[Federal Register Volume 82, Number 58 (Tuesday, March 28, 2017)]
[Notices]
[Pages 15393-15400]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-06055]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-80298; File No. SR-C2-2017-011]
Self-Regulatory Organizations; C2 Options Exchange, Incorporated;
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change
Related to Rule 6.15
March 22, 2017.
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 March 15, 2017, C2 Options Exchange, Incorporated (the
``Exchange'' or ``C2'') filed with the Securities and Exchange
Commission (the ``Commission'') the proposed rule change as described
in Items I and II below, which Items have been prepared by the
Exchange. The Exchange filed the proposal as a ``non-controversial''
proposed rule change pursuant to Section 19(b)(3)(A)(iii) of the Act
\3\ and Rule 19b-4(f)(6) thereunder.\4\ 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.
\3\ 15 U.S.C. 78s(b)(3)(A)(iii).
\4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange seeks to amend Rule 6.15. The text of the proposed
rule change is provided below, (additions are in italics; deletions are
[bracketed])
* * * * *
C2 Options Exchange, Incorporated
Rules
Rule 6.15. Nullification and Adjustment of Options Transactions
including Obvious Errors
The Exchange may nullify a transaction or adjust the execution
price of a transaction in accordance with this Rule. However, the
determination as to whether a trade was executed at an erroneous
price may be made by mutual agreement of the affected parties to a
particular transaction. A trade may be nullified or adjusted on the
terms that all parties to a particular transaction agree, provided,
however, that such agreement to nullify or adjust must be conveyed
to the Exchange in a manner prescribed by the Exchange prior to 7:30
a.m. Central Time on the first trading day following execution. It
is considered conduct inconsistent with just and equitable
principles of trade for any participant to use the mutual adjustment
process to circumvent any applicable Exchange rule, the Act or any
of the rules and regulations thereunder.
(a)-(m) No change.
. . . Interpretations and Policies:
.01-.06 No change.
.07 Complex Orders and Stock-Option Orders:
(a) If a complex order executes against individual legs and at
least one of the legs qualifies as an Obvious Error under paragraph
(c)(1) or a Catastrophic Error under paragraph (d)(1), then the
leg(s) that is an Obvious or Catastrophic Error will be adjusted in
accordance with paragraphs (c)(4)(A) or (d)(3), respectively,
regardless of whether one of the parties is a Customer. However, any
Customer order subject to this paragraph (a) will be nullified if
the adjustment would result in an execution price higher (for buy
transactions) or lower (for sell transactions) than the Customer's
limit price on the complex order or individual leg(s). If any leg of
a complex order is nullified, the entire transaction is nullified.
(b) If a complex order executes against another complex order
and at least one of the legs qualifies as an Obvious Error under
paragraph (c)(1) or a Catastrophic Error under paragraph (d)(1),
then the leg(s) that is an Obvious or Catastrophic Error will be
adjusted or busted in accordance with paragraph (c)(4) or (d)(3),
respectively, so long as either: (i) the width of the National
Spread Market for the complex order strategy just prior to the
erroneous transaction was equal to or greater than the amount set
forth in the wide quote table of paragraph (b)(3) or (ii) the net
execution price of the complex order is higher (lower) than the
offer (bid) of the National Spread Market for the complex order
strategy just prior to the erroneous transaction by an amount equal
to at least the amount shown in the table in paragraph (c)(1). If
any leg of a complex order is nullified, the entire transaction is
nullified. For purposes of Rule 6.15, the National Spread Market for
a complex order strategy is determined by the National Best Bid/
Offer of the individual legs of the strategy.
(c) If the option leg of a stock-option order qualifies as an
Obvious Error under paragraph (c)(1) or a Catastrophic Error under
paragraph (d)(1), then the option leg that is an Obvious or
Catastrophic Error will be adjusted in accordance with paragraph
(c)(4)(A) or (d)(3), respectively, regardless of whether one of the
parties is a Customer. However, the option leg of any Customer order
subject to this paragraph (c) will be nullified if the adjustment
would result in an execution price higher (for buy transactions) or
lower (for sell transactions) than the Customer's limit price on the
stock-option order, and the Exchange will attempt to nullify the
stock leg. Whenever a stock trading venue nullifies the stock leg of
a stock-option order or whenever the stock leg cannot be executed,
the Exchange will nullify the option leg upon request of one of the
parties to the transaction or in accordance with paragraph (c)(3).
* * * * *
The text of the proposed rule change is also available on the
Exchange's Web site (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at
[[Page 15394]]
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 the
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to amend C2 Rule 6.15 to add Interpretation
and Policy .07. This filing is based on a proposal recently submitted
by Chicago Board Options Exchange, Incorporated (``CBOE'') and approved
by the Securities and Exchange Commission (the ``Commission'').\5\
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\5\ See Securities Exchange Act Release 80040 (February 14,
2017), 82 FR 11248 (February 21, 2017) (Order Approving SR-CBOE-
2016-088).
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In 2015, the Exchange and other options exchanges adopted a new,
harmonized rule related to the adjustment and nullification of
erroneous options transactions, including a specific provision related
to coordination in connection with large-scale events involving
erroneous options transactions.\6\ The Exchange believes that the
changes the options exchanges implemented with the new, harmonized rule
have led to increased transparency and finality with respect to the
adjustment and nullification of erroneous options transactions.
However, as part of the initial initiative, the Exchange and other
options exchanges deferred a few specific matters for further
discussion.
