[Federal Register Volume 85, Number 103 (Thursday, May 28, 2020)]
[Notices]
[Pages 32086-32092]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11399]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88923; File No. SR-CBOE-2020-046]
Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of
Filing and Immediate Effectiveness of a Proposed Rule Change Relating
to the Debit/Credit Price Reasonability Check
May 21, 2020.
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 May 14, 2020, Cboe Exchange, Inc. (``Exchange'' or ``Cboe Options'')
filed with the Securities and Exchange Commission (``SEC'' or
``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 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
Cboe Exchange, Inc. (the ``Exchange'' or ``Cboe Options'') proposes
to amend its debit/credit price reasonability check. The text of the
proposed rule change is provided below.
(additions are italicized; deletions are [bracketed])
* * * * *
Rules of Cboe Exchange, Inc.
* * * * *
Rule 5.34. Order and Quote Price Protections Mechanisms and Risk
Controls
The System's acceptance and execution of orders, quotes, and bulk
messages, as applicable, pursuant to the Rules, including Rules 5.31
through 5.33, and orders routed to PAR pursuant to Rule 5.82 are
subject to the following price protection mechanisms and risk controls,
as applicable.
(a) No change.
(b) Complex Orders.
(1) Definitions. For purposes of this subparagraph (b):
(A)-(C) No change.
(D) Calendar Spread. A ``calendar'' spread is a two-legged complex
order with one leg to buy a number of calls (puts) and one leg to sell
the same number of calls (puts) with the same exercise price but
different expiration dates.
(2) No change.
(3) Debit/Credit Price Reasonability Checks.
(A) The Exchange cancels or rejects a complex order (or unexecuted
portion) that is a limit order for a debit strategy with a net credit
price that exceeds a pre-set buffer, a limit order (or unexecuted
portion) for a credit strategy with a net debit price that exceeds a
pre-set buffer, or a market order (or unexecuted portion) for a credit
strategy that would execute at a net debit price that exceeds a pre-set
buffer (the pre-set
[[Page 32087]]
buffers are determined by the Exchange on a class and strategy (i.e.,
vertical, calendar, butterfly, orders with different expiration dates
and exercise prices) basis).
(B) The System defines a complex order as a debit or credit as
follows:
(i)-(ii) No change.
(iii) an order for which all pairs and loners are debits
(credits) is a debit (credit). For purposes of this check, a
``pair'' is a pair of legs in an order for which both legs are calls
or both legs are puts, one leg is a buy and one leg is a sell, and
the legs have the same expiration date but different exercise prices
(i.e., vertical), [or] the same exercise price but different
expiration dates (i.e., calendar), or the exercise price for the
call (put) with the farther expiration date is lower (higher) than
the exercise price for the nearer expiration date. A ``loner'' is
any leg in an order that the System cannot pair with another leg in
the order. Notwithstanding the foregoing, if the stock component of
a stock-option order is to buy (sell), the stock-option order is a
debit (credit).
(a) No change.
(b) The System then pairs legs to the extent possible [with the
same exercise prices] across expiration dates, pairing one [leg]call
(put) with the [leg]call (put) that has the next nearest expiration
date and the same or next lower (higher) exercise price.
(c) A pair of calls is a credit (debit) if the exercise price of
the buy (sell) leg is higher than the exercise price of the sell
(buy) leg (if the pair has the same expiration date) or if the
expiration date of the sell (buy) leg is farther than the expiration
date of the buy (sell) leg (if the [pair has the same] exercise
price of the sell (buy) leg is the same as or lower than the
exercise price of the buy (sell) leg).
(d) A pair of puts is a credit (debit) if the exercise price of
the sell (buy) leg is higher than the exercise price of the buy
(sell) leg (if the pair has the same expiration date) or if the
expiration date of the sell (buy) leg is farther than the expiration
date of the buy (sell) leg (if the [pair has the same] exercise
price of the sell (buy) leg is the same as or higher than the
exercise price of the buy (sell) leg).
* * * * *
The text of the proposed rule change is also available on the
Exchange's website (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the
Secretary, and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The proposed rule change amends the debit/credit price
reasonability check for complex orders in Rule 5.34(b)(3) to expand its
applicability and provide flexibility with respect to its application.
