[Federal Register Volume 61, Number 68 (Monday, April 8, 1996)]
[Notices]
[Pages 15549-15553]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-8551]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37048; File No. SR-Phlx-96-08]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 to the Proposed Rule Change by the 
Philadelphia Stock Exchange, Inc. Relating to Customized Index and 
Equity Options

March 29, 1996.
    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 February 22, 1996, 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. On March 21, 1996, the Exchange submitted to 
the Commission Amendment No. 1 to the proposed rule change.\3\ The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
    \2\ 17 CFR 240.19b-4 (1994).
    \3\ In Amendment No. 1, the Exchange proposes to amend its 
filing so that (1) customized equity options may be traded on any 
options-eligible issue, whether or not it is listed for traditional 
options trading on the Phlx, and (2) the position limit for 
customized narrow-based (industry) index options are 24,000, 36,000, 
and 48,000 contracts, as compared to existing position limit tiers 
for traditional narrow-based index options. See Letter from Gerald 
D. O'Connell, First Vice President, Market Regulation and Trading 
Operations, Phlx, to Michael Walinskas, Branch Chief, Office of 
Market Supervision (``OMS''), Division of Market Regulation 
(``Market Regulation''), Commission, dated March 21, 1996.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx proposes to adopt Rule 1069A, Customized Options, to 
govern the trading of customized or flexible index and equity options 
on the Exchange. Specifically, the Exchange proposes to trade 
customized options on the following two broad-based (market) index 
options currently traded on the Phlx: Value Line Composite Index 
(``VLE'') and National Over-the-Counter Index (``XOC''). The Phlx also 
proposes to trade customized industry (narrow-based) index options 
pursuant to the proposed rule, specifically, the following four 
industry index options currently traded on the Phlx: Bank Index 
(``BKX''), Gold/Silver Index (``XAU''), Semiconductor Index (``SOX'') 
and Utility Index (``UTY''). In addition, the Phlx is proposing to 
trade customized equity options on securities which are options-
eligible pursuant to Phlx Rule 1009, and have been designated as such 
by the Options Committee.\4\

    \4\ Id.
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    Proposed Rule 1069A contains the characteristics, trading procedure 
and other provisions applicable to trading customized options. All 
customized options would trade in the trading crowd of the 
corresponding non-customized option. Customized options would not be 
continuously quoted, nor are series pre-established. The Exchange notes 
that the Automated Options Market (``AUTOM'') system will not be 
available for customized options.
    In order to initiate a transaction, a Requesting Member submits a 
Request-for-Quote (``RFQ'') to the appropriate trading crowd, 
announcing the terms of the quote sought. The characteristics, 
including which terms and to what degree customization will be 
available,

[[Page 15550]]
are outlined in Rule 1069A(a).\5\ For example, the exercise strike 
price can be specified at the time the quote is requested in terms of a 
specific index value number (e.g., 553.5), a method for fixing such 
number (e.g., 10 basis points over the index value at a certain time, 
or with the future trading at a certain price), or a percentage of 
index value calculated as of the open or close of trading on the 
Exchange on the trade date (e.g., 5% above the close). Similarly, 
respecting customized equity options, the exercise strike price can be 
specified in terms of a specific dollar amount rounded to the nearest 
one-eighth of a dollar, or a percentage of the underlying security 
rounded to the nearest tick.

