[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