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\6\ See Securities Exchange Act Release 74900 (May 7, 2015), 80
FR 27392 (May 13, 2015) (SR-C2-2015-012) (the ``Initial Filing'').
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Specifically, the options exchanges have been working together to
identify ways to improve the process related to the adjustment and
nullification of erroneous options transactions as it relates to
complex orders \7\ and stock-option orders. The goal of the process
that the options exchanges have undertaken is to further harmonize
rules related to the adjustment and nullification of erroneous options
transactions. As described below, the Exchange believes that the
changes the options exchanges and the Exchange have agreed to propose
will provide transparency and finality with respect to the adjustment
and nullification of erroneous complex order and stock-option order
transactions. Particularly, the proposed changes seek to achieve
consistent results for participants across U.S. options exchanges while
maintaining a fair and orderly market, protecting investors and
protecting the public interest.
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\7\ See Rule 6.13(a) (defining complex orders and stock-option
orders).
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The Proposed Rule is the culmination of this coordinated effort and
reflects discussions by the options exchanges whereby the exchanges
that offer complex orders and/or stock-option orders will universally
adopt new provisions that the options exchanges collectively believe
will improve the handling of erroneous options transactions that result
from the execution of complex orders and stock-option orders.\8\
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\8\ An exchange that does not offer complex orders and/or stock-
option orders will not adopt these new provisions until such time as
the exchange offers complex orders and/or stock-option orders.
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The Exchange believes that the Proposed Rule supports an approach
consistent with long-standing principles in the options industry under
which the general policy is to adjust rather than nullify transactions.
The Exchange acknowledges that adjustment of transactions is contrary
to the operation of analogous rules applicable to the equities markets,
where erroneous transactions are typically nullified rather than
adjusted and where there is no distinction between the types of market
participants involved in a transaction. For the reasons set forth
below, the Exchange believes that the distinctions in market structure
between equities and options markets continue to support these
distinctions between the rules for handling obvious errors in the
equities and options markets.
Various general structural differences between the options and
equities markets point toward the need for a different balancing of
risks for options market participants and are reflected in this
proposal. Option pricing is formulaic and is tied to the price of the
underlying stock, the volatility of the underlying security and other
factors. Because options market participants can generally create new
open interest in response to trading demand, as new open interest is
created, correlated trades in the underlying or related series are
generally also executed to hedge a market participant's risk. This
pairing of open interest with hedging interest differentiates the
options market specifically (and the derivatives markets broadly) from
the cash equities markets. In turn, the Exchange believes that the
hedging transactions engaged in by market participants necessitates
protection of transactions through adjustments rather than
nullifications when possible and otherwise appropriate.
The options markets are also quote driven markets dependent on
liquidity providers to an even greater extent than equities markets. In
contrast to the approximately 7,000 different securities traded in the
U.S. equities markets each day, there are more than 500,000 unique,
regularly quoted option series. Given this breadth in options series
the options markets are more dependent on liquidity providers than
equities markets; such liquidity is provided most commonly by
registered market makers but also by other professional traders. With
the number of instruments in which registered market makers must quote
and the risk attendant with quoting so many products simultaneously,
the Exchange believes that those liquidity providers should be afforded
a greater level of protection. In particular, the Exchange believes
that liquidity providers should be allowed protection of their trades
given the fact that they typically engage in hedging activity to
protect them from significant financial risk to encourage continued
liquidity provision and maintenance of the quote-driven options
markets.
In addition to the factors described above, there are other
fundamental differences between options and equities markets which lend
themselves to different treatment of different classes of participants
that are reflected in this proposal. For example, there is no trade
reporting facility in the options markets. Thus, all transactions must
occur on an options exchange. This leads to significantly greater
retail customer participation directly on exchanges than in the
equities markets, where a significant amount of retail customer
participation never reaches the Exchange but is instead executed in
off-exchange venues such as alternative trading systems, broker-dealer
market making desks and internalizers. In turn, because of such direct
retail customer participation, the exchanges have taken steps to afford
those retail customers--generally Priority Customers--more favorable
treatment in some circumstances.
[[Page 15395]]
Complex Orders and Stock-Option Orders
As more fully described below, the Proposed Rule applies much of
the Current Rule to complex orders and stock-option orders.\9\ The
Proposed Rule deviates from the Current Rule only to account for the
unique qualities of complex orders and stock-option orders. The
Proposed Rule reflects the fact that complex orders can execute against
other complex orders or can execute against individual simple orders in
the leg markets. When a complex order executes against the leg markets
there may be different counterparties on each leg of the complex order,
and not every leg will necessarily be executed at an erroneous price.
With regards to stock-option orders, the Proposed Rule reflects the
fact that stock-option orders contain a stock component that is
executed on a stock trading venue, and the Exchange may not be able to
ensure that the stock trading venue will adjust or nullify the stock
execution in the event of an obvious or catastrophic error. In order to
apply the Current Rule and account for the unique characteristics of
complex orders and stock-option orders, proposed Interpretation and
Policy .07 is split into three parts--paragraphs (a), (b), and (c).
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\9\ In order for a complex order or stock-option order to
qualify as an obvious or catastrophic error at least one of the legs
must itself qualify as an obvious or catastrophic error under the
Current Rule. See Proposed Rule .07(a)-(c).
