[Federal Register Volume 88, Number 185 (Tuesday, September 26, 2023)]
[Notices]
[Pages 66088-66091]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-20809]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98451; File No. SR-Phlx-2023-07]


Self-Regulatory Organizations; Nasdaq PHLX LLC; Order Granting 
Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To 
Make Permanent Certain P.M.-Settled Pilots

September 20, 2023.

I. Introduction

    On February 23, 2023, Nasdaq PHLX LLC (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
make permanent the pilot program to permit the listing and trading of 
options based on 1/100 the value of the Nasdaq-100 Index (``Nasdaq-
100'') and the Exchange's nonstandard expirations pilot program 
(collectively, the ``Programs''). The proposed rule change was 
published for comment in the Federal Register on March 2, 2023.\3\ On 
April 7, 2023, pursuant to section 19(b)(2) of the Act,\4\ the 
Commission designated a longer period within which to approve the 
proposed rule change, disapprove the

[[Page 66089]]

proposed rule change, or institute proceedings to determine whether to 
disapprove the proposed rule change.\5\ On May 11, 2023, the Exchange 
filed Amendment No. 1 to the proposed rule change (``Amendment No. 
1'').\6\ On May 31, 2023, the Commission instituted proceedings to 
determine whether to approve or disapprove the proposed rule change and 
published Amendment No. 1 for notice and comment.\7\ On August 28, 
2023, the Commission designated a longer period for Commission action 
on proceedings to determine whether to approve or disapprove the 
proposed rule change, as modified by Amendment No. 1.\8\ The Commission 
did not receive any comment letters and is approving the proposed rule 
change, as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 96980 (February 24, 
2023), 88 FR 13161 (``Notice'').
    \4\ 15 U.S.C. 78s(b)(2).
    \5\ See Securities Exchange Act Release No. 97260, 88 FR 22498 
(April 13, 2023). The Commission designated May 31, 2023, as the 
date by which the Commission shall approve or disapprove, or 
institute proceedings to determine whether to approve or disapprove, 
the proposed rule change.
    \6\ In Amendment No. 1, the Exchange inserts two footnotes and 
amends a sentence in order to further clarify parts of the empirical 
analysis performed by the Exchange. Amendment No. 1 is available at: 
https://www.sec.gov/comments/sr-phlx-2023-07/srphlx202307.htm.
    \7\ See Securities Exchange Act Release No. 97624, 88 FR 37107 
(June 6, 2023).
    \8\ See Securities Exchange Act Release No. 98232, 88 FR 60525 
(September 1, 2023). The Commission designated October 28, 2023, as 
the date by which the Commission shall either approve or disapprove 
the proposed rule change.
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II. Background

    When cash-settled \9\ index options were first introduced in the 
1980s, they generally utilized closing-price settlement procedures 
(i.e., p.m. settlement).\10\ The Commission became concerned with the 
impact of p.m.-settled, cash-settled index options on the underlying 
cash equities markets, and in particular, added market volatility and 
sharp price movements near the close on expiration days.\11\ These 
concerns were heightened during the ``triple-witching'' hour on the 
third Friday of March, June, September, and December when index 
options, index futures, and options on index futures expired 
concurrently.\12\ Academic research at the time provided at least some 
evidence suggesting that futures and options expirations contributed to 
excess volatility and reversals around the close on those days.\13\
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    \9\ The seller of a ``cash-settled'' index option pays out the 
cash value of the applicable index on expiration or exercise. A 
``physical delivery'' option, like equity and ETF options, involves 
the transfer of the underlying asset rather than cash. See 
Characteristics and Risks of Standardized Options, available at: 
https://www.theocc.com/Company-Information/Documents-and-Archives/Options-Disclosure-Document.
    \10\ See Securities Exchange Act Release No. 65256 (September 2, 
2011), 76 FR 55969, at 55972 (September 9, 2011) (SR-C2-2011-008) 
(Order approving proposed rule change to establish a pilot program 
to list and trade SPXPM options on the C2 Options Exchange, 
Incorporated) (``C2 SPXPM Approval'').
    \11\ See id.
    \12\ See id.
    \13\ See Securities and Exchange Commission, Division of 
Economic Risk and Analysis, Memorandum dated February 2, 2021 on 
Cornerstone Analysis of PM Cash-Settled Index Option Pilots 
(September 16, 2020) (``Pilot Memo'') at 5, available at: https://www.sec.gov/files/Analysis_of_PM_Cash_Settled_Index_Option_Pilots.pdf (citing, among 
other papers, Stoll, Hans R., and Robert E. Whaley, ``Expiration day 
effects of index options and futures,'' Monograph Series in Finance 
and Economics, no. 3 (1986)).
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    In light of the concerns with p.m. settlement and to help 
ameliorate the price effects associated with expirations of p.m.-
settled, cash-settled index products, in 1987, the Commodity Futures 
Trading Commission approved a proposed rule change by the Chicago 
Mercantile Exchange (``CME'') to provide for a.m. settlement \14\ for 
index futures, including futures on the S&P 500 Index.\15\ The 
Commission subsequently approved a proposed rule change by Cboe Options 
Exchange (``Cboe Options'') to list and trade a.m.-settled options on 
the S&P 500 Index.\16\ In 1992, the Commission approved Cboe Options' 
proposal to transition all of its European-style cash-settled options 
on the S&P 500 Index to a.m. settlement.\17\ However, in 1993, the 
Commission approved a proposed rule change allowing Cboe Options to 
list p.m.-settled options on certain broad-based indexes, including the 
S&P 500, expiring at the end of each calendar quarter (since approved 
as permanent).\18\ Starting in 2006, the Commission approved a number 
of proposals, on a pilot basis, permitting Cboe Options to introduce 
other index options with p.m.-settlement. These include p.m.-settled 
index options expiring weekly (other than the third Friday) and at the 
end of each month,\19\ as well as p.m.-settled S&P 500 Index options 
and Mini-S&P 500 Index options expiring on the third Friday of the 
month.\20\
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    \14\ The exercise settlement value for an a.m.-settled index 
option is determined by reference to the reported level of the index 
as derived from the opening prices of the component securities on 
the business day before expiration.
    \15\ See Proposed Amendments Relating to the Standard and Poor's 
500, the Standard and Poor's 100 and the Standard Poor's OTC Stock 
Price Index Futures Contract, 51 FR 47053 (December 30, 1986) 
(notice of proposed rule change from the CME). See also Securities 
Exchange Act Release No. 24367 (April 17, 1987), 52 FR 13890 (April 
27, 1987) (SR-CBOE-87-11) (noting that the CME moved the S&P 500 
futures contract's settlement value to opening prices on the 
delivery date).
    \16\ See Securities Exchange Act Release No. 24367 (April 17, 
1987), 52 FR 13890 (April 27, 1987) (SR-CBOE-87-11).
    \17\ See Securities Exchange Act Release No. 30944 (July 21, 
1992), 57 FR 33376 (July 28, 1992) (SR-CBOE-92-09). The Commission 
also approved proposals by other options markets to transfer most of 
their cash-settled index products to a.m. settlement. See, e.g., 
Securities Exchange Act Release No. 25804 (June 15, 1988), 53 FR 
23475 (June 22, 1988) (SR-NYSE-87-11 and 88-04).
    \18\ See Securities Exchange Act Release No. 31800 (February 1, 
1993), 58 FR 7274 (February 5, 1993) (SR-CBOE-92-13). See also 
Securities Exchange Act Release Nos. 54123 (July 11, 2006), 71 FR 
40558 (July 17, 2006) (SR-CBOE-2006-65); and 60164 (June 23, 2009), 
74 FR 31333 (June 30, 2009) (SR-CBOE-2009-029).
    \19\ See Securities Exchange Act Release Nos. 62911 (September 
14, 2010), 75 FR 57539 (September 21, 2010) (SR-CBOE-2009-075); 
76529 (November 30, 2015), 80 FR 75695 (December 3, 2015) (SR-CBOE-
2015-106); and 78531 (August 10, 2016), 81 FR 54643 (August 16, 
2016) (SR-CBOE-2016-046).
    \20\ See Securities Exchange Act Release Nos. 68888 (February 8, 
2013), 78 FR 10668 (February 14, 2013) (SR-CBOE-2012-120); and 70087 
(July 31, 2013), 78 FR 47809 (August 6, 2013) (SR-CBOE-2013-055).
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    Subsequently, other exchanges, including Phlx, sought to permit the 
listing and trading of p.m.-settled options on certain broad-based 
indices. In December 2017, the Commission approved Phlx's nonstandard 
expirations pilot program on a pilot basis (``Nonstandard Pilot'').\21\ 
In April 2021, the Commission approved Phlx's pilot to permit the 
listing and trading of options based on 1/100 the value of the Nasdaq-
100 (``XND'' or ``XND options'') on a pilot basis (``XND Pilot'').\22\ 
In the course of approving both Programs, the Commission reiterated its 
concern about the potential impact on the market at expiration for the 
underlying component stocks for a p.m.-settled, cash-settled index 
option.\23\ However, the Commission also recognized the potential 
impact was unclear.\24\ The

[[Page 66090]]

Commission approved the Programs on a pilot basis to allow the Exchange 
and the Commission to monitor for and assess any potential for adverse 
market effects.\25\ In order to facilitate this assessment, the 
Exchange committed to provide the Commission with data and analysis for 
each pilot \26\ and to make such data publicly available.\27\ In 
addition to the Exchange's data and analysis, Cornerstone Research also 
conducted an analysis at the direction of Staff from the Commission's 
Division of Economic and Risk Analysis. The analysis utilizes the level 
of expiring p.m.-settled index options open interest and the measures 
of volatility and price reversals for the corresponding index futures, 
the underlying cash index, and index component securities in the 
minutes leading up to and immediately following the market close to 
study the effects of pilot programs allowing p.m.-settled index 
options. The Pilot Memo is discussed in more detail below.
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    \21\ See Securities Exchange Act Release No. 82341 (December 15, 
2017), 82 FR 60651 (December 21, 2017) (SR-Phlx-2017-79) 
(``Nonstandard Approval Order''). The Commission subsequently 
approved proposed rule changes to amend the Nonstandard Pilot to 
allow the Exchange to also list p.m.-settled options with Tuesday 
and Thursday expirations on the Nasdaq-100 and the Nasdaq-100 Micro 
Index. See Securities Exchange Act Release Nos. 95391 (July 29, 
2022), 87 FR 47797 (August 4, 2022) (SR-Phlx-2022-22); and 96411 
(November 30, 2022), 87 FR 74688 (December 6, 2022) (SR-Phlx-2022-
38).
    \22\ See Securities Exchange Act Release No. 91524 (April 9, 
2021), 86 FR 19909 (April 15, 2021) (SR-Phlx-2021-07) (``XND 
Approval Order'').
    \23\ See Nonstandard Approval Order, 82 FR at 60653 and XND 
Approval Order 86 FR at 19911. See also Securities Exchange Act 
Release Nos. 64599 (June 3, 2011), 76 FR 33798, 33801-02 (June 9, 
2011) (order instituting proceedings to determine whether to approve 
or disapprove a proposed rule change to allow the listing and 
trading of SPXPM options); C2 SPXPM Approval, 76 FR at 55972-76; and 
68888 (February 8, 2013), 78 FR 10668, 10669 (February 14, 2013) 
(order approving the listing and trading of SPXPM on Cboe Options).
    \24\ See XND Approval Order, 86 FR at 19909.
    \25\ See XND Approval Order, 86 FR at 19911 and Nonstandard 
Approval Order, 82 FR at 60653.
    \26\ See XND Approval Order, 86 FR at 19910-19911 and 
Nonstandard Approval Order, 82 FR at 60652-60653.
    \27\ See, e.g., Securities Exchange Act Release Nos. 84835 
(December 17, 2018), 83 FR 65773, at 65773-74 (December 21, 2018) 
(SR-Phlx-2018-80) (stating the Exchange will make public on its 
website any data and analysis it submits to the Commission under the 
Nonstandard Pilot); and 93447 (October 28, 2021) 86 FR 60719, at 
60720 (November 3, 2021) (SR-Phlx-2021-66) (stating the Exchange 
makes public on its website data and analysis previously submitted 
to the Commission under the XND Pilot and committing to make public 
any data or analyses submitted in the future).
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III. Description of the Proposal, as Modified by Amendment No. 1

    The Exchange proposes to make permanent the Nonstandard Pilot and 
the XND pilot. The Nonstandard Pilot permits the Exchange to open p.m.-
settled options on broad-based indexes that expire (1) on the last day 
of the trading month (``EOM expirations'') and (2) on any Monday, 
Wednesday, or Friday (other than the third Friday-of-the-month or days 
that coincide with an EOM expiration) and, with respect to options on 
the Nasdaq-100 (``NDX'' or ``NDX options'') and XND options, any 
Tuesday or Thursday (other than days that coincide with the third 
Friday-of-the-month or an EOM expiration). The XND Pilot permits the 
listing of XND options, which are European-style and cash-settled, and 
have a contract multiplier of 100. The contract specifications for XND 
options mirror those of the NDX options contract listed on the 
Exchange, except that XND options are based on 1/100 of the value of 
the Nasdaq-100, and are p.m.-settled pursuant to Options 4A, Section 
12(a)(5) of the Phlx Rules.
    The Nonstandard Pilot was extended on multiple occasions, including 
recently, and is set to expire on November 6, 2023.\28\ Similarly, the 
XND Pilot was extended on multiple occasions and is set to expire on 
November 6, 2023.\29\
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    \28\ See Securities Exchange Act Release No. 97385 (April 26, 
2023), 88 FR 27549, at 27549-27550 (May 2, 2023) (SR-Phlx-2023-13) 
(``Programs Extension'').
    \29\ See id.
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    The Exchange states it has provided pilot data to the Commission 
with respect to the Programs, pursuant to the Nonstandard Approval 
Order and the XND Approval order.\30\ The Exchange also states it 
provides ongoing monthly data in addition to the data provided in the 
Notice.\31\ Now, the Exchange proposes to make the Programs permanent.
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    \30\ See Notice, 88 FR at 13175. The Exchange has made public on 
its website data and analyses previously submitted to the Commission 
under the Programs. See http://www.nasdaqtrader.com/Trader.aspx?id=currentregulatory.
    \31\ See Programs Extension, 88 FR at 27549-27550.
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IV. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as modified by Amendment No. 1, is consistent with the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\32\ In particular, the Commission finds that the 
proposed rule change, as modified by Amendment No. 1, is consistent 
with section 6(b)(5) of the Act,\33\ which requires, among other 
things, that the Exchange's rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest. In its proposal 
to make the Programs permanent, the Exchange addressed market capacity 
around the market close and provided an empirical assessment of the 
impact of its p.m.-settled index options on options market quality. 
Each of these elements is discussed in greater detail below. As stated 
above, no comments were received on the proposed rule change.
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    \32\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \33\ 15 U.S.C. 78f(b)(5).
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Market Impact Considerations

    The Exchange's analysis presents data that the introduction of 
p.m.-settlement is correlated with an increase in options trading tied 
to the Nasdaq-100.\34\ The data shows an increase in trading volume and 
notional open interest for NDX and XND options during the sample 
period.\35\
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    \34\ See Notice, 88 FR at 13167.
    \35\ See id. at 13163.
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    In addition to reviewing the data and analysis provided by the 
Exchange, the Commission reviewed the analysis in the Pilot Memo, which 
evaluates whether higher levels of expiring open interest in p.m.-
settled index options results in increased volatility and price 
reversals around the close. The Pilot Memo shows that the market share 
for p.m.-settled options, in particular options on S&P 500 Index, has 
grown substantially since 2007.\36\ The Pilot Memo examines whether and 
to what extent expiring open interest in p.m.-settled index options is 
empirically related with the tendency of the corresponding index 
futures, the underlying index, or index components to experience 
increased transitory volatility and price reversals around the time of 
market close on expiration dates. The Pilot Memo concludes that, 
although expiring p.m.-settled index option open interest may have a 
statistically significant relationship with volatility and price 
reversals of the underlying index, index futures, and index component 
securities around the market close, the magnitude of the effect is 
economically very small.\37\ For example, the largest settlement event 
that occurred during the time period studied in the Pilot Memo (a 
settlement of $100.4 billion of notional on December 29, 2017) had an 
estimated impact on the futures price of only approximately 0.02% (a 
predicted impact of $0.54 relative to a closing futures price of 
$2,677).\38\
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    \36\ See Pilot Memo at 2. The Pilot Memo also examined options 
on the Russell 2000 Index and the Nasdaq-100. However, during the 
time period covered by the study (2007-2018), the markets for both 
a.m.- and p.m.-settled options on these indexes were very small 
compared to the size of that for S&P 500 Index options. In addition, 
because p.m.-settled NDX options were only introduced in 2018, the 
number of observations for NDX options was much smaller than for 
other indexes. See id. at 4.
    \37\ See id. at 3.
    \38\ See id.
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    In order to analyze the effect of a very large increase in 
settlement volume for Nasdaq-100 p.m.-settled options contracts, the 
Exchange uses the estimated regression coefficients in the Pilot Memo 
to estimate the change in the volatility of index futures prices when 
settlement volume increased from

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the 25th percentile to the 75th percentile.\39\ For both the S&P 500 
Index and the Nasdaq-100, the Exchange estimates the relative impact 
would be small for both indexes.\40\
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    \39\ See Notice, 88 FR at 13173-13174.
    \40\ See id. at 13174.
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    The Exchange also provides additional analysis on market capacity 
around the market close.\41\ Specifically, the Exchange presents data 
that the closing auction volume on the equity market have become much 
larger than the opening auction, which may indicate that there is 
sufficient liquidity in closing auctions to absorb liquidity demand 
associated with p.m.-settlement of NDX and XND options.\42\ In 
addition, the Exchange states that the liquidity available at or around 
the close would be able to mitigate any excess volatility created by 
the options settlement at the market close.\43\
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    \41\ See id.
    \42\ See id.
    \43\ See id.
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    Further, the Exchange represents that it has sufficient systems 
capacity to handle p.m.-settled options on broad-based indexes with 
nonstandard expirations dates and has not encountered any issues or 
adverse market effects as a result of listing them.\44\
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    \44\ See Notice, 88 FR at 13176.
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Market Quality Considerations

    The Exchange also completed an analysis intended to evaluate 
whether the Programs impacted the quality of the NDX options market. 
Specifically, the Exchange presents findings on three market 
characteristics: trading volume, open interest, and spreads. The 
Exchange concludes that there is no evidence that NDX and XND options 
contracts, which are p.m.-settled, would result in reduced trading 
activity or degradation in market quality of the a.m.-settled index 
options.\45\ The Exchange notes within its analysis that it seems 
unlikely that the introduction of XND option contracts had a 
significant impact on the market quality of the full-sized NDX option 
contracts.\46\
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    \45\ See id.
    \46\ The Exchange states that given that the size of the market 
(measured in volume) for XND options volume is small compared to 
that of other p.m.-settled NDX options, the Exchange believes the 
introduction of XND option contracts is unlikely to adversely impact 
the market quality of a.m.-settled NDX options. See Amendment No. 1, 
supra note 6.
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    Further, the Exchange observed a consistent decrease in relative 
quoted spread from 2017 to 2022 for NDX options.\47\ When the Exchange 
compared the spread trend of NDX monthly contracts to that of QQQ 
monthly contracts, the Exchange states that the results suggest that 
there is gradual decrease in both the NDX monthly contracts spread and 
the QQQ contracts spread during the sample period.\48\ The Exchange 
uses duration weighted relative quoted spread as a measure of the cost 
of trading and examines whether the introduction of p.m.-settled index 
options results in any deterioration of spreads for am-settled NDX 
options.\49\ The Exchange finds a consistent decrease in the relative 
quoted spread is prevalent from 2017 to 2022 and no obvious change in 
the trend following the introduction of p.m.-settled index options.\50\ 
The analysis also considered whether the move from a.m. settlement to 
p.m. settlement for Friday weekly expirations (other than third-Friday-
of-the-month) led to changes in spreads for those contracts.\51\ The 
sample timeframe was from July 2017 through August 2018.\52\ The 
relative quoted spread decreased during first part of 2018 and increase 
in May and June 2018; however, it remained comparable to the 2017 
average.\53\ Overall, the Exchange observes no evidence of 
deterioration of spreads associated with the introduction of p.m.-
settled NDX options.\54\
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    \47\ See Notice, 88 FR at 13171.
    \48\ See id. at 13171-13172, 13175-13176.
    \49\ See id. at 13169-13170.
    \50\ See id.
    \51\ See id.
    \52\ See id. at 13170-13173. The Exchange used a regression 
analysis to test whether the spread of NDX contracts changed after 
the introduction of p.m.-settled index options. See Notice, 88 FR at 
13171. The regression model is meant to study the effect of the 
introduction of Friday p.m.-settled NDX options expirations (on all 
but the third Friday of the month) that occurred in January 2018. 
See Amendment No. 1, supra note 6.
    \53\ See Notice, 88 FR at 13173.
    \54\ See id.
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    The Commission believes that the evidence contained in the 
Exchange's filing, the Exchange's pilot data and reports, and the Pilot 
Memo analysis demonstrate that the Programs have benefitted investors 
and other market participants by providing more flexible trading and 
hedging opportunities while also having no disruptive impact on the 
market. The market for p.m.-settled options has grown in size over the 
course of the Programs, and analysis of the pilot data did not identify 
any significant economic impact on the underlying component securities 
surrounding the close as a result of expiring p.m.-settled options nor 
did it indicate a deterioration in market quality (as measured by 
relative quoted spreads) for an existing product when a new p.m.-
settled expiration was introduced. Further, significant changes in 
closing procedures in the decades since index options moved to a.m. 
settlement may also serve to mitigate the potential impact of p.m.-
settled index options on the underlying cash markets.
    Accordingly, the Commission finds that the proposed rule change, as 
modified by Amendment No. 1, is consistent with section 6(b)(5) of the 
Act \55\ and the rules and regulations thereunder applicable to a 
national securities exchange.
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    \55\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\56\ that the proposed rule change (SR-Phlx-2023-07), as modified 
by Amendment No. 1, be, and hereby is, approved.
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    \56\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\57\
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    \57\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-20809 Filed 9-25-23; 8:45 am]
BILLING CODE 8011-01-P