[Federal Register Volume 61, Number 215 (Tuesday, November 5, 1996)]
[Notices]
[Pages 56991-56993]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-28314]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37887; File No. SR-Phlx-96-39]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change Relating to the 
Selective Quoting Facility for Foreign Currency Options

October 29, 1996.

I. Introduction

    On August 20, 1996, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section

[[Page 56992]]

19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder,\2\ a proposed rule change to amend the foreign 
currency option selective quote facility.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    Notice of the proposed rule change was published for comment in the 
Federal Register on September 20, 1996.\3\ No comments were received on 
the proposal. This order approves the proposal.
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    \3\ Securities Exchange Act Release No. 37688 (September 16, 
1996) 61 FR 49515.
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II. Description of the Proposal

    The foreign currency option (``FCO'') Selective Quoting Facility 
(``SQF'') establishes criteria to determine whether the bid/ask 
quotation for each FCO series is eligible for transmission to the 
Options Price Reporting Authority (``OPRA'') for off-floor 
dissemination to securities data vendors. Implemented in 1994,\4\ the 
SQF, a feature of the Exchange's Auto-Quote system, was intended to 
reduce the number of strike prices being continuously updated and 
disseminated, thus resulting in more timely and accurate FCO quote 
displays. Specifically, designating as ``inactive'' those series that 
are away-from-the-money or not recently traded eliminates quote changes 
in those series that have the least amount of investor interest, thus 
reducing the dissemination delays caused by thousands of quote changes 
in volatile trading periods.
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    \4\ Securities Exchange Act Release No. 33067 (October 19, 
1993), 58 FR 57658 (October 26, 1993) (File No. SR-Phlx-92-23).
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    Currently, the SQF categorizes certain FCO strikes as ``non-
update'' or ``inactive'' strikes, which are disseminated with the OPRA 
indicator ``I'' and zeroes (e.g., 000-000), in lieu of a market. In 
contrast, ``update'' or ``active'' strikes include, at minimum: (1) 
Around-the-money strikes in near-term American style options, and (2) 
strikes with open interest that have traded with the previous five 
days. Around-the-money strikes were recently \5\ defined as those with 
an approximate 10, 20, 30, 40 and 50 delta.\6\ Active strikes may also 
be added at the initiative of the Exchange or in response to a request 
by the Specialist or an FCO Floor Official.
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    \5\ Securities Exchange Act Release No. 36636 (December 26, 
1995) 61 FR 209.
    \6\ ``Delta'' is a measure of how much an option premium changes 
in relation to changes in the underlying security. For example, a 50 
delta represents that for every one point move in the spot price of 
an underlying foreign currency, the option moves \1/2\.
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    When a series is inactive, those bids and offers are no longer 
updated in the Exchange's Auto-Quote system for dissemination.
    However, if interest is then voiced in any such series, it can be 
activated immediately upon establishment of a quote in that series. 
Inactive strikes with open interest (that have not traded in the 
previous five days) are quoted once at the close of trading each day 
for purposes of mark-to-market valuation. Because inactive series are 
not continuously updated and disseminated, quotation processing times 
are reduced such that quotes respecting active strikes are updated and 
disseminated to customers much more quickly.
    The Exchange amended the SQF last year \7\ to reduce the number of 
strikes considered active by: (1) Eliminating from the definition of 
active strikes those series with open interest that have not traded 
within the previous five trading days, but nevertheless requiring a 
closing quotation; (2) ``de-activating'' strikes intra-day that no 
longer fit the definition of active; and (3) redefining around-the-