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First, proposed Interpretation and Policy .07(a) governs the review
of complex orders that are executed against individual legs (as opposed
to a complex order that executes against another complex order).\10\
Proposed Rule 6.15.07(a) provides:
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\10\ The leg market consists of quotes and/or orders in single
options series. A complex order may be received by the Exchange
electronically, and the legs of the complex order may have different
counterparties. For example, Market-Maker 1 may be quoting in ABC
calls and Market-Maker 2 may be quoting in ABC puts. A complex order
to buy the ABC calls and puts may execute against the quotes of
Market-Maker 1 and Market-Maker 2.
If a complex order executes against individual legs and at least
one of the legs qualifies as an Obvious Error under paragraph (c)(1)
or a Catastrophic Error under paragraph (d)(1), then the leg(s) that
is an Obvious or Catastrophic Error will be adjusted in accordance
with paragraphs (c)(4)(A) or (d)(3), respectively, regardless of
whether one of the parties is a Customer. However, any Customer
order subject to this paragraph (a) will be nullified if the
adjustment would result in an execution price higher (for buy
transactions) or lower (for sell transactions) than the Customer's
limit price on the complex order or individual leg(s). If any leg of
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a complex order is nullified, the entire transaction is nullified.
As previously noted, at least one of the legs of the complex order must
qualify as an obvious or catastrophic error under the Current Rule in
order for the complex order to receive obvious or catastrophic error
relief. Thus, when the Exchange is notified (within the timeframes set
forth in paragraph (c)(2) or (d)(2)) of a complex order that is a
possible obvious error or catastrophic error, the Exchange will first
review the individual legs of the complex order to determine if one or
more legs qualify as an obvious or catastrophic error.\11\ If no leg
qualifies as an obvious or catastrophic error, the transaction stands--
no adjustment and no nullification.
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\11\ Because a complex order can execute against the leg market,
the Exchange may also be notified of a possible obvious or
catastrophic error by a counterparty that received an execution in
an individual options series. If upon review of a potential obvious
error the Exchange determines an individual options series was
executed against the leg of a complex order or stock-option order,
proposed Rule 6.15.07 will govern.
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Reviewing the legs to determine whether one or more legs qualify as
an obvious or catastrophic error requires the Exchange to follow the
Current Rule. In accordance with paragraphs (c)(1) and (d)(1) of the
Current Rule, the Exchange compares the execution price of each
individual leg to the Theoretical Price of each leg (as determined by
paragraph (b) of the Current Rule). If the execution price of an
individual leg is higher or lower than the Theoretical Price for the
series by an amount equal to at least the amount shown in the obvious
error table in paragraph (c)(1) of the Current rule or the catastrophic
error table in paragraph (d)(1) of the Current Rule, the individual leg
qualifies as an obvious or catastrophic error, and the Exchange will
take steps to adjust or nullify the transaction.\12\
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\12\ Only the execution price on the leg (or legs) that
qualifies as an obvious or catastrophic error pursuant to any
portion of Proposed Rule 6.15.07 will be adjusted. The execution
price of a leg (or legs) that does not qualify as an obvious or
catastrophic error will not be adjusted.
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To illustrate, consider a Customer submits a complex order to the
Exchange consisting of leg 1 and leg 2--Leg 1 is to buy 100 ABC calls
and leg 2 is to sell 100 ABC puts. Also, consider that Market-Maker 1
is quoting the ABC calls $1.00-1.20 and Market-Maker 2 is quoting the
ABC puts $2.00-2.20. If the complex order executes against the quotes
of Market-Makers 1 and 2, the Customer buys the ABC calls for $1.20 and
sells the ABC puts for $2.00. As with the obvious/catastrophic error
reviews for simple orders, the execution price of leg 1 is compared to
the Theoretical Price \13\ of Leg 1 in order to determine if Leg 1 is
an obvious error under paragraph (c)(1) of the Current Rule or a
catastrophic error under paragraph (d)(1) of the Current Rule. The same
goes for Leg 2. The execution price of Leg 2 is compared to the
Theoretical Price of Leg 2. If it is determined that one or both of the
legs are an obvious or catastrophic error, then the leg (or legs) that
is an obvious or catastrophic error will be adjusted in accordance with
paragraphs (c)(4)(A) or (d)(3) of the Current Rule, regardless of
whether one of the parties is a Customer.\14\ Although a single-legged
execution that is deemed to be an obvious error under the Current Rule
is nullified whenever a Customer is involved in the transaction, the
Exchange believes adjusting execution prices is generally better for
the marketplace than nullifying executions because liquidity providers
often execute hedging transactions to offset options positions. When an
options transaction is nullified the hedging position can adversely
affect the liquidity provider. With regards to complex orders that
execute against individual legs, the additional rationale for adjusting
erroneous execution prices when possible is the fact that the
counterparty on a leg that is not executed at an obvious or
catastrophic error price cannot look at the execution price to
determine whether the execution may later be nullified (as opposed to
the counterparty on single-legged order that is executed at an obvious
error or catastrophic error price).
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\13\ See Rule 6.15(b) (defining the manner in which Theoretical
Price is determined).
\14\ See Rule 6.15(a)(1) (defining Customer for purposes of Rule
6.15 as not including a broker-dealer, Professional Customer, or
Voluntary Professional Customer).
