[Federal Register Volume 60, Number 114 (Wednesday, June 14, 1995)]
[Notices]
[Pages 31334-31336]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-14538]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35822; File No. SR-PHLX-95-33]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc., Relating to the 
Automatic Execution of National Over-the-Counter Index Options

June 8, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on May 11, 
1995, the Philadelphia Stock Exchange, Inc., (``PHLX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II 
and III below, which Items have been prepared by the self-regulatory 
organization. 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 PHLX proposes to limit the eligibility of National Over-the-
Counter Index (``XOC'') options for execution through the automatic 
execution (``AUTO-X'') feature of the PHLX's Automated Options Market 
(``AUTOM'') system. Specifically, the PHLX proposes to limit the AUTO-X 
eligibility of XOC options to XOC series where the bid is $10 or less. 
XOC series where the bid is greater than $10 will no longer be AUTO-X 
eligible and any such AUTOM-delivered orders will be subject to manual 
execution.
    The text of the proposed rule change is available at the Office of 
the Secretary, PHLX, and at the Commission.

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 self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has 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

    AUTOM, which has operated on a pilot basis since 1988 and was most 
recently extended through December 31, 1995,\1\ is the PHLX's 
electronic order 

[[Page 31335]]
routing, delivery, execution and reporting system for equity and index 
options. AUTOM is an on-line system that allows electronic delivery of 
options orders from member firms directly to the appropriate specialist 
on the Exchange's trading floor.

    \1\See Securities Exchange Act Release No. 35183 (December 30, 
1994), 60 FR 2420 (January 9, 1995) (order approving File No. SR-
PHLX-94-41). See also Securities Exchange Act Release Nos. 25540 
(March 31, 1988), 53 FR 11390 (order approving AUTOM on a pilot 
basis); 25868 (June 30, 1988), 53 FR 25563 (order approving File No. 
SR-PHLX-88-22, extending pilot through December 31, 1988); 26354 
(December 13, 1988), 53 FR 51185 (order approving File No. SR-PHLX-
88-33, extending pilot program through June 30, 1989); 26522 
(February 3, 1989), 54 FR 6465 (order approving File No. SR-PHLX-89-
1, extending pilot through December 31, 1989); 27599 (January 9, 
1990), 55 FR 1751 (order approving File No. SR-PHLX-89-03, extending 
pilot through June 30, 1990); 28625 (July 26, 1990), 55 FR 31274 
(order approving File No. SR-PHLX-90-16, extending pilot through 
December 31, 1990); 28978 (March 15, 1991), 56 FR 12050 (order 
approving File No. SR-PHLX-90-34, extending pilot through December 
31, 1991); 29662 (September 9, 1991), 56 FR 46816 (order approving 
File No. SR-PHLX-91-31, permitting AUTO-X orders up to 20 contracts 
in Duracell options only); 29782 (October 3, 1991), 56 FR 55146 
(order approving File No. SR-PHLX-91-33, permitting AUTO-X for all 
strike prices and expiration months); 29837 (October 18, 1991), 56 
FR 36496 (order approving File No. SR-PHLX-90-03, extending pilot 
through December 31, 1993); 32906 (September 15, 1993), 58 FR 15168 
(order approving File No. SR-PHLX-92-38, permitting AUTO-X orders up 
to 25 contracts in all options); and 33405 (December 30, 1993), 59 
FR 790 (order approving File No. SR-PHLX-93-57, extending pilot 
through December 31, 1994).
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    Certain orders are eligible for AUTOM's automatic execution 
feature, AUTO-X.\2\ AUTO-X orders are executed automatically at the 
disseminated quotation price on the Exchange and reported to the 
originating firm. Orders that are not eligible for AUTO-X are handled 
manually by the specialist.