    \5\ The Exchange notes that Rule 1069A generally parallels the 
provisions of Rule 1069 governing foreign currency options.
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    The exercise style can be either American or European, regardless 
of the exercise style of the non-customized option. The expiration date 
can also be customized, specifying any business day--any month, day and 
year within five years for customized index options and three years for 
customized equity options. However, customized options may not expire 
on any day that falls on, or within two business days of (prior or 
subsequent to) a mid-month expiration day for a non-customized option 
on the same underlying index or security (other than a quarterly 
expiring index option).
    With respect to the minimum size of customized market index option 
quotes, if there is no open interest in the particular series when an 
RFQ is submitted, the minimum value size of an RFQ is $10 million 
underlying equivalent value; if there is open interest, the minimum 
value size of an RFQ is $1 million underlying equivalent value, or the 
remaining underlying equivalent value on a closing transaction, 
whichever is less. The underlying equivalent value is defined as the 
aggregate underlying value of a customized index option (index 
multiplier times the current index value) multiplied by the number of 
customized index options. The minimum value size for a responsive quote 
in customized market index options is $1 million underlying equivalent 
value, or the remaining underlying equivalent value on a closing 
transaction, whichever is less.
    With respect to the minimum size of customized industry index 
option quotes, if there is no open interest in the particular series 
when an RFQ is submitted, the minimum value size of an RFQ is $5 
million underlying equivalent value; this amount is one-half of the 
minimum size proposed by the Phlx and currently in place on other 
options exchanges for flexible broad-based index options. Where there 
is open interest, the minimum value size of an RFQ is $1 million 
underlying equivalent value, or the remaining underlying equivalent 
value on a closing transaction, whichever is less. The minimum value 
size for a responsive quote is $1 million underlying equivalent value, 
or the remaining underlying equivalent value on a closing transaction, 
whichever is less.
    With respect to the minimum size of customized equity option 
quotes, if there is no open interest in the particular series when an 
RFQ is submitted, the minimum value size of an RFQ is 250 contracts; if 
there is open interest, the minimum value size of an RFQ is 100 
contracts, or the remaining size on a closing transaction, whichever is 
less. The minimum value size for a responsive quote in customized 
equity options is 100 contracts, or the remaining size on a closing 
transaction, whichever is less.
    However, assigned Registered Options Traders (``ROTs'') are 
required to respond to each RFQ with a certain minimum size. Respecting 
broad-based index options, assigned ROTs are required to respond with 
at least $10 million underlying equivalent value or the dollar amount 
requested in the RFQ, whichever is less. Respecting narrow-based index 
options, assigned ROTs are required to respond with at least $5 million 
underlying equivalent value or the dollar amount requested in the RFQ, 
whichever is less. Respecting customized equity options, assigned ROTs 
are required to respond with a market of at least 250 contracts or the 
dollar amount requested in the RFQ, whichever is less.
    The settlement value for customized index options may be specified 
as the value reported at the: (i) close of trading (P.M.-settled), (ii) 
opening (A.M.-settled) of trading on the Exchange, or (iii) as an 
average over a specified period of time, within parameters established 
by the Exchange. For example, the third category includes the average 
of the index's opening and closing settlement values on the expiration 
date, the average of the index's high and low values on the expiration 
date, or the average of the index's opening, closing, high and low 
values on the expiration date. However, American style index options 
exercised prior to the expiration date can only settle based on the 
closing value on the exercise date. Customized index options may be 
designated for settlement in U.S. dollars, British pounds, Canadian 
dollars, Deutsche marks, European Currency Units, French francs, 
Japanese yen or Swiss francs. With respect to the settlement process 
applicable to customized equity options, exercise settlement shall be 
by physical delivery of the underlying security pursuant to Rule 1044.
    With respect to the quote format, a bid and/or offer in the form of 
a specific dollar amount reflected as a fractional price (e.q., \1/8\, 
\1/4\), or a percentage of the underlying security or underlying 
equivalent value, rounded to the nearest minimum tick shall be 
acceptable. The option type may be a put, call or hedge order.\6\

    \6\ See Rules 1000(b)(7) and 1066(f).
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    The quoting and trading procedure, beginning with the RFQ, is 
enumerated in Rule 1069A(b). Submitting an RFQ in the appropriate 
trading crowd is the first step in quoting customized options. The 
Requesting Member must announce and submit an RFQ ticket containing the 
following: (1) underlying index or security, (2) type, (3) exercise 
style, (4) expiration date, (5) exercise price, (6) settlement value 
(AM or PM) and currency for index options, (7) response time, (8) 
account type, (9) size, and (10) intent to cross. On receipt of an RFQ 
in proper form, the Requesting Member shall cause the terms of the RFQ 
to be immediately displayed for dissemination as an administrative text 
message through the Options Price Reporting Authority (``OPRA'').\7\

    \7\ Operationally, the Requesting Member provides this 
information to a key puncher, who enters it into Exchange systems.
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    Following the RFQ announcement, a preset response time will begin, 
during which members may provide responsive quotes. As stated in Rule 
1069A(b)(2), the response time, between two and 15 minutes, will be 
determined by the Options Committee, depending on the complexity of the 
RFQ. During the response time, qualified members may provide responsive 
quotes to the RFQ, which may be entered, modified or withdrawn during 
such response time.
    At the end of the response time, the Requesting Member shall 
determine the best bid and offer (``BBO''), in accordance with Rule 
1014, displaying and disseminating such market with reference to the 
corresponding RFQ. However, where two or more bids/offers are at 
parity, priority will be afforded to bids/offers submitted by assigned 
ROTs.
    Following the determination of the BBO, a BBO Improvement Interval 
may be invoked if the Requesting Member rejects the BBO or the BBO is 
for less than the entire size requested. The BBO