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Paragraph (c)(4)(A) of the Current Rule mandates that if it is
determined that an obvious error has occurred, the execution price of
the transaction will be adjusted pursuant to the table set forth in
(c)(4)(A). Although for simple orders paragraph (c)(4)(A) is only
applicable when no party to the transaction is a Customer, for the
purposes of complex orders paragraph (a) of Interpretation and Policy
.07 will supersede that limitation; therefore, if it is determined that
a leg (or legs) of a complex order is an obvious error, the leg (or
legs) will be adjusted pursuant to (c)(4)(A), regardless of whether a
party to the transaction is a Customer. The Size Adjustment Modifier
defined in subparagraph (a)(4) will similarly apply (regardless of
whether a Customer is on the transaction) by virtue of the
[[Page 15396]]
application of paragraph (c)(4)(A).\15\ The Exchange notes that
adjusting all market participants is not unique or novel. When the
Exchange determines that a simple order execution is a Catastrophic
Error pursuant to the Current Rule, paragraph (d)(3) already provides
for adjusting the execution price for all market participants,
including Customers.
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\15\ See Rule 6.15(c)(4)(A) (stating that any non-Customer
Obvious Error exceeding 50 contracts will be subject to the Size
Adjustment Modifier defined in sub-paragraph (a)(4)). The Size
Adjustment Modifier may also apply to the option leg of a stock-
option order that is adjusted pursuant to Proposed Rule 6.15.07(c).
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Furthermore, as with the Current Rule, Proposed Rule 6.15.07(a)
provides protection for Customer orders, stating that where at least
one party to a complex order transaction is a Customer, the transaction
will be nullified if adjustment would result in an execution price
higher (for buy transactions) or lower (for sell transactions) than the
Customer's limit price on the complex order or individual leg(s). For
example, assume Customer enters a complex order to buy leg 1 and leg 2.
Assume the NBBO for leg 1 is $0.20-1.00 and the NBBO for
leg 2 is $0.50-1.00 and that these have been the NBBOs since the market
opened.
A split-second prior to the execution of the complex order
a Customer enters a simple order to sell the leg 1 options series at
$1.30, and the simple order enters the Exchange's book so that the BBO
is $.20-$1.30. The limit price on the simple order is $1.30.
The complex order executes leg 1 against the Exchange's
best offer of $1.30 and leg 2 at $1.00 for a net execution price of
$2.30.
However, leg 1 executed on a wide quote (the NBBO for leg
1 was $0.20-1.00 at the time of execution, which is wider than
$0.75).\16\ Leg 2 was not executed on a wide quote (the market for leg
2 was $0.50-1.00); thus, leg 2 execution price stands.
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\16\ See Rule 6.15(b)(3).
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The Exchange determines that the Theoretical Price for leg
1 is $1.00, which was the best offer prior to the execution. Leg 1
qualifies as an obvious error because the difference between the
Theoretical Price ($1.00) and the execution price ($1.30) is larger
than $0.25.\17\
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\17\ See Rule 6.15(c)(1).
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According to Proposed Rule 6.15.07(a) Customers will also
be adjusted in accordance with Rule 6.15(c)(4)(A), which for a buy
transaction under $3.00 calls for the Theoretical Price to by adjusted
by adding $0.15 \18\ to the Theoretical Price of $1.00. Thus, adjust
execution price for leg 1 would be $1.15.
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\18\ See Rule 6.15(c)(4)(A).
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However, adjusting the execution price of leg 1 to $1.15
violates the limit price of the Customer's sell order on the simple
order book for leg 1, which was $1.30.
Thus, the entire complex order transaction will be
nullified \19\ because the limit price of a Customer's sell order would
be violated by the adjustment.\20\
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\19\ If any leg of a complex order is nullified, the entire
transaction is nullified. See Proposed Rule 6.15.07(a).
\20\ The simple order in this example is not an erroneous sell
transaction because the execution price was not erroneously low. See
Rule 6.15(a)(2).
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As the above example demonstrates, incoming complex orders may
execute against resting simple orders in the leg market. If a complex
order leg is deemed to be an obvious error, adjusting the execution
price of the leg may violate the limit price of the resting order,
which will result in nullification if the resting order is for a
Customer. In contrast, Interpretation and Policy .02 to Rule 6.15
provides that if an adjustment would result in an execution price that
is higher than an erroneous buy transaction or lower than an erroneous
sell transaction the execution will not be adjusted or nullified.\21\
If the adjustment of a complex order would violate the complex order
Customer's limit price, the transaction will be nullified.
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\21\ See Rule 6.15.02.
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As previously noted, paragraph (d)(3) of the Current Rule already
mandates that if it is determined that a catastrophic error has
occurred, the execution price of the transaction will be adjusted
pursuant to the table set forth in (d)(3). For purposes of complex
orders under Proposed Rule .07(a), if one of the legs of a complex
orders is determined to be a Catastrophic Error under paragraph (d)(3),
all market participants will be adjusted in accordance with the table
set forth in (d)(3). Again, however, where at least one party to a
complex order transaction is a Customer, the transaction will be
nullified if adjustment would result in an execution price higher (for
buy transactions) or lower (for sell transactions) than the Customer's
limit price on the complex order or individual leg(s). Again, if any
leg of a complex order is nullified, the entire transaction is
nullified. Additionally, as is the case today, if an Official
determines that a Catastrophic Error has not occurred, the Trading
Permit Holder will be subject to a charge of $5,000.\22\
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\22\ See Rule 6.15(d)(3).
