuant to
the price/time priority rule on NYSE Arca. See NYSE Arca Rule
6.76A(a)(1)(A)(ii).
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New Section 10(3)(i)(B) provides that if the option is subject to
the Size Pro-Rata execution algorithm,\15\ Public Customer limit orders
resting on the limit order book at the execution price will execute
against the Directed Order first. Then, the Directed Market Maker shall
receive the greater of: the pro-rata allocation to which such Directed
Market Maker would otherwise be entitled pursuant to the Size Pro-Rata
execution algorithm or the Directed Allocation of 40% of the Directed
Order. If there are multiple resting quotes/orders from the same
Directed Market Maker, the Directed Allocation will be allocated among
those quotes/orders on a size pro-rata basis. Once the Directed
Allocation is determined, any remaining contracts associated with the
Directed Market Maker's quotes/orders are excluded from the remaining
pro-rata allocation. If there are any remaining contracts of the
Directed Order, they will be allocated on a size pro-rata basis among
the remaining Participants (except the Directed Market Maker). For
example:
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\15\ Chapter VI, Section 10(1)(B).
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Example 2 (Pro-Rata)
NBBO: $1.00 x $1.05
BX Options Book
Firm1 Public Customer Order A Sell 20 at $1.05
MM2 Quote B $1.00 x $1.05 (size 100 x 100)
MM3 Quote C $1.00 x $1.05 (size 50 x 50)
MM4 Quote D $1.00 x $1.05 (size 100 x 100)
BX Options Best Offer: 270 at $1.05
BX receives a Directed Order to buy 100 contracts at $1.05 directed to
MM3:
20 contracts execute against Firm1 Public Customer Order A due to
Public Customer priority
40 contracts execute against MM3 Quote C as a Directed Allocation
(40% of 100 contract buy order)
MM2 and MM4 each receive 20 contracts on a size pro-rata basis (50%
each of 40 remaining contracts)
New Section 10(3)(ii) deals with the situation where BX's
disseminated price is the NBBO but the quotation disseminated by the
Directed Market Maker on the opposite side of the market from the
Directed Order is inferior to the NBBO. In such case, the Directed
Order shall be automatically executed and allocated to those quotations
and orders at the NBBO in accordance with this Section as follows:
Example 3 (Price/Time or Pro-Rata--Same Outcome)
NBBO: $1.00 x $1.05
BX Options Book
Firm1 Order A Sell 100 at $1.05
MM2 Quote C $1.00 x $1.06 (size 100 x 100)
BX Options Best Offer: 100 at $1.05
BX receives a Directed Order to buy 50 contracts directed to MM2:
50 contracts execute against Firm1 Order A
The Directed Order is completely filled
MM2 does not receive a Directed Allocation because Quote C is not part
of BX Options' best offer nor the NBBO
New Section 10(3)(iii) covers the situation where BX's disseminated
price is not the NBBO; then, the Directed Order shall be processed in
accordance with Chapter VI, Sections 7, 10 and 11.
Example 4 (Price/Time or Pro-Rata--Same Outcome)
CBOE Quote: $1.00 x $1.05 (size 10 x 10)
BX Options Book
MM1 Quote A $1.00 x $1.06 (size 100 x 100)
MM2 Quote B $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 150 at $1.06
NBBO: $1.00 x $1.05 (size 160 x 10)
BX receives a Directed Order to buy 110 contracts at $1.06 directed to
MM2:
10 contracts are routed and executed against the better away offer
of $1.05 (CBOE)
Because the CBOE offer is executed, BX Options is now the NBBO
40 contracts execute against MM2 Quote B as a Directed Allocation
(40% of 100 contracts remaining from the Directed Order)
60 contracts execute against MM1 Quote A
In this example, BX was not initially at the NBBO, but once the
National Best Offer (``NBO'') was exhausted, BX's offer of 150
contracts at $1.06 became the NBO. BX proposes to permit the Directed
Allocation at the next price level, even though the Directed
Participant was not at the NBBO at the time of order receipt, as
described further below. BX understands that other options exchanges'
directed order programs limit directed allocations to situations where
the directed party is at the NBBO at the time of receipt of the
[[Page 15389]]
directed order. BX believes that it is consistent with the purpose of
the NBBO requirement to structure its Directed Order program as
proposed herein for the following reasons.
