[Federal Register Volume 83, Number 247 (Thursday, December 27, 2018)]
[Notices]
[Pages 66779-66782]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27992]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-84870; File No. SR-NYSEAMER-2018-39]
Self-Regulatory Organizations; NYSE American LLC; Order
Instituting Proceedings To Determine Whether To Approve or Disapprove a
Proposed Rule Change To Allow Flexible Exchange Equity Options Where
the Underlying Security Is an Exchange-Traded Fund That Is Included in
the Option Penny Pilot To Be Settled in Cash
December 19, 2018.
I. Introduction
On September 20, 2018, NYSE American LLC (``NYSE American'' or the
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act
[[Page 66780]]
of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule
change to modify the rules related to Flexible Exchange (``FLEX'')
Options to allow FLEX Equity Options where the underlying security is
an Exchange-Traded Fund (``ETF'') that is included in the Option Penny
Pilot to be settled in cash.\3\ The proposed rule change was published
for comment in the Federal Register on October 11, 2018.\4\ On November
19, 2018, pursuant to Section 19(b(2) of the Act,\5\ the Commission
designated a longer period within which to either approve the proposed
rule change, disapprove the proposed rule change, or institute
proceedings to determine whether to disapprove the proposed rule
change.\6\ The Commission received one comment on the proposed rule
change.\7\ This order institutes proceedings under Section 19(b)(2)(B)
of the Act\8\ to determine whether to approve or disapprove the
proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ For the definitions of ``FLEX Options,'' ``FLEX Equity
Options,'' and ``Option Penny Pilot,'' see infra notes 9 and 11.
\4\ See Securities Exchange Act Release No. 84364 (October 4,
2018), 83 FR 51535 (October 11, 2018) (``Notice'').
\5\ 15 U.S.C. 78s(b)(2).
\6\ See Securities Exchange Act Release No. 82994 (April 4,
2018), 83 FR 15441 (April 10, 2018). The Commission designated
January 9, 2019, as the date by which it should approve, disapprove,
or institute proceedings to determine whether to disapprove the
proposed rule change.
\7\ See Letter to Brent J. Fields, Secretary, Commission, from
Samara Cohen, Head of ETF Global Markets, BlackRock, dated November
27, 2018 (``BlackRock Letter'').
\8\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposal and Comments Received
The Exchange has proposed to amend NYSE American Rule 903G(c) to
allow for cash settlement for certain FLEX Equity Options.\9\
Currently, FLEX Equity Options settle by physical delivery of the
underlying security.\10\ The Exchange proposes, in the case of a FLEX
Equity Option whose underlying security is an ETF that is included in
the Option Penny Pilot \11\ (``FLEX ETF Option''), to allow settlement
either by the delivery of cash or, as currently permitted under the
Exchange rules, by physical delivery of the underlying security.\12\
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\9\ A ``FLEX Option'' is a customized options contract that is
subject to the rules in Section 15, Flexible Exchange Options. See
NYSE American Rule 900G(b)(1). A ``FLEX Equity Option'' is an option
on a specified underlying equity security that is subject to the
rules of Section 15. See NYSE American Rule 900G(b)(10).
\10\ See NYSE American Rule 903G(c)(3)(i). There is an exception
to physical settlement for settlement of FLEX Binary Return
Derivatives (``ByRDs''). See NYSE American Rules 900G(b)(17),
903G(c)(3)(ii), and 910ByRDs.
\11\ The ``Option Penny Pilot'' is a pilot program by the
options exchanges that permits certain option classes to be quoted
in penny or nickel increments on a pilot basis. See NYSE American
Rule 960NY, Commentary .02. See also Securities Exchange Act Release
No. 55162 (January 24, 2007), 72 FR 4738, 4739 (February 1, 2007)
(SR-Amex-2006-106) (``Option Penny Pilot Approval Order''). The
Option Penny Pilot is currently set to expire on December 31, 2018.
See NYSE American Rule 960NY, Commentary .02.
\12\ See proposed NYSE American Rule 903G(c)(3)(ii). The
Exchange proposes conforming changes to NYSE American Rule
903G(c)(3) to reflect that the proposed rule change would add a
second exception to the general requirement for physical settlement
for FLEX Equity Options. See proposed NYSE American Rule
903G(c)(3)(i) and (iii).