[[Page 15551]]
Improvement Interval is a two minute time period during which the BBO 
may be matched or improved. As a result of the Improvement Interval, a 
new BBO is established. The parity/priority principles applicable 
during this time period, including the ability of assigned ROTs to join 
the new BBO, are discussed below.
    A trade in customized options cannot be executed until the end of 
the response time or BBO Improvement Interval. Once the response time 
or BBO Improvement Interval ends, the Requesting Member is given the 
first opportunity to trade on the market, and must promptly accept or 
reject the BBO, unless an intention to cross was stated in the RFQ. The 
Requesting Member has no obligation to accept any bid or offer for a 
customized option. If the Requesting Member rejects the BBO or the BBO 
size exceeds the entire size requested, another member may accept such 
BBO or the unfilled balance of the BBO. Acceptable of a bid/offer 
creates a building contract under Exchange rules. Failure to promptly 
accept the BBO results in the expiration of the BBO and the RFQ.
    The Exchange notes that no ROT or Specialist may trade customized 
options from the trading floor for a market maker account without being 
an assigned ROT. Assigned ROTs would be subject to certain obligations 
respecting the trading of customized options. For example, the 
affirmative and negative market making obligations of Rule 1014(c) 
apply. Further, assigned ROTs are required by proposed Rule 
1069A(b)(ii) to respond with a market of the minimum size.\8\ The 
Exchange also notes that at least two ROTs will be assigned to each 
customized option. Because of these obligations, assigned ROTs who 
responded with a quote during the response time may join a new bid/
offer voiced during the Improvement Interval, provided they do so 
immediately. Enabling assigned ROTS to join such new bid/offer affords 
them parity at that new BBO. Assigned ROTs must apply pursuant to the 
appropriate Exchange form.

    \8\ However, assigned ROTs are not required to provide 
continuous quotes or markets at a certain minimum spread (quote 
spread parameters).
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    Generally, on the Exchange options floor, a cross may take place in 
accordance with Rule 1064. With respect to customized options, an 
intention to cross must be stated as part of the RFQ. After the BBO has 
been determined, the Requesting Member intending to cross must bid (or 
offer) at or better than the BBO. If such bid is at the BBO, joining it 
placed the Requesting Member behind the existing BBO pursuant to the 
time priority principles of Rule 1014(g), because the BBO was 
established first. That BBO must first be satisfied before the 
Requesting Member can execute a cross at that price.
    If the Requesting Member's bid/off is better than the BBO, the 
Requesting Member must first allow the trading crowd a reasonable 
opportunity to respond to his improved market. Then, the Requesting 
Member must offer (or bid) the other side of the cross by at least the 
minimum variation. An assigned ROT who responded with a market during 
the response time may immediately join the Requesting Member's bid/
offer, thus matching and achieving parity at that new price. Then, the 
Requesting Member can not execute the entire cross without affording 
the appropriate split to any assigned ROT at parity.

II. Self-Regulatory Organization's Statements Regarding 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

    The purpose of the proposal is to trade options with flexible 
characteristics in an exchange auction environment. The Phlx is 
specifically proposing to trade customized index and equity options, 
where several different contract specifications will be available for 
customization, including the exercise price, exercise style, expiration 
date and method for determining the exercise settlement value.
    The Exchange believes that customized options will provide 
important trading opportunities, which may currently be unavailable due 
to pre-set expiration dates, exercise prices and exercise styles. For 
example, although the XOC is American style, a flexible XOC contract 
could be crafted pursuant to Rule 1069A as a European style option. 
Thus, customization offers new trading potential respecting existing 
securities.
    Currently, there exists an active over-the-counter (``OTC'') market 
in options, where basic option features can be customized. These 
customized options are often traded by institutional investors with 
specific trading needs. In response, the Exchange seeks to trade 
customized options in an exchange auction market environment, with the 
Options Clearing Corporation (``OCC'') as issuer and guarantor. Thus, 
customized options are structured with a minimum size reflecting the 
larger-sized trades of these institutional users.
    Proposed Rule 1069A is based upon rule 1069, Customized Foreign 
Currency Options, a product that the Exchange traded since November 
1994.\9\ Generally, customized options shall be traded in accordance 
with many of the existing equity option and index option rules. Rule 
1069A, however, contains new trading procedures unique to customized 
options. In addition, the proposal, to a large extent, is similar to 
proposals by other exchanges to trade flexible options.\10\

