[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