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The Exchange states that it believes that it is appropriate to
introduce cash settlement as an alternative for FLEX ETF Options
because ETFs generally have increasingly become a major part of
investors' portfolios, allowing investors to take advantage of many
unique opportunities to hedge their portfolios and manage risk.\13\ The
Exchange asserts that physical settlement possess certain risks with
respect to volatility and movement of the underlying security at
expiration that market participants may need to hedge against and cash
settlement does not present these same risks.\14\
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\13\ See Notice, supra note 4, at 51535-36.
\14\ See id. at 51536. The Exchange also states that market
participants trade cash-settled FLEX ETF Options in the over-the-
counter market and exchange trading would provide benefits to these
market participants. See id.
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The Exchange states that it seeks to allay concerns about cash-
settled equity options by proposing to adopt cash settlement as an
alternative settlement method for 64 ETFs that are included in the
Option Penny Pilot.\15\ The Exchange adds that generally index options
are cash-settled and derive their value from a disseminated index
price, and that similarly ETFs typically have their values linked to a
disseminated index price.\16\ The Exchange states that the option
classes included in the original pilot were chosen based on being one
of the most actively-traded multiply-listed options classes and also
states that the most recent expansion identified the most-active
classes based on the ``underlying security's `national average daily
volume over a six-month period.' '' \17\
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\15\ See id.
\16\ See id.
\17\ See id. The Commission notes that the criteria for
qualifying for the Option Penny Pilot is based on the national
average daily volume over a six month period in the options class
itself, not based on the volume of the underlying ETF. See
Securities Exchange Act Release No. 60711 (September 23, 2009), 74
FR 49419 (September 28, 2009) (SR-NYSEArca-2009-44) (``Option Penny
Pilot Expansion Order'') and Securities Exchange Act Release No.
61106 (December 3, 2009), 74 FR 65193 (December 9, 2009) (NYSEAmex-
2009-74) (Option Penny Pilot Expansion Notice'').
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The Exchange states that cash-settled FLEX ETF Options would be
subject to the same position limits as non-cash-settled FLEX ETF
Options (i.e., the position limits in NYSE American Rule 906G).\18\ The
Exchange represents that it confirmed with the Options Clearing
Corporation (``OCC'') that OCC can support the clearance and settlement
of cash-settled FLEX ETF Options.\19\ The Exchange also states that it
believes the Exchange and the Options Price Reporting Authority
(``OPRA'') have the necessary systems capacity to handle the additional
traffic associated with the listing of cash-settled FLEX ETF Options
and that it believes that its members will not have a capacity issue as
a result of the proposal.\20\ The Exchange represents that it does not
believe that the proposed rule change will cause fragmentation of
liquidity.\21\ The Exchange further represents that it will monitor the
trading volume associated with the options series listed as a result of
this proposed rule change and the effect, if any, of these series on
market fragmentation and on the capacity of the Exchange's automated
systems.\22\
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\18\ See Notice, supra note 4, at 51536. The Exchange adds that
other existing regulatory safeguards, such as exercise limits and
reporting requirements, would also continue to apply. See id. at
51537. The Commission notes that NYSE American Rule 906G provides
generally that there are no position limits for FLEX Equity Options,
but that positions in FLEX Options that expire on a third Friday-of-
the-month expiration day (``Expiration Friday'') will be aggregated
with positions in non-FLEX Options on the same underlying and
subject to the position limits applicable to such options. See NYSE
American Rule 906G(b).
\19\ See Notice, supra note 4, at 51536.
\20\ See id.
\21\ See id.
\22\ See id.
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The Exchange represents that it will have an adequate surveillance
program for cash-settled FLEX ETF Options and states that it intends to
use the same surveillance procedures, including procedures concerning
surveillance for manipulation, for cash-settled FLEX ETF Options that
it uses for the Exchange's other options products.\23\ The Exchange
states that it believes manipulating the settlement price of cash-
settled FLEX ETF Options would be difficult because of the size of the
market for such ETFs.\24\ According to the Exchange each cash-settled
FLEX ETF Option is sufficiently active so as to alleviate concerns
about the potential
[[Page 66781]]
for manipulation.\25\ The Exchange states that the vast liquidity of
ETF options and the underlying equities markets and the high level of
participation among market participants that enter quotes or orders in
ETF options would, according to the Exchange, make it very difficult
for a single participant to alter the prices of each security
underlying an ETF without becoming exposed to regulatory scrutiny and
that such attempt at manipulation would be cost-prohibitive.\26\
Moreover, the Exchange states that it is a member of the Intermarket
Surveillance Group (``ISG'') and therefore would have access to
surveillance and investigative information regarding trading in the
underlying securities.\27\
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\23\ See id.
