Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Related to Complex Orders

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, notice is hereby given that on February 25, 2016, Chicago Board Options Exchange, Incorporated (“CBOE” or the “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The Exchange seeks to amend its rules related to complex orders. The text of the proposed rule change is provided below.

(additions are italicized; deletions are [bracketed])

Chicago Board Options Exchange, Incorporated Rules

Rule 6.53C. Complex Orders on the Hybrid System

(a) Definition: No change.

(b) Types of Complex Orders: No change.

(c) Complex Order Book

No change.

(d) Process for Complex Order RFR Auction: Prior to routing to the COB or once on PAR, eligible complex orders may be subject to an automated request for responses (“RFR”) auction process.

(i) For purposes of paragraph (d):

(1) “COA” is the automated complex order RFR auction process.

(2) A “COA-eligible order” means a complex order that, as determined by the Exchange on a class-by-class basis, is eligible for a COA considering the order's [marketability (defined as a number of ticks away from the current market),] size, complex order type (as defined in paragraphs (a) and (b) above) and complex order origin types (as defined in subparagraph (c)(i) above). Complex orders processed through a COA may be executed without consideration to prices of the same complex orders that might be available on other exchanges.

(ii) Initiation of a COA:

(A) The System will send an RFR message to all Trading Permit Holders who have elected to receive RFR messages on receipt of (1) a COA-eligible order with two legs (including orders submitted for electronic processing from PAR) that is better than the same side of the derived net market or (2) a complex order with three or more legs that (A) meets the class[, marketability], size, and complex order type parameters of subparagraph (d)(i)(2) and is better than the same side of the derived net market or (B) is marketable against the derived net market, designated as immediate or cancel, and meets the class [, marketability,] and size parameters of subparagraph (d)(i)(2) .[, in both cases] Complex orders as described in subparagraph (ii)(A)(2) will initiate a COA regardless of the order's routing parameters or handling instructions (except for orders routed for manual handling). Immediate or cancel orders that are not marketable against the derived net market in accordance with subparagraph (ii)(A)(2)(B) will be cancelled. The RFR message will identify the component series, the size and side of the market of the COA-eligible order and any contingencies, if applicable.

(B) No change.

(iii)-(ix) No change.

The text of the proposed rule change is also available on the Exchange's Web site ( 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 the Statutory Basis for, the Proposed Rule Change

1. Purpose

On October 2, 2015, the Exchange submitted immediately effective filing SR-CBOE-2015-081, which amended Exchange rules related to the initiation of a complex order auction (“COA”). The purpose of SR-CBOE-2015-081 (as well as predecessor filing SR-CBOE-2014-017) was to limit a potential source of unintended Market-Maker risk (fully described below) related to how the Exchange's Hybrid Trading System (the “System”) calculates risk parameters under Rule 8.18 when complex orders leg into the market.

Under Rule 8.18, CBOE offers Market-Makers that are obligated to provide and maintain continuous electronic quotes in an option class the Quote Risk Monitor Mechanism (“QRM”), which is functionality to help Market-Makers manage their quotes and related risk. Market-Makers with appointments in classes that trade on the System must, among other things, provide and maintain continuous electronic quotes in a specified percentage of series in each class for a specified percentage of time. To comply with this requirement, each Market-Maker may use its own proprietary quotation and risk management system to determine the prices and sizes at which it quotes. In addition, each Market-Maker may use QRM.

A Market-Maker's risk in a class is not limited to the risk in a single series of that class. Rather, a Market-Maker is generally actively quoting in multiple classes, and each class may comprise hundreds or thousands of individual series. The System automatically executes orders against a Market-Maker's quotes in accordance with the Exchange's priority and allocation rules. As a result, a Market-Maker has exposure and risk in all series in which it is quoting in each of its appointed classes. QRM is an optional functionality that helps Market-Makers, and TPH organizations with which a Market-Maker is associated, limit this overall exposure and risk.

Specifically, if a Market-Maker elects to use QRM, the System will cancel a Market-Maker's quotes in all series in an appointed class if certain parameters the Market-Maker establishes are triggered. Market-Makers may set the following QRM parameters (Market-Makers may set none, some or all of these parameters):

• A maximum number of contracts for that class (the “contract limit”) and a specified rolling time period in seconds within which such contract limit is to be measured (the “measurement interval”);
• a maximum cumulative percentage (which is the sum of the percentages of the original quoted size of each side of each series that trade) (the “cumulative percentage limit”) that the Market-Maker is willing to trade within a specified measurement interval; or
• a maximum number of series for which either side of the quote is fully traded (the “number of series fully traded”) within a specified measurement interval.