    \9\ Securities Exchange Act Release No. 34925 (November 1, 1994) 
(SR-Phlx-94-18).
    \10\ See, e.g., CBOE Rules, Chapter XXIVA; and Amex Rules, 
Section 15, Rules 900G, et. seq.
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    For example, to ensure orderly trading, customized options will 
begin trading at 10:00 AM, one half hour after the normal opening of 
trading index options on the Exchange, in order to limit the burden on 
the trading crowd. Customized industry index and equity options would 
trade until 4:10 PM, to correspond to the non-customized option, 
similar to customized market index options, which would trade until 
4:15 PM. The Exchange notes that no trading rotations will occur in 
customized options.
    In order to minimize the market impact of this product, the 
expiration date may not fall on, or within two business days before or 
after the normal mid-month Friday expiration for options. In addition, 
customized options will be subject to a separate position limit of, on 
the same side of the market: 200,000 broad-based index option 
contracts, four times the current position limits for narrow-based 
index option contracts,\11\ and, respecting customized equity options, 
three times the current limit applicable to the listed equity option. 
The Exchange believes that their proposed market index and equity 
option position limits are similar to existing or proposed provisions 
of other exchanges. The text of the proposed rule specifies the 
following

[[Page 15552]]
position limit tiers for both customized equity and industry index 
options as follows: (1) 24,000, 36,000 or 48,000 customized industry 
index option contracts; and (2) 75,000, 60,000, 31,500, 22,500 or 
13,500 customized equity option contracts.

    \11\ See Amendment No. 1, supra note 3.
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    Generally, customized option positions are not taken into account 
when calculating position limits for non-customized options on the same 
index.\12\ A separate exercise limit would also apply, equivalent to 
the applicable position limit. The minimum exercise size would be the 
lesser of $1 million or the remaining size of the position respecting 
index options, and the lesser of 100 contracts or the remaining size of 
the position respecting equity options.

    \12\ However, positions in P.M.-settled customized index options 
shall be aggregated with positions in quarterly expiring options 
(``QIXs'') on the same index, if the customized option expires at 
the close of trading on or within two business days of the last 
trading day in a quarter. The Exchange is authorized to trade QIXs 
pursuant to Rule 1101A(b)(iv), although none currently trade.
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    In order to enhance customer protection, the proposal requires 
assigned ROTs to submit a Letter of Guarantee \13\ issued by a clearing 
member organization, specifically accepting financial responsibility 
for all customized option transactions made by such person. Moreover, a 
minimum of $100,000 in net liquid assets is required to be maintained 
by assigned ROTs. Floor Brokers must maintain a minimum of $50,000 in 
net capital to qualify to trade customized options. Both assigned ROTs 
and Floor Brokers must immediately notify the Exchange's Examinations 
Department upon failure to be in compliance with these requirements.

    \13\ See Phlx Rule 703.
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    Although customized options will not be continuously quoted, once 
an RFQ is received, its terms, as well as the responding quotes, will 
be disseminated by Exchange systems. The terms of any resulting trade 
will also be disseminated. Specifically, the Requesting Member will 
ensure immediate dissemination to OPRA, which will, in turn, 
disseminate the information to subscribing vendors in the form of an 
administrative text message. The Exchange believes that transparency in 
customized options will be preserved by prompt and complete quotation 
and transaction reporting. The Exchange expects to utilize a separate 
computer system to handle customized index and equity options, similar 
to the system utilized for customized foreign currency options.
    Unlike the provisions of other exchanges,\14\ discretionary 
transactions will not be permitted in customized index and equity 
options. Thus, the existing provisions of Rule 1065 will apply to 
prohibit such transactions. The Exchange also notes that there will be 
no specialist in customized options. The assigned specialist in the 
non-customized option must apply to be an assigned ROT in order to 
participate. The current responsibilities of a Specialist to determine 
a market based on the bids and offers voiced as well as to disseminate 
bids/offers and trades will be handled by the Requesting Member. The 
Exchange believes that this procedure is similar to market maker 
systems on other exchanges. Nevertheless, customized options will trade 
in the crowd of the non-customized option in order to facilitate 
participation by assigned ROTs who will most likely be trading in the 
non-customized option.

