[Federal Register Volume 78, Number 121 (Monday, June 24, 2013)]
[Notices]
[Pages 37870-37873]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-14962]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69782; File No. SR-ISE-2013-38]
Self-Regulatory Organizations; International Securities Exchange,
LLC; Notice of Filing of Proposed Rule Change Related to Market Maker
Risk Parameters and Complex Orders
June 18, 2013.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on June 5, 2013, the International Securities Exchange, LLC (the
``Exchange'' or the ``ISE'') filed with the Securities and Exchange
Commission (``Commission'') the proposed rule change as described in
Items I, II, and III below, which items have been prepared by the
Exchange. The Commission is publishing this notice to solicit comments
on the proposed rule 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 proposes to mitigate market maker risk by requiring
market makers to enter values in the Exchange-provided risk parameters
and by limiting the types of complex orders that can leg-into the
regular market. The text of the proposed rule change is available on
the Exchange's Web site www.ise.com, at the principal office of the
Exchange, 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 self-regulatory organization has
[[Page 37871]]
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, Proposed Rule Change
1. Purpose
On [sic] Pursuant to ISE Rule 722 and 804, the Exchange currently
provides functionality that will automatically remove a market maker's
quotes in all series of an options class when certain parameter
settings are triggered. Specifically, there are four parameters that
can be set by market makers on a class-by-class basis. These parameters
are available for market maker quotes in single options series and for
market maker quotes in complex instruments on the complex order book.
Market makers establish a time frame during which the system
calculates: (1) The number of contracts executed by the market maker in
an options class; (2) the percentage of the total size of the market
maker's quotes in the class that has been executed; (3) the absolute
value of the net between contracts bought and contracts sold in an
options class, and the absolute value of the net between (a) calls
purchased plus puts sold, and (b) calls sold plus puts purchased. The
market maker establishes limits for each of these four parameters, and
when the limits are exceeded within the prescribed time frame, the
market makers quotes are removed.\3\
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\3\ The Exchange is proposing certain non-substantive changes to
the text of Rules 722 and 804 for clarity. The changes shorten the
first sentence in Rule 804 by deleting ``if the market maker trades,
in the aggregate across all series of an options class during a
specified time period'' and to delete ``(established by the market
maker), within a time frame specified by the market maker'' as the
text might be confusing in its current form and is redundant with
other text within the Rule. To assure clarity, the Exchange also
proposes to specify that the first parameter is a number of
``total'' contracts ``in the class,'' and to specify that the fourth
parameter is a net value based on puts and calls purchased and sold
``in the class.'' Finally, the Exchange proposes to use a uniform
construction of ``the specified . . .'' for each of the four
parameters. The same clarifying changes are also proposed with
respect to Rule 722, as the language in both rules is identical
except for the fact that Rule 722 applies to market maker quotes for
complex orders. The Exchange is not proposing to alter the operation
of the functionality, other than to make use of the parameters
mandatory.
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The purpose of this functionality is to allow market makers to
provide liquidity across potentially hundreds of options series without
being at risk of executing the full cumulative size of all such quotes
before being given adequate opportunity to adjust their quotes. For
example, if a market maker can enter quotes with a size of 20 contracts
in 150 series of an options class, its total potential exposure is 3000
contracts in the options class. To mitigate the risk of executing all
3000 contracts without evaluating its positions, the market maker risk
functionality will automatically remove its quotes in all series of the
options class after it has executed a specified number of contracts
(e.g., 100) in series of that options class during a specified time
period (e.g., 5 seconds).
To assure that all quotations are firm for their full size, the
parameter calculations occur after an execution against a market
maker's quote takes place. For example, if a market maker has set a
parameter of 100 contracts during a 5 second interval for an options
class, and has executed a total of 95 contracts in the options class
within the previous 3 seconds, a quote in a series of that class with a
size of 20 contracts continues to be firm for all 20 contracts. In this
example, an incoming order could execute all 20 contracts of the quote,
and following the execution, the total size parameter would add 20
contracts to the running total of 95. Since the total size executed
within the 5 second time frame exceeds the 100 contracts established by
the market maker for the options class, all of the market maker's
quotes in the options class would be removed. The market maker would
then enter new quotes in the class.
Use of these risk management tools has always been voluntary under
the rules. Similarly, from a technical perspective, market makers
currently do not need to enter any values into the applicable fields,
and thus effectively can choose not to use these tools. The Exchange
proposes to amend the rule to make it mandatory for market makers to
enter values into all four of the quotation risk management parameters
for all options classes in which it enters quotes. The purpose of the
rule change is to prevent market makers from inadvertently entering
quotes without risk-management parameters. In this respect, the
Exchange notes that all ISE market makers currently use the parameters
when entering quotes. However, it is possible that a market maker could
inadvertently enter quotes without populating one or more of the risk
parameters, resulting in the member being exposed to much more risk
than it intended. Accordingly, ISE market makers have requested that
the Exchange modify the trading system to reject quotes if there are
any missing risk management values for the options class.