Pursuant to the debit/credit price reasonability check, the Exchange
cancels or rejects a complex order (or unexecuted portion) that is a
limit order for a debit strategy with a net credit price that exceeds a
pre-set buffer, a limit order (or unexecuted portion) for a credit
strategy with a net debit price that exceeds a pre-set buffer, or a
market order (or unexecuted portion) for a credit strategy that would
execute at a net debit price that exceeds a pre-set buffer (the pre-set
buffers are determined by the Exchange). The System defines a complex
order as a debit (credit) if all pairs and loners are debits
(credits).\5\ For purposes of the debit/credit price reasonability
check, a ``pair'' is a pair of legs in an order for which both legs are
calls or both legs are puts, one leg is a buy and one leg is a sell,
and both legs have the same expiration date but different exercise
prices \6\ or the same exercise price but different expiration
dates.\7\ A ``loner'' is any leg is an order that the System cannot
pair with another leg in the order.
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\5\ Rule 5.34(b)(3)(B). The System also determines certain call
and put butterfly spreads as debits and credits. See id.
\6\ The proposed rule change defines this as a ``vertical,''
which is consistent with the definition of a vertical in Rule
5.34(b)(1)(A).
\7\ The proposed rule change defines this as a ``calendar,'' and
adds the definition of a calendar spread to Rule 5.34(b)(1)(D).
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(1) The System first pairs legs to the extent possible within each
expiration date, pairing one leg with the leg that has the next highest
exercise price.
(2) The System then pairs legs to the extent possible with the same
exercise prices across expiration dates, pairing one leg with the leg
that has the next nearest expiration date.
(3) A pair of calls is a credit (debit) if the exercise price of
the buy (sell) leg is higher than the exercise price of the sell (buy)
leg (if the pair has the same expiration date) or if the expiration
date of the sell (buy) leg is farther than the expiration date of the
buy (sell) leg (if the pair has the same exercise price).
(4) A pair of puts is a credit (debit) if the exercise price of the
sell (buy) leg is higher than the exercise price of the buy (sell) leg
(if the pair has the same expiration date) or if the expiration date of
the sell (buy) leg is farther than the expiration date of the buy
(sell) leg (if the pair has the same exercise price).
(5) A loner to buy is a debit, and a loner to sell is a credit.
The System does not apply the debit/credit price reasonability
check to an order for which the System cannot define whether it is a
debit or credit.
Background
The Exchange implemented a debit/credit reasonability check in
2016.\8\ The version of the debit/credit price reasonability check in
place until the Exchange's System migration on October 7, 2019 was
substantially similar to the current version described above. However,
under that version, the Exchange previously applied the debit/credit
price reasonability check to pairs with different expiration dates and
exercise prices for which the call (put) with the farther expiration
date is lower (higher) than the exercise price for the nearer
expiration (i.e., diagonals), except to options that are European-
settled.\9\ Diagonal options in European-settled options were excluded
from the debit/credit price reasonability check, because certain market
conditions could cause options with nearer expirations to be worth more
than options with farther expirations (as further discussed below).
Additionally, under the prior version of the debit/credit price
reasonability check, while the Exchange did not apply a pre-set buffer,
it was able to apply the debit/credit price reasonability check on a
class-by-class basis.
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\8\ See Securities Exchange Act Release Nos. 76960 (January 21,
2016), 81 FR 4728 (January 27, 2016) (SR-CBOE-2015-107) (Notice of
Filing of Amendment No. 2 and Order Granting Accelerated Approval of
Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto,
Relating to Price Protection Mechanisms for Quotes and Orders); and
79589 (December 19, 2016), 81 FR 94469 (December 23, 2019) (SR-CBOE-
2016-086).
\9\ Id.
