[Federal Register Volume 62, Number 79 (Thursday, April 24, 1997)]
[Notices]
[Pages 20048-20055]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-10556]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38519; File No. SR-Phlx-96-38]


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

April 17, 1997.
    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 March 6, 
1997, the Philadelphia Stock Exchange, Inc. (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') Amendment No. 1 to the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the self-regulatory organization. The proposed rule change, as 
originally filed, was published in the Federal Register on September 
24, 1996.\1\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ See Securities Exchange Act Release No. 37691 (September 17, 
1996), 61 FR 50060.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Rule 19b-4 of the Act, proposes to amend its 
proposal \2\ to adopt Rule 1079, Index and Equity FLEX \3\ Options, 
which would govern the trading of customized or flexible (``FLEX'') 
index and equity options on the Exchange, as follows: (1) Customization 
of equity FLEX option strike prices for calls will not be permitted; 
(2) regardless of the specific parity/priority provisions for assigned 
Registered Options Traders (``ROTs'')/Specialists, all FLEX 
transactions must be in compliance with Section 11(a) of the Act; (3) 
clarify that once a FLEX option is quoted, the Request-for-Quote 
(``RFQ'') remains open that day unless a trade occurs, replacing the 
concept of ``markets remaining open;'' (4) the provision that the 
executing member has priority over other members seeking to trade with 
a booked order would be deleted; (5) FLEX trading hours, although 
currently established as 10 a.m. to 4:10/4:15 p.m., could be changed to 
any time within regular non-FLEX trading hours; (6) increase the 
industry (narrow-based) index options position and exercise limits; (7) 
add an introductory paragraph and reference to Rule 1079 to Floor 
Procedure Advice (``Advice'') F-28; (8) exclude solicited orders and 
broker-dealer crosses from the 25% minimum guaranteed right of 
participation for crossing transactions; (9) utilize the current 
reporting authority for calculating FLEX index values; (10) designate 
all Phlx index options as eligible for FLEX options, subject to Options 
Committee approval; (11) determine the best market at the end of the 
response time based on price; and (12) adopt a $1,000,000 net capital 
requirement for index FLEX specialists. This amendment also restates 
the original proposal. In the original proposal, the Exchange had 
proposed to trade FLEX options on specific Phlx index options. At this 
time, the Exchange proposes to designate all Phlx index options as 
eligible for FLEX options trading, subject to Options Committee 
approval.\4\ Thus, the Phlx is proposing to trade FLEX options on 
industry (narrow-based) index options pursuant to the proposed rule, in 
addition to market (broad-based) index options. Further, the Phlx is 
proposing to trade equity FLEX options on securities which are options-
eligible pursuant to Rule 1009, with the Options Committee designating 
the specific issues.
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    \2\ The original proposal was published for comment in 
Securities Exchange Act Release No. 37691 (September 17, 1996) (File 
No. SR-Phlx-96-38).
    \3\ The term ``FLEX'' is a trademark of the Chicago Board 
Options Exchange, Inc. (``CBOE'').
    \4\ The following are the current Phlx market index options: 
Value Line Composite Index (``VLE''), National Over-the-Counter 
Index (``XOC''), and U.S. Top 100 Index (``TPX''). The following are 
the current Phlx industry index options: OTC Industrial Average 
Index (``OTZ''), Bank Index (``BKK''), Gold/Silver Index (``XAU''), 
Semiconductor Index (``SOX'') and Utility Index (``UTY''), Forest 
and Paper (``FPP''), Plane (``PLN''), Phone (``PNX''), and Oil 
Service (``OSX''). Because the Super Cap Index (``HFX'') is neither 
a market or and industry index, the Exchange applies a position 
limit of 5,500 contracts for the non-FLEX overlying option. This 
position limit is lower than the position limit tiers for 
standardized non-FLEX industry index options.
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    Proposed rule 1079 contains the characteristics, trading procedure 
and other provisions applicable to trading FLEX TM 
3 options. All FLEX options must be quoted and traded in the 
trading crowd of the corresponding non-FLEX option. The Exchange notes 
that the Automated Options Market (``AUTOM'') system will not be 
available for FLEX options. Proposed Rule 1079 also states that 
although FLEX options are generally subject to the rules in the options 
section,\5\ to the extent that the provisions of Rule 1079 are 
inconsistent with other applicable Exchange rules, Rule 1079 takes

[[Page 20049]]

precedence with respect to FLEX options.
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    \5\ See Phlx Rules 1000, et. seq.
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    Because FLEX options would not be continuously quoted, nor are 
series pre-established, the variable terms of FLEX options shall be 
established by the following process. In order to initiate a 
transaction, a Requesting Member must submit an 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, are outlined in Rule 1079(a).\6\ For example, the 
exercise strike price respecting index FLEX options 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).\7\ Similarly respecting equity FLEX 
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. 
However, the Exchange proposes to amend its original proposal to state 
that customization of equity FLEX option strike prices for calls will 
not be permitted; only strikes that may be listed pursuant to Rule 1012 
are eligible, such that the strike price must be consistent with strike 
price intervals permissible for equity options.\8\
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    \6\ Rule 1079 generally parallels the provisions of Rule 1069 
governing foreign currency options.
    \7\ Initially, the exercise strike price will not be available 
for customization as a percentage, pending systems enhancements.
    \8\ See Rule 1012, Commentary .05.
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    The exercise style can be either American or European,\9\ 
regardless of the exercise style of the listed option.\10\ The 
expiration date can also be customized, specifying any business day 
(non-holiday)--any month, day and year within five years for index flex 
options and three years for equity FLEX options. However, FLEX 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-FLEX 
option on the same underlying index or security (other than a quarterly 
expiring index option \11\). In addition, a FLEX option cannot expire 
on the same day that series is established at OCC.\12\
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    \9\ An American style option may be exercised at any time up to 
its expiration, while a European style option can only be exercised 
on its expiration day. See Phlx Rule 1000(b)(35).
    \10\ In certain circumstances, European style equity FLEX 
options may be adjusted to require the delivery upon exercise of a 
fixed amount of cash. See Options Clearing Corporation (``OCC'') By-
Law, Article VI, Section 11, Interpretation and Policy .08.
    \11\ Quarterly expiring index options expire on the first 
business day of the month following the end of the calendar quarter.
    \12\ This provision replaces language in Rule 1079(a)(6)(C) of 
the original proposal stating that a new series cannot be opened on 
the day of exercise.
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    With respect to the minimum size of market index FLEX 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 an index FLEX option (index multiplier 
times the current index value) multiplied by the number of index FLEX 
options. The minimum value size for a responsive quote is market index 
FLEX 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 industry index FLEX 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 equity FLEX 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 equity FLEX options is 100 
contracts, or the remaining size on a closing transaction, whichever is 
less.
    Despite the aforementioned minimum size requirements, assigned ROTs 
and an assigned Specialist are required to respond to each RFQ with a 
certain minimum size. Respecting broad-based index FLEX options, 
assigned ROTs and the assigned Specialist are each 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 FLEX options, assigned ROTs and an assigned Specialist are each 
required to respond with at least $5 million underlying equivalent 
value or the dollar amount requested in the RFQ, whichever is less. 
Respecting equity FLEX options, assigned ROTs and the assigned 
Specialist are each 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 index FLEX options may be specified as the 
value reported on the Exchange at the: (i) Close of trading (P.M.-
settled), (ii) opening of trading (A.M.-settled), or (iii) as an 
average over a specified period of time, within parameters established 
by the Exchange.\13\ 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 
FLEX options exercised prior to the expiration date can only settle 
based on the closing value on the exercise date.\14\ Index FLEX 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 equity FLEX options, exercise settlement shall be 
by physical delivery of the underlying security pursuant to Rule 1044. 
Also, equity FLEX options will be subject to

[[Page 20050]]

the exercise-by-exception procedures of OCC.\15\
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    \13\ The Exchange proposes to retain its existing securities 
information vendor as the reporting authority for FLEX index 
options, respecting any additional index value calculations required 
due to the type of customization offered by FLEX options. The 
Exchange is not proposing, at this time, to utilize its own Index 
Calculation Engine (``ICE'') System as the reporting authority for 
FLEX options. See Securities Exchange Act Release No. 38292 at n. 4. 
(February 14, 1997) (SR-Phlx-96-36).
    \14\ This limitation is currently in place on other exchanges 
trading FLEX options and with respect to other American style A.M.-
settled index options. See Characteristics and Risks of Standardized 
Options Trading, February 1994, at page 48.
    \15\ OCC Rule 805 provides for automatic exercise of in-the-
money options at expiration without the submission of an exercise 
notice to OCC if the price of the security underlying the option is 
at or above a certain price (for calls) or at or below a certain 
price (for puts); and the non-exercise of an option at expiration if 
the price of the security underlying the option does not satisfy 
such price levels.
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    With respect to the quote format of FLEX options, a bid and/or 
offer in the form of a specific dollar amount reflected as a fractional 
price (e.g., \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.\16\
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    \16\ See Rules 1000(b)(7) and 1066(f).
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    The quoting and trading procedure for FLEX options, beginning with 
the RFQ, is enumerated in Rule 1079(b). Submitting an RFQ is the first 
step in quoting FLEX options. The Requesting Member must first announce 
the RFQ to the trading crowd of the non-FLEX option and then submit an 
RFQ ticket, containing the following: (1) Underlying index or security, 
(2) type, (3) exercise style, (4) expiration date, (5) exercise price, 
and, respecting index FLEX options, (6) settlement value (e.g., A.M. or 
P.M.) and (7) the designated settlement currency. Thereafter, on 
receipt of an RFQ in proper form, the assigned Specialist or the 
Requesting Member shall cause the terms of the RFQ to be disseminated 
as an administrative text message through the Options Price Reporting 
Authority (``OPRA'').\17\ RFQs, responsive quotes, booked orders and 
completed trades will be promptly reported to OPRA and disseminated as 
an administrative text message. The Exchange notes that although 
certain information is not required to be part of the RFQ (such as 
account type, crossing intention, response time and size), this 
information will be reflected on the final order ticket. Further, the 
size and crossing intention must be voiced as part of voicing the 
trade.
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    \17\ Operationally, the Requesting Member provides this 
information to data entry personnel, who enter 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 
paragraph (b)(2), the response time, between two and 15 minutes, will 
be determined by the Options Committee, which may depend on the 
complexity of the RFQ.\18\ during the response time, qualified members 
may provide responsive quotes to the RFQ, which may be entered, 
modified or withdrawn during such response time.
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    \18\ Initially, the Options Committee has established a response 
time of ten minutes. Although this Committee will be authorized to 
change the response time within the permissible range, any such 
change will be preceded by notice to the Exchange membership. The 
Exchange believes that such a change does not require a filing with 
the Commission pursuant to Section 19(b). See also CBOE Rule 
24A.4(a)(3)(iii).
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    At the end of the response time, the assigned Specialist, or if 
none, the Requesting Member shall determine the best bid and offer 
(``BBO''), based on price, 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/Specialists. The Exchange has also added language to the text of 
the proposed rule and Advice stating that all transactions must be in 
compliance with Section 11(a) of the Securities Exchange Act of 1934 
and the rules promulgated thereunder.
    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.\19\ The BBO 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, which is disseminated with reference to the 
corresponding RFQ. An assigned ROT and the assigned Specialist who 
responded with a market during the response time may immediately join 
the new BBO.
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    \19\ Once a BBO has been established at the end of the response 
time, if a member bids/offers, the BBO Improvement Interval is thus 
triggered.
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    A trade in FLEX 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 by voicing a bid/offer in the 
trading crowd.\20\ The Requesting Member has no obligation to accept 
any bid or offer for a FLEX 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. 
Acceptance of a bid/offer creates a binding contract under Exchange 
rules.
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    \20\ Thus, when a Requesting Member seeks to trade on the 
established BBO, an assigned ROT/Specialist cannot participate. For 
example, where the BBO is 6-7, if the Requesting Members seeks to 
sell 500 contracts at 6, the Requesting Member has priority for that 
purpose.
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    Once the BBO is established, the RFQ remains open that trading day, 
unless a trade occurs, and a member may re-quote the market with 
respect to the open RFQ without submitting an additional RFQ. If a 
trade occurs, a new RFQ is required. Only an assigned ROT or assigned 
Specialist who responded to the open RFQ during the response time or 
BBO Improvement Interval may immediately join the re-quoted market, 
thus matching for parity purposes. Neither the Requesting Member, nor 
the re-quoting member, is given the first opportunity to trade on the 
re-quoted market. Thus, replacing ``markets remaining open'' with the 
RFQ remaining open is another change from the original proposal.\21\
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    \21\ Previously, the Exchange proposed to allow markets to 
remain open, but not be firm, such that members had to re-quote the 
market.
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    Further, there will be a limit order book for FLEX options. The 
Specialist in the listed non-FLEX equity or index option, whether or 
not assigned in FLEX options, must accept FLEX orders on the FLEX book 
after completion of the RFQ process. Only customer day limit orders may 
be placed on the index FLEX or equity FLEX option book. Booked orders 
expire at the end of each trading day. The limit price and size must be 
written on the RFQ ticket and disseminated as an administrative text 
message through OPRA. In order to trade with the book, an executing 
member must quote the market and announce the trade. The Exchange 
proposes to delete the provision that the executing member has priority 
over other members, including assigned ROTs and the assigned 
Specialist, seeking to trade with the booked order. The purpose of this 
change is to trade FLEX options off the book similarly to non-FLEX 
options, noting that this consistency should prevent confusion.
    Generally, on the Phlx options floor, a cross may take place in 
accordance with Rule 1064. With respect to FLEX options, after the BBO 
has been determined, the Requesting Member intending to cross must bid 
(or offer) at or better than the BBO. Whenever a Requesting Member 
intends to cross, after the BBO is determined, with or without a BBO 
Improvement Interval, the Requesting Member must announce an intention 
to cross, and then bid and offer at or better than the BBO. If the 
Requesting Member's bid/offer is at the BBO, the Requesting Member may 
execute 25% or a fair split, whichever is greater, of the contraside of 
the order that is the subject of the RFQ. For instance, if there are 
two members on parity at the BBO, the Requesting Member and an assigned 
ROT, the Requesting Member is entitled to receive 50% of the contra-
side contracts, which is a fair split, not just the 25%

[[Page 20051]]

guaranteed minimum right of participation. The remainder of the contra-
side is split in accordance with the parity/priority provision 
applicable to determining the BBO, such that assigned ROTs/Specialists 
may be afforded priority.
    If the Requesting Member's bid/offer improves the existing BBO, an 
assigned ROT or assigned Specialist who responded with a market during 
the response time or BBO Improvement Interval, may immediately join the 
Requesting Member's improved bid or offer, thus matching for parity 
purposes. However, the Requesting Member may execute 25% or a fair 
split, whichever is greater, of the contra-side of the order that is 
the subject of the RFQ. The remainder of the contra-side is split in 
accordance with the parity/priority provision applicable to determining 
the BBO, such that assigned ROTs/Specialists may be afforded priority. 
However, broker-dealer crosses and solicited orders, as defined in Rule 
1064, are not eligible for the split afforded by these crossing 
provisions (sub-paragraphs (A) and (B)). Instead, such orders are, 
after the announcement of an intention to cross, executable in 
accordance with sub-paragraphs (5) and (6). Specifically, such orders 
must be announced and bid/offered, under the FLEX crossing provision. 
No 25% minimum guaranteed right of participation applies to solicited 
orders or broker-dealer/broker-dealer crosses.
    The Exchange notes that an ROT and Specialist may trade FLEX 
options as an assigned ROT/Specialist or as a non-assigned ROT/
Specialist. However, the FLEX assigned Specialist must be the 
specialist in the non-FLEX option. ROTs and Specialists must apply on 
the appropriate Exchange form to be assigned in FLEX options. An 
assigned ROT or assigned Specialist may choose to be assigned in a 
particular FLEX option, but must respond with a market respecting any 
FLEX option upon request by a Floor Official.
    Assigned ROTs and the assigned Specialist will be subject to 
certain obligations respecting the trading of FLEX options. For 
example, the affirmative and negative market making obligations of Rule 
1014(c) apply. Further, assigned ROTs and the assigned Specialist are 
required by paragraph (b)(ii) to respond with a market of the minimum 
size.\22\ At least two ROTs and/or a Specialist shall be assigned to 
each FLEX option. If there is a Specialist, the FLEX option will trade 
pursuant to the specialist system, just as non-FLEX options currently 
do on the Exchange. If, however, there is no assigned Specialist in a 
FLEX option, two assigned ROTs are required for that FLEX option to 
trade.
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    \22\ However, assigned ROTs and assigned Specialists are not 
required to provide continuous quotes or markets at a certain 
minimum bid-ask differential (quote spread parameter).
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    Because of the minimum size obligations, assigned ROTs and the 
assigned Specialist are afforded priority over other bids/offers at 
parity during the response time. Further, assigned ROTs and the 
assigned Specialist who responded with a market during the response 
time may join a new bid/offer voiced during the Improvement Interval 
and prior to a cross, provided they do so immediately and subject to 
preserving the priority of customer orders. Enabling assigned ROTs and 
the assigned Specialist to join such new bid/offer affords them parity 
at that new BBO.
    There will be no trading rotations in FLEX options, either at the 
opening or at the close of trading. The Exchange also amended the 
original proposal to state that FLEX options trading must be effected 
during the hours established by the Exchange. Such hours shall be 
within regular Exchange trading hours (for the non-FLEX option) on each 
business day, except that the Exchange in its discretion may determine 
at any time to narrow or expand FLEX trading hours to encompass, but 
not exceed, the trading hours of the non-FLEX option. Initially, unless 
otherwise determined by the Exchange, transactions in FLEX options may 
be effected each trading day from 10 AM to: (1) 4:15 PM respecting 
market index FLEX options; and (2) 4:10 PM respecting industry index 
FLEX and equity FLEX options.\23\
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    \23\ The trading hours for options may change. FLEX trading will 
have to be within established trading hours for the non-FLEX 
product. See e.g., SR-Phlx-97-04.
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    Generally, FLEX option positions are not taken into account when 
calculating position limits for non-FLEX options on the same index.\24\ 
Accordingly, broad-based index FLEX options currently approved for non-
FLEX options trading will be subject to a separate position limit of 
200,000 contracts on the same side of the market.\25\ Narrow-based 
index FLEX options will be subject to a position limit of four times 
the current position limit--36,000, 48,000 or 60,000 contracts on the 
same side of the market.\26\ Respecting equity FLEX options, the 
position limit will be three times the current limit applicable to the 
listed equity option--75,000, 60,000, 31,500, 22,500 or 13,500 
contracts on the same side of the market. The Exchange notes that both 
the market index FLEX option limits as well as the equity FLEX option 
limits are the same as the provisions of other exchanges.\27\ The 
Exchange also believes that four times the non-FLEX limit is an 
appropriate limit for industry index FLEX options.\28\
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    \24\ 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 
on certain index options pursuant to Rule 1101A(b)(iv), although 
none currently trade.
    \25\ The following are the current Phlx market (broad-based) 
index options: Value Line Composite Index (``VLE''), National Over-
the-Counter Index (``XOC''), and U.S. Top 100 Index (``TPX''). If 
the Exchange wants to list and trade FLEX options on a broad-based 
index subsequently approved for non-FLEX options trading, the 
Exchange must submit a 19b-4 filing with the Commission proposing 
appropriate FLEX market index options position limits.
    \26\ The following are the current Phlx industry (narrow-based) 
index options: OTC Industrial Average Index (``OTZ''), Bank Index 
(``BKX''), Gold/Silver Index (``XAU''), Semiconductor Index 
(``SOX'') and Utility Index (``UTY''), Forest and Paper (``FPP''), 
Plane (``PLN''), Phone (``PNX''), and Oil Service (``OSX''). Because 
the Super Cap Index (``HFX'') is neither a market nor an industry 
index, the Exchange applies a position limit (5,500 contracts) that 
is lower than the position limit tiers for standardized non-FLEX 
industry index options. Accordingly, the position limit for FLEX 
options overlying the Super Cap Index will be 22,000 contracts (4 
times 5,500 contracts--the existing non-FLEX position limit).
    \27\ See e.g., CBOE Rule 24A.7(b).
    \28\ See Phlx Rule 1001A(b). In 1996, these limits were raised 
from 6,000, 9,000 or 12,000 contracts to 9,000, 12,000 or 15,000 
contracts. Securities Exchange Act Release No. 37863 (October 24, 
1996) (File No. SR-Phlx-96-33). Thus, the proposed change in the 
corresponding FLEX limits is a change from the original proposal 
reflecting four times the previous limits.
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    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.
    The proposal requires any ROT and Specialist to submit a Letter of 
Guarantee \29\ issued by a clearing member organization, specifically 
accepting financial responsibility for all FLEX option transactions 
made by such person. Moreover, an assigned Specialist in FLEX index 
options shall be required to maintain a minimum of $1,000,000 in net 
capital. An assigned ROT in FLEX index options will be required to 
maintain a minimum of $100,000 in net liquid assets. Floor Brokers must 
maintain a minimum of $50,000 in net capital to qualify to trade FLEX 
options. Assigned ROTs, the assigned Specialist and Floor Brokers

[[Page 20052]]

must immediately notify the Exchange's Examinations Department upon 
failure to be in compliance with these requirements. The Exchange may 
waive the financial requirements of this Rule in unusual circumstances. 
Assigned Specialists/ROTs in FLEX equity options, as well as non-
assigned ROTs/Specialists in FLEX options, are required to comply with 
Exchange financial requirements.\30\
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    \29\ See Phlx Rule 703.
    \30\ See Phlx Rule 703.
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    The Exchange also proposes to adopt Floor Procedure Advice F-28, 
Trading Index and Equity FLEX Options, to parallel most of the 
provisions of Rule 1079(b), including those pertaining to requesting 
quotations, responses, determining the BBO, the BBO Improvement 
Interval, executing a trade and crossing. Advice F-28 is not proposed 
to contain a fine schedule, such that it does not require inclusion in 
the Exchange's minor rule violation enforcement and reporting plan. 
This amendment adds an introductory paragraph containing portions of 
Rule 1079(a) and (b), as well as a specific reference to Rule 1079.

II. Self-Regulatory Organization's Statements 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 statement.

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 flexible index and equity options, with 
several different contract specifications available for customization, 
including the exercise price (except equity FLEX call options), 
exercise style, expiration date and method for determining the exercise 
settlement value.
    The Exchange believes that flexible 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 VLE is European style, a flexible VLE contract could be 
crafted pursuant to Rule 1079 as an American 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. Customizing 
option terms enables an investor to more closely tailor investment 
strategies to option products. These customized options are often trade 
by institutional investors with specific trading needs. In response, 
the Exchange seeks to trade FLEX options in an exchange auction market 
environment, with the OCC as issuer and guarantor.\31\ Thus, FLEX 
options are structured with a minimum size reflecting the larger-sized 
trades of these institutional users.\32\
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    \31\ For a discussion of clearance and settlement procedure for 
FLEX options, see Securities Exchange Act Release No. 37318 (June 
18, 1996) (SR-OCC-96-03). For example, OCC may depart from regular 
expiration date procedures and deadlines in the case of equity FLEX 
options, pursuant to OCC Rule 805, Interpretation and Policy .03.
    \32\ The Exchange notes that the Commission has previously 
designated index and equity FLEX options as standardized options for 
the purposes of the options disclosure framework established under 
Rule 9b-1 of the Act. See Securities Exchange Act Release No. 37824 
(October 15, 1996).
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    The proposed rule, Rule 1079, is based upon the Exchange's Rule 
1069, Customized Foreign Currency Options, and Exchange experience with 
trading this product since November, 1994.\33\ Generally, FLEX options 
shall be traded in accordance with many existing option and index 
option rules; however, Rule 1079 contains certain new trading 
procedures unique to FLEX options. In addition, the Exchange believes 
that the proposal is similar to the rules and proposals of other 
exchanges respecting flexible options.\34\
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    \33\ Securities Exchange Act Release No. 34925 (November 1, 
1994) (SR-Phlx-94-18).
    \34\ See, e.g., CBOE Rules 24A.1-24A.17; Amex Rules 900G, et. 
seq.; and PSE Rules 8.100-8.115.
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    Several such common provisions are intended to ensure orderly 
trading. For example, the Exchange has determined that, initially, FLEX 
options will begin trading at 10 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. Industry index and equity FLEX options 
will trade until 4:10 PM, to correspond to the non-FLEX option, similar 
to market index FLEX options, which would trade until 4:15 PM. The 
Exchange may establish other trading times within the regular trading 
hours for the non-FLEX option, including coordination with FLEX trading 
hours on other exchanges and reflecting new trading hours for non-FLEX 
options.\35\
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    \35\ Under this proposal, the Exchange understands that 
expanding and narrowing FLEX trading hours within the regular 
trading hours of the particular product would not require a proposed 
rule change pursuant to Section 19(b) of the Act. The Exchange, 
however, will notify its members if any such change should be made.
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    As another example, the RFQ process, which allows a set period of 
time for bids and offers to be determined, is also designed to create 
an orderly trading environment, recognizing that greater variation in 
option terms requires sufficient time to respond with a quote. The 
response time and the BBO Improvement Interval should thus promote 
depth and liquidity as well.
    In order to provide adequate liquidity in FLEX options, two 
assigned members, whether ROTs or Specialists, are required for each 
FLEX option, and must be present for a trade to occur.\36\ In addition, 
the minimum size requirements are intended to attract depth and 
liquidity to FLEX options.
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    \36\ See Floor Procedure Advices A-10, Specialist Trading with 
Book, and C-1, Ascertaining the Presence of ROTs in Trading Crowd, 
which require that, in addition to the Specialist, an ROT be present 
during a transaction.
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    Other FLEX provisions are intended to minimize the market impact of 
this product. For one, the expiration date may not fall on or within 
two business days before or after the normal mid-month Friday 
expiration for options. Because the expiration date of FLEX options may 
not correspond to a non-FLEX expiration, FLEX options should not affect 
the market for the underlying security at the same time, thereby not 
placing added pressure on that security at the same time. This, in 
turn, minimizes the impact of FLEX options on the marketplace.
    Second, position and exercise limits will apply to FLEX options, 
although separate from those applicable to non-FLEX options. The 
Exchange believes that separate, higher limits and non-aggregation are 
appropriate for FLEX options, which are intended to compete with OTC 
options that are not subject to such limits. The higher limits reflect 
the institutional nature and resulting larger size of FLEX options.
    In order to enhance customer protection, certain financial 
standards will apply, including a capital requirement and a Letter of 
Guarantee from a clearing firm respecting FLEX options trading. The 
Exchange believes that the existence of separate position and exercise 
limits serves a customer protection function as well, by reducing 
systemic risk.
    Although FLEX options are characterized by variable terms, not all

[[Page 20053]]

FLEX option terms can be customized. As stated above, the expiration 
date cannot fall on certain days. Customization of equity FLEX option 
strike prices for calls will not be permitted, due to tax issues 
arising out of the definition of a qualified covered call. Thus, only 
equity option call strikes that may be listed pursuant to Rule 1012 are 
eligible, such that the strike price must be consistent with strike 
price intervals permissible for equity options. In addition, American-
style index FLEX options exercised prior to the expiration date can 
only settle based on the closing value on the exercise date. Despite 
these restrictions on customization,\37\ the Phlx believes FLEX options 
should nevertheless address a market need for variation in contract 
terms.
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    \37\ See also, supra note 5.
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    Not only will FLEX options combine variable terms with an auction 
marketplace and OCC guarantee, but FLEX options will also offer 
transparency of quotes and trades, because the proposal requires prompt 
and complete quotation and transaction reporting. Although flexible 
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 assigned Specialist, or if none, the 
Requesting Member will ensure immediate dissemination to OPRA in the 
form of an administrative text message, which will, in turn, 
disseminate the information to subscribing vendors.
    The Exchange expects to implement a separate computer system to 
handle index and equity FLEX options, similar to the system utilized 
for customized foreign currency options. The Exchange expects that 
initially FLEX options will be entered into this system at a limited 
number of locations on the trading floor, which will be described in 
detail by notice to the options trading floor.
    The Exchange proposes to utilize a limit order book for FLEX option 
orders resulting from the RFQ process. The purpose of the book is to 
accommodate customers who have specified a limit price for a FLEX 
option order that is away from the market established during the RFQ 
process. The limit order book will be limited to customer day limit 
orders, which must be accepted by the Specialist, whether or not that 
Specialist is assigned in FLEX options. As such, the Specialist must 
monitor FLEX markets for any booked orders. The Exchange is requiring 
all Specialists, whether acting as an assigned FLEX Specialist or not, 
to maintain a FLEX book for consistency with the procedures for non-
FLEX options and to prevent investor confusion. The Exchange believes 
that the FLEX order book should serve as a useful tool for customers, 
as does the current limit order book respecting non-FLEX options. With 
respect to booked orders for the same FLEX option (identical terms), 
Rule 1014 will apply to determine priority and parity among such 
orders.\38\ When trading with a booked order, a member must re-quote 
the market and announce the trade.
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    \38\ The Exchange notes that although the principles of price/
time priority and simultaneous bids/offers at parity of Rule 1014 
apply, the enhanced specialist participation of sub-paragraphs (g) 
(ii) and (iii) are not applicable to FLEX options.
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    The Exchange proposes to delete the provision in the original 
proposal that the executing member has priority over other members, 
including assigned ROTs and the assigned Specialist, seeking to trade 
with the booked order. The purpose of this change is to trade booked 
FLEX options similarly to non-FLEX options, noting that this 
consistency should prevent confusion.
    The Exchange also proposes that an RFQ remain open that trading 
day, as opposed to expiring immediately, as long as a trade has not 
occurred. As with non-FLEX options, before attempting to trade on an 
existing BBO, the market should be re-quoted. The advantage of an RFQ 
remaining open is that a re-quote does not require the submission of a 
new RFQ, thereby avoiding the delay of a new response time where such 
time may not be needed due to a recent quote. Because an option quoted 
earlier in the trading day should be easier to price, such that a new 
response time is not required, the Exchange believes that it may be 
burdensome to repeat the RFQ process. Thus, RFQs remaining open 
streamlines FLEX trading and eliminates unnecessary delays. Any time a 
market is re-quoted that day, the new BBO and any resulting trade are 
disseminated with reference to the original RFQ. However, once a trade 
occurs, a new RFQ is required.\39\
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    \39\ The Exchange notes that the Options Committee may determine 
to establish an abbreviated response time for a new RFQ, because the 
full ten minutes may not be required for pricing determinations.
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    Certain aspects of proposed Rule 1079 differ from FLEX provisions 
of other exchanges. For instance, discretionary transactions would not 
be permitted in index and equity FLEX options.\40\ Thus, the existing 
provisions of Rule 1065 will apply to prohibit such transactions.
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    \40\ See e.g., CBOE Rule 24A.6.
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    Second, the Exchange also notes that there may not be a Specialist 
in FLEX options. Where there is an assigned FLEX Specialist, that FLEX 
option will trade pursuant to the Phlx's specialist system. Where there 
is no assigned FLEX Specialist, two assigned ROTs are required. Only 
the assigned Specialist in the non-FLEX (listed) option may apply to be 
an assigned Specialist in the FLEX option,\41\ but is not required to 
do so in order to participate. Instead, the non-FLEX Specialist may be 
an assigned ROT in the FLEX option, or not assigned at all. 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 
may be handled by the Requesting Member, where there is no assigned 
Specialist in that FLEX option. If a trade occurs where the Requesting 
Member is not a participant and there is no assigned Specialist, the 
responsibility to submit the trade falls upon the seller or largest 
participant, in accordance with existing trading procedure.\42\
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    \41\ If the option is not listed on the Exchange, specialist 
functions may be allocated by the Exchange pursuant to Phlx Rules 
500 et seq.
    \42\ See Floor Procedure Advice F-2, Time Stamping, Matching and 
Access to Matched Trades.
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    Third, the Exchange has also determined that FLEX options will 
trade in the crowd of the non-FLEX option in order to facilitate 
participation by assigned ROTs who will most likely be located in that 
crowd. The Exchange believes that encouraging market making activity, 
whether or not assigned, should foster liquidity in FLEX options.
    Further, the proposed crossing procedure differs from that of other 
exchanges.\43\ A guaranteed minimum right of participation of 25%, or a 
fair split, whichever is greater, applies to crosses in both index and 
equity FLEX options, other than broker-dealer crosses and solicited 
orders.\44\ The purpose of the split is to attract interest in 
Exchange-traded FLEX options by guaranteeing members who bring FLEX 
orders to the Phlx as part of the contra-side participation on that 
trade when matching or improving the BBO.

[[Page 20054]]

Nevertheless, this procedure prevents other market participants who are 
obligated to provide markets, from being excluded from FLEX option 
crosses. This, in turn, should prevent assigned ROTs and assigned 
Specialists from being discouraged from assuming the obligations of 
FLEX options assignment. Thus, the Phlx believes that this crossing 
procedure should promote deep and liquid markets for FLEX options.
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    \43\ Pursuant to CBOE Rule 24A.5(e)(iii), Submitting Members 
representing index FLEX crosses, after indicating an intention to 
cross or act as principal, have priority on the BBO for the largest 
of \1/2\ of the trade, $1 million Underlying Equivalent Value 
(``UEV'') or the remaining UEV on a closing transaction, and if 
improving the BBO, for the largest of \2/3\ of the trade, $1 million 
UEV or the remaining UEV on a closing transaction. With respect to 
equity FLEX option crosses, there is a right to a 25% split on both 
the CBOE and the Amex, and on the PSE if improving the BBO. See 
e.g., Securities Exchange Act Release No. 37051 (March 29, 1996) 
(SR-CBOE-96-20).
    \44\ See CBOE Rule 24A.5(f).
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    In determining the BBO after the response time ends, the time 
priority principles of Rule 1014 (as well as the size precedence 
provisions of Rules 119 and 120) do not apply. Instead, the best price 
is given priority, with all bids/offers at that price deemed to be 
parity, regardless of when during the response time such bid/offer was 
voiced. In addition, where two or more bids/offers are at parity, 
priority is afforded to bids/offers submitted by assigned ROTs or the 
assigned Specialist over non-assigned ROTs/Specialists. In addition, 
after the BBO Improvement Interval, an assigned ROT or assigned 
Specialist who responded with a market during the response time, even 
though that market did not constitute the BBO and even though such 
trader may not have responded during the Improvement Interval, may 
immediately join the new BBO. Lastly, when a market is requoted based 
on an open RFQ, an assigned ROT or assigned Specialist who responded to 
the open RFQ during the response time or BBO Improvement Interval may 
immediately join the re-quoted market, thus matching for parity 
purposes. These procedures are intended to attract market maker 
interest, and thus liquidity, to FLEX options trading. In summary, the 
purpose of these provisions is to encourage assignment and reward those 
who actively make markets.
    In view of the obligations of assigned ROTs and Specialists to make 
a market of a certain minimum size as well as that each FLEX option 
traded must have at least two assigned ROTs or assigned Specialists, 
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 or assigned Specialist has over non-assigned market participants in 
voicing bids/offers and determining the BBO is similar to that of other 
exchanges.\45\ This priority is limited to voicing bids/offers to 
establish a BBO. For purposes of joining bids/offers during or after 
the BBO Improvement Interval, parity, not priority, is afforded to 
assigned ROTs and the assigned Specialist. Priority for assigned ROTs 
and the assigned Specialist is also based on the need to offset the 
obligations of assigned ROTs and the assigned Specialist.
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    \45\ See e.g., CBOE Rule 24A.5(e) (i) and (ii).
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    The Exchange has also added language to the text of the proposed 
rule stating that all transactions must be in compliance with Section 
11(a) of the Act and the rules promulgated thereunder, in order to 
emphasize that such provisions apply, and for consistency with 
provisions of other exchanges.\46\ Pursuant to Section 11(a) of the 
Act, bids/offers relying on the exemption of Section 11(a)(1)(G) must 
yield time priority to any bid/offer of a customer. Thus, due to 
Section 11(a), assigned ROTs/Specialists would not be afforded priority 
pursuant to Rule 1079 over a customer. In addition, crossing 
transactions may not be subject to a minimum right of participation, 
because a customer-to-customer cross would not be required to yield the 
remainder (75%) to assigned ROTs/Specialists.
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    \46\ See e.g., CBOE Rule 24A.5(e).
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    The purpose of adopting new Advice F-28 is to incorporate it into 
the Floor Procedure Advice Handbook for easy reference on the trading 
floor. The principal provisions of Rule 1079(b) establishing a FLEX 
options trading procedure are incorporated into the Advice, with a 
citation to the full text of Rule 1079 for additional provisions.
Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6 of this 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, by 
creating a FLEX options trading procedure in proposed Rule 1079 to 
enable the trading of flexible index and equity options. The Exchange 
believes that the proposed trading procedure, crafted in consideration 
of the complexity of variable terms and the larger sizes reflective of 
institutional users, should ensure that just and equitable principles 
of trade govern FLEX options trading. The Exchange also believes that 
the financial requirements and assigned ROT and assigned Specialist 
obligations should promote liquidity, as well as the protection of 
investors trading FLEX options. Furthermore, the customization of 
option features and terms should enable investors to better manage 
trading and investment risk as well as more closely tailor Exchange-
traded options to their specific investment strategies and objectives. 
Thus, FLEX options unite certain attributes of negotiated transactions 
with the many benefits of an exchange auction marketplace, including 
transparency and OCC as guarantor.
    Because the proposed procedure is designed to minimize market 
impact and contains important customer protection provisions, the 
Exchange believes that it should prevent fraudulent and manipulative 
acts and practices. The Exchange also believes that the proposal is 
consistent with Section 11A, because FLEX options enable the Exchange 
to compete fairly with other exchanges and the OTC market, as well as 
with Section 11(a), because customer priority is preserved under the 
proposal.

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

    With 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 or 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

[[Page 20055]]

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-96-38 and should be submitted by May 15, 1997.

    For the Commission by the Division of Market Regulation, 
Pursuant to delegated authority.\47\
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    \47\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-10556 Filed 4-23-97; 8:45 am]
BILLING CODE 8010-01-M