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Other than honoring the limit prices established for Customer
orders, the Exchange has proposed to treat Customers and non-Customers
the same in the context of the complex orders that trade against the
leg market. When complex orders trade against the leg market, it is
possible that at least some of the legs will execute at prices that
would not be deemed obvious or catastrophic errors, which gives the
counterparty in such situations no indication that the execution will
later by adjusted or nullified. The Exchange believes that treating
Customers and non-Customers the same in this context will provide
additional certainty to non-Customers (especially Market-Makers) with
respect to their potential exposure and hedging activities, including
comfort that even if a transaction is later adjusted, such transaction
will not be fully nullified. However, as noted above, under the
Proposed Rule where at least one party to the transaction is a
Customer, the trade will be nullified if the adjustment would result in
an execution price higher (for buy transactions) or lower (for sell
transactions) than the Customer's limit price on the complex order or
individual leg(s). The Exchange has retained the protection of a
Customer's limit price in order to avoid a situation where the
adjustment could be to a price that a Customer would not have expected,
and market professionals such as non-Customers would be better prepared
to recover in such situations. Therefore, adjustment for non-Customers
is more appropriate.
Second, proposed Interpretation and Policy .07(b) governs the
review of complex orders that are executed against other complex
orders. Proposed Rule 6.15.07(b) provides:
If a complex order executes against another complex order and at
least one of the legs qualifies as an Obvious Error under paragraph
(c)(1) or a Catastrophic Error under paragraph (d)(1), then the
leg(s) that is an Obvious or Catastrophic Error will be adjusted or
busted in accordance with paragraph (c)(4) or (d)(3), respectively,
so long as either: (i) The width of the National Spread Market for
the complex order strategy just prior to the erroneous transaction
was equal to or greater than the amount set forth in the wide quote
table of paragraph (b)(3) or (ii) the net execution price of the
complex order is higher (lower) than the offer (bid) of the National
Spread Market for the complex order strategy just prior to the
erroneous transaction by an amount equal to at least the amount
shown in the table in paragraph (c)(1). If any leg of a complex
order is nullified, the entire transaction is nullified. For
purposes of Rule 6.15, the National Spread Market for a complex
order strategy is determined by the National Best Bid/Offer of the
individual legs of the strategy.
[[Page 15397]]
As described above in relation to Proposed Rule 6.15.07(a), the first
step is for the Exchange to review (upon receipt of a timely
notification in accordance with paragraphs (c)(2) or (d)(2) of the
Current Rule) the individual legs to determine whether a leg or legs
qualifies as an obvious or catastrophic error. If no leg qualifies as
an obvious or catastrophic error, the transaction stands--no adjustment
and no nullification.
Unlike Proposed Rule 6.15.07(a), the Exchange is also proposing to
compare the net execution price of the entire complex order package to
the National Spread Market (``NSM'') for the complex order
strategy.\23\ Complex orders are exempt from the order protection rules
of the options exchanges.\24\ Thus, depending on the manner in which
the systems of an options exchange are calibrated, a complex order can
execute without regard to the prices offered in the complex order books
or the leg markets of other options exchanges. In certain situations,
reviewing the execution prices of the legs in a vacuum would make the
leg appear to be an obvious or catastrophic error, even though the net
execution price on the complex order is not an erroneous price. For
example, assume the Exchange receives a complex order to buy ABC calls
and sell ABC puts.
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\23\ NSM is the derived net market for a complex order package.
See e.g., Rule 6.13.02 (utilizing the term derived net market in the
context of complex order strategies). For example, if the NBBO of
Leg 1 is $1.00-2.00 and the NBBO of Leg 2 is $5.00-7.00, then the
NSM for a complex order to buy Leg 1 and buy Leg 2 is $6.00-9.00.
\24\ See CBOE Rule 6.81(b)(7). All options exchanges have the
same order protection rule. CBOE Rule 6.81 applies to C2 pursuant to
Section E of C2 Chapter VI.
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If the BBO for the ABC calls is $5.50-7.50 and the BBO for
ABC puts is $3.00-4.50, then the Exchange's spread market is $1.00-
4.50.\25\
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\25\ The complex order is to buy ABC calls and sell ABC puts.
The Exchange's best offer for ABC puts is $7.50 and Exchange's best
bid for is $3.00. If the Customer were to buy the complex order
strategy, the Customer would receive a debit of $4.50 (buy ABC calls
for $7.50 minus selling ABC puts for $3.00). If the Customer were to
sell the complex order strategy the Customer would receive a credit
of $1.00 (selling the ABC calls for $5.50 minus buying the ABC puts
for $4.50). Thus, the Exchange's spread market is $1.00-4.50.
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If the NBBO for the ABC calls is $6.00-6.50 and the NBBO
for the ABC puts is $3.50-4.00, then the NSM is $2.00-3.00.
If the Customer buys the calls at $7.50 and sells the puts
at $4.00, the complex order Customer receives a net execution price of
$3.00 (debit), which is the expected net execution price as indicated
by the NSM offer of $3.00.
If the exchange were to solely focus on the $7.50 execution price
of the ABC calls or the $4.00 execution price of the ABC puts, the
execution would qualify as an obvious or catastrophic error because the
execution price on the legs was outside the NBBO, even though the net
execution price is accurate. Thus, the additional review of the NSM to
determine if the complex order was executed at a truly erroneous price
is necessary. The same concern is not present when a complex order
executes against the leg market under Rule 6.15.07(a) because the
Exchange is modifying its system in order to ensure the leg will
execute at or within the NBBO of the leg markets.\26\
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\26\ The proposed rule change to modify Exchange systems to
ensure the legs of a complex order will execute against legs in the
simple order market within the NBBO of the simple order market will
be in a separate filing.