    \14\ See e.g., CBOE Rule 24A.6.
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    Under the proposal, the RFQ must state the size and account type, 
in addition to the other components, which are similar to those of 
other exchanges.\15\ The RFQ is intended to detail the information 
necessary for ROTs to make a market, enhancing the accuracy of such 
market in view of the fact that customized option series are not pre-
established and thus do not appear on trading sheets. The Exchange 
believes that stating the size and account type in the RFQ is important 
to the market making function.

    \15\ See, e.g., CBOE Rule 24A.4(d)(ii).
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    Further, the proposed crossing procedure differs from that of other 
exchanges. The Exchange notes that stating an intention to cross in the 
RFQ is similar to the procedures of other exchanges.\16\ Prohibiting a 
cross on the BBO is consistent with the parity/priority principles of 
Rule 1014(g), because the Requesting Member's later-voiced bid does not 
have time priority over the established BBO. With respect to an intent 
to cross at a price better than the existing BBO, the proposal would 
afford assigned ROTs an opportunity to immediately join the Requesting 
Member's market. Thus, no guaranteed minimum right of participation 
exists for a Requesting member intending to cross.\17\ Instead, the 
Exchange believes it is critical to its ability to attract market maker 
interest, and thus liquidity, to customized options trading to afford 
assigned ROTs the ability to achieve parity.

    \16\ See, supra note 10.
    \17\ Pursuant to CBOE Rule 24A.5(e)(iii), Submitting Members 
representing index FLEX crosses are entitled to a one-half split on 
the BBO and a two-thirds split if improving the BBO.
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    In view of the obligations of assigned ROTs to make a market of a 
certain minimum size as well as that each customized option traded must 
have at least two assigned ROTs, the Exchange believes this ability to 
match is critical to the success of the product. The Exchange notes 
that the priority that an assigned ROT has over non-assigned market 
participants in voicing bids/offers and determining the BBO is similar 
to that of other exchanges.\18\ This priority is limited to voicing 
bids/offers to establish a BBO; for purposes of joining bids/offers 
during the Improvement Interval or crossing procedure, parity, not 
priority, is afforded to assigned ROTs. Priority for assigned ROTs is 
also based on the need to offset the obligations of assigned ROTs. The 
Exchange has also proposed to limit the ability of traditional option 
ROTs and Specialists to trade customized options, by requiring 
assignment in order to participate.

    \18\ See e.g., CBOE Rule 24A.5(d) (i) and (ii).
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    The Exchange believes that assignment of ROTs with respect to 
customized options serves to ensure that these ROTs are qualified in 
terms of financial requirements, to encourage and monitor that each 
customized option has two assigned ROTs, and to offset the more 
substantial market making obligations associated with customized 
options. The absence of the customized option market making obligation 
implies that the benefits of market maker status, including favorable 
margin treatment, should not be extended to non-assigned ROTs. The 
Exchange believes that non-assigned market makers should not be 
permitted to participate as ROTs, because the viability of customized 
options is in the market making response, which the Exchange believes 
would be enhanced by affording exclusivity to assigned ROTs. The 
Exchange believes that these enhancements and this exclusivity are both 
reasonable and necessary to the liquidity of customized options. The 
Exchange notes that non-assigned ROTs may nevertheless trade customized 
options as customers through a qualified Floor Broker.
    The Exchange believes that the proposed rule change is consistent 
with Section 6 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, prevent fraudulent and manipulative acts and 
practices, as well as to protect investors and the public interest, in 
creating a customized options trading procedure in proposed Rule 1069A 
to enable the trading of flexible index and equity options. The 
Exchange believes that the proposed trading procedure should

[[Page 15553]]
ensure that just and equitable principles of trade govern customized 
options trading. The Exchange also believes that the financial 
requirements and assigned ROT obligations should promote liquidity, and 
thus, the protection of investors trading customized options.

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 reasons for so finding or (ii) as to 
which the Phlx 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, NW, Washington, DC 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 in the 
Commission's Public Reference Section, 450 Fifth Street, NW, 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of the Phlx. All 
submissions should refer to File No. SR-Phlx-96-08 and should be 
submitted by April 29, 1996.

    For the Commisson by the Division of Market Regulation, pursuant 
to delegated authority.\19\

    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-8551 Filed 4-5-96; 8:45 am]
BILLING CODE 8010-01-M