[Federal Register Volume 59, Number 232 (Monday, December 5, 1994)]
[Unknown Section]
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From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-29791]
[[Page Unknown]]
[Federal Register: December 5, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35015; File No. SR-Phlx-93-14]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval of Amendment Nos. 1 and 2 to the Proposed
Rule Change Relating to Hedge Order Spread Priority
November 29, 1994.
On April 1, 1993, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to permit various types of hedge
orders to attain spread priority. On November 17, 1994, the Phlx
submitted Amendment Number 1 (``Amendment No. 1'') to the proposal to
clarify, among other things, that the proposed priority principles in
the original filing will only apply to hedge orders and to remove
synthetic option orders from the definition of hedge order.\3\ On
November 23, 1994, the Phlx filed Amendment No. 2 (``Amendment No. 2'')
to the proposal to clarify the definition of multi-spread transaction
in Commentary .02 to Rule 1066 and amend Options Floor Procedure Advice
F-14 to reference the procedures for the execution of synthetic
orders.\4\
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\1\15 U.S.C. Sec. 78s(b)(1) (1982).
\2\17 CFR Sec. 240.19b-4 (1991).
\3\See Letter from Gerald D. O'Connell, First Vice President,
Phlx, to Michael Walinskas, Derivative Products Regulation, SEC,
dated November 17, 1994.
\4\See Letter from Gerald D. O'Connell, First Vice President,
Phlx, to Michael Walinskas, Derivative Products Regulation, SEC,
dated November 23, 1994.
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Notice of the proposed rule change was published for comment and
appeared in the Federal Register on November 17, 1993.\5\ No comments
were received on the proposal. This order approves the proposal, as
amended.
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\5\See Securities Exchange Act Release No. 33179 (November 10,
1993), 58 FR 60715.
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I. Description of the Proposal
The Phlx proposes to permit certain types of hedge orders to attain
spread priority, i.e., to be executed as a single transaction, with
priority over certain existing bids or offers for each leg of the
transaction. Under the proposal, the Exchange is amending Rule 1066 to
define the types of hedge orders that would be eligible for spread
priority. Specifically, paragraph (f) of Rule 1066 would be amended to
define the term hedge order to include spread orders, straddle orders,
and combination orders for the same account.\6\ Additionally, Rule
1066(g) would be amended to define a synthetic option order as an order
to buy or sell a stated number of option contracts and buy or sell the
underlying stock in an amount that would offset (on a one-for-one
basis) the option position. This proposed definition would include buy-
writes, synthetic calls, and synthetic puts. As with hedge orders,
synthetic options may be quoted at a net debit or credit.\7\
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\6\A combination order under proposed Rule 1066(f)(3) would
include conversions (generally, a transaction involving buying the
underlying stock, buying a put, and selling call) and reversals
(generally, a transaction involving selling the underlying stock,
selling a put, and buying a call). See Amendment No. 1 and
Securities Exchange Act Release No. 22373 (Aug. 29, 1985), 50 FR
36686 (Sept. 9, 1985).
\7\See Amendment No. 1.
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Currently, Phlx Rule 1033(d) affords priority to certain spread
transactions. Under this provision, an eligible spread is executable as
a single transaction at a total net credit/debit against one other
member that represents all legs of the trade provided that net credit/
debit improves the established market for the spread as measured by the
aggregate price of the respective legs, if executed individually. The
new proposed language to Rule 1033(d) would clarify that in order to
establish whether a spread transaction has improved the established
market, at least one option leg must be executed at a better price than
the established market for the option and no option leg can be executed
outside of the established market.\8\ Pursuant to this proposed rule
change, all of the types of hedge orders defined in proposed Rule
1066(f) would be eligible for spread priority.\9\ Rule 1033(e) would
clarify the priority principles applicable to synthetic options,\10\
and Rule 1033 would also be amended to add headings to each paragraph
for quick reference to the appropriate topic.
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\8\See Amendment No. 2.
\9\Amendment No. 1 clarifies that synthetic options will not be
eligible for hedge order priority.
\10\Because spread priority principles will not apply, the
option leg of a synthetic option order will have to be executed at a
price better than the established market in order to be eligible for
net debit/credit quoting and execution. The option leg of a
synthetic option order, in that instance, will receive price
priority under the normal priority principles (i.e., it must better
the existing market to receive priority.) See Amendment No. 1 and
Rule 1014.
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As a result of the proposed changes to Rules 1066 and 1033,
corresponding changes to OFPA F-4 will be required. OFPA F-4 (Orders
Executed as Spreads, Straddles, or Combinations) would be amended to
reflect the definitional changes to Rule 1066. Accordingly, the title
would be changed to ``Orders Executed as Spread, Straddle, Combination
or Synthetic Orders,'' and the text would reflect the new term,
synthetic orders. OFPA F-4 would additionally require the marking of
order tickets executed in reliance upon the spread priority rules with
a ``syn'' for synthetic orders in addition to the existing requirement
that spreads, straddles, and combinations also be marked with the
identifier ``sp,'' ``st,'' or ``comb.'' Also, the Phlx will disseminate
the appropriate Options Price Reporting Authority (``OPRA'') prefix as
an indicator that each option leg was executed as part of a hedge
transaction.\11\ A new Advice enumerating the procedure for executing
hedge orders is also proposed for both equity option and foreign
currency option (``FCO'') floors. OFPA F-14 (Executing Hedge Orders)
restates the definitions in Rule 1066(f) and the priority procedures in
Rule 1033(d) and (e) for easy reference by floor persons in the floor
procedure advice handbook. Finally, Advice D-2, Instances of Non-
Liability for Floor Brokers or Specialists, would be amended to include
synthetic orders.
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\11\ See Amendment No. 1.
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Certain changes proposed by the Phlx to Rules 1066 and 1033 are
applicable solely to the trading of FCOs. The Phlx believes these
changes will allow Phlx market participants to utilize foreign currency
options contracts more effectively as risk hedging instruments. The
Exchange notes that the FCO markets tend to attract and be utilized by
sophisticated institutional and corporate investors. This is in part
due to the nature of the instruments and the tremendous size of the
underlying currency markets. Sophisticated institutional and corporate
investors frequently effect ratio and multi-part transitions, rather
than relying on one-to-one spreads and other orders.
First, because Rule 1033 deals with priority for different types of
spreads, existing Commentary .02 of Rule 1066 is proposed to be moved
to Rule 1033(f). Because Rule 1066 generally contains definitional
provisions, a new Commentary .02 to Rule 1066 would be adopted
containing a definition of multi-spread transactions in FCOs.\12\
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\12\The Phlx amended Commentary .02 to Rule 1066 to require that
all legs of a multi-spread transaction be for the same account. See
Amendment No. 2.
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Second, Rule 1033(g) is proposed to be added to state that for
options on foreign currency, a spread order may consist of a different
number of contracts so long as the number of contracts differ by a
permissible ratio. As a result, ratio spreads would become eligible for
spread priority pursuant to Rule 1033(d). For purposes of this rule, a
permissible ratio would be defined as one-to-one, on-to-two, one-to-
three, and two-to-three.
Third, proposed Rule 1033(h) is a new paragraph governing multi-
spread priority for an FCO participant holding two spread type orders
for the same amount. Eligible multi-spread transactions in FCOs, as
defined in new Commentary .02 of Rule 1066, could be executed as a
single transaction as long as at least one of the individual legs of
each individual spread (up to a maximum of six legs for the total
transaction, or two spreads) is executed at a better price than the
established bid or offer for that option, and that no option leg is
executed at a price outside of the established bid or offer for that
option contract. The language of Rule 1033(h) parallels existing
language in Rule 1033(f), relating to three-way transactions.\13\
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\13\Proposed amended rule 1033(f) defines three-way transactions
as spread, straddle, and combination orders of three individual
series in the same FCOs where (i) the order size for each of the
three individual series are equal to each other, or (ii) the
combined order size of any two series on the same side of the market
is either equal to the order size of the third series or differs
from the order size of the third series by a permissible ratio. A
permissible ratio is any one of the following: one-to-one, one-to-
two, one-to-three, and two-to-three.
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Finally, OFPA F-16 (Two-Way, Three-Way and Multi-Spread
Transactions) is proposed by the Phlx for adoption. This Advice
restates the aforementioned definitions and procedures regarding FCO
spread priority for easy reference by floor persons in the floor
procedure advice handbook.
II. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5).\14\ In particular, the
Commission believes the proposal is consistent with the Section 6(b)(5)
requirement that the rules of an exchange be designed to promote just
and equitable principles of trade and not to permit unfair
discrimination between customers, issuers, brokers, and dealers.
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\14\15 U.S.C. Sec. 78f(b)(5) (1982).
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The Commission believes that the proposal will ensure adequate
protection to investors because the rule as amended will only afford
priority to those transactions that improve the established market for
the spread, as measured by the aggregate price of all legs of the
transaction. Because the rule provides that at least one leg of the
transaction must be executed at a better price than the established
market for the option and that no leg of the transaction may be
executed outside of the established market for the option series, the
Commission believes that this change affords greater protection to the
limit order book and therefore, that customer limit orders will not be
disadvantaged. Furthermore, because the Rule currently requires that
one member must represent all legs of the trade and that the trade may
only be executed against one other member, public customers are still
less likely to lose priority to hedge orders. The Commission believes
the proposal is a reasonable effort by the Phlx to accommodate the
ability to price hedge orders more competitively while at the same time
not disadvantaging the public customer limit order book. The Commission
also notes that the priority principles applicable to synthetic options
remain unchanged, i.e., the option leg will have to be executed at a
price better than the established market in order to receive price
priority.\15\
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\15\See supra notes 9 and 10.
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The Phlx has created a new Advice, OFPA F-14, that restates the
definitions of hedge orders contained in Rule 1066(f) and enumerates
the priority principles contained in Rule 1033. Additionally, the Phlx
has amended OFPA F-4 to, among other things, require the marking of
order tickets executed in reliance upon the spread priority rules. OFPA
F-14 simply restates the definitions and principles already established
in Rules 1066 and 1033 for easy reference by floor traders. Moreover,
the amendment to OFPA F-4 merely crates a new trade identifier for
synthetic options similar to that already required the hedge orders.
Accordingly, the Commission believes these changes raise no new or
unique regulatory issues.
Several other changes are applicable only to foreign currency
options. The Phlx has added Commentary .02 to Rule 1066 to provide a
definition of multi-spread transactions, and new paragraph (h) to Rule
1033 was created to allow multi-spread transactions in FCOs for the
same account to be executed as a single transaction in accordance with
spread priority principles. Although the Commission has been concerned
that granting priority to ratio orders and multi-part transactions
would allow institutional orders to preempt public customer orders, the
Commission believes the above changes are appropriate in the context of
the FCO market only for several reasons. First, the Commission notes
that the FCO market is dominated by institutions and sophisticated
corporate investors who regularly utilize ratio orders and conduct
multi-spread transactions. Second, because the number of public
customer orders placed on the books of foreign currency specialists is
not significant, preemption of customer orders is unlikely. Third, the
priority rules applicable to multi-spread transactions mirror the
priority rules currently in place for three-way spread type orders, as
stated in Rule 1033(e). Because a multi-spread order, as defined by
Commentary .02 to Rule 1066, combines two-way and/or three-way spread
transactions (to a maximum of six legs for the total transaction), and
must be for the same account, the Commission believes that this change
will allow institutional investors to better utilize sophisticated
trading techniques involving FCO's without altering the existing
priority principles applicable to three-way orders.
The proposal also permits spread orders in the FCO market to
consist of a different number of contracts provided the number of
contracts differ by a permissible ratio. This will permit ratio orders
to become eligible for spread priority pursuant to Rule 1033(d). The
Commission recognizes the predominance of institutional investors and
the prevalence of spread-type ratio orders in the FCO markets.
Accordingly, the Commission believes the ability to utilize ratio
orders will facilitate opportunities for risk hedging.
The Phlx has restated the above changes to the definitions and
priority principles applicable to FCOs in OFPA F-16 for easy reference
by floor persons. Therefore, the Commission does not believe these
changes raise any new or unique regulatory issues.
Finally, OFPA D-2 has been amended to provide for the inclusion of
synthetic options. Because synthetic orders consist of two separate
transactions which may be quoted at a net debit/credit, the Commission
notes there will be instances where floor members will be unable to
fill both components of the order at the net price. Accordingly, the
Commission believes it is proper to include synthetic orders within
OFPA D-2 so as not to subject floor members to liability for failure to
fill an order at a specified price.
The Commission finds good cause for approving Amendment Nos. 1 and
2 to the proposed rule change prior to the thirtieth day after the date
of publication of notice thereof in the Federal Register. Amendment No.
1 permits synthetic orders to be quoted at a net debit/credit, and also
removes synthetic options from the definition of hedge order. The
ability to quote in net prices will permit market participants to price
these orders more precisely, which should result in greater efficiency
and improved liquidity in their execution, and better prices for
investors. Furthermore, the Commission notes that the exclusion of
synthetic orders from the definition of hedge order will have the
effect of not extending the spread priority rules to synthetic orders.
The Commission believes this will prevent the excessive loss of
priority to public customers on the limit order book. Additionally, the
Amendment requires the stock portion of synthetic options and
conversions and reversals to be executed prior to the execution of the
option portion of the transaction. The Commission believes this change
is consistent with previous instances where the Commission has required
related transactions to be effected prior to the execution of the
options order, in order to prevent stock prices from being influenced
by the options leg of the transaction. The definitions of hedge order
in Rule 1066(f) and multi-spread transaction in Commentary .02 to Rule
1066 in Amendment No. 2 have also been amended to include the
requirement that all legs of the transaction(s) be for the same
account.\16\ The Commission believes these changes will prevent the
unbundling of orders for the purpose of taking advantage of the
benefits of the spread priority rules. Amendment No. 2 also creates a
new paragraph (d) in OFPA F-14 for synthetic option orders. This change
simply restates for the benefit of floor personnel the procedures
involved in executing synthetic orders and, therefore, raises no new or
unique regulatory issues. Finally, in Amendment No. 2, the Phlx
inserted the clause ``in accordance with Rule 1014'' to paragraph (e)
of Rule 1033. The Commission notes that this change clarifies that
synthetic orders are not eligible for special priority rules and that
they must instead be executed in accordance to the Phlx's normal order
priority principles, which are referenced in Rule 1014 (g) and (h).
Accordingly, the Commission believes it is consistent with Sections
6(b)(5) and 19(b) of the Act to approve Amendment Nos. 1 and 2 to the
proposed rule change on an accelerated basis.
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\16\Amendment No. 1 clarifies the definition of hedge order
while Amendment No. 2 relates to multi-spread transactions.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1 and 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying at the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the above-mentioned
self-regulatory organization. All submissions should refer to the file
number in the caption above and should be submitted by December 27,
1994.
It therefore is Ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change, as amended, (SR-Phlx-93-14) is
approved.
\17\15 U.S.C. Sec. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
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\18\17 CFR Sec. 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-29791 Filed 12-2-94; 8:45 am]
BILLING CODE 8010-01-M