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In order to incorporate NSM, Rule 6.15.07(b) provides that if the
Exchange determines that a leg or legs does qualify as on obvious or
catastrophic error, the leg or legs will be adjusted or busted in
accordance with paragraph (c)(4) or (d)(3) of the Current Rule, so long
as either: (i) The width of the NSM for the complex order strategy just
prior to the erroneous transaction was equal to or greater than the
amount set forth in the wide quote table of paragraph (b)(3) of the
Current Rule or (ii) the net execution price of the complex order is
higher (lower) than the offer (bid) of the NSM for the complex order
strategy just prior to the erroneous transaction by an amount equal to
at least the amount shown in the table in paragraph (c)(1) of the
Current Rule.
For example, assume an individual leg or legs qualifies as an
obvious or catastrophic error and the width of the NSM of the complex
order strategy just prior to the erroneous transaction is $6.00-9.00.
The complex order will qualify to be adjusted or busted in accordance
with paragraph (c)(4) of the Current Rule because the wide quote table
of paragraph (b)(3) of the Current Rule indicates that the minimum
amount is $1.50 for a bid price between $5.00 to $10.00. If the NSM
were instead $6.00-7.00 the complex order strategy would not qualify to
be adjusted or busted pursuant to .07(b)(i) because the width of the
NSM is $1.00, which is less than the required $1.50. However, the
execution may still qualify to be adjusted or busted in accordance with
paragraph (c)(4) or (d)(3) of the Current Rule pursuant to .07(b)(ii).
Focusing on the NSM in this manner will ensure that the obvious/
catastrophic error review process focuses on the net execution price
instead of the execution prices of the individual legs, which may have
execution prices outside of the NBBO of the leg markets.
Again, assume an individual leg or legs qualifies as an obvious or
catastrophic error as described above. If the NSM is $6.00-7.00 (not a
wide quote pursuant to the wide quote table in paragraph (b)(3) of the
Current Rule) but the execution price of the entire complex order
package (i.e., the net execution price) is higher (lower) than the
offer (bid) of the NSM for the complex order strategy just prior to the
erroneous transaction by an amount equal to at least the amount in the
table in paragraph (c)(1) of the Current Rule, then the complex order
qualifies to be adjusted or busted in accordance with paragraph (c)(4)
or (d)(3) of the Current Rule. For example, if the NSM for the complex
order strategy just prior to the erroneous transaction is $6.00-7.00
and the net execution price of the complex order transaction is $7.75,
the complex order qualifies to be adjusted or busted in accordance with
paragraph (c)(4) of the Current Rule because the execution price of
$7.75 is more than $0.50 (i.e., the minimum amount according to the
table in paragraph (c)(1) when the price is above $5.00 but less than
$10.01) from the NSM offer of $7.00. Focusing on the NSM in this manner
will ensure that the obvious/catastrophic error review process focuses
on the net execution price instead of the execution prices of the
individual legs, which may have execution prices outside of the NBBO of
the leg markets.
Although the Exchange believes adjusting execution prices is
generally better for the marketplace than nullifying executions because
liquidity providers often execute hedging transactions to offset
options positions, the Exchange recognizes that complex orders
executing against other complex orders is similar to simple orders
executing against other simple orders because both parties are able to
review the execution price to determine whether the transaction may
have been executed at an erroneous price. Thus, for purposes of complex
orders that meet the requirements of Rule 6.15.07(b), the Exchange
proposes to apply the Current Rule and adjust or bust obvious errors in
accordance with paragraph (c)(4) (as opposed to applying paragraph
(c)(4)(A) as is the case under .07(a)) and catastrophic errors in
accordance with (d)(3).
Therefore, for purposes of complex orders under Proposed Rule
6.15.07(b), if one of the legs is determined to be an obvious error
under paragraph (c)(1), all Customer transactions will be nullified,
unless a Trading Permit Holder (``TPH'')
[[Page 15398]]
submits 200 or more Customer transactions for review in accordance with
(c)(4)(C).\27\ For purposes of complex orders under Proposed Rule
6.15.07(b), if one of the legs is determined to be a catastrophic error
under paragraph (d)(3) and all of the other requirements of Rule
6.15.07(b) are met, all market participants will be adjusted in
accordance with the table set forth in (d)(3). Again, however, pursuant
to paragraph (d)(3) where at least one party to a complex order
transaction is a Customer, the transaction will be nullified if
adjustment would result in an execution price higher (for buy
transactions) or lower (for sell transactions) than the Customer's
limit price on the complex order or individual leg(s). Also, if any leg
of a complex order is nullified, the entire transaction is nullified.
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\27\ Rule 6.15(c)(4)(C) also requires the orders resulting in
200 or more Customer transactions to have been submitted during the
course of 2 minutes or less.