\24\ See id.
\25\ See id. at 51536-37.
\26\ See id. at 51537.
\27\ See id.
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The Commission received one comment letter, which supports the
proposed rule change.\28\ The commenter states that it agrees with the
Exchange that the proposal alleviates several potential challenges
associated with physical settlement and presents advantages to the end
investor. This commenter asserts that the proposal would lead to
greater standardization of contract terms, mitigate counterparty risk,
increase price discovery, and improve information dissemination, which
would lead to greater transparency.\29\
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\28\ See BlackRock Letter, supra note 7.
\29\ See id.
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III. Proceedings To Determine Whether To Approve or Disapprove SR-
NYSEAMER-2018-39 and Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act to determine whether the proposal should be
approved or disapproved.\30\ Institution of such proceedings is
appropriate at this time in view of the legal and policy issues raised
by the proposed rule change, as discussed below. Institution of
disapproval proceedings does not indicate that the Commission has
reached any conclusions with respect to any of the issues involved.
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\30\ 15 U.S.C. 78s(b)(2)(B).
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Pursuant to Section 19(b)(2)(B) of the Act, the Commission is
providing notice of the grounds for disapproval under consideration.
The Commission is instituting proceedings to allow for additional
analysis and input concerning the proposed rule change's consistency
with the Act \31\ and, in particular, with Section 6(b)(5) of the Act,
which requires, among other things, that the rules of a national
securities exchange be designed to prevent fraudulent and manipulative
acts and practices, to promote just and equitable principles of trade,
to remove impediments to and perfect the mechanism of a free and open
market and a national market system and, in general, to protect
investors and the public interest.\32\
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\31\ 15 U.S.C. 78f(b)(5).
\32\ Id.
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As discussed above, the Exchange proposes to modify NYSE American
Rule 903G(c)(3)(ii) to allow cash settlement for FLEX ETF Options. In
its proposal, the Exchange acknowledges that concerns have been raised
in the past regarding the susceptibility of cash-settled equity options
to manipulation. The Exchange asserts that to address such concerns, it
has proposed to limit cash settlement to options on a narrow set of
ETFs that are the most actively traded, as evidenced by the inclusion
of options on those ETFs in the Option Penny Pilot.\33\ The Commission
notes that the goal of the Option Penny Pilot since its inception has
been to analyze the impact of penny quoting on options spreads,
transaction costs, payment for order flow, and quote message
traffic.\34\ As a result, the Option Penny Pilot eligibility criterion
is based on the national average daily volume of the options classes
rather than the volume in the underlying securities.
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\33\ See Notice, supra note 4, at 51536.
\34\ See Option Penny Pilot Approval Order, supra note 11, at
4740. As noted in the 2009 Option Penny Pilot Expansion Order, for
example, the pilot report provided information on the most active
and least active options classes in the pilot and analyzed the
impact the pilot had on those options in certain specified areas.
See supra note 17, at 49420. See also Option Penny Pilot Expansion
Notice, supra note 17, at 65194.
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The Commission notes that critical to any assessment of the
potential for manipulation when trading cash-settled options on ETFs is
also an analysis of the liquidity and depth of the market for both the
ETFs underlying the options and the component securities of the ETFs
themselves. The Exchange has not, however, provided any specific data,
analysis, and studies demonstrating that the ETFs underlying the
options included in the Option Penny Pilot have the liquidity necessary
to adequately address concerns on the risks of manipulation and
potential for market disruption that may arise from cash settlement on
such options.
As noted above, because options in the Option Penny Pilot are
assessed every six months based on options trading volume, we believe
the 64 ETFs underlying the options in the Option Penny Pilot that the
Exchange identifies generally in its proposal were those eligible for
the pilot as of the date the Exchange submitted its proposal to the
Commission. This raises further questions, which are not addressed in
the current proposal, as to how the Exchange will treat options on
those ETFs that become ineligible for the Option Penny Pilot in the
future, as well as how to analyze the potential for manipulation and
market disruption from future ETFs underlying options that are not yet,
but later, included in the Option Penny Pilot and will therefore become
eligible for cash settlement under the Exchange's proposal.
