[Federal Register Volume 61, Number 186 (Tuesday, September 24, 1996)]
[Notices]
[Pages 50060-50065]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-24367]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37691; File No. SR-Phlx-96-38]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the Philadelphia Stock Exchange, Inc., Relating to the
Listing and Trading of FLEX Index and FLEX Equity Options
September 17, 1996.
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 August
21, 1996, the Philadelphia Stock Exchange, Inc., (``Phlx'' or
Exchange'') filed with the Securities and Exchange Commission (``Sec''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by the Self-
regulatory organization. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
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 adopt Rule
1079, Index and Equity FLEXTM \1\ Options, to govern the trading
of customized or flexible (``FLEX'') index and equity options on the
Exchange. Specifically, the Exchange proposes to trade FLEX options on
the following two broad-based (market) index options currently traded
on the Phlx: Value Line Composite Index (``VLE'') and National Over-
the-Counter Index (``XOC``). The Phlx also proposes to trade FLEX
industry (narrow-based) index options pursuant to the proposed rule on
the following four industry index options currently traded on the Phlx:
Bank Index (``BKX''), Gold/Silver Index (``XAU''), Semiconductor Index
(``SOX'') and Utility Index (``UTY''). In addition, 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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\1\ The term ``FLEX'' is a trademark of the Chicago Board
Options Exchange, Inc. (``CBOE'').
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Proposed Rule 1079 contains the characteristics, trading procedure
and other provisions applicable to trading FLEX options. All FLEX
options would trade 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 Phlx options. Proposed
Rule 1079 also states that although FLEX options are generally subject
to the rules in the options section, to the extent that the provisions
of Rule 1079 are inconsistent with other applicable Exchange rules,
Rule 1079 takes precedence with respect to FLEX options.
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 submits a Request-for-Quote (``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).\2\ 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). 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.
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\2\ The Exchange notes that Rule 1079 generally parallels the
provisions of Rule 1069 governing foreign currency options.
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The exercise style can be either American or European,\3\
regardless of the exercise style of the listed option.\4\ 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). In addition, a
[[Page 50061]]
new series cannot be opened on the day of exercise.
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\3\ 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).
\4\ European style equity FLEX options may be adjusted to
require the delivery upon exercise of a fixed amount of cash. See
proposed amendments to the Options Clearing Corporation (``OCC'')
By-Law, Article IV, Section 11, Interpretation and Policy .08 in
Securities Exchange Act Release No. 37318 (June 18, 1996) (SR-OCC-
96-03).
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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 in 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.
However, assigned Registered Options Traders (``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 at the: (i) close of trading (P.M.-settled), (ii)
opening (A.M.-settled) of trading on the Exchange, or (iii) as an
average over a specified period of time, within parameters established
by the Exchange. 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. 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 the exercise-by-exception
procedures of OCC.\5\
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\5\ 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.\6\
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\6\ See Rules 1000(b)(7) and 1066(f).
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The quoting and trading procedure for FLEX options, beginning with
RFQ, is enumerated in Rule 1079(b). Submitting an RFO in the
appropriate trading crowd is the first step in quoting FLEX options.
The Requesting Member must announce and submit an RFQ ticket containing
the following: (1) Underlying index or security, (2) type, (3) exercise
style, (4) expiration date, (5) exercise price, and (6) settlement
value (A.M. or P.M.) and currency for index FLEX options. On receipt of
an RFQ in proper form, the assigned Specialist, or if none, 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'').\7\ RFQs, responsive quotes and completed trades
will be promptly reported to OPRA and disseminated as an administrative
text message.
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\7\ Operationally, the Requesting Member provides this
information to a key puncher, who enters 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.\8\ 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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\8\ Initially, the Options Committee has established a response
time of 10 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.
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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''), in accordance with Rule 1014, 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 and the assigned Specialist.
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. 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.
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
[[Page 50062]]
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. 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.
Once the BBO is established, it remains open that trading day.
Because the market remains open, a member may re-quote the market
without submitting an additional RFQ. An assigned ROT or assigned
Specialist who responded may immediately join that market, thus
matching for parity purposes. However, markets remaining open are not
firm, as defined in Rule 1033(a).
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.
Customers 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
submitted for dissemination. In order to trade with the book, an
executing member must quote the market and announce the trade. The
executing member has priority over other members, including assigned
ROTs and the assigned Specialist, seeking to trade with the booked
order.