While entering values into the quotation risk parameters will be
mandatory to prevent an inadvertent exposure to risk, the Exchange
notes that market makers who prefer to use their own risk-management
systems can enter values that assure the Exchange-provided parameters
will not be triggered.\4\ Accordingly, the proposal does not require
members to manage their risk using the Exchange-provided tools.
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\4\ For example, a market maker could set the value for the
total number of contracts executed in a class at a level that
exceeds the total number of contracts the market maker actually
quotes in an options class.
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The Exchange also proposes to amend Rule 722 to limit a potential
source of unintended market maker risk related to how the market maker
risk parameters under Rule 804 are calculated when complex orders leg-
into the regular market.\5\ As discussed above, by checking the risk
parameters following each execution in an options series, the risk
parameters allow market makers to provide liquidity across multiple
series of an options class without being at risk of executing the full
cumulative size of all such quotes. This is not the case, however, when
a complex order legs-into the market. Because the execution of each leg
is contingent on the execution of the other legs, the execution of all
the legs in the regular market is processed as a single transaction,
not as a series of individual transactions.
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\5\ Pursuant to ISE Rule 722(b)(3)(ii), complex orders may be
executed against bids and offers on the Exchange for the individual
legs of the complex order, provided the complex order can be
executed while maintaining a permissible ratio by such bids and
offers.
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For example, if individual orders to buy 10 contracts for the Jan
30 call, Jan 35 call, Jan 40 call, Jan 45, and Jan 50 calls are
entered, each is processed as it is received and the market maker
quotation parameters are calculated following the execution of each 10-
contract order. However, if a complex order to buy all five of these
strikes ten times is entered and is executed against bids and offers
for the individual series, the market maker parameters for quotes in
the regular market are calculated following the execution of all 50
contracts. In the example discussed previously, when the market maker
had set a limit of 100 contracts for the options class and had executed
95 contracts, the amount by which the next transaction might exceed 100
is limited to the largest size of its quote in a single series of the
options class. In that example, since the largest size the market maker
was quoting in any one series was 20 contracts, the market maker could
not have exceeded the 100 contract trigger by more than 15
[[Page 37872]]
contracts (95 + 20 = 115). With respect to a complex order with five
legs 20 times, the next transaction against the market maker's quotes
potentially could be as large as 100 contracts (depending upon whether
there are other market participants same price), creating the potential
in this example that the market maker could exceed the 100 contract
limit by 95 contracts (95 + 100 = 195) instead of 15.
As the example demonstrates, the legging-in of complex orders
presents higher risk to market makers as compared to regular orders
being entered in multiple series of an options class in the regular
market as it allows market makers to exceed their parameters by a
greater number of contracts. Because this risk is directly proportional
to the number of legs associated with a complex order, ISE market
makers have requested that the Exchange prevent complex orders from
legging into the market if they have a large number of legs. The
Exchange therefore proposes to limit the legging functionally to
complex orders with no more than either two or three legs, as
determined by the Exchange on a class basis.\6\ The Exchange notes in
this respect that over 85% of all complex orders have only two legs and
that very few complex orders are entered with more than three legs. The
Exchange believes that the potential risk to market makers in the
regular market of allowing orders with more than three legs (in some
cases more than two legs) to leg-into the market, far out-weighs the
potential benefit of offering such functionality to a very limited
number of orders.
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\6\ The Exchange will issue a circular to members identifying
the options classes for which legging is limited to complex orders
with two legs and those for which legging is limited to complex
order with three legs. The Exchange will provide members with
reasonable notice prior to change the limit applicable to an options
class.
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Complex orders with more than three legs (in some cases more than
two legs) that could leg into the market except for the proposed
limitation will be available for execution on the complex order book.
The Exchange notes in this respect that the execution priority rules
contained in ISE Rule 722(b)(2) often prevent the execution of complex
orders that might otherwise be executable. Specifically, Rule 722(b)(2)
provides that the legs of a complex order cannot be executed at the
same price as a Priority Customer Order in the regular market unless
another leg of the order is executed at a price that is better than the
best price in the regular market.\7\ In other words, if there is a
Priority Customer Order on the book in one or more of the series of a
complex order, the net price of the complex order has to improve upon
the price that would be available if the complex order legged-into the
market. Thus, currently there can be complex orders resting on the book
that cannot leg-into the market because the permissible ratio cannot be
satisfied by the bids and offers in the regular market or because there
are Priority Customer Orders in the regular market in one or more of
the series of the complex order that prevent its execution.