The purpose of the requirement for the directed participant to be
at the NBBO is to encourage such participant to quote competitively
rather than to quote a wide market and wait for directed orders to
arrive. BX believes that permitting the Directed Market Maker to
receive a Directed Allocation even if such market maker was not on the
NBBO at the time of receipt of the Directed Order still encourages
competitive quoting. The Directed Order will trade at the NBBO at the
time it was received with whatever contracts are available. If, and
only if, contracts remain, then the order can execute at the next price
level. At that next price level that is the new NBBO, the Directed
Market Maker must be on the NBBO. Under the proposal, such market maker
is being rewarded for being at the next best price, consistent with the
purposes of the NBBO requirement. The market maker has an incentive to
quote competitively because quoting a tick or two away from the NBBO is
likely to result in very little trading for that market maker,
especially if other quotes and orders are at or closer to the NBBO and
especially in more liquid options.
Providing market makers with an enhanced allocation for order flow
that is specifically directed to that market maker when the market
maker is not initially on the NBBO is fair and does not create
incentives to avoid quoting at the NBBO. There is fierce competition
within the BX Options market and within the broader options market
place. Within the BX Options market, there are many market makers who
compete for available order flow on the basis of their quoted price. If
a market maker's price is not equal to or better than all other quoted
prices, they will simply not trade until all other market makers (and
all other participants) trade at the superior price. This creates and
supports healthy competition among market makers to quote the best
price possible. In addition to the competition among market makers,
there are also other market participants (broker-dealer, Public
Customer, professional, etc.) who compete against each other and
against market makers based on price, thus providing a further
incentive for market makers to provide the best price possible.
Finally, in the broader options marketplace, BX Options market makers
not only have to compete with the market makers and participants on the
BX Options market, but also with the plethora of market makers and
other participants who quote or post orders on options exchanges other
than BX Options. Indeed, the incentive to provide a competitive quote
is strong due to the inherently competitive nature of today's options
markets. Necessarily, a market maker who does not match or improve the
NBBO on a consistent basis does not trade often. This proposal does not
create a disincentive for a market maker to match or improve the NBBO.
BX believes that this is an issue of timing of the directed allocation
and not whether it is appropriate to afford a directed allocation at
the next price level.
Providing directed order functionality should also add an
additional layer of competition among those market makers who attempt
to attract directed order flow. When market makers approach order flow
providers to send directed order flow, the order flow providers expect
clear data as evidence that directing order flow to the market maker
will benefit the order flow provider and more importantly the order
flow provider's customers. As more market makers attempt to attract
order flow, they will likely need to show ever improving quote
statistics. If a market maker were to quote $0.01 outside the NBBO in
hopes of capturing some miniscule amount of order flow at a better
price than everyone else, the order flow provider would see this in
their quality of execution statistics and simply stop directing order
flow to the market maker. Here again, there is a strong incentive to be
matching or improving the NBBO in order to attract order flow and
trade.
BX notes that at the time of the approval of the first directed
order programs, routing among the options exchanges occurred through a
central linkage process and executions through multiple price levels
were not as seamless and efficient as today. In the current
environment, executions occur across multiple price levels with
simultaneous outbound routing. BX believes that order execution should
not be inhibited by the artificial constraint of limiting directed
allocations to directed participants who are on the NBBO at the time of
order receipt in an options marketplace with vigorous competition and
actively changing markets. It is sufficient for the directed
participant to be on the NBBO at the time of execution.
New Section 10(3)(iv) incorporates several additional provisions
respecting the Directed Order process. Specifically, a Directed Market
Maker shall not be entitled to receive a number of contracts that is
greater than the size associated with their order or quote at a
particular price level. This provision is common in other options
exchanges' directed order programs and is intended to incent Directed
Market Makers to show more size. Much like a market maker has an
incentive to match or improve the NBBO in order to trade more often, a
market maker also has the incentive to display as much liquidity as
possible in order to trade more volume. The resulting additional size
at the NBBO benefits investors by making the market more liquid, which,
in turn, makes it easier for investors to enter and exit their specific
options positions.
In addition, Directed Allocations are rounded up to the next whole
number.