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Third, proposed Interpretation and Policy .07(c) governs stock-
option orders. Proposed Rule 6.15.07(c) provides:
If the option leg of a stock-option order qualifies as an
Obvious Error under paragraph (c)(1) or a Catastrophic Error under
paragraph (d)(1), then the option leg that is an Obvious or
Catastrophic Error will be adjusted in accordance with paragraph
(c)(4)(A) or (d)(3), respectively, regardless of whether one of the
parties is a Customer. However, the option leg of any Customer order
subject to this paragraph (c) will be nullified if the adjustment
would result in an execution price higher (for buy transactions) or
lower (for sell transactions) than the Customer's limit price on the
stock-option order, and the Exchange will attempt to nullify the
stock leg. Whenever a stock trading venue nullifies the stock leg of
a stock-option order or whenever the stock leg cannot be executed,
the Exchange will nullify the option leg upon request of one of the
parties to the transaction or in accordance with paragraph (c)(3).
Similar to proposed Interpretation and Policy .07(a), an options
leg (or legs) of a stock-option order must qualify as an obvious or
catastrophic error under the Current Rule in order for the stock-option
order to qualify as an obvious or catastrophic error. Also similar to
Proposed Rule 6.15.07(a), if an options leg (or legs) does qualify as
an obvious or catastrophic error, the option leg (or legs) will be
adjusted in accordance with paragraph (c)(4)(A) or (d)(3),
respectively, regardless of whether one of the parties is a Customer.
Again, as with Proposed Rule 6.15.07(a), where at least one party to a
complex order transaction is a Customer, the Exchange will nullify the
option leg and attempt to nullify the stock leg if adjustment would
result in an execution price higher (for buy transactions) or lower
(for sell transactions) than the Customer's limit price on the complex
order or individual leg(s).
The stock leg of a stock-option order is not executed on the
Exchange; rather, the stock leg is sent to a stock trading venue for
execution. The Exchange is unaware of a mechanism by which the Exchange
can guarantee that the stock leg will be nullified by the stock trading
venue in the event of an obvious or catastrophic error on the Exchange.
Thus, in the event of the nullification of the option leg pursuant to
Proposed Rule 6.15.07(c), the Exchange will attempt to have the stock
leg nullified by the stock trading venue by either contacting the stock
trading venue or notifying the parties to the transaction that the
option leg is being nullified. The party or parties to the transaction
may ultimately need to contact the stock trading venue to have the
stock portion nullified.
Finally, the Exchange proposes to provide guidance that whenever
the stock trading venue nullifies the stock leg of a stock-option
order, the option will be nullified upon request of one of the parties
to the transaction or by an Official acting on their own motion in
accordance with paragraph (c)(3). There are situations in which buyer
and seller agree to trade a stock-option order, but the stock leg
cannot be executed. The Exchange proposes to provide guidance that
whenever the stock portion of a stock-option order cannot be executed,
the Exchange will nullify the option leg upon request of one of the
parties to the transaction or on an Official's own motion.
Implementation Date
In order to ensure that other options exchanges are able to adopt
rules consistent with this proposal and to coordinate the effectiveness
of such harmonized rules, the Exchange proposes to delay the operative
date of this proposal to April 17, 2017.
2. Statutory Basis
The Exchange believes that its proposal is consistent with the
requirements of the Act and the rules and regulations thereunder that
are applicable to a national securities exchange, and, in particular,
with the requirements of Section 6(b) of the Act.\28\ Specifically, the
proposal is consistent with Section 6(b)(5) of the Act \29\ because it
would promote just and equitable principles of trade, remove
impediments to, and perfect the mechanism of, a free and open market
and a national market system, and, in general, protect investors and
the public interest.
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\28\ 15 U.S.C. 78f(b).
\29\ 15 U.S.C. 78f(b)(5).
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As described above, the Exchange and other options exchanges are
seeking to adopt harmonized rules related to the adjustment and
nullification of erroneous options transactions. The Exchange believes
that the Proposed Rule will provide greater transparency and clarity
with respect to the adjustment and nullification of erroneous options
transactions. Particularly, the proposed changes seek to achieve
consistent results for participants across U.S. options exchanges while
maintaining a fair and orderly market, protecting investors and
protecting the public interest. Based on the foregoing, the Exchange
believes that the proposal is consistent with Section 6(b)(5) of the
Act \30\ in that the Proposed Rule will foster cooperation and
coordination with persons engaged in regulating and facilitating
transactions.
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\30\ 15 U.S.C. 78f(b)(5).
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The Exchange believes the various provisions allowing or dictating
adjustment rather than nullification of a trade are necessary given the
benefits of adjusting a trade price rather than nullifying the trade
completely. Because options trades are used to hedge, or are hedged by,
transactions in other markets, including securities and futures, many
TPHs, and their customers, would rather adjust prices of executions
rather than nullify the transactions and, thus, lose a hedge
altogether. As such, the Exchange believes it is in the best interest
of investors to allow for price adjustments as well as nullifications.
The Exchange does not believe that the proposal is unfairly
discriminatory, even though it differentiates in many places between
Customers and non-Customers. As with the Current Rule, Customers are
treated differently, often affording them preferential treatment. This
treatment is appropriate in light of the fact that Customers are not
necessarily immersed in the day-to-day trading of the markets, are less
likely to be watching trading activity in a particular option
throughout the day, and may have limited funds in their trading
accounts. At the same time, the Exchange reiterates that in the U.S.
options markets generally there is significant retail customer
participation that occurs directly on (and only on) options exchanges
such as the Exchange. Accordingly, differentiating
[[Page 15399]]
among market participants with respect to the adjustment and
nullification of erroneous options transactions is not unfairly
discriminatory because it is reasonable and fair to provide Customers
with additional protections as compared to non-Customers.