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In connection with the System migration on October 7, 2019, the
Exchange adopted the current version of the debit/credit price
reasonability check.\10\ The Exchange adopted flexibility to apply a
buffer rather than the flexibility to turn the debit/credit price
reasonability check on or off, as the Exchange believed it would
provide
[[Page 32088]]
additional flexibility to adapt the check to market conditions. The
Exchange inadvertently omitted the debit/credit price reasonability
check's application to the diagonal pairs that were subject to the
check under the prior version of the rule; however, the debit/credit
price reasonability check was included in the new System and has been
applied to complex orders, including diagonals, since October 7, 2019.
The Exchange did not exclude European-settled options from the debit/
credit price reasonability check in the Rules, as it previously did,
because the System was built to permit the buffer to be modified on a
class-by-class basis as well as a strategy basis. The proposed rule
change codifies the applicability of the debit/credit price
reasonability check to diagonal pairs, as well as the Exchange's
ability to modify the debit/credit price reasonability check on class
and strategy basis, which the Exchange believes is appropriate given
that market conditions impact classes and strategies in different
manners, and the flexibility will permit it modify the debit/credit
price reasonability check to adapt to these market conditions so that
legitimate strategies may receive execution opportunities.
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\10\ See Securities Exchange Act Release No. 86923 (September
10, 2019), 84 FR 48664 (September 16, 2019) (SR-CBOE-2019-057).
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As discussed in the rule filing that first proposed adoption of the
debit/credit price reasonability check, the System determines whether
an order is a debit or credit based on general options volatility and
pricing principles, which the Exchange understands are used by market
participants in their option pricing models.\11\ With respect to
options with the same underlying:
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\11\ Securities Exchange Act Release Nos. 76960 (January 21,
2016), 81 FR 4728 (January 27, 2016) (SR-CBOE-2015-107) (Notice of
Filing of Amendment No. 2 and Order Granting Accelerated Approval of
Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto,
Relating to Price Protection Mechanisms for Quotes and Orders); and
79589 (December 19, 2016), 81 FR 94469 (December 23, 2019) (SR-CBOE-
2016-086).
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if two calls have the same expiration date, the price of
the call with the lower exercise price is more than the price of the
call with the higher exercise price;
if two puts have the same expiration date, the price of
the put with the higher exercise price is more than the price of the
put with the lower exercise price; and
if two calls (puts) have the same exercise price, the
price of the call (put) with the nearer expiration is less than the
price of the call (put) with the farther expiration.
In other words, a call (put) with a lower (higher) exercise price
is more expensive than a call (put) with a higher (lower) exercise
price, because the ability to buy stock at a lower price is more
valuable than the ability to buy stock at a higher price, and the
ability to sell stock at a higher price is more valuable than the
ability to sell stock at a lower price. A call (put) with a farther
expiration is more expensive than the price of a call (put) with a
nearer expiration, because locking in a price further into the future
involves more risk for the buyer and seller and thus is more valuable,
making an option (call or put) with a farther expiration more expensive
than an option with a nearer expiration.
Proposed Application to Certain Diagonal Pairs
Under the current the debit/credit price reasonability check, the
System only pairs calls (puts) if they have the same expiration date
but different exercise prices or the same exercise price but different
expiration dates. With respect to pairs with different expiration dates
but the same exercise price,\12\ a pair of calls is a credit (debit)
strategy if the expiration date of the sell (buy) leg is farther than
the expiration date of the buy (sell) leg, and a pair of puts is a
credit (debit) strategy if the expiration date of the sell (buy) leg is
farther than the expiration date of the buy (sell) leg. However, based
on the principles described above, if the sell (buy) leg of a pair of
calls has a farther expiration date (and thus is more expensive) than
the expiration date of the buy (sell) leg as well as a lower exercise
price (and thus is more expensive) than the exercise price of the sell
(buy) leg, then the pair is a credit (debit) (as is the case if the
exercise prices of each call were the same under the current rule).
Similarly, if the sell (buy) leg of a pair of puts has a farther
expiration date (and thus is more expensive) than the expiration date
of the buy (sell) leg as well as a higher exercise price (and thus is
more expensive) than the exercise price of the buy (sell) leg, then the
pair of puts is a credit (as is the case if the exercise prices of each
put were the same under the current rule).
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\12\ A complex order consisting of a buy leg and a sell leg with
different expiration dates are commonly referred to in the industry
as a ``calendar spread.''