Example 5 (Price/Time or Pro-Rata--Same Outcome)
NBBO: $1.00 x $1.05
BX Options Book
MM1 Quote A $1.00 x $1.05 (size 100 x 100)
MM2 Quote B $1.00 x $1.05 (size 50 x 50)
BX Options Best Offer: 150 at $1.05
BX receives a Directed Order to buy 91 contracts at $1.05 directed to
MM2:
37 contracts execute against MM2 Quote B as a Directed Allocation
(40% of 91 = 36.4 rounded up to 37)
54 contracts execute against MM1 Quote A
BX understands that the directed order programs of other options
exchanges have generally limited the amount of the directed allocation
to 40% of the size of the directed order, which is what BX has proposed
herein. Because BX intends to round that allocation up to the nearest
whole number, BX acknowledges that it is mathematically possible for
its proposed Directed Allocation to exceed 40% in certain situations,
but, of course, because it is rounding to the nearest whole number,
rounding will necessarily never result in more than one additional
options contract being added to the Directed Allocation. Even if such
one additional contract caused the Directed Allocation to exceed 40%,
BX believes that this is appropriate and reasonable because it is only
one contract, regardless of the percentage.\16\ Other options
entitlement programs approved by the Commission sometimes exceed a 40%
guarantee, also in limited, mathematically-driven situations. For
[[Page 15390]]
example, the specialist or lead market maker entitlement permits the
allocation of five contracts and less to a particular participant,
which is much greater than the one contract proposed herein (i.e. the
specialist entitlement allows for a 100% allocation for orders of 5
contracts or less).\17\ Furthermore, specialist entitlement programs
also provide for a 60% allocation in situations where the split is
between two participants. Furthermore, pursuant to proposed
subparagraph (iv)(C), the Directed Allocation is available for the life
of the order. If a Directed Order is not executed upon receipt, it
retains its status as a Directed Order, such that, once it becomes
executable, it is subject to Directed Order Handling under new Section
10(3).
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\16\ Generally, the larger the number of contracts being
rounded, the smaller the percentage, with some mathematical
variation. For example, an order of 9 contracts would round up from
3.6 to 4 contracts or 44.44% of the order, whereas an order for
91contracts would be rounded up for directed allocation purposes
from 36.4 to 37 contracts or 40.66% of the order.
\17\ The specialist on NYSE MKT receives a 100% allocation on
orders of 5 contracts or less and 40% of other eligible orders, even
though the specialist's quoting obligation is the same as the
proposed BX Options Directed Market Maker quoting obligation.
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Example 6 (Price/Time or Pro-Rata--Same Outcome)
CBOE Quote: $1.00 x $1.05 (size 10 x 10)
NBBO: $1.00 x $1.05 (size 160 x 10)
BX Options Book
MM1 Quote A $1.00 x $1.06 (size 100 x 100)
MM2 Quote B $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 150 at $1.06
BX receives a non-routable Directed Order to buy 100 contracts at $1.06
directed to MM2:
The order is posted on the BX Options book at $1.05 and displayed at
$1.04 \18\
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\18\ See Chapter VI, Section 11.
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CBOE updates its quote to $1.00 x $1.07 (size 10 x 10)
The new NBBO is $1.00 x $1.06 (size 160 x 150)
The Directed Order can now execute against the BX Options book at $1.06
as follows:
40 contracts execute against MM2 Quote B as a Directed Allocation
(40% of the 100 contract buy order)
60 contracts execute against MM1 Quote A
The Exchange believes that it is useful and beneficial for the
order to retain its status as a Directed Order, because this handling
is consistent with the order instructions and original intent of the
submitting Participant. On other options exchanges, the ``directed
order'' designation is only considered upon receipt of the order.\19\
BX believes that its Participants may find this feature attractive;
otherwise, Participants might consider cancelling and re-entering the
order so it is treated as a Directed Order, which would be less
efficient and would increase message traffic. BX does not believe that
retaining directed order status on the book is controversial or
inconsistent with the Act. Nor does BX believe that it undermines the
policy underpinnings of directed order programs. Rather, it is an
innovative enhancement intended to make entering directed orders more
efficient and modern. It is possible that more directed allocations
will occur because orders retain their directed order status, but the
same result could be achieved today by, inefficiently, reentering
directed orders rather than leaving them on the book as non-directed
orders.
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\19\ See e.g., Phlx Rule 1080(l)(ii), which provides: When the
Exchange's disseminated price is the NBBO at the time of receipt of
the Directed Order, and the Directed Specialist, SQT or RSQT is
quoting at the Exchange's disseminated price, the Directed Order
shall be automatically executed and allocated in accordance with
Rule 1014(g)(viii).
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In addition, the Directed Market Maker is entitled to the Directed
Allocation at all price levels at which the Directed Market Maker has
an order or quote. This is intended to reflect that orders are
executable at multiple price levels, and that, today, market makers can
enter orders at multiple price levels.