If the Exchange determines the Market-Maker has traded more than the contract limit or cumulative percentage limit, or has traded at least the number of series fully traded, of a class during the specified measurement interval, the System will cancel all of the Market-Maker's electronic quotes in that class (and any other cases with the same underlying security) until the Market-Maker refreshes those quotes (a “QRM Incident”). A Market-Maker, or TPH organization with which the Market-Maker is associated, may also specify a maximum number of QRM Incidents that may occur on an Exchange-wide basis during a specified measurement interval. If the Exchange determines that a Market-Maker or TPH Organization, as applicable, has reached its QRM Incident limit during the specified measurement interval, the System will cancel all of the Market-Maker's or TPH Organization's quotes, as applicable, and the Market-Maker's orders resting in the book in all classes and prevent the Market-Maker and TPH organization from sending additional quotes or orders to the Exchange until the earlier to occur of (1) the Market-Maker or TPH organization reactivates this ability or (2) the next trading day.

The purpose of the QRM functionality is to allow Market-Makers to provide liquidity across most series in their appointed classes without being at risk of executing the full cumulative size of all their quotes before being given adequate opportunity to adjust their quotes. For example, if a Market-Maker can enter quotes with a size of 25 contracts in 100 series of class ABC, its potential exposure is 2,500 contracts in ABC. To mitigate the risk of having all 2,500 contracts in ABC execute without the opportunity to evaluate its positions, the Market-Maker may elect to use QRM. If the Market-Maker elects to use the contract limit functionality and sets the contract limit at 100 and the measurement interval at five seconds for ABC, the System will automatically cancel the Market-Maker's quotes in all series of ABC if 100 or more contracts in series of ABC execute during any five-second period.

To assure that all quotations are firm for their full size, the System performs the parameter calculations after an execution against a Market-Maker's quote occurs. For example, using the same parameters in class ABC as above, if a Market-Maker has executed a total of 95 contracts in ABC within the previous three seconds, a quote in a series of ABC with a size of 25 contracts continues to be firm for all 25 contracts. An incoming order in that series could execute all 25 contracts of that quote, and, following the execution, the total size parameter would add 25 contracts to the previous total of 95 for a total of 120 contracts executed in ABC. Because the total size executed within the previous five seconds now exceeds the 100 contract limit for ABC, the System would, following the execution, immediately cancel all of the Market-Maker's quotes in series of ABC. The Market-Maker would then enter new quotes for series in ABC. Thus, QRM limits the amount by which a Market-Maker's executions in a class may exceed its contract limit to the largest size of its quote in a single series of the class (or 25 in this example).

The Exchange proposes to amend Rule 6.53C regarding complex orders to limit a potential source of unintended Market-Maker risk related to how the System calculates risk parameters under Rule 8.18 when complex orders leg into the market. As discussed above, by checking the risk parameters following each execution in a series, the risk parameters allow a Market-Maker to provide liquidity across multiple series of a class without being at risk of executing the full cumulative size of all its quotes. This is not the case, however, when a complex order legs into the regular market (i.e. the market for individual, or simple, orders). Because the execution of each leg of a complex order is contingent on the execution of the other legs, the execution of all the legs in the regular market is processed as a single transaction, not as a series of individual transactions.

For example, if market participants enter into the System individual orders to buy 25 contracts for the Jan 30 call, Jan 35 call, Jan 40 call and Jan 45 call in class ABC, the System processes each order as it is received and calculates the Market-Makers parameters in class ABC following the execution of each 25-contract call. However, if a market participant enters into the System a complex order to buy all four of these strikes in class ABC 25 times, which complex order executes against bids and offers for the individual series (i.e. legs into the market), the System will calculate the Market-Maker's parameters in class ABC following the execution of all 100 contracts. If the Market-Maker had set the same parameters in class ABC as discussed above (100-contract limit with five-second measurement interval) and had executed 95 contracts in class ABC within the previous three seconds, the amount by which the next transaction might exceed 100 is limited to the largest size of its quote in a single series of the class. In that example, since the largest size of the Market-Maker's quotes in any series was 25 contracts, the Market-Maker could not have exceeded the 100-contract limit by more than 20 contracts (95 + 25 = 120). However, with respect to the complex order with four legs 25 times, the next transaction against the Market-Maker's quotes potentially could be as large as 100 contracts (depending upon whether there are other market participants at the same price), creating the potential in this example for the Market-Maker to exceed the 100-contract limit by 95 contracts (95 + 100 = 195) instead of 20 contracts.