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Therefore, the proposed rule change expands the debit/credit price
reasonability check to pair calls (puts) with different expiration
dates if the exercise price for the call (put) with the farther
expiration date is lower (higher) than the exercise price for the
nearer expiration date in addition to those with different expiration
dates and the same exercise price. Specifically, the proposed rule
change amends subparagraph (c)(2)(C) to state, for purposes of the
debit/credit price reasonability check, a ``pair'' is a pair of legs in
an order for which both legs are calls or both legs are puts, one leg
is a buy and one leg is a sell, and the legs have different expiration
dates and the exercise price for the call (put) with the farther
expiration date is the same as or lower (higher) than the exercise
price for the nearer expiration date. The proposed rule change also
amends subparagraphs (b)(3)(B)(iii)(b) through (d) to incorporate these
orders with different expiration dates and exercise prices. When
pairing legs across expiration dates, the System will pair one call
(put) with the call (put) that has the next nearest expiration date and
the same or next lower (higher) exercise price.
Based on the pricing principles described above, a pair of calls is
a credit (debit) strategy if the expiration date of the sell (buy) leg
is farther than the expiration date of the buy (sell) leg (if the
exercise price of the sell (buy) leg is the same as or lower than the
exercise price of the buy (sell) leg). A pair of puts is a credit
(debit) strategy if the expiration date of the sell (buy) leg is
farther than the expiration date of the buy (sell) leg (if the exercise
price of the sell (buy) leg is the same as or higher than the exercise
price of the buy (sell) leg).\13\ Entering a calendar spread with a
credit (debit) strategy at a debit (credit) price (or that would
execute at a debit (credit) price), which price is inconsistent with
the strategy, may result in executions at prices that are extreme and
potentially erroneous.
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\13\ The proposed rule change makes no changes to the debit/
credit price reasonability check with respect to pairs of orders
with the same expiration date but different exercise prices.
Therefore, the rule filing omits references to the portions of the
current rule related to those pairs to focus on the changes made to
pairs with different expiration dates.
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Below are examples demonstrating how the System determines whether
a complex order with two legs, which have different expiration dates
and different exercise prices, is a debit or credit, and whether the
System will reject the order pursuant to the debit/credit price
reasonability check, with a pre-set buffer of $10.00.\14\
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\14\ The same principles would apply to complex orders with more
than two legs, which include two legs that can be paired in this
way.
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Example #1--Limit Call Spread
A Trading Permit Holder enters a spread to buy 10 May 30 XYZ
calls and sell 10 Aug 20 XYZ calls at a net debit price of -$20.00.
The
[[Page 32089]]
System defines this order as a credit, because the buy leg is for
the call with the nearer expiration date and higher exercise price
(and is thus the less expensive leg). The System rejects the order
back to the Trading Permit Holder because it is a limit order for a
credit strategy that contains a net debit price, as it exceeds the
pre-set buffer.
Example #2--Limit Put Spread
A Trading Permit Holder enters a spread to buy 20 May 30 XYZ
puts and sell 20 Apr 20 XYZ puts at a net credit price of $15.00.
The System defines this order as a debit, because the buy leg is for
the put with the farther expiration date and the higher exercise
price (and thus the more expensive leg). The System rejects the
order back to the Trading Permit Holder because it is a limit order
for a debit strategy that contains a net credit price, as it exceeds
the pre-set buffer.
Proposed Flexibility
Given the different characteristics applicable to different
classes, the Exchange proposes to determine the pre-set buffer on a
class-by-class basis. As discussed above, the prior version of the
check excluded application of the check to pairs for which the exercise
price for the call (put) with the farther expiration date is lower
(higher) than the exercise price for the nearer expiration date in
European-settled options (which is a group of classes), which
demonstrates the need to apply different parameters to different
classes. The Exchange will issue an Exchange notice for all pre-set
buffers, including any changes to those buffers.\15\
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\15\ See Rule 1.5.