The Exchange believes that its proposal to adopt the ability to
adjust a Customer's execution price when a complex order is deemed to
be an Obvious or Catastrophic Error is consistent with the Act. A
complex order that executes against individual leg markets may receive
an execution price on an individual leg that is not an Obvious or
Catastrophic error but another leg of the transaction is an Obvious or
Catastrophic Error. In such situations where the complex order is
executing against at least one individual or firm that is not aware of
the fact that they have executed against a complex order or that the
complex order has been executed at an erroneous price, the Exchange
believes it is more appropriate to adjust execution prices if possible
because the derivative transactions are often hedged with other
securities. Allowing adjustments instead of nullifying transactions in
these limited situations will help to ensure that market participants
are not left with a hedge that has no position to hedge against.
The Exchange also believes its proposal related to stock-option
orders is consistent with the Act. Stock-option orders consist of an
option component and a stock component. Due to the fact that the
Exchange has no control over the venues on which the stock is executed
the proposal focuses on the option component of the stock-option order
by adjusting or nullifying the option in accordance with paragraph
(c)(4)(A) or (d)(3). Also, nullifying the option component if the stock
component cannot be executed ensures that market participants receive
the execution for which they bargained. Stock-option orders are
negotiated and agreed to as a package; thus, if for any reason the
stock portion of a stock-option order cannot ultimately be executed,
the parties should not be saddled with an options position sans stock.
B. Self-Regulatory Organization's Statement on Burden on Competition
C2 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. Importantly, the Exchange
believes the proposal will not impose a burden on intermarket
competition but will rather alleviate any burden on competition because
it is the result of a collaborative effort by all options exchanges to
harmonize and improve the process related to the adjustment and
nullification of erroneous options transactions. The Exchange does not
believe that the rules applicable to such process is an area where
options exchanges should compete, but rather, that all options
exchanges should have consistent rules to the extent possible.
Particularly where a market participant trades on several different
exchanges and an erroneous trade may occur on multiple markets nearly
simultaneously, the Exchange believes that a participant should have a
consistent experience with respect to the nullification or adjustment
of transactions. The Exchange understands that all other options
exchanges that trade complex orders and/or stock-option orders intend
to file proposals that are substantially similar to this proposal.
The Exchange does not believe that the proposed rule change imposes
a burden on intramarket competition because the provisions apply to all
market participants equally within each participant category (i.e.,
Customers and non-Customers). With respect to competition between
Customer and non-Customer market participants, the Exchange believes
that the Proposed Rule acknowledges competing concerns and tries to
strike the appropriate balance between such concerns. For instance, the
Exchange believes that protection of Customers is important due to
their direct participation in the options markets as well as the fact
that they are not, by definition, market professionals. At the same
time, the Exchange believes due to the quote-driven nature of the
options markets, the importance of liquidity provision in such markets
and the risk that liquidity providers bear when quoting a large breadth
of products that are derivative of underlying securities, that the
protection of liquidity providers and the practice of adjusting
transactions rather than nullifying them is of critical importance. As
described above, the Exchange will apply specific and objective
criteria to determine whether an erroneous transaction has occurred
and, if so, how to adjust or nullify a transaction.
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
Because the foregoing proposed rule change does not: (i)
Significantly affect the protection of investors or the public
interest; (ii) impose any significant burden on competition; and (iii)
become operative for 30 days from the date on which it was filed, or
such shorter time as the Commission may designate, it has become
effective pursuant to Section 19(b)(3)(A)(iii) of the Act \31\ and
subparagraph (f)(6) of Rule 19b-4 thereunder.\32\
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\31\ 15 U.S.C. 78s(b)(3)(A)(iii).
\32\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)
requires a self-regulatory organization to give the Commission
written notice of its intent to file the proposed rule change at
least five business days prior to the date of filing of the proposed
rule change, or such shorter time as designated by the Commission.
The Exchange has satisfied this requirement.
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A proposed rule change filed pursuant to Rule 19b-4(f)(6) under the
Act \33\ normally does not become operative for 30 days after the date
of its filing. However, Rule 19b-4(f)(6)(iii) \34\ permits the
Commission to designate a shorter time if such action is consistent
with the protection of investors and the public interest. The Exchange
has asked the Commission to waive the 30-day operative delay so that
the proposal may become operative immediately upon filing. The
Commission believes that waiving the 30-day operative delay is
consistent with the protection of investors and the public interest as
it will allow the Exchange to implement the proposed rule change by
April 17, 2017 in coordination with the other options exchanges.
Accordingly, the Commission hereby waives the operative delay and
designates the proposal operative upon filing.\35\
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\33\ 17 CFR 240.19b-4(f)(6).
\34\ 17 CFR 240.19b-4(f)(6)(iii).
\35\ For purposes only of waiving the 30-day operative delay,
the Commission has also considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
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At any time within 60 days of the filing of the proposed rule
change, the Commission summarily may temporarily suspend such rule
change if it appears to the Commission that such action is: (i)
Necessary or appropriate in the public interest; (ii) for the
protection of investors; or (iii) otherwise in furtherance of the
purposes of the Act. If the Commission takes such action, the
Commission shall institute proceedings to determine whether the
proposed rule should be approved or disapproved.
[[Page 15400]]
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-C2-2017-011 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-C2-2017-011. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of the filing also will be available
for inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-C2-2017-011, and should be
submitted on or before April 18, 2017.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\36\
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\36\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-06055 Filed 3-27-17; 8:45 am]
BILLING CODE 8011-01-P