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 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 contra-side 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 25%. The remainder of the
contra-side is split in accordance with the parity/priority provision
set forth in proposed Rule 1079(b)(3).
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 set forth in proposed
Rule 1079(b)(3).
The Exchange notes that an ROT and Specialist may trade FLEX
options as an assigned ROT/Specialist or as a non-assigned ROT/
Specialist. 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.\9\ At least two ROTs and/or a Specialist shall be assigned to
each FLEX option. Because of these 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,
provided they do so immediately. Enabling assigned ROTs and the
assigned Specialist to join such new bid/offer affords them parity at
that new BBO.
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\9\ 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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There will be no trading rotations in FLEX options, either at the
opening or at the close of trading. Unless otherwise determined by the
Exchange, transactions in FLEX options may be effected each trading day
from 10:00 A.M. to: (1) 4:15 P.M. respecting market index FLEX options;
and (2) 4:10 P.M. respecting industry index FLEX and equity FLEX
options.
Generally, FLEX option positions are not taken into account when
calculating position limits for non-FLEX options on the same index.\10\
Accordingly, broad-based index FLEX options will be subject to a
separate position limit of 200,000 contracts on the same side of the
market. Narrow-based index FLEX options will be subject to a position
limit of four times the current position limit--24,000, 36,000 or
48,000 contracts on the same side of the market. 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 limit as well as the equity FLEX
option limits are the same as the provisions of other exchanges.\11\
The Exchange also notes that because the market index FLEX option limit
is eight times the non-FLEX limit and the equity FLEX option limit is
three times the non-FLEX limit, the Exchange believes that four times
the non-FLEX limit is an appropriate limit for industry index FLEX
options.
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\10\ 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
pursuant to Rule 1101A(b)(iv), although none currently trade.
\11\ See e.g., CBOE Rule 24A.7(b).
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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 \12\ issued by a clearing member organization, specifically
accepting financial responsibility for all FLEX option transactions
made by such person. Moreover, a minimum of $100,000 in net liquid
assets is required to be maintained by assigned ROTs and assigned
Specialists. 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 must immediately notify the Exchange's
Examinations Department upon failure to be in compliance with these
requirements.
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\12\ See Phlx Rule 703.
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The Exchange also proposes to adopt Floor Procedure Advice
(``Advice'') F-28, Trading Index and Equity FLEX Options, to parallel
most of the
[[Page 50063]]
provisions of Rule 1079(b), including those pertaining to requesting
quotations, response, 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. The
text of the proposed rule change is available at the Office of the
Secretary, the Exchange, and at the Commission.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the 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 statements.
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, 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
traded by institutional investors with specific trading needs. In
response, the Exchange seeks to trade FLEX options in an exchange
auction market environment, with the Options Clearing Corporation
(``OCC'') as issuer and guarantor.\13\ Thus, FLEX options are
structured with a minimum size reflecting the larger-sized trades of
these institutional users.\14\
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\13\ 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.
\14\ 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. 31910
(February 23, 1993).
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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.\15\ Generally, FLEX options
shall be traded in accordance with many existing equity option and
index option rules; however, Rule 1079 contains certain new trading
procedures unique to FLEX options. In addition, the proposal is similar
to the rule and proposals by other exchanges respecting flexible
options.\16\
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\15\ Securities Exchange Act Release No. 34925 (November 1,
1994) (SR-Phlx-94-18).
\16\ See, e.g., CBOE Rules 24A. 1--24A.17; Amex Rules, Section
15, Rules 900G, et. seq.; and PSE Rules 8.100--8.115.
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Several of the proposed provisions are intended to ensure orderly
trading. For example, FLEX options will begin trading at 10:00 A.M.,
one half hour after the normal opening of options trading on the
exchange, in order to limit the burden on the trading crowd. Industry
index and equity FLEX options will trade until 4:10 P.M., to correspond
to the non-FLEX option, similar to market index FLEX options, which
would trade until 4:15 P.M. The Exchange may establish other trading
times, including coordinating with FLEX trading hours on other
exchanges and reflecting new trading hours for non-FLEX options.
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.\17\ In addition,
the minimum size requirements are intended to attract depth and
liquidity to FLEX options.
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\17\ See Floor Procedure Advises A-10, Specialist Trading with
Book, and C-1, Ascertaining the Presence of ROTs in a Trading crowd,
which require that, in addition to the Specialist, a 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
existence of separate position and exercise limits serves a customer
protection function as well, by reducing systemic risk.