Example 7 (Price/Time or Pro-Rata--Same Outcome)
NBBO: $1.00 x $1.05
BX Options Book
MM1 Quote A $1.00 x $1.05 (size 20 x 20)
MM2 Quote B $1.00 x $1.05 (size 10 x 10)
MM3 Quote C $1.00 x $1.06 (size 100 x 100)
MM2 Quote D $1.00 x $1.06 (size 50 x 50)
BX Options Best Offer: 30 at $1.05
BX receives a Directed Order to buy 110 contracts at $1.06 directed to
MM2:
20 contracts execute against MM1 Quote A
10 contracts execute against MM2 Quote B
$1.05 price level is completely exhausted
32 contracts execute against MM2 Quote D as a Directed Allocation
(40% of 80 remaining contracts from buy order)
48 contracts execute against MM3 Quote C
New Quoting Requirement for All Market Makers
BX also proposes to change the quoting obligation applicable to its
Market Makers. Currently, Chapter VII, Section 6(d) provides that on a
daily basis, a Market Maker must during regular market hours make
markets consistent with the applicable quoting requirements specified
in these rules, on a continuous basis in at least sixty percent (60%)
of the series in options in which the Market Maker is registered. It
further provides that, to satisfy this requirement with respect to
quoting a series, a Market Maker must quote such series 90% of the
trading day (as a percentage of the total number of minutes in such
trading day) or such higher percentage as BX may announce in advance.
BX Regulation may consider exceptions to the requirement to quote 90%
(or higher) of the trading day based on demonstrated legal or
regulatory requirements or other mitigating circumstances.
BX proposes to better align its market maker quoting requirement
with that of other exchanges, such as NYSE Arca and NYSE MKT.
Specifically, BX proposes to reduce the quoting requirement for non-
Directed BX Options Market Makers as follows: A Market Maker must quote
such options 60% of the trading day (as a percentage of the total
number of minutes in such trading day) or such higher percentage as BX
may announce in advance. BX Regulation may consider exceptions to the
requirement to quote 60% (or higher) of the trading day based on
demonstrated legal or regulatory requirements or other mitigating
circumstances. This obligation will apply to all of a Market Maker's
registered options collectively, rather than on an option-by-option
basis. Compliance with this obligation will be determined on a monthly
basis. This is the same requirement as on other options exchanges.\20\
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\20\ See NYSE Arca Rule 6.88 and NYSE MKT Rule 964.1NY.
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BX believes that this is appropriate for two reasons. First, BX's
current Market Maker quoting requirement is much more stringent than
certain other exchanges. Quoting each series 90% of the trading day is
much more stringent than looking at all options in which a Market Maker
is registered, because it allows for some number of series not to be
quoted at all, as long as the overall standard is met. This better
accommodates the occasional issues that may arise in a particular
series, whether technical or manual. The existing requirement may at
times discourage liquidity in particular options series because a
market maker is forced to focus on a momentary lapse rather than using
the appropriate resources to focus on the options series
[[Page 15391]]
that need and consume additional liquidity. As a new market, BX
believes that it can better attract Market Makers to the BX Options
market and grow its market if its quoting obligation is more in line
with that of other exchanges. In addition, as BX seeks to introduce
directed orders, the market maker quoting obligation has become an
obstacle to crafting a competitive, attractive directed order program.
Specifically, because the Commission has required directed participants
to be subject to heightened quoting obligations as compared to non-
directed market makers, BX would have to adopt a Directed Market Maker
quoting obligation more stringent than the current 90% of the time/60%
of the series requirement for regular BX Options Market Makers. BX does
not believe that a quoting requirement for greater than 90% of the time
would attract Directed Market Makers to BX Options, as BX embarks on
growing its market with new functionality and features. In fact, a more
stringent quoting requirement would likely discourage new market makers
from participating in the BX Options market and inhibit current market
makers' ability to provide liquidity effectively.
New Quoting Requirement for Directed Market Makers
New Section 10(3)(iv)(D) makes clear that Directed Market Makers
are subject to the quoting requirements of new Chapter VII, Section
6(d)(iv). Specifically, in options in which it receives Directed
Orders, a Directed Market Maker must quote 90% of the trading day (as a
percentage of the total number of minutes in such trading day) or such
higher percentage as BX may announce in advance. BX Regulation may
consider exceptions to the requirement to quote 90% (or higher) of the
trading day based on demonstrated legal or regulatory requirements or
other mitigating circumstances. This obligation will apply collectively
to all series in all of the options in which the Directed Market Maker
receives Directed Orders, rather than on an option-by-option basis.
Compliance with this obligation will be determined on a monthly basis.
This quoting obligation is more stringent than that which is applicable
to regular BX Options Market Makers, who will now have to quote, under
this proposal, at least 60% of the time the Exchange is open for
trading in registered options. Such quotations must meet the quote
width requirements of Chapter VII, Section 6(d)(ii). Once a Directed
Market Maker receives a Directed Order, the heightened quoting
obligation is triggered and applies to the options in which the
Directed Market Maker receives Directed Orders.