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Additionally, the proposed rule change will permit the Exchange to
determine a different buffer on a strategy basis. In other words, the
Exchange may have different buffers applicable to calendars, verticals,
butterflies, and orders whose legs have different exercise prices and
different expiration dates for which the exercise price for the call
(put) with the farther expiration date is lower (higher) than the
exercise price for the nearer expiration date (which the check will
apply pursuant to this rule change). Strategies are impacted
differently by market conditions just as classes are impacted
differently by market conditions. As noted, the previous version of the
check excluded European-style options from the diagonal pair check, but
applied the check to those options for other strategy pairs (such as
calendars and verticals), which demonstrates that different strategies
may need different parameters.
As previously noted, the Exchange understands that in certain
market conditions, particularly in volatile conditions as have recently
occurred, the general pricing principles described above may not apply
to certain classes or strategies. For example, it is possible that the
leg with the farther expiration may be trading at a discount and thus
is worth less than the leg with the nearer term expiration, and thus
entering a diagonal or calendar strategy as a debit may be consistent
with the then-current market.\16\ In such conditions, the Exchange may
deem it appropriate to increase the buffer to permit these orders to be
accepted for electronic processing. While an order with a diagonal or
calendar strategy entered as a debit in normal market conditions may
appear erroneous and be appropriately rejected, in volatile market
conditions, such an order entered as a debit may be accurately
reflecting the market, and the Exchange believes it would be
appropriate to provide such an order with electronic execution
opportunities. The proposed flexibility to establish pre-set buffers on
a class and strategy basis will permit the Exchange to respond to
unusual market conditions as soon as practicable.
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\16\ This would apply to calendar spreads and orders with legs
with different expiration dates and exercise prices for which the
exercise price for the call (put) with the farther expiration date
is lower (higher) than the exercise price for the nearer expiration
date, but not vertical spreads, demonstrating the need to apply
different buffers to different strategies. It is for this reason
that the previous version of the debit/credit price reasonability
check did not apply to these diagonal strategies in European-settled
options.
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In the wake of recent market volatility caused by the ongoing
coronavirus pandemic, certain classes exhibited backwardation, which
occurs when series with the farther expirations are worth less than
series with the nearer term expirations. As discussed above, this is
the opposite of what occurs pursuant to general options pricing
principles in normal market conditions. Given this backwardation,
market participants were submitting diagonal [sic] in certain classes
(which were European-settled) with debit prices, which were consistent
with market conditions, but the System was rejecting those orders
because they did not satisfy the debit/credit price reasonability check
(as the buffer was set to $0).
This issue became exacerbated beginning on March 16, when the
Exchange suspended open outcry trading due to the coronavirus pandemic.
When the trading floor was open, market participants had the option to
submit orders that the System rejected to the trading floor for
execution in open outcry. However, that requires additional time, which
may introduce price risk to the execution, which is heightened when the
markets are volatile. With the closure of the trading floor, market
participants have no way to execute these orders with legitimate
strategies on the Exchange, except by submitting them as separate
orders, which introduces market and execution risk. Between March 16
and April 9, the System rejected an average of approximately 215 SPX
complex orders with two legs and a diagonal strategy each trading day,
with a low of fewer than 100 and a high above 500.\17\ This range
demonstrates the impact of market conditions on the pricing on this
strategy in SPX. On trading days with higher volatility, more SPX
orders were submitted with this strategy as credits rather than debits,
which were consistent with market conditions but unable to execute on
the Exchange. However, these orders were unable to execute on the
Exchange, because they did not satisfy the debit/credit price
reasonability check. The proposed rule change will permit the Exchange
to modify the buffer of these strategies to provide execution
opportunities to these legitimately priced orders (while providing
continued protection to other strategies in the class (and other
classes) not impacted by current market conditions).
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\17\ SPX options have been impacted by backwardation given
recent market conditions. As a European style option, the Exchange
notes diagonal pairs in SPX were excluded from the debit/credit
reasonability check. The Exchange intends to widen the buffer for
SPX diagonal pairs upon effectiveness of this filing based on market
conditions, the characteristics of SPX options, and data reviewed by
the Exchange, which increased buffer corresponds to the exclusion of
these options under the prior version of the reasonability check.