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, which
will, in turn, disseminate the information to subscribing vendors in
the form of an administrative test message.
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
[[Page 50064]]
be entered into this system at a limited number of locations on the
trading floor.
The Exchange proposes to utilize a limit order book for FLEX
options. 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 order book will be
limited to customer day limit order, which must be accepted by the
Specialist, whether or not that Specialist is assigned in FLEX options.
As such, the Specialist is responsible for the execution of booked
orders. The Exchange is requiring all Specialists to maintain a FLEX
book for consistency 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.\18\ When trading with a booked order, a
member, after re-quoting the market, receives priority over other
members, including assigned ROTs and the assigned Specialist. This
provision is intended to encourage members to step forward to trade
with booked orders, recognizing that any member, including an assigned
ROT or assigned Specialist, could have done so. It also encourages
members to monitor changes that may render a booked limit order
executable, similar to non-FLEX options.
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\18\ The Exchange notes that although Rule 1014's principles of
price and time priority, as well as simultaneous bids/offers at
parity, apply to FLEX options trading, the enhanced specialist
participation of sub-paragraphs (g) (ii) and (iii) are not
applicable to FLEX options.
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The Exchange also proposes that the markets resulting from an RFQ
remain open that trading day, as opposed to expiring immediately. As
with non-FLEX options, before attempting to trade with an existing BBO,
the market should be re-quoted. The variable terms integral to this
product combined with the larger minimum size aimed at institutional
trading needs render it difficult to sustain a firm quote in a
constantly changing market. Thus, open markets are not firm, not
subject to the guarantees of Rule 1033(a), and must be re-quoted. The
advantage of markets remaining open is that such a re-quote does not
require the submission of a new RFQ, thereby avoiding the delay of a
new response time. Because an option that was quoted earlier in the
trading day does not require a new response time, the Exchange believes
that it would be burdensome to repeat the RFQ process. Instead, markets
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.
Unlike the provisions of other exchanges,\19\ discretionary
transactions would not be permitted in FLEX index and equity options.
Thus, the existing provisions of Rule 1065 will apply to prohibit such
transactions. The Exchange also notes that there may not be a
specialist in FLEX options. Only the assigned Specialist in the non-
FLEX (listed) option may apply to be an assigned Specialist in the FLEX
option, but is not required to do so in order to participate. 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.\20\ 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. Encouraging market making activity, whether or not assigned,
should foster liquidity in FLEX options.
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\19\ See e.g., CBOE Rule 24A.6.
\20\ See Floor Procedure Advice F-2, Time Stamping, Matching and
Access to Matched Trades.
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Further, the proposed crossing procedure differs from that of other
exchanges.\21\ 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. The purpose of the split is to attract interest in
Exchange-traded FLEX options by guaranteeing members who bring FLEX
orders to the Phlx a part of the contra-side participation on that
trade when matching or improving the BBO. 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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\21\ Pursuant to CBOE Rule 24A.5(e)(iii), Submitting Members
representing index FLEX crosses, after indicating an intention to
cross or act as principal, are entitled to a one-half split on the
BBO and a two-thirds split if improving the BBO. 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 is improving the BBO. See
e.g., Securities Exchange Act Release No. 37051 (March 29, 1996)
(SR-CBOE-96-20).
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In determining the BBO after the response time ends, where two or
more bids/offers are at parity, priority is afforded to bids/offers
submitted by assigned ROTs or the assigned Specialist. 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. These procedures affording to assigned
traders priority during the response time and parity during the
Improvement Interval 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.\22\ This priority is limited to voicing bids/offers to
establish a BBO; for purposes of joining bids/offers during the
Improvement Interval or crossing procedure, 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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\22\ See e.g., CBOE Rule 24A.5(e)(i) and (ii).
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The Exchange notes that non-assigned ROTs and Specialists may trade
FLEX options, but without the obligations or concomitant advantages of
assignment. The Exchange also notes that trading in FLEX options will
count toward the in-person and in-assigned trading requirements of Rule
1014 and Advice B-3. In addition, the purpose of adopting new Advice F-
28 is to incorporate it into the Floor Procedure
[[Page 50065]]
Advice Handbook for easy reference on the trading floor.
The Exchange believes that the proposed rule change is consistent
with Section 6 of the 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, in
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, 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 as well as the OTC market.
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
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days 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 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 October 15, 1996.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\23\
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\23\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-24367 Filed 9-23-96; 8:45 am]
BILLING CODE 8010-01-M