Lastly, Section 10(3)(iv)(E) will provide that the Exchange will
determine which options have the Directed Allocation functionality
available.\21\ BX will issue an Options Trader Alert to inform its
Participants in which options the Directed Allocation will be
available.
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\21\ Directed Orders received in options where BX Options is not
offering Directed Order processing will not be rejected; instead,
such orders will be handled normally as non-Directed Orders.
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Conclusion
In summary, BX seeks to compete with the many options exchanges
that offer directed orders in their respective markets and seeks to
introduce directed order functionality, as described above.
2. Statutory Basis
The Exchange believes that its proposal is consistent with Section
6(b) of the Act \22\ in general, and furthers the objectives of Section
6(b)(5) of the Act \23\ in particular, in that it is designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to foster cooperation and
coordination with persons engaged in facilitating transactions in
securities, and to remove impediments to and perfect the mechanisms of
a free and open market and a national market system, and, in general,
to protect investors and the public interest, because it will establish
a directed order process similar to what operates on other exchanges,
as explained in detail herein, which will provide Participants with
additional choices among the many competing exchanges with regard to
their execution needs and strategies. BX Options operates in an
intensely competitive environment and seeks to offer the same services
that its competitors offer and in which its customers find value.
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\22\ 15 U.S.C. 78f(b).
\23\ 15 U.S.C. 78f(b)(5).
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In its approval of other options exchange directed order programs,
the Commission has, like proposals to amend a specialist guarantee,
focused on whether the percentage of the ``entitlement'' would rise to
a level that could have a material adverse impact on quote competition
within a particular exchange, and concluded that such programs do not
jeopardize market integrity or the incentive for market participants to
post competitive quotes.\24\ BX's proposed Directed Allocation of 40%
is consistent with the directed order allocations of other options
exchanges, except for the impact of rounding up, as described above,
which BX does not believe is significant. BX notes that the remaining
portion of each order will still be allocated based on the competitive
bidding of market participants. In addition, at the time of execution,
a BX Options Directed Market Maker will have to be quoting at the NBBO
for the size of the Directed Allocation to receive the Directed
Allocation, which is intended to incent the Directed Market Maker to
quote aggressively, because he cannot merely step up and match the NBBO
after the Directed Order is received. Similarly, BX believes there is
an incentive for Directed Market Makers to quote competitively even
though they may receive a Directed Allocation when such Directed Market
Maker is not on the NBBO at the time of order receipt, but is at the
time of execution. BX also notes that BX Options Directed Market Makers
will have greater quoting obligations than other BX Options Market
Makers.
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\24\ See Securities Exchange Act Release No. 51759 (May 27,
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. The competition among the
options exchanges is vigorous and this proposal is intended to afford
the BX Options market the opportunity to compete for directed order
flow. In that regard, the proposal is pro-competitive and will offer
market participants an additional venue for the execution of directed
orders. The Exchange does not believe that the proposal imposes a
burden on intra-market competition not necessary or appropriate in
furtherance of the purposes of the Act, because the ability to send
directed orders is available to all Participants, and the ability to
become a Market Maker is available to all Market Makers.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to
[[Page 15392]]
90 days of such date if it finds such longer period to be appropriate
and publishes its reasons for so finding or (ii) as to which the
Exchange consents, the Commission shall: (a) By order approve or
disapprove such proposed rule change, or (b) institute proceedings to
determine whether the proposed rule change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. The Commission also requests and
encourages interested persons to submit comments on the following
specific questions:
Unlike the Directed Order rules of other options
exchanges, BX's proposed rule would not require that a Directed Market
Maker be quoting at the NBBO at the time a Directed Order is received.
Would the lack of the NBBO quoting requirement impact market makers'
incentives to quote competitively? If so, how? If not, why? If other
options exchanges eliminated the requirement that Directed Market
Makers quote at the NBBO to receive Directed Orders as part of their
Directed Order process, what, if any impact would there be on market
maker quoting behavior, and more generally on the quality of quotations
in the options markets?
Under the proposed rule, a Directed Market Maker to whom
an order is directed in an option subject to the exchange's Price/Time
execution algorithm would receive a 40% allocation ahead of orders of
other market participants, including customer orders that had time
priority over the Directed Market Maker's quotation. What, if any,
concerns does this raise for the options markets?
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-BX-2013-016 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-BX-2013-016. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available
for inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-BX-2013-016, and should be
submitted on or before April 1, 2013.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-05543 Filed 3-8-13; 8:45 am]
BILLING CODE 8011-01-P