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Under normal market conditions, these prices would be considered
erroneous.\18\ However, during unusual market conditions, these prices
are consistent with those market conditions, and the Exchange believes
such orders should have electronic execution opportunities at prices
consistent with the market. Under the current rule, the Exchange could
have changed the buffer, but that change would have applied to all
classes and all strategies. Given that backwardation does not impact
pricing for all classes, and all strategies, the Exchange did not make
that change, as it believes the System would have accepted many
erroneously priced orders in addition to the
[[Page 32090]]
legitimately priced orders in the impacted classes and strategies. The
proposed rule change would permit the Exchange in similar circumstances
to modify the buffer in classes and strategies whose pricing was
impacted by changed market conditions, while maintaining the same level
of protection for classes and strategies whose pricing was not impacted
by those market conditions. The Exchange would consider market
conditions, investor demand, and other relevant factors when
determining whether to modify a buffer amount to attempt to create an
appropriate balance between protection against executions at
potentially erroneous prices and provision of execution opportunities
for legitimately priced orders.
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\18\ As noted above, under the prior version of the rule, the
diagonal pairs in European-style options were always excluded from
the debit/credit price reasonability check (and thus two-legged
complex orders with a diagonal pair in European-settled classes were
always accepted into the System in all market conditions). Applying
a widened buffer to diagonal pairs in European-style options under
the current rule would be consistent with the prior version of the
rule.
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The Exchange offers a suite of risk controls, as described in Rule
5.34, which are designed to prevent trades at potentially erroneous
prices. The debit/credit price reasonability check is an example of one
of these risk controls. If the Exchange modified the debit/credit check
buffer for a class or strategy in response to changes in market
conditions, there are other risk controls that would separately apply
to incoming orders to provide other protections against executions at
potentially erroneous prices. The Exchange regularly monitors the
application of the debit/credit price reasonability check, including
the number of orders rejected as a result of the check. Additionally,
the Exchange monitors orders that may be executed at erroneous prices
pursuant to Rule 6.5. The Exchange considers all of these factors, and
the factors described above, when determining whether to modify the
parameters of the available risk controls, including the debit/credit
check buffer.
The Exchange announces any changes to these parameters to market
participants by Exchange notice pursuant to Rule 1.5. As noted above,
market participants requested that we modify the buffer in certain
classes with respect to diagonal pairs (as would be permitted by the
proposed rule change) in connection with recent volatility. The
proposal was presented to Trading Permit Holders at a town hall held on
March 12, 2020 (which was available to all Trading Permit Holders and
attended in person or by phone by hundreds of participants), at which
the Exchange indicated, among other things, that it was seeking a rule
change to permit such a modification. While requests for the change
have decreased in recent weeks given the calming of the markets, the
Exchange believes the proposed rule change will permit it to respond
efficiently to any future changes in market conditions that may occur
in connection with the ongoing coronavirus pandemic or other potential
events.
2. Statutory Basis
The Exchange believes the proposed rule change is consistent with
the Securities Exchange Act of 1934 (the ``Act'') and the rules and
regulations thereunder applicable to the Exchange and, in particular,
the requirements of Section 6(b) of the Act.\19\ Specifically, the
Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \20\ requirements that the rules of an exchange be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in securities, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest. Additionally,
the Exchange believes the proposed rule change is consistent with the
Section 6(b)(5) \21\ requirement that the rules of an exchange not be
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers.
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\19\ 15 U.S.C. 78f(b).
\20\ 15 U.S.C. 78f(b)(5).
\21\ Id.
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In particular, the proposed rule change expands the applicability
of the current debit/credit price reasonability check to additional
complex order strategies for which the Exchange can determine whether
the order is a debit or credit. By expanding the orders to which these
checks apply, the Exchange can further assist with the maintenance of a
fair and orderly market by mitigating the potential risks associated
with additional complex orders trading at prices that are inconsistent
with their strategies (which may result in executions at prices that
are extreme and potentially erroneous), which ultimately protects
investors. This proposed expansion of the debit/credit price
reasonability check promotes just and equitable principles of trade, as
it is based on the same general option and volatility pricing
principles the System currently uses to pair calls and puts, which
principles the Exchange understands are used by market participants in
their option pricing models. As discussed above, the Exchange
previously applied the debit/credit price reasonability check to pairs
for which the exercise price for the call (put) with the farther
expiration date is lower (higher) than the exercise price for the
nearer expiration as proposed (until less than six months ago).