    \2\Orders for up to 100 contracts are eligible for AUTOM and 
public customer orders for up to 25 contracts are eligible for AUTO-
X. See Securities Exchange Act Release No. 32000 (March 15, 1993), 
58 FR 15168 (March 19, 1994) (order approving File No. SR-PHLX-92-
38).
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    The Commission approved the use of AUTO-X as part of the AUTOM 
pilot program in 1990.\3\ In 1991, the Commission approved a PHLX 
proposal to extend AUTO-X to all equity options.\4\ According to the 
PHLX, the Exchange initially implemented AUTO-X for all equity options 
and index options. The PHLX notes that in its order approving the 
extension of AUTO-X to all equity options, the Commission noted that 
the proposal would enable all PHLX equity options to be eligible for 
AUTO-X.\5\ Accordingly, the Exchange believes that because extending 
AUTO-X to all options was not required nor was it filed as mandatory, 
the Exchange retains the ability to limit its implementation, 
consistent with the Act. Similarly, the Exchange states that orders for 
up to 25 contracts are eligible for AUTO-X, but this number is a 
maximum, such that different PHLX options are subject to a different 
AUTO-X order size cap.

    \3\See Securities Exchange Act Release No. 27599 (January 9, 
1990), 55 FR 1751 (January 18, 1990) (order approving File No. SR-
PHLX-89-03).
    \4\See Securities Exchange Act Release No. 28978 (March 15, 
1991), 56 FR 12050 (March 21, 1991) (order approving File No. SR-
PHLX-90-34).
    \5\See Securities Exchange Act Release No. 28978, supra note 4.
    Notwithstanding this ability, as part of an effort to extend the 
benefits of automatic execution floor-wide, the Exchange implemented 
Floor Procedure Advice (``Advice'') A-13, ``Auto-X Engagement/
Disengagement Responsibility.''\6\ The PHLX states that in Advice A-13 
the Exchange adopted an affirmative obligation, punishable by a fine 
administered pursuant to the PHLX's minor rule plan, that AUTO-X be 
implemented floor-wide. In that proposal, the Exchange cited the goal 
of maximizing floor-wide use of AUTO-X and ensuring specialist activity 
during adverse market conditions. The PHLX does not believe that these 
goals are eroded by the proposal at hand, which is limited to certain 
series in one index option.

    \6\See Securities Exchange Act Release No. 29575 (August 16, 
1991), 56 FR 41715 (August 22, 1994) (order approving File No. SR-
PHLX-91-16). Advice A-13 states that options specialists are 
responsible for engaging AUTO-X for an assigned option within three 
minutes of completing the opening or reopening rotation of that 
option. In addition, the Advice indicates that, under extraordinary 
circumstances, a specialist may be provided with an exemption from 
receiving orders through AUTO-X and may disengage the system upon 
approval by two floor officials.
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    In direct contrast to the Commission's concerns with options 
exchanges limiting the availability of execution systems to out-of-the-
money call series,\7\ The PHLX is limiting AUTO-X to the most active 
around-the-money series. The Exchange also included in Advice A-13 the 
ability to disengage AUTO-X in extraordinary circumstances with Floor 
Official approval. Thus, the Exchange recognized that conditions may 
exist which warrant the limitation of AUTO-X.

    \7\See The Division of Market Regulation, The October 1987 
Market Break (February 1988).
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    At this time, the PHLX proposes to limit the use of AUTO-X for XOC 
orders. Under the proposal, only those XOC series where the bid is at 
or below $10 at the end of the trading day will be eligible for AUTO-X, 
effective the next trading day. The PHLX states that these lower-priced 
XOC series generally receive the most interest from public customers. 
Accordingly, the Exchange believes that these series are most 
appropriate for automatic execution.\8\ The Exchange intends to clearly 
communicate to its membership and AUTOM users the proposed AUTO-X 
limitation for XOC options through an information circular.