Accordingly, the Exchange believes that preventing orders with more
than three legs (in some cases more than two legs) from legging-into
the market does not create any unusual circumstances on the complex
order book. The Exchange further notes that priority of complex orders
on the complex order book is not impacted by the proposed rule
change.\8\
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\7\ Pursuant to ISE Rule 100(a)(37A) and (37B), a Priority
Customer Order is an order for the account of a person or entity
that (i) is not a broker or dealer in securities, and (ii) does not
place more than 390 orders in listed options per day on average
during a calendar month for its own beneficial account(s).
\8\ For example, if there are multiple complex orders for the
same strategy at the same price with four or more legs, they will be
executed pursuant to Rule 722(b)(3) (i.e., in time priority or pro-
rata bases on size (with or without Priority Customer priority)).
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2. Statutory Basis
The Exchange believes that its proposal is consistent with Section
6(b) of the the [sic] Act\9\ in general, and furthers the objectives of
Section 6(b)(5) of the Act\10\ in particular, in that it is designed to
promote just and equitable principles of trade, to remove impediments
to and perfect the mechanism for a free and open market and a national
market system, and, in general, to protect investors and the public
interest.
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\9\ 15 U.S.C. 78f(b).
\10\ 15 U.S.C. 78f(b)(5).
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The Exchange believes that requiring market makers to enter values
into the risk parameters provided by the Exchange will not be
unreasonably burdensome, as all ISE market makers currently utilize the
functionality. Moreover, the Exchange is proposing this rule change at
the request of its market makers to reduce their risk of inadvertently
entering quotes without populating the risk parameters. As discussed
above, the Exchange will be modifying the trading system to
automatically reject quotations unless the parameters are populated
with values, which will protect market makers from inadvertent exposure
to excessive risk. Reducing such risk will enable market makers to
enter quotations with larger size, which in turn will benefit investor
through increased liquidity for the execution of their orders. Such
increased liquidity benefits investors because they receive better
prices and because it lowers volatility in the options market.
The Exchange also believes it is reasonable to limit the types of
complex orders that are eligible to leg-into the market. In this
respect, the Exchange notes that the vast majority of complex orders
consist of only two legs, which will be unaffected by this rule change.
Moreover, the Exchange believes that the potential risk of continuing
to offer legging functionality for complex orders with more than three
legs (in some cases with more than two legs) limits the amount of
liquidity that market makers are willing to provide in the regular
market. In particular, market makers may reduce the size of their
quotations in the regular market because they are at risk of executing
the cumulative size of their quotations across multiple options series
without an opportunity to adjust their quotes. Accordingly, reducing
market maker risk in the regular market by limiting the legging
functionality to orders with no more than three legs (in some cases
with no more than two legs) will benefit investors by encouraging
additional liquidity in the regular market. This benefit to investors
far exceeds the small amount of potential liquidity provided by the few
complex orders that have more than three legs (in some case more than
two legs).
B. Self-Regulatory Organization's Statement on Burden on Competition
The proposed rule change does not impose any burden on competition.
The proposed rule change to make it mandatory for market makers to
populate the quotation risk management parameters is being made at the
request of ISE market makers to prevent the inadvertent entry of quotes
without risk-management parameters. Market makers who prefer to use
their own risk-management systems can enter out-of-range values so that
the Exchange-provided parameters will not be triggered. Accordingly,
the proposal does not require members to manage their risk using an
Exchange-provided tool. The proposed change to limit legging
functionality to complex orders of no more than three legs (in some
cases no more than two legs) will reduce risk to market makers that are
quoting in the regular market. As such, the proposal may encourage
market makers to increase the size of their quotations, thereby adding
liquidity on the Exchange.
[[Page 37873]]
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
The Exchange has not solicited, and does not intend to solicit,
comments on this proposed rule change. The Exchange has not received
any unsolicited written comments from members or other interested
parties.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the publication date of this notice or within
such longer period (1) as the Commission may designate up to 45 days of
such date if it finds such longer period to be appropriate and
publishes its reasons for so finding or (2) as to which the self-
regulatory organization consents, the Commission will:
(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:
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-ISE-2013-38 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.
All submissions should refer to File Number SR-ISE-2013-38. 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 ISE. 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-ISE-2013-38 and should be
submitted on or before July 15, 2013.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\11\
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\11\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-14962 Filed 6-21-13; 8:45 am]
BILLING CODE 8011-01-P