The Exchange also takes the position that cash settlement for
options is not unique because other options exchanges trade cash-
settled options.\35\ Cash-settled options on equity securities such as
ETFs that hold specific component securities, however, are unique and
present distinct issues different from cash-settled index options that
track an index. The Commission notes that allowing for cash settlement
of FLEX ETF Options, as proposed, would permit cash settlement on a
significantly broader set of equity options than that previously
approved. Further, it is not clear from the Exchange's proposal how the
expanded use of cash settlement for equity options may bear on the
potential for manipulation or impact market quality since, as noted
above, the proposal lacks any supporting data or analysis on these
issues.
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\35\ See Notice, supra note 4, at 51536.
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The Exchange proposes to apply the same position limits to cash-
settled FLEX ETF Options as for other FLEX Equity Options. The
Commission notes that the Exchange generally does not impose position
limits for FLEX Equity Options unless the FLEX Equity Options'
expiration coincides with an Expiration Friday.\36\ This means that
there would be no position limits, including on the days leading up to
and surrounding Expiration Friday, for many of the cash-settled FLEX
ETF Options under the proposal. The Commission is therefore concerned
that the lack of position limits for non-Expiration Friday expiring
cash-settled FLEX ETF Options could make them more susceptible to
manipulation and could lead to market disruption.
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\36\ See NYSE American Rule 906G(b).
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Finally, the Commission notes that the proposal would allow for
settlement in cash or by physical delivery on options that otherwise
have the same terms. The Commission notes that allowing both physical
delivery and cash settlement alternatives could
[[Page 66782]]
increase market fragmentation and raise additional manipulation
concerns.
The Commission notes that under the Commission's Rules of Practice,
the ``burden to demonstrate that a proposed rule change is consistent
with the Exchange Act and the rules and regulations issued thereunder .
. . is on the self-regulatory organization [`SRO'] that proposed the
rule change.'' \37\ The description of a proposed rule change, its
purpose and operation, its effect, and a legal analysis of its
consistency with applicable requirements must all be sufficiently
detailed and specific to support an affirmative Commission finding,\38\
and any failure of an SRO to provide this information may result in the
Commission not having a sufficient basis to make an affirmative finding
that a proposed rule change is consistent with the Exchange Act and the
applicable rules and regulations.\39\
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\37\ Rule 700(b)(3), Commission Rules of Practice, 17 CFR
201.700(b)(3).
\38\ See id.
\39\ See id.
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For these reasons, the Commission believes it is appropriate to
institute proceedings pursuant to Section 19(b)(2)(B) of the Act to
determine whether the proposal should be approved or disapproved.
IV. Commission's Solicitation of Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
issues identified above, as well as any other concerns they may have
with the proposal. In particular, the Commission invites the written
view of interested persons concerning whether the proposal is
consistent with Section 6(b)(5) or any other provision of the Act, or
the rules and regulations thereunder. Although there do not appear to
be any issues relevant to approval or disapproval that would be
facilitated by an oral presentation of views, data, and arguments, the
Commission will consider, pursuant to Rule 19b-4, any request for an
opportunity to make an oral presentation.\40\
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\40\ Section 19(b)(2) of the Exchange Act, as amended by the
Securities Act Amendments of 1975, Public Law 94-29 (June 4, 1975),
grants the Commission flexibility to determine what type of
proceeding--either oral or notice and opportunity for written
comments--is appropriate for consideration of a particular proposal
by a self-regulatory organization. See Securities Act Amendments of
1975, Senate Comm. on Banking, Housing & Urban Affairs, S. Rep. No.
75, 94th Cong., 1st Sess. 30 (1975).
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Interested persons are invited to submit written data, views, and
arguments regarding whether the proposal should be approved or
disapproved by January 17, 2019. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
January 31, 2019. The Commission asks that commenters address the
sufficiency of the Exchange's statements in support of the proposal
which are set forth in the Notice,\41\ in addition to any other
comments they may wish to submit about the proposed rule change.
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\41\ See Notice, supra note 4.
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Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NYSEAMER-2018-39 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-NYSEAMER-2018-39. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
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 website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing also will be available for inspection
and copying at the principal office of the Exchange. All comments
received will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-NYSEAMER-2018-39 and should be submitted
on or before January 17, 2019. Rebuttal comments should be submitted by
January 31, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\42\
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\42\ 17 CFR 200.30-3(a)(57).
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Brent J. Fields,
Secretary.
[FR Doc. 2018-27992 Filed 12-26-18; 8:45 am]
BILLING CODE 8011-01-P