As this example demonstrates, legging of complex orders into the regular market presents higher risk to Market-Makers than executing their quotes against individual orders entered in multiple series of a class in the regular market, because it may result in Market-Makers exceeding their risk parameters by a greater number of contracts. This risk is directly proportional to the number of legs associated with a complex order. Market-Makers have expressed concerns to the Exchange regarding this risk.

In order to alleviate this potential risk to Market-Makers, the Exchange, in SR-CBOE-2015-081, amended Rule 6.53C(d) to, among other things, provide that a COA will be initiated when a complex order with three or more legs is designated as IOC and meets the class, marketability, and size parameters of subparagraph (d)(i)(2). The Exchange observed IOC orders causing the risk to Market-Makers described above and believed the previous amendment proposed in SR-CBOE-2015-081 would reduce that risk by initiating a COA in those circumstances. The Exchange is now proposing to fine tune this requirement by amending Rule 6.53C(d)(ii)(A)(2)(B) to provide that a COA will be initiated when a complex order with three or more legs that is marketable against the derived net market is designated as immediate or cancel and the order meets the class and size parameters of subparagraph (d)(i)(2).

As noted above, it is the legging of complex orders into the regular market that presents the potential risk to Market-Makers. Generally, a complex order has the potential to leg into the market when the complex order is marketable against leg quotes. For example, if the derived net market of a complex order strategy is 1.00-1.20 and a complex order to buy or sell at $1.10 is entered, the complex order would not execute against the legs of the regular market because the leg markets (which make-up the derived net market) cannot satisfy the order. A complex order to buy at $1.20 or higher or to sell at $1.00 or lower (i.e., an order that is marketable against the derived net market) would potentially be executable against the leg quotes. However, the current rule requires the Exchange to initiate a COA for a complex order with three or more legs that is designated IOC and meets the class, marketability, and size parameters of subparagraph (d)(i)(2), even if the complex order is not marketable against the derived net market. Complex orders that are not marketable against the derived net market do not pose the same risk to Market-Makers as complex orders that are marketable against the derived net market because, as noted above, it is marketable complex orders that can leg into the market and execute against individual quotes causing the risk to Market-Makers. Thus, the Exchange is proposing to amend Rule 6.53C(d)(ii)(A)(2)(B) as described above. Additionally, IOC orders that are not marketable against the derived net market in accordance with subparagraph (ii)(A)(2)(B) will be cancelled, which allows order entry firms to use their own sophisticated technology to manage their orders helping to remove impediments to and perfect the mechanism of a free and open market.

Currently, the marketability parameter in Rule 6.53C(d)(i)(2), defined as a number of ticks away from the current market, sets the price at which a complex order will initiate a COA. To avoid confusion, the Exchange proposes to remove the marketability parameter from the definition of “COA-eligible order,” which will remove the Exchange's flexibility to set the price at which a complex order will initiate a COA. The Exchange does not foresee any issues with removing the flexibility to determine the price at which a COA will be initiated because the Exchange does not foresee a future need to modify the price at which auctions are initiated. If unforeseen circumstances arise where the Exchange believes it is necessary to modify the price at which auctions are initiated then the Exchange will submit a subsequent rule filing. Additionally, removing such flexibility may provide increased certainty to market participants about the price at which a complex order will initiate a COA, helping to remove impediments to and perfect the mechanism of a free and open market.

The Exchange proposes to hardcode the price at which a complex order may initiate a COA in Rule 6.53C(d)(ii)(A). For example, assuming all of the non-price specific requirements are met, a complex order with two legs under subparagraph (d)(ii)(A)(1) and a complex order with three legs under subparagraph (d)(ii)(A)(2)(A) will initiate a COA if the derived net market is 1-1.20 and the complex order is to buy at $1.01 or higher or to sell at 1.19 or lower. As described above, assuming the non-price specific requirements are met, a complex order with three legs under subparagraph (d)(ii)(A)(2)(B) will initiate a COA if the derived net market is 1-1.20 and the complex order is to buy at $1.20 or higher or to sell at $1.00 or lower. Initiating a COA in these situations will relieve the risk to Market-Makers noted above, which helps promote just and equitable principles of trade by relieving risk to Market-Makers allowing them to more efficiently and effectively provide important liquidity.

In short, SR-CBOE-2015-081, among other things, identified certain orders that potentially cause the risk to Market-Makers described above (i.e., complex orders with three or more legs that are designated as IOC and meet the class, marketability, and size parameters of subparagraph (d)(i)(2)). This proposal goes a step further and focuses on the above orders that are marketable against the derived net market. This is consistent with the purpose of SR-CBOE-2015-081, which was to alleviate the potential risk to Market-Makers. Additionally, this proposal helps to further balance the protection of Market-Makers with the desire of market participants entering IOC orders to have those orders cancel if not immediately executed. The Exchange also notes that the Exchange is removing its flexibility with regards to the marketability parameter.