    \8\For example, the PHLX states that on trade date January 25, 
1995, 40 XOC transactions occurred, 38 of which involved a customer. 
Only two of these trades involved execution prices greater than $20, 
while 10 trades were above $10 but less than $20; 28 customer trades 
were below $10. The 28 customer trades represented 439 contracts out 
of a total of 531 contracts.
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    The proposal is also in response to recent volatility in the over-
the-counter (``OTC'') markets, which has made it increasingly difficult 
for specialists and market makers to monitor quotations to reflect 
changes in the markets for the underlying securities. The PHLX states 
that sufficient time is necessary for such adjustments, particularly 
because participation in AUTOM and AUTO-X is obligatory.
    In addition to volatility, the Exchange believes that a 
specialist's obstacles in hedging XOC positions with underlying OTC 
securities, which is particularly relevant to the XOC, also warrants 
the proposed AUTO-X limitation. For example, in order to hedge XOC 
exposure, positions in OTC securities are typically purchased and sold. 
The PHLX states that the aggregate bid/ask differential for the XOC's 
component securities is often greater than $5 wide, reflecting the 
volatility of those markets as well as the relatively high value of the 
XOC itself.\9\ The PHLX states that in recognition of these 
circumstances, the Commission recently approved an Exchange proposal to 
widen the quotation spread parameters applicable to the XOC.\10\

    \9\The bid/ask differential in the underlying securities is 
determined by adding the bids for such securities and dividing by 
100 (the number of securities comprising the XOC) to arrive at the 
composite bid; and then similarly adding the offers and dividing by 
100 to arrive at a composite, or average, offer.
    \10\See Securities Exchange Act Release No. 34781 (October 3, 
1994), 59 FR 51467 (October 11, 1994) (order approving File No. SR-
PHLX-94-28).
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    Exchange By-Law Article X, ``Standing Committee,'' Section 10-18, 
``Options Committee,'' grants authority over all connections and 
communications on the options floor, such as AUTOM, to be Options 
Committee, which has authorized the proposed AUTO-X limitation. 
Pursuant to this authority, the Options Committee has determined, in 
the interest of maintaining fair and orderly markets, to amend the 
eligibility of XOC orders for automatic execution.
    The Exchange notes that AUTOM users will continue to be afforded 
the advantages of automatic execution for XOC series priced at low or 
moderate levels. According to the PHLX, public customers (i.e., 
``customers'' who are not associated with broker-dealer organizations 
or subject to discretionary authorization by associated persons of 
broker-dealers) most often choose XOC series priced at $10 or less for 
investment.\11\ The proposal does not affect the AUTO-X eligibility of 
any other equity or index option.

    \11\See note 7, supra. The Exchange notes similar results on 
trade date February 7, 1995.
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    In addition, the PHLX notes that it is consistent with the 
practices of other options exchanges to limit automatic execution 
eligibility to certain series, such as near-term, at-the-money 

[[Page 31336]]
series.\12\ Thus, for competitive reasons, the Exchange seeks to create 
a level playing field with respecting automatic execution parameters.

    \12\For example, on the Chicago Board Options Exchange, Inc. 
(``CBOE''), only the four most active puts and calls in the two 
near-term months in Nasdaq 100 Index options are eligible for the 
CBOE's Retail Automated Execution System.
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    The PHLX believes that the proposal is consistent with Section 6(b) 
of the Act, in general, and, in particular, with Section 6(b)(5), in 
that it is designed to promote just and equitable principles of trade 
and to prevent fraudulent and manipulative acts and practices. 
Specifically, the Exchange believes that the aforementioned 
circumstances (volatility and hedging) respecting the XOC warrant an 
AUTO-X limitation in the interest of maintaining fair and orderly 
markets. The PHLX notes that option series where the bid is more than 
$10 may represent a premium of $1,000 ($10 multiplied by 100); 
accordingly, expensive errors may result from the automatic execution 
of a high-priced option series before the option quote has been updated 
to reflect a change in the price of an underlying security. According 
to the PHLX, in certain cases such trades occur by way of orders from 
professional investors, which undercut the use of market making 
capital, and, in turn, detrimentally affect liquidity.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The PHLX does not believe that the proposed rule change will impose 
any inappropriate burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reason for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) By order approve such proposed rule change, or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
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 inspection and copying at the 
Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. Copies of such filing will also be available for 
inspection and copying at the principal office of the above-mentioned 
self-regulatory organization. All submissions should refer to the file 
number in the caption above and should be submitted by July 5, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\

    \13\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-14538 Filed 6-13-95; 8:45 am]
BILLING CODE 8010-01-M