However, this price check did not apply to orders with these strategies
in option classes with European-style settlement. Therefore, to the
extent the Exchange determines to increase the pre-set buffer for a
class with European-style settlement, the Exchanges notes these orders
were not subject to this price check under the previous version of the
rules.
Additionally, until less than six months ago, the Exchange
previously had flexibility to apply this check on a class-by-class
basis, and the proposed rule change to permit the Exchange to determine
buffers on a class-by-class basis is consistent with that previous
authority. The Exchange believe class flexibility is appropriate to
permit the Exchange to apply reasonable buffers to classes, which may
exhibit different trading characteristics and have different market
models. The proposed rule change to permit the Exchange to determine
buffers for different strategies will further permit the Exchange to
modify this parameter in response to market conditions, which may
create pricing conditions that are contrary to the general pricing
principles described above. In such conditions, the System may reject
legitimately priced complex strategies given volatile market conditions
that would generally be erroneously priced in normal market conditions.
The Exchange believes this flexibility is appropriate, as it will
provide additional execution opportunities given then-current market
conditions, which will ultimately benefit investors.
This price check does apply to market orders that can be defined as
a net credit or debit,\22\ which if within the pre-set buffer, will
execute upon entry at the price of the market. With a wider buffer, the
Exchange understands that market orders may execute within a wider
price range. However, the Exchange believes the proposed rule change to
permit wider buffers by class and strategy will still protect investors
and the public interest, even with its application to market orders.
The purpose of a market order is to execute at the then-current market.
As noted above, the then-current market for a market order submitted as
a debit strategy may be a
[[Page 32091]]
credit price rather than a debit price. Therefore, an investor may want
to enter a market order with that strategy so that it executes at a
credit price, and the proposed rule change may provide that order with
an execution opportunity. The Exchange believes it is appropriate that
a market order be permitted to execute at such a price, as a market
participant that submits a market order in that market may expect
execution at such a price. While a market participant generally takes
on more market risk when submitting a market order rather than a limit
order, particularly when markets are volatile, the Exchange believes
that even if it sets a wider buffer in a class, it has other risk
controls in place to help prevent complex market orders from erroneous
executions.\23\ Given that market participants will receive sufficient
advance notice of any changes the Exchange makes to the pre-set
buffers, the Exchange believes the proposed rule change will continue
to protect investors that submit complex market orders, as they will
know the price range within which their market orders may execute.
Additionally, the proposed flexibility to apply buffers by strategy as
well as class will permit the Exchange to continue to apply the check
with a narrower buffer to orders, including market orders, based on
market conditions. In other words, only market orders submitted in
classes and strategies with wider buffers would be eligible for
executions within a wider price range.
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\22\ Therefore, currently market orders the System cannot define
as a credit or debit do not receive any protection from the debit/
credit price reasonability check. Additionally, the Exchange notes
that market orders in options that are European-settled that had a
diagonal strategy were not subject to the previous version of the
debit/credit price reasonability check.
\23\ See, e.g., Rule 5.34(b)(2) (which prevents a market order
from executing at a net debit price after receiving execution at a
net credit price), (b)(5) (which prevents orders (including market
orders) with certain strategies from executing outside of an
acceptable price range), and (b)(6) (which prevents orders from
executing more than a buffer amount outside of the then-current
SNBBO).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The proposed rule change will not impose any burden on intramarket
competition, because the debit/credit price reasonability check will
continue to apply to all incoming complex orders of all Trading Permit
Holders in the same manner. The proposed rule change expands the
applicability of the current check to additional complex orders for
which the Exchange can determine whether the order is a debit or
credit, which will help further prevent potentially erroneous
executions and benefits all market participants. Any Exchange-
determination of different pre-set buffers for different classes and
different strategies will similarly apply to complex orders of all
Trading Permit Holders. The proposed rule change does not impose any
burden on intermarket competition, as it is intended to prevent
potentially erroneously priced orders from entering Cboe Options'
System and executing on Cboe Options' market, while providing the
Exchange with sufficient flexibility to provide execution opportunities
to orders that may not be erroneously priced in certain market
conditions. The Exchange believes the proposed rule change would
ultimately provide all market participants with additional protection
from anomalous or erroneous executions and additional execution
opportunities when appropriate.
The Exchange believes the proposal will enhance risk protections,
the individual firm benefits of which flow downstream to counterparties
both at the Exchange and at other options exchanges, which increases
systemic protections as well. The Exchange believes enhancing risk
protections will allow Trading Permit Holders to enter orders and
quotes with further reduced fear of inadvertent exposure to excessive
risk, which will benefit investors through increased liquidity for the
execution of their orders. Without adequate risk management tools, such
as the one proposed to be enhanced in this filing, Trading Permit
Holders could reduce the amount of order flow and liquidity they
provide. Such actions may undermine the quality of the markets
available to customers and other market participants. Accordingly, the
proposed rule change is designed to encourage Trading Permit Holders to
submit additional order flow and liquidity to the Exchange, which may
ultimately promote competition. The proposed flexibility may similar
provide additional execution opportunities, which further benefits
liquidity in potentially volatile markets. In addition, providing
Trading Permit Holders with more tools for managing risk will
facilitate transactions in securities because, as noted above, Trading
Permit Holders will have more confidence protections are in place that
reduce the risks from potential system errors and market events.
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
The Exchange has filed the proposed rule change pursuant to Section
19(b)(3)(A)(iii) of the Act \24\ and Rule 19b-4(f)(6) thereunder.\25\
Because the 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, if consistent with the protection of
investors and the public interest, the proposed rule change has become
effective pursuant to Section 19(b)(3)(A) of the Act \26\ and Rule 19b-
4(f)(6) thereunder.\27\
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\24\ 15 U.S.C. 78s(b)(3)(A)(iii).
\25\ 17 CFR 240.19b-4(f)(6).
\26\ 15 U.S.C. 78s(b)(3)(A).
\27\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii)
requires the Exchange to give the Commission written notice of the
Exchange's intent to file the proposed rule change, along with a
brief description and text of 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 under Rule 19b-4(f)(6) \28\ normally
does not become operative for 30 days after the date of the filing.
However, pursuant to Rule 19b-4(f)(6)(iii),\29\ the Commission may
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 proposed
rule change may become operative immediately. The Commission believes
that the proposal to extend the debit/credit price reasonability check
to diagonal strategies could help to prevent diagonal strategy orders
from executing at erroneous prices. The Commission believes that the
proposal to allow the Exchange to modify the debit/credit price
reasonability check on a class and strategy basis will provide the
Exchange with flexibility to modify the price check so that it applies
appropriately to different classes and strategies, which may have
different trading characteristics or may be affected differently by
market conditions. The Commission notes that the Exchange will issue an
Exchange notice for all pre-set buffers and will provide advance notice
of any changes to the pre-set buffers. For these reasons, the
Commission believes that waiver of the 30-day operative delay is
consistent
[[Page 32092]]
with the protection of investors and the public interest. Accordingly,
the Commission hereby waives the 30-day operative delay and designates
the proposal operative upon filing.\30\
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\28\ 17 CFR 240.19b-4(f)(6).
\29\ 17 CFR 240.19b-4(f)(6)(iii).
\30\ For purposes only of waiving the 30-day operative delay,
the Commission has 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 necessary or
appropriate in the public interest, for the protection of investors, or
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 change should be approved or
disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic comments:
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to rule-comments@sec.gov. Please include
File Number SR-CBOE-2020-046 on the subject line.
Paper comments:
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-CBOE-2020-046. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (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 website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 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. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-CBOE-2020-046, and should be submitted
on or before June 18, 2020.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\31\
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\31\ 17 CFR 200.30-3(a)(12), (59).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-11399 Filed 5-27-20; 8:45 am]
BILLING CODE 8011-01-P