The Exchange will announce the implementation date of the proposed rule change in a Regulatory Circular to be published no later than 90 days following the effective date of this filing. The implementation date will be no later than 180 days following the effective date of this filing.

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. Specifically, the Exchange believes the proposed rule change is consistent with the Section 6(b)(5) 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) requirement that the rules of an exchange not be designed to permit unfair discrimination between customers, issuers, brokers, or dealers.

In particular, the Exchange believes the proposed rule change is consistent with the purpose of SR-CBOE-2015-081, which was to alleviate a potential risk to Market-Makers that arises through the use of QRM. Complex orders with three or more legs that are designated as IOC and meet the class and size parameters of subparagraph (d)(i)(2) and that are marketable against the derived net market (which the Exchange has identified as potentially causing risk to Market-Makers) will COA, which helps promote just and equitable principles of trade by relieving risk to Market-Makers allowing them to more efficiently and effectively provide important liquidity. Orders that are designated as IOC and meet the class and size parameters of subparagraph (d)(i)(2), but that are not marketable against the derived net market, will be cancelled, which allows order entry firms to use their own sophisticated technology to manage their orders helping to remove impediments to and perfect the mechanism of a free and open market. The Exchange is also removing flexibility with regards to the marketability parameter. Although the Exchange prefers flexibility, the Exchange does not foresee the need to retain flexibility with regards to the marketability parameter and hardcoding the parameter may help avoid confusion with regards to the price at which a complex order will initiate a COA, which also helps to remove impediments to and perfect the mechanism of a free and open market.

The Exchange also believes the proposed rule change to initiate a COA upon receipt of complex orders with three or more legs that are designated as IOC and meet the class and size parameters of subparagraph (d)(i)(2) and that are marketable against the derived net market is consistent with the requirement that Market-Makers' quotes be firm under Rule 602 of Regulation NMS. The proposed rule change does not relieve Market-Makers of their obligation to provide “firm” quotes. If a complex order in a Hybrid class with three or more legs goes through COA and then legs into the market for execution upon completion of the COA, at which point the complex order would execute against a Market-Maker's quotes based on priority rules, the Market-Maker must execute its quotes against the order at its then-published bid or offer up to its published quote size, even if such execution would cause the Market-Maker to significantly exceed its risk parameters. However, prior to the end of COA (and thus prior to a complex order legging into the market), a Market-Maker may adjust its published quotes to manage its risk in a class as it deems necessary, including to prevent executions that would exceed its risk parameters. In this case, the firm quote rule does not obligate the Market-Maker to execute its quotes against the complex order at the quote price and size that was published when the order entered the System and initiated the COA. Rather, the Market-Maker's firm quote obligation applies only to its disseminated quote at the time an order is presented to the Market-Maker for execution, which presentation does not occur until the System processes the order against the leg markets after completion of the COA. Thus, the proposed rule change is consistent with the firm quote rule.

B. Self-Regulatory Organization's Statement on Burden on Competition

CBOE does not believe that the proposed rule change will impose any burden on intramarket or intermarket competition that is not necessary or appropriate in furtherance of the purposes of the Act. The Exchange does not believe the proposed rule change will impose any burden on intramarket competition because all IOC orders will be treated equally by the Exchange. The proposed rule change is intended to reduce risk to Market-Makers that are quoting in the regular market. CBOE believes that the proposed rule change will promote competition by encouraging Market-Makers to increase the size of and to more aggressively price their quotes, which will increase liquidity on the Exchange. To the extent that the rule change makes CBOE a more attractive marketplace, market participants are free to become Trading Permit Holders on CBOE and other exchanges are free to amend their rules in a similar manner. Furthermore, the Exchange does not believe the proposed rule change will impose any burden on intermarket competition because the rule change does not materially affect the outcome or purpose of SR-CBOE-2015-081, which was to alleviate potential risk to Market-Makers using QRM. The Exchange also does not believe hardcoding the price at which a complex order may initiate a COA will impose a burden on competition.

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:

A. significantly affect the protection of investors or the public interest;

B. impose any significant burden on competition; and

C. 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) of the Act and Rule 19b-4(f)(6) thereunder. 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 will 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-2016-014 on the subject line.

Paper Comments

• Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-CBOE-2016-014. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/sro.shtml ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-CBOE-2016-014, and should be submitted on or before March 31, 2016.