money active strikes as the five options with an approximate 10, 20, 
30, 40 and 50 delta, instead of those four above and four below the 
spot price. This change was precipitated by volatility in the foreign 
currency markets causing dramatic fluctuation in foreign currency 
exchange rates, and, in turn, the addition of many strike prices to 
accommodate the new trading ranges of the underlying currencies. 
Therefore, the changes were intended to alleviate this burden and to 
improve the timeliness and accuracy of FCO quotes.
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    \7\ See Securities Exchange Act Release No. 36636, supra note 5.
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    In building system enhancements to implement this change, testing 
revealed that the delta-based around-the-money strikes did not most 
accurately capture around-the-money interest and was not the most 
efficient or simple method of determining those strikes, as originally 
contemplated by the FCO floor. The Exchange had previously sought to 
define active strikes using deltas, in order to correspond to the 
terminology used by traders and to capture strikes of certain 
volatilities, which was an improvement upon having a set number. During 
testing, it was determined that the definition of around-the-money 
strikes should be revisited, resulting in the proposal at hand.
    The purpose of the proposal is to codify certain system 
enhancements pertaining to the SQF into the governing Rule and Floor 
Procedure Advice.\8\ Specifically, the current proposal redefines 
around-the-money active strikes as two in-the-money strikes and six 
out-of-the money strikes for both puts and calls. The purpose of this 
change is to more accurately reflect the most active series for 
dissemination of the most significant and meaningful quotes. FCO floor 
representatives determined that the 10-50 delta range did not 
necessarily incorporate such strikes. Each morning, under the proposal, 
the SQF would set eight calls and eight puts for each FCO expiration 
month. Previously, under the delta-based method, at least ten series 
were activated, and, in certain cases, more than five strikes out-of-
the-money were required to capture the 50 delta and less than five 
captured the 50 delta in-the-money. Thus, based on specialist 
experience, the ``two in the six out-of-the-money'' definition garners 
those strikes that are active daily and have the most trading interest. 
Furthermore, preliminary testing revealed that 10% fewer strikes in the 
sample were activated under the new definition. Therefore, the Exchange 
does not believe that the number of resulting strikes should differ 
significantly from the delta-based method. The actual number for each 
FCO depends upon the fluctuations in the underlying currency. Likewise, 
the Exchange believes that the ``two in the six out'' method is easier 
to discern for customers, floor traders, Exchange staff, and vendors 
alike.
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    \8\ Phlx Rule 1012, Commentary .04 and Floor Procedure Advice 
(``Advice'') F-18, FCO Expiration Months and Strikes Prices--
Selective Quoting Facility.
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    Rule 1012, Commentary .04 establishes the minimum strikes to be 
activated, thus permitting the Exchange to designate other strikes as 
active. In this regard, the Exchange proposed to add the language ``at 
minimum'' to the Advice, for consistency with Rule 1012. In 
implementing the ability to activate other strikes, the Exchange has 
also designated as active all expiration months (except long-term) and 
around-the-money European style options. Activating expiration months 
other than the first three months became necessary due to complex 
system needs related to disseminating implied volatility levels using 
an outside vendor. Activation of around-the-money strikes is currently 
needed in all months to continue disseminating these levels under 
existing system configurations. With respect to end-of-month FCOs, only 
the first three expiration months are currently activated. Further, 
European style options are treated the same as American style options 
by the SQF system, such that the around-the-money definition activates 
the same strikes. The Exchange notes that these changes were 
implemented by FCO Committee

[[Page 56993]]

representatives to facilitate the smooth operation of the SQF, and this 
proposal codifies this result by adding the permissive language from 
the Rule into the Advice.
    The Exchange believes that the proposed rule change is consistent 
with Section 6 \9\ of the Act in general, and in particular, with 
Section 6(b)(5),\10\ in that it is designed to promote just and 
equitable principles of trade, prevent fraudulent and manipulative acts 
and practices, to foster cooperation and coordination with persons 
engaged in regulating, clearing, settling, processing information with 
respect to, and facilitating transactions in securities, as well as to 
protect investors and the public interest. Specifically, the Exchange 
believes the proposal promotes just and equitable principles of trade 
by facilitating speedier dissemination of FCO markets. Although the 
proposal may, but does not necessarily, result in a greater number of 
active strikes, the Exchange believes that any additional activation of 
strikes is necessary to ensure that SQF dissemination includes truly 
active strikes. Thus, the proposal balances the need to prevent 
excessive quote disseminations with preserving meaningful dissemination 
of FCO quotes. The proposal is also designed to facilitate coordination 
between the Exchange, the Options Clearing Corporation (``OCC''), OPRA 
and securities information vendors. A quote will always be disseminated 
when a trade occurs in a previously-inactive series and quotes in 
inactive series can always be requested from the trading crowd, 
consistent with the protection of investors and the public interest. In 
sum, the Phlx believes that the proposed changes to the SQF should 
facilitate the specialists' ability to focus on active series, which 
should, in turn, result in tighter, more liquid markets, consistent 
with Section 6(b)(5).
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    \9\ 15 U.S.C. 78f.
    \10\ 15 U.S.C. 78f(b)(5).
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange and, in 
particular, the requirements of Section 6(b)(5).\11\ The Commission 
believes that the proposed amendments to the SQF will result in timely 
and accurate FCO quote displays in series of known or probable interest 
to public customers, rather than those with improbable public investor 
interest, thereby helping the Phlx to maintain fair and orderly options 
markets.
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    \11\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Phlx proposes to redefine around-the-money active 
strikes as two in-the-money strikes and six out-of-the-money strikes 
for both puts and calls. According to the Exchange, the purpose of this 
change is to more accurately reflect the most active series for 
dissemination of the most significant and meaningful quotes. The 
Exchange states that FCO floor representatives determined that the 10-
50 delta range did not necessarily incorporate such strikes. Each 
morning, under the proposal, the SQF will set eight calls and eight 
puts for each FCO expiration month. Previously, under the delta-base 
method, at least ten series were activated, and, in certain cases, more 
than five strikes out-of-the-money were required to capture the 50 
delta and less than five captured the 50 delta in-the-money.
    According to the Exchange, based on specialist experience, the 
``two in and six out-of-the-money'' definition garners those strikes 
that are active daily and have the most trading interest. The Exchange 
states that the number of resulting strikes should not differ 
significantly from the delta-based method. The Exchange states that 
preliminary testing revealed that 10% fewer strikes in the sample were 
activated under the new definition, though the actual number for each 
FCO depends upon the fluctuations in the underlying currency. The 
Exchange also believes that the ``two in and six out'' method is easier 
to discern for customers, floor traders, Exchange staff, and vendors 
alike. Therefore, the Commission finds that the proposal may benefit 
investors and help the Phlx maintain fair and orderly markets by 
allowing for the updating and dissemination of quotations that are most 
useful to FCO market participants.
    Rule 1012, Commentary .04 establishes the minimum strikes to be 
activated, thus permitting the Exchange to designate other strikes as 
active. In this regard, for consistency with Rule 1012, the Exchange 
proposed to add the language ``at minimum'' to the Advice. The 
Commission finds this conforming change appropriate.
    In addition, the Commission believes that the proposal protects 
market participants by providing for the dissemination of one bid/ask 
quote at the end of each day for non-update series with open interest. 
This quote will provide option holders with an indication of the market 
for that option and will provide the OCC with a closing value to mark 
the market for margin and capital purposes.
    The Commission continues to believe, as it has concluded 
previously,\12\ that the SQF, as amended, will not create an advantage 
to FCO participants on the trading floor with the trading of options 
series not disseminated to the public. Public customers are protected 
by the feature of the SQF which requires a quotation to be disseminated 
after an options series is activated but before a trade can be entered. 
Accordingly, a participant who is physically on the trading floor will 
learn of the specialist's market for a given options series when the 
series is activated and a quote is published, nearly identical in time 
to a potential customer watching a vendor screen off-floor.
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    \12\ See Securities Exchange Act Release No. 33067 (October 19, 
1993), 58 FR 57458 (order approving SQF, SR-Phlx-92-23); Securities 
Exchange Act Release No. 36636, supra note 5.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (File No. SR-Phlx-96-39) is 
approved.

    \13\ 15 U.S.C. 78s(b)(2).
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    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-28314 Filed 11-4-96; 8:45 am]
BILLING CODE 8010-01-M