[Federal Register Volume 65, Number 233 (Monday, December 4, 2000)]
[Notices]
[Pages 75755-75757]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30769]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43623; File No. SR-PCX-00-04]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Pacific Exchange, Inc. Relating to Buy-Writes & Book 
Priority

November 27, 2000.
    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 March 3, 2000, the Pacific Exchange, Inc. (``PCX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'' or 
``SEC'') the proposed rule change as described in Items I, II and III 
below, which Items have been prepared by the Exchange. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange is proposing to amend its rules to facilitate the 
execution of stock/option orders on the Exchange. Below is the text of 
the proposed rule change. Proposed new language is italicized and 
proposed deletions are in [brackets].
* * * * *

para. 5139  Priority of Bids and Offers

    Rule 6.75. Except as provided by Rule 6.76 below, the following 
rules of priority shall be observed with respect to bids and offers:
    (a)-(c) No change.
    (d) Notwithstanding anything in paragraphs (a) and (b) to the 
contrary, when a member is holding a spread order, a straddle order, or 
a combination order, or stock/option order and is bidding or offering 
on the basis of a total credit or debit for the order and has 
determined that the order may not be executed by a combination of 
transactions with or within the bids and offers displayed by the Order 
Book Official or other members, in procedures determined by the Options 
Floor Trading Committee, then the order may be executed as a spread, 
straddle, or combination, or stock/option order at the total credit or 
debit with one or more members without giving priority to bids or 
offers for the individual option series of the Order Book Official or 
of other members at the post that are no better than the bids or offers 
comprising such total credit or debit.
    Commentary: .01-.03--No change.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange 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 Exchange 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

1. Purpose
    The Exchange's priority rules for options provide, in general, that 
the highest bids and lowest offers have priority over other bids and 
offers, except that orders in the Limit Order Book have priority over 
other bids and offers at the same price.\3\ The rules further provide 
if there are two or more bids (or offers) representing the highest bid 
(or lowest offer), and no orders in the Limit Order Book are involved, 
then priority is afforded to those bids (or offers) in the sequence in 
which they were made.\4\ PCX Rule 6.75(d) currently allows three 
exceptions to the priority rules with respect to ``spread orders,'' \5\ 
``straddle orders,'' \6\ and ``combination

[[Page 75756]]

orders.'' \7\ As discussed below, the Exchange is now proposing to add 
a fourth exception, for stock/option orders,\8\ including those that 
are commonly known as ``buy-writes.''
---------------------------------------------------------------------------

    \3\ See PCX Rules 6.75(a)-(b).
    \4\ Id.
    \5\ A ``spread order'' is an order to buy a stated number of 
option contracts and to sell the same number of contracts (or 
contracts representing the same number of shares of the underlying 
security) of the same class of options. See PCX Rule 6.62(d).
    \6\ A``straddle order'' is an order to buy or to sell the same 
number of options of each type with respect to the same underlying 
security and having the same exercise price and expiration date 
(e.g., an order to buy two XYZ July 50 calls and to buy two XYZ July 
50 puts is a straddle order.) In the case of adjusted options 
contracts, a straddle order need not consist of the same number of 
put and call contracts if such contracts both represent the same 
number of shares of the underlying security. See PCX Rule 6.62(g).
    \7\ A ``combination order'' is an order involving a number of 
call option contracts and the same number of put option contracts 
with respect to the same underlying security. In the case of 
adjusted options contracts, a combination order need not consist of 
the same number of put and call contracts if such contracts both 
represent the same number of shares of the underlying security. See 
PCX Rule 6.62(h).
    \8\ A stock/option order is an order to buy or sell a stated 
number of units of an underlying or a related security coupled with 
either: (i) The purchase or sale of option contract(s) of the same 
series on the opposite side of the market representing the same 
number of units of the underlying or related security; or (ii) the 
purchase and sale of an equal number of put and call option 
contracts, each having the same exercise price, expiration date and 
number of units of the underlying or related security, on the 
opposite side of the market representing in aggregate twice the 
number of units of the underlying or related security See PCX Rule 
6.62(j).
---------------------------------------------------------------------------

    Currently, under Rule 6.75(d), when a member is holding a spread 
order, a straddle order or combination order, and is bidding or 
offering on the basis of a total credit or debit for the order, and has 
determined that the order may not be executed by a combination of 
transactions with or within the bids and offers displayed by the Order 
Book Official or other members, then the order may be executed as a 
spread, straddle or combination at the total credit or debit with one 
or more members without giving priority to bids or offers for the 
individual option series of the Order Book Official or of other members 
at the post that are no better than the bids or offers comprising such 
total credit or debit.
    For example, a spread order may be executed as follows: assume that 
a floor broker is holding a spread order that requires selling 20 June 
25 XYZ calls and buying 20 July 25 XYZ calls, and further assume that 
there is an order in the book to buy 5 June 25 XYZ calls and there are 
no orders in the book to sell July 25 XYZ calls. The floor broker could 
attempt to execute the spread order as three separate transactions: (1) 
Sell 5 June 25 calls to the Book; (2) sell 15 June 25 calls to the 
trading crowd; and (3) buy 20 July 25 calls from the trading crowd. If 
the customer's order specified a limit price of a specific debit 
amount--$1, for example--the order might theoretically be filled in 
this manner. Thus, if the broker could sell all 20 June calls at 4 and 
buy all 20 July calls at 5, the spread order could be filled as long as 
the customer's limit price was no more than a debit of $1. However, if 
the order in the book was to buy the June calls at 4, and the crowd was 
bidding 3\7/8\ for those calls, the broker could not fill the orders at 
the customer's limit price. In this example, the broker is placed at 
undue market risk in attempting to execute the order as separate 
transactions. If the broker sold 5 June calls to the book and, while 
consummating the trade, the XYZ stock ticks up \1/2\ a point, the crowd 
would likely be unwilling to trade the remaining calls at a price that 
is within the customer's limit. The broker is then left with an error.
    To avoid that problem, floor brokers typically call for a quote 
from the crowd for the entire spread. Following the previous example 
involving the June/July call spread, the trading crowd might provide a 
bid of $1 credit for the spread, which would satisfy the customer's 
limit price. This may occur, in accordance with Rule 6.75(d), even 
though one leg of the spread has traded at a price equal to the price 
of an order in the book on the other side of the market, i.e., it 
``touches the book.'' The rationale for this exception is, as described 
previously, that without it a broker would assume undue risk in 
executing the spread order and many spread orders would otherwise 
remain unexecuted.
    A similar problem exists for stock/option orders, such as buy-
writes, which involve writing call options and purchasing the 
underlying stock.\9\ For example, a customer may want to sell 10 XYZ 
July calls and buy 1000 shares of XYZ stock. The broker will typically 
enter the trading crowd and call for a market for the buy-write. The 
crowd will generally provide a two sided market expressed in the form 
of a total debit or credit--for example, $1 bid, $1\1/2\ offered--which 
will represent both the market to ``buy'' the buy-write ($1) as well as 
the market to ``sell'' the buy-write ($1\1/2\). If the customer is a 
seller and accepts the trading crowd's $1 bid on the transaction, then 
the stock and option portions of the trade will both have to be 
completed before the trade is fully consummated.\10\
---------------------------------------------------------------------------

    \9\ This strategy is also referred to as ``covered call 
writing.'' As stated in the Characteristics and Risks of 
Standardized Options:
    ``If the writer of a physical delivery call option owns or 
acquires the amount of the underlying interest that is deliverable 
upon exercise of the call, he is said to be a covered call writer. 
EXAMPLE: An individual owns 100 shares of XYZ common stock. If he 
writes one physical delivery XYZ call option--giving the holder the 
right to purchase 100 shares of the stock at a specified exercise 
price--this would be a covered call. If he writes two such XYZ 
calls, one would be covered and one would be uncovered.''
    [Citation omitted in original].
    \10\ See Options Floor Procedure Advice A-6, which provides in 
part:
    ``When a stock/option order is taken to a crowd for execution, 
the stock transaction must be effected prior to the option 
transaction pursuant to Rule 6.47, Commentary .04. The following 
procedure should be observed:
    After agreement with other members of the crowd has been reached 
as to the terms of the transaction, the option order tickets shall 
be written up and time-stamped. However, the order tickets should 
not be turned in to the Order Book Official at this time. The 
members shall attempt to immediately affect the transaction in the 
underlying or related security. If the stock transaction cannot be 
executed immediately or is effected at a price different than the 
agreed-upon price, the members shall not be held to the option 
transaction. If the stock transaction is effected at the agreed-upon 
price, than all the members who participated in the option 
transaction shall be held to their agreed-upon price. At the time 
the stock transaction is effected, the option trade tickets should 
be given to the Order Book Official.
    This procedure applies to all executions of stock/option 
orders.''
    [Citation omitted in original].
---------------------------------------------------------------------------

    Following the previous example, assume that the market in the 
underlying stock is 65\7/8\-66\1/8\ and the market in the overlying 
July 65 calls is 2-2\1/4\. The customer would receive an execution at a 
total credit of $1 if the stock is executed at $66 and the calls are 
executed at $2. However, if the stock trades at 66\1/8\, the price of 
the option could be adjusted to 1\7/8\, so that the net debit is $1.
    To complicate this matter, if there is an order in the book to buy 
5 July 65 calls at 2, the buy-write cannot be executed unless either 
the stock trades at a price other than 66 or the trading crowd is 
willing to trade the buy-write with a stock/option ratio other than 
one-to-one. This is the case because, under PCX Rule 6.75, buy-writes 
are not afforded the same priority rule exemption that applies to 
spread, straddle and combination orders. Instead, buy-writes are only 
afforded a limited exemption to the priority rule, i.e., ``a stock/
option order has priority over the bids and offers of members in the 
trading crowd, but not over the bids and offers of the Order Book 
Official.''
    Therefore, the Exchange is proposing to modify Rule 6.75 to provide 
stock/option orders with the same exemptive relief from Rule 6.75(a)-
(b) that currently applies to spread orders, straddle orders and 
combination orders. The Exchange believes that this rule change will 
facilitate transactions in securities because it will allow floor 
brokers to execute stock/option orders more promptly, as a single 
package, without regard to other orders that may be in the Order Book 
at the time. This

[[Page 75757]]

will allow brokers to focus on other orders they are representing. It 
will allow brokers to avoid undue liability and to avoid having to 
spend an inordinate amount of time in executing stock/option orders in 
compliance with the current restrictions of Rule 6.75 relating to 
orders in the order book. It will also allow stock/option orders to be 
executed when otherwise they might not be executed under Rule 6.75. The 
Exchange believes that the current exemptions for spread, straddle and 
combination orders under Rule 6.75 should be extended to include stock/
option orders based upon just and equitable principles of trade.
2. Basis
    The Exchange believes that this proposal is consistent with Section 
6(b) of the Act,\11\ in general, and furthers the objectives of Section 
6(b)(5),\12\ in particular, in that it is designed to facilitate 
transactions in securities, promote just and equitable principles of 
trade, and to protest investors and the public interest.
---------------------------------------------------------------------------

    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on 
Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor 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 self-regulatory organization consents, the Commission will--
    (A) By order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposal is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 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 Room. Copies of such filing will also be available for 
inspection and copying at the principal office at the PCX. All 
submissions should refer to File No. SR-PCX-00-04 and should be 
submitted by December 26, 2000.

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

    \13\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-30769 Filed 12-1-00; 8:45 am]
BILLING